The American Scholar - The Disadvantages of an Elite Education - By William Deresiewicz

The American Scholar - The Disadvantages of an Elite Education - By William Deresiewicz
(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.

Bailout, and government response - other view

There is an interesting post today at naked capitalism: Stiglitz; "Fannie’s and Freddie’s free lunch about justification of bailouts. US government is busy bailing out over-aggressive risk taking institutions with risk-averse sweat-and-blood money of the taxpayer who is more concerned about ways of paying his dues in a gloomy job market. This is wrong. But situation has grey areas when viewed from government side.

The institutions blame their woes on a US slowdown unashamedly pointing finger at the maxed out US consumer who has loan is past, present and future earnings to the devil himself. Let me remind you that these were the very devils who cheered on the US consumer down the valley of distress as they minted money at his/her expense. They sacrificed the consumer for the shareholder. As a reward, their shareholders lavished the boards and executives with benefits and bonuses. Today the US government is doing the exact reverse thing. It is bailing out the carefree risk-lords with shareholders’ money. At both side it is the layman at the receiving end. Yet it is not so simple.

From a government’s perch, the reality is confusing. Institutions are taxpayers themselves and hence stakeholders. They are also income sources and service providers for citizens. A large number of institutions are foreign exchange earners for their country. Governments view certain sectors as drivers of competitive advantage. US views finance and money management as its competitive advantage. A government might opine that a running system is easier to coax into order than let the system falter. Yet whatever the reason, they must be elaborated and opened to public scrutiny.

There are of course many lessons from the current crisis. Arnold Kling has thrown in his perspective here. However, that is when the sun breaks out. Right now, from within the eye of the storm, things are more difficult and often survival or preservation always gains top priority. We tend to salvage whatever we can even disregarding our lives. The roar of the catastrophy drowns the calls of prudence. I believe something similar is happening with governments globally. In their rush to do something – they may not necessarily do the right thing.

A comprehensive regulatory overhaul is definitely a take-away from this crisis. I believe, it is also important to take this regulation global. Further, taxation and social security needs to be overhauled. At the farthest “public goods” need to be defined and reworked. The most essential takeaway will be a disaster control program that tests scenarios and develops action plans to emergency alleviation. The system of academics, consultants and media (what we have currently) does not create enough accountability to identify scenarios and develop action plan. No doubt the system currently does that. But it is not treated seriously enough to become a disaster management system. Else the forecasts of lot of bloggers (including high profile ones like Dr. Roubini) would have triggered an enquiry.

Dollar and Yuan

We have two dramatic posts one detailing dethroning of the dollar at Vox and Yves Smith points to possible slow appreciation of Yuan here naked capitalism: China to Slow Yuan Appreciation? This is the essential dilemma that global central banks face today. The artificial currency pegs that Dr. Roubini calls Bretton Woods 2.

The first part dollar dethroning indicates that in the long term countries should not keep pegged to the dollar. The second argues that in the near term, China would refrain from un-pegging from the dollar. Now this is classic! If China sticks on to dollar too long, it will have to contend with inflation and systemic issues including devaluing reserves. On the other hand if goes for one-off devaluation it will expose its exports sector to global competition abruptly. But it will bring 300 million Chinese (the affluent ones) into the global consumer community. At the moment, that will be a big blessing.

Current exchange rate system is creating / forcing people to be global workers and local consumers. This benefits the local economy at the expense of global systemic balance. To ensure counter balancing we need global consumers and global workers supported by global capital and global regulation. By embracing the globalized system, all nations have committed to this balanced cooperative world vision. And I hope nothing we do can upset this eutopian step.

How did Germany avoid great inflation in 1979? � Mostly Economics

How did Germany avoid great inflation in 1979? Mostly Economics
Amol Agarwal points to interesting paper relating to German experience with inflation during the 1979 slowdown. Broadly the learning implies controlling the money supply using predictable medium term targets.

I do not believe at this stage simple controlling will help. This might result in excess money, accumulated in one part of the system (or big money), broadcasting it into the broader system. This permeation will absolutely guarantee high inflation. Conversely, less painful (for the masses) solution may be to keep excess money localized and slowly suck it out of the system.

