Posts filed under ‘Economics’
Thinking of Walter Bagehot (forgotten panics and not-so-forgotten bankers)
After a weekend in Henley closing the strategic marketing and global business environment modules, and endless talks about the capital markets, including a valuable late-hour conversation in the plane with an economist whose expertise are intangibles, I felt I needed to dwell on the past knowledge to gain some perspective on the issue.
And who better than Walter Bagehot and his Lombard Street. I’d rather externalise the explanation on who’s Walter Bagehot using Wikipedia, but it suffices to say that he was the chief editor of the Economist, as well as a banker, and had studied mathematics and philosophy. What’s more interesting, that was in 1873.
1873 was also a year of panic: another crisis that lasted for four years (roughly like the 1929s’ depression), beginning with a mortgage crisis, another link worth externalising to the Chronicle Review. (Thanks to Brisebois 
)
Many will see analogies between what has happened in the past and what’s happening today. Even though, we tend not to care about what happened so long ago (or maybe not that long) and good lessons are simply forgotten. We could know so much if we simply didn’t collectively forget!
Because, in times of panic, what should a central bank do? Bagehot thought “that it must in time of panic do what all other similar banks must do; that in time of panic it must advance freely and vigorously to the public out of the reserve.”
But still a conditions for the intervention: “first that these loans should only be made at a very high rate of interest. This will operate as a heavy fine on unreasonable timidity, and will prevent the
greatest number of applications by persons who do not require it. The rate should be raised early in the panic, so that the fine may be paid early; that no one may borrow out of idle precaution without paying well for it; that the Banking reserve may be protected as far as possible.”
Where should we stop? “that at this rate these advances should be made on all good
banking securities, and as largely as the public ask for them. [...] But if securities, really good and usually convertible, are refused by the Bank, the alarm will not abate, the other loans made will fail in obtaining their end, and the panic will become worse and worse.”
“The only safe plan for the Bank is the brave plan, to lend in a panic on every kind of current security, or every sort on which money is ordinarily and usually lent. This policy may not save the Bank; but if it do not, nothing will save it.”
After all, some things could be done much better, but doing nothing leaves us all worse off. Guess what, the alternative was also tried a lot of years before, in the panic of 1825, also another long-lost panic, when “the Bank of England at first acted as unwisely as it was possible to act. [...] The reserve being very small, it endeavoured to protect that reserve by lending as little as possible. The result was a period of frantic and almost inconceivable violence; scarcely any one knew whom to trust; credit was almost suspended; the country was [...] within twenty-four hours of a state of barter. Applications for assistance were made to the Government, but [...] the Government refused to act…”
Ring a bell, maybe?
The ant, the grashopper and the interest rates
I sincerely wished I could write about something else, but these days I’ve been spending a great deal of the time I don’t have absorbed by the financial markets.
And I’ve come to think of Aesop’s fable (click here for the Wikipedia entry): the ants and the grasshoppers, and the way they would have related to interest rates.
Since the ants are the hard-working ones in the fable. They are the ones that build the real economy, the ones that have their savings in the bank, in the safest financial products. On the other hand the grasshoppers don’t really worry about working hard, they are prone to risk and they aim for quick profits, regardless of the consequences.
Okay, now with the interest rates. Reasonably low interest rates benefit the ants because they can access funding with a reasonable price and still get a basic return for their savings while keeping them safe for the future. After all they are risk-averse creatures.
But if the interest rates go too low, close to nil, then it’s the time for the grasshoppers. Who cares about saving, who cares about the long term while short term is cheaper and you can still carry-trade. Short-term benefits are in order, even castles in the sand if they can be sold somehow, and when there’s no limit to the castles in the sand you can build, there’s no limit to growth. Screw Kondratiev!
In the end, it seems that the ants will end up saving the grasshoppers, just like in the fables. Lesson learned… or is it not? 
