China impressions

There have been no posts because I just finished up a Korea/China trip.  My experience in Korea consisted of more of an introduction to the life of western expats teaching English (they drink a lot) than it was an education in the life and economic system of Koreans, so I'm going to focus on China.

Since this was my first time in China, it doesn't really help me understand China very much outside of giving me a rough understanding of what their GDP per capita, adjusted for purchasing power parity, looks like in real life*. Still, there were some interesting things that I learned on this trip.

1. Traffic - it looks almost like a first world country, but then there are some notable differences.  People on bikes seem to feel like they have a right to go wherever they want to without regards to any kind of traffic laws - kind of like the critical mass people in the US but as individuals.  They are often going the wrong way in a two way street, so looking both ways is always important. There aren't very many pedestrian walkways without bikes, and sometimes cars, honking at people to get out of the way. Taxi's are also ruder than in the US - I've seen numerous taxis with their available lights on reject passengers for apparently no reason.  People don't look at their blind spots when the merge, but thankfully they also avoid driving in the blind spot of other cars. There seem to be way more cars than parking spots.

2. Paying for things. First, there are no tips - this makes it hard to get better service unless the person is intrinsically motivated to provide it, while at the same time when this is combined with no sales tax it makes paying relatively easy when the final cost is the listed price. The exception was when I had to haggle.  Sticking close to someone who looks Chinese and can speak the language definitely helped, since it implies that there is someone who knows the scene who is looking out for their friend. One of the shop keepers even mentioned that they find it hard to get good prices when there is an Asian person helping a white person shop.  Otherwise, everything made in China was really cheap, which made certain imported goods like wine seem ridiculously expensive.  I would be surprised if China ever develops a market for rented videos while people can still buy any DVDs they want to see on the sidewalk for the equivalent of 50 cents.

3. Food and drink: McDonald's delivers 24/7. It seems like no one drinks anything like tap water**, nor do they like to drink anything cold. Only places expecting foreigners will have cold drinks. A restaurant with a poor beer selection in the US would have an amazing selection if it were compared to the restaurants in Korea and China.  Perhaps because of the lack of cold beverages, there is a much larger selection of cold dishes than I've seen in the states.  Chinese restaurants will have one menu per table, and often they will have items on the menu that are expensive and that they don't stock because they don't expect anyone to order.  These expensive items are also there because there is huge income inequality in China and these restaurants want to capture as much of the market as they can.

4. Brands*** seem to have a lot more value in China.  It seems to be one of the main ways they can differentiate quality. The premium brands are really expensive, which is part of the point. They see sales as a betrayal - they buy the brands precisely because the brands are expensive and therefore exclusive. This extends beyond products into the job market.  Most people would prefer to work at a company that their parents have heard of, regardless of whether or not it is a better opportunity than a small growing company.  

5. Real estate. Rents are ridiculously low relative to the prices, as many people have pointed out.  I was more intrigued by the policy that makes it illegal for people in certain areas to sell or rent out their homes. They are living in poverty when the real estate they own but can't sell is worth millions of dollars.  In the middle of Beijing it didn't seem like vacancy rates were absurdly high, but this is the type of thing where an anecdotal visit does not give very much useful information.

In China, there were a lot of ridiculously poor people working at very low productivity jobs such as taking the subway into the city each day to set up little shops on the sidewalk.  There is definitely room for them to move up the value chain, the question is whether or not their human capital and overall economic system will be flexible enough to allow these people to move to higher productivity jobs.

*The main surprise in Korea was getting a glimpse of what poverty can look like in a homogeneous population. Also, as I walked down the main market area into the poorer sections the things for sale got progressively weirder.
**Not drinking the water is important for foreigners, so it might also be a good idea to be careful when ordering hotpot.
***There are counterfeits, but they are obviously much lower quality.

Links to the past

I recently ran across some old posts (1 to 2 years old) that highlight some important ideas.

1. My friend commented on how she keeps getting cut off by Prius drivers and it reminded me of this post*. When people act in an acknowledged socially responsible way, they are more likely to treat other people worse. It is like most people are keeping track of their karma and they feel comfortable as long as it is flat.

2. Another post highlights studies that show that we value what we have to work for.  This explains why some writers turn to esoteric writing** - their main ideas are not good enough to stand on their own, but if people have to struggle to identify their ideas before they have a chance to evaluate them then perhaps the reader will value the ideas more highly.

