MULE VARIATIONS

Word of the Day: Spin-in

2008-12-02T10:56:00.001Z

Summary:
Spin-ins are startups founded by people from a more established parent company. They usually work to develop products and technology aligned with the goals of the mothership, but keep track of everything (including venture capital raised) on a separate balance sheet. If certain technical milestones are hit, the spin-in is then absorbed back into the company, which it can then ride to profitability or leverage to raise further rounds. Cisco Systems has long been a major proponent of this strategy, and it’s clearly worked for them.

Notes:
But there’s also another way to do it. A spin-in doesn’t have to be a simple technology play. Instead, the parent company works with investors (since it has the clout) and the management team to build a real company with real revenues of its own. That way, if it gets gobbled back up after two or three years, it can be immediately accretive to the parent company. This is an attractive option for bigger companies looking to balance their investment in innovation against dilution of corporate earnings. Not to mention that it will help both venture firms and management teams address the issue of liquidity in a world where IPOs, mergers and acquisitions are becoming few and far between.

Quote of the Day

2008-09-23T20:29:00.001+01:00

"Buffett once told me there are three 'I's in every cycle. The 'innovator,' that's the first 'I.' After the innovator comes the 'imitator.' And after the imitator in the cycle comes the idiot." -Theodore Forstmann, quoting Warren Buffett

King's men must put themselves together again - FT.com

2008-09-20T01:37:00.004+01:00

Summary:
John Gapper explains why banks and insurance companies got addicted to complexity, through the practice of dicing up cashflows and risk. Origin of practice traces back to Black, Scholes and Merton, 1973. The appeal to financial institutions derives from four reasons: it skews the odds in favour of those who hold the technology; structured finance has been a huge money-spinner; complexity produced yield; and, most perilously, structured finance gave banks and others more chances to take on "tail risk." The future of finance and regulations now looks very uncertain. The crisis has exposed gaping holes in the US regulatory structure. The current system is outdated (devices in the 1930s). The biggest regulatory gap involves over-the-counter (OTC) derivatives. (Published: 19/09/08)

Notes:

worst financial crisis in US markets since 1929

the investment banks and insurers that caused the problem did so by taking mortgages and first packaging and repackaging them into bizarrely complex securities, and then topping them off with derivatives

e.g. AIG had been writing credit default swaps (CDS)

a form of derivative allowing one financial institution to pass the risk of a bond defaulting on to another

sold them to banks wanting to protect themselves against defaults on collateralised debt obligations (CDOs), built from sub-prime mortgages

when these CDS plunged in value because the market stopped trusting what they were worth, AIG came close to bankruptcy and was bailed out by the US Treasury

dicing up of cashflows and risk

has been a growing part of markets since Fischer Black, Myron Scholes and Robert Merton, three US academics, devised a way to value options in 1973

over the ensuing three decades, banks and insurance companies got addicted to complexity
four reasons

it skews the odds in favour of those who hold the technology

rading in markets is essentially a zero sum game, in which you have an equal chance of winning or losing
but: banks have been able to shift the odds by using computer models that others lack, to trade in volatility, for example

structured finance has been a huge money-spinner

i.e. the practice of using the cashflows from stocks and bonds to create other securities
every institution involved in creating and selling structured bonds, from banks to ratings agencies to insurance companies, gained a big fee every time such a bond was issued

complexity produced yield

in an era of low interest rates, pension funds and insurance companies found it hard to earn much money from cash

so any instrument that appeared safe but paid a higher interest rate than Treasury bonds, which mortgage-backed securities did, found ready buyers

the problem was that these securities paid a higher yield than other triple A rated paper precisely because they were complex

investors got paid more to hold them because they were so difficult to understand

structured finance gave banks and others more chances to take on "tail risk"

this is an insurance-like trading strategy:

one institution writes swaps or options that provide it with regular payments in exchange for taking another's risk of default

in most cases, this produces profits, but occasionally it is disastrous

was AIG's downfall

huge uncertainty over the future of finance and of regulation

risks of financial institutions devoting themselves to the underwriting and sale of complex securities have become abundantly clear

complexity is a good way to make money, but it also causes bank runs

crisis has exposed gaping holes in the US regulatory structure

largely devised in the 1930s and is outdated

the supervision of banks and investment banks is done by different bodies while insurers are regulated by US states

biggest regulatory gap involves over-the-counter (OTC) derivatives

the contracts traded among banks and insurance companies that lie at the heart of the financial crisis
not regulated at all in the US since they were excluded by the federal government from Commodities Futures Trading Commission oversight eight years ago

Quote of the Day

2008-09-20T01:12:00.000+01:00

"Allowing investment banks to be leveraged to the tune of 30 to 1 is the equivalent of playing Russian roulette with five of the six chambers of the gun loaded. If one adds the off-balance-sheet liabilities to this leverage, you might as well fill the sixth chamber with a bullet and pull the trigger." - Michael Lewitt

Why global capitalism needs global rules - FT.com

2008-09-19T23:12:00.002+01:00

Summary:
Philip Stevens argues that once the financial storm has settled, politicians will need to consider what the crisis tells us about the nature of the world we live in. One thing it revealed is that governments have been left with responsibility without power. The grip of individual states on the levers of economic management decisively weakened, but the loss of control has not been matched by any corresponding diminution of responsibility. Tensions like this, resulting from globalization, are not restricted to just the economy. Voters want the ease of movement across national borders that comes with cheap travel, but they also want governments to control immigration and cross-border crime. They want to buy cheap electronics from China, but they blame politicians when global supply chains threaten job security at home. If the politicians want the liberal market system to work, they will have to make multilateralism work. We need global governance, and a set of credible international rules. (Published: 18/09/08)

Notes:

once the storm abates the task for politicians will be to ask some bigger questions

Putting aside the technicalities of collateralised debt obligations, capital ratios and the rest, what does the crisis tell us about the nature of the world in which we now live?

growing tension between global integration and a shortage of credible international governance

governments have been left with responsibility without power

tensions as a result of globalization

grip of individual states on the levers of economic management decisively weakened

few political leaders outside the US were even vaguely aware of the degree to which their own banking systems were held hostage to the subprime loans made to American homeowners

but: loss of control has not been matched by any corresponding diminution of responsibility

voters still hold their own politicians to account for the insecurities that flow from interdependence

blaming someone else offers insufficient answer to the homeowners trapped in negative equity or to depositors or creditors in a failing bank

voters want the ease of movement across national borders that comes with cheap travel

but they also want governments to control immigration and cross-border crime

voters want to buy cheap electronics from China

but they blame politicians when global supply chains threaten job security at home

tensions are not susceptible to neat solutions

but: all point in the same direction

interdependence is no longer an abstract noun
governments need to find ways to reclaim some of the sovereignty lost to globalisation

means more global governance: credible international rules

consequences of financial shocks

capitalism will survive
but: risk of a retreat to economic nationalism

if the politicians want the liberal market system to work, they will have to make multilateralism work

Word of the Day: The Pecora Commission

2008-09-19T01:40:00.003+01:00

Commission established by the U.S. Senate to study the causes of the crash of 1929. The hearings lasted for two years (1932 - 1934) and resulted in the U.S. Congress passing the Glass-Steagall Act in 1933, which mandated a separation between commercial banks, which take deposits and extend loans, and investment banks, which underwrite, issue, and distribute stocks, bonds, and other securities.

What Should Government Guarantee? - EconLog

2008-09-19T00:47:00.002+01:00

Summary:
Arnold Kling says that financial markets are inherently unstable because they are based on trust and inherently lacking transparency. In fact, trust and reputation replace transparency in financial intermediation; if it were perfectly transparent, there would be no need for it, one could do its business oneself. Deposit insurance helps facilitate trust. It removes all motivation for the consumer to worry about the bank's risk management. It is, however, up to the insurer (FDIC) to worry. Any system can be gamed eventually, so it's a challenge for the regulators to stay one step ahead of the banks. Bear Stearns, Freddie and Fannie, Lehman, and AIG were not FDIC-insured banks, yet there creditors are being rescued. Ad hoc-ness of Fed and Treasury causing some resentment. Regulators should try to anticipate crises and prevent them. But almost by definition, the crises that do occur will be ones that they did not anticipate, and the responses will have to be somewhat ad hoc. (Published: 16/09/08)

Notes:

financial markets are inherently unstable

because financial intermediation inherently replaces transparency with trust

if my bank were perfectly transparent, then I would know everything about its loans

including the underlying risks of the real estate developers, small businesses, and individuals to whom it is lending money
in that case, I would not need a bank,I could just make those loans myself.

so if you assume perfect transparency, you assume away the need for financial intermediation

you have to assume the opposite of perfect transparency, highly imperfect transparency

with reputation and trust serving as substitutes

deposit insurance helps facilitate trust

private insurance pool might work, but people trust government-provided deposit insurance even more

the consumer loses all motivation for worrying about the bank's risk management
by contrast: the insurer has to worry a lot

in the U.S., the FDIC has been getting better over the years, but you can never get complacent

any system can be gamed eventually, so it's a challenge for the regulators to stay one step ahead of the banks

Bear Stearns, Freddie and Fannie, Lehman, and AIG

institutions that are not FDIC-insured banks

question arises about whether some of their creditors ought to be protected by the government

note: financial blow-up has not come from private hedge funds

highly leveraged and unregulated business

having some regulated, insured institutions, like the banks, is good

we can or should not try to regulate everyone

regulators should try to anticipate crises and prevent them

but almost by definition, the crises that do occur will be ones that they did not anticipate, and the responses will have to be somewhat ad hoc

Quote of the Day

2008-09-18T18:46:00.001+01:00

“The rule is that financial operations do not lend themselves to innovation. What is recurrently so described and celebrated is, without exception, a small variation on an established design, one that owes it distinctive character to the aforementioned brevity of the financial memory. The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version. All financial innovation involves, in one form or another, the creation of debt secured in greater or lesser adequacy by real assets.” - J.K. Galbraith, "A Short History of Financial Euphoria"

The K-T Boundary - The Epicurean Dealmaker

2008-09-18T15:13:00.007+01:00

Summary:
Epicurean Dealmaker elaborates on John Gapper's FT comment about how the investment banking industry got to this stage. The problematic component of i-banking is the capital markets business. Maintaining a credible and effective capital markets operation has always been an expensive proposition, compared to the advisory side of the business. When fixed commissions were eliminated, the huge capital markets business of a typical investment bank could no longer support itself financially. Started using a much larger amount of money trading for their own account, on a proprietary basis. As a result of US's ballooning trade deficit, and low interest rates under Greenspan, capital markets operations became the dominant business line of all major investment banks over the past couple of decades. Compensation systems at investment banks could not deal with this development. Imbalances built up, risk and return became misaligned. But capital markets business has always been an integral part of an investment bank's advisory business. No better definition of market-based advice, and no better example of the type of added value an integrated investment bank can bring to its client. Pure advisory boutiques cannot deliver this sort of advice, because they do not have the capital markets arms to deliver it. Catch-22. capital markets capabilities cannot pay for themselves without proprietary trading operations. (Published: 16/09/08)

Notes:

how did the investment banking industry get itself into this pickle, and where does it go from here?
John Gapper, "May Day": the elimination of fixed commissions for stock trades in 1975

launched the industry onto the path of relentless growth in capital, people and profits

capital markets business

securities sales and trading activities
has always been a key component of the investment banking model
but: maintaining a credible and effective capital markets operation has always been an expensive proposition

requires a lot of people, information technology, dedicated real estate, and other doodads that cost a lot of money to install and a lot of money to maintain
unlike the advisory side of the business

your typical M&A banker requires very little in the way of infrastructure

May Day: when fixed commissions were eliminated, the huge capital markets business of a typical investment bank could no longer support itself financially

banks needed to find another use for all that investment in infrastructure
Salomon Brothers:

first to make the transition from using relatively small amounts of in-house capital to support underwriting and market-making activities to using a much larger amount of money trading for their own account, on a proprietary basis

because they were "in the flow" and saw the securities markets from the privileged position of market makers, "prop desks" at investment banks started making money hand over fist

i.e. they started acting like hedge funds

ballooning federal deficits of the Reagan years

resulted in huge trading volumes in fixed income securities and related derivatives

led to an explosion in equity trading

accompanied the internet boom

Alan Greenspan

plying the financial markets with liquidity "like a whorehouse madam plies shore-leave sailors with booze"

result: capital markets operations became the dominant business line of all major investment banks over the past couple of decades

trouble in paradise

problems caused by trying to incorporate a volatile principal-oriented business like proprietary trading into an organization that was otherwise focused on agency business like M&A advisory, capital raising, and underwriting

when the prop traders made a bundle betting for the firm, they brought home annual bonuses that struck even the highly overcompensated bankers in M&A and corporate finance as nothing short of obscene
when their trades blew up in their faces everybody else at the firm suffered big cuts in compensation regardless of how good their individual years had been

compensation systems at investment banks could not deal with this development

proprietary traders, CDO structurers, and derivatives specialists began taking and holding positions with longer and longer risk tails

but still got measured and paid based on systems designed to measure the annual production of a banker conducting traditional agency business, like M&A or equity underwriting

imbalances built up, risk and return became misaligned, "and various pieces of shit began hitting various fans"
paying traders, corporate financiers, and M&A advisors with long-vesting restricted stock did create some sort of alignment with the firm's and shareholders' interests

but: it was too blunt an instrument to contain and control the stresses building up in the new hybrid hedge fund-investment banking model

why didn't the investment banks abandon the securities sales and trading business when it became unprofitable after May 1975? Three reasons:

commissions did not vanish in one fell swoop after May 1, 1975

competition was introduced, and commissions shrank gradually over a number of years
investment banks did not necessarily see the writing on the wall for quite some time

by the time they realized that pure agency capital markets was now and forever a loss leader business, it was in many respects too late to change

capital markets businesses were always large

controlling roughly half the resources of a typical investment bank and sometimes more
very difficult to kill a business line with so much human, psychological, and political capital committed to it

plus sharp-elbowed leaders who are committed to fight for it

most importantly: the capital markets business has always been an integral part of an investment bank's advisory business

obvious for corporate finance activities like selling bonds to raise capital for a railroad or underwriting an initial public stock offering for a technology company

raising capital for corporate clients has always been an extremely important business line for investment banks

was really the only business investment banks conducted for many years after their separation from commercial banks in the 1930s after Glass-Steagall

until the emergence of a new business in the late 1970s which came to be known as mergers and acquisitions advisory

"client bankers" to Ford Motor Company, CSX Corporation, and Netscape did and do rely heavily on their buddies on the capital markets desk to gauge investor demand, structure attractive security offerings, and help sell their clients' securities to new investors

M&A bankers rely heavily and often on their capital markets colleagues, too

in the case of corporate clients, there is all sorts of useful intelligence an M&A banker can glean from his capital markets partners

bears directly on the approach, feasibility, and potential price of doing a deal

publicly traded corporations want to know how the markets will react to the announcement of a transaction

CEOs want to know who are the top 20 critical investors they should talk to to explain the rationale for selling a division or buying their biggest competitor

there is no better definition of market-based advice, and no better example of the type of added value an integrated investment bank can bring to its client

pure advisory boutiques cannot deliver this sort of advice, because they do not have the capital markets arms to deliver it

capital markets operations of any consequence are too expensive to support solely with the revenues a successful M&A practice brings in

Catch-22:

advisory practices cannot compete with fully integrated investment banks in all situations without capital markets capabilities
but: capital markets capabilities cannot pay for themselves without proprietary trading operations

we seem to be stuck with the integrated i-bank model, whether we like it or not

Roubini Misses the Boat on Regulation - Mish's blog

2008-09-18T15:13:00.002+01:00

Summary:
Mike Shedlock argues that the cause of the financial crisis is not lack of regulation, as argued by by Roubini et al., but government intervention in free markets and fractional reserve banking. Government promoted an ownership society mentality and established HUD, FHA, Fannie, Freddie, and hundreds of affordable housing programs. But government promotion of housing put an artificial bid on housing that a free market never would have, raising the price of housing. In addition, the simple reason Moody's, Fitch, and the S&P do such a miserably poor job is government sponsorship. If Moody's, Fitch, and the S&P had to survive based on how good their ratings were instead of a model where the SEC says they have to rate everything, the problem with rating agencies would be cleared up overnight. The Fed is part of the problem too. The creation of the Fed was a blatant intrusion on the free market in the first place, but the Greenspan Fed's allowance of sweeps was economically equivalent to reducing the reserve-requirement ratio to zero for banks with sweep programs. Ultimately, the problems can be blamed on fractional reserve lending and the ability to create money (credit really) at will by borrowing it into existence. (Published: 10/09/08)

Notes:

Roubini correct about US becoming United Socialist State Republic of America

but: wrong about what went wrong and who is to blame

e.g. the "fanatically and ideologically zealot free-market laissez-fair administration"
e.g. "ideologue regulators who literally held a chain saw at a public event to smash unnecessary regulations"

true cause: government meddling in the free markets

there does not need to be regulation of Fannie Mae or Freddie Mac because neither should have existed in the first place

it was government meddling in the free markets that created Fannie and Freddie

government meddling in the free market will always blow up
no matter how many government regulators one threw at Fannie or Freddie, both were going to blow up sooner or later

ownership society mentality

the HUD, FHA, Fannie, Freddie, and hundreds of affordable housing programs all came out of "ownership society" type thinking

sponsorship of such entities creates a problem that regulators can never get right

the bureaucratic mission inevitably takes on a life of its own

government promotion of housing put an artificial bid on housing that a free market never would have

that artificial bid had the exact opposite effect of what was intended
every government sponsored affordable housing program raised the price of housing

regulation could not fix that basic flaw and eventually the model blew up with ever increasing efforts to keep the ponzi scheme operative

Ponzi schemes always blow up as soon as but not before the pool of greater fools runs out

solution to all the above problems is simple

eliminate government sponsorship of housing

i.e. abolish the FHA, the HUD, Fannie Mae, Freddie Mac, Ginnie Mae, and every silly program on the books to create affordable housing

government sponsorship of rating agencies

many blame lack of regulation for the incredible fiasco at the rating agencies

the simple reason Moody's, Fitch, and the S&P do such a miserably poor job is government sponsorship

solution is easy: End government (SEC) sponsorship of the big three

far past Time To Break Up The Credit Rating Cartel

if Moody's, Fitch, and the S&P had to survive based on how good their ratings were instead of a model where the SEC says they have to rate everything, the problem with rating agencies would be cleared up overnight

no amount of regulation can possibly cure flaws that arise out of government sponsorship

Fed is the problem

creation of the Fed was a blatant intrusion on the free market
Greenspan Fed, ever wanting to "help" banks make more profits, instituted a policy of sweeps

note on sweeps

retail deposit sweep programs increase bank earnings by reducing the amount of noninterest bearing deposits that banks hold at Federal Reserve banks

a bank's transaction deposits beyond approximately the first $50 million are subject to a 10 percent reserve requirement ratio, which is satisfied by holding vault cash or noninterest-bearing deposits at Federal Reserve banks

in contrast, savings deposits are subject to a zero percent ratio.

retail deposit sweep programs take advantage of this difference by "sweeping" transaction deposits into savings deposits

that is, relabeling transaction deposits as savings deposits for reserve-requirement purposes.

this is economically equivalent to reducing the reserve-requirement ratio to zero for banks with sweep programs

effectively, the end of binding statutory reserve requirements

every penny has been swept out and lent out (10 times over) thanks to the Greenspan Fed and fractional reserve lending

what cannot be paid back will be defaulted on

securitization problems

in a free market with a sound currency, the originate to securitize model, aided and abetted by the rating agencies, would never have occurred in the first place

None of the problems can be blamed on "free-market laissez-faire policies"

every one of them can be blamed on fractional reserve lending and the ability to create money (credit really) at will by borrowing it into existence

After 73 years: the last gasp of the broker-dealer - FT.com

2008-09-16T17:11:00.004+01:00

Summary:
According to John Gapper, recent events mark the end of 73 years of full-service investment banking, i.e. buying and selling shares and bonds for customers as well as advising companies and trading with its own capital. In order to generate the revenues needed to match larger institutions, banks such as Lehman scurried into risk-taking that eventually sunk them. Two milestones in the history of IBs: 1933 Glass-Steagall Act (enforced the separation of banks and investment banks) and May 1 1975 (fixed commissions for trading securities were abolished) Despite the latter setting off a squeeze on broking revenues, IBs prospered for the next 30 years, mainly through gambling with their own (and later others') capital. But the gambles were potentially life-threatening: IBs did not have sufficient capital to cope with a severe setback in the housing market or markets generally. According to Gapper, there are two options for Goldman and Morgan Stanley: sell out to a large commercial bank with a big capital and deposit base, or scale back heavily, or abandon, their broker-dealer arms and become more like big hedge funds or private equity funds. (Published: 15/09/08)

Notes:

Goldman Sachs and Morgan Stanley last hold-outs among Wall Street's independent investment banks

future also in doubt

full-service investment bank is doomed

i.e. buying and selling shares and bonds for customers as well as advising companies and trading with its own capital
in order to generate the revenues needed to match larger institutions, banks such as Lehman scurried into risk-taking that eventually sunk them.

investment banks in future will be smaller, specialist institutions

like the merchants of old

history

1933 Glass-Steagall Act

enforced the separation of banks and investment banks
e.g. Morgan Stanley founded in 1935

May 1 1975

fixed commissions for trading securities were abolished

set off a squeeze on broking revenues

abolition of the system that has enriched them in good times and pulled many of them through during long periods of market slack,

investment banks had relied on these commissions during the financial doldrums following the 1973 oil crisis.

following 1975, investment banks went on to enjoy 30 years of prosperity

grew rapidly, taking on thousands of employees and expanding around the world
but: under the surface they were ratcheting up their risk-taking

was increasingly hard to sustain themselves by selling securities

the traditional core of their business -

because commissions had shrunk to fractions of a percentage point per trade

so they were forced to look elsewhere for their profits

started to gamble more with their own (and later others') capital

Salomon Brothers pioneered the idea of having a proprietary trading desk that bet its own money on movements in markets

at the same time as the bank bought and sold securities on behalf of its customers

banks insisted that their safeguards to stop inside information from their customers leaking to their proprietary traders were strong

but there was no doubt that being "in the flow" gave investment banks' trading desks an edge

also expanded into the underwriting and selling of complex financial securities

e.g collateralised debt obligations
were aided by the Federal Reserve's decision to cut US interest rates sharply after September 11 2001

set off a boom in housing and in mortgage-related securities

catch: investment banks were taking what turned out to be life-threatening gambles

did not have sufficient capital to cope with a severe setback in the housing market or markets generally

when it occurred, three (so far) of the five biggest banks ended up short of capital and confidence

a bank can be highly skilled in risk management and trading, as Goldman has proved

but: a single big mistake may spark a fatal spiral

two options for Goldman and Morgan Stanley

sell out to a large commercial bank with a big capital and deposit base

e.g. Merril
could provide them with sufficient backing for their capital markets divisions, which can be revenue and profit powerhouses in good times.

scale back heavily, or abandon, their broker-dealer arms and become more like big hedge funds or private equity funds

would involve a switch from sell side to buy side, where most money is now made
in exchange for becoming much smaller, they might retain their high margins

Dangerous Economic Territory - The Globalist

2008-09-13T21:51:00.004+01:00

Summary:
David Smick ("The World is Curved") thinks that the politicization of globalization is putting a quarter of century of amazing prosperity and global poverty reduction at risk, potentially sending the US back to Seventies-like period of economic devastation. Globalization, free trade and liberalized financial markets have been a bipartisan success story (Reagan and Clinton). Was a tool to break away from the economically suffocating 70s. But this period of political consensus is at risk of coming to an end. Part of the financial market turbulence, and dollar weakness, in recent times stems not only from subprime-related credit uncertainties, but also from uncertainties about the direction of U.S. politics. Growing belief that the financial world, politically speaking, has entered uncharted political waters. Today’s voters look at globalization’s downsides with not enough appreciation of its tremendous upsides, and the political community is at risk of creating the conditions for a global financial disaster. Urgent need to expand the base of financial capital ownership and reduced the wealth gap. (Published: 09/09/08)

Notes:

last quarter century

relatively seamless, bipartisan political consensus in favor of free trade and liberalized financial markets

globalization neither a Republican nor Democratic phenomenon

not much difference in economic policymaking between Bill Clinton and Ronald Reagan
both Reagan and Clinton grabbed on to globalization as a flawed yet essential tool to break away from the economically suffocating 1970s

quarter-century of amazing prosperity and global poverty reduction

period of policy consensus is at risk of coming to an end

both political parties in the United States backing away from the pro-globalization policies championed by Bill Clinton
part of the financial market turbulence, and dollar weakness, in recent times stems not only from subprime-related credit uncertainties

also from the uncertainties about the direction of U.S. politics

US politicians engaging in populist attacks on capital formation, entrepreneurial initiative and wealth creation

problem with politicizing globalization

world financial markets until now have set the price of U.S. financial assets, including the price of stocks

at relatively high values
based on the assumption that the Clinton-Reagan model of free trade, liberalized capital markets and long-term robust growth will remain largely intact

new political universe emerging: less patience for freely liberalized trade

questions of the hour are:

How will markets in coming years reprice the changing nature of the political environment?
Will an aggressive downward repricing of financial assets happen in a climate of panic?

threat for financial markets of unwise political change is very real

growing belief that the financial world, politically speaking, has entered uncharted political waters

today’s voters look at globalization’s downsides with not enough appreciation of its tremendous upsides

helped U.S. economy pull itself out of the 1970s period of economic heartache
1980s and 1990s produced a renaissance of American confidence and optimism about the future
level of global wealth creation and poverty reduction that would have seemed far-fetched, verging on pure fantasy, in the late 1970s

return to the seventies?

economically devastating period

politicians flirting with protectionist, class warfare policies that would unravel economic success that a broad international coalition worked desperately to achieve

in rejecting the free-trade, liberalized financial market agenda of Bill Clinton, political community is at risk of creating the conditions for a global financial disaster

first we’ll see a steady loss of global investor confidence in the US
followed by shrinking of liquidity and credit availability
then a protracted period of stagnant economic growth far below potential
weaker growth will beget even more protectionist, class warfare rhetoric and policy
will further shrink confidence in the US throughout the international system

need to expand the base of the investor class

future of globalization is politically unpredictable fundamentally because the base of financial capital ownership is so small
wealth gap is widening

as a result, globalization’s political base of support remains tenuous at best

Ownership vs markets - Stumbling and Mumbling

2008-09-13T19:29:00.005+01:00

Summary:
Chris Dillow argues that the traditional capitalist ownership structure is responsible for the credit crunch, not free markets as others have argued. Banks lost money on mortgage derivatives because of principal-agent failings, i.e. bosses (principals) don't know what the traders (agents) are doing. Traders have an incentive to take risk: life-changing bonus; gains exceeds benefits of prudence. Also, little pressure upon banks' executives to be prudent because when shareholding is dispersed, no individual shareholder has much incentive to rein in management. There has been more "bad" financial innovation that good ones. With good financial innovation it is very difficult for anyone to own its beneficial effects, it's a public good. Gains from “bad” financial innovation are more appropriable, hence we get more of it. Finally, banks' reluctance to lend to each other stems from the inability of management of such complex organisations to know everything. Banks should become more like venture capitalists, i.e. using an internal market, allocating capital to semi-independent divisions, which put in their own capital. (Published: 12/09/08)

Notes:

Samuel Brittan and Anatole Kaletsky: credit crunch is undermining the case for free market capitalism

but: crucial distinction between free markets and traditional capitalist ownership structures

credit crunch does more to highlight the failing of the latter than of free markets

Four reasons

Banks lost money on mortgage derivatives because of principal-agent failings

principals (banks’ bosses) didn’t understand what agents (traders) were doing,
traders had incentives to take on excessive risk

because the gains from doing so - a life-changing bonus - exceeded the benefits of prudence.