Hallowed are the American taxpayers…
Hallowed are the American taxpayers
as they are the ones that will pay this huge bill,
Hallowed is the American Treasury
as it will acquire junk assets in the name of the Americans,
Hallowed are the international creditors
cos they will get increased risk premiums from a riskier debt,
Hallowed are the Feds
pushing forward a plan they don’t know if will suffice,
Hallowed is the growing debt
it will at least double in the forthcoming years,
Hallowed is the forgotten Laffer Curve
now supposed to work better if turned downwards,
Hallowed is the non-interventionist state
that implements socialist ideas in times of distress,
Hallowed are the big investment banks
allowed to merge to hide their shortcomings and ignominies,
Hallowed are the plunging assets
as they will be allowed to survive with their old values in the balance sheets,
Hallowed are the short sellers
sinners never repented from what they did in 1929,
no longer allowed to arbitrate or cover risks,
Hallowed are the politics
for they will still adore the taxes,
Hallowed are we all
for we will long feel the ripple effect of short-sighted politicians and unelected officials.
Sorry for the mental rambling, forgive me my rantings, but it’s been a hell of a week… time to change the subject though…
Freddie Mac and Fannie Mae (Houston we’ve got a problem)
Even the most important (and supposedly liberal) economy in the world has its contradictions. And in this continuous deleveraging process that it’s suffering two huge pieces have fallen. Well, in fact, they have not fallen but been saved by the bell, at the last minute, by the American taxpayers. Or maybe not?
Let’s go step by step. This kind of operations are called nationalisations all over the world (and bringing them under government’s control in the US). Now the shareholders and the debtors of Freddie Mac and Fannie Mae have a problem. But the deleveraging process had to stopped somehow, somewhere. And that line was worth defending.
Avoiding the discussion about moral hazard, six months ago I was writing about the Financial weapons of mass destruction unleashed in the US (the party is over) and also about The new cycle of capital recovery (who’s financing your debt now?) Let’s use the same ideas now to seek coherence in the present situation.
Let’s summarise the whole reasoning and see where it leads to:
- Freddie Mac & Fannie Mae’s shareholders (and many other shareholders and creditors too) have lost a lot of money, true. We still haven’t seen that in the news, but a lot of sovereign funds must have lost fortunes. The time will come when they’ll have to account for them.
- Taxpayers will have to pay a lot of money now, true.
- The consequences could be worse if the taxpayers didn’t intervene, so it’s worth doing it, true. This line should not be crossed.
- So we do it, we nationalise Freddie Mac and Fannie Mae. Done. And to avoid moral hazard their shareholders must have an important loss, otherwise the system would be asymmetric. Or did any companies volunteer to share their big gains not so long ago?
- Shareholders and debt holders of those companies must be unhappy and worried about the soundness of the American economic system, reasonable. Wouldn’t you after losing that much? They’ll think twice before investing again in the US. Sensible thought, and yet that’s where our problems begin.
- Taxpayers are paying. I said that in number 2. But, can they afford the bill? The US is a country with a huge fiscal and commercial deficit, so it depends on foreign inflows of capital. Just follow the previous links to my half-year-old articles to see more.
- The taxpayers only have two ways to pay the bill: increasing taxes or further going into debt. I don’t see any of the presidential candidates advocating for higher taxes so I assume it will be the second option. The treasury will have to emit further debt, and not in small quantities. I’m approximating here but, these huge numbers are in order of the current debt volume. In other words, the US debt might be doubling because of these nationalisations.
- Doubling the debt volume means a lot about a country’s ability to repay it: it roughly halves the quality of the debt. We know that the US debt is a high quality debt, but that quality will subsequently be slashed down.
- The world has a few very important lenders, mainly Asian countries. Need I say which one? But they are not that enthusiastic with investing in the US any more. The foreign inflows into the US economy have been steadily declining in the last months.
Now for the conclusion, do we really expect the international lenders to go and help the same country that has given them important losses? Could we have an “holistic” response to keep the international lenders happy without incurring in moral hazard? Will they, after the negative experience, keep buying increasing quantities of worse quality debt?
The equation is something like this:
- ↓↓↓ availability of capital in the markets
- ↑↑↑ losses lenders and investors have suffered
- ↓↓↓ their predisposition to invest again
- ↑↑↑ increase in US debt needed
- ↓↓↓ decrease in the US debt quality
Well, there’s no easy exit to this cycle. The US will be pressured to compensate the international lenders of their loses if they want to keep capital inflows going. But isn’t that strikingly close to the definition of moral hazard? Notwithstanding, which are the other options to keep the flow going?
