Wednesday, December 17, 2008
Thursday, December 11, 2008
Monday, December 08, 2008
Friday, December 05, 2008
Wednesday, December 03, 2008
Yves Smith has another excellent post on problems with Keynesian response to the crisis. She quotes Tom Ferguson on how Keynes would have chose global rebalancing as a key solution. There is merit in old Keynesian approach when there is increase debt repayment capability in the future. Currently, US needs jobs and work, but thanks to weird gloabal policies it has neither. So it is dependant on "investor-like" income generation - i.e. through capital appreciation and investment. This, to me, is pushing the ignorant risk-averse citizens along a high-risk cutting edge finance path. This is unfair to US citizens who are not aware how long it will take to repay the stimulus. And dont even think you can print your way out of it! Thus the global rebalancing solution seems only way out. But, as Yves Smith points out, there are hurdles.
I dont see any reason why exchange rate realignment + concerted international financial regulation cannot solve this problem.
Global banking regulation needs reform and Shiller has also highlighted this his new book (I just saw the interview - waiting for the book). There is something fundamentally wrong with accounting policies that let banks lower capital requirements based on "perceived" asset price increases. The same regulation also creates holes in balance sheets as asset prices falls. This regulation needs to be suspended for sometime - (upside suspension), banks be forced to take all the write-downs marking the assets to agreed upon prices (lets call them steady state prices) - and then made to raise capital enough to sustain them.
Secondly exchange rate realignment is absolutely must. I have been harping about this on this blog comments for long now. US must become producer and China and surplus countries must become consumers. Without this there is no resolution of this crisis.
Finally, there is likely to be a diplomatic war to protect and isolate the consumers an keep the consumer to itself. Such a trading barrier game will be detrimental to global prospects and will decrease the total pie. If a big ship(US and EU) is sinking - one way is to protect your resuce boat - or save the ship. Former saves you comfortably but leaves the world with just a boat! and latter is difficult but the Ship stays so we are better off.
Tuesday, December 02, 2008
Mumbai Terror attacks started last Wednesday and it was Friday before it ended with 190+ dead and scores injured. Twitter covered the best news on the Mumbai Terror with real time rumour-destroying coverage from fellow Mumbaikars.
Tanta or Doris Dungey passed away at very young age of 47. James Hamilton has a good post on So long Tanta with a few must-read links.
It is time to sweat the grey -cells to make my country better. The current political system is wreaking havoc with the world's largest democracy. It is time to take action. Welcome to a new revolution!
Monday, November 24, 2008
China wants to run this game for a wee-bit longer
let CNY depreciate against the dollar. But this relation is difficult to hold if USD depreciates and commodities rise.
With 2 trillion at stake - War is not yet a possibility
"stimulus". As one part of the world's "skin in the US game" increases the probability of war will
increase. War has many benefits for regimes. It aggregates the population, it creates employment, creates a stimulus, creates an enemy outside of the regime. In this matter India is lethargic and will never have enough "mind in this game". But war is on the horizon - and I am scared.
China and India must become consumers - US must become producer
Import restriction response is a threat
USD and Gold - Printing currency does not matter
real value is able to discount this printing phenomenon. The only way this might work is - if US has some means where it can aggregate this printed money and destroy it as write-down or something. Printing will set the new money in motion and it has to be collected and destroyed else there will be devaluation.
Currently"US denominate" (in terms of thoughts) people are asking this question hence possibility of US dollar depreciating does not seem feasible - it never does to local as it does not matter so long as other things remain equal. But "other things" like commodities do not remain equal - hence the effect is actually measured as rise in commodity prices. (Or conversely - commodity tries to retain value - whereas USD depreciates).
Further one must understand that equity is open to risks whereas debt has the habit of correcting / adjusting for currency changes. (Particularly cross currency debt).
Wednesday, November 19, 2008
The last decade was characterised by excessive accumulation of wealth by soverign entities. Central Banks accumulated large surplus - that was parked in US treasuries and later in riskier asset classes (through SWFs). This is one of the primary drivers of the current crisis. VoxEu examines the reason for soverign wealth accumulation and suggests that this was primarily done to avoid exchange rate appreciation.
Economy as a Wealth managing engine
Any domestic economy serves as wealth creating and wealth distributing engine. We can imagine an economy as equivalent to two different motors linked in tandem (feeding into each other). Entreprenuership is common name given to the wealth creation motor. Governments add inefficieny into this motor by interfearing with it. What governments are really concerned about is the woking of the other motor - the wealth distribution motor.