Banks have been reluctant to lend to each other

not so much because each bank fears its counterparty will not repay the money
but: because they fear they’ll need the money themselves

because banks just don’t know what sort of losses they are sitting on
it’s impossible for managers of such complex organizations to know everything

Banks are under-capitalized because chief executives have traditionally had incentives to maximize earnings by using leverage

pressure upon them to be more prudent has been absent partly

because when shareholding is dispersed, no individual shareholder has much incentive to rein in management
[note: is shareholding too dispersed? 70% of all stock in America is now owned by financial institutions; as John Bogle said, in relation to Enron-type scandals, "the problem is that shareholders aren't owners anymore, they're agents of owners, and they do not actively engage in corporate governance, making sure that companies are managed for their shareholders etc.; instead they are more actively engaged in trading pieces of paper back and forth and they don't seem to care much about anything except whether the CEO meets the earnings expectations he's promised or doesn't; sometimes these expectations are met by fair means, but sometimes by foul ones" - like Dillow, Bogle also focuses on the ownership, but he blames it on the traditional owners capitalism having been replaced by managers capitalism]

Good financial innovation has been lacking

because it’s very difficult for anyone to own its beneficial effects;

it’s a public good

gains from “bad” financial innovation are more appropriable.

so we get more of it
e.g. overly complex mortgage derivatives

solution

not nationalization

bad way of solving principal agent problems

perhaps instead, banks should make more use of internal markets

i.e. should become more like venture capitalists

allocating capital to semi-independent divisions, which put in their own capital
would restrain traders’ risk-taking

as they can not so easily hide behind the fact that losses are spread over the whole firm

would reduce the problem of asymmetric information between banks’ senior managers and trading desks

as there’s a simpler test of how well the latter do: whether they can hand over enough hard cash to cover their required returns

Falling Down - The New Republic

2008-09-12T00:18:00.002+01:00

Summary:
Jospeh Stiglitz blames the current crisis are the financial system's latest innovations, fee structures that were often far from transparent. Imperfections of information (resulting from the non-transparency) led to imperfections in competition. Allowed banks to generate enormous profits and private rewards that were not commensurate with social benefits. Worst problems (e.g. subprime mortgage market) occurred when non-transparent fee structures interacted with incentives for excessive risk-taking. Too much effort has been devoted to increasing profits, creating financial products that enhanced risk, and not enough to increasing real wealth. Financial markets frequently fail to do what they are supposed to do in allocating capital and managing risk. Painful lesson from the 1930s and today is that the invisible hand often seems invisible because it's not there. (Published: 10/09/08)

Notes:

Adam Smith: the market leads the economy, as if by an invisible hand, to economic efficiency and societal wellbeing

Great Depression

1 in 4 Americans out of a job
Smith's self-regulating markets a fallacy?

some economists: in the long run the market's restorative forces will take hold, and we will recover

Keynes's retort: In the long run, we are all dead.

i.e. could not afford to wait

today, 75 years later: another shock

unofficially in recession
more than half year since jobs were created

"If the Great Depression undermined our confidence in macroeconomics (the ability to maintain full employment, price stability, and sustained growth), it is our confidence in microeconomics (the ability of markets and firms to allocate labor and capital efficiently) that is now being destroyed."

resources were misallocated and risks were mismanaged so severely that the private sector had to go running to the government for help, lest the entire system melt down
cumulative gap between what our economy could have produced and what we will produce over the period of our slowdown estimated to be more than $1.5 trillion

had we invested in actual businesses
rather than e.g. mortgages for people who couldn't afford their homes

financial markets rightly blamed

it is their responsibility to allocate capital and manage risk, and their failure has revived several old concerns of the political (and economic) left

increasing dependence on service sector

including financial service
decreasing reliance on manufacturing
is the whole thing was a house of cards?

i.e. aren't "hard objects" the "core" of the economy? And if so, shouldn't they represent a larger fraction of our national output?

the food we eat, the houses we live in, the cars and airplanes that we use to transport us from one place to another, the gas and oil that provides heat and energy

answer: no

live in a knowledge economy, an information economy, an innovation economy

because of our ideas, we can have all the food we can possibly eat with only 2 percent of the labor force employed in agriculture
even with only 9 percent of our labor force in manufacturing, we remain the largest producer of manufactured goods

better to work smart than to work hard
our investments in education and technology have enabled us to enjoy higher standards of living than ever before
we would do even better if we had more resources in these sectors

but: our recent success may based on a house of cards

in recent years financial markets created a giant rich man's casino, in which well-off players could take trillion dollar bets against each other

weren't just gambling their own money
were gambling other people's money

were putting at risk the entire financial system, indeed, our entire economic system

now we are all paying the price

financial markets as the brain of the economy

supposed to allocate capital and manage risk

when they do their job well, economies prosper
when they do their job badly everyone suffers

financial markets are amply rewarded for their work

in recent years, they have received over 30 percent of corporate profits
standard mantra in economics was that these rewards were commensurate with their social return.

i.e. financial wizards might walk off with a great deal of money but the rest of society is better off

because our capital generates so much more productivity than in societies with less well-developed--and less rewarded--financial markets

part of the rewards that accrue to financial markets are thus for encouraging innovation

through venture capital firms and the like

financial innovation to blame

financial system's latest innovation was to devise fee structures that were often far from transparent and that allowed it to generate enormous profits

private rewards that were not commensurate with social benefits

imperfections of information (resulting from the non-transparency) led to imperfections in competition

helps to explain why the usual maxim that competition drives profits to zero seemed not to hold

the worst problems (e.g. subprime mortgage market) occurred when non-transparent fee structures interacted with incentives for excessive risk-taking

financial managers got to keep high returns made one year, even if those returns were more than offset by losses the next

had those in the financial sector allocated capital and risk in a way that fueled the economy, they would have had handsome profits

but they wanted more

so established incentive structures that encouraged gambling

if they gambled and won, they could walk away with a share of the profits.

if they gambled and lost, the investors would bear the consequences

current woes in America's financial system are not an isolated accident

more than one hundred financial crises worldwide in the last 30 years or so
in each of these instances, financial markets failed to do what they were supposed to do in allocating capital and managing risk

e.g. in the late '90s, for instance, so much capital was allocated to fiber optics that, by the time of the crash, it was estimated that 97 percent of fiber optics had seen no light

problem with the U.S. economy is not that we have allocated too many resources to the "soft" areas and too few to the "hard" (i.e. services/knowledge vs. manufacturing)

not necessarily the case that we have allocated too many resources to the financial sector and rewarded it too generously
but:

too little effort was devoted to managing real risks that are important

i.e. enabling ordinary Americans to stay in their homes in the face of economic vicissitudes

too much effort went into creating financial products that enhanced risk

too much energy has been spent trying to make an easy buck
too much effort has been devoted to increasing profits and not enough to increasing real wealth

whether that wealth comes from manufacturing or new ideas

painful lesson from the 1930s and today:

The invisible hand often seems invisible because it's not there.

at best, it's more than a little palsied.

at worst, the pursuit of self-interest--corporate greed--can lead to the kind of predicament confronting the country today

Is there an exit strategy? - The Guardian

2008-09-11T22:59:00.002+01:00

Summary:
Kenneth Rogoff argues that weak banks must be allowed to fail or merge (with ordinary depositors being paid off by government insurance funds), so that strong banks can emerge with renewed vigour. Efforts to block a healthy and normal dynamic will ultimately only prolong and exacerbate the problem. Number of central banks currently very exposed. Have to ways of dealing with hits to their balance sheet: through inflation, or recapitalisation by taxpayers. Both solutions are extremely traumatic. Fairness issue: why should ordinary taxpayers foot the bill to bail out the financial industry? Poorest will be hardest hit by inflation tax. More regulation is necessary but is not the whole answer. Today's financial firm equity and bond holders must bear the main cost, or there is little hope they will behave more responsibly in the future. (Published: 08/09/08)

Notes:

becoming apparent that, after a period of epic profits and growth, the financial industry now needs to undergo a period of consolidation and pruning

weak banks must be allowed to fail or merge (with ordinary depositors being paid off by government insurance funds), so that strong banks can emerge with renewed vigour
efforts to block a healthy and normal dynamic will ultimately only prolong and exacerbate the problem

not allowing the necessary consolidation is weakening credit markets, not strengthening them

Fed, ECB and BOE

particularly exposed
collectively have extended hundreds of billions of dollars in short-term loans to both traditional banks and complex, unregulated "investment banks"

not end of the world if central banks are faced with a massive hit to their balance sheets

but: history suggests that fixing a central bank's balance sheet is never pleasant

faced with credit losses, a central bank can

either dig its way out through inflation (inflation tax)

but: raging inflation causes all kinds of distortions and inefficiencies
inflation has spiked during the past year, conveniently facilitating a necessary correction in the real price of houses

or await recapitalisation by taxpayers

but: taxpayer bailouts are seldom smooth and inevitably compromise central bank independence

both solutions are extremely traumatic

fairness issue

financial sector has produced extraordinary profits

official US statistics indicate that financial firms accounted for roughly one-third of American corporate profits in 2006
multi-million dollar bonuses on Wall Street and in the City of London have become routine

financial firms have dominated donor lists for all the major political candidates in the 2008 US presidential election

why should ordinary taxpayers foot the bill to bail out the financial industry?

why not the auto and steel industries, or any of the other industries that have suffered downturns in recent years?
this argument is all the more forceful if central banks turn to the "inflation tax"

falls disproportionately on the poor

have less means to protect themselves from price increases that undermine the value of their savings

after a period of massive expansion during which the financial services sector nearly doubled in size, some retrenchment is natural and normal

the sub-prime mortgage loan problem triggered a drop in some financial institutions' key lines of business

particularly their opaque but extremely profitable derivatives businesses

some shrinkage of the industry is inevitable
central banks have to start fostering consolidation, rather than indiscriminately extending credit

time to take stock of the crisis and recognise that the financial industry is undergoing fundamental shifts

is not simply the victim of speculative panic against housing loans

certainly better regulation is part of the answer over the longer run

but it is no panacea
today's financial firm equity and bond holders must bear the main cost, or there is little hope they will behave more responsibly in the future

All in this together? - FT.com

2008-09-08T15:24:00.006+01:00

Summary:
Overview of the economic situation and outlook for the UK, Eurozone, US and Japan. The global slowdown is the result a of a number of simultaneous shocks (the commodities shock, the housing shock and the credit shock) that have hit countries in different ways. In the US the focus is on the credit crunch, and the economy has proved resilient in the face of the commodities and housing shocks, whereas the UK and the Eurozone appear more affected by the commodities shock. The UK appears particularly vulnerable, with utility price rises feeding through fast. The ECB is mainly concerned about sticky prices and inflation. The US may be experiencing a Road Runner moment, and plummet as of yet. Doubts as to whether the credit crunch or the commodities shocks dominates the slowdown. Different outcomes depending on the true cause. (Published: 07/08/08)

Notes:

UK: Utility price rises feed through fast

UK has replaced the US as the economy seen to be at greatest risk of a severe downturn

economic outlook has deteriorated more rapidly over the past quarter than that of any other advanced economy

OECD now expects the UK economy to shrink for the rest of this year

unlike any other Group of Seven economy

Darling: economic circumstances facing Britain may be the worst in 60 years
Bank of England:

"sluggish real income growth and constraints on the ability of households to borrow dampen consumer spending, while the weak outlook for demand and the housing market [will] lead to falls in business and residential investment"

so far, the dominant effect has been the squeeze on household and corporate incomes from higher global commodity prices

has been exacerbated by a sharp depreciation in sterling

which raised import prices

and a liberalised market in gas and electricity

has fed higher utility prices through the economy faster than in continental Europe

fear is that, looking forward, tight credit conditions combined with Britain's high levels of debt and rapidly falling house prices are likely to prove more troubling than in many other countries

Eurozone: Concerns surround 'sticky' inflation

eurozone slowdown

mainly the result of higher commodity prices

have hit consumer spending

should gradually revive if commodities now remain stable or decline

as well as slowing global demand for exports from the 15-member bloc

i.e. appreciation of the euro against the dollar

until very recently has sharply aggravated the effect of slowing US growth on eurozone trade

ECB sees price-setting mechanisms as working differently in the eurozone and the US

requiring it to operate a more hawkish policy
prices in the eurozone are "stickier":

once inflation has become elevated, it stays there for longer

financial turmoil a risk to growth

but ECB insists that there is little evidence of a eurozone credit crunch

surveys suggest banks have tightened credit standards significantly
but lending to the private sector has continued to grow strongly

housing markets in Spain and Ireland have weakened sharply but corrections there are not seen as a big problem at eurozone level

US: Credit pain may yet reach its worst

markets surprised by the strength of US growth in Q2

but: this growth came almost entirely from net trade

fear is that with the rest of the world weakening, the US will receive much less support from trade in the months ahead

US economy has so far proved resilient to its house price crash, the credit squeeze and higher oil prices

question is whether the economy is not very vulnerable to financial disruptions - or whether time lags are just longer than originally thought

Fed thinks it is mostly a question of lags

e.g. unemployment jumped unexpectedly to a five-year high of 6.1 per cent in August

many experts fear that the peak impact of the credit crisis on real activity is yet to come

most expect a very weak second half

with the possibility of a quarter or two of negative growth around the turn of the year, as the effect of tax rebates wears off

Fed cannot rule out a deeper and more protracted downturn

officials increasingly downbeat on the outlook for growth outside the US

one reason why the Fed now appears more comfortable keeping interest rates at 2 per cent for an extended period

Japan: The contribution from exports goes

economy contracted by a sharper than expected 0.2 per cent in Q2

does not have the luxury of a high-growth cushion to help it absorb shocks

net exports contributed nothing to growth

for years Japan's main economic driver along with export-related capital spending

until few months ago, falling exports to the US had been largely compensated for by rising shipments to Europe, the Middle East, Russia and other emerging economies

but while exports to some developing countries are still robust, they are no longer enough to plug the gap left by falling demand from the US and, now, Europe

no improvement in domestic consumption

unlikely in light of weak wages and a softening jobs market
Japan will have to wait for a recovery in global demand before growth picks up again

cause of the global slowdown

recent sell-off in global commodity markets

signals growing concern that economic weakness could continue to spread in the months ahead

many investors have gone from believing in a "decoupling" story to seeing a globally synchronised downturn

prompting a bounce in the dollar

seen as a safe-haven in a global downturn

but: may be that just as the "decoupling" hypothesis was naive, the notion of a globally synchronised downturn may also be simplistic

world's economies are battling a set of roughly simultaneous shocks that differ in their scope and reach

commodities shock

hit all economies more or less equally through sharp rises in food and energy prices that preceded the latest partial retreat

credit shock

global in reach but uneven in its impact

effects greatest in the US and UK and least marked in Japan and the emerging world (the eurozone lying somewhere in between)

housing shock

residential prices crashing in a number of economies including the US, UK, Spain and Ireland

all have been accompanied by economic spillovers from events in each economy

effect is like seeing several large rocks thrown into a pond at once, each sending ripples that run across each other

different interpretations of global events in different parts of the world

US: tendency is to emphasise the credit squeeze

not just domestically, but globally too

other industrialised nations: experts attribute the Q2 global slowdown to what was then a surge in oil prices

aggravated by the swing in trade

(un)importance of the financial crisis

some think US experience suggests that the global economy may just not be very vulnerable to financial disruptions

could be that the credit shock was less important and the commodity price shock more important to the world economy than we thought

or a Road Runner moment?

possible US economy, having scuttled off the edge of a cliff and kept going for a brief while, looks down and plummets

Fed thinks financial stress will have a big impact on growth in the months ahead

credit squeeze appears to be most potent when it is combined with falling house prices and strained household balance sheets

as in the US and the UK
but: falling house prices may turn out to be a broader problem

early 2000s saw a house price boom in dozens of countries
OECD: real house price gains are now "decelerating nearly everywhere"

commodities and consumer and business confidence

has fallen sharply in non-US industrialised economies

bodes ill for consumption and investment

suggests that confidence may be an important channel in its own right

transmitting weakness that originated in the US

possible that the main cause of poor confidence was the surge in commodity prices

if so, confidence should recover as commodity prices subside

if the slowdown outside America was primarily a story of commodity prices - and not a global credit squeeze

then after a weak period mid-year the world economy should pick up again
US would by year-end again underperform relative to its peers but would continue to see support from exports

even if the commodities story is right, there are risks ahead

the oil market in particular remains tight and could rebound if the global growth scare abates

credit squeeze

if the credit squeeze is the key, weakness could spread as global banks cut lending
non-US industrialised economies may anyway still be incapable of sustaining autonomous growth

much depends on the performance of the big emerging economies

above all China

some experts still doubt the ability of the big emerging economies to substitute domestic demand for exports.

China and its peers may either slow more sharply than anticipated or reaccelerate too quickly, igniting inflation at home and in commodity prices, before they are forced to slam on the brakes again, with potentially global consequences

Is the Market Still a Future Indicator? - The Big Picture

2008-09-07T21:16:00.003+01:00

Summary:
Barry Ritholz with some thoughts on the Efficient Market Hypothesis, or the idea of markets efficiently reflecting future corporate earnings. Clearly not the case. Some examples: credit crunch; dotcom crash. Note in later case, markets were initially pricing stocks as if earnings didn't matter, whereas three years later some profitable, debt-free tech firms were trading below cash on hand. Stockmarkets now more likely to move in tandem, even lag the trajectory of profits. Blamed on the proliferation of hedge funds. Is making markets increasingly focused on breaking news and short-term swings, rather than longer-term fundamentals. Yet, to an EMH proponent, hedge funds should make markets more, not less efficient. Robert Schiller: The huge mistake EMH proponents have made: just because markets are unpredictable doesn't mean they are efficient. That false leap of logic was one of the most remarkable errors in the history of economic thought. (Published: 11/08/08)

Notes:

Efficient Market Hypothesis:

the markets constitute a future discounting mechanism

i.e. efficiently reflects future corporate earnings

makes sense, as one ostensibly buys stocks in companies to claim bucketfuls of their future profits

i.e. behaves like a crystal ball

should have died a quite death

but on Wall Street, myths, bad theories, and old information linger far longer than one would expect

WSJ: "For decades, turns in the stock market typically led earnings by roughly six months. But during the past decade or so, stocks have moved roughly in tandem with, and occasionally lagged, the trajectory of profits, notes Tobias Levkovich, Citigroup's chief U.S. strategist."
plenty of examples of where markets simply get it wrong

exhibit A: credit crunch

began in August 2007 (though some had been warning about it long before that)
despite all of the obvious problems that were forthcoming, after a minor wobble, stock markets raced ahead
by October 2007, both the Dow Industrials and the S&P500 had set all time highs
so much for that discounting mechanism!

dotcom crash

March 2000: the market was essentially pricing stocks as if earnings didn't matter

growth could continue far above historical levels indefinitely
value was irrelevant
How'd that work out?

3 years later:

some of the most profitable, debt free tech and telecom names were trading below their book value

some were even trading below cash on hand.

the market had "efficiently" priced a dollar at seventy-five cents

most fascinating aspect of this is the opportunity for anyone in t he market to identify inefficiencies

discover where the market has a non random error -- we've called it Variant Perception over the years -- and you have a potentially enormous money making opportunity
is the reason why everyone doesn't simply dollar cost average into index funds

its the lure of the big score

proliferation of hedge funds

is making markets increasingly focused on breaking news and short-term swings, rather than longer-term fundamentals.

contribute to this phenomenon are the narrow niche focuses used to differentiate amongst funds and raise capital
but: to an EMH proponent, hedge funds should make markets more, not less efficient

their long lock period (when investors cannot take out cash) means they should have a longer time horizon for investment themes to play out.

Robert Schiller

"The huge mistake EMH proponents have made: just because markets are unpredictable doesn't mean they are efficient. That false leap of logic was one of the most remarkable errors in the history of economic thought."

Greenspan: Housing Stabilization Key to Crisis End - WSJ

2008-09-07T20:30:00.003+01:00

Summary:
Greenspan: A necessary condition for an end to the current global financial crisis is the stabilization of the price of homes in the U.S. Stable home prices will clarify the level of equity in homes, the ultimate collateral support for much of the financial world’s mortgage-backed securities. We won’t really know the market value of the asset side of the banking system’s balance sheet — and hence banks’ capital — until then. Public policy can hasten this process by not prematurely propping up housing starts and by expanding the underlying demand for homes generally. The most effective initiative, though politically difficult, would be a major expansion in quotas for skilled immigrants. Skilled immigrants tend to form new households, by far the most important source of new home demand. (Published: 13/08/08)

Word of the Day: Haircut

2008-09-07T20:12:00.002+01:00

The percentage by which an asset's market value is reduced for the purpose of calculating capital requirement, margin, and collateral levels, or the difference between the actual market value of a security and the value assessed by the lending side of a transaction.

Notes:

The term haircut comes from the fact that market makers can trade at such a thin spread.
When they are used as collateral, securities will generally be devalued since a cushion is required by the lending parties in case the market value falls.