The deleveraging process is not quite over yet. And the US treasury is constrained between a series of conditions that cannot be all met at the same time. But worse of all, the whole country’s economy virtuous circle is broken and has turned into a vicious one. The economy is not sustainable any more. Houston we’ve got a problem.
On a positive note, there are more sides to this story. Two ideas:
- The US are the main market for those that are financing them. That means that, at least, they are financing a nation that is giving them back part of their finance and holding the activity of their industry. While this cycle exists, things won’t be so grim.
- Other economic areas don’t have this vicious circle, but are falling into stagflation instead. Even with its shortcomings, the US is still a growing economy. There are not that many around. The solvency of the US economy is still holding. And they have the resuscitated dollar.
And another Damocles sword:
- Is this the end of the intervention over Freddie Mac and Fannie Mae? Will these funds be enough? That depends on the still falling value of their assets and their growing insolvencies when people won’t be able to repay their mortgages. Who knows how much money will still have to be injected… and where else.
Reflections from a high-speed train (inbetween Madrid and Barcelona)
I often travel the route Barcelona Madrid (and backwards) for the day. By plane it’s rather tiresome and expensive: with an open fare you end up paying around 400€ for a 630 km flight (+ 630 km back).
Barcelona – Madrid is the world’s busiest route with 971 operations per week. The second one is Sao Paulo – Rio (894 per week) then Jeju/Seoul Gimpo (858 per week) and fourth is Melbourne/Sydney (851 per week).
In fact you have to go very low in the ranking to find another crowded European route. That would be Rome – Milan with less than 600 operations per week, which, by the way, is more than the most crowded North American continental route: Las Vegas – Los Angeles (553 per week)
Source: www.oag.com, data from September 2007
But things change. And this milk cow for the airlines faces its first serious menace ever: the high speed Spanish train service, also called AVE.
These brand new trains travel the distance of 630km (410 miles) in two hours and 35 minutes. Not too bad when it’s compared with the plane that takes roughly two and a half hours (not just flying but also spent in the check in and departure processes), and possibly more.
But, from an economic point of view, there are many hidden costs that must be taken into account. After all, what is it that you do in a plane? Well, you sit in a narrow seat, trying not to disjoint your legs, and pray that the person that will be sitting beside you is not extra overweight. In the train you have plenty of space. Being uncomfortable has a cost.
How much? Well, it depends on what you’re willing to pay to be more comfortable, of course, and how much your time costs.
How much are you willing to pay for that extra nap? Well, in a 45-minute-long flight, you’re going to have maximum thirty minutes of uninterrupted sleep. You won’t be able to sleep while you queue, while you’re being inspected at the burdensome security checks, while you wait your turn. But on a continuous 2 hours 35 minutes journey you’ll be able to.
As for opportunity costs, you won’t be able to do anything in the plane, apart from opening your laptop for half an hour. It’s completely wasted time. In the train you can use your computer as much as you want, use your phone, combine them and access the internet. Work, eat, talk, whatever you wish.
But externalities must also be taken into account. Environmental footprints can be four times higher for planes than for trains. That means that the train will always be more sustainable and, if we ever are to reflect the true external costs, energy efficiency will give the train an important lead over the plane.
Add those costs up: discomfort costs, opportunity costs, externalities and you will have a very competitive mean of transport. Which only means that competition has been increased, with a comparable service at a better price. In the end, consumers will be benefited from the additional choices, lower prices and the increased service levels that competition will bring.
That was what I was thinking when I decided to open the textbook I was carrying with me. The Managing Financial Resources module awaited me. Fortunately it was half way to Barcelona, 300 km per hour (186.41 mph), still an hour to go.
The new cycle of capital recovery (who’s financing your debt now?)
Following with the article Financial weapons of mass destruction unleashed in the US (the party is over) that I recently wrote, it seems like the liquidity storm is enjoying some calm. Not a bad thing when liquidity is the tip of the solvency iceberg, and when investors need a break in the increasingly bearish market.
Yes, it all began with an excess of funds that permitted spending in excess. And from that excess, excessive and ultra sophisticated imaginative investing products were made. The trouble is that they were so complicated that the risk wasn’t understood enough, or simply ignored. Now the risk has resurfaced again and debt ratings are on its way down.