In case of economies creating wealth using labour arbitrage, it is the wealth distribution motor that matters more. If this motor is working perfectly then the national income is able to percolate to the lowest rungs of the society. Unfortunately this is not so in developing Asia. The local governments role is of creating, improving and efficiently running this engine. But the measures taken by developing Asian governments had, intentionally or otherwise, no such effect. Indian government is talking of inclusive development - but its only lip-service. Only China built infrastructure but followed policy of enforced migration (to and from) and managed this to certain extent. These indicate a weakness of this critical motor in developing Asia.
The policy of accumulating further wealth while leaving the wealth distribution mechanism broken has lead to rise of very-high income population in developing Asia while low end remains poor. It is interesting that this is a good policy so long as reserve build-up is within a certain limit. Beyond this limit, a policy of allowing exchange rate appreciation may have achieved better wealth dispersion (at least globally) - than what we have achieved. This policy would have raised inflation, and consequently incomes across the income pyramid.
There is a need to put this VoxEu research under further scrutiny. There is definitely a lot of merit in the argument. We need to understand the wealth distribution/dispersion process in more detail. Obviously the theory I suggested above has holes and needs thorough examination.
Tuesday, November 18, 2008
Friday, November 14, 2008
Just want to know if the store shelves in major super markets are full or empty। At this time, they should start stacking up for Christmas sale - so it should be full।
Can you help me with feedback over next few days? If possible can you post pictures? or email them to rahuldeodhar (-a-t-) yahoo (d-o-t) com! Do include brief store details - name, area, city etc.
Wednesday, November 12, 2008
The trouble is this will make non-china manufacturing cheaper - leading to job loss from manufacturing sector. However if China really wants to move to a consumption driven economy then there will be job shift to services and out of manufacturing.
This is more critical now। If China misses a step then we are all goner! The question is will china bite the bullet!
Tuesday, November 04, 2008
"How to avoid the credit crunch?"
For Rating Agencies
See thou character. Give thy thoughts no tongue,
Nor any unproportioned thought his act.
For investors - particularly those who misguide people on CNBC
Give every man thy ear, but few thy voice;
Take each man's censure, but reserve thy judgment.
For US / UK and European Consumers
Costly thy habit as thy purse can buy,
For Mortgage dealers (they heeded but CDS borrowers didnt)
Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
For all market operators
This above all: to thine ownself be true,
And it must follow, as the night the day,
Thou canst not then be false to any man
By now you must have recognised this is Shakespeare's Hamlet! Edited snippets from Lord Polonius' advice to son Lartes.
Yet here, Laertes! aboard, aboard, for shame!
The wind sits in the shoulder of your sail,
And you are stay'd for. There; my blessing with thee!
And these few precepts in thy memory
See thou character. Give thy thoughts no tongue,
Nor any unproportioned thought his act.
Be thou familiar, but by no means vulgar.
Those friends thou hast, and their adoption tried,
Grapple them to thy soul with hoops of steel;
But do not dull thy palm with entertainment
Of each new-hatch'd, unfledged comrade. Beware
Of entrance to a quarrel, but being in,
Bear't that the opposed may beware of thee.
Give every man thy ear, but few thy voice;
Take each man's censure, but reserve thy judgment.
Costly thy habit as thy purse can buy,
But not express'd in fancy; rich, not gaudy;
For the apparel oft proclaims the man,
And they in France of the best rank and station
Are of a most select and generous chief in that.
Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
This above all: to thine ownself be true,
And it must follow, as the night the day,
Thou canst not then be false to any man.
Farewell: my blessing season this in thee!
- Shakespeare in Hamlet (Lord Polonius advice to son Lartes)
Hat tip - to Free exchange blog from The Economist (for inspiration!)
Monday, November 03, 2008
Sunday, November 02, 2008
Friday, October 31, 2008
The economics of labour market intermediation | vox - Research-based policy analysis and commentary from leading economists
Wednesday, October 29, 2008
Now we already knew they would happen, didn't we?
The risks arise in the next step. Here the money system goes
into self preservation mode rather than help push the bailout effects down to
individuals and small businesses. Here second bailout will be required. But this
bailout will need concurrent regulatory changes so that the money system does
not simply fatten up – but actually pushes the recovery stimulus down the chain.
The size of this stimulus will be at least twice the first bailout.I think, these two bailouts will have to clean the system.
Beyond this will be a period of lull. This is the time individuals and small
businesses start reducing their loan outstanding. This is likely to take long
time in case of US.
Mish's Global Economic Trend Analysis: White House: "Banks Need To Stop Hoarding Money"
Second bailout - FIs into self-preservation mode
Tuesday, October 28, 2008
Monday, October 27, 2008
- How the size of bet influences the probability of event.