3. Robin Hanson thinks that IQ isn't that useful a metric - how often people decide to think rationally also matters.  However, I wonder how much of the "rationality quotient" measure is explained by the combination of IQ and Conscientiousness.  A low rationality quotient is how some types of smart people are often very stupid***.

4. Falkenblog looks at the importance of teaching kids how to think about the big picture.  While the macro perspective is more important than he gives it credit for (students who think about the big picture should realize that they need to learn something useful), I am mainly resharing this link for how he worked the comic into his post.

5. Bryan Caplan reminds us that people who think that the 2008 crash changed everything in macroeconomics were missing something to begin with.

*Or rather, it reminded me that I had read it and I had to look through my google reader's history to find a relevant article.

**Beyond the obvious "People would hate me if they knew what I truly thought" reasons.

***Low emotional intelligence is another reason high IQ people are stupid, even if they are otherwise very rational.

The BOJ/MoF Put

People used to talk about a "Greenspan Put."  The idea was that if the markets fell too much, Greenspan, then the chairman of the Federal Reserve, would step in and prevent investors from losing too much money.  The effect was almost as if they had bought an option - a put - to protect themselves from a large drop in the markets.

These days, it is looking like there is a BOJ/MoF put for people interested in selling the yen. Selling the currency with the lowest interest rates, which in recent history has been the yen, is a popular trade because if markets don't move then the seller will make money*. 

Recently, the yen has actually been strengthening, but Japan's finance minister just announced that they were buying dollars and selling yen when the yen was trading around 83.  The Bank of Japan released a statement supporting these actions.

The Bank of Japan strongly expects that the action taken by the Ministry of Finance in the foreign exchange market will contribute to a stable foreign exchange rate formation.

Traders interested in selling the yen and buying the dollar are able to take large positions when they believe they have a central bank backstopping their trade.  Of course, this backstop only matters when the traders selling yen have been losing money, so the best way to trade it may be from a tactical perspective of fading yen rallies rather than a long term "sell and hold" approach.  

*Short term interest rates in the US are low enough that this isn't as profitable to do versus the dollar unless a longer term currency forward is used. If a longer term forward contract is traded, the trade is impacted by both movements in interest rates and in currencies. This isn't as popular as trading purely currency or purely interest rates because most traders like to take specific risks and avoid exposure to variables that they are less familiar with.

Monetary Policy and the Bubble

Senior vice president and research director at the Atlanta Fed, David Altig, has a post up at Macroblog discussing the connection between monetary policy and housing bubbles.  He is responding to John Taylor's comments at Jacksonhole where Taylor blames loose monetary for the housing bubble, citing a recent VAR study that found the deviation from the Taylor rule to be a large explanatory variable. Altig responds with points that deviations from the Taylor rule in the US are correlated with looser lending standards, and that this effect was not seen in Europe and in the UK, where the latter had a large increase in debt and housing prices similar to what happened in the United States.

My view of this debate is as follows:

1. You can prove many preconceived notions by carefully selecting your data set, or citing people who do. This applies to both sides.
2. The United Kingdom should be analyzed more like a large offshore financial center, so its own monetary policy's deviation from a Taylor rule would obviously be less important than exogenous variables.
3. Loose monetary policy might be behind looser lending standards. The banks that aren't relaxing their lending standards their lending standards when monetary policy is loose are likely to lose business. This argument is similar to the typical Austrian Economist's response to the rational expectations arguments against the Austrian Business Cycle Theory. Businesses that don't want to participate in the boom because it is unsustainable have to participate in some form because it is the only game in town.
4. Monetary policy was too loose and helped speed along a crisis, but the properties of the finance industry make bubbles and their subsequent crashes inevitable.

The Nurture Bias

Via Reddit, I came across an article about a new study by Eric Turkheimer that suggests that nurture may be more important than nature, at least relative to numbers suggested by previous studies. The newer studies are careful to include identical twins where one grew up broken homes, which has a very negative impact. So extremely bad development can have an impact on intelligence.  This raises the estimations of the nurture impact, but only for 

In the same article RIchard Nisbett, a psychologist who wrote the very excellent The Geography of Thought, shows how people will skew the results.

The findings will undoubtedly please those parents who already send their children to good schools, drive them to violin lessons in the afternoon, and then drag them around museums at the weekend. "So you haven't wasted your time, money and patience on your children after all," Nisbett says.