In the US/UK today, the excess money has already permeated through the system. Increased debt burden and consumption triggered by rising house prices have already spread the excess money deep and wide. Hence a monetary tightening at this stage will have high adverse impact on US/UK population. More money in the system and alive and kicking employment alone could have been a solution if it weren't for the high household debt. Household debt burden simply inflates if value of money goes down. Hence bankruptcy laws and loop-holes therein are most critical. Prof. Elizabeth Warren realizes this and hence her strong emphasis on modification to bankruptcy laws. I understand South Korea, Australia and EU are in same situation as US/UK.

In the rest of the world, the money has not permeated as well. Sovereign funds, reserves and to some extent big money have limited the spread. In any case situation is better than US/UK. Here monetary tightening might be a useful tool. Emerging markets and other countries could do better than emulate the west in this regard.

The future is tough! Let us just hope we don't forget the lesson this time!

Rising commodity prices, excess money and bailouts

World is definitely in perilous situation. Expenses are rising thanks to commodity price increase. Households incomes are falling as businesses fail. Growth is slowing thanks to high cost of debt. Investments are stuck as selling assets at crazy prices is no longer possible. Only thing rising is commodity prices!

Commodity prices - what drives them?

To understand this, we need to go to first principles wherein goods and money are tradable. From here it follows that when the value of money looses its way - goods will be the lodestone, the compass. After all money is used FOR goods! We need to realise that money by itself means nothing. Money is intermediary, a common denominator amongst goods. The best mechanism to protect oneself from arbitrary manifestation of value of money is to have the goods! This has prompted the rush for commodities - the most standardized goods available to international financial community. And naturally, the prices of commodities and goods have lined themselves up in the pecking order of importance to the society. Naturally oil (presumably inelastic demand) pegs itself at the very top.

Cancerous growth of money!

Excess money is one of the root causes of the current situation. The excess money flow was further exaggerated by pegged exchange rates. Initially the increased money supply was cornered effectively by small group, mainly Central banks (reserves) and investors(wealth). The excess liquidity did not reach the masses inflation symptom was masked. The situation seemed like positive spiral. Reserves became trophies and wealth always was one. The ensuing trophy-chase, magnified by leverage, soon trounced one asset class after other. And then we hit the tipping point. Today we are bailing out the first casualties of calamity. The bailout mechanism is infusing more liquidity into the system. Like fighting cancer with cancer or fire with fire. And most likely we will be left with ashes or cancer!

Is capital destruction reasonable solution?

Capital destruction is a painful but sure-fire solution. The least we can do is to stop excess capital creation - that means bailouts will be few and far between. Further on unpegging exchange rates will help destroy some excesses. Write-offs will destroy some more. In worst case only the last person caught holding the bag will be hit. In reasonable circumstances, they will be rehabilitated. In best case - we can rewind and restart where we left off.

Questions from Barry Ritholtz

Barry Ritholtz has posed 12 questions related to current global economic situation to the readers. It has incited lot of interesting responses all must read. Here are my 2 dollars (no cents any more!) on the topic.

US Consumer spending, Housing
From first principles, US consumer spending should reduce until the time incomes become greater than interest cost, food and basic expenses. US housing loans are non-recourse loans (as I understand it) –hence jingle mail is best solution to get rid of the liability. Other loans, particularly credit card loans, might become a threat. To make an impact on the economy, this change requires strong-willed cost cutting across the population. This implies that downturn in US will be both prolonged and deep.

Can US avoid this debt trap?
There is a possibility that through structuring, financial engineering US can get out of this situation. It needs a creative solution involving legal, financial and regulatory skills put together. Following ideas can help define a solution:

• The human life is finite but firms’ life is infinite.
• All dues need not be paid back and all debt cannot be waived off
• The process of repayment of dues may be unfair – some people may choose to pay more than their share. (One example is taxes – taxes are unfair payments between individuals) In addition, some organizations will bear larger losses.

Inflation – how much, how soon, how to avoid
The excess money supply created over the past decade has to manifest itself. For long, this excess money remained contained with few resulting in a crop of billionaires, few sovereign wealth funds and overall salary hikes. After a certain passage of time, this wealth has to trickle down. This is what is happening currently. This will continue until such time the excess wealth exists. Wealth contraction can help correct inflation problem quickly. It implies currency revaluations, deep stock market corrections or pricking of asset bubbles. But this will create a lot of pain for the most important class of people politically – the influencers.

Employment – worse still to come – but totally avoidable
Employment is function of jobs available and skill availability. There is a strong mismatch here. If you don’t have skills jobs will move where skills are available. But will the low-skills jobs come back to you? US, in my humble opinion, needs a stronger manufacturing. That will take-off only if US dollar is correctly priced. We have already seen employment spurts with dollar falls.

