Saturday, December 15, 2007

2008: Images from the Crystal ball!

I am putting together some statements that are taking my sleep away. I am going away to the calm of sea to mull over these. Or, may be, I am trying to run away from these. Here goes:
Wealth dynamics

  1. A handful few own or influence large amounts of wealth.
  2. A large part (read almost all) is dollar denominated and has just lost about 10% of its value!
  3. Some of these wealthy few are actually countries (China, Abu Dhabi, Netherlands, Singapore etc)
  4. Some of these countries (China particularly) have worked hard to accumulate this wealth. They will not like their wealth to loose value.
  5. Even if few of them feel they can and should move out of dollar, it will start a landslide. To put it crudely it means if few people (even one of the few people) loose their cool at this stage we will have a run on the dollar and that wont be good day to say the least!
  6. Here are some thoughts on dollar valuation by Menzie Chinn , Mark Thoma has some links here and here, by Tyler Cowen of Marginal Revolution and by Don Boudreaux.

Meanwhile Oil is another link that crosses currencies and assets
  1. It impacts consumption basket across income classes
  2. Dollar decline (or rising oil prices) meaning there will be impact across income classes

Break to US
  1. Expenses
    o American non-food consumption basket has considerable import component!
    o As dollar depreciates, the average monthly cost of living will rise.
    o This will mean there will lot more defaults (particularly at border of sub-prime and prime)
  2. Source of funds
    o US banks and mortgage lenders have lent to sub-prime borrowers. ( Read Greenspan’s take on that here)
    o That sub-prime borrower is willing (if he has money - let us assume he is not a cheat as most people are not cheats) to pay but his occasional income is enough to pay his mortgage – but just so.
    o If he is found to be sub-prime, he pays higher interest rate to cover for other sub-primes who will not be paying.
  3. Net-Net
    o Meaning that will seal his fate – he will default.
    o If cost of living increases then he defaults.
    o This makes sub-prime defaults a self-fulfilling prophesy!
    o US consumption should anyway slowdown (even if there is some demand elasticity)
  4. Observations
    o Why do thing above read partly like income statement and partly like balance sheet?
    o Aren’t the wrong parts (of the financial statements) represented there?
  5. Reads
    o Tanta (just one link here but there is loads of stuff in here just browse through - )
    o Herb Greenberg interviews Mark Hanson

Cut to income
  1. Income for majority of Americans cannot rise if the same job can be done somewhere else in the world at lower cost.
    o Note "majority"
    o Or the job need not be done at all! As Ian Dew-Becker and Robert J. Gordon explore in their new paper
  2. These people may move into sub-primes if there are any job losses
  3. Great thing is there will be job gains (if dollar depreciates) unless the up-the-value-chain trick has worked for non-US manufacturers.
  4. So there will be gain in American competitiveness – but against whom – Chinese or Europeans
  5. Does it then mean new problems for just emerging Europe? It does, right?
    o Tyler Cowen again on impact on Europe

Cut back to wealth
  1. When people accumulated wealth, they promptly invested in various asset classes.
  2. This drove up the asset prices.
  3. My guess is – the wealthy bought out more assets that can be purchased by consumers in the coming years.
  4. Asset creation drives economy and that drives incomes and wealth
    o The trick is to know that income and income growth are highly correlated i.e. higher the income higher the income growth!
    o So technically if asset financing (by highest income earners) is far outpacing asset buying (by medium and low income earners)
  5. Asset prices should correspond to income of medium and low income earners as they are asset purchasers.
  6. But not so as this is asset financing bubble.
  7. Since this boom is in asset financing – asset creators are using this opportunity to "lighten" the wealth burden of the wealthy
  8. Is this good old "money-lender lending at exorbitant rates story" wine in a new bottle?

Government bailout
  1. Then should governments bail out anyone?
  2. Will real people be bailed out or only organizations who made idiotic mistakes? Read Tanta on Paulson plan here
  3. What have you to say on the proposition –
    o If lenders just hold on to sub-prime for long enough they may actually, earn a decent profit. They just have to hold on to this long enough.
    o The question is how long?
    o It is a question of nerves.