- Is it possible to increase the size of bet and thereby get a coordinated buy-in in favour of the bet without resorting to illegal, immoral means.
- Has it happened in some stocks - and if so how.
In sum, the problem is plausible. But it impacts upside as well. Yet, human nature is not adept at understanding or complaining about this "surprising" good fortune. So how can we deal with it?
Thursday, October 23, 2008
Peston's Picks: Now there are runs on countries
Naked Capitalism: Is another Emerging markets Crisis in motion? (Note interesting comments particularly by Richard Kline)
Regional Banks post losses
Biggest US Bank Wachovia shows off a BIG loss!
And now here is the quote that ignites the real economy wick!
This is phase 2 of the crisis. The repurcussions will move east geographically towards China in coming months. Holt on tight.
Ohio’s largest banks all suffered losses. National City said it planned to cut
about 4,000 jobs, or 14 per cent of its workforce, over the next three years
after the bank posted a net loss of $729m, or 85 cents a share. Fifth Third
reported a quarterly loss of $56m, or 61 cents per share, and KeyCorp lost $36m,
or 10 cents per share.
Wednesday, October 22, 2008
oversold does not necessarily mean undervaluedthe stock market increasingly seems to serve as a quick proxy for how the economy is doing, when it has a strong propensity to give false positivesMarc Faber comments -"The governments in this world have no other option but to print money. That will lead down the road to inflation,'' Faber said. "You don't need to be an economist graduated from Harvard to know we're already in a recession. They will just put white paint on a crumbling building....""To rebuild economic health in the United States, you need a serious recession that will last several years,'' he said. "The patient that got drunk on credit growth needs to go into rehabilitation. To give him more alcohol, the way the Fed and the Treasury propose to do, is the wrong medicine."Chirstopher Whalen comment - In anticipation of such heavy losses, banks are now diverting capital into loan loss reserves rather than seeking to make new loans.And a fantastic snippet from Andrew Ross Sorkin at the New York Times:
“Our purpose is to increase confidence in our banks and increase the confidence of our banks, so that they will deploy, not hoard, their capital,” Mr. Paulson said in a statement Monday. “And we expect them to do so, as increased confidence will lead to increased lending. This increased lending will benefit the U.S. economy and the American people.”...But Mr. Paulson is making a big assumption about confidence, because until the real economy recovers — which could take more than a year — lending to Main Street is unlikely to return rapidly to normal levels.“It doesn’t matter how much Hank Paulson gives us,” said an influential senior official at a big bank that received money from the government, “no one is going to lend a nickel until the economy turns.” The official added: “Who are we going to lend money to?” before repeating an old saw about banking: “Only people who don’t need it.”
Housing has another 10-15% to fall (see here for a reminder), and that assumes no overshoot or second leg down due to a sharp increase in unemployment. And this won't happen quickly, either. Alt-A and option ARM resets continue at high levels through 2011 (in fact, 2009 is a bit of a lull, so we might have a false sense that the crisis here has passed midway through the year).
Here we need to pause and remember two main things. First is unless we know what is everyone hiding and what is it exactly worth we wont get anywhere. Second is markets have failed till now so there has to be someone willing to roll up his/her sleeves and get his/her hands dirty and really look at every single mortgage / asset. Asset backed instruments will work better if we have better information on underlying assets.
So now will someone please stand-up and help me look at this crumbling house in US that sits in balance sheet of bank in timbucktoo!
Monday, October 20, 2008
Before the recession, it was John Peirrepont Morgan who (with similar model) helped US wrest the development initiative from Britain and France. This business model in general and particularly Lehman gave the US - silicon valley, factory based manufacturing, organised retail industry after 1930 recession. These are the very institutions that have helped the US keep up, nay lead the economic development of the world. Without Lehman, and its ability to manage this leverage US would have fallen before the rise of Japan in 1980. US also owes the latest "best decade" (time around Clinton era) to capital sourced from this very model. The excesses during that era - spawned biggest bubble ever - its still inflating in other parts of the world. This bubble pushed the innovation envelope beyond the regulatory scope and therein lies the problem. US has lot that it owes to this model.
There is a lot of blame-game and political gibberish that surrounds demise of Lehman and current financial crisis. Ordinary citizens will do well to not heed any media and rather read up on opinions of unbiased professors from top educational institutes. My reading leads me to believe that both Obama and McCain have misunderstood the problem. Obama has good economic research support - but his speeches do not communicate the understanding of his team. But I would bet on Obama (just purely based on his team).
