Posts filed under ‘Microeconomy’
And we are no longer asking “why” to the crisis
It’s amazing how we tend to forget. Not so long ago some people were still being blamed, bankers mostly, the beheaded god Alan Greenspan, some professional confidence man (aka con) Bernie Madoff, and a few more, but except for the latter that has even seen the disgrace in its own family, the former have gone back to their oversized bonuses and Mr. Greenspan is enjoying a deserved retirement, maybe with less conferences than what he had hoped for.
We’ll end up believing that the crisis is more a natural catastrophe, like those earthquakes in Japan, than a punishment. Isn’t it always easier not to blame yourself? God, with infinite power and without any need for an explanation, has just decided to punish you. And that’s all. Why think? Why blame? Why even change?
A system that privatises gains and socialises losses can’t be good. And that’s what we are seeing all over the world. All citizens end up sharing the burden. The “too big to fail” has been finally accepted by the whole humanity, the final enshrinement of the “moral hazard”.
Maybe we have finally reached our destination. We are capitalists when it’s time to reap benefits, but socialists with losses. Be aware, that only applies to big corporations. Finally, the richer 5% has some way to outgrow us all, to keep concentrating more and more power in their hands and make sure that when they fail they won’t have to answer for it.
I read today in the news that this year General Electric, in spite of a huge profit figure (true, it could have been better but it’s still huge) is only paying 7.4% of their profit in taxes. Congratulations to their accounting department, finding every possible trick, every crack in the fiscal legislation, every opportunity not to pay… But, at the end of the day, do you feel like they are making the same effort as citizens are? How much do you personally pay?
And another example, this time from Spain, from the likely next president in another year, a sentence in a conference in Germany: “If Spain is having a bad time it’s not the Spaniard’s fault”. Whose fault is it then? The hidden external enemy? God’s?
Beware, things that do not work can’t last for long…
Dubai has financing troubles but… is it making a profit?
More than two years ago I was writing about Conspicuous consumption: from Thornstein Veblen to Jumeirah Palm. The reference to Dubai was almost mandatory of course. I’ve been to Dubai and I like the place. We all know that recently it has run into some trouble financing its debt. They are expecting a bailout from the United Arab Emirates which are playing hard to get.
My personal view is that they will get this bailout. Actually, I have little doubt of it. They must be now in the midst of a power struggle about how to manage all that. We have to remember that many western nations rushed to finance banks only to discover that they had forgotten to write down a few conditions in the contract about the remunerations to top managers and suddenly the public opinion cared more about those millions’ destination than for the rest of thousands of millions.
Leaving that aside, Dubai is similar to a long-term investing fund. In the long run you get your returns, not before. To manage it you need to be very cold, and not let the circumstances blind you.
But everything in Dubai is so shiny that it blinds you. That’s good for the brand, of course. So we have this dilemma: building shiny things maybe is not that good for the long run but, what else do you have to sustain your brand that very very shiny things?
No matter what happens now, the shiny brand is not so appetising anymore. And investors will think twice before risking again. I don’t want to compare Dubai to a Ponzi scheme, it is not, but to achieve the desired returns it needs to be able to sustain the investments arrival for a long-term period. Is it going to?
Since I’m not the Delphos’ Oracle I leave the reflection here. A small hint: it’s all about fundamentals. In the long run, an investment will survive and flourish if its a sound business. If we are dependent on a brand that requires too high a burning money rate, probably it won’t.
Having investors is a thing, when you lose them you can resource to forced investors (also called taxpayers) or stakeholders that have other interests (power in exchange for money, for instance) but, having a big enough profit for the expected yield, that’s another thing…
For the pain in Spain, the banks are to blame (amongst others, let’s say)
Being these days in Barcelona I’m amazed how several publications, I’m thinking of Forbes and their “Spanish banks in top form” article, can be so blind and misleading. If Spanish banks are in top form, buckle up Dorothy, as the ride is going to be very rough all over the world, you ain’t seen nothing!
And the ride is going to be long and rough for Spain. How else could a developed country withstand more than 20% unemployment in a deflationary context, with a plunging internal demand. Sounds contradictory with Forbes’ article? Just keep reading.
- The real state bubble was worse than people predicted. And the worst was in Spain where we constructed, and have yet to sell, at least as many new houses than in the US alone with around six times more inhabitants, and around one third of the European Union with ten times more inhabitants… does that make sense?