Credit Crisis 'Only Now Beginning' - Bloomberg

2008-09-07T19:40:00.003+01:00

Summary:
David Goldman, a portfolio strategist at Asteri Capital, talks about the outlook for the U.S. financial-services industry, the impact of the hedge-fund model on market volatility and his investment advice. This is not a mere recession, it's a change in the lives of Americans. We're still in the credit bubble, because of contractual obligations the banks have. The credit crunch hasn't started yet, merely a mild indisposition so far. The credit crunch is what comes next, and it will be brutal. The hedge fund business is very vulnerable. All in the same trade all the time and every turn is like a stampede out of a crowded theater. Only the big funds that have a lock on capital may do well. If you marked everyone to market now, the banks would be in very bad shape, many insolvent. Isn't going to happen and banks will try to generate enough earnings in order to bring in the capital back while they pretend that they're still solvent. But losses from consumer lending may pile up faster. We may have a deflationary outcome, destroying huge amounts of wealth in the form of homes and equities and companies is in principle inflationary. (Published: 14/08/08)

Notes:

not a recession, not a blip: it's a change in the lives of Americans who've spent the last 10 years in the delusion that they'd fund their retirement by selling homes back and forth to eachother at higher prices

the financial industry enabled them by sustaining this delusion
delusion is now coming unravelled

no one is going to retire, entire neighborhoods will turn into slums and financials will trade at 50% of book

a year from now we're still going to have a very weak economy;

that may be long enough to find the bottom;

but it's going to take a rebuilding of household balance sheets, ie a lot of saving

what we have now is a lot of dis-saving

Mr Market is going to have to kick their teeth down their throats to change their behaviour

hedge fund business now (compared to 1998) is much bigger and much more vulnerable

with everyone forced to take the same trade, volatility intra-month so great that those investors who are committed to a month by month sharp ratio low volatility strategy will be forced to redeem and you get wild swings and illiquidity and inability to liquidate positions
we're going to have a serial catastrophe of hedge funds

particularly the type of fund that thought it was a great idea to buy loans at 90 cents to the dollar and won't be able to sell them at 80 later this year

private equity can make money in this kind of market, if you're right and you willing to take massive volatility intra-month, and hang on for a year or two; you can do extremely well

but if you have to grind out returns month by month, which is the conventional hedge fund model, you end up creating volatility because you're all in the same trade all the time and every turn is like a stampede out of a crowded theatre

hedge funds are one of the major sources of volatility, and have become one of the major sources of risk

the most important thing to keep in mind is: we have not had a credit crunch yet; we've had a 20% annual rate of increase of bank lending to corporations, and an even faster rate of securities purchases; we've had a credit bubble continuing

this is because banks are contractually locked into make loans, largely revolving credits, which they can't get out of
so the credit crunch is only begining to start

we're now seeing banks cut off home equity lines to consumers, we're seeing the beginning of cut off credit card lines;
but we had a spike in credit card usage because since the home equity lines were cut off, consumers used their credit cards
the credit crunch is only now beginning because bank capital is so restricted by losses to date that they will have to begin shutting of credit to households and corporations

and that's when we're going to get the defaults

what we have had in aggregate is a credit bubble till today; a credit crunch is technically the wrong expression;

the credit crunch is what comes next, and will be brutal compared to the mild indisposition we've had for the past 12 months

financial institutions would be well-advised to try and clear their books as quickly as possible

take the pain now because it will be more painful later

SIVs are essentially a corpse waiting to be buried;

you now have a highly ambiguous situations regarding all of the off-balance sheet assets of banks;
the Federal Accounting Standards Board (FASB) was supposed to have ruled in a way that would force banks to take several billion dollars of asset-backed securities and take them out of off-balance sheet structures and consolidate them back on their books, which would increase the capital demands on the banks

that was one of the reasons that financial stocks were in such hot water during May and June;

the FASB turned around and postponed that ruling;

obviously they looked at the distressed state of the banks and decided that it was a bad time to stress their capital base again;
so a great deal of this remains under negotiation or in complete unclarity because the regulators, the FASB and the SEC, have not decided what to do about it

if you marked everyone to market now, the banks would be in very bad shape;

they certainly would have inadequate tier one capital, many of them would be insolvent

wouldn't be the first time, the banking system might have been insolvent in 1990, also might have been in 1981

so no one is going to mark the stuff to market;

the question is can they generate enough earnings in order to bring in the capital back while they pretend that they're still solvent;

but the problem is, as the rot gets into the consumer sector and the losses pile up from consumer loans and high yield loans, my view is their capital is going to be decreasing; instead of earning their way out of it, they're going to be piling up fresh losses

the only hedge fund model that will work now is to be huge and have a lock on money for a long period of time;

if you can take the courage of your convictions and ignore 10 or 20 or 30% down months in order to get 50% up years, then this is a good thing to do;
and if you want to invest in hedge funds, find managers whose convictions you believe in, who are willing to swing for the fences, and will insist on taking your money for a period of time and have the courage to do it
or keep it in treasury bills

I believe that we're going to have an enormous taxpayer bailout for the GSEs and for a number of banks; i think it will look like the 80s, when we had a $700b bill for the S&Ls, but it will be larger

in an economy where there aren't enough hedges, the price of hedges can be arbitrarily high

what's the price of a last ticket on the Paris-Marseille express on the night of that the Germans march into Paris? The answer is how much do you have in your pocket;
we may have a deflationary outcome, destroying huge amounts of wealth in the form of homes and equities and companies is in principle inflationary;

the hedge against this in the form of commodity investing has turned out not to work that well in the last several weeks,
and the signals that we're getting from the TIPS market - the break-even inflation rate between TIPS and coupons - has actually come in to the lowest in years;
so we may have an inflationary environment

Globalisation and the costs of international trade from 1870 to the present - Vox EU

2008-09-07T18:13:00.002+01:00

Summary:
Many analysts suggest that rising oil prices will sharply reduce international trade. This paper argues to the contrary, noting that transport costs constitute a limited share of trade costs (about 1/3rd). Instead of transportation costs, the biggest reversal of international trade in recent history is linked to large increases in protectionist measures. Moreover, evidence from the first wave of globalisation suggests that higher shipping costs are unlikely to significantly dampen international commerce – only protectionism would seriously threaten trade. Compared with historical patterns, the level of bilateral trade costs is still high for many country pairs, especially for those that are far away from each other. This means that there is scope for trade costs to fall further. Unless there is a backlash in the form of rising protectionism, world trade has the potential to keep growing strongly over the coming decades. (Published: 16/08/08)

Back to bust? High technology on course for harder times - FT.com

2008-09-07T16:29:00.006+01:00

Summary:
The IT industry may be about to face its toughest period since the dotcom bust due to the slowdown in the economy. Corporate demand, the IT industry's main source of prosperity, will fall significantly. Instability in the financial markets, declining new hires and weakening corporate profits will result in a lowering of capital expenditure and a premium being placed on operational efficiency. This is likely to play out over the next 9 months, with tech stock, already down 19% over the last 12 months, to fall further. Other recent trends that will compound the impact of the economic slowdown are the increase in choice leading to price deflation; the rise of software as a service and virtualisation. Consumer spending and spending on advertising, an important source of revenues for many Web 2.0 startups are also in decline. The downturn, however, may be less painful than the dotcom crash. There is less overcapacity in the industry, and increasing demand from the emerging world for IT services is compensating for the slowdown in the US and UK. (Published: 14/08/08)

Notes:

information technology industry may be about to face its toughest period since the dotcom bust
forgotten side of the technology world: industry's main source of prosperity is the corporate customer

the engine that powers Silicon Valley and the rest of the technology industry
"flashy gadgets such as Apple's iPhone and online consumer services such as Facebook may have captured the popular imagination and created new technology fortunes, but they are not the industry's main source of prosperity"

companies account for 60-65 per cent of the end-market for technology

consumer technology represents only about 20-25 per cent

governments make up the rest

with a pronounced economic slowdown in the US and the UK, this engine has started to sputter:

weakening corporate profits
decline in new hires
instability in the financial markets

these have historically all been warning signs of lower capital spending ahead

based on the usual lag, the turmoil in credit markets of the past year virtually guarantees that corporate spending on technology will fall over the next nine months or so

technology demand, which has been growing recently at an annualised rate of 5-6 per cent, could decline by 10 per cent

tech stock investors

investors in tech stocks are invariably drawn by the promise of superior growth

made the sector a stock market stand-out for much of last year, as a slowing US economy made growth stocks rarer
industry's seemingly endless hype cycle feeds this optimism

there's always a new computing architecture about to go mainstream, a new must-have gadget, and a Next Big Thing

optimism is often justified given the big markets that new technologies can create

but: investors frequently pay dearly for that potential
"If it doesn't work, you get your neck broke"

tech stocks have fallen 19 per cent over the 12 months to the end of July

nearly double the rate of the overall market

operational execution at a premium

"I expect the slowdown to profoundly impact Silicon Valley internet, networking and technology companies over the next 12 to 18 months"
"Technology start-ups should already be tightening their cost controls and turning their attention to the nuts and bolts of operational efficiency."
"There are still numerous long-term growth opportunities across Silicon Valley, but operational execution is at a premium and much more of a differentiator than it has been in many years."

Jim Breyer, partner in VC firm Accel Partners

recent trends in the technology industry compounding the impact of the worsening economic environment

availability of choice -> price deflation

thanks to the rise of the internet and other standards-based technologies
made it easier for buyers to shop around

many corporate buyers have come to count on these to help them continually reduce the overall size of their tech budgets

When the 1990s tech boom reached its peak, corporate buyers were often tied to proprietary systems from single suppliers

that is no longer the case
result: a severe price deflation has taken hold in some corners of corporate technology

rise of "software as a service" and virtualisation

two of the most powerful recent technology trends that exemplify this change
software as a service (SAS)

involves shifting corporate computing tasks to online services

e.g. using a company such as Google to provide an e-mail service
"I don't have to buy servers, I don't have to buy storage, I don't have to do back-ups"

many of these service companies have priced their services at rock-bottom rates

relying on attracting large volumes of customers to spread their large fixed costs

"We're talking about products that are one tenth the cost of things that were hawked in the last recession"

virtualisation

makes it possible to run several computing workloads on a single server,

greatly reducing the number of machines that companies need to buy and maintain

trends like these have created new markets and supported the rise of new companies

but 1: they have also exposed those whose technologies or business models are not suited to the changing times

e.g. Sun Microsystems

soared in the dotcom boom as its proprietary servers became the mainstay of Web 1.0

but has struggled to adapt to the latest generation of low-cost, standards-based machines and open-source software

but 2: even tech companies that have been better positioned to ride this wave are starting to feel the pinch.

due to weaker corporate demand

companies taking a more "pragmatic" approach to their tech budget

putting off buying new services

not just weaker corporate demand

consumer spending on tech, though far less significant overall and traditionally less prone to big dips, could also be hit in a wider downturn
another big source of growth, the rapid rise in online advertising, has slowed notably this year in the face of a wider softening in consumer advertising

after growing nearly 26 per cent in 2007, online advertising in the US, is predicted to grow by only 17.5 per cent this year and 14.5 per cent in 2009, before growth eventually pushes back above 20 per cent in 2011

search still dominates
people are cutting back on typical display ads

this slowdown in advertising could not have come at a worse time

many of the consumer web companies created since the dotcom crash have been avidly building an audience in the expectation that they will cash in through advertising

downturn will not be anywhere near as painful as the one that hit the industry at the start of this decade

late-1990s tech binge was more than a bubble in stock market valuations:

it also reflected a massive bubble in tech spending

internet euphoria
fear that many older IT systems would not be able to handle the date shift at the turn of the millennium

combined to produce a boom in corporate spending

we don't have the overcapacity in IT systems we had going into the last downturn

capital spending in the US has been low by historical standards for the past four years

will cushion the blow from any fall now

demand from emerging world growing

after many years of investment, these markets are finally on the brink of becoming significant money-earners for some of the industry's biggest players.

at its current growth rates, these "growth markets" may account for nearly 30 per cent of its revenues in five years' time

Silicon Valley is once again turning into a place of "haves" and "have-nots"

those start-ups that raised a comfortable cushion of cash from investors to see them through this more uncertain period and those that risk being left high and dry if business turns down

Ending the Nation-State Myth - Project Syndicate

2008-09-07T13:25:00.006+01:00

Summary:
Devin Stewart on the nation-state myth. Whereas the idea of a state is useful and necessary, the idea of the nation-state is an illusion, and, like religion, requires a leap of faith. Identities within nations are often as varied as they are between nations. E.g. China's "Han majority" is linguistically, culturally, and even genetically diverse. China is much more than a nation-state. The concept “Chinese” is a meaningless word that was fabricated to justify rule over minorities. The Japanese are particularly keen to think of themselves as one "people" and talk of "Japaneseness", but actually comprise Ainu, Koreans, Chinese, Filipinos, and Ryuku. Closely related to the Nation-State Myth is the Origin Myth. The origin myth continues ad infinitum until we reach humanity’s common ancestor. The nation-state concept offers a way to consolidate and legitimize a state’s rule over a group of people, although the contours of a cultural community rarely coincide with a political entity. It obscures the fact that humanity's greatest threats are global and do not respect national sovereignty. If policymakers are to address today’s problems, they must think more broadly. An introduction to ethics in international affairs — moral philosophy, human rights, and the role of non-state actors — should be mainstreamed in international relations curricula. (Published: 03/09/08)

Notes:

nation-state myth conflates two ideas

one that is concrete: the state
one that is fuzzy: the nation

the state

utility of the state is clear

a necessary organizing principle that allows people to pool their resources for the common good and mobilize against common threats

whether they are floods or invading armies

the state is also the final arbiter of law

state power is even on the rise

partly as a backlash to globalization and as a result of growing wealth from energy markets

the nation-state

the nation-state as a basis for statecraft obscures the nature of humanity’s greatest threats

pollution, terrorism, pandemics, and climate change are global phenomena.

do not respect national sovereignty
necessitate global cooperation

origin of the nation-state idea is unclear

most agree that it offered a way to consolidate and legitimize a state’s rule over a group of people

whether defined by a common language, culture, or ethnicity

problem is that the contours of a cultural community rarely coincide with a political entity

nor does the ideal of national unity account for internal diversity and conflict

like religion, the nation-state myth requires a leap of faith

identities within nations

are fluid, even from minute to minute
division of core and periphery is common in many countries
person’s identity would change during the course of a conversation

China

often thought to be governed by the Han majority

but: this group is linguistically, culturally, and even genetically diverse
Ian Buruma: it is not clear what people mean by “China.”

e.g. Taiwan is an independent state but is officially part of China
Chinese culture and language has spread all over the world
“China” is much more than just a nation-state

Taiwanese scholar Lee Hsiao-feng

recently argued that the concept “Chinese” is a meaningless word that was fabricated to justify rule over minorities

Japan

some argue that Japan is an example of a nation-state

Japanese people actually comprise Ainu, Koreans, Chinese, Filipinos, and Ryuku

stubborn Japanese response: “Yes, but we want to believe that there is a Japanese people.”

they even have a field of study devoted to examining what it means to be Japanese

Japanese scholar Yoshihisa Hagiwara

argues that since it is not grounded in fact, the nation-state myth is bound to dissolve, giving way to an understanding that we are merely individuals who are part of a global community
laments that the Japanese are especially fond of the idea of “Japaneseness,” making it possible that Japan may become the “last hero” of a dying ethos

the Origin myth

e.g. ancestors from Norway

actually from Sweden

but where do you stop

the origin myth continues ad infinitum until we reach humanity’s common ancestor

or an actual myth

a black egg in China, a spear in the ocean in Japan, or the interaction of fire and ice in France

implication for policy

if policymakers are to address today’s problems, they must think more broadly

one place to start may be to reexamine the concept of the nation-state

which students around the world are taught is the basic unit of international relations
beyond the core Realist theories of balance of power, an introduction to ethics in international affairs — moral philosophy, human rights, and the role of non-state actors — should be mainstreamed in international relations curricula

a united front against the biggest problems facing the world will require a fundamental shift in attitude

away from parochialism and toward a redefinition of self-interest

enlightened self-interest can be state-based

but interests would be re-defined to encompass universal principles

such as the Universal Declaration of Human Rights

if these interests are to gain universal recognition, we will need to shed the nation-state myth once and for all

Quote of the Day

2008-09-06T23:15:00.002+01:00

"This bright new system, this practice in the United States, this practice in the United Kingdom and elsewhere, has broken down. Growth in the economy in this decade will be the slowest of any decade since the Great Depression, right in the middle of all this financial innovation. It is the most complicated financial crisis I have ever experienced, and I have experienced a few... Changes are going to have to be made to the global financial system." - Paul Volcker

Bob Farrell's 10 Rules for Investing - Market Watch

2008-09-05T14:10:00.003+01:00

Summary:
10 Rules for investors by Bob Farrell (chief stockmarket analyst, Merril Lynch). Markets tend to return to the mean over time; Excesses in one direction will lead to an opposite excess in the other direction; There are no new eras -- excesses are never permanent; Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways; The public buys the most at the top and the least at the bottom; Fear and greed are stronger than long-term resolve; Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names; Bear markets have three stages -- sharp down, reflexive rebound and a drawn-out fundamental downtrend; When all the experts and forecasts agree -- something else is going to happen; Bull markets are more fun than bear markets. (Published: 11/06/08)

Notes:

investment rules

tailor-made for tough times, allowing you to stick to a plan just when you need it most

a rulebook is important in any market climate

but: it tends to get tossed when stocks are soaring

sage investors warn people not to confuse a bull market with brains

Bob Farrell

pioneered technical analysis in the late 1950s

rates a stock not only on a company's financial strength or business line but also on the strong patterns and line charts reflected in the shares' trading history

also broke new ground using investor sentiment figures to better understand how markets and individual stocks might move

10 rules

Markets tend to return to the mean over time

when stocks go too far in one direction, they come back
both euphoric and pessimistic markets can cloud people's heads

"It's so easy to get caught up in the heat of the moment and not have perspective. Those that have a plan and stick to it tend to be more successful."

Excess in one direction will lead to an opposite excess in the other direction
There are no new areas - excesses are never permanent

many investors try to find the latest hot sector

soon a fever builds that "this time it's different."

never really is

when that sector cools, individual shareholders are usually among the last to know and are forced to sell at lower price

it's very hard to switch and time the changes from one sector to another

find a strategy that you believe in and stay put

Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways

a popular sector can stay hot for a long while, but will fall hard when a correction comes

The public buys the most at the top and the least at the bottom

many market technicians use sentiment indicators to gauge investor pessimism or optimism, then recommend that investors head in the opposite direction

Fear and greed are stronger than long-term resolve

investors can be their own worst enemy, particularly when emotions take hold
it's critical for investors to understand how they're cu

if you can't handle a 15% or 20% downturn, you need to rethink how you invest

Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names

markets and individual sectors can move in powerful waves that take all boats up or down in their wake

there's strength in numbers, and such broad momentum is hard to stop
in these conditions you either lead, follow or get out of the way

when momentum channels into a small number of stocks, it means that many worthy companies are being overlooked and investors essentially are crowding one side of the boat

Bear markets have three stages -- sharp down, reflexive rebound and a drawn-out fundamental downtrend
When all the experts and forecasts agree -- something else is going to happen

"If everybody's optimistic, who is left to buy? If everybody's pessimistic, who's left to sell?"

Bull markets are more fun than bear markets

War for Wealth and Supercapitalism - GlobalBiz

2008-09-05T11:09:00.003+01:00

Summary:
Peter Day interviews Robert Reich (Berkeley) and Gabor Steingart (Der Spiegel). Reich believes we've entered an era of super-capitalism. Technology incubated during the cold war. Lowered cost of transporting goods and communication. Container ships and satellite communication. Led to globalization. Consumers and investors doing very well. No more job security due to this globalization and technological advances. Generates huge instability and upheaval, not seen since late 19th century. People need to understand the costs. We need to pay attention to how governments regulate and design markets and try to do a better job. Gabor Steingart believes our way of life and stability are under threat from the rise of Asia. Not a flat world because China and India are competing with our blue collar workers under a very different set of rules. E.g. child labour, no trade unions, environment. Free trade is not the answer for up to 1/3 of our workforce. Need political actions. Not tariffs and quotas, but heavy investment in education, trade agreements, informing consumers and pooling resources between Western countries. (Published: 02/09/08)

Notes:

Robert Reich

democracy (in the sense of caring for many citizens) under threat in an age of big business
capitalism in its modern form began in late 19th century

huge consolidation of industry

created some social problems

social inequality
terrible industrial towns and cities
health and safety problems

struggled with those problems for decades

not completely overcome
but: factories moved away

capitalism in 1940-1950s

in every industry 3 or for 4 major producers

generated huge economies of scale

we assumed that they were natural
that inevitably there would only be room for 3 or 4 major producers per industry

gave America big advantage

in a big country the economies of scale are thought to occur more radically
compared to Europe split up into national champions into different countries

allowed in industrial unions

hadn't seen before in the US
could negotiate with an entire industry because there were only 3 or 4 major producers
producers were willing to give unions pretty much what they wanted because they could pass on the additional cost to consumers or it was compensated by productivity gains

very stable for a long time
consumers and investors didn't do very well

not much choice
not huge returns for investors

mid 1970s

everything began to change
lot of the technologies that had been incubated during the cold war began to be available; technologies even that came about through the Vietnam war

new transportation and communication technologies

container ships, satellite communication

whole idea of a container ship was designed, developed and subsidized by the US military

those technologies began to knit the world together

in ways that nobody had foreseen

globalization is the result

became practical
cost of getting stuff from overseas to the US plummets
companies in the US could contract out, to outsource abroad, to become supply chains

something else happened

the technologies themselves undermined the vast economies of scale

became possible for smaller producers to tailor their goods and services exactly to the taste of smaller groups of consumers

two sides of a coin

consumers and investors doing very well

many more options

instability means our entire job structure is thrown to the winds

we're seeing the replacement of industrial capitalism with the tail that used to be its servant, financial capitalism

bankers used to lend money for productive purposes

new companies or old companies, goods and service producers

now financial part of the economy has become a very predominant thing in lots of countries

tail is wagging the dog

super-capitalism

in almost every industry, the parts that are most dynamic, most inventive, are parts that are basically small businesses, that are highly disruptive, where people have no job security at all, where tomorrow the new business may move out and go someplace else
is putting pressures on the old businesses to be more dynamic as well
hence we are seeing not only in bad times but also in good times huge numbers of people being fired permanently
the entire old high-volume standardized mass-production type of employment is gone
cost pressure on everyone in the system

driving business to cut everything

in super-capitalism, we're seeing increasingly a huge increase in consumer choice, investor choice, dynamism, and also the other side of that coin, huge instability, huge upheaval, we haven't seen since late 19th century

solution

understanding the choices

consumers love the choices, investors love it when the stock prices go up
but if you say to them there's a Faustian bargain, are you willing to understand and accept all of the instability that comes with it?

maybe not
maybe we need more regulation again
pendulum is swinging back

need to understand that the dynamism that we have is wonderful

but there are social costs to it
need to pay attention to how governments regulate and design markets and try to do a better job

trouble with regulating: law of unintended consequences kicks in?

process of trial and error
FDR in 1932: "we're going to try things, may not always work, but we have to try them; worst thing we can do is stand back and do nothing"

Gabor Steingart

way of life of the rich world is under threat from the rise of Asia
far from unifying the world, globalization is a diversifying force
takes issue with the view that globalization has made the world flat for everyone

if world is flat, then it is heavily tilted towards Asia and the East
world was flat maybe 20 years ago

competing only between the Western countries
500m people competing under nearly the same rules and regulations

China, India, Eastern Europe

1.5bn people joined the world labour market
were competing against our mostly blue collar workers under a completely different set of rules and regulations

formerly flat world became rocky road for them

if you're the owner of capital it is a flat world

you can invest wherever you want to invest

not the same for ordinary workers

strenght and reach shrinking

free trade doesn't mean the same anymore because the terms of trade have changed

free trade requires both partners to believe in a free market economy

China/India not a free market economy; they're guided economies

not protectionism

calling for political action

trade is not a law of nature

need to frame it, shape it

need to level the playing field

free trade is not the answer for maybe 1/3 of our workforce

they cannot compete under these conditions
they have nothing to offer in this world labour market
we have to take care of them

not tarrifs and quotas

heavy investment in education
also means trade agreements with the low wage countries
fight for the ban of child labour

30 year ago we were fighting against child labour because it was a moral issue
130m children are fighting against our blue collar workers

an economic issue

isn't this just a snapshot of how it is now? aren't higher wages and more education going to come along in China? West better get used to this competition?

could be naive
20 years people were saying China would be a democracy
no progress on environmental issues

ask for 50 years exemption

is a long time

solution

education

blue collar workers need to be given huge upgrade

more information to consumers

consumers can make their own decisions if they have the information

e.g. red/green dot on products; red not member of Kyoto protocol, or trade unions forbidden