Low inflation together with high-income concentration creates rapid wealth
  1. Low inflation keeps essential services cost lower
  2. Beyond a point its difficult to splurge even if your income increases from that point on
    o Consumption tapers off but not necessarily income ( more on that in next years post)
  3. Meaning if you reach a theoretical threshold creating wealth becomes super easy!
    o Bill Gates once said – "It is the first million that is difficult to make"
  4. Does this imply that low inflation keeps poor people poor
    o If the poor derive their incomes from sectors that form the inflation basket – is it not logical that those poor will remain poor
    o As food is central component of the inflation basket – and always under watch – results in farmers remaining poor and needing assistance.
    o You might want to read Chris Blattman’s paper here , Amol Agrawal links to IMF chief economist
  5. A low-inflation policy is detrimental to GINI score ( I mean it polarizes wealth more effectively – more so away from poor and with the rich)
    You might want to read this link at The big picture

Labor and Capital
The artificial currency pegs seem to have expanded the money supply (in respective currencies) far higher than actual underlying value of products and goods
o This implies value has been limited compulsively
o Implies inflation should be higher
To me it indicates that global monetary system is signaling presence of threshold for how much capital can be present in the system.

An apology for over-simplificationYes thoughts are over-simplified. They may really be dumb. I have not put together data to test these statements and my information is primarily what my mind has retained after reading various articles.

A little disclaimer…
Also, since these are a little dumb I should remind you that they are mine… (pukka original!!) and these do not represent my employer’s views on these topic.
And finally…The divergence and weirdness of the things mentioned above confound me. I may just be out of my mind. These things happen to people who are about to leave for a holiday (15 days of bliss) after a long time (1.5 years!). I am supposed to pack my bags and head to the sea.
So hoping that these points have triggered many thoughts for the year-end, I sign off for 2007. I promise to delve into most of them next year.
Meanwhile, have a great Christmas and a great new years eve. Remember to buy some gift and make your donations – we just might need those things!

Monday, December 03, 2007

Why certain people stay poor?

When world embraced capitalism, it embraced, as Milton Friedman puts it, equality of opportunity and freedom of choice. It also embraced, as Karl Marx anticipated,  income inequality and therefore poverty.  Poverty, the product of capitalism, is a real circumstance.  Since capitalism also offers everyone a fair chance to rise above his circumstance and create wealth, there is not much discord with this arrangement. In fact, coupled with an enabling infrastructure provided by a democratic government, this represents one of the fairest civil structures yet created.

So why do some people remain condemned to poverty? To understand this, we need to understand poverty a little bit better.

Transient Poverty Vs Structural Poverty

Poverty, essentially (i.e. theoretically), is transient. In a stable, fair capitalist economy, there is a certain amount of population that always remains at the bottom - below the poverty threshold - of the income pyramid. By labour and enterprise, this population rises to the next income class. Simultaneously, competitive pressures force certain other people below the poverty threshold. These represent the transient poor. These people are currently poor but by no means restrained by their current poverty against rising through the income pyramid.

Then are there people who by currently being poor are condemned to be poor for their entire life, and even those of generations to follow? Sadly yes, and quite a few of them at that.

Dynamics of Poverty - Scaling up the Income pyramid

The income pyramid represents the basic framework on which the graph of poverty is drawn. The line income of a household will trace over time is determined by, other things remaining same, the age of the household and change in their income.

As mentioned earlier, a typical household has two ways of moving up the income pyramid - labour and enterprise. But a household below the poverty threshold, has only one way out - hard labour! This household does not have savings or income surplus or any access to finance (they are sub-prime!) to kick-start any enterprise. Even now, a household would not have a problem if labour opportunities are assured. Here is where the cusp of the problem lies. Labour does not always help this household scale the income pyramid.

The biggest hurdle - poverty!

Labour demand of an economy shifts every year across sectors. A very distinct shift is noticeable in farm labour's shift into industrial labour. Within this drastic shift there are micro-shifts moving between sectors from metals to plastics, from mechanical to electrical, from plumbing (hydraulics/pneumatics) to instrumentation (switch-gear). This movements create a chasm between available skill and desired skill. This chasm is difficult to cross without investment of time and money. Both of which our poor household does not have. Hence our poor household works twice as hard but does not get added surplus that can springboard it into the next income class.

