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Tuesday, February 22, 2011

Financial Crisis and Democracy

One of the features of the current financial crisis is the way it interacts with democracy. The crisis touches the very core of democracy both in principle and by its sheer size. In this, the current crisis is far different than any we have seen previously.

First, the way in which necessities of few banks have been scaled to compulsory levy on the masses is one example. Within a country, the stress on the lowest income class has increased due to lack of jobs and increased burden of taxes. It will increase further with inflation and cost of basis services rising. All this for no fault of theirs. 

Second, this crisis also spans across democratic divisions of countries. Icelandic population must consider bailing out those of UK and Netherlands who made idiotic investments. In a similar fashion, Germans must consider bailing out Spain, Portugal etc. The US consumer is effectively bailing out the world.

Third, the size of bailout and enormity of impact of actions is such that common people are suffering. Even earlier, there were bailouts and recessions. But never was the scale this large and impact so lasting.

In such a scenario, one can understand why there are political issues. The developments in Middle East and North Africa (MENA) are, in all likelihood, the first steps. The citizens there were confident that their governance structure was not the best and felt compelled to deploy better mechanisms like democracy. In developed and democratic world, we are not sure what is a better alternative. But in any case this situation will not resolve in a year. We will have to live with this for the better part of this decade.

Friday, February 18, 2011

Retrofitting explanations - Don't listen to Finance news channels!

Why are food prices soaring? Why did the markets rise? Why did they tank? We get decisive answers to these question on news channels on daily basis. But almost everyone of them uses explanation retrofitting.

For example, take rising food prices. In such a context, discussing prices only in relation to demand supply seems inadequate. It may still be dominant variable influencing prices but the recent changes to prices cannot be explained by demand supply alone. For one, the change in consumption of emerging economies and change in prices over 5 year period does not tally the thesis. To infer demand supply realities from prices, i.e. doing reverse, is like retrofitting explanation to fit the thesis. Investors and talking heads are guilty of this en masse. The problem with retrofitting explanation is that it checks all the boxes, every cause-effect link seems strong. Except, there is often no link in reality.

Imagine what would happen if we started a school science experiment to produce oxygen only there won't be a test tube to collect the oxygen we have isolated. That would be released into the air. Thereafter, the teacher will ignite a match near the place where oxygen should have been collected and it will burn - a test that confirms oxygen. Now did the match burn from the oxygen we isolated from the experiment or did it burn using oxygen from the ambient air itself? In science this is a flawed experiment. But if a finance channel would definitely report it as success and, in all probability, markets will rise 1-2% because of such discovery!

To be fair to economics scientists, social systems are difficult to model because of this problem. The economists and social scientists know this and thus are always tentative in their evaluations. Famously, they are two-handed, they always propose an alternative explanation starting with "on the other hand...". Market analysts, on the other hand, are forceful in their views and exude confidence where there is none to be found in the foundations itself.

Investors, thus, must be vary of making mental models based on the forceful arguments of the market analysts. Such mental models are often just assumptions because of the flawed fundamentals. And these are the most difficult assumptions to challenge.

My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle

Thursday, February 03, 2011

Missing the technical bounce-back on Nifty

Indian markets had a technical bounce back and I missed it! At first I was expecting some kind of a pause at 5400 on Nifty. However the type of fall in the markets over the past few days coupled with the volumes had me in a fix. It looked like markets would simply drive through 5400 and land somewhere closer to 5300 or lower. So I had invested not more than 10% of the cash. Nevertheless I exited out of my positions and will patiently for levels of around 5200 for another mini-bottom.

Meanwhile, as we discussed earlier, the market is on track to form first of its two corrections. To quote my earlier post:
We will have two bottoms and three tops during 2011. Depending on how you look at the cycles, we had 2 or 3 of them last year. Consequent to the cyclicality, portfolios will have to churn thus leading to healthy performance of the brokerages and investment banks. I would expect asset managers to have a decent year again.
I believe we will be set for the peak around May-June or thereabouts and a correction around September. It is possible that the September correction will be shallower than the one we are experiencing right now. Naturally, I expect alert fund managers to have a decent year in calendar 2011. In these views I am contradicting most experts and talking heads.

Note & disclaimer:
This is not advice to buy or sell or trade in any security. Please invest post careful research and analysis. I will not bear responsibility for your actions.

My book "Subverting Capitalism & Democracy" is available on Amazon and Kindle.

Wednesday, February 02, 2011

Defining Real Productivity

I read that again! Someone just said "The productivity of developed market work-force is higher than developing market work-force." And it irritated me again. It is time to refine the concept of productivity. 

Why is it irritating?
Let us imagine two fellows, one out of shape banker who rides a car, while other, a physically fit cyclist Lance Armstrong-like fellow. Now the banker can definitely ride longer, faster than our Lance Armstrong. 

But that does not say anything about physical potential of the two competitors. If we want to choose one of them as a contender for survival course, it would be impossible to choose based on this view. Rather, the only thing it shows us is the difference between availability of productivity enhancing capital investments.

In terms of economies, what such a difference in labour productivity implies is the need for investment. In other words, it shows us that the developing economy in question needs capital infusion for being competitive.

We need to measure Real Productivity
I think we need another variable. Let us call it "real productivity". This variable will be designed to be used while comparing two economies at different points in the development scale. This should help us understand various things including ability of the workforce to adapt to change, ability to deliver variety of work, etc.

Real Productivity will, possibly, refer to volume of various types of work achieved in one day adjusted for capital assistance. It will be profile (distribution) of workforce against predefined job categories. The job categories on one side will be highly knowledge intensive and on the other end will be highly physical oriented. The profile of developing country workforce will be bottom-loaded while that of developed country will be top-loaded. Somewhere between the two extremes of the distribution lies an important threshold. Below this threshold the factor limiting the workforce is external or opportunity related like financial capital in the form of equipment and machinery. In other words by bringing the capital it is possible to improve productivity. Above the threshold, the factors limiting productivity are structural in nature - like education or skills. These factors take long time to change and cannot be resolved easily. At the threshold is a chasm that can be bridged only through proper policy direction and grass-root efforts. Whether a country (i.e. economy) crosses this chasm depends on quality of their government. The differences across the chasm are not easily bridged and hence the competitive advantage is not under threat. However, if an economy has already crossed the chasm it can pose a significant threat as the factors differentiating it with other economies are easily corrected.

The assumptions that most people make is that developing country workforce is still across this chasm. That is where I do not agree with them. If not India, China and Brazil have already crossed the chasm. It is only a matter time before they catch up with other developed economies. Having said that, it is possible to back-track across the chasm as well. A political unrest and upheaval tends to set the nation back.  

In sum
We need a new metric to understand the changing economic landscape of nations. A "real productivity" variable as we discussed should improve our understanding of this economic landscape.