Fundamentally, average US Joe and Jane are equally to blame for the current crisis. The average Joe and Jane spent more than they earn or could earn in the near future. The number of clothes, toys, electronics, etc that people have bought are actually lower. The most people spent was on housing. At a very fundamental level, its not their fault as well -as human emotions are wired differntly and if there is nothing perceptible (like own money) to loose people tend to take risk - thats what people did with housing. But people should have known better - afterall even though it wasnt perceptible it was still their money. People dont realise what costly mistake they have done. It will impact their economic well-being for next decade. Unfortunately ignorance is not an excuse - so the blame and misery is compounded. So everyone has skeletons in their cupboards.
For average US citizen to survive the crisis, it will take boot strapping. But bootstrapping will happen when the current debt is paid off. And its going to take a really long time to work through it. Prof. Elizabeth Warren has amazing work in this field. She is also trying to protect average Joe /Jane from transactions where housing companies duped the citizens. Further she is trying to protect them from credit card bills as well. It would be great if people support her.
Lastly, the ability to ride out of this current crisis rises out of capability and opportunity to innovate and create new sources of value addition. This happens through new businesses, SME and related job creation. With Lehman's and demise of high risk capital - US has lost its main recovery financier. It is thus that US will cede its economic supremacy to others unless US fixes the system. Does it have the political comprehension and will to do so? Its for US citizens to decide.
Wednesday, October 15, 2008
Poverty is not going to go away. At any point in time there will be poor people. The real problem of poverty is that poor people do not have the means to move out of poverty. In other words, this is structural poverty. I have looked at this in my earlier post - “Why certain people stay poor?"
Poverty that will not go away should be transient poverty. Where people fall into poverty because of illness or bad luck etc but have access to resources to help them get back into income generating households.
The poverty solution will have two main elements. First is identification of threshold for the economy. Second is enabling this segment with tools and resources to move out of poverty cycle.
Poverty and its relation to population under certain threshold income
I have a problem with calculation of this threshold income. Generally, poverty is defined as people earning under a certain threshold income. The threshold income, therefore, is calculated using consumer price indices of various items required for minimum subsistence.
Rather threshold income should be X-sigma deviation from median population. This approach is far more likely to identify target population.
Poverty and relation to people at bottom of income pyramid.
Poverty is not about people being at the bottom of income pyramid. There will always be people at the bottom of the pyramid. The argument is what if the bottom is higher now. I have a problem with this approach as well. If everyone is higher then we have inflation. It means poor people though not poor by definition, continue to get low quality goods. To add to this they are not even defined poor so no reform reaches them.
Why this solution does not work?
Readers will recognize that the solution I have proposed is not new. And experience suggests it does not work. The main reason is lack of other infrastructure.
- Poverty reduces access to legal protection. Poor people do not have resources (mainly time – as it directly impacts income) to strive for justice. Hence they can be taken for a ride.
- Poverty increases current or future health-care expenses. As I highlighted earlier, healthcare represents a snake in this snake-and-ladder game of climbing the income pyramid. Rising healthcare cost are sure to keep poor families continuously poor.
- Poverty reduces probability for higher education thereby creating ceiling for income growth of the household. Thus occasional poverty (in a lifecycle of a family) become sustained or structural poverty.
- Poor people do not have time to identify best employment opportunities for themselves. They have to go by word of mouth or past skills.
The legal and healthcare related infrastructure can prevent poor household from sinking further. It is a down-side protection. Then you need up-side push. This requires infrastructure like free education, employment exchanges, access to finance for entrepreneurship, technical support for diversification of household income etc.
Poverty is recognized to be the bane of the modern economic landscape. But escaping structural poverty is possible.
Legal and healthcare infrastructure is systemic necessity. A lot of work has been done on education for the poor as well. Mobile phone based employment exchange for the poor is technically feasible. Access to capital through micro-finance is well researched. All the pieces of the puzzle are in place. It is just a matter of connecting the dots.
This post is dedicated to Blog Action Day 2008 on Poverty.
Previous posts on poverty:
1) Layout of poverty (Jan 10, 2008)
2) Why certain people stay poor? (Dec 03, 2007)
3) Selling costly products to bottom of pyramid (Nov 08, 2007)
4) How city development impacts poverty - Why Bihar should ensure there are no slums in Mumbai? (Dec 03, 2005)
Friday, October 03, 2008
Yves Smith and Megan McArdle - two of the most important voices in the current day finance and economics come together over a wide-ranging chat. Yves talks about wide array of things I like including Mandelbrot and Peter Lynch. Fantastic interview – must watch all 67 minutes of it!
Here are a few comments I have based on the interview.