Western cooperation

only 10% of population
need to pool our resources, interests

every citizens to rethink globalization

real change needs more than politicians saying it
need educated citizens about globalization

globalization is a complex process, not simple

The Dangerous Myth of Energy Independence - Informed Comment

2008-09-05T10:04:00.004+01:00

Summary:
Robin M. Mills argues that the world is not running out of oil, that the current high energy prices are the result of a long period of low prices and under-investment, as well as irrational hostility between suppliers and consumers. Ideas about forestalling an oil crisis by ‘energy independence’, or by military action, are mistaken. The proper energy policy should be energy security, not energy independence. Objective profoundly harmed by climate, with elements of paranoia, racism and Islamophobia. Energy security is achieved when suppliers find markets, and markets find supply, at prices permitting both of them economic stability and growth, which requires a complex web of inter-relationships between producers and consumers. Policies to encourage US domestic production, increase efficiency and introduce alternative energy sources are desirable, often for environmental rather than energy security reason, but they have to be pursued with vigour and resolution. Promises to ‘jawbone’ OPEC into supplying more oil sit very oddly with the US’s uniquely comprehensive moratoria on offshore oil and gas production. Need a rational and balanced dialogue about how to co-operate on bringing that abundant energy to consumers. (Published: 02/09/08)

Comment:

current high energy prices emerge from a long period of low prices and under-investment

fruit of the breakdown of international energy relationships in the oil crises of 1973-4 and 1978-80

high prices are not due to a lack of resources in the ground

remains vast potential around the world for increasing recovery from

existing fields,
discovering new oil, e.g. recently deepwater Brazil
largely untouched US offshore
‘unconventional’ sources such as Canada’s famous ‘oil sands’
biofuels
synthetic fuels from natural gas and coal, and others

ideas about forestalling an oil crisis by ‘energy independence’, or by military action, are therefore mistaken

such ‘solutions’ are likely to create the crisis they seek to mitigate

proper objective of energy policy: not independence, but security

objective profoundly harmed by climate, with elements of paranoia, racism and Islamophobia
energy security is achieved when suppliers find markets, and markets find supply, at prices permitting both of them economic stability and growth

requires a complex web of inter-relationships between producers and consumers

attempts by a major nation to achieve energy self-sufficiency are very distorting to economic competitiveness

even worse when bad relations with major energy suppliers, and conflicting messages about future energy policy, discourage much-needed investment

if one side believes they are buying oil from terrorists, and the other thinks they are selling to neo-imperialists, it is not surprising that

oil prices are high
investment is lacking and
most of world oil reserves are monopolised by state companies

the Middle Eastern nations have generally been very reliable suppliers, and use of a mythical ‘oil weapon’ is very unlikely

any régime would be reliant on its oil earnings to sustain the economy
while strategic reserves in the industrialised countries give some ‘staying power’ to outlast an embargo

policies to encourage US domestic production, increase efficiency and introduce alternative energy sources are desirable

often for environmental rather than energy security reasons
but: they have to be pursued with vigour and resolution

US energy policy has been more erratic and hostile to increasing output than most of the Middle Eastern countries

‘pork barrel’ subsidies and the interminable, inconclusive debates over whether to open new exploration areas, build new pipelines and terminals for clean natural gas, extend support for renewable energy and increase mileage standards
promises to ‘jawbone’ OPEC into supplying more oil sit very oddly with the US’s uniquely comprehensive moratoria on offshore oil and gas production

military ‘control’ of oil is not achievable or cost-effective

expenditure on such wars vastly exceeds the value of any oil ‘secured’
while production can struggle along in war-torn areas, it is impossible to develop major new fields

‘Police actions’ to deal with specific threats are entirely reasonable

as long as they are multi-lateral and proportional to the danger posed
and carried out competently
grandiose military adventures destroy the co-operation which is essential for global energy trade

‘Energy independence’ is a chimera, expensive, unachievable, and swimming against the tide of greater global economic integration
world is not running out of oil

we need a rational and balanced dialogue about how to co-operate on bringing that abundant energy to consumers
if the profound misunderstanding of, and hostility towards, the Middle East, continues, the house of energy security is being built on sand

Globalisation as the great unbundling(s): What should governments do? - Vox EU

2008-09-04T15:07:00.003+01:00

Summary:
Richard Baldwin describes the evolution of globalization in terms of stages in an unbundling process. The first and second industrial revolutions let to a spatial unbundling of factories and consumers. The social consequence were dire. Governments reacted by partially unbundling income and consumption. In the late part of the 20th century, as a result of ever-lower transport and labour costs, the factories themselves became unbundled as supply chains were internationalized. This caused relatively few problems as the manufacturing sector was greatly reduced by then. Around the start of the 21st century, the resolution of globalization increased further, as offices came to be unbundled next. Various service components are now being outsourced and offshored. This radically widens the circle of affected workers. The three key characteristics of this new wave of globalization are the unpredictability of its consequences; the suddenness with which it can affect jobs; and its greater resolution, acting on the level of individuals, rather than firms, sectors or skill groups. As was the case with the first unbundling phase, this latest wave of globalization will require a revamp of education policies, welfare states, and labour organisations. (Published: 04/09/08)

Notes:

today's globalization is different

been saying this for decades, but this time, it’s really different

late 19th Century and first three-quarters of the 20th

meant the spatial unbundling of factories and consumers
costs of moving goods, people, and ideas fell rapidly

especially for goods

steamships and railroads allowed things to be profitably made far from where they were consumed

first (steam) and second (chemical/electric) industrial revolutions fostered and were fostered by the first unbundling

these revolutions also transformed the skill mix a nation needed for succes

universal, free, and compulsory primary education was one governmental reaction, but far from the only

social consequences of the first unbundling were dire

winners won more than the losers lost
winner-loser pattern stressed societies to the breaking point
governments reacted by partially unbundling income and consumption

the ‘social market economy’ in Europe
the ‘New Deal’ in the US

late 20th century

costs of moving goods, people, and ideas fell rapidly

especially for ideas.

cheap and reliable telecommunications made it profitable to organise complex manufacturing tasks that previously required physical proximity
factories were unbundled

supply chains were internationalised

today’s factories don’t make things

they make bits and pieces that are assembled somewhere and sold somewhere else

globalisation began operating at a higher resolution

instead of harming or helping the fortunes a firm as a whole, it could reach right into the factory and help or harm a particular production stage, a particular department, or even a particular job

due to the government’s earlier unbundling of incomes and consumption, the resulting winner-loser pattern caused few problems

compared to those experienced in the 1920s and 1930s
but: problems were small since the affected sector, manufacturing, was small

two-thirds of Europe’s value added was profoundly non-traded

two-thirds of Europe’s labour-force faced little international competition

moreover the affected workers shared common traits

low-skill, low-education
government policies could readily be designed to redress their plight

new century: new wave of globalization

economic unbundling rolled on

costs for ideas fall rapidly

the cheap-and-reliable sharing of audiovisual material and documents in editable form combined with cheap-and-reliable continuous communication

email and Skype instead of fax and phone

since audiovisual and textual materials are critical to much of Europe’s service sector – as intermediate or final goods – the new wave of economic unbundling expands on a new axis

in the New Century, Europe’s offices are unbundled

various service components are outsourced and increasingly off-shored

this radically widens the circle of affected workers

three key elements of this high resolution globalization

unpredictability

winners and losers much harder to predict

by their very nature, lower trade costs for goods tend to affect all traded goods in roughly similar ways

this is why one could tell which sectors would win from further trade cost cuts.

when the main barrier is the cost of exchanging information across distance (trading ideas), it is difficult to identify winning and losing tasks

knowing the direct cost of telecommunications is not enough

it interacts in complex and poorly understood ways with the nature of the task and the task’s interconnectedness with other tasks

suddenness

job which three years ago was considered absolutely safe may today be offshored to India
reason for this suddenness lies in the nature of complex interactions within factories and offices

telecommunication costs have fallen rapidly but the impact has been quite different for different tasks

may be due to the organisation of tasks within offices and factories

this organisation has changed more slowly

but: at some point (tipping point) cheap communication costs line up with new management technology and a new task can be offshored to a lower cost location

individuals, not firms, sectors or skills groups

forces of globalisation now achieve a far finer resolution

international competition will increasingly play itself at the level of tasks within firms

new paradigm competition is on a much more individual basis

compare with first unbundling

firm-against-firm competition was globalisation’s finest level of resolution

firms as black-box bundles of tasks

in sectors where backward and forward linkages among firms were important, a nation’s sector could be viewed as a bundle of firms whose joint actions determined the sector’s competitiveness

the competition was sector-against-sector

individual firms who were not competitive on a stand-alone basis might still prosper due to the agglomeration economies flowing from their location

implications for policy

first unbundling saw primary education brought into the public sector and radically transformed

governments realised that farm and factory require different skill sets

but: as farmers moved to factories, new vagaries faced them – redundancies, inflation, and more

part of the reaction was to establish welfare states
equally important was the establishment of labour organisations

likewise, the new unbundling will require a revamp of education policies, welfare states, and labour organisations

education

Children must learn how to learn while they are learning reading, writing, and arithmetic

new wave is associated with much greater uncertainty, so flexibility is the key to allowing Europe to seize the opportunities of globalisation while minimising the adjustment costs

stronger families

dysfunctional families retard the formation of the abilities needed for successful performance in modern society

Europe needs stable families, especially those with young children

Better structured trade unions

today’s trade union structure arose in the first half of last century

not always the most appropriate for the new wave

shocks are no longer mainly associated with skill groups or particular sectors

globalisation operates at a much great resolution

trade unions either need to become more narrowly focused
or more broadly focused

Sterling takes a royal pounding - FT.com

2008-09-03T23:43:00.003+01:00

Summary:
In the UK, high borrowing costs, a painful housing market correction and losses in the financial sector mean most of the UK's assets have been dramatically revalued down. Sterling has suffered as a result. However, was overvalued. Sterling s likely to fall further in the long run, as the North Sea fields wind down and the UK imports more oil and gas. Questionable government schemes have reduced confidence in the pound. Bank of England, needs to worry about weaker pound, not government. The MPC must now contend with rising import costs. Weakness of sterling means the Bank will need tighter monetary policy than would otherwise be necessary to bring inflation back down to the target of 2 per cent from its August level of 4.4 per cent. (Published: 03/09/08)

Summary:

UK is exposed in three ways to the aftermath of the credit squeeze

has heavily overvalued housing
has most indebted consumers in the world
has an economy that is peculiarly reliant on financial services

high borrowing costs, a painful housing market correction and losses in the financial sector mean most of the UK's assets have been dramatically revalued down

Sterling has suffered as a result

is now trading at levels closer to those it plumbed in the aftermath of Black Wednesday than to the highs of last summer

shift was inevitable: pound was overvalued last year

moving away from growth based primarily on consumer and business spending at home to an equilibrium that encourages more exports is a necessary correction

on a real trade-weighted basis, the pound is now at its historic average

is likely to fall further in the long run

as the North Sea fields wind down and the UK imports more oil and gas

big danger is that a weak government will resort to more of the panic measures that have done such damage to confidence in the UK over the past 12 months

Bank of England, needs to worry about weaker pound, not government

the MPC must now contend with rising import costs

weakness of sterling means the Bank will need tighter monetary policy than would otherwise be necessary to bring inflation back down to the target of 2 per cent from its August level of 4.4 per cent

Oil refining byproduct becomes a hydrogen goldmine - R&D Magazine

2008-09-03T22:37:00.003+01:00

Summary:
A commercial-scale process to extract and reuse pure hydrogen from the hydrogen sulfide that naturally contaminates unrefined oil, including oil sands, has been developed by a collaboration between the U.S. Dept. of Energy's Argonne National Laboratory and Kingston Process Metallurgy Inc. (KPM) of Kingston, Ontario. It is less energy- and capital-intensive that existing processes, such as the Claus process. The reactions between the hydrogen sulfide and copper and the copper sulfide and air release energy that helps to heat the system. It produces sulfuric acid as a byproduct and is resistant to contaminants such as ammonia and various hydrocarbons, converting them to their elemental state instead. Thus far this process has only been demonstrated in the lab. A pilot scale reactor will be developed next. (Published: 03/09/08)

Notes:

hydrogen sulfide present in crude oil and raw natural gas

conventionally removed using Claus process, invented more than 100 years ago

energy- and capital-intensive

limited in terms of the other types of impurities it can handle

costly energy-intensive modules that scrub other contaminants, such as ammonia, methane and carbon dioxide from raw oil and natural gas must be separately attached to Claus processing facilities

loses the hydrogen in the process

gets converted into water

Argonne and KPM method

centered around a molten copper reactor

innovative process technology that is more energy-efficient than existing methods

in the reactor, hydrogen sulfide gas is first separated from the crude oil stock, using technology already in place

this gas is then bubbled though molten copper

releases pure hydrogen

the hydrogen is then captured for use as a valued product
as the sulfur reacts with the copper, the copper is gradually turned into copper sulfide

in addition the process creates concentrated sulfuric acid

used widely in the chemical industry and which has become a valued agricultural commodity
the concentrated sulfuric acid is created when copper sulfide is reacted with air to recover the pure copper

releases a concentrated stream of sulfur dioxide which is then reacted with water
the copper is then reused in the process with negligible losses

the reactions between the hydrogen sulfide and copper and the copper sulfide and air release energy that helps to heat the system

enables the products to be efficiently harvested
system operates at a temperature of about 1,200 degrees Celsius

contaminants such as ammonia and various hydrocarbons are reformed to their elemental constituents

demonstrated in lab

next step is to develop a pilot scale reactor

Companies will be able to retrofit their facilities with the process technology or construct new plants that incorporate it

China's next gold - FT.com

2008-09-03T20:35:00.002+01:00

Summary:
China's rise as a manufacturing powerhouse should be no cause for hysteria. Above all, it is a story of human progress: millions of Chinese are being lifted out of poverty each year by the country's rapid economic growth. Furthermore, consumers in developed countries benefit from the "China price". Competition from China may lead to job losses, but so can competition from across the street or new technology. This merely reinforces the need for the governments of rich countries to help workers who have lost their jobs, just as they should also be providing business-friendly regulations and infrastructure, and an excellent education system. Bankruptcies and job losses are part of the incessant process of economic change. The developed world needs to continue to increase the quality and sophistication of its manufactured products. The true challenge posed by China as the workshop of the world is likely to be environmental: by buying so many products from China, we have moved greenhouse gas emissions to a place where they will not be curbed by the schemes of western regulators, and where they make a wonderful excuse for western inaction. China must be persuaded to play its part in global efforts to cut emissions. (Published: 12/08/08)

Notes:

China is poised to overtake the US as the world's largest producer of manufactured goods

no cause for hysteria

good news far outweighs the bad

e.g. in China itself:

millions of people are being lifted out of poverty each year by the country's rapid economic growth
a story of human progress

too rarely acknowledged by those who fear China

e.g. developed world

citizens benefit from the "China price" as consumers

competition from China can drive businesses under and destroy jobs

but: so can competition from across the street, or from new technologies

China's success reinforces the long-standing need for the governments of rich countries to help workers who have lost their jobs

just as they should also be providing business-friendly regulations and infrastructure, and an excellent education system

bankruptcies and job losses are part of the incessant process of economic change

they would only be cause for a systemic worry if there was evidence that the developed world could not adapt to Chinese competition

so far, there is little sign of that

instead, the developed world continues to increase the quality and sophistication of its manufactured products

the US willingly pays four times the Chinese price for electronics and machinery from other developed countries

15 years ago it would pay only three times

suggesting that developed-country manufacturers are shifting towards ever more sophisticated goods

true challenge posed by China as the workshop of the world is likely to be environmental

by buying so many products from China, we have moved greenhouse gas emissions to a place where they will not be curbed by the schemes of western regulators, and where they make a wonderful excuse for western inaction
China must be persuaded to play its part in global efforts to cut emissions;

that task will be far harder than meeting the challenge of Chinese competition

Quote of the Day

2008-09-03T20:21:00.001+01:00

“Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works”. - John Stuart Mill

Entrepreneurs versus corporate managers - IMD

2008-09-03T18:48:00.003+01:00

Summary:
An IMD study looks at the main differences between entrepreneurs and corporate managers. Key differences: 1) Long-term/short-term decision making. Contrary to expectations, entrepreneurs proved to be the group with the greatest focus on building a long-term business. Corporate executives operated far more from a monthly or quarterly framework. The reason behind this difference is that an entrepreneur ends up creating an end result – a product, market or firm – which looks very little like what they started out to accomplish in the first place. The big difference is in the goal of trying to create something big and enduring. 2) Marketing information. Entrepreneurs tend not see the point of such information. To them, market research lies in the principle of the proof of the pudding being in the eating. Under this line of thought, positive market feedback consists of trying to sell something and being successful – and negative feedback the opposite - being unsuccessful at selling something which therefore requires some re-thinking. 3) Money. Entrepreneurs showed themselves to be far more cost conscious than their corporate counterparts – who were much more willing to throw big budget at things with uncertain outcomes. 4) Competition. Where corporate executives were seen to be highly focused on the competition, entrepreneurs are far more concerned with whom they can establish solid partnerships - almost to the exclusion of worrying about competition. (Published: August 2008)

Globalization: Where to from here? - Rogue Economist Rants

2008-09-03T13:17:00.004+01:00

Summary:
Rogue Economist argues that global inflation is the result of the type of globalization that we witnessed in the past three decades, a very different from kind of globalization from what we have seen in previous periods in history. Whereas before, globalization was really nothing more than global trade among nations, in the last 30 years it also involved the outsourcing of businesses activities, from manufacturing to back-end processes. Initially this led to increased productivity for the developed nations: increased profitability for the firms, and lower prices for consumers. Newly created wealth looking for investments led to bubbles such as the sub-prime crisis. More recently, the outsourcing of back-end process led to higher pay for workers in developing countries, creating demand for the same goods (previously unaffordable). Governments started to invest trade surplusses in much needed infrastructure projects. Both the increased demand and the increased number of infrastructure projects led to globally inflationary prices. Developed countries have become consumerist economies, where outsourcing has led to stagnant wages for many. So far that has been mitigated by lower prices of goods. (Published: 20/08/08)

Notes:

globalization of last three decades very different from kind we have seen in previous periods in history
before: really nothing more than global trade among nations

nations with a comparative advantage in producing one good exported a surplus to other countries, in exchange for goods where these other countries had a comparative advantage
this increased the diversity of products available in all countries that participated, not to mention enriched many parties who facilitated such trades

past three decades: the distribution and outsourcing of business processes of large corporations into different countries

i.e. it is not the physical trading of end products, but the parceling of different corporate activities of single corporations into different locations

mainly to arbitrage differences in cost, expertise, and logistical practicality

was the next logical step in the globalizing of business

companies that traded in different localities would, in the process of conducting their businesses, discover different ways to enhance profitability, productivity, and to differentiate themselves from the competition
in the process of doing so, major activities were uprooted from their home countries and transferred to other countries that could offer lower input labor costs

first to be outsourced were basic manufacturing processes

then it led to the outsourcing of more complicated production processes

eventually to the outsourcing of the back office work that facilitated the corporate administration of the business itself

latest to be outsourced has included even the more expensive research, analysis, and design of the products of these companies

outsourcing of manufacturing

outsourcing of corporate activities to countries where they could be done more cheaply has led to huge increases in the productivity of the outsourcing companies

were able to lower the selling price of their products

thereby making them affordable to a larger number of consumers in their home countries

lower cost likely also led to significant increases in profitability of these same companies

translated into newly-created wealth for their shareholders

increased productivity and lower prices

led to new wealth in the developed countries

these became funds that could be released for new ventures and businesses

because the prices of goods were going down in these developed countries, excess discretionary income was created for the consumer

led to opportunities for newer businesses

created new jobs and new opportunities for the locals

many who would otherwise have wallowed in poverty working in the farm now found work in the new industrial sites being set up
globalization has been a boon for countries with rapidly growing populations

these population increases would have been catastrophic had it not been for globalization
only so much work to be done in the farm
many of these people would be unemployed if not for the new factories

low-cost labor was therefore in plentiful supply for the outsourcers

for as long as new people arrived to staff new capacity, these outsourcers could secure a continuous outflow of cheap goods

but: has had a lot of enemies from countries from both sides of the deal

the ones that lost the jobs

significant portions of their population lost jobs, and continue to be displaced by this phenomenon

but: influx of new businesses likely created new jobs for many of the displaced

these new businesses likely were not as labor-intensive as before, but rather smaller, and tended to focus on the small niches created by rising discretionary income
but: because of the downward effects of the globalization of processes, many of the displaced and existing workers in the developed countries could no longer demand increasing wages from their employers

because much of the work they did could now be standardized, codified, and therefore, be done in any other place in the world, this constrained their ability to negotiate increasing amounts of compensation
for a while, the decreasing cost of goods mitigated this stagnation in wages

and the ones that got them

because labor was plentiful, they were never paid the same as they would have been had they been in the companies’ home country

was the point of locating the factory there in the first place, so they could secure cheap labor
result: no significant market arose in the developed markets for the very products these factories and companies were creaking out

but: began to change when relatively more middle class range of services began to be outsourced:

the back office work

new wealth

corporate shareholders continued to enjoy increasing profits

whether they invested in developing countries directly, or indirectly, through their companies that outsourced to those countries

much of this new-found wealth needed to be re-invested

not everything was re-invested in the same business or to the developing countries
needed to diversify

so they invested some in their own countries
but: fewer investing opportunities available to them domestically

because much of the capital-intensive production facilities were already being set up in developing countries

fewer business opportunities than available funds

therefore: money began to flow to speculative assets

stocks, property, financial instruments, etc

for as long as new money poured into these assets, they increased in value

seemed to be sensible thing to do

bubble after bubble therefore arose in many of these assets.

froth

once a significant froth develops in an asset, there has to be a correction

these investible funds have grown exponentially

both because of continuing profitability of the globalized businesses
and because the continuing profits in assets that appreciated in value created more funds

because of the current size of the outstanding investment, the froth has lately become very big, and very speculative

e.g. sub-prime capital market that recently burst in the US

a market for an asset class invested in by funds in other developed markets looking for yield

this latest contagion has the potential to undermine the rest of the other-wise still humming economies of these developed countries

because of the size of the losses, and the growing inter-connectedness of the financial markets in the developed economies

global inflation

outsourcing of back-office jobs

paid more than the traditional factory work

was a boon for the next generation of Third World workers

i.e. the ones who had gone on to higher education, thanks to the money earned by their parents or older brothers and sisters employed in the industrial factories

demand was created for more of the middle class luxuries previously unaffordable there

this increased demand led to inflationary prices for these goods

because these goods were marketed globally, this led to global inflationary prices

trade surplusses enjoyed by governments

nations whose manufactured goods were affordable in many developed nations, but had a citizenry who could not afford much of what was being produced elsewhere

ringing year after year of trade surpluses
much needed infrastructure developments projects got under way

too many countries investing in infrastructure projects, all at the same time

leads to inflationary prices for all input costs

this is where we are in the world right now

developed countries have morphed into consumerist economies

have enjoyed years of increasing productivity gains due to outsourcing

outsourcing may have led to stagnant wages for many

but the declining price of goods immediately resulting from it has pretty much mitigated its effect

have an investor class increasingly bowed by an increasing pile of liquidity and cash

but not enough useful investments to put them into
much of this wealth will probably be invested in low-yielding placements, or worse, in investments that will lose significant value

developing nations

people are only now beginning to afford First World luxuries
but: not in significant enough numbers as to replace the loss of business with a major trading partner

increasing global inflation

due to the slowly increasing number of people demanding the same products

driving up the scarcity of certain commodities

The four horsemen of the market - MarketWatch

2008-09-03T10:07:00.004+01:00

Summary:
Views of Jeremy Grantham, Bob Rodriguez, John Hussman and Steve Leuthold. Grantham believes the market fundamentals are very bad, in for two years of disappointment. No time to take risks. Reason is global economic growth is slowing under the weight of increasingly illiquid credit markets and inflationary pressures. Slashes corporate earnings, resulting in poor to middling for equities worldwide. Stocks in both developed and emerging markets are "substantially overpriced." Also concerned about sputtering growth of China. Rodriguez is on "buyer's strike" regarding high-quality bonds with maturities greater than two years. Believes that longer-term Treasury yields aren't substantial enough to compensate investors for inflation's eroding impact on purchasing power. Continues to focus on "caution and capital preservation." Hussman said he's looking for another shoe to drop once investors recognize that the U.S. has not avoided recession. U.S. is mired in recession, and once investors realize that earnings expectations are overblown, stocks will take another major hit. Leuthold is pretty positive. Believes bottom has been made. Economy is going to start showing some positive signs sometime in the first half of 2009. Iis getting in early: loading up on shares of biotechnology and alternative-energy companies in particular. (Published: 29/08/08)

Notes:

Jeremy Grantham

chief investment strategist at GMO

highly regarded Boston-based manager of institutional and high-net-worth accounts

makes buy and sell decisions with a combination of computerized technical analysis and old-fashioned spadework

but: nowadays, digging for attractively valued stocks is mostly hitting rocks

"The fundamentals have turned out to be worse than I had thought. My advice would be, don't take any risk."

i.e. in this market, don't be a hero; live to fight another day

reason:

global economic growth is slowing under the weight of increasingly illiquid credit markets and inflationary pressures

weaker growth slashes corporate earnings

since stock prices are tied to earnings, the outlook for equities worldwide is poor to middling

"Stocks in both developed and emerging markets are "substantially overpriced," with the possible exception of high-quality blue-chip companies that have strong, defensible global franchise."
"I underestimated in almost every way how badly economic and financial fundamentals would turn out. Events must now be disturbing to everyone, and I for one am officially scared!"
biggest fears: that "the whole global economy will be weaker than the market expects for quite a considerable time."