In that scenario we had several options: to cut the excessive spending or to find new lenders. Looks like we’ve encountered some new ones.
The first are the public lenders, also known as monetary authorities. By increasing the monetary mass, and providing low-term credit to low rates, we have financed ourselves. Not a bad thing to do if we were a socialist economy, which we are not. But time will say if we have many other options. I fear we don’t.
Wait, there’s still another option. The ones that actually created the liquidity bubble are coming to our rescue. After all they are the ones benefiting from selling 100$ barrels of dark oil. And now they can come to rescue our banks, our real state using sovereign funds. Suspiciously these new lenders remind me a lot of the old ones…
Both refuel the shrinking bubble in the hope of inflating it again, but in the meantime the true inflation is rising and growth going down the slope. Either we finance ourselves or we trust in opaque investment artefacts coming from non-democratic countries.
But this time, if we are being refinanced, it will be either at higher rates or lower prices, there’s no way to ignore the risk. Are we really aware of the costs of refinancing? Are we facing the real issue here? Reality tends to be stubborn.
Financial weapons of mass destruction unleashed in the US (the party is over)
It supposedly began with a bubble. Just another bubble like the one I described on The South Sea Company (or how Sir Isaac Newton spurned the dismal science). The bubble was fuelled by an excess of liquidity. It had to end someday. We learned the word subprimes. We knew it had to mean trouble.
Liquidity injections were administered and succeeded. But they were just patches for a bigger problem. And then they asymmetrised the risk: there were institutions willing to provide liquidity when needed, to reward higher risks, to stimulate the economy further up and away from reality. Until the moral hazard was too huge.
And then it ended too abruptly. The wells of money simply drained and, those whose business was to ensure the efficient distribution of liquidity between the different players just became inefficient. From excess to world wide scarcity, even for sound projects. It became a financial crises.
Few crises have been so focused on the financial system like this one. Because that’s what’s really in trouble here, the whole financial system. I began in the UK with Northern Rock, now nationalised thanks to Alistair Darling. In the meantime Daniel Bouton from Societe Generale didn’t know what was happening in his bank until he lost more than his reputation. And the Swiss face value is also in an all-time-low: just take a look at UBS and Credit Suisse (also First Boston).
But where really is too darn hot is in the US. Bearn Sterns is in flames, expiring his final breath. Bought by $270 million, it was valued about $20.000 million one year ago. A 85-year-old Wall Street institution simply died.
And those that bought companies using leveraging, namely private equity, now see the liabilities piling on top of the roof. Take a look at Blackstone: their profit for the last quarter was less than a half of what was expected, and dropping. Of course its value is dropping too.
We gave it complete freedom. They took it. They invested again and again in the same risky assets, albeit chopped and transformed so they didn’t look like they were the same: collateralised debt, mortgage insurances, mortgage reinsurances, credit swaps and all kinds of derivatives that were the same dog, different collar.
And when the system was in trouble: more liquidity. Await for some more in the next days. New bolts and flashes from the Fed to try to contain it all. But no regulations… in any case it would be too late for that. And always paying a huge price in inflation… until that game is not longer possible.
The dollar’s dropping. The safe heaven for savings all over the world that financed the US debt has ended. If you add up the soaring energy prices, and the huge public deficits, the US credibility is under minimum. The country risk is dangerously rising… no more overspending, no more cheap financing, the party is over.
Economy cycles, Schumpeter and tumbling again.
One of the great aportations of Schumpeter was his approach to the Economy from different points of view, not just from a mathematical, technical or mechanical one, but from the diverse social sciences: human history, sociology, anthropology and even psychology.
I love his concept of the business cycles. They are based on the creative destruction idea. That’s the process that the entrepreneur leads, supported by innovation, to destroy the old way processes were run and substitutes them for new ones. Destruction and creation both at the same time. That means a whole cycle: birth and death. That was in 1911.
But Schumpeter wasn’t the only one talking about cycles. Kitchin also did, in1923, from Harvard. His cycles were bigger than the already well known seasonal cycles, lasting for approximately four years. They were to be known as stocking/destocking cycles.