Credit Crunch – impact on financial sector
Financial sector has itself to blame with the way it handled the excess money supply. Financial sector will go through salary rationalization, product rationalization, management control rationalization – in simple words it needs to go through Business process re-engineering. All financial companies need to talk to James Champy en masse. There is a lot of cost to be cut in these companies.

US Politics and war
The outcome of US election will have no impact on the crises. The current crises and possible solutions require unreasonably high skills of diplomacy. The potential for wars for forcible resolution of economic litigation will soon increase and pose direct threat to world peace. This will be most inconvenient for US. World economies will not take US opinion courtesy of Iraq and Afghanistan experience. It will take a real leader – a statesman – to sort out this mess without the war pains. I believe Hillary Clinton is lucky to have missed the nomination.

In Sum
We are going through one of the worst phases of economic history. No doubt we will come out of it. The only question is will we come out wiser?

A Threat to Globalisation

Let me first categorically state that I am pro-globalisation. Recently there is a careful weighing of pros and cons of globalisation. You can read Tyler Cowen, Mark Thoma and Brad Delong on this. I have a few points to add to this:
Globalisation as envisaged in theory and the practial globalisation that we are experiencing are two different animals. The first is the goal where the world economic system intends to move to. The second is represents a deviation, an intermediate stage, from the prior status (pre-globalised industrialsation) towards our goal of true globalisation. Let me hypothesize what differences we have.

• We have relatively free capital movement but we have a little restricted labour movement. The difference is in quantum and direction both.
• We have locally-wealthy-but-globally-poor pools able to kick start local economic development - but do not "export" this development through "consumption".
• We have economies that articificially create/sustain some competitive advantages longer than its "best-before-date" either through currency pegs, money market intervention or other things.
• We have created higher income polarity - possibly -keeping certain section of population in the low-income pole through a combination of slower skill-upgradation programmes or by keeping industry profitability low throguh subsidies or under the pretense of inflation targeting. Classic case oil and food - future case WATER!
• On the other pole - i.e. high income pole we have multiplying effects of first - increasing savings for similar incomes and second - increasing incomes through market mechanics. The increased savings are result of either flexi-taxes courtsey capital account convertibility or lower costs courtsey inflation control and subsidy. The increasing incomes is what accelerates the income differential - recently this has happened through asset price bubbles and otherwise through productivity gains as a result of globalisation.
• Further there is huge - amazingly huge - increase in cost of the tools of success in globalised world - parimarily higher (grad and post grad) education, health care (i.e for maintaining employability and lower cost when sick).
• Finally - globalisation, in all probability, seems to be irreversible development and will proceed towards the goal (i.e. real globlisation!).
  

Therefore, the current state has the pros and cons mixed up. The matter needs more debate and in-depth analysis. Today was just a welcome start!

Jeffrey Lacker on - The Fed Risks Moral Hazard

Jeffrey Lacker made a speech in London about Fed's bailout of Bear Sterns. The speech has amazing clarity about financial stability and central banking. It is a must read! Since I read it on the big picture - I am linking to it there.
The Big Picture Lacker: The Fed Risks Moral Hazard

Update:

Now here is the explanation and analysis of the Fed President Jeffrey Lacker's speech by Yves Smith. This is one of the reason why I am a fan of Yves Smith!

Thats why not much to add from my side. Here is the link: naked capitalism: Should the Fed Be Independent?

World without Oil.org

Let me first admit - I have a bias towards simulations and moreso towards game-based simulations.

World without Oil is one example why I have this bias. A few months ago an email exchange with a famous game designer Jane McGonigal introduced me to this game. And how soon have we come to this! The game simulated a world without oil and there is a whole lot of content on what people's responses have been to this crises. I guess that resource is now ripe to be tapped. I believe, the resource needs to be advertised and shared more.

Further I believe, the game now needs to be extended. Here are some ideas:

• First of all make the game global.
• It needs a downloadable mobile scoring app that can keep score for oil savings in 3-4 key areas. It could be - for example - everytime we go for a tank full we enter Odo reading and gas filled and cost/ charges we paid. We score higher if we travel more miles per gallon than average. We score higher for using subway etc.
• Make it include other resources as well - water, food, environment, money(considering US credit crises) etc. If we dont print an email - we get some points for saving a tree - etc.
• Hopefully we can simply enter that into a mobile phone / sms based web server and our points get updated twitter style - then we can blog about it- share it - earn identifiable and referable badges - like belts in karate. Everyone starts with Level 1 and lets say goes to Level 12 - they can display this badge on their website/blog etc.