How long? "I would guess at least two years of sustained disappointment."

particularly uneasy about China

leading engine of world growth seems to be sputtering
"I worry on behalf of the global economy at the consequences of China stumbling, the whole level of global imports and exports would start to drop."

Bob Rodriguez

manager of FPA Capital Fund and bond-focused sibling FPA New Income Fund
"He's not naturally the most optimistic person you'll ever chat with. Even in the best times he's looking for the gray lining in a silver cloud. That's one of the reasons you invest with him."
on a self-proclaimed "buyer's strike" regarding high-quality bonds with maturities greater than two years.

believes that longer-term Treasury yields aren't substantial enough to compensate investors for inflation's eroding impact on purchasing power
wants to get 5% on 10-year Treasurys before venturing back

recently yielded 3.8%

"We will not provide long-term capital to borrowers with unsound and unwise business management practices at unattractive real yields. We require a higher level of compensation -- i.e. more yield, for these potential risks."

continues to focus on "caution and capital preservation"

John Hussman

runs two portfolios: stock-focused Hussman Strategic Growth Fund and bond-centric Hussman Strategic Total Return Fund

both are run with a careful eye to valuations and broad economic conditions that dictate the degree of market risk that Hussman is willing to accept

for Hussman nowadays, risk-taking doesn't offer much reward

"We're fully hedged"

meaning that a portfolio won't be affected, positively or negatively, by market gyrations

reason: Hussman said he's looking for another shoe to drop once investors recognize that the U.S. has not avoided recession

"The stock, bond and foreign-exchange markets continue to trade essentially on the theme that the global economy is weakening, but that the U.S. has dodged a recession."
Investors' consensus is mistaken, Hussman contends

"U.S. is mired in recession, and once investors realize that earnings expectations are overblown, stocks will take another major hit."

"The potential downside could be abrupt, leaving little opportunity to make defensive changes after the fact"

Steve Leuthold

flagship funds include Leuthold Core Investment Fund and sibling Asset Allocation Fund

has offered targeted portfolios with catchy names like the bear-market Grizzly Short Fund (GRZZX) and the bottom-fishing Undervalued and Unloved Fund (UGLYX)
convinced that the U.S. economy is in recession

but: points out that the stock market typically bottoms around the midpoint of the downturn
reckons the economy entered recession toward the end of 2007
the extensive valuation criteria he uses tell him there's now light at the end of the tunnel

"The bottom has been made. The economy is going to start showing some positive signs sometime in the first half of 2009."
is getting in early

loading up on shares of biotechnology and alternative-energy companies in particular
keeping a modest amount in oil drillers and natural gas producers

Quote of the Day

2008-09-02T21:02:00.002+01:00

"A lot of people in the car industry - and this is a seachange since the 1990s - have come to see dependence on gasoline as the growth bottleneck in the industry's future. They think that the real constraint on the ability to grow the car market will be dependence on a fuel that causes global warming, that puts money in the pockets of dictators, that has enormous price volatility and so forth. So they want to get off gasoline, because they now see it as a limit to their future prospects." - Jonathan Rauch, in an interview with Russ Roberts on EconTalk discussing the Chevy Volt

Snake Oil and Deflation - RGE Monitor

2008-09-02T15:25:00.002+01:00

Summary:
London Banker argues that the core problem leading to the current seizure of the credit markets is the misallocation of credit into unproductive works during the boom years. Markets all over the world carelessly followed the path of under-production, dis-savings and over-consumption as the path to prosperity. No amount of new credit will solve the problem unless the distortions promoting misallocation are redressed through fiscal and regulatory policy changes. Bailouts and recapitalisation of failed policies of the past are only digging a deeper hole, betraying more capital of younger generations into the unproductive works financed by the current generation. Correcting the bias toward betrayal of capital will not be popular or easy. Correcting the bias toward unproductive investments will require a massive change of political structures, financial intermediation channels, savings and consumption habits, and economic incentives. Savings must be encouraged and must be allocated to productive investments that will yield not just future prosperity but social equity to minimise political conflicts. But those who sold us or imposed on us the current set of policies and practices will be re-bottling their snake oil under new labels. (Published: 08/08/08)

Notes:

“Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works”. - John Stuart Mill
obvious facts

borrowing short through commercial paper to lend long on mortgages and credit cards to bad credits with inadequate collateral is not a sound business model

yet somehow the alchemy of securitisation with a sprinkling of AAA pixie dust was widely accepted as turning financial lead into gold

a house, once built, is not a productive asset as it produces no revenue but instead absorbs a high proportion of its owner’s income on mortgage interest, property taxes, maintenance and utilities
credit card debt, once consumption goods are purchased, produces no productive income stream for repayment of the debt but instead becomes an obstacle to future consumption as debt service eats up a rising proportion of stagnant wages
a car that weighs twice as much and uses twice as much fuel is not as productive as a car that is small and fuel efficient, and costing twice as much will harm more productive savings and investment with the excess debt borrowed for its purchase
the financial sector, as intermediaries between savers and productive ventures requiring capital, should never rise to the point where it alone represents over thirty percent of economic activity

Nonetheless:

markets all over the world carelessly followed the path of under-production, dis-savings and over-consumption as the path to prosperity,

in fact: path to a betrayal of capital into hopelessly unproductive works

core problem leading to the current seizure of the credit markets is the misallocation of credit into unproductive works during the boom years

no amount of new credit will solve the problem unless the distortions promoting misallocation are redressed through fiscal and regulatory policy changes
bailouts and recapitalisation of failed policies of the past are only digging a deeper hole, betraying more capital of younger generations into the unproductive works financed by the current generation

Correcting the bias toward betrayal of capital will not be popular or easy

correcting the bias toward unproductive investments will require a massive change of political structures, financial intermediation channels, savings and consumption habits, and economic incentives

challenge virtually every assumption made by at least two generations of American businessmen and consumers and exported globally

Regulatory policies promoting misallocation of capital

elimination of restrictions on bank dealing and brokerage of securities and derivatives
self-determined models-based capital adequacy calculation
ratings-based weightings of capital assets
accounting reforms that permitted off-balance sheet financings
acceptance of ill-transparent corporate structures

Savings must be encouraged and must be allocated to productive investments that will yield not just future prosperity but social equity to minimise political conflicts.
Those who sold us or imposed on us the current set of policies and practices will be re-bottling their snake oil under new labels.

We must be wary before buying bulk lots in the tens of billions of dollars worth of the same old snake oil that has sickened our economies and political processes already.

In the US: bailouts of Bear Stearns/JPM and Freddie/Fannie; perpetuates the subsidies to speculation and unproductive housing markets.
In the UK: talk of a cut in stamp duty (a transfer tax on house sales)

Snake oil, unfortunately, wins elections because it appeals to constituencies that are politically important

as a result, we may be entering a dangerous phase where the democratic structures are biased to economically damaging policies that further harm future growth and prosperity

because investment in unproductive works is so widespread as to form part of the popular culture

Too much risk? - Interfluidity

2008-09-01T23:19:00.002+01:00

Summary:
Steve Waldman argues against the conventional wisdom that the financial system took on "too much risk" in recent years. Hundreds of billions of dollars were poured into new suburbs, while very little capital was devoted e.g. to the alternative energy sector. Capital was withdrawn from a variety of industries deemed "uncompetitive", because to gamble on recovery is far too great a risk. Big central banks, whose investment largely drove the credit boom, were (and still are) seeking safety, not risk. The housing boom was born less from inordinate risk-taking than from the unwillingness of investors to take and bear considered risks. Huge institutions are treating the financial system like a bank: depositing trillions in generic "safe" instruments and expecting wealth to somehow appear. A generation of professionals were trained to forget that investing is precisely the art of taking economic risks, then delivering the goods or eating the losses. Investors' childlike demand for safety has made the financial world terribly risky. We must not pretend that risk can be regulated or innovated away. (Published: 07/08/08)

Makeover Mandated for U.K. Life Science Sector - GEN

2008-09-01T18:38:00.004+01:00

Summary:
UK Trade and Investment (UKTI) believes that the UK biotech industry’s recent battering by the press gave a very one-sided view of the true international potential of the country’s life science sector. Not only is the UK second to the U.S. in terms of biotech industry size but it leads Europe with its pharmaceutical exports. But the U.K. has been slow in publicizing its strengths. Therefore, the UKTI was charged by the government with marketing the U.K.’s life sciences internationally. The result was the UK Life Science Marketing Strategy which was drafted earlier this year. Workstreams aim to optimize how U.K. academia and industry sells itself internationally, in terms of comprehensive and consistent messaging, financing (using marketing to increase the amount of international VC funding in the U.K.), and also how best to communicate with potential partners and investors in key countries. A tool kit has been developed that will allow any UK life science company to access and take the most relevant messages with them in terms of UK innovation, support industry, tax incentives, and academic background. UKTI and the Strategy Implementation Board hope that executing and further developing the U.K. life science market over the next five years will significantly boost the country’s standing within the international arena, increase inward investments, business, and collaborations, as well as make the U.K. industry a more cohesive force. (Published: 01/09/2008)

VC Funding for Biotech Companies Withering - GEN

2008-09-01T16:26:00.003+01:00

Summary:
Despite an abundance of funding as well as scientific and technological progress, the environment for investing in the life science industry seems to have changed dramatically. The change has been most dramatic for the biotech sector. In theory, the level of VC investments made in life science at any time should not be significantly affected by short-term fluctuations in stock market activity or the economy. Drought of new public money coming into venture-backed companies through IPOs, however, as well as increasing caution on the part of acquirers have biotech venture investors hanging on tighter to their wallets and checkbooks. Money is still there but it is going to be harder for biotechnology companies to obtain. Particularly true given the increased competition for investment with medical device and equipment companies as well as new competition from biofuels and alternative energy companies for investment dollars. (Published: 01/09/2008)

Notes:

Q1 2007: record highs in venture investments in biotechnology, medical device, and healthcare firms

average investments in these areas maintained nearly the same levels through the end of the Q1 2008

Q2 2008: venture investing in general made a major downturn

no public offerings of any venture-backed company
life science

far fewer venture dollars went to a smaller number of life science companies
in Q1, U.S. life science venture capital firms made 315 investments aggregating nearly $3 billion
in Q2, there were 215 such investments aggregating $1.9 billion

biotech: change even more dramatic

number of biotechnology venture backings fell by nearly 50% (to 89 investments)
dollar amount invested fell by more than 40% from Q1 ($919m vs. $1.5b)

outside the U.S., the venture financing value fell nearly 50% in the same period

proportion of life science dollars going to biotech has also shifted compared to medical devices and equipment as well as other healthcare ventures

biotech firms’ share of investments made in the life science industry fell to below 40% from approximately 45% in 2007

average amount invested in biotechnology, though, remained high in Q2

more than $10 million
investments have ranged from $8.4 to 11.8 million over the past six quarters

Factors behind the change

biotechnology investments, like most venture capital investments, are inherently risky

in today’s uncertain economic climate, many investors are opting to sit out and wait for more certainty in the market before they invest

biotech investments generally take longer to mature than nonbiotech investments

for those life science investors who are nervous about the long term in the current environment, investments that have a shorter return time, such as those in medical devices and other healthcare ventures, have become more attractive

emergence of clean energy as an alternative investment category that is growing in favor with long-term investors

venture capitalists whose portfolios include longer-term investments are shifting their dollars from biotechnology to solar energy, wind power, and other sustainable energy solutions

constriction/lack of liquidity in the public equity markets

compare

in 2007 there were 31 IPOs of life science companies, 11 of them for biotechnology companies.

in the first half of 2008, four life science firms including one biotech, Bioheart, made IPOs

decline may result from a number of factors some of which are not specific to life science investing

general investor apprehension
the debt crisis
Sarbanes-Oxley and related regulations

lack of liquidity in the public markets has also resulted in public companies taking on private investments from venture capitalists

e.g. Cadence Pharmaceuticals, Antisoma, Xanthus Pharmaceuticals
investment of venture capital into public companies and later-stage private companies means that even less is being spent on early-stage companies

lack of liquidity in the U.S. markets has also led a number of biotechnology companies to go public through the London Stock Exchange’s Alternative Investment Market (AIM)

life science acquisitions have also taken a beating

compare:

47 venture-backed life science companies were acquired in 2007
only 12 have been taken over in the first half of this year, eight of which were acquired in the first quarter

take-over values down from 2007

total value of the 36 acquisitions made last year for which transaction values were made public was $7.4 billion
so far this year, the aggregate amount of the seven deals for which financial terms were disclosed was $2.2 billion.

in theory, the level of VC investments made in life science at any time should not be significantly affected by short-term fluctuations in stock market activity or the economy

drought of new public money coming into venture-backed companies through IPOs, however, as well as increasing caution on the part of acquirers have biotech venture investors hanging on tighter to their wallets and checkbooks.

money is still there but it is going to be harder for biotechnology companies to obtain

particularly true given the increased competition for investment with medical device and equipment companies as well as new competition from biofuels and alternative energy companies for investment dollars

Asia and Global Stagflation - Vox EU

2008-09-01T15:16:00.004+01:00

Summary:
Barry Eichengreen argues that Asia needs tight money, appreciated exchange rates, and fiscal stimulus. Despite the growth of inter-Asia trade, Asian economies are not decoupled from the West, as latter is buyer of final product. As growth in Europe and US is coming to standstill, will have impact on Asia. Nor is Asia being spared from turbulence in credit markets. In addition, Asia has imported inflation from the US by following the Fed's rate cuts. Asian economies need demand restraint but got demand stimulus instead. Inflation rates at 10 year highs. Now negative real interest rates in many Asian economies: unhealthy subsidy for borrowing by households and firms, artificial stimulus to consumptioin. Caused Asian crisis 10 years ago. Central banks need to increase interest rates. Alternative will be even more painful increases later. Will push up exchange rate and slow down economy. Asia can sustain demand under these circumstances by means of fiscal policy: tax cuts and increases in public spending on locally-produced goods. (Published: 19/06/2008)

Notes:

Asian developing economies not decoupled from rest of the world

despite growth of inter-Asia trade, West ultimately needs to buy their final product

but: growth in US and Europe slowing to standstill

Asia also negatively affected by turbulence in credit markets

spreads greatly increased between August 2007 and Feb 2008

Philippines: 200 base points
Indonesia: 131
Korea: 93
China: 70

declined after Bear-Stearns rescue

growth will not stop, but slowdown is likely
new development, in addition to slowdown: acceleration of inflation

April headline inflation for Asia ex Japan: 7.5% (core: 4.5%)
10 year high

origin of Asian inflation

came from US: sharp rate cuts by Fed in response to subprime crisis

Asian countries followed in order to prevent appreciation of their currencies

cuts were not appropriate for Asia

last thing needed in Asia is lower interest rates
Asian economies need demand restraint but got demand stimulus instead
causes inflationary pressure

additional factors are geopolitical uncertainty, oil-market speculation, bad weather and ethanol programs

affect headline inflation

failure of Asian central banks to tighten more aggressively in turn tends to re-export inflation back to the West

what Asian economies should do

should raise rates

higher interest rates will push up the exchange rate and damp down inflation

have been half-hearted efforts in this direction, but they have not done the job

negative real interest rates!

Indonesia: central bank rate is 8.5%, inflation rate above 10%
Philippines: central bank rate is 5.25%, but inflation rate is 10%.
Vietnam: central bank rate is 14%, but its inflation rate is 25%.

negative real interest rates make no sense in Asia

because they are growing at or near capacity
negative real rates are an unhealthy subsidy for borrowing by households and firms

they encouraged inefficient investment and excessive leverage in Asia in the first half of the 1990s

was followed by Asian crisis

negative interest rates and their artificial stimulus to consumption and investment are also reason why we haven’t seen more of a slowdown in Asia

reason why we haven’t seen more recoupling.

but: now that Asian central banks are being forced to tighten, we will see more evidence of their economies slowing down

Asian currencies will appreciate against both the dollar and the euro

Although the Fed and the ECB may raise rates as well, both inflation and growth are weaker than in Asia, so they will have reason to respond more moderately

alternative to painful interest rate increases now will be even more painful increases later

Asia can sustain demand under these circumstances by means of fiscal policy

tax cuts and increases in public spending on locally-produced goods will limit the contraction of aggregate demand
will push up the exchange rate still further

as they stimulate the demand for locally-produced goods

will moderate the rise in import prices and further contain inflationary pressure

should be calibrated to US and global slowdown
should be explicitly temporary

apart from case of China perhaps

conclusion: Asia needs tight money, higher exchange rates, and fiscal stimulus

has been Argued by Bush administration for last three years
but: now need for a change in the Asian policy mix is more urgent than ever

The sacred mystery of capital - Prospect Magazine

2008-08-31T17:50:00.005+01:00

Summary:
Julian Gough compares capitalism and modern economics to religion. The advance of science has removed the divine mystery from much of life, but in the past 30 years, the advance of free market capitalism has put it back. Only modern economics can now provide forces that we don’t understand. Modern high finance, like the Latin of the Christian Church, has profound mysteries at its core. Not even bankers know what a collateralised debt obligation cubed really is. The abandonment of the gold standard in 1971 was the crucifixion and resurrection of capitalism; the traumatic and liberating event which allowed capitalism to be purely religious and entirely driven by faith. As with all religions, once its link to the physical world was severed, free market capitalism mourned briefly, then experienced a surge of energy and expansion. From "fiat lux" to “fiat money.” But as with all religious expansions, success bred hubristic dementia. The elevation of metaphysical above physical turned into a kind of contempt for the physical. (Published: July 2008)

Five most important lessons I've learned as an entrepreneur - Guy Kawasaki

2008-08-26T14:19:00.003+01:00

Summary:
Guy Kawasaki gives a list of five things he learned from being an entrepreneur: focus on cash flow; make a little progress every day; try stuff; ignore the schmexperts; never ask anyone to do something that you wouldn't do. (Published: 18/08/08)

Notes:

Focus on cash flow

cash is what keeps the doors open and pays the bills
paper profits on an accrual accounting basis is of no more than secondary or tertiary importance for a startup

Make a little progress every day

wrong: big-bang theory of marketing

fantastic launch that creates such inertia that you flow to "infinity and beyond"
press writes about "overnight successes" because they seldom happen, not because that's how all businesses work

correct: make a little progress every day

making product slightly better, increasing your skill in one small way, closing one more customer, ...

Try stuff

wrong: better to be smart than lucky, because if you're smart, you can out-think the competition
correct: luck is a big part of many successes

two consequences

don't be too bummed out when you see a bozo succeed

luck favours the people who try stuff, not simply think and analyze

Ignore schmexperts

i.e. the bad combination of schmucks who are experts, or experts who are schmucks
when you first launch a product, they'll tell you it isn't necessary, can't really work, faces too much competition, ...

Never ask anyone to do something that you wouldn't do

goes for customers to employees

e.g. "fill out these 25 fields of personal information to get an account for our website"
e.g. "fly coach to Mumbai, meet all day, and fly back that night"

if you follow this principle, you'll almost always have a good customer service reputation and happy employees.

Lessons from a “lost decade” - The Economist

2008-08-26T14:09:00.003+01:00

Summary:
Some major differences between the US housing bubble and Japan's bubble in the early 90s are overstated. They were comparably severe, and the Japanese policymakers were not slower than American ones to cut interest rates and loosen fiscal policy after the bubble burst. In a way, the US is even more exposed than Japan was, due to a much lower savings rate among the population (more difficult to prop up consumer spending). There are a number of advantages the US today has over Japan back then. The US regulatory system, financial markets and political structure are more transparent, pressing banks into recognising losses and repairing their balance-sheets quicker. The cost of its housing bust is spread across other countries, with foreigners holding a large slice of American mortgage-backed securities and sovereign-wealth funds have provided new capital for American banks. American exports are booming, thanks in part due to a cheap dollar. (Published: 21/08/08)

Notes:

Japan's decade of stagnation

followed property bubble

burst in early 1990s

was fueled by cheap money and financial liberalisation
people assumed property prices could not fall nationally

when property prices fell borrowers defaulted and banks cut their lending
result was decade with average growth of <1%

some difference between US and Japanese situations are overstated

no major difference in relative size of property bubbles

America's house prices actually rose more and are likely to fall further

Japanese home prices have since fallen by just over 40%
American prices already down by 20%, many economist expect another 10%

Japan's commercial property boom was smaller than America's

Japan had stockmarket bubble bursting year earlier than in property

hurt banks, because they counted part of their equity holdings in other firms as capital
but its impact on households was modest, because only 30% of the population held shares, compared with over half of Americans.

Japanese policymakers not slower than American ones to cut interest rates and loosen fiscal policy after the bubble burst

BoJ began to lower interest rates in July 1991, soon after property prices began to decline.

discount rate was cut from 6% to 1.75% by the end of 1993

two years after American house prices started to slide, the Fed funds rate has fallen from 5.25% to 2%

Japan gave its economy a big fiscal boost

the cyclically adjusted budget deficit increased by an annual average of 1.8% of GDP in 1992 and 1993

similar to America’s budget boost this year

Japan’s monetary and fiscal stimulus did help to lift the economy

after a recession in 1993-94, GDP was growing at an annual rate of around 2.5% by 1995

but: deflation also emerged that year

pushing up real interest rates and increasing the real burden of debt

from here on that Japan made its biggest policy mistakes

in 1997 the government raised its consumption tax to try to slim its budget deficit

with interest rates close to zero, the BoJ insisted that there was nothing more it could do

only much later did it start to print lots of money

America’s inflation rate of above 5% is an advantage

not only are real interest rates negative

inflation is also helping to bring the housing market back to fair value with a smaller fall in prices than otherwise

in a way, America is more exposed than Japan was

when its bubble burst in 1991, Japan’s households saved 15% of their income

by 2001 saving had fallen to 5%
helped to prop up consumer spending

America’s saving rate of close to zero leaves no such cushion

monetary and fiscal relief were necessary but not sufficient to revive Japan’s economy

missing ingredient was a clean-up of the banking system

on which Japanese firms were more dependent than their American counterparts
Japanese banks hid their bad loans beneath opaque corporate structures, and curtailed new lending to profitable businesses
vicious circle developed, whereby banks’ bad loans depressed growth which then created more bad loans.