The legend says that Rothschild had already discovered the cycles before, on Wall Street, around the beginning of the XXth Century. But, instead of making his name famous, decided to use them to fill his pockets. A group of investors followed and, with the help of mathematicians, they found a 41-month investing stock cycle in 1912. If they became rich, they didn’t become rich enough: as of today we don’t know their names. And the cycles are still named after Kitchin (slimmed down to 40 months).
Later, new longer cycles were supposedly discovered: Juglar cycles, around 9-10 years and Kuznets cycles, around 15-20 years…
And there are also Kondratiev waves, around 48-60 years, and the most disputed of them all. There are supposedly a few Kondratiev cycles identified: The Industrial Revolution (1787-1842), The Bourgeois Kondratiev (1843-1897), The Neo-Mercantilist Kondratiev (1898-1950?) and the The Fourth Kondratiev (1950?- 2010?). The numbers with interrogation marks are of course just approximations written long ago. Could we be close to the end of the Fourth Kondratiev? In any case the projections didn’t know anything about subprimes, wars or energy prices. And Nikolai Kondratiev was a Soviet economist (not that the fact discredits him but he was kind of eager to prove that Western capitalist economies were susceptible to high performance volatility opposed to planned ones).
But, even not having any cycle under his name (an injustice from my point of view) it was Schumpeter who already identified and described the four phases of every cycle: boom- recession-depression-recovery. It’s the existence of the four phases that converts a fluctuation into a cycle. A stubborn aspect of reality that tends to repeat itself (not only in Economy though). This page of the National Bureau of Economic Research about Business Cycle Expansions and Contractions is interesting enough.
Yet again cycles catch so many off-guard. It’s interesting to see…
Why is the cost of food skyrocketing? (think twice before assuming we’re more hungry)
I’ve been having a conversation about food prices. It’s a fact that they have skyrocketed lately, and they don’t look like they’re going to go down soon. Why is that?
The first reason is, of course, that now we are more people eating. I personally haven’t changed my eating habits, but a lot of Chinese, fortunately, have. The huge Asian country witnessed the birth and nurturing of million of “little Buddhas” that serve as a sign that a lot of Chinese don’t suffer the fate of their not-only-culturally impoverished parents. And the more people eating, the more scarce food becomes, and that drives prices up, the simple law of demand.
Prices soaring? Not guilty!
Another way of explaining why the prices raise is because of utility. Utility describes what the consumers feel about the products: the more utility, the more people are willing to pay for it. Food is not only useful but really necessary. That necessity is expressed in the price. Utility, thus, is part of the price of the product. If this was the beginning of the XXth century, Eugen von Böhm-Bawerk would say it’s not utility but marginal utility, and he’d be right. The utility depends on the eyes of the beholder. And the utility of food becomes less important as you are fed, and then focus to things like not-so-useful diamonds.
Thus the price is ultimately related to scarcity and utility. Food becoming more scarce means that we’re going to pay more for it. And don’t expect that to change.
But is it so great the difference between food consumptions? A few years ago we had all these surpluses at both sides of the Atlantic Ocean, not knowing what to do with so much cereals and milk, heavy-subsidised goods, and now we are running out of them? That surely would mean great savings for the EU and US governments and tax-payers!
So, where have all the surpluses gone? Have the “little Buddhas” eaten so much? I don’t think so.
A system is, by definition, an ordered set of elements that includes relationships between them. In a price system then, there are not only products, but also a series of relationships that link them. Those relationships are key to understanding the whole system. Some of them establish products as complementary or substitutionary. The former will need each other thus demand of fuel will raise the more vehicles exist, the latter will substitute each other thus the use for private cars will shrink in congested cities that develop efficient mass-transportation systems. In that case the perceived utility for public transportation will be greater for some people, boosting demand.
Surprisingly substitutive: guilty!
When biofuel was invented everyone hailed the newborn as a chance for sustainable energy production. Now we had something useful and expensive to convert our cereal overstocks into. Very high subsidies were required to start building alternative sources of energy like this one, but there was a case for it: less dependency from “dangerous countries” and a lot of big corporations interested in the processes (and subsidies). A great alternative to fossil fuels was being born, and also a less polluting one.
