What a week! *sigh*

What a week we had.

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!

Great Depression, China, US, War, defaults and other comments

Yves Smith, my favourite financial commentator, has one great post titled China's Smoot Hawley- a reaction to Micheal Pettis (another of my favourites) article. Its an awesome post and worth read - including the comments. I was naturally late to this friday party - so here are my comments on the post!

Hunger of deprived and hunger of developed is different

So pre-Mao chinese hunger and post-Den Chinese hunger are two different animals. If a developed country goes hungry, violence is also a fallout. Sale of guns has risen in US for a good reason. We have to realise that people on ground know best.

China wants to run this game for a wee-bit longer

China has nearly 1.5-2 trillion dollars in USD assets. Now China wants just a little bit of time to save some of it. China believes that this is their sweat money. The way around as they see it is to
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

The cost of Iraq war was about a trillion (vague recollection). And it was a trillion dollar
"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

I have been making this point for like ages now (even in comments to your posts). A recovery without demand from China and India will not happen. US is not going to be a consumer - it has to be a producer. The best way to get these 3 billion people into consumption fold is by letting exchange rates correct. SE Asia and other surplus countries will need to do the same.

Import restriction response is a threat

I hope there is enough sense to not impose import restrictions. Yet, I fear India and China will impose them eventually. There will be a race to corner the "able" consumers for domestic industries. China has a difficult decision to make then. The domestic consumer will be a loser and their money will be looted by domestic corporation. Though it will be done sophisticatedly as a economic process.The best way to get domestic consumption going is to first get the latent demand for best brands going. For that you need to keep imports open.

USD and Gold - Printing currency does not matter

There is a lot of talk that Us can print its way out of the crisis. It is surely doing that. However,
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).

In sum

Welcome to eye of the storm!!

Links:

Yves Smith, Naked Capitalism, China's Smoot Hawleys

Micheal Pettis, China Financial Markets, Rising unemploymentt and trade policies

Soverign Wealth accumulation and wealth dispersion process efficiency

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.

In Sum
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.

Links:
Asian Exchange Rate asymmetry - Voxeu.org

Financial Crisis - Moving Towards a solution

Finally the quest for solution, both long term and short term, has began. It was going on in hapazard manner across blogs and opinions in newspapers but the most intelligent response comes from Voxeu.org.

They have published and edited version of essays suggesting action plan for G20 leaders to stabilise the economy and fix the financial system. Its 76 pages all worth reading!! Enjoy!

The Core of the organisation - the Honda story

I have read a lot of talk about Core-competency in the past decade. I have seen companies make a mockery of the core-competency issue. I often look at the top management and check how many of the top management team came from "core-competency team". In most - hardly any. Many in fact absued it so much that management gurus like Tom Peters were left screming on their blogs!

Organisations have to evolve an ethic of honouring its core-competency. Forbes highlights how Honda promotes in engineers to top ranks - and not marketers or accountants - engineers! This is the truest way to honour your commitment to "core competency".

Hat tip - Paul Buchheit

Are the store-shelves empty?

We are precariously placed in the recession। Sadly my reading of political and economic news tells me that the top honchos have just messed up pretty big. I am looking for validation.

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.

The Chinese Dilemma!

There is an interesting post at Marginal Revolution on Chinese model. Tyler Cowen smartly collects lot of pros and cons on the matter. Yet, this is very critical at this stage.

World economy had predominantly two engines of growth - the US consumer and Chinese producer. Both had second and third order effects that accelerated the economy. Now US consumer is dysfunctional - at least for some time to come. So the world looks at China!

China is also aware of the issue. It wants the huge savings rate to translate into consumption and therefore demand. The only way to get the saving population to start spending and kick-start consumption is to let them buy brands that have build up aspirations in their minds. This will be possible with letting CNY appreciate and letting the products be available freely.

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!

Links:

Marginal Revolution - Tyler cowen - This is another premium blog on finance and economics.

We were warned!!

I was really surprised when I realised that entire credit crunch and related problems were highlighted and we were warned back in 16th century itself.

"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.

-Full advice-
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!)

Interesting reading about China

All roads lead to China -by Richard Burbaker has a post with interesting link to China Dilemma - a collection of 18 chapters though he mentions 19.


Link:
The Big Picture | All Roads Lead To China

"Commodities as Anti-Dollar"?

Yves Smith has a recent post on whether commodities, particularly oil is finding favour as anti-dollar. In the comments, you will find some arguments about oil demand and fundamentals.