Size of the financial system is huge and you have to shrink to manageable size before you can rescue it.
Yves and Megan mention that the government would have to buy an asset valued on the books at 70cents at 75 cents to capitalise the system. Now we have a system where company accountants set the floor and government tries to fund accordingly.
I think it would be better if instead of capitalising the system, government set itself up as buyer of last resort. Lets say if government sets a price at which it will buy those assets at 30cents. Thus government would set the floor and then investors can compete for price discovery.
The central point here is what is the amount government should value it at. In the case of housing at least it might be a little easier. Average (median) house prices should be around 20-30% lower than average (median) incomes. That can be set as the bottom in case of housing.
Of course this is way to simplified.
Embedded leverage – defaults increase from 3% to 6% impacts capital adequacy disproportionately.
What happens if this happens to higher rated tranch – i.e. AAAs? In such a scenario, the entire basket (all tranches AA, BBB etc) get impacted. Going forward this is what is likely to happen. I think this is much more likely and dangerous!
Falling dominoes – system that’s far more interlinked for its own good
There are few metaphors on stopping the falling dominos. The first is what is called the scorched earth policy. Here you create controlled destruction to offset the oncoming destruction. So to stop forest fires controlled fires are used. Second is containing the damage. This is how they stop flooding of submarines in case of water breach.
Yves invokes references from Mandelbrot - that was fabulous I thought. It leads us to solutions for self propagating replicating and cascading systems. These systems must have identified points for intervention. Yves refers to these points and need to create such points.
The dominoes set-up for world records usually use such points. In case the dominoes accidently fall. Using these points you can isolate the rest of the system by decoupling at those points.
Yves recommends regulatory constraints on who can trade what with whom. That is one way. Other way is to continuously test the system - like hackers test the IT system security of enterprises. Thats because no matter what regulations you can set - there will be ways to break it.
10-year reduction in mortgage defaults – why you cannot trust it?
This is one exceptional point raised in the question. If 10 years data tells you that mortgage defaults are reducing will you believe it? It depends! In fact Taleb actually warns of exactly this.
Aesop has a fable wherein the Ogre keeps its life in a little bird and thus becomes powerful. The hero has to attack the bird or in this case the underlying asset. If house prices exceed the median incomes and stray way out of line then you know that the last 10 year data is misleading you.
Finally -Yves Smith the dictator – Manhattan Project
Now this is one part that I would really love to hear more of. that section was too brief. I think we need to prod Yves into a plan for the Manhattan project. Very amazing Yves and Megan.
Monday, September 29, 2008
I have been harping on the fact that the impending recession is result of excess money. Therefore unless money supply contracts and goes below a certain threshold, we are unlikely to see any recovery. We are now in the first step of capital destruction.
Like I mentioned earlier, in the first step, it is the money system that bears the risk. The regulator has no alternative but to ensure that the system survives. This is where the current bailout package (lets call it bailout 1) is aimed at.
The risks arise in the next step. Here the money system goes into self preservation mode rather than help push the bailout effects down to individuals and small businesses. Here second bailout will be required. But this bailout will need concurrent regulatory changes so that the money system does not simply fatten up – but actually pushes the recovery stimulus down the chain. The size of this stimulus will be at least twice the first bailout.
I think, these two bailouts will have to clean the system. Beyond this will be a period of lull. This is the time individuals and small businesses start reducing their loan outstanding. This is likely to take long time in case of US.
Further to this is the rosy skies and sweet smell of growth and increasing wealth.
What is currently called bailout is actually second bailout – the first was tax rebate stimulus of USD 150billion in around Feb- March 2008
Wednesday, September 24, 2008
This touched a niggling thought in my mind. Is the US taxpayer carrying the burden of global financial system bailout?
US taxpayer is financing the “global” liquidity crises. Is it not similar to central bank intervening in domestic markets to provide liquidity? So in effect, the US is acting like central bank of the world. Then does the US have the clout/muscle to regulate globally?
If US attempts so - is a political transgression. Naturally, this will lead to diplomatic games that often result in lot of dinner and drink expenses and little else.
If not, US taxpayer is getting a raw deal. In effect, the already stretched taxpayer is bearing the global financial rescue burden. At this point, it is overwhelming. Add to it consumption responsibility that developing countries expect US to carry out. I think the system is near break. It is MUST that global leaders / central banks sit and hammer out the solution at a global level. Else, we will be perilous close to political turmoil.
Wednesday, September 17, 2008
Lehman Brothers’ is no more. But, instead of cheering the Fed for not using tax-payers money, I think Fed has not fully nullified the threat. Moreover, I am siding with Lehman.