I would love to brainstorm on this. If anyone is interested let me know!

Excess Money and its flow pattern

I am sure you people have already heard this podcast from Russ Roberts' interview of Gene Epstein on Gold Fed and money. There is something really interesting in the points he makes. Epstein talks about 2 ways US fed govt can monetize its deficit.

• First is the monetising of future revenues - pushing incomes up so that taxes go up and therefore government revenues.
• The second is creation of future debt Fed buying government notes and bonds and supplying money.
  

The interesting part is - the first goes through the economy across income classes (leading to distribution of the excess money) and therefore creates expected outcomes (inflation). The second, however, is cornered by "big money" (SWF and likes) and never goes into the system. Or actually it takes longer and and more complicated feedback loop to distribute the effects of the excess money. This leads (or led) everyone to believe - falsely - that system is still stable. The reality remains that system has just postponed its instability. Possibly, what we are seeing is the "mean reversion" after some of the effects became evident.

It would be wonderful to know what Yves Smith and others think on this one. Let me know what you think about this one.

Negative equity on cars - is it damaging?

Felix Salmon in his excellent blog at portfolio.com discusses Why negative equity in car loans is not a problem? To me the post looks at the perspective of financial institution rather than a household that is in debt.

Ideally, asset backed debt is safer for the debtors as they can sell the asset and square-off the debt at any point. In case of negative equity the debtor is in lose-lose situation. If they sell off the asset they loose a tool for income generation, while simultaneously retaining a part of the liability. This puts the household further into the debt trap. I guess Prof. Elizabeth Warren will have to downgrade her forecasts even further. This implies that consumption will suffer for longer than anticipated period.


Such situations elaborate the difference between debt and equity. When the worst strikes - equity vanishes but debt sticks on! And it creates problems. Hence I believe, the appropriate title should be Why negative equity on car loans is not a problem for banks? What say ye?

Financial crises and Recession risks

The current financial crises problem is a problem of capital destruction leading to recessionary risks.

The destruction of capital is happening at financial institution level and individual level. At the financial institutional (FI) level - where brokers who have guranteed capital (i.e. deals etc) are finding it diffficult to fund these commitments. At the individual level wherein individuals are finding it difficult to repay their debt.

The government and quasi- government institutions are targeting relief efforts at the first level. This is primarily to avoid a systemic default and thereby keep a channel open for aid to reach the second level. It is also logistically difficult to address the individuals directly. The recessionary risk, consequently, also attacks two levels - firms (broader than FIs) and individuals. The capital destruction puts a lot of strain on spending plans of firms making them costly. This also puts strain on individuals' spending plans. A slowdown in the consumer spending is catastrophic for an economy like US.

Now given the eminent slowdown in consumer spending, the FIs go into a mode of self preservation. They push the risks down the chain - through higher interest rates, higher equity contribution for same level of spending. This prevents the government aid from reaching to the individual (where it should actually flow). In fact even if now government were to push aid to individuals - institutions will nullify the effect by cornering higher share of the pocket from individuals for repayment.

This is primarily (and simplistically) why no recession-avoiding efffort will be of any use. The only beneficiaries will be share holders of financial institutions. Even those can realise the value in the longer term. In fact this aggravates the probability of recession by pressurising the marginal borrowers (who were good but just so) because of higher interest cost. The situation parallels that shown in movie Titanic where the people on rescue boats refused lower class passengers letting them drown to protect themselves. Fed has given the boat to the FIs and most likely FIs wont allow anyone (individuals) to get on board. The individuals will either drown sooner or later in the sea of debt! Here comes the iceberg - all hands to the bridge!

The best the regulator can do is to efficiently catalyze the process - i.e. lessen the pain on the down swing and push the economy back on to growth track.

Dollar headed for a decline?

Late last year I made some observations about the economic future and some of them are panning out as expected. As mentioned pressure on US dollar is considerable. Mark Thoma in Economists' view linked to Martin Feldstein's falling dollar article.

I was amused by the article and commented on one particular statement. Here it is:

"Despite the recent dollar decline, America’s trading partners still have large trade surpluses. ... So the more competitive dollar is not causing fundamental trade problems for America’s trading partners."