I think Oil price movement were retro-fitted to fundamentals. In other words, the movement in oil was primarily as a value retainer against dollar. But two things happened that twisted the outcomes. First, dollar strengthened (for whatever reasons) and second more money rushed into oil taking it too far away from retro-fitted fundamentals.

Now we are about to witness a second flight into "value". Are we foreseeing another commodity upswing? I think we need to watch Oil, Gold and other key commodities. But one thing is sure - perishable agri-commodities will not be able to retain value for the length of time that we are looking at.

Time to watch out and hold tight!

Links

naked capitalism: Is the "Commodities as Anti-Dollar" Trade Back?

The economics of labour market intermediation | vox - Research-based policy analysis and commentary from leading economists

David Autor has a fantastic post on Vox on economics of labour market intermediation. Labour markets are imperfect and they are kept that way by interest of recruiters and employees. In the end both loose but still there is enough weight in status quo.

Let us consider an employer and a prospective employee. There is no way for the employer to know the employees performance in previous organisation. Therefore the metric is salary drawn currently.  Now if, by any chance, an employee accepts a job with lower salary then his salary growth is lower! This appears unfair - but its actually a manifestation of inefficient market at work. The only way this situation corrects is when imperfection on other side - i.e. you have a desperate employer. 

As per my experience the intermediaries actually twist this situation to the benefit of the employer. Hence most of the time employees distrust HR managers and intermediaries. That is the reason salaries are secret. Often even though companies treat everyone fairly - employees still feel distrust.

In sum, there needs to be two areas of research in this. First - does this behaviour actually benefit the employer at all. Second - does this distort the labour markets to an extent that it impacts the economy. My intuitive guess is no on first count and yes on second. 

Links:

The economics of labour market intermediation | vox - Research-based policy analysis and commentary from leading economists.

Banks need to stop hoarding money - or should they?

Mike Shedlock posts an interesting comment to a White house recommendation (directive?) to banks to stop hoarding money. Prof. David Beckworth however explains why banks are hoarding money.

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.

To my mind this reaction is rational given the accounting requirements and state of real economy.

There is a serious need to assess accounting norms for banks in the light of Fed guarantees. Banks may be holding too much reserves, capitalising a little too much among other things*. So if indeed Fed is going to prevent the systemic collapse then banks may be able to free some money. But of course its not as simple as that - the issue needs more understanding.

Further, with real economy showing signs of slowing, banks are reluctant to lend. (Rather, banks are now being sensitive to slow-down signs that were present even before the financial crisis!) Now is the time for bailout 2 to materialise. Though this one needs to be aimed at the consumer rather than banks. Banks may be used as a transmission mechanism for this bailout.

Note:

I dont mean to say that bank's have enough capital - but what I mean is so long as Fed gurantees are in place the banks may be better off (for easing out of this crisis) in lending rather than increasing researves. Banking system may need a lot more capital later once we are out of crisis - but the time to get the capital may not be now!

Links:
Mish's Global Economic Trend Analysis: White House: "Banks Need To Stop Hoarding Money"
Second bailout - FIs into self-preservation mode

Macro and other Musings - Is there are credit crunch?

Development 2.0 is gathering steam

One of the many things Web 2.0 will help streamline is poverty alleviation and development of backward regions of the world. World bank's PSD blog earlier had a post about what this development 2.0 needs. Their recent post hints at a BBC initiative that has potential.

Links:
Development 2.0
A lesson in openness - PSD Blog - World Bank Group

USD strength is an opportunity!

Confused Capitalist JW has a post today about how to make money in the moment. I agree with him totally. The current rush to USD assets is actually an opportunity to convert USD liquidity into other currency assets, particularly CNY (Chinese Yuan). If you see the behavior of Chinese markets vis-a-vis global markets you will see some strains of this actually happening. 

Under the hood of these flows, however you will see the reason why the systemic destruction of capital will be cyclical in nature. The cycle is similar to Roger's adoption curve in marketing. Small, smart money managers are "early adopters", big money is fast follower, everyone else follows big money (and that changes the equations - validating the theory - to an extent). The individual investors are typically the laggards - if they follow this they loose money. If they stay put they might make some actually.

The entire cyclical movement of money also lends credit to rising oil and gold price theories. So I will watch these commodities closely. Further the mechanics of this wind-down will be cyclical - with different wave-length. I guess this means its time for traders to earn their money. Welcome to the rough ride roller-coaster!

