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!