America's regulatory system, financial markets and political structure will not let it procrastinate for so long

has a more transparent regulatory structure which presses banks into recognising losses and repairing their balance-sheets

even if regulators were slow to recognise that the banks were shifting risky securitised assets off their balance-sheets in the first place

over the past year, American banks have been quicker than those in Japan in the 1990s to disclose and write off losses and raise new capital

in Japan it took a long while before the political will was there to use taxpayers’ money to plug the banking system

big test for America’s Treasury will be how quickly it recognises the need to nationalise Fannie Mae and Freddie Mac, the teetering mortgage giants

Americ's advantage over Japan

America is spreading the costs of its housing bust across other countries

foreigners hold a large slice of American mortgage-backed securities
sovereign-wealth funds have provided new capital for American banks

America’s booming exports have helped to support its economy

thanks to the cheap dollar

in contrast, the yen’s sharp appreciation after Japan’s bubble burst hurt exports at the same time as domestic demand was being squeezed

Finding the Mess Behind the Mess - The New York Times

2008-08-25T21:00:00.002+01:00

Summary:
According to Tyler Cowen, the US is unlikely to experience a lost decade as Japan did in the 1990s, but there will still be a long and protracted process of recovery. Number of problems in the real economy are underlying the financial crisis, and will remain once the financial crisis clears up. Problems faced by the US economy: lack of personal savings (people have for years treated rising asset prices as substitute for personal saving); credit crisis stopping banks from investing our savings and making loans; lower consumer spending, need to produce for export; still excess of homes in the market; energy prices. Further fiscal stimulus and excessive banking regulation will make things worse. Solving these problems will be like untangling a bunch wires: need to carefully pull the right wires, in the right sequence. (Published: 23/08/08)

Notes:

Japanese recession in 1990s

set off by bursting real estate bubble
took economy more than a decade to resume steady, noticeable growth

unlikely to happen in the US

but will still see protracted process of recovery

may take longer than the usually year or two to climb out of recession

usually a crisis in the real economy behind every financial crisis

based in some underlying structural deficiency
even if financial crisis is bottoming out, sooner or later the real crisis must be faced

problems in the US economy

fundamental problem in the US economy:

for years people treated rising asset prices as a substitute for personal savings

as long as your home's value rose every year, you didn't have to set aside so much from your paycheck

if your stocks went up, so much the better

asset prices haven't been rising much lately

many people will need more savings for their retirement or possible emergencies

second problem

US economy enduring a credit crisis

many banks trying to raise more capital and make fewer loans

savings are good for the economy when they lead to investment, but there is no guarantee that financial institutions will be allocating capital efficiently

third problem

lower consumer spending

will require the US economy to make some shifts

may mean fewer Starbucks and fewer new homes, but more tractor production for export to foreign markets

shifting some consumption to investment probably beneficial to the economy in the long run

in the short term, may mean job losses and costly readjustments

fourth problem

still excess homes on the market

housing prices need to fall further

such price declines make banks less solvent and thus worsen the credit crisis

politicians would like to moderate this fall in prices, prolonging the adjustment process

fifth problem

energy prices

high prices will encourage conservation and cleaner energy alternatives

but: voters want low gasoline prices and winter heating bills

politicians see lower energy prices as a way to help the economy in the short run, and as a way to win votes

evolution of energy prices may not follow any kind of desirable logic

danger that the Fed will view high energy prices as a sign of permanent inflation and tighten the money supply growth prematurely

what should policy makers do?

counterproductive path: further fiscal stimulus in form of tax rebates

can raise consumer spending and bolster economy in the short run
works only by pushing consumers to spend rather than to save

merely postpones the needed adjustments by providing a grab bag of goodies at exactly the wrong time

another danger: excessive bank regulation

regulatory structure for financial institutions has failed in the current crisis,

change is in order

but shouldn't reform in a way that will discourage bank lending and weaken the tie between savings and investment

banks already allergic to very risky mortgages
we shouldn't overreact by punishing them for past mistakes

regulatory reform needs to be forward-looking rather than focused on penance

recipe for success likely requires, in ht right combinations and in the right sequences

smooth adjustment into new growth sectors
more savings from disposable income
cleaning up the housing mess
well-functioning energy markets
more effective financial intermediation

but: neither the government or the Fed can control this process

Fed can add regulatory and monetary clarity, but there isn't any magical bullet

Japanese failed to break out of their recession quickly because they didn't promptly close down or clean up their bank problems

so far, Fed and other regulators show no signs of making this mistake
but: not enough to guarantee a successful transition

American economy will be tested for its deftness

test will be difficult because there isn't a single enemy to focus on

undoing a bunch of tangled wires

if you don't pull on the right wires in the right order, the mess becomes worse
if you pull too hard, the whole thing can break
but if your first pulls are good ones, the untangling becomes easier with each move

like our economy's situation today

if we expect too much too quickly, we'll make matters worse
but: there's a way out of the mess, and it lies in our hands

Profit-maximization as the sole goal of a corporation - Creative Capitalism

2008-08-22T16:46:00.005+01:00

Summary:
Martin Wolf on the nature of the firm. "What is the goal of the limited liability, joint-stock company, the core institution of the contemporary capitalist economy?" Important distinction between the role of the firm and its goal. Role is to provide valuable goods and services, whereas its goal is to maximize profit. Different views of the firm: as a bundle of contracts, as a social organism, as having culture and history, and as having/offering meaning. Big differences between Anglo-American capitalism and capitalism in rest of the world. Differences focus on the nature of ownership of the firm, the existence of a market for corporate control, and whether or not a firm can be bought and sold. Implications for relationship with employees, efficiency and creativity. Room for enduring divergence in the forms of capitalism is bigger than those working in the Anglo-American intellectual tradition appreciate. Evidence on the (in)effectiveness of takeovers and the recent sad experiences in financial markets rather suggests Anglo-American capitalism may be on the way out. (Published: 17/08/08)

Notes:

What is the goal of the limited liability, joint-stock company, the core institution of the contemporary capitalist economy?

distinction between goal of the firm and its role

role of companies: to provide valuable goods and services

i.e. outputs worth more than their inputs

great insight of market economics is that they will do this job best if they are subject to competition

goal of the firm: profit-maximization

or shareholder value maximization

its more sophisticated modern equivalent

goal of profit-maximization drives the firm to fulfill its role

market in corporate control

competitive market for corporate control forces companies to maximize shareholder value

or at least behave in ways that the market believes will lead them to do so
if companies fail to oblige, the company will be put “into play."

thus, in Anglo-American shareholder-driven capitalism, maximization of shareholder value (as perceived by the market) must perforce be the goal of the company
not the case in countries where a market in corporate control does not exist

in such countries, companies must earn a high enough return on capital to survive

but this need not be a shareholder value-maximizing return

views of the firm

company as a bundle of contracts

Anglo-American view of the company
contracts between the company, its employees and, quite often, its suppliers and even distributors
many contracts relational

cannot be written down in any precise form
companies are hierarchies in which people engage voluntarily

they necessarily work on the basis of trust in what is often a very long-term relationship:

"I work extra hard to meet a deadline now, in return for consideration when I need to look after my elderly mother later on."

for many companies, trustworthiness is an essential ingredient in their long-term success.

company as social organism

companies are social organisms created by a highly gregarious mammalian species with a unique capacity for large-scale co-operation over time and space

companies have cultures and histories

companies have/offer meaning

for many of those most closely associated with them

committed workers in successful companies do not work in order to maximize shareholder value or even to earn the largest possible living

indeed, it is impossible to direct most companies solely by the goal of profit-maximization

they have to be aimed at the intermediate goal of producing and developing goods and services that people want to buy and are worth more in the market than they cost to produce

company is an entity that can be freely bought and sold

Anglo-Saxon view
not shared by rest of the world

for many cultures, a company is viewed as being an enduring social entity

e.g. for many Japanese, one can no more sell a company over the heads of its workers than one can sell one’s grandmother

in this view, goods and services can be bought and sold.
companies, like countries (or, as we all now agree, people), must not be

if companies can be freely bought and sold, relational contracts are hardly worth the paper they are (not) written on

relational contracts depend on continuing interaction among specific people inside the business

rational employees will act opportunistically

because they will always expect their company to do the same

the longer and more reliable relationships are expected to be, the less likely such opportunistic behaviour is to emerge

not necessarily the case that companies which operate under the assumption that they can be bought and sold (like GM) will operate more successfully in terms of maximizing shareholder value than those which do not

e.g. Toyota is a better car company than GM in almost all dimensions.
the failure of Japanese capitalism to achieve the highest level of productivity and sustained dynamism may have far more to with

repression of domestic competition in many markets for goods and,
above all, services, rather than with the absence of an active market for corporate control.

ownership of the firm

Anglo-Saxon view: shareholders are the owners
rest of the world: core workers are the owners

shareholders are not genuine owners

they are merely an (ever-shifting) group of people with a claim to the residual incomes

contribute nothing of value to the competitive strengths of the firm

enjoy the benefits of limited liability

are well able to diversify the risks they run

core workers have the biggest (undiversifiable) investment in the firm

and thus the greatest exposure to firm-specific risks

the interests of the core workers are, therefore, paramount

capital-market arrangements (and associated views of the firm) that enforce shareholder value maximization may make companies work less efficiently than otherwise, in terms of their primary role, by precluding a range of potentially valuable relational contracts inside the firm

such restrictions may have powerful effects on comparative advantage

by shifting countries away from those activities in which companies that benefit from long-term relational contracts are likely to be most effective

room for enduring divergence in the forms of capitalism is bigger than those working in the Anglo-American intellectual tradition appreciate

without an active market for corporate control, managements rule companies

they also acts as a trustee for a range of stakeholders, of which core workers are the most important
Anglo-American capitalism gives primary direction of companies to capital markets

because these companies cannot be forced to maximize shareholder value, they can indeed undertake a range of costly “charitable”activities

provided they do not threaten the company’s ability to survive

one of the most interesting questions over the next generation is whether the Anglo-American form of capitalism will flourish and expand, or not

some of the evidence on the (in)effectiveness of takeovers and the recent sad experiences in financial markets rather suggests not
but: active financial markets do bring big benefits

particularly in financing new companies and enforcing greater discipline on badly run businesses

the more “Anglo-American” capitalism becomes and so the more shareholder driven

the less “creative” it is likely to be
the less concerned with wider social results it is likely to be

The selfish hegemon must offer a New Deal on trade - FT.com

2008-08-19T18:49:00.001+01:00

Summary:
Jagdish Bhagwati claims the US is again suffering from the Diminished Giant Syndrome. As a result, the altruistic hegemon has become a selfish hegemon. No longer practices what it preaches. Seeing free trade now as a costly giveaway to others at the expense of the US. Continuously asking What's in it for me? Cause for Doha talks collapse. Obama's agenda for change flawed: export protectionism. Agenda for institutional change needs to address the true causes of the anxiety in the US today: India and China exports growing; competition intensified ("kaleidoscopic comparative advantage"); ongoing technical change threatening assembly line jobs. (Published: 19/08/08)

Notes:

Diminished Giant Syndrome

perception of American decline

e.g. 1980s, fear of Japan
19th century Britain, fear of US and Germany

US become fearful giant
typically accompanied by a switch from U.S. leadership to myopic and self-indulgent pursuit of "what's in it for us" economic policies in the world arena
from "altruistic" hegemon to "selfish" hegemon (Charles Kindleberger)

on back of economic anxiety in country

many in both political parties see freer trade now as a costly giveaway to others at the expense of the US

ask "what's in it for me?"

Only an agenda for institutional change, one that addresses the true causes of the anxiety in the US today, has a chance of returning trade policy to sanity.

failed Doha talks

illustrates the collapse of American leadership
US has been the central spoiler

refusing to cut its trade-distorting subsidies significantly even though they are universally recognised as intolerable

While making negligible concessions itself, the US was insisting on difficult concessions from India, made even more troublesome politically because of the insubstantial offer on US subsidies
US has also muscled in to its bilateral preferential trade agreements (PTAs) conditions unrelated to trade at the expense of their partner nations

does not practise what it preaches and demands
because the labour lobbies believe that American wages have been stagnant because of competition from the developing nations
export protectionism

doubly offensive about this exercise of political muscle is that it is advanced in the language of altruism

not: by saying frankly that it is because "our unions are worried about competition"
but: by pretending that it is "in your workers' interests".

An altruistic hegemon would not be playing these games; a selfish hegemon will do little else.

Obama

part of his agenda for change is that the US should now impose even more draconian labour requirements in future PTAs, and that the NAFTA should be revised to incorporate yet tougher labour requirements

he is making export protectionism, and the reputation of the US as a selfish hegemon, worse, not better

Different kind of change is in order

must reflect a holistic view of the new reality that the US confronts

in particular: the economic anxiety that overwhelms US workers today stems from the increased fragility of their jobs

new reality

India and China today are growing and exporting rapidly

the Gullivers in a Lilliputian world economy
create tsunamis for specific industries where their exports concentrate

competition has intensified

margins of competitive advantage have shrunk
"kaleidoscopic comparative advantage"

no chief executive or any of his workers in tradable industries leads a happy life any more

always someone, from somewhere, breathing down his neck

leads to volatility of jobs, as you have an advantage today and can lose it tomorrow.

labour-saving technical change continuously threatens assembly-line jobs for the unskilled

assembly lines continue but increasingly do not have workers on them;
they are managed from a glass cage by skilled operators whose jobs increase instead.

Obama needs a deeper understanding of the anxiety-causing "new epoch" to define his new agenda shorn of protectionism

McCain admirably stands for free trade but shows no evidence whatsoever of comprehending that this needs to be situated in an institutional context that requires a serious overhaul
Who will ultimately offer us the right New Deal?

Our Electric Future - The American

2008-08-02T15:57:00.002+01:00

Summary:
Andy Grove calls for a strategy that can deflect our march toward persisting conflict by strengthening our energy resilience. The strategy includes a policy that favors sticky energy (i.e. electricity) with multiple sources and aggressively moving vehicles first toward dual-fuel mode and ultimately to running on just electricity. Focus in the past on energy independence was misguided: talking about “independence” in terms of one product in an otherwise seamless global economy is a contradiction. Energy resilience is what's needed instead, i.e. strengthening our ability to adjust to such changes. Because electricity is the stickiest form of energy (it stays in the land where it is produced), and because it is multi-sourced, it will give us the greatest degree of energy resilience. Shifting to electricity has the added advantage of helping to mitigate a major environmental threat. However, we can't rely on market forces alone: absence of common interests among the industry players is a major obstacle to action. (Published: 01/08/08)

Summary:

significance of US first a supplier, and later as a consumer of oil has decline

relative decline as a supplier accelerated in the 70s, after OPEC was formed, and again when it flexed its muscles by precipitating the oil shock
significance as a customer started to decline in the early 90s as some of the developing Asian economies started to grow at a rapid rate, requiring prodigious amounts of petroleum

OPEC has enormous control over its customers

energy is the lifeblood of all economies
availability of petroleum determines whether an economy grows or declines
availability of petroleum determines employment levels

in turn determines national political stability

Project Indepedence

kicked of by Nixon in early 70s
goal

“At the end of this decade, in the year 1980, the United States will not be dependent on any other country for the energy we need to provide our jobs, to heat our homes, and to keep our transportation moving.”

dramatically failed to meet that goal
after Nixon, president after president set similar gboals

every target was missed
became more and more dependent on imported petroleum
net energy imports doubled between 1970 and 1980, and then again by 1990

goals were unwise

faulty goals lead to the wrong actions

problem:

US became more and more integrated into a global economy

goods, information, and oil move unimpeded across national boundaries

oil flows toward the highest bidder, just like all other goods
talking about “independence” in terms of one product in an otherwise seamless global economy is a contradiction

correct goal

to strengthen our energy resilience

we must protect the U.S. economy from interruptions in the supply of such a critical commodity

whether those interruptions are related to natural or political causes.

the appropriate aim is to strengthen our ability to adjust to such changes

how? by increasing our reliance on electricity

electricity: energy that sticks

moves to the highest bidder
Fleets of tankers carry it across oceans day and night

natural gas

can also move around, but with extra difficulties

on land, it can be transported in pipelines
to carry it across oceans requires liquefaction and expensive, high-tech ships that can carry this liquid in strong, deeply cooled containers

electricity

it is “sticky”:

it can be transported only over land

i.e. it stays in the continent where it is produced

it is a multi-sourced form of energy

petroleum, coal, wind, hydroelectric, nuclear and solar

if one source suffers a shortage, we can produce electricity from another

because electricity is the stickiest form of energy, and because it is multi-sourced, it will give us the greatest degree of energy resilience
nation will be best served if we dedicate ourselves to increasing the amount of our energy that we use in the form of electricity

transportation: hardest nut to crack

transportation uses more than half of all the petroleum consumed in this country
conversion will not be easy

requires substantial growth in generation capacity as well as in the capacity and reach of the transmission infrastructure
requires that vehicles be able to run on electric power

with the size and weight of ordinary automobiles, current technology allows electric cars to run only 100 miles or so before their batteries need to be recharged

many drivers can live with this limitation most of the time
but few will find the condition satisfactory all of the time

new technology

often shows up in this manner: it is not completely satisfactory in the beginning, but good enough to get going
such approaches are known as “disruptive technologies.”

starting low and moving up

waiting game

automobile industry,

has been waiting instead for batteries to improve until they can allow electric cars to enter the marketplace with the same driving range as gasoline-fueled cars

battery developers

have been waiting for demand from the automobile industry to develop before fully committing the resources required to do the job

generation and transmission infrastructures

have not been built up to service the potentially explosive demand from transportation

our exposure to the vagaries of oil supply is growing by the month

must accelerate conversion to electricity in a major way

U.S. government should lead the way by requiring that a growing percentage of new cars be built with dual-fuel capability

dual fuels

dual-fuel cars would have both an electric engine and an auxiliary gasoline engine to augment it
dual capabilities are often built into machines to help with technology transitions

e.g. laptops with both wired and wireless connection

forces of disruptive technology would eventually bring about improvements in battery technology, ultimately allowing the production of an all-electric car with satisfactory driving range

process won’t happen quickly enough on its own

no matter how fast the production of dual-fuel cars is ramped, replacing the bulk of the approximately 250 million cars on the roads in the United States with new cars will take a decade or more

retro-fitting

need to retro-fit the low-mileage part of the fleet first

estimates show that converting these vehicles to dual-fuel operation, even with electricity providing no more than 50 miles of driving range between daily recharging, could cut petroleum imports by 50 to 60 percent

a stunning opportunity

task requires major effort and investment

may need to apply tax incentives to offset the cost of the retrofit and couple them with deep discounts on the cost of electricity used by the vehicle over some initial period, such as one to two year

environment

shifting to electricity has the added advantage of helping to mitigate a major environmental threat
shift from petroleum-based vehicles to electricity-based ones would move the locus for addressing carbon emissions from millions of individual vehicles to far fewer centralized electricity-generating plants

controlling emissions thus becomes an industrial task, easier technologically.

estimates indicate a potential reduction of carbon emissions of around 50 percent through such a shift

can't rely on market forces

automobile manufacturing, battery production, and the generation and transmission of electricity are all represented by different industries

each with its own financial aims

absence of common interests is a major obstacle to action

requires the coordinated commitment of several industries

startups and new ventures, not limited by the economic rules of established industries, can break the gridlock in time

but: we don’t have the time

Condi Rice: “The politics of energy is warping diplomacy in certain parts of the world”

oil has been a major factor in many wars, and it could be again
Kissinger: “Today’s relationship between China and the United States is very similar to that of Germany, a rising country at the turn of the 20th century, and Britain, an established one. Their conflict over resources eventually led to war.”
We are in a period of time in the world today where there is a shortage of resources.

we will face “an era of persisting conflict.”
need for a strategy that can deflect our march toward this “persisting conflict” by strengthening our energy resilience
policy that favors sticky energy with multiple sources and that aggressively moves vehicles first toward dual-fuel mode and ultimately to running on just electricity provides the answer.

33% of China's Carbon Footprint Blamed on Exports - abc News

2008-07-31T23:37:00.002+01:00

Summary:
A Carnegie Mellon study finds that one third of China's carbon dioxide emissions are a direct result of the manufacture of goods destined primarily for developed countries. These "export goods emissions" account for 6% of the global emissions. International policy at the moment tends to penalise the country which produces goods rather than the one that consumes them. China has a point arguing that the US and Europe should bear the burden of responsibility for the emissions as they demand and consume the products. How to fairly apportion the liability for China's exported emissions is the million-dollar question. (Published: 29/07/08)

Notes:

scale of China's emissions

hot topic since it was forecast that they could surpass US emissions as the world's leader in 2007

may have already happened

Carnegie Mellon study:

2005: one-third of China's carbon dioxide emissions are pumped into the atmosphere in order to manufacture exported goods

many of them "advanced" electronics goods destined for developed countries

i.e. developed countries import many of the products that contribute to China's greenhouse gas emissions

"export goods emissions" account for 1.7 billion tonnes of China's carbon dioxide

represents 6% of total global emissions

equivalent of Germany, France and the UK's combined emissions

compare 1987: exports accounted for just 230 million tonnes

12% of China's total emissions

China very aware that much of its carbon footprint is export emissions

has used this as an argument against adopting Kyoto-Protocol-like emissions caps
argues that other major emitters, including the US and Europe, should bear the burden of responsibility for the emissions as they demand and consume the products

International policy at the moment tends to penalise the country which produces goods rather than the one that consumes them

How to fairly apportion the liability for China's exported emissions "is the million-dollar question"

Benito Müller of the Oxford Institute for Energy Studies, UK

"It's just like narcotics," says Müller. "Who is responsible, the drug baron or the junkies?

Quote of the Day

2008-07-31T22:58:00.001+01:00

“When the facts change, I change my mind – what do you do, sir?” - John Maynard Keynes

Word of the Day: The Paradox of Thrift

2008-07-31T22:42:00.003+01:00

Posits that if we all individually cut our spending in an attempt to increase individual savings, then our collective savings will paradoxically fall because one person’s spending is another’s income – the fountain from which savings flow.

Notes:

But, as pointed out by Steve Waldman:

often forgotten hidden assumption in the "paradox of thrift"

true: one person's spending is another person's income
but: does not follow that an increase in saving translates to a decrease in aggregate income

two kinds of spending: consumption and investment

e.g. buying Ferrari vs. laying a subway line

nearly all savings are actually spent on investment goods

no "paradox of thrift":

what is "saved" is really spent on current production of future capacity

plenty of paychecks to go around

no "fallacy of composition": individually and in aggregate, today's thrift lays the groundwork for tomorrow's abundant consumption

but: for this to work out, two things must be true:

today's savings must be invested in projects that will actually generate future wealth
savers must believe they will retain a stake in the increased wealth commensurate with the size and wisdom of their investments

we have a financial system in order to make these facts true

Quote of the Day

2008-07-31T21:58:00.003+01:00

“God created the bulk but the Devil created the surface.” - Wolfgang Pauli

Financial system failure and the paradox of thrift - Interfluidity

2008-07-31T21:09:00.004+01:00

Summary:
Steve Waldman responds to yesterday's article by Paul McCully. Points out that under normal circumstances there is no paradox of thrift because savings is actually invested, i.e. spent on the current production of future capacity, and lays the groundwork for future consumption. Saving does not translate into a decrease of aggregate income. Issue only arises when the financial system breaks down: when investors lose faith in the quality of available investments or their ability to collect the proceeds (in real terms), they resort to precautionary storage (commodities, gold, art), i.e. saving of the wrong kind. Precautionary storage, not thrift itself, is the villain of the tale. Storage eats wealth. Encouraging consumption is not the solution. Feeds into a vibe that saving is so uncertain and money so volatile that one might as well spend. Much better to develop a financial system that actually performs, that identifies fruitful projects, puts current resources to work and allocates claims fairly. The financial system has failed because it erred grievously. Not a problem we can spend our way out of. To fix the financial system we have to change it, not rally to its support. (Published: 31/07/08)

Notes:

paradox of thrift

posits that if we all individually cut our spending in an attempt to increase individual savings, then our collective savings will paradoxically fall because one person’s spending is another’s income – the fountain from which savings flow

often forgotten hidden assumption in the "paradox of thrift"

true: one person's spending is another person's income
but: does not follow that an increase in saving translates to a decrease in aggregate income

two kinds of spending: consumption and investment

e.g. buying Ferrari vs. laying a subway line

nearly all savings are actually spent on investment goods

no "paradox of thrift":

what is "saved" is really spent on current production of future capacity

plenty of paychecks to go around

no "fallacy of composition": individually and in aggregate, today's thrift lays the groundwork for tomorrow's abundant consumption

but: for this to work out, two things must be true:

today's savings must be invested in projects that will actually generate future wealth
savers must believe they will retain a stake in the increased wealth commensurate with the size and wisdom of their investments

we have a financial system in order to make these facts true

if the investment industry is capable of finding or initiating projects likely to satisfy future wants, and if financial claims are predictable and stable stores of value: no paradox of thrift

issue only arises when the financial system breaks down

when investors lose faith in the quality of available investments or their ability to collect the proceeds (in real terms), they pull out savers' Plan B: precautionary storage

they buy gold, or oil, or art, or whatever, and they keep it, generating scarcity rents for those who can offer perceived value stores
but very little in the way of general income and employment.

precautionary storage, not thrift itself, is the villain of the tale

when a dynamic of precautionary storage takes hold, vulgar Keynesian prescription is to encourage consumption

in extremis that might be a good idea

because if all everyone does is hoard, it's hard to figure what to invest in

except maybe storage tanks

but: it's much better to develop a financial system that actually performs, that identifies fruitful projects and allocates claims fairly
storage eats wealth, while productive enterprise creates it

people know this
no one "invests" in gold or oil when a financial system is working

they do so when it is broken: like now

we're at a point where people are beginning to shift from investment to storage

because of a well-deserved loss of confidence in the financial system

but: not at a point where there's so little economic activity that we can't foresee future wants
encouraging people to go shopping in order to help the economy?

desperate last resort
encouraging consumption now is nihilistic

feeds into a vibe that saving is so uncertain and money so volatile that one might as well spend, 'cuz who knows what tomorrow might bring

right way to sustain aggregate demand and maintain current income is to figure out what we should be investing in

not: stocks, bonds, or CDOs
but: factories, windmills, or schools
and then to put current resources to work

financial system is failing spectacularly

because it erred grievously

it built homes and roads and sewers that oughtn't have been built

it "invested" in vacations and plasma televisions

it paid itself handsomely for doing so

not a problem we can spend our way out of
to fix the financial system we have to change it

not rally to its support

we will know we've put things right when thrift is something we can celebrate

when we save because we are excited about what we are creating rather than frightened by what we might lose

The Paradox of Deleveraging - Pimco

2008-07-31T18:54:00.004+01:00

Summary:
Paul McCully (M.D. of Pimco) defends Paulson's request to Congress for unlimited spending power on the grounds that the financial system is victim of the paradox of deleveraging: every levered financial institution is in the process of delevering their balance sheets, a wise thing to do on an individual level. Collectively, however, it is creating deflation in the assets from which leverage is being removed: not all levered lenders can shed assets and the associated debt at the same time without driving down asset prices. Solution similar as when the economy faces a paradox of thrift: in order to break the negative feedback loop, the Fed should borrow and spend. I.e. both a monetary and fiscal policy response are needed, not just a monetary one. But: levering Uncle Sam’s balance sheet to buy or guarantee assets to temper asset deflation does put the taxpayer at risk. Not popular, but ultimately in the taxpayer's best interest. (Published: 30/07/08)

Notes:

paradox of thrift

posits that if we all individually cut our spending in an attempt to increase individual savings, then our collective savings will paradoxically fall because one person’s spending is another’s income – the fountain from which savings flow

part of a whole range of macroeconomic concepts under the label of the paradox of aggregation:

what holds for the individual doesn’t necessarily hold for the community of individuals

understanding this paradox is absolutely vital to understanding macroeconomics

and even more so to understanding what is presently unfolding in global financial markets

year ago: burst of double bubbles in housing valuation and housing debt

every levered financial institution decided individually that it was time to delever their balance sheets

at the individual level, that made perfect sense

at the collective level, it has given us the paradox of deleveraging:

when we all try to do it at the same time, we actually do less of it

because we collectively create deflation in the assets from which leverage is being removed

put differently, not all levered lenders can shed assets and the associated debt at the same time without driving down asset prices

has the paradoxical impact of increasing leverage by driving down lenders’ net worth

negative feedback loop!

need both a monetary and fiscal policy response, not just a monetary one

lower short-term interest rates via Fed easing are, to be sure, useful in mitigating deflating asset prices

particularly if they serve to pull down long-term rates, which are the discount rates for valuing assets with long-dated cash flows.

but monetary easing is of limited value in breaking the paradox of deleveraging if levered lenders are collectively destroying their collective net worth
what is needed instead is for somebody to lever up and take on the assets being shed by those deleveraging

that somebody is the same somebody that needs to step up spending to break the paradox of thrift: the federal government

needs to lever up its balance sheet to absorb assets being shed through private sector delevering

so as to avoid pernicious asset deflation

i.e. should borrow and spend

that’s a fiscal policy operation

fiscal policy is not made by a few learned technocrats above the political fray of the democratic process, but is squarely in the hands of the legislative branch

consisting of 535 politicians, with far more lawyers than economists among them

levering up Uncle Sam’s balance sheet, to buy assets to break asset deflation resulting from the paradox of deleveraging

still seems to be a foreign, if not a sinful proposition

should not be

hear endlessly that any levering up of Uncle Sam’s balance sheet to buy assets must be done in a way that “protects tax payers.”

by definition, levering Uncle Sam’s balance sheet to buy or guarantee assets to temper asset deflation will put the taxpayer at risk

but will do so for their own collective good!