Whoa! While I agree that US dollar needs to correct itself to more competitive levels, the above statement is discomforting. As Alex mentioned if dollar decline was for real US trade deficit should have increased. Thats not happened because "almost" all trading partners have currencies pegged (overtly or covertly) to the dollar. Hence dollar decline takes all this basket of currencies lower.

The "almost" in above statement refers to oil! Oil is delinking from USD denomination. Other commodities are catching onto this idea. And all US trade partners need oil and commodities. As oil and key commodities move relative to dollar you will see more pain for US and trading partners, creating an incentive to stem the currency depreciation.

Now comes the main dilemma - as these countries move away from dollar peg - their reserve start losing value. At the least $ 1.5 trillion is held in reserves by major trading partners - even a percentage point here makes quite a big contribution to their GDP - so its like rock and hard place situation.

This, to my mind, will put a hell lot more downward pressure on the dollar than has ever seen before!

Though this raises US mfg competitiveness but hits Europe hard in their face. The trading partners' might face crises - and lets hope its just monetary and not a social unrest. (thats why you have something called country risk)

To my mind a stronger USD easing out is much better way out of current mess. Funnily US has an incentive/self interest to devalue the dollar - but doing so will mean push everyone into a deep downward spiral.

RD

This summarises my logic neatly. And I even got a comment reply from Organic George. Here it is:

Organic George says...
Rahul is spot on with his "delinking" comment.My company trades commodities from all over the world. We understand that the Euro is the new dollar when it comes to pricing.

I guess most of the Irory tower crowd is waiting for one of their own to write a paper to prove it.

It feels good to get a positive response. And its also in the news as Yves Smith points out! I am definitely elated!

Asset prices rising - Is trouble brewing?

There are reasons to believe that "investor demand" is driving asset prices through the roof. The "investor" crowd dynamics and the wealth they bring to this party may be acting as a self-reinforcing mechanisms at the core of this increase. If this party has gone on too far then we are in for trouble. A really big trouble.

Invested - appreciated - invested more!
This cycle has continued in almost every globalized economy. The increasing returns from the initial run of this cycle did bring in lot of new investors. The cycle, luckily, kept going enriching investor class substantially. This brought into "investment focus" various "asset classes" - like commodities, real estate, currencies etc. The cycle kept turning till about June 2007.

The last buyer - Where art thou?
Typically all investments terminate with end-user or what we can call the last buyer. Road investment look for the car /truck driver - mall investments look for the shopper - and houses look for the person wanting to stay.
The real estate sector, typically, is the first to look for last buyer. But there we had some interesting toxic concoction brewing - with easy credit flowing into the sector. As the sub-prime crises unfolded last year - the real estate sector finally started looking for the last buyer. It didn't find any.
The reality dawned upon the masses that "real estate" was priced too high for the real buyer. Based on current prices the real buyers will have to slog for many years before they can make any significant impact as "last buyers".
This is probably true for all "asset classes". Real estate (residential and commercial), stocks, bonds, non-agri commodities, derivatives across the globe are at the vortex of this hurricane. These asset classes have experienced tremendous upward force. The asset classes at the periphery - agri-commodities, are beginning to feel the force putting upward pressure on inflation - particularly food prices.

A Quick conclusion
If the hypotheses is true we are in for a particularly long painful period.
Even most powerful hurricane drops the things it throws in the air. So will prices drop - in real terms - either through inflation shooting up making this new wealth worthless or prices will deflate to a pain-point.
The most dramatic inflection point will come, if at all, within two quarters where large money will take sides on either possibilities - anticipating a killing. Let us brace for impact.
Meanwhile - we will look at what may have caused this in a little more details - and like always only hypotheses.

 

Technorati Tags: asset prices,recession,US slowdown

US indebtedness - The scope of the debt trap

Technorati Tags: US Slowdown

The long-term implications of high US personal (or family) debt may be worse than we anticipate. Various forecasts, discounting economic outputs from "back-to-normal" scenario 2-4 years in the future, may not have accounted for the problem correctly.

Debt stick on - even increases in bad times
Debt, much unlike losses, has an uncanny ability to stick - tying up future cash-flows for years, thereby constraining future consumption. Debt sticks on through job-losses, bankruptcies. In fact it increases - either in form of accumulated interest or future interest rates or loan availability. At least in India, where we do not have personal bankruptcies, this created systemic household poverty for generations. Drawing parallels from that, I believe, the time it will take to get the balance-sheets of US families to saner level of gearing might be much longer. Further more, for US, this exercise needs to be undertaken in/around recession years. Though it may not be generations, like in developing India, but it cannot be simply 2-4 years we anticipate.