Short Selling

There has been a lot of blame allocated to shorts. Ajay Shah put his arguments against banning short-selling in "Why ban short selling?". But there are ways where short-sellers can impact the market mechanism adversely.

Now fundamentally, there is nothing wrong with short-selling. Even shorts with borrowed shares are fine and so are naked shorts. Yet, I haven't read detailed analysis of mechanism of how short-selling is causing the market panic.

Generally markets operate on a play between probabilities. The buyers believes probability of gain in buying the object is high, whereas seller allocates higher probability to making a gain by selling. Short-selling pay-off, in-essence, becomes function of two variables - the probability of the bet and size of the bet. Generally these are independant variables.

However, as we deal with wealth concetration risks, the size of bet starts influencing the probability of the event. When big money moves on a bet - it coordinates the operation across futures and swaps in stocks trading in different geographies leading to coordinated move making the bet a self-fulfilling prophecy. This is precisely the pain area. In order to understand this better we need to know:

1. How the size of bet influences the probability of event.
2. 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.
3. 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?

Country defaults lighting the Forex fuse?

There is now talk of run on countries. The countries in question are Iceland, Hungary, Pakistan, Ukraine, Belarus, South Africa, Argentina and South Korea. Have a read here:

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)

The risk is enhanced by possible political response. The breadth of possible political response of these set of countries is wide as ever. This will no doubt exert pressure on Forex markets. So what will give first.

I have believed in dollar weakness all along. Initially I thought it will be the China RMB USD friction that will trigger it. But increasingly I suspect the wear down will happen from Euro and GBP side. In other words - a European slowdown can visibly translate into Euro weakness more easily than US slowdown reflecting in USD weakness.

Financial Crisis - Goes regional, triggers a real economy shock!

The financial crisis is not becoming real economy crisis in an explosive war-like situation. I wish to highlight the first (noticeable) explosions showing crisis moving regional and hitting the real economy. As always all links refer to Nakedcapitalism.com (one of my favourite blogs).

This was the result of financial crisis (among others)
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!

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.

This is phase 2 of the crisis. The repurcussions will move east geographically towards China in coming months. Holt on tight.

Depression 2.0 dilemma - Inflation, deflation, capitalise, solvency

If at all you have just one blog to read - please read naked capitalism. Yves Smith is absolute best! Here is another song of praise - naked capitalism: It Isn't Over Until the Fat Lady Sings

The post looks a wide ranging issues including gems people will do well to remember.

oversold does not necessarily mean undervalued

the 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 positives

Marc 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!

LEssons for Poverty alleviation - The economics of civil strife

Dr. Dani Rodrick points to an article by Oeindrila Dube and Juan Vargas. (Dani Rodrik's weblog: The economics of civil strife). The paper concludes that when prices of labour intensive commodity rise - strife reduces a benefits are wide spread. Whereas when prices of capital intensive commodity rises - strife increases if benefits are concentrated. This has some lessons for poverty alleviation programs.

I am tempted to go to my example of snakes-and ladder model for poverty. Here snakes are poverty creators and ladders are poverty alleviaters. Ladders are typically income related and snakes are expense related.

In the context of ladders, poverty alleviation has two-fold objectives. First is to have ladder-accessibility to all (income growth / economic growth of labour intensive activities). Second is to have more ladders (income generating activities supporting /surrounding the capital intensive sectors)

A quick view on the strife part of paper

In my view, strife actually happens when both the above conditions are negated. Or if income generating opportunities are not available to large scale population while being selectively available to few. AND whatever other income generating opportunities are available are not growing. When oil prices increase in Columbia did not translate into ancillary economic activity then strife is definite.

Getting over Lehman

To many this post may sound a little late, but for the past few weeks there have been a spate of shows in the media on current financial crisis. Mostly the shows interview/seek opinions from morons but occassionally an expert pops in with same I-blame-Lehman punditry that I am sick of by now. These experts are misguiding the people.

So I want to rant on one of their two main arguments. First is Lehman is dead because of excessive leverge and financial stupidity and thank god for it. Then these people go on to rant upon how the business model is flawed.

Lehman problem is a little different - the business model is built on high leverage and Lehman's ability to manage it. The leverage was 32 times its equity at the time of default. Lehman underestimated the size of bets - money betting for a fall in its share price. If they would have correctly anticipated this then they would be out of trouble.

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.