Fed and Bear Stearns

put up $29 billion on nonrecourse terms to buy assets so as to facilitate the merger of Bear Stearns into JPMorgan
was a fiscal policy operation, conducted by the Fed

demonstrated by

(1) the fact that the Fed sold a similar amount of Treasuries from its portfolio, increasing the supply of Treasuries in the market by the same amount
(2) the fact that any losses the Fed experiences on that $29 billion will reduce dollar-for-dollar the amount of seigniorage profits that the Fed remits to the Treasury.

$29 billion is actually a loan to a Limited Liability Corporation (LLC) set up to hold the Bear assets

but the bottom line is that we the taxpayers bought $29 billion of Bear’s assets

logically, it should have been conducted by the Treasury using appropriated spending power from Congress

but: that “right” solution was not legally available to the Treasury, whereas the Fed did have the power to act

Fed has power to lend to essentially anybody against any collateral, so long as it declares it is necessary to do so because of “unusual and exigent circumstances.”

Paulson’s request to Congress to give him the power to spend unlimited amounts of taxpayers’ funds to buy the debt or equity of Fannie Mae and Freddie Mac

Paulson is going to get most of what he wants

if only because legislators are too fearful of the consequences if they stiff arm him

But: between now and then, the Federal Reserve stands ready to lend to Fannie and Freddie

unlike the case with the $29 billion spent for Bear’s assets, any Fed lending to Fannie and Freddie is explicitly being billed as a “bridge” to Treasury lending or investing in the agencies
this is the way it should be: bailouts and backstops with taxpayer funds should be legislated by Congress and placed on the Treasury’s, not the Fed’s, balance sheet

Treasury should also buy out the Fed’s $29 billion loan to the LLC holding Bear’s assets, putting it on the Treasury’s balance sheet, where it belongs

currently, in the United States, asset price deflation is the menace at hand, not goods and services price deflation (cfr. Japan)

asset price deflation can be every bit as nefarious as goods and services deflation
Bernanke sees the role of the central bank as different in deflationary times than inflationary times:

inflation

often associated with excessive monetization of government debt
virtue of an independent central bank is its ability to say “no” to the government

deflation

excessive money creation is unlikely to be the problem
more cooperative stance on the part of the central bank may be called for

not inconsistent with the independence of the central bank

any more than cooperation between two independent nations in pursuit of a common objective is inconsistent with the principle of national sovereignty

Japan faced both the paradox of thrift and the paradox of deleveraging

screaming for the Bank of Japan to subordinate itself for some time to the fiscal authority

US currently only experiencing the paradox of deleveraging, not the paradox of thrift

though the latter malady is certainly a fat tail risk if the former malady is not ameliorated, notably in house prices

conventional wisdom: when an economy faces a paradox of private thrift, it is appropriate for the sovereign to go the other way

borrowing money to spend directly or to cut taxes, taking up the aggregate demand slack

is precisely what Congress did earlier this year, sending out $100+ billion of rebate checks, funded with increased issuance of Treasury debt.

Good ole fashioned Keynesian stuff!

but: conventional wisdom is struggling mightily with the notion that when the financial system is suffering from a paradox of deleveraging, the sovereign should lever up to buy or backstop deflating assets

analytically, there is no difference:

both the paradox of thrift and the paradox of deleveraging can be broken only by the sovereign going the other way

not a fun thing to do, but it is the right thing to do

There is hope yet for science park toilers - FT.com

2008-07-31T00:12:00.004+01:00

Summary:
Jonathan Guthrie sees evidence that the level of innovation in the UK appears to be declining. Not much coming out of universities anymore. We're living through a fallow period for innovation, fundamental innovation is slowing up after a remarkable 40 year boom. Internet investment bubble, Schumpeterian explanation: copycats to pile in on the upswing of an innovation wave. Was a fiasco for VC investment in UK. Returns negative for average fund set up after 1996 over 5 to 10 year periods. Confidence has weakened further with the credit crunch, which has closed the market for flotations. Less money was invested in European technology start-ups last quarter than at any time since 2001. Venture capital is more fragile this side of the Atlantic than in the US. Technology investment in UK will probably recover. VCs need to market themselves, focus on the lofty top decile, not the mediocre median. Early stage technology investment is attractive as a way to lay small bets on risky, glamorous propositions. Also need a handful of breakthroughs that are immensely remunerative. Biotech lost cost. Renewable energy and power savings big hope. (Published: 30/07/08)

Notes:

little backing from City for fledgling tech companies on UK's science parks
Jon Moulton, a private equity investor who backs technology start-ups as a hobby

“In the UK the level of innovation appears to be declining. Universities are being picked over very hard for ideas, but not a lot is coming out of them.”

likens UK early stage technology investors to ufologists

instead of joining hands and imploring Martians to land, they hope, equally fruitlessly, for a worthwhile return on investment

living through a fallow period for innovation

Walter Herriot of the St John’s Innovation Centre

“There is a slowing up in fundamental invention, though not in the creation of niche applications.”
reflecting on the advent in the past 40 years of personal computers, the internet and mobile phones, he says: “I cannot see an equivalent explosion in the near term.”

similar to Schumpeter's view

proposed that innovation progresses in waves
profitable breakthroughs occurrs in the troughs of economic cycles

encourages copycats to pile in on the upswing, feeding economic instability

cfr internet investment bubble

now looks more like a belated dash into a maturing technology rather than the new era it was billed as at the time

fiasco has constrained any advertising claims for venture capital based on recent performance

funds set up after 1996 have typically lost 1.4 per cent a year over five years and 1.8 per cent over 10 years

according to the British Private Equity and Venture Capital Association

Confidence has weakened further with the credit crunch, which has closed the market for flotations

less money was invested in European technology start-ups last quarter – €950m (£747m) – than at any time since 2001

Apax, progenitor of European venture capital, launched a fund last spring with no venture capital component
Braveheart is concentrating on follow-on financings;
3i has pulled out of early stage investment altogether

Venture capital is a more fragile flower on the eastern shores of the Atlantic than in the US

Sir Ronald Cohen, founder of Apax,

“The perception is that the early stage is tougher, you raise less money when you float, and there is less liquidity afterwards.”

is technology investment is doomed to dwindle away to nothing in the UK?

will probably recover
dotbomb losses will drop out of short-term performance statistics during the next few years.
returns need not then be spectacular – a long-term average is 4.5 per cent – to lure investors back
trade bodies such as the BVCA, meanwhile, can do their bit by quoting returns exclusive of “exceptional losses” chalked up on internet plays
marketing emphasis should be on the lofty top decile, not the mediocre median

early stage technology investment is attractive as a way to lay small bets on risky, glamorous propositions

absorbs just more than £1bn a year in the UK

no backers stake money they cannot afford to lose
in some respects it resembles alternative investments, such as art or wine, more than big buy-outs or quoted shares

task that science park toilers face is to produce a handful of breakthroughs that are immensely remunerative

little can be hoped for from biotech

stricken by unprofitability as persistent as a hypochondriac’s bad back

materials scientists have engineered a UK nanotechnology sector so tiny it is virtually invisible
most to go for in renewable energy and power saving systems

"scope for technological leaps equivalent to the shift from mainframes to PCs” (Sir Ronald Moulton)

The Rogoff doctrine - Paul Krugman's blog

2008-07-30T21:55:00.004+01:00

Summary:
Paul Krugman takes issue with Rogoff's call for "a couple of years of sub-trend growth to rebalance commodity supply and demand at trend price levels." The relative rise in price of oil and commodities is a result of their limited supply in the face of rapid global economic growth. It is the way the markets are supposed to work. Since when, Krugman asks, does economic analysis say that the way to deal with limited supplies of one resource is to reduce employment of other resources, so that the relative price of the limited resource returns to “trend”? (Published: 30/07/08)

Quote of the Day

2008-07-30T21:42:00.000+01:00

"It is much easier to be critical than to be correct." - Benjamin Franklin

The world cannot grow its way out of this slowdown - FT.com

2008-07-30T16:30:00.004+01:00

Summary:
Kenneth Rogoff says the global commodity price inflation is not surprising, given that we've experienced the most remarkable growth boom in modern history. Global economy is still growing too fast, and a global recession is necessary to rebalance commodity supply and demand at trend price levels. Efforts to maintain high growth through macroeconomic stimulus, will only result in even higher commodity prices and ultimately a bigger crash in the not-too-distant future. Bail-out activities in response to the ever-deepening financial crisis are compromising inflation stabilisation effort. Gains from this have to be weighed against the long-run cost of re-anchoring inflation expectations later on. Poorly run financial firms need to be allowed to go out of business, and the industry needs to shrink commensurate with the sharp fall in key lines of business related to mortgage securitisation and derivatives. Central banks need to raise interest to combat inflation, and Treasuries maintain fiscal discipline rather than giving in to the temptation of tax rebates and fuel subsidies. (Published: 29/07/08)

Notes:

huge spike in global commodity price inflation is evidence that the global economy is still growing too fast

not surprising: world has just experienced perhaps the most remarkable growth boom in modern history

huge cumulative rise in global growth during the 2000s

little wonder that commodity suppliers have found it increasingly difficult to keep up, even with sharply rising prices

for many commodities, particularly energy and metals, new supply requires long lead times of five to 10 years

although demand response is more nimble, it has been greatly dulled by a wide variety of subsidies and distortions in fast-growing emerging markets

without significant global recession it will probably take a couple of years of sub-trend growth to rebalance commodity supply and demand at trend price levels

if all regions attempt to maintain high growth through macroeconomic stimulus, main result is going to be higher commodity prices and ultimately a bigger crash in the not-too-distant future

surprising how many leading policymakers and economic pundits believe that policy should aim to keep pushing demand up

US: aggressive tax rebates, steep interest rate cuts and an ever-widening bail-out net for financial institutions
China: briefly flirted with prioritising inflation, now resumed putting growth as the clear number one priority
Dollar bloc countries: have slavishly mimicked expansionary US monetary policy

rapid growth is putting huge upward pressure on inflation

Europe: ECB coming under increasing domestic and international political pressure as Europe's growth decelerates

if all regions try expanding demand, even the short-term benefit will be minimal

commodity constraints will limit the real output response globally
most of the excess demand will spill over into higher inflation

central bankers mainly looking at wage growth

argue that there is nothing to worry about as long as wage growth remains tame

globalisation continues to shrink unskilled labour's share of global income.

but: as goods prices rise, wage pressures will eventually follow

ever deepening financial crisis as a rationale for expansionary global macroeconomic policy

bail-out activities compromising inflation stabilisation effort
may be convenient to have several years of elevated inflation to help bail out homeowners and financial institutions

but: the gain has to be weighed against the long-run cost of re-anchoring inflation expectations later on

also: not obvious that the taxpayer should absorb continually rising contingent liabilities

financial firms need to be allowed to go out of business

financial industry needs to shrink commensurate with the sharp fall in key lines of business related to mortgage securitisation and derivatives
airline industry often goes through periods of excess capacity

giant companies going out of business or merging
we have grown accustomed to these traumas and learned to live with them, as in many other industries

banking industry holding nations hostage each time they experience consolidation

As major central banks extend their discount windows to complex investment banks whose business lines are evolving and churning constantly, "crises" of consolidation are surely going to become more frequent.

financial market regulation is never going to be stringent enough in booms

that is why it is important to be tougher in busts

so that investors and company executives have cause to pay serious attention to risks

"if poorly run financial institutions are not allowed to close their doors during recessions, when exactly are they going to be allowed to fail?"

need to introduce more banking discipline

policymakers must refrain from excessively expansionary macroeconomic policy at this juncture and accept the slowdown that must inevitably come at the end of such an incredible boom
for most central banks, this means significantly raising interest rates to combat inflation
for Treasuries, this means maintaining fiscal discipline rather than giving in to the temptation of tax rebates and fuel subsidies
"In policymaker's zealous attempts to avoid a plain vanilla supply shock recession, they are taking excessive risks with inflation and budget discipline that may ultimately lead to a much greater and more protracted downturn."

Word of the Day: Backshoring

2008-07-30T14:19:00.004+01:00

Refers to manufacturing increasingly moving back to the West, or, rather, to where the markets are. This does not necessarily mean that all of it will return to the West, as emerging countries are also enormous markets (local production will serve local consumption there). But narrowly defined production costs will become less important in deciding where to locate manufacturing. See de Meyer and Holweg.

A silver lining to high oil prices - FT.com

2008-07-30T13:49:00.004+01:00

Summary:
Arnoud de Meyer and Matthias Holweg anticipate a trend of "back-sourcing" due to rising energy and commodity costs: manufacturing will increasingly move to where the markets are, including back to the UK. Few companies that have gone global have so far achieved the full cost efficiencies they had envisaged, and this will get worse. Two common mistakes that companies make when deciding to source components from abroad are: they tend to only calculate the static costs of a supply chain, and they assume that costs will remain stable. Furthermore, global supply lines might be cost-competitive but they certainly are not carbon-competitive, which is gaining in importance. As a result, narrowly defined production costs will become less important in deciding where to locate manufacturing. This presents an opportunity for Western manufacturing, provided the skills and tacit knowledge that is needed for manufacturing are preserved. Companies may also have to learn how to efficiently operate smaller flexible units that produce the customised products for the local market. (Published: 30/07/08)

Notes:

Increased transport costs resulting from higher energy prices and carbon taxes

may create an opportunity for a revival in western manufacturing

Most strategic decisions in companies are influenced by new "paradigms"

path-breaking new concepts
globalisation was certainly the paradigm of the past decade
application of such paradigms tends to behave like a pendulum

swinging towards one extreme, and eventually swinging back

Is it possible that the pendulum may swing back for global manufacturing?

premise of global sourcing and exploiting lower labour costs for manufacturing in eastern Europe and the Bric countries

largely built on the cost of transport

dropped by a third between 1960 and the turn of the millennium

result of introduction of containers and the rise of third-party logistics providers

shipping goods reliably from one end of the world to the other without owning any of the transport assets in between

with further help from

trade liberalisation and agreements

stable currencies that reduced the risks in establishing global supply lines

research shows that few companies that have gone global achieved the full cost efficiencies they had envisaged

some even found that "offshoring" their operations was more expensive than sourcing or manufacturing locally

subsequently returned to their home country

cost of logistics may be a lot more important than originally estimated

others found that product cost was indeed much lower, yet this cost reduction was traded off with much reduced quality

e.g. recent highly publicised product recalls

companies commit two common mistakes when deciding to source components from abroad

tend to only calculate the "static" cost of a supply chain

basically adds the unit cost ex-supplier factory and the transport cost together
lower labour cost reduces the unit cost of the product

generally offsets the higher transport cost of bringing it into the UK from China

other costs are often not considered or underestimated

e.g. the additional cost for buffer stocks

supply chain becomes inherently less able to respond to swings in demand or changes in technology

e.g. risk of obsolescence or running out of stock

drastically increases, yet often is not factored into the calculation.

e.g. cost of quality defects

rises tremendously when a defect is discovered in a shipped batch arriving in Europe and costly air freight has to be used to refill the supply line

e.g. co-ordination cost of working over long distances

often taken for granted

tend to assume that costs remain stable, not account for "dynamic" costs

perception is that countries in eastern Europe, China and India have inexhaustible labour pools that one can tap into at low cost

and that all these workers are trained to the needed level

recent experiences

Eastern Europe

car manufacturers find that local labour pools of trained workers have been virtually exhausted
inflation in the cost of trained labour is in double-digits as manufacturers are competing for labour

India

trained staff will change jobs several times per year if they see the prospect of higher salaries elsewhere

annual turnover of 20 per cent being normal
labour cost inflation rising to 25 per cent a year in some regions, such as Bangalore or Pune.

China

trained middle manager in the car sector, fluent in English and Mandarin, will earn more in Shanghai than in Wolfsburg or Birmingham

carbon footprint gaining in importance

global supply lines might be cost-competitive but they certainly are not carbon-competitive
rising consumer conscience about the impact of patterns of consumption
manufacturers with offshored operations will find it increasingly hard to justify sending products half-way around the globe if they can be made as easily close by

recovery of competitiveness in the manufacturing sector

long been dismissed as an obsolete part of a "service economy"
"backshoring" trend

manufacturing will increasingly come back to where the markets are
does not mean that all of it will come back

emerging countries are also enormous markets and local production will serve local consumption there

but: companies will have to think increasingly in terms of networks or portfolios of plants

narrowly defined production costs will become less important in deciding where to locate manufacturing

developing the opportunity

UK will need to preserve the skills and the tacit knowledge that is needed for manufacturing
may have to learn how to efficiently operate smaller flexible units that produce the customised products for the local market

Quote of the Day

2008-07-30T11:34:00.001+01:00

"Spreadsheets are easy; science is hard." - Shaywitz and Taleb

Shaywitz and Taleb in answer to the question "Why do pharmaceutical companies, which spend billions of dollars each year trying to turn advances into treatments, have so little to show for their efforts?"

Drug research needs serendipity - FT.com

2008-07-30T11:00:00.003+01:00

Summary:
David Shaywitz and Nassim Taleb write that the pharma industry is suffering as a result from a mismeasure of uncertainty. Despite promise of molecular revolution and drugs by design, pipelines are dwindling. Pharma companies seek to identify the largest markets they can find, develop products for these customers and boost efficiency of development process. Wrong approach, for two reasons: drug sales notoriously hard to foresee (yields more false precision than true insight), and drug development process is also very difficult to predict. This strategy fails to reduce exposure to negative uncertainty (all the bad things that can happen during drug development), and eliminates much of the exposure to positive uncertainty (serendipity). Pharma's trend of outsourcing may open up possibility for innovators with a greater appreciation of the nuances of science to do a lot better. (Published: 30/07/08)

Notes:

molecular revolution: was supposed to enable drug discovery to evolve from chance observation into rational design

yet dwindling pipelines threaten the survival of the pharmaceutical industry

what went wrong?
answer: the mismeasure of uncertainty

academic researchers underestimated the fragility of their scientific knowledge

we still do not understand what causes most disease
scarcity of good animal models for most human disease
academic science tends to focus on the "bits and pieces" of life - DNA, proteins, cultured cells - rather than on the integrative analysis of entire organisms, which can be more difficult to study
yet: real scientific progress has occurred

pharmaceuticals executives overestimated their ability to domesticate scientific research: spreadsheets are easy; science is hard

pharma companies seek to identify the largest markets they can find and develop products for these customers

sensible in theory, but less so in practice, for two reasons:

drug sales are notoriously difficult to foresee

even at the time the medicine hits the market
i.e. predicting sales a decade or more ahead of registration, when the research and development process typically begins, is generally a fool's errand

yields more false precision than true insight.

yet: much of contemporary pharma R&D is driven by this sort of rigid planning.

drug development process is also very difficult to predict

because of both our limited understanding of disease and our inevitably imperfect understanding of the effect any new compound will have on the body

most modern medications were discovered in the old-fashioned way: by accident
e.g. Viagra, originally developed as treatment for chest pain

pharma companies have been trying to boost output by increasing efficiency

narrowing focus to a handful of disease areas
shelving safe but ineffective compounds without fully exploring their scientific potential
trying to ensure that each project the company is working on is carried out with a clearly defined market segment in mind

this strategy often fails significantly to reduce exposure to negative uncertainty - all the bad things that can happen during drug development - and eliminates much of the exposure to positive uncertainty (serendipity) that remains so vital

managers so intent on maintaining focus that important opportunities for novel discovery are lost

as is the intellectual space for tinkering and capitalising on the chance observations and unexpected directions so important in medical research

pharma executives are creating an ever-more-rigid environment

and then wondering why their productivity is going down
and why they have such difficulty attracting and retaining talent

diruptive innovation

pharmaceutical industry is ripe for disruptive innovation

but: the barriers to entry have been far too high for anyone new to break through

however: pharma companies trying to cut costs by outsourcing large parts of their operations

in response service providers have sprung up around the world to fulfil these functions

if the trend to outsourcing continues and if the main competence of pharma companies becomes (as some have suggested) simply their ability to orchestrate the entire process, it is not difficult to imagine that an innovator - particularly an innovator with a greater appreciation of the nuances of science - might be able to do this a lot better

Quote of the Day

2008-07-30T10:10:00.002+01:00

"The problem is that we have socialism for the rich and rugged free enterprise capitalism for the poor." Martin Luther King

Word of the Day: (Statistical) Arbitrage

2008-07-29T21:20:00.004+01:00

Summary:
Arbitrage is the practice of taking advantage of a price differential between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices. The transactions must occur simultaneously to avoid exposure to market risk, or the risk that prices may change on one market before both transactions are complete. In practical terms, this is generally only possible with securities and financial products which can be traded electronically.

Statistical arbitrage (as opposed to deterministic arbitrage) refers to highly technical short-term mean-reversion strategies involving large numbers of securities (hundreds to thousands, depending on the amount of risk capital), very short holding periods (measured in days to seconds), and substantial computational, trading, and IT infrastructure. It involves data mining and statistical methods, as well as automated trading systems. StatArb has become a major force at both hedge funds and investment banks.