Debt cause social pain
Corporate turnaround experts understand the kind of discipline and dispassionate execution it requires just to make small improvements. And it is still easier with a "company" than with household expenditures. Household cannot cut jobs and costs the way corporates can. Governments in progressive countries, like in US, tend to intervene with additional spending on social support - particularly education and healthcare. That spells problem for US.

In sum
We need to understand for median household debt what would be a good time frame get back in shape. We also need to understand the costs required to get them back in shape. The real future outcomes will lie hidden in these details.
As soon as we correctly value and discount these costs, the bearish-ness will vanish. Bulls don't like bullshit about recovery. Show us a real recovery and it's cost and we will "bear" it all the way into a bull run!

 

International Finance - A systemic weakness?

In my last post, I mentioned that wealth concentration exposed the financial systems to risks. The risk is compounded by inherent weakness of the financial system that  were not designed to accommodate. These systems are weak and plagued by complicated issues.

• Firstly, these were created as a subset of national governance systems. Consequently the flexibility of these systems are limited by the overall governance infrastructure in each nation.
• Also, unlike the capital movements, these standalone national regulatory systems are not inter-connected in any meaningful manner. Meaning any response to international financial crises will be subject to foreign-policy-like ambiguities and negotiations and, therefore, delays.
• The regulations are patchy - unable to control global momentum.

Popular, informed expert opinion is also weighing in on this shortcoming.
You can read Michael J. Panzner

in the modern global financial system, where many participants are either unregulated or are monitored by a patchwork of country or sector-specific regulatory overseers, chances are that a derivatives-related catastrophe will see a similar lack of coordination that will produce a far more devastating outcome than if it was a purely domestic affair.

It is one thing for a central banker to summon the heads of various financial firms into a room to sort out the mess at hedge fund LTCM, as the New York Federal Reserve chief reportedly did in 1998. Despite the fact that the Fed had limited statutory authority in the matter, it is not hard to see why none of those who were asked to attend turned down the "invitation."

However, if a derivatives time-bomb is set off by the failure of a large London-based hedge fund, will a banker in the Cayman Islands, an investor in Japan, an insurer in Germany, and a regulator in France feel similarly inclined to respond, or even to take the lead? That is assuming, of course, that those affected even understand what is going on or why it may be relevant to their own interests. Overall, there appears to be little, if any strategy in place for dealing with cross-border financial upheaval.

And Marshall Jevons linking to Davos

At the World Economic Forum in Davos, Mr Knight said the “major challenge” for regulators was the “the Balkanisation of regulation – fragmented across market segments, across national jurisdictions and yet we want to have a global financial system”.

And Dani Rodrick

How do you deal with capital flows when they are so prone to boom-and-bust cycles and generate (roughly once a decade) financial crashes with painful economic consequences?  The mainstream answer is that you do not regulate capital flows directly--through capital controls such as financial transactions taxes or deposit requirements--but you rely instead on prudential regulation of financial intermediaries. The best way to avoid crashes, this argument goes, is not to "throw sand in the wheels of international finance" (as Tobin famously put it), but to make sure that intermediaries do not take excessive risks.

In Sum...
A system so designed will be prone to momentum effects. The momentum is aggravated by wealth concentration. International finance needs to evolve beyond the free capital movement to counter this risk. A system of seamless regulatory response needs to be developed. Hopefully the thinkers at Davos will lay the first stone of a potent globalized interlinked system.

Market behaviour - Is Wealth Concentration a risk?

The world markets have taken a beating for a few trading sessions. We are all confounded by the speed, breadth and uniformity in the correction. As usual, yours truly already expressed it long ago (!) with loads of hypotheses and un-correlated facts. So lets start looking at one out of those - my favourite - Wealth Concentration!

Wealth concentration has increased
The past two decades has created lot of substantially wealthy and globally connected individuals/families. Their numbers were always increasing, but they may have crossed a certain potency threshold in terms of numbers and size of wealth available with each.

And they are connected - creating a super machine!

Thanks to information age, these individuals are now better connected globally. This new found strength enables investors to create companies, investment vehicles, repatriate profits and in general take more risks, faster. This is, in part, the source of complex corporate structure and ever-more complicated investment products.