When something as old as Lehman fails, it must be one hell of a crisis. Actually, it is, and I have been harping on it. Yet the fact remains that something that survived the great depression will be no more. Many people have said that Dick Fuld was wrong in not selling to KDB. Yet surprisingly employees of Lehman I know – believe there must be a reason. Some say if you prick Dick Fuld, he bleeds green! They still believe in their top boss –even after the bankruptcy.
I do not believe that incredibly talented people at Lehman did something way different than what GS, MS and ML have done. There is something fundamentally wrong when you see Lehman and ML scurrying for capital – like there is no tomorrow.
Fed solution not complete
The Fed’s reaction to Lehman’s troubles was erratic. On one hand, it did not bail our Lehman but bailed out AIG. So they bust their argument about tax-payers money. I think Fed, with all the experience at the table, has failed to deliver creative solution to the crisis.
So where is the solution?
A single regulator, even as big as the Fed, cannot deliver a solution to current crisis. I think a global consensus needs to evolve. Global central bankers acting in sync can possibly solve this crisis sooner. It is time to take the John Pierpont Morgan solution. Get all central bankers into one room and lock the room until they get to the solution.
The current crisis begs for a need for new globally relevant regulatory framework. This framework needs to buy time for companies under attack – while not using any taxpayer’s money. However, looking at WTO, I think we are long way away from such a situation.
One other important learning from the crisis is that global accounting practices are not as robust as they seem. The root cause of this crisis rest in the accounting principles that allow asset values to move away from ground realities. Asset values moved along with fabricated-market realities leading to self-propagating bubbles.
Another accounting goof-up has been notional value changes creating real cash-flow profits. There is evidence of similar occurrence in a lot of trusts and funds. It seems irrational to me.
Aligned incentives are critical for firm survival. In this matter, I think Lehman was much better off. The employee benefit program tied long-term employees’ fate into the fate of the firm. I believe you cannot get better than this. A real hard look at compensation is definitely warranted.
I end with a hope.
I hope in 2 years time, Dick Fuld and his team miraculously claws back with the Lehman Brothers’ name. I hope to see those golden letters on greenback on that building in Wall Street – just where they were for more than a century. I hope Dick Fuld has something up his sleeve. I really hope. And, I hope they do it soon.
Thursday, September 11, 2008
- The loss of US policy independence in accordance with the impossible trinity
- This poses threats to globalization in the context of US losing independence.
- US (excess consumption no saving) is polar opposite of Japan (lower consumption high savings).
The current new-found affinity for US dollar is actually repulsion to EM markets rather than affinity to US dollar. This money will go to newly spiced up US exporters. Exporters loose their competitiveness as it is derived from US dollar weakness. People loose money. It doesn’t matter in which currency you loose it – its lost. Loosing it in dollars makes it little better for the rest of us because there are just too many dollars sitting in vaults these days.
Welcome to the down-cycles.
Tuesday, September 02, 2008
Current market slowdown will express itself in a cyclical matter with cycles accelerated or compressed within a short span of time. It is better not start pre-mature celebrations. It makes more sense to track the frontier of this storm wave. However, 5 years down from today we will marvel at the low-high-low-high forecast cycles wondering what were analysts thinking!
Into the cycle…
On the first anniversary of the slowdown, the US GDP was revised upwards much to the cheer of the markets. Experts like Tyler Cowen, Brad DeLong and others have already looked under the hood and have not found anything remarkable. US GDP seemingly grew on the back of strong manufacturing performance. The news coincided with a slowdown in Europe. This gave a chilling clue that possibly US growth came at the expense of a European growth. This newfound US competitiveness against the EU is primarily due to exchange rate weakness of the dollar. The dollar regained strength on the news of GDP uptick undoing the competitive forces. Thus, the situation is now ripe for US consumer uptick expectation and further realignment when it does not happen.
The down cycle oscillations…
The situation is likely to oscillate for at least another cycle. All the gains in competitiveness are still addressing American and European consumers. This, to my mind, is critical weakness of the currency system. I expect this cycle to oscillate until European consumers stop consuming at the next uptick, waiting for growth that is more fundamental and hence robust. Therefore, the last cycle will not produce a GDP increment as this time. The sooner this stabilizes the better. The more these cycles run on, the more loss of confidence will create panic. How long will this run and how spectacularly will it end is difficult to predict.
The consolidating cycles – more oscillations…
The next wave of cyclicality will hit when actually Chinese and Indian consumers hit the global markets. As global manufacturers rush to address this demand, they will unleash a new wave of competition. The resultant action will create a cyclical rebalancing in currency markets. Even this cyclicality will create an oscillation difficult to fathom/ predict.