But what we didn’t anticipate was that move would tie prices of food and energy together. Thanks to the newly created market distortion (sorry, I mean subsidy) now there are new induced scarcities throughout the food chain: for example less and more expensive grain for livestock for example. Nobody anticipated either, until the Nobel laureate Paul Crutzen did, that more farming requires more nitrogen, and that nitrogen is highly polluting, especially when it gets released to the atmosphere as nitrous oxide (N2O) by means of biofuel.
There are many implications of the use of biofuels, some positive, some are not. But it’s not easy to take a look to the global picture. In between of so many interested views and sponsored applied science it will take some time and a lot of effort to get perspective on the issue. But one thing is clear: don’t blame it on the “little Buddhas”.
Apple’s scarcity rent (MacOS X in your PC: the hackintosh is born)
I think there’s little discussion that Apple’s operating systems are much more usable and friendly to the user than the ones created by Microsoft. Given the fact that the first used to precede the latter that could mean also a lack of observation skills by Microsoft, but that’s not the point. The point is that denotes a different strategic positioning for each company:
- Apple is focused towards customers. No redundant or extra menus, just the basic essential needs. utmost usability. But the trade-off also comes to one price: lack of support to several devices or open platforms. To ensure a controlled experience, controlling the hardware becomes necessary.
- Microsoft is focused towards providers. They define an open system and they build hundreds of thousands of drivers to be able to include each and every hardware even made. They are backwards compatible, ensuring the incorporation of legacy systems. The downside: too much variety hampers your ability to control the user’s experience.
The focus to providers, to the whole industry, means building a cluster of companies around that are able to freely introduce their products to an interoperable market. That’s quite interesting, isn’t it? Companies are able to build their own standards, to compete, and Microsoft simply supports them.It seems that a user should choose between a system tailored for her or a system thought for interoperability. Tough choice, huh?
Simplified like that one would say “let’s choose a system designed solely for the users”. But that’s not quite true. Both systems have users in mind, only a divergent focus. But a focus towards the industry means being able to access a pool of competing hardware. And that means lower prices… ain’t that nice for the user? Maybe the focus wasn’t the user, but she is directly benefited of having an interoperable and open hardware industry.That’s why the nerds simply won.But history makes strange turns. And Apple has changed a lot through the times. Two important swerves:
- Intel was PC, Motorola was Mac. Intel was winning in price and product. Mac switched.
- PC was MSDOS, and always backward compatible. Mac wasn’t, and in a bold move decided to switch to UNIX. Now Mac is more stable.
And the result is that Mac is standardised in its kernel and equipment, dwelling in the well of PC-compatible hardware and leaving behind its own proprietary hardware.There’s no real hardware difference between a PC and a Mac any more. Only slight differences that make them slightly different. That’s all. And, on top of it, a very different OS working in (almost) the same setup.And then Apple made another bold move. Decided to go open source. I could write a lot about open source, but the main point of it is releasing the sources so that developers can make better working programs and the quality of the applications and the user experience can be enhanced.And some hackers just did it. Netkas, ToH, BrazilMac and many more rebuilt the system kernel and adapted a few drivers so Mac OS would work in a standard (and advanced enough) PC setup. And voilà. MacOSX was born. Hackintoshes were born.
take a good look, this picture is for real, MacOS in my PCIt works, I promise. I have both systems installed (for educative purposes of course) and MacOS X simply rocks. It makes the most of your hardware. Far more stable, far faster, far more usable.MacOS X version 10.5, also called Leopard, was hackintoshed just one week after its launch. So, if it can be done, why aren’t they?Why keep making software for a minority instead of addressing a big market share? Apple wants to keep selling its hardware… that’s a reason enough. Apple wants to segment its public, that’s another reason too. Is Apple learning from hackintoshers or would prefer them silenced?Let’s say it all loud. PC and Macs are no longer different. Many of us, PC users, could be able to choose between two operating systems tomorrow. Microsoft’s monopoly could be broken, and Dell could be providing alternative hardware to Mac users tomorrow, breaking Apple’s monopoly too. Two monopolies that do their best to help each other, regardless of appearances.Why must we be constricted to only one OS? Why should the OS determine who you buy your hardware from? There’s no objective reason for those market imperfections that are simply hampering consumers.Unless Apple decides to fire first…
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