Springboard for the poor - education and micro-finance!

The only way to help the poor out of this negative spiral is by making their labour ready for the market requirement and giving their enterprise a launch-pad.

Free training and education need to be made available to the poor. Agencies must use proper forecasting techniques and relevant research localised to the area to train the labour making them employable. Example - Locals in an area ear-marked for food processing zone, can trained in repairing, maintaining food grade machinery. Farmers can be trained in operating E-choupal kiosks and accessing mandi prices.

Micro-finance has a distinct role to play in this area. It gives the poor, access to capital to start their enterprise. Please remember micro-finance gives "access to capital". It implies financing "accessories" for the enterprise. And since its capital, return is estimated through study of potential viability  forecast of the enterprise. Thus micro-finance can be a robust springboard.

And the safety net...

We discussed two main levers that give poor households income advantage. But poor households also need a safety net in the form of accessible healthcare and low-cost banking facilities.

Healthcare represents one variable that can reverse income gains very fast. Rising healthcare costs have pushed many a household into the depths of poverty. Hence access to clean and complete healthcare is absolute essential.

Low cost banking is a worthy enabler for the poor helping them keep their assets safe and secure thereby granting small insurance against thefts and burglary etc. It also helps bank create a credit history for the household. This history (knowledge / information) acts as a de-risking element for the household making mainstream banking credit available when required.

Such a minimum safety net would indeed be a great service a nation can do for its poor.

In sum...

Poverty is not always transient. It is a nations responsibility to create adequate anti-poverty infrastructure to help its poor rise the income pyramid. Proper training and Education, accessible micro-finance provide great opportunities for income enhancing ventures to blossom. Adequate safety-nets through clean and accessible healthcare and access to low-cost banking provide critical support to household's growth initiatives.

Sunday, December 02, 2007

Use value Vs sale value and Innovation

GDP, the scorecard of economic performance, does not adequately differentiate between Use value and Sale value. This can be illustrated with a simple example.

Use Value Vs Sale Value - Example

The GDP contribution of one coconut is sold is price of that coconut let say Rs 6/-.

A village buyer then drinks the water and eats the fleshy part of coconut, use outer fiberous cover as scrubber, uses the hard shell as a soap holder and later uses all of this as fuel to heat his bathing water.

A city buyer, typically, drinks the coconut water and eats the fleshy part and rest of it is discarded as garbage.

Now the use value of Rs 6/- is totally different in each case. This is what Karl Marx explained, in his paper called "Capital", the difference between use value and sale value. In this difference, or the divide between use value and sale value, lie many possibilities for innovation both for economic learning and entrepreneurial innovation.

Economic Learning opportunities - the hypotheses

First is related to computing GDP numbers. This divide implies that economies with higher ability to extract use value should feature higher than they actually do. Consequently, the algorithms used for estimating this value need to be tweaked to accommodate this difference.

Secondly, we need to interpret the GDP numbers carefully. A country may be actually creating more value than the GDP suggests.

Thirdly, I wonder if that is why economic development is accompanied by stress and loss of happiness (if it happens i.e.). Possibly in our hearts we know that by spending on packaged coconut water, plastic soap boxes and branded scrubbers we are actually in a loss (in terms of costs vs added benefit) than we were using plain old coconut.

Entrepreneurial Opportunities

On the other side, it also leads me to believe possibility of entrepreneurial innovation would be highest at the  innovations bridging this divide. An apt example can be found in the story of "Idea on a leaky platter". Entrepreneurs can gain immensely from bridging this divide.

Bridging this divide helps increase measured GDP. Secondly the adoption of these innovation is much faster (it already exists!), therefore easier to monetise (that the only thing entrepreneur has to do!). It also leads to productivity gain as firm-based efficiencies come into play.

In Sum

Innovation at the divide between use value and sale value holds a lot of promise in terms of success for investors and entrepreneurs. It is this area we should be concentrating upon. What say?