The wavelength of the cycle…
Making money given the cyclicality of the world economy in the near-term, implies understanding the wavelengths of the cycles. As of now I believe we can only expect to understand down-cycle waveleangth. The consolidating-cycles will be far more complex and knowing their wavelength will be more difficult.
The down-cycles, as mentioned above, we can argue will have peak-to-trough time of at least 2 GDP reporting periods. Implying these will play out over little less than a year. Lead indicators of GDP like retail sales, car sales, energy consumption, inventories etc. also tend to influence markets during down-cycles. However, I think these indicators distort the way GDP growth diffuses through the economy and hence may mislead the markets. Actual GDP measurements may turn out to be more robust on upside and downside than predicted using lead indicators. Thus what was a single cycle may actually be aggregation of auxiliary-cycles. The main cycle though can be expected to follow GDP readings. The imposing auxiliary -cycles, if large enough in magnitude, can distort the wavelength.
The near-future is going to be cyclical, with accelerated/compressed cycles. Most likely cycles will have wavelength (twice of peak-to-trough) of 4 GDP reporting periods. Auxiliary-cycles may play spoil-sport within the cycle. Making money in such an environment is equivalent to wave-surfing. At each peak you have to make enough to take you till the next peak! Thus making money is quite tough and entails highest risks. Welcome to the beach!
Wednesday, August 27, 2008
Emerging economies learnt the formula for growth in the past decade. It involved promoting investment and job creation, encouraging spending thereby triggering a virtuous cycle of development. This formula is great to initiate or prime the economy - but it is poor mechanism for transmission of wealth across income classes. Savings and host of economic factors ensure that the distribution of wealth so generated is lop-sided favouring the higher-income class.
Most of the economies seems to have decided that answer to rising in-equality is in faster-higher-better priming. Partly, they cast their economies in the mould of market-share winning corporates. And like corporates these economies are intent on keeping "costs" down. The resultant "profits" were enormous and increasing. But there was a little difference with normal corporates. The employees of normal corporates interact back with the market. But employees of this nation-corporate only interact with themselves. (Either because of direct or indirect trade barrier like managed exchange rates) Therefore the higher profits could not be channeled into stake-holders - due to fear of inflation. So these had to be invested somewhere. So it is that this enormous forever-swelling pool of money found its way into US assets. Pushing the US consumer to carry this "little" extra burden. Then the unthinkable happened - US broke down - it was the last (Yuan) straw that broke the US back.
Now central banks are looking for growth. Now the same old principles wont apply. US consumer is not going to take any more burden. New consumers will have to be introduced into the system. China and India - these two countries who can inject tremendous amount of vitality into the system because of sheer numbers. But at current exchange rates both China and India are too small to carry the burden of US consumer.
As mentioned in yesterday's post, exchange rate revaluation will impact at least 2 trillion of China holdings. Opening the domestic market to world will further deplete this reserve. China will find itself in apparantly bad situation (first-order effect is pain). Fundamentally however this situation will better address the income discrepancy than its current policy - through third and fourth order effects. Yet can any country set aside the pain. I doubt - rather this will trigger a battle for consumer.
Now there is a reverse implication of this. The "real" savings estimated in terms of purchaing power of future goods - will decline so long as exchange rate barriers dont break. This while savings are actually rising and inflation is low - and exchange rates are pegged. Anecdotally we can see amount of money required to maintain lifestyle is increasing faster than what inflation and wealth increase are telling us.
Exchange rate is key hurdle - from multiple sides - in addition to conventional fundamental reasons. There is going to be lot of pressure on Yuan at-least. Thats why my higher conviction on Yuan appreciation.
#) Some ideas half -developed - but important to highlight so posted half-baked.
#) James Fallow asked straight questions - I call them level 1 questions - we need to ask level 2 questions. E.g. relative pay-of to Chinese worker should be made in PPP terms or relative to China income distribution.
#) Just as I finished this I get this amazing article at Vox by Robert Dekle, Jonathan Eaton and Samuel Kortum. Will comment on it later.
Tuesday, August 26, 2008
China has limited options. A large part of its wealth is loaned to the US. Now the only volatile variable in this is exchange rate. If you have 2 trillion dollars sitting out there when exchange rate varies by 10% - I am sure you heart is in your mouth. If that much money has to retain value then it has to sit on something more robust than US debt!
For China, the only other way to retain value is to keep the relationship intact (because China CAN control one side of the peg!). But by committing to manage exchange rate - China now has no option but to be the large buyer of additional US debt. This is fine if China believes it can shore-up all the "remaining" US debt.