- That had to be financed, obviously. Huge inflows of capital made sure of that. And the banks were the ones financing the developers to an amount roughly the size of half the GDP. Banks had been selling their interests in real state at the peak, getting rid of that business in the best moment. The capital markets bought them all.
- Once the developers failed, as they necessary had to, their assets and debts reverted to the banks. Now the banks are again on the business of real state in Spain, in fact leading it. The part of that business that was in the capital markets has obviously slumped (more than 80%), but of course that’s just one part of the financing they had. Those losses are mostly latent.
- In short that means that Spain may have bad debts roughly the size of 25% of its GDP. And that part is in the hands of the banks. But as they have been forced to absorb those, they are the first interested not to write off any of those debts, but to convert them to overpriced assets. In fact they bought the whole failed developments for the price of the mortgage. But that price was not right anymore. Which incentive do these banks have to lower the asset prices thus assuming losses and revealing the truth? None at all.
- Search for the balance sheets! The truth is still there, albeit hidden somehow. And they know, obviously. Why else would small Spanish banks be frantically merging with each other? There is a reason for that.
Spanish banks are simply hiding their losses. The real state market has not found its equilibrium yet. While they can, the main owners of the real state will try to contain the offer, placing things selectively in the market trying not to overwhelm the current tiny demand and betting for a better future where they will be able to reign on the real state business again.
In the meantime, Spanish banks are trying to con their customers with preferred shares. Issuing them and selling at nominal prices while re-buying those at the capital markets at real prices (half the price?). So, how is that for responsibility? What will their customers think of them in the future when they discover they actually have made an illiquid investment that they will not fully recover?
And yes, they have been more prudent in some aspects than their European counterparts. But that’s not enough. What would happen if they started marking loans to market? or assets to market? That would definitely be an eye opener, and a disaster.
Recovery or rebound? (long lasting pains)
It’s always nice to hear that Japan has grown a 3.7%. It makes eye-catchy headlines. But if you go deeper you see that the figure is just the annualisation of a mere 0.9% between April and June, and that in the first quarter the slump was around 11%. What does that tell us about statistical significance? After all, interpreting the figures will always be mediated by our wishful thinking.
A quarter may take us out of a formal recession but won’t make a new trend. I am the first whose wishful thinking would like this to be over, but it doesn’t seem likely to me. Still a lot of pain to endure to reverse the trend. Many things are pending to be able to grow healthily, albeit I admit that growth doesn’t need to be healthy to be growth.
And when growth gets here again, there will be more pain to endure. Companies have made put themselves in protection mode, rightsized…sorry, I meant downsized; they may have made extraordinary things to get their products moving, to appease their customers and investors. Everything to get to the end of the tunnel. But that won’t be enough.
I hate to seem gloomy. I am not. My message here is quite simple. Even if we find the right path for recovery, we won’t be at the same place we’d left. Things will have changed. When the scared company opens its shell again, it may find itself in a very different place. Some currents will have dried out. Fortunately, and that’s where my optimism lies, new wells will start flowing, somewhere. But they won’t be at the same place we took for granted long ago.
Also we will have proven our customers there are other ways, that we can do more with less. That we can remove that slack, streamlined our operations, adjusted our overheads and given better quotes. Hopefully, they will have based their recovery on that, they won’t let us go back again to the previous business conditions. And we will have to adapt to that: more pain. The leakage of jobs will go on after the recovery is here. And no sense of urgency can last forever. Sometimes it’s easy to retrench than to transform oneself.
A silly example from my daily life. Calling from India to Spain five minutes costs 10€ with my Spanish cell. Driven by the necessity not to waste resources, the experiment is to do the same with my Indian cell: 54 rupees, which are approximately 0.85€. Do you think I’m going to use my Spanish cell here again?
Although this might seem irrelevant, it’s a sign that we customers are not that stupid after all.
Did you know that the Hilton Group is about to become extinct? Blackstone bought it for $26 billion in 2007, right now they owe $21 billion in debt. Refinancing that debt won’t cost that much right now, that’s not the problem. The problem is somewhere else: executive customers have massively forgot their loyalty to the firm seeking cheaper alternatives.
Did you know that the huge amount of money that Air India is losing just required its intervention? Probably you did. Same happens with other main Indian Airlines. The interesting part is that the low cost carriers that operate here are not losing money.
