BUSINESS CASE

Here Comes the Sun

The Solana power plant, which opened in 2013, covers 3 square miles of the Arizona desert in Gila Bend, about 70 miles from Phoenix. Whereas most solar installations rely on photovoltaic panels that convert light directly into electricity, Solana uses a system of mirrors to concentrate the sun’s heat on black pipes, which convey that heat to tanks of molten salt. The heat in the salt is, in turn, used to generate electricity. The advantage of this arrangement is that the plant can keep generating power long after the sun has gone down, greatly enhancing its efficiency.

Solana is one of only a small number of concentrated thermal solar plants operating or under construction. Solar power has been rapidly rising in importance, with the amount of electricity generated by solar increasing over 400% between 2008 and 2015. There are a number of reasons for this sudden rise, but the Obama stimulus—which put substantial sums into the promotion of green energy—was a major factor. Solana, in particular, was built by the Spanish company Abengoa with the aid of a $1.45 billion federal loan guarantee; Abengoa also received $1.2 billion for a similar plant in the Mojave Desert.

While Solana is a good example of stimulus spending at work, it is also a good example of why such spending tends to be politically difficult. There were many protests over federal loans to a non-American firm, although Abengoa had the necessary technology, and the construction jobs created by the project were, of course, in the United States. Also, the long-term financial viability of solar power projects depends in part on whether government subsidies and other policies favoring renewable energy will continue, which isn’t certain.

In terms of the goals of the stimulus, however, Solana seems to have done what it was supposed to: it generated jobs at a time when borrowing was cheap and many construction workers were unemployed.

QUESTIONS FOR THOUGHT

BUSINESS CASE

The Perfect Gift: Cash or a Gift Card?

It’s always nice when someone shows his or her appreciation by giving you a gift. Over the past few years, more and more people have been showing their appreciation by giving gift cards, prepaid plastic cards issued by a retailer that can be redeemed for merchandise. The best-selling single item for more than 80% of the top 100 American retailers, says GiftCardUSA.com, is their gift cards.

What could be more simple and useful than allowing the recipient to choose what he or she wants? And isn’t a gift card more personal than cash or a check?

Yet several websites are now making a profit from the fact that gift card recipients are often willing to sell their cards at a discount—sometimes at a fairly sizable discount—to turn them into cold, impersonal dollars and cents.

Cardpool.com is one such site. At the time of writing, it offers to pay cash to a seller of a Whole Foods gift card equivalent to 88% of the card’s face value. For example, the seller of a card with a value of $100 would receive $88 in cash. But it offers cash equal to only 70% of a Gap card’s face value. Cardpool.com profits by reselling the card at a premium over what it paid; for example, it buys a Whole Foods card for 88% of its face value and then resells it for 97% of its face value.

Many consumers will sell at a sizable discount to turn gift cards into cash. But retailers promote the use of gift cards over cash because much of the value of gift cards issued never gets used, a phenomenon known as breakage.

How does breakage occur? People lose cards. Or they spend only $47 of a $50 gift card, and never return to the store to spend that last $3. Also, retailers impose fees on the use of cards or make them subject to expiration dates, which customers forget about. And if a retailer goes out of business, the value of outstanding gift cards disappears with it.

In addition to breakage, retailers benefit when customers intent on using up the value of their gift card find that it is too difficult to spend exactly the amount of the card. Instead, they end up spending more than the card’s face value, sometimes even more than they would have without the gift card.

Gift cards are so beneficial to retailers that instead of rewarding customer loyalty with rebate checks (once a common practice), they have switched to dispensing gift cards. As one commentator noted in explaining why retailers prefer gift cards to rebate checks, “Nobody neglects to spend cash.”

However, the future may not be quite so profitable for gift card issuers. Hard economic times have made consumers more careful about spending down their cards. And legislation enacted in 2009 requires that cards remain valid for at least five years. As a result, breakage has fallen sharply, although it still amounts to more than $1 billion a year.

QUESTIONS FOR THOUGHT

BUSINESS CASE

PIMCO Bets on Cheap Money

Pacific Investment Management Company, generally known as PIMCO, is one of the world’s largest investment companies. Among other things, it runs PIMCO Total Return, the world’s largest mutual fund. Bill Gross, who headed PIMCO from 1971 until 2014, was legendary for his ability to predict trends in financial markets, especially bond markets, where PIMCO does much of its investing.

In the fall of 2009, Gross decided to put more of PIMCO’s assets into long-term U.S. government bonds. This amounted to a bet that long-term interest rates would fall. This bet was especially interesting because it was the opposite of the bet many other investors were making. For example, in November 2009 the investment bank Morgan Stanley told its clients to expect a sharp rise in long-term interest rates.

What lay behind PIMCO’s bet? Gross explained the firm’s thinking in his September 2009 commentary. He suggested that unemployment was likely to stay high and inflation low. “Global policy rates,” he asserted—meaning the federal funds rate and its equivalents in Europe and elsewhere—“will remain low for extended periods of time.”

PIMCO’s view was in sharp contrast to those of other investors: Morgan Stanley expected long-term rates to rise in part because it expected the Fed to raise the federal funds rate in 2010.

Who was right? PIMCO, mostly. As the figure shows, the federal funds rate stayed near zero, and long-term interest rates fell through much of 2010, although they rose somewhat very late in the year as investors became somewhat more optimistic about economic recovery. Morgan Stanley, which had bet on rising rates, actually apologized to investors for getting it so wrong.

Bill Gross’s foresight, however, was a lot less accurate in 2011. Anticipating a significantly stronger U.S. economy by mid-2011 that would result in inflation, Gross bet heavily against U.S. government bonds early that year. But this time he was wrong, as weak growth continued. By late summer 2011, Gross realized his mistake as U.S. bonds rose in value and the value of his funds sank. He admitted to the Wall Street Journal that he had “lost sleep” over his bet, and called it a “mistake.” It was a mistake from which he never fully recovered. Most observers agreed that the losses PIMCO suffered from Gross’s bad bet in 2011 played a major rule in his departure in 2014.

QUESTIONS FOR THOUGHT