Now this situation is ripe for other nations, funds, entities to gradually off-load their USD holdings and retire to the peace of Euro, gold or some other value retainer. They are attracted by buying options for raw-materials i.e. food and energy. That makes the case for rising energy and food prices. This is same old logic behind this new-found attraction - hedging. Countries would ideally like to lock their costs in current prices to protect against future rise. So US debt problem now extends to US assets.
Where will China get the money to buy US assets?
While large part of the money comes from running trade surplus (for a little while), some part also comes through Chinese savings and investments. Chinese FDI is in a position to buy lot of US assets and given the situation - it will do so. Implication is if you have to shore up the Yuan for sometime and release it later - you will make a tidy dollar profit - if it is of any value.
So how do we retain - rather add value - sit on cash?
Sitting with cash (in local currency) is great stratgy for retaining value in local context. US domestic investors are ok with dollar profit - if they are going to spend it domestically. But most investors look to increase or at least preserve value. This was ok when dollar was default currency. It helped measure value - hence retain and enhance value. That was why nations bought US assets not because they were unusally attractive.
The other metric of value is the purchasing power. Lets say 10 dollars fetched one meal in 2008. Then all the current holdings should be measured in no. of meal terms. Then its easier to measure and enhance value again. So the best value retainers will be derieved from future consumption basket. So in-effect real hard-core hedging should help retain value. If smartly done - you may end up top of the heap.
Surely there is some hidden risk there too...
The situation becomes more critical if we realise that "contract enforcability" underlying the hedges can be threatened. This risk is sure to increase as money involved increases - i.e. when China realises it holds larger and larger share of US debt outstanding - and by that time China's stake would be probably greater than 4 trillion. Once China does realise - we are going to be in really, really tough times. In old times - this situation would be enough to cause a war. In today's times I hope not.
Note: - The nakedcapitalism post is must read. It connects, complements and analyses this theme from Larry Summers FT article, Brad Setser (article I linked yesterday), William Greider, Dani Rodrik, Thomas Palley and El-Erian. I am fan of Yves Smith!
Also Steven Kamin has interesting findings at Vox.
Monday, August 25, 2008
There is a great new post from Brad Setser at CPR. He highlights a quote from Dr. Yu Yongding that highlights the dilemma facing China as an investor in US debt.
“If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic … If it is not the end of the world, it is the end of the current international financial system.” "-Dr. Yu Yongding @ Brad Setser: Follow the Money
US creditors are in a waiting game. It is also a losing game. So long as they pick-up the US debt instruments, and supply more credit to US - things are fine. This is aggravating the US deficit problem. If US policymakers start rectifying the problem - they will do things that will upset this fine balance. It takes me back to my december 2007 post.
This waiting game has big money at stake. The pay-offs are larger and margin of error is small. This looks like a lose-lose game to me. What say ye?
Thursday, August 07, 2008
Its time to put higher conviction on my view that Chinese currency must appreciate. There is too much weighing in on the this side of the bargain that it will happen. Foreign currency inflows. to my mind, are anticipating a gain from one-time appreciation of the Chinese currency. Further let me speculate that with a one-off appreciation China will see a run on the currency. Foreign capital is likely to pull out possibly netting up to 15% return for the expedition.
This is running very similar to GBP devaluation. I would really love to know which side is Soros playing this time. After all its a known game for him.
Friday, August 01, 2008
(Jane McGonigal from Avant Game twittered about this link. ) talks about short-comings of US education. The most fantastic part for me was the following quote
Being an intellectual begins with thinking your way outside of your assumptions and the system that enforces them. But students who get into elite schools are precisely the ones who have best learned to work within the system, so it’s almost impossible for them to see outside it, to see that it’s even there. Long before they got to college, they turned themselves into world-class hoop-jumpers and teacher-pleasers, getting A’s in every class no matter how boring they found the teacher or how pointless the subject, racking up eight or 10 extracurricular activities no matter what else they wanted to do with their time.During the earlier years innovation and challenging the boundaries by simple interaction of different cultures. There were barriers to cultures interacting. Thus top schools, by getting a diverse group together, facilitated the best learning environments. The system was right for the time.
Today technology has broken those barriers. Today learning must come from independent thought. And this is very difficult to induce independant thought. Schools are now trying to build on the diversity base, that they are familiar with, and add newer cross-discipline projects.
Cross-disciplining is expected to be next level of idea generation. Economics interacting with Physics, Medicine with mathematics, economics and thermodynamics - a lot of these fields are cropping up. I believe, education is in good hands. The most we can accuse it is for being slow with change.