Notes:

Despite economic slowdown VC returns remain positive in Q1 2008 - NVCA

2008-07-29T15:25:00.005+01:00

Summary:
Venture capital returns, as measured by the private equity performance index (PEPI), have been falling across all investment horizons ending Q1 2008, but still compare favourably to stock indices like the NASDAQ and S&P500 according to NVCA. The economy’s biggest effect on the venture market has been indirect — the IPO and mergers/acquisitions markets are hurting, which means VCs have to pump more money into later-stage companies. Causes lower returns. According to Mark Heesen, returns will fall even further if the exit market doesn’t improve. (Published: 29/07/08)

Notes:

one-year private equity performance index (PEPI) showed the greatest change from
Q4 2007

7.6 point decrease to 13.3% in Q1 2008.

historically, short-term horizons show significant fluctuations quarter over quarter based on large exits impacting the return

next largest consecutive quarterly change occurred in the ten-year time horizon

PEPI decreased by 1.1 points quarter-over-quarter

three year performance also posted a modest decline from the previous quarter

decreasing .2 percentage points from 9.7% in Q4 2007 to 9.5% in Q1 2008

five-year and twenty-year performance figures showed modest quarter-over quarter increases

to 9.1% and 16.8%, respectively

Venture returns across all horizons, except the five-year horizon, outperformed public
market indices, NASDAQ and the S&P 500, through 3/31/2008

Mark Heesen:

"The IPO market has now been essentially shut down for venture-backed companies for over seven months. Combined with a skittish M&A market, shorter term performance returns are and will continue to be impacted."
"Our asset class continues to out perform many other investment alternatives
including the public markets over the long term. But we will need to see the exit markets improve dramatically to maintain that position in the coming year."

Quote of the Day

2008-07-29T13:08:00.001+01:00

“If I had asked my customers what they wanted, they would have said a faster horse.” - Henry Ford

America’s Addiction and the New Economics of Strategy - HarvardBusiness.org

2008-07-29T11:33:00.002+01:00

Summary:
Umair Haque we're not just addicted to oil, but to everything. We're not entering Peak Oil, but Peak Consumption. Current financial system is a house a cards that's in the process of collapsing. Consumption in developed world has been subsidised by developing countries: goods at low prices, and reinvestment of their revenues into our government and mortgage debt. Ignored costs like pollution, community fragmentation, and abusive labour standards. Our economy is built on firms whose very purpose is to sell, to relentlessly push people into endlessly consuming, without ever considering the long-run consequences. But we're entering a world where consumption must slow. Haque proposes that being able to break yesterday’s maladaptive consumption addiction is at the heart of next-generation advantage. Next global financial system will be powered by firms that can shift past nihilistic, meaningless industrial-era corporate purpose, beyond acting as mere pushers of an addiction. (Published: 29/07/08)

Notes:

house of cards that is the global financial system

emerging markets seek export-led growth
they undervalue their currencies, so their exports are more competitive purely in terms of price

amounts to essentially a subsidy to consumers on the other side of the table – those in the developed world

emerging markets accumulate surpluses, and recycle them:

lend them back to the US and UK in the form of government and mortgage debt, stabilizing their economies

amplifies the existing consumption subsidy in developed countries through leverage
artificial cheapness further amplified by simple fact the true costs of production haven't been factored in - until now

very real costs like pollution, community fragmentation, and abusive labour standards

we’ve been able to consume mercilessly and remorselessly – with no regard for the human, social, or environmental consequences, to us or to others

not just cheap oil we’re addicted to: it’s cheap everything

world we’re entering isn’t really of Peak Oil as it is one of Peak Consumption

tentative economic history of the 21st century:

Emerging markets – and the people that broke their backs in them – lent the developed world tremendous amounts. What did the developed world do with it? Instead of investing it in tomorrow, they spent it on McMansions, Hummers, and strip malls.

could have chosen, instead, to invest

anything would have been a more sensible choice than naïve consumption

education, energy, healthcare, transportation, even a more sensible and rational kind of finance

problem with strategy

our economy is built on firms whose very purpose is to sell
to relentlessly push people into endlessly consuming, without ever considering the long-run consequences

tough choices for boardroom

entering a world where consumption must slow
Does it continue to hawk stuff that “satisfies” largely artificial needs?
Or does it choose to do something authentic, meaningful, and purposive – something that makes us all radically better off than we were before?

new strategy

At the heart of next-generation advantage is, paradoxically, being able to break yesterday’s maladaptive consumption addiction – not fuel it

It is firms who can shift past nihilistic, meaningless industrial-era corporate purpose – beyond acting as mere pushers of an addiction – who will power the next global financial system.

Treasury's mortgage rescue plan - Peston's Picks

2008-07-29T09:53:00.004+01:00

Summary:
Robert Peston on Sir James Crosby's assessment of the outlook for mortgage finance. Darling worried by risk that the chronic shortage of mortgage finance could lead house prices to fall much further and faster than would be warranted on the basis of notional economic fundamentals. Discusses the importance of MBS to mortgage lending and the UK economy. Consequences of the credit crunch: demand for MBS dried up; no cash for mortgage lending; only five or six banks still able to lend; lending more expensive; lending only to the most reliable borrowers; rising number of defaults; exacerbating house price fall and weakening consumer demand. Crosby's likely to recommend action. Either Bank of England becomes the market-maker of last resort for mortgage-backed bonds; or government guarantees, on commercial terms, billions of pounds of better quality tranches of new mortgage-backed securities (i.e. taxpayers underwriting a huge slug of the mortgage market). Significant risks to the health of the economy from doing nothing. (Published: 29/07/08)

Notes:

Sir James Crosby, FSA

assessment of the outlook for mortgage finance
forecasting that a chronic shortage of mortgage finance for homebuyers and homeowners will continue throughout this year, 2009 and 2010

importance of mortgage-backed securities (MBS)

finance from the sale of MBS was equal to two-thirds of all net new mortgage lending in the UK by 2006

total stock of UK MBS was a staggering £257bn out of total residential mortgages of £1200bn by end 2007

equivalent to around a fifth of the value of the British economy

consequences of the credit crunch (almost exactly one year ago)

demand for MBS completely dried up

still almost impossible for any bank to issue mortgage-backed securities

no cash to meet even the current reduced demand for mortgages from homeowners who need to refinance their debts and from prospective homebuyers

leading banks are expecting the net increase in mortgage lending to fall to £60bn in 2008, from £110bn last year and a similar amount in 2006

drop of 45%
shrinkage that reflects a collapse in mortgage approvals for house purchase

banks also struggling both to raise other forms of wholesale funding and to extend the maturity of their existing debts
squeeze on the money they have available for new mortgages is exacerbated by their obligation to repay around half of their existing mortgage-backed borrowings over the coming three years
likely to be a rise in the number of mortgage holders who can't pay their debts
mortgage finance is now only available to those with utterly reliable earnings and deposits equivalent to at least 25% of the value of what they want to borrow

what little lending there is is now dominated by the UK's biggest five or six banks

small banks and building societies making almost no new loans
many mortgage intermediaries expected to disappear

shortage of mortgage finance likely to exacerbate the fall in house prices and the weakness of consumer spending

recommendations

government needs to attempt to re-open the market for mortgage-backed securities

to prevent the banks becoming so strapped for cash that the housing market would go from decline to meltdown

two possibilities

Bank of England becomes the market-maker of last resort for mortgage-backed bonds

Bank agrees to lend to almost any financial or investment institution against the security of mortgage-backed bonds bought by the relevant institution
Bank would be guaranteeing that if the market for such bonds were shut, it would make sure that the bonds did not become totally illiquid

government guarantees, on commercial terms, billions of pounds of better quality tranches of new mortgage-backed securities

i.e. taxpayer would be providing a promise that it would pick up the tab in the event that the value of of those securities was impaired by a huge rise in repayment difficulties or defaults by mortgage borrowers
i.e. taxpayers underwriting a huge slug of the mortgage market

other possibility: government should not intervene, on the basis that such intervention may create more difficulties than it would solve

but: would be significant risks to the health of the economy from doing nothing

Darling deeply troubled by the risk that the chronic shortage of mortgage finance could lead house prices to fall much further and faster than would be warranted on the basis of notional economic fundamentals

wants to prevent house prices overshooting on the way down, just as they overshot on the way up, and thereby wreaking massive damage to the economy

America must not act rashly over inflation - FT.com

2008-07-28T22:30:00.000+01:00

Summary:
Mark Gertler warns against Fed targeting of headline inflation. Points out that core inflation has remained steady and low. Rapid increases in the relative prices of energy and food cannot go on indefinitely. Once this process dies down, as long as core inflation remains anchored, headline inflation must converge to it. Fed has adjusted monetary policy to sustain the core measure at a steady, low rate, and headline inflation is still well below that of stagflationary 70s. Impact of increasing inflation expectations, despite moving upwards, has yet to show up in the behaviour of core prices and wages. There are signs that forces that have pushed headline above core inflation are beginning to reverse due to laws of supply and demand. Funneling core inflation through a tight oscillating path even over the medium term is beyond a central bank's capability and may wreak havoc on the real economy. Monetary tightening is needed, however, in many emerging economies. A policy response from the Fed is needed that recognises the complexities of the inflationary process. Learn lesson from Japan. (Published: 28/07/08)

Notes:

startling jump in US consumer price inflation over past several months

entering inflationary spiral like in 70s?
careful inspection of underlying mechanics shows that

almost all the increase in headline CPI inflation is due to rocketing energy and food prices
inflation excluding energy and food is significantly lower

core CPI was just 2.4% over past year

just over Fed's comfort zone of 1-2%

uptick last month due to feeding through of food and energy costs to core prices
but: over coming year, below-capacity output growth and softening oil and commodity prices are likely to push core inflation back towards comfort zone

distinction between headline and core inflation important

sustained move of headline inflation to levels of 70s is unlikely without an accompanying increase in core component

reason: although they can be highly persistent, rapid increases in the relative prices of energy and food cannot go on indefinitely

once this process dies down, as long as core inflation remains anchored, headline inflation must converge to it

e.g. late 1960s to late 1970s

Fed lost control over core inflation

increased nearly in lock-step with overall inflation

this decade

Fed has adjusted monetary policy to sustain the core measure at a steady, low rate

despite prolonged periods of departure of headline inflation from core

but gaps typically under 100 basis points annually

headline inflation indeed uncomfortably in 3-4% range recently

but: is well below that of the stagflationary 70s

signs that forces that have pushed headline above core inflation are beginning to reverse

oil prices declined >10% over past several weeks
commodity prices have softened also
laws of supply and demand suggest this may not be a transitory phenomenon

root cause of increase in energy and food prices was most probably rising global demand
global economic activity expected to slow down considerably

demand for oil and commodities is likely to weaken along with it

will place downward pressure on relative prices of these goods

targeting headline inflation directly will not help

in environment of gyrating energy and food prices inflation, targeting headline inflation requires the central bank to engineer offsetting changes in the path of core inflation

but: prices of most core items adjust only sluggishly

funneling core inflation through a tight oscillating path even over the medium term beyond a central bank's capability

simply too much uncertainty over both the timing and the overall impact of its interest rates moves on core inflation to believe that a central bank could smoothly accomplish this task
sharp interest rate adjustments likely to accompany this attempted fine-tuning exercise could wreak havoc on the real economy

is high headline inflation unmooring inflation expectations?

would lead us back to the 70s
some measures of inflation expectations are edging upwards

needs to be taken seriously

but: impact of increasing inflation expectations has yet to show up in the behaviour of core prices and wages

core inflation has remained stable
growth in nominal unit labour costs also remains benign

is what most pricing of core items is based on

Fed's reputation for keeping core inflation stable may have kept the expectation relevant for price- and wage-setting in line
also: to date, wage-setters appear to understand that, however unfortunate, the relative increase in energy and food prices is something beyond the central bank's control

something they must live with

many emerging countries: picture different

above-capacity output growth has pushed core inflation up along with headline
also: high output growth among these economies has been an important factor in the global commodity price boom
here monetary policy needs tightening

inflation is a real concern

but: policy response is needed that recognises the complexities of the inflationary process

including its global nature
not simple knee-jerk reaction!

lesson from Japan

a fractured credit system can induce prolonged stagnation, even in an advanced economy

given uncertain conditions of the US financial and real sectors, goal should be to achieve price stability in a way that continues to keep low the possibility that this economy could suffer a similar fate

When to start - Seth Godin

2008-07-27T17:28:00.005+01:00

"The best time to start was last year. The second best time to start is right now." - Seth Godin

Notes:

When to start

The best time to start is when you've got enough money in the bank to support all contingencies.
The best time to start is when the competition is far behind in technology, sophistication and market acceptance.
The best time to start is when the competition isn't too far behind, because then you'll spend too long educating the market.
The best time to start is when everything at home is stable and you can really focus.
The best time to start is when you're out of debt.
The best time to start is when no one is already working on your idea.
The best time to start is when your patent comes through.
The best time to start is after you've got all your VC funding.
The best time to start is when the political environment is more friendly than it is now.
The best time to start is after you've got your degree.
The best time to start is after you've worked all the kinks out of your plan.
The best time to start is when you're sure it's going to work.
The best time to start is after you've hired the key marketing person for the new division.
The best time to start was last year. The best opportunities are already gone.
The best time to start is before some pundit declares your segment passe. Too late.
The best time to start is when the new generation of processors is shipping.
The best time to start is when the geopolitical environment settles down.

Actually, as you've probably guessed, the best time to start was last year. The second best time to start is right now.

Quote of the Day

2008-07-26T18:48:00.003+01:00

"It's probably true that hard work never killed anyone, but why take the chance?" - Ronald Reagan

Notes:

Buffett on how the management of large organizations is extremely hard work, which is why he has taken the "easy route": just sitting back and working through great managers who run their own shows. "My only task is to cheer them on, sculpt and harden our corporate culture, and make major capital-allocation decisions."

Quote of the Day

2008-07-26T18:44:00.004+01:00

"We shape our buildings, and afterwards our buildings shape us." - Churchill

Notes:

Buffet uses this quote in reference to organizations apparently becoming slow-thinking, resistant to change, and smug as they grow bigger

China's currency needs to rise further - FT.com

2008-07-26T17:30:00.004+01:00

Summary:
Three years after lifting the renminbi's dollar peg, and an appreciation of 20% against the dollar, the currency remains substantially undervalued, and undervaluation has in fact increased. The nominal exchange rate appreciation has not kept up with that of the equilibrium value of the currency, i.e. the value consistent with economic fundamentals. China has remained heavily dependent on investment and growing trade surpluses to sustain its double-digit growth rate. A change to more consumption-driven growth is required, but will be difficult as long as household income continues to decline as a share of GDP. The main source of the problem is a serious misalignments in the real exchange rate and the real interest rate. Unless China narrows gap between the real and equilibrium exchange rate of the renminbi, it will find it ever harder to prevent speculative capital inflows from undermining its pursuit of independent monetary policy. (Published: 22/07/08)

Notes:

3 years since lifting of renminbi's dollar peg

currency has become more flexible and appreciated about 20% against the dollar
yet: under-valuation of the renminbi has increased

real trade-weighted exchange-rate has appreciated only 15%

only about a third of what's needed

equilibrium value of the currency has risen faster than real trade-weighted exchange rate

i.e. the value consistent with economic fundamentals

external surplus has mushroomed

current account surplus has soared

from 3.6% of GDP in 2004 to 11.3% last year

official reserves grew by massive $280b in H1 2008

rapid productivity growth in export industries has enhanced China's competitiveness

also:

central bank has strengthened controls on capital inflows

consumer price inflation has risen to 8%

China's new exchange rate policy has not been helpful

in "rebalancing" economic growth towards consumption and away from investment and net exports
nor in alleviating the repression in the banking system

both of which are strongly in China's own interest

China has remained heavily dependent on investment and growing trade surpluses to sustain its double-digit growth rate

investment exceeded two-fifths of GDP last year for the fifth consecutive year

main cause: low interest rates (now negative in real terms)

in part because the authorities are reluctant to adjust upward for fear of attracting even more speculative capital inflows
low lending rates

contribute to an excess demand for loans and thus the high share of investment in GDP

low deposit rates

have depressed the growth of household income far below the levels that would have been achieved with less financial repression

contribution of consumption to GDP growth remains depressed

last year the government slightly increased its own outlays on health, education and other social programmes as a share of GDP

first time in more than five years

but: was not enough to offset the multi-year decline in household consumption, which slumped to a new low of only 35 per cent of GDP

China will find it hard to change to more consumption-driven growth as long as household income continues to decline as a share of GDP

rebalancing the sources of growth will require more rapid appreciation of the renminbi as well as other policy adjustments

bank profitability has suffered as authorities engage in massive sterilisation

to prevent increases in inter-national reserves from spilling over into an undesirably rapid increase in bank lending

central bank has raised the level of required reserves 19 times since mid-2005

note: reserves pay a negative real return

authorities have also "sold" banks huge volumes of sterilisation bonds that bear negative real yields

have more than offset these implicit taxes on banks by maintaining a large spread between lending and deposit interest rates

but: this spread will erode as further domestic financial reform and globalisation expand the alternatives available to Chinese savers and borrowers

progress on China's currency regime should not be evaluated by focusing exclusively on movements in the renminbi/dollar exchange rate

China is still suffering from serious misalignments in two crucial relative prices:

the real exchange rate and the real interest rate

unless China narrows gap between the real and equilibrium exchange rate of the renminbi, it will find it ever harder to prevent speculative capital inflows from undermining its pursuit of independent monetary policy

needs to reduce the scale of intervention and sterilisation
needs to increase interest rates significantly

or it will continue to face strong headwinds in rebalancing the sources of its economic growth

needs sharply accelerate the pace of renminbi appreciation

step revaluation of the renminbi would be helpful

How to fix a broken venture capital model - EETimes

2008-07-25T21:34:00.004+01:00

Summary:
Interview with Matthew Nordan about why the current VC model is broken, especially in the case of materials, energy and environment sector investing. The linear path from angel to VC to IPO no longer works due to greater costs, longer gestation times, greater technological uncertainty and ill-defined problems. This is a time of great experimentation and visible discomfort. New type of VC machine needed. Smartest venture firms cultivate relationships with the buyers of technologies. Nordan also has four rules for venture companies: Make non-obvious matches of technologies and solutions; be suspicious of exponential growth; maximize options to avoid surprises from left field; and avoid focusing on an ideal technology to such an extent that you fail to see a "good enough" technology in its wake. (Published: 22/07/08)

Notes:

Matthew Nordan, Lux Research, President

ideas on how to make startup financing work again

old machine

linear path

angel funding -> VC financing -> (some cases growth equity/PE) -> public markets

works really well for IT

don't need tremendous amount of money; pretty capital efficient investments

also for life sciences

because there's a rule book that you can follow by using the FDA and EMEA approval cycles as a way of determining how far the company is

none of those rules exist in the materials, energy and environment world

and you need more money over longer periods of time (gestation times in excess of a decade)

frequently break 10 year close-ended fund cycles that VCs as a rule have

with greater levels of technology risks further down the cycle, down into the land where you have 10s of millions of dollars of investment being made by PE and growth equity funds

machine doesn't work; need a new machine

new machine

some innovations promising; but you don't know what works till folks have seen a 25% IRR on doing it in a new way
interesting: fund that raises small amounts of money to be able to go out and seed companies to get them to a stage that they are ready for a venture fund

cut of that first part of the technology development cycle and get it to fit into a 10-year close-ended structure

interesting: project financiers beginning to construct joint venture vehicles where there may be a carve-out slice of equity for the venture financiers that may get them some returns (some meat to take home to the cave for the LPs) before the company is able to achieve the liquidity of it

particularly for water and waste technologies

venture funds have responded by specializing

Rockport and Kleiner Perkins Caufield & Byers

invest in early-stage technology

Riverstone and FourWinds

invest in deployment of semi-mature technologies

only a few funds like Vantage Point try to span the gamut of development and deployment
new model of "clear-cutting" VCs

exemplified by Khosla Ventures
represent funders of last resort

ultimately this a time of great experimentation and visible discomfort

will be 5 to 10 years before we know which of any of those ingredients are going to work out

bringing in the growth equity partner between VC and IPO

growth equity is coming back
VCs are not prepared to extend funding into the hundreds of millions of dollars

smartest venture firms cultivate relationships with the buyers of technologies

smart venture firms talk to the customers of potential startups to say what problems do you need solved five years down the line?

ranging from OEMs in the semiconductor field to utility companies in the energy field

then build a startup based on the wish-lists of those customers

business plans get ripped apart five times over before the company ultimately decides what it is that it's supposed to be doing
difference from an energy environment perspective is that the problems are generally less well defined; lack of definition

as opposed to software: explicit problem that they're trying to solve upfront
e.g. Green Fuel Technologies Corp., algae company

intended to use algae to process wastes from natural gas plants and ferment biomass fuels
turns out that you can get a lot more revenue from the same unit of algae, not by fermenting it to make biofuels, but by selling it as fish feed, or as an additive
the desiccated algae itself are more valuable than the biofuels that you can make from them

at least in the current state; may change over time

four rules for venture companies

make non-obvious matches of technologies and solutions;
be suspicious of exponential growth;
maximize options to avoid surprises from left field and to be aware of unexpected breakthroughs;

e.g. emerging "solar antenna" that can tune in to 800-900 nm waves, thus obsoleting several small-scale solar technologies
also involves carefully quantifying all externalities

e.g. the water-use requirements for ethanol and biodiesel make so-called clean energies look dirty when total inputs are taken into account.

avoid focusing on an ideal technology to such an extent that you fail to see a "good enough" technology in its wake

Utilities say grid can handle rechargeable cars - MSN Money

2008-07-25T19:08:00.003+01:00

Summary:
Energy industry officials believe they will be able to cope with the increased electric demand when rechargeable cars become a reality. Industry has already dealt with increased electric demand from millions of plasma TVs (cars consume 4x more electricity). Changeover from ICE to electric is likely to be gradual (still lot of issues with batteries to be solved). Will thus be able to handle it in same way as they handled plasma TVs. Most electric cars will likely be charged during off-peak electric use times, utilities should have no problem generating enough electricity. Potentials problems: rise in oil price causes transition to be very rapid; stress on distribution system in certain areas; electric vehicles getting larger and requiring far more electricity for recharging; and demands from people that their vehicles be recharged quickly, drawing more electricity during peak times. (Published: 23/07/08)

Notes:

cars vs. plasma TVS

rechargeable cars consume about four times the electricity as plasma TVs

but: industry already has dealt with increased electric demand from the millions of plasma TVs sold in recent years
experience will help them deal with the vehicle fleet changeover

Mark Duvall, program manager for electric transportation, power delivery and distribution for the Electric Power Research Institute

Plug-In 2008 conference

"So as long as the changeover from internal combustion engines to electric vehicles is somewhat gradual, they should be able to handle it in the same way"

"We've already added to the grid the equivalent of several years' production of plug-in hybrids."

"The utilities, they stuck with it. They said, 'All right, that's what's happening. This is where the loads are going, and we're going to do this.'"

Automakers are planning to bring rechargeable vehicles to the market as early as 2010

but will take much longer for them to arrive in mass numbers, due in part to a current lack of large-battery manufacturing capacity

auto and battery companies still are working on the lithium-ion battery technology needed for the cars, and on how to link the battery packs to the vehicles

Efrain Ornelas, environmental technical supervisor with Pacific Gas and Electric Co. in San Francisco

"We see the vehicle penetration levels coming at a rate that's manageable. It's not like tomorrow the flood gates are going to open and 100,000 vehicles are going to come into San Francisco or something like that."
PG&E will be able to track their charging patterns and plan accordingly for the future

current demand

utility officials say they already are coping with increased demand

especially during peak-use periods in the afternoon and early evening
rest of the day, most utilities have excess generating capacity that could be used to recharge cars
most electric cars will likely be charged during off-peak electric use times, utilities should have no problem generating enough electricity

the preparation doesn't mean electric vehicles will be accommodated without problems and good planning

since people with the means to buy electric cars likely will live in the same areas, utilities worry about stress on their distribution systems
if high gasoline prices could push sales of rechargeable electric vehicles well into the millions by 2020, that could stress the system
other possible problems include

electric vehicles getting larger and requiring far more electricity for recharging
demands from people that their vehicles be recharged quickly, drawing more electricity during peak times

choice for consumers

consumers will face a lot of choices about when and where they charge up their cars and how much they want to pay for the electricity
utilities likely will raise rates to charge cars during peak use times, generally from around noon to 8 p.m., and lower them for charging during low-use hours

e.g. PG&E charges 30 cents per kilowatt hour to charge an electric vehicle during peak hours, he said, but charges only 5 cents from midnight to 7 p.m

talk of the cars storing electricity and sending it back to the power companies during peak times

officials say that's a long way off