And when we are out of the crisis, if Air India and Hilton make it, surely by reducing prices and streamlining operations, the customers they will face will get accustomed to the new conditions and will keep asking more for less. After all their own streamlining depends on that. What used to be exceptional will become somehow the norm and the companies not aware of that change will suddenly open their shells in a dry desert.
Banco Santander: a rising star (but not that bright)
If you’ve been reading in the news on how Banco Santander is covering its customers over Madoff’s losses, and how it’s been cherry picking some banks in distress, as well as not using the Spanish’s government toxic assets relief measures you’ll be thinking that they are a rising star. And they are, I won’t be the one to deny that, but maybe they are not rising as much as it might look like. In any case, in comparative terms, their are enjoying a privilleged position, especially because the rest of competitors are worse off. The star ain’t that bright.
Santander, a beautiful port city in the north of Spain
Let’s focus on the bank’s last announcement where they claim to be covering their customer’s losses. Let’s go deeper into the figures for some interesting hints.
The bank is including in its 2008 books an extraordinary expense of €500 million with that purpose. Wait! Weren’t they €1,680 million?
Okay. Here’s the trick. Santander is emitting new preferential shares, creatures born half-debt half-shares. Those, in 10 years will be worth €1,680 million less any increment of the initial fund deposit and the earnings to the present date of those funds (whatever that figure might be). What is insured is the initial investment, nothing else. It will be recovered not now, but in ten years. And with no actualisation at all.
For any investor that means bearing a couple of huge opportunity costs: the one already borne and the one that lays ahead. That’s how €1,680 million transform into 500€. The preferential shares will be liquid in ten year’s time. In the meantime yielding a mere 2% per year.
So, what should an investor do? Some will think about it, if its true that, when they invested, Santander was selling these funds as their own trademark, not referring to the real custodian behind. It’s great to sell something that works well solely under your name, as long as it keeps working well! And that entails a responsibility.
But many will simply sign this rebate deal and forget about it. And with the deal the compulsory renounce of any legal claims against Santander, and the curious obligation to keep working with them for the next decade. Not too bad for many considering the alternative of entering a judicial quagmire that will carry expenses for sure as uncertain the outcome may be.
And here comes the final reflection that, from my point of view, explains many things about the Spanish banks. People in Spain, unlike in the US, take their time to assume their losses. At the moment there’s not property market in Spain as people are not selling, waiting for hint of hope to recover what they paid for it. And, as long as there are no transactions, there are no prices.
With raising unemployment covered by benefits that won’t last forever, eventually, many people will have to face reality. So will the Spanish banks. If Santander is betting that, when this moment comes, the worst will be over and the economy will be going upwards, I’m really sorry to bet in the opposite direction.
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? 
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.
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.
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”.
(The mistake of) further leaning the supply chain in difficult times
Operations have always interested me. I’ve worked with supply chains, studied them, comprehended them. But, what I don’t understand, is why that motto of “leaning the supply chain” is considered an universal truth. Reminds me that one of “leaning -and trimming- the organisation” whose long-term results -only now are beginning to be known.
Because sometimes leaner is simply not the most adequate choice. Sometimes you need to be able to offer greater flexibility, better response, even at a greater cost.
What did prompt this reflection in my mind? Well, a friend of mine wanted to buy a new car, so I told him it would be a good moment because the car sales had dropped around 10% this year in Spain.
It looks like the bargaining power of customers has increased, hasn’t it?
Well. In fact something slightly different has happened. Concessionaires have resolved to reduce costs, specially reducing stock. They only have the star models, but not anything that may be a little customised. That means nine months for my friend to get the model he wants. Can you imagine that?
I understand that promoting a series of basic models by penalising the consumption of the rest of the catalogue is a way to reduce variability and variety. But that could be useful in a highly busy and stressed supply chain and that’s not exactly the case.
In this case I understand we should focus the supply chain in some strategical intent to promote sales in a weak season. That way we shouldn’t want to reduce variety but induce new sales. And that means offering an appealing selection for the customer and an improved service. I don’t exactly see improved service with lead times around nine months.
In this case, the savings are surely lower than the opportunity cost of not selling a model. Specially when you still have plenty of space left in the premises (I bet they have not shrunk because of market’s weakness), and specially when competitors may have chosen a different strategy.
Sometimes some savings are simply not worth it.
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