Financial System, Infrastructure is old

Financial sector infrastructure, designed along national lines in a non-globalized era, is not able to grasp the increasing complexities of the newly globalized investment playground. The regulators still have to develop a "court sense". The current systems cannot control the high velocity international money movements generated by these investors.

The investors themselves don't know the risks

While these investors are (Wall) street smart, they are not the smartest! They are faced with unfathomable complexity - posed by globalization of products, services, capital and concurrent nationalisation of labour, consumption, markets (since driven by national regulators with nation-based systems).

We have just realised US housing markets, Australian banks, Chinese regulators and European central bankers are lot closer than we could have anticipated.

In Sum..

Globalisation has brought forth new set of complexities that are still difficult to gauge. Further wealth concentration have created high mass (volume) - high velocity monetary movements accentuated by innovative structures that can compromise the current financial systems. High velocity, high volume money flow can create "Shock-and-Awe" impact on many asset markets. Consequently, risk has increased many-fold.

The layout of poverty

I mentioned in a previous post why certain people stay poor. In the meanwhile, there have been lots of articles on poverty I have highlighted those below as well. Yet, I don't think enough work has been done to classify and understand different types of poverty. I believe the efforts in classification will help devise better solutions to the problem. I do not claim to be an authority on the subject but I am trying my best to think through the issue.

A different poverty - volatility induced poverty
I have highlighted two broad levels of classification i.e. transient and structural. Under structural poverty, we have a type off poverty that arises out of high net-income volatility combined with adequate average income. This kind of poverty is induced by volatility -in gross incomes and in expenses - both on unpredictable time scale (un-seasonal). Day-laborers, artisans etc suffer this kind of poverty more often. Farmers dependant of rain-water also suffer this kind of poverty. Dean Karlan and Sendhil Mullainathan have explored this here.

The unpredictability of expenses leads to in-debtedness. The flow of credit to this sector comes at high costs hence in-debtedness tends to be self-reinforcing - particularly with higher expense volatility. Hence cash-flows are directed towards life-sustenance rather than investments. In other words - expenses for healing, medicine, food, essential tools etc tend to be favored against education, savings etc. Such people find themselves caught in a structural poverty. I suspect healthcare is the most critical expense of the rest. It reduces income and increases expense at the same time! Also healthcare costs tend to be higher as nutrition is not proper. For them snakes-and-ladder game of scaling the income pyramid seems hopelessly crawling with snakes of healthcare costs denying them the ladders of savings and education.

Framework for solution
A first principles approach suggests that anything that reduces volatility (both income or expense) will be of great benefit. We can also easily conclude that smoothening incomes comes first, before smoothening expense is important. Next, it is absolutely essential to reduce expenses - particularly healthcare, food (proper nutrition) and education (for future). Yet most solutions to their problems tend to addressing volume not volatility. These solutions are likely to fail unless they add an element that suppresses volatility.

Income diversification
The growth in rural incomes in India has come from income stream diversification. Farmers have used tractors, pick-ups for transportation thereby leading to stable earnings and alongwith highly volatile agri-income. This resultant reduction in income volatility has set them on path of prosperity.


Expense smoothening Credit?
Simply throwing credit at this kind of poverty problem is not a solution. Credit repayments impose a smooth addition on their volatile expenses making their situation worse. (Hence farmer suicides in India). Indian rural banking is abound with stories of farmers wanting to pay two months installments together when they have money - and not being able to pay even one months installment in distress times. If their loan repayment schedule were to match the income generation schedule they will have much less to worry about.


In sum
Poverty reducing initiatives need to appreciate the differences in poverty. Volatility induced poverty can be tackled by addressing income volatility first, then expense volatility and then quantum of income and expenses. Expenses on healthcare, food and education are critical and need to be reduced.

Must read links:
Innovation for Poverty Action
MIT poverty action lab -
Is microfinance too rigid?
Marshall Jevons highlights course on poverty and some other links
Poverty in pictures -
Does poverty kill PSD blog links to some important conclusions

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
3. Some Readings - Stephen Gordon puts dollar in relation to oil.

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!

Why certain people stay poor?

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

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

Transient Poverty Vs Structural Poverty

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

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

Dynamics of Poverty - Scaling up the Income pyramid

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

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

The biggest hurdle - poverty!

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

Springboard for the poor - education and micro-finance!

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

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

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

And the safety net...

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

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

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

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

In sum...

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