A lot of parents really want to believe that nurture is really important, so they are very quick to jump to conclusions so "not raising kids in a poor, broken home is important but once you are richer nurture differences matter less" gets turned into the parenting fallacy of "this study supports nurture, and therefore you are right to do everything that common sense tells us is good for children."

Pessimists and the Output Gap

Arnold Kling has a good post up responding to John Taylor's view of the Taylor rule. Arnold Kling highlights a key issue: The main disagreement between hawks (people who want the central bank to focus on fighting inflation) and doves (people who want the bank to focus on stimulating the economy)  is actually about the true nature of the output gap. Mainstream economists are more likely to use traditional measures, which are unstable but generally indicate that the Fed  is either about right or needs to engage in unconventional practices. However, those outside the mainstream are more likely to be economic pessimists about the potential of the overall economy (such as the recalculation theorists or others sympathetic to the Austrian school's idea of malinvestment), view the output gap as much smaller than traditional measures, and worry more about inflation than trying to stimulate the economy in its current form.

If economic pessimists believe there is a small output gap, that should mean that economic pessimists should be more worried about inflation than deflation.  What does that make economic pessimists who believe that deflation is the main problem? They either aren't pessimistic on the economic system in general and believe that policy stimulus will help but it won't be forthcoming (like Krugman), or if they are pessimistic on the system as a whole their approach will probably be to reject the framework of the relationship between the output gap and inflation entirely since it doesn't fit into their view of the world. 

Convergence and Beta

One thing that many people in finance do not fully understand is economic convergence. The dominant assumption seems to be that absolute convergence holds - the less developed a country is the more it will grow. The first decade of the 2000's has done little to dissuade this view. Investors focusing on the BRICs have been very profitable. Brazil, Russia, India and China have relatively functional institutions compared to the rest of the emerging world, and their resources and human capital have justified a level of bullishness on them. Other countries such as the Next 11 or the CIVETS (There is some overlap) are seen as the next group of countries for emerging investors to focus on.

Absolute convergence of these countries is basically taken as a given by investors looking at these groups*. In reality, the political instability in many of the countries makes the convergence of all of these countries unlikely. Some of these countries are probably going to grow at a high rate, but without improved institutions many will stagnate and some will regress in the face of economic and political instability. 

Investors counting on convergence to work like magic are comfortable with the framework of convergence in part because they are comfortable with the notion of beta. High risk countries are supposed to make them  money the same way that high risk stocks do. However, these investors don't realize that beta doesn't always work in the long run as even though there is an equity premium low beta stocks outperform high beta stocks. The same is likely true for convergence, so the countries with the highest room to converge really might be like high beta stocks - lottery tickets that will under perform.

This analogy suggests that those looking to go long emerging markets should at the very least err on the side of going long more developed emerging countries where the political risk is less extreme.

*The people who made the groups did try to pick countries with positive fundamentals but there aren't that many countries so they are bound to make some bad choices.


1. Teacher efficiency is analyzed in LA by the LA Times.  It turns out that what teachers are paid for are not related to their teaching effectivity.  The next step towards sanity would be to create these links, and to find some ways to actually fire the poorly performing teachers.

2. A survey from Fidelity suggests that a lot of people are borrowing against their 401(k)'s.  This is another factor keeping consumer spending high relative to private sector income.

3.  Tyler Cowen looks at whether it was the fiscal policy of Australia that has helped their economy avoid a deep recession. He mentions Australia's connection with China's economic demand, which seems to be the dominant variable. However, he leaves out their high trend inflation, which helps them avoid problems other central banks reach when they hit the zero bound.

4. A caricature of futurists. Not entirely inaccurate.

Inflation uncertainty

Tyler Cowen linked to two posts highlighting how high monetary policy uncertainty is today due to the high levels of inflation variability. The striking thing about these posts is that at our low inflation rate, the standard deviation of inflation is just as high as it was during the 70’s.

Using the month on month changes of inflation (bottom of top chart) instead of year on year changes (top of top chart) we see inflation variability spiking in mid 2006 rather than early 2009. Furthermore, the comparison the blogs make to the 70’s glosses over that by very similar measures, inflation uncertainty was much higher in the 50’s.

Of course, this may just be due to the crazy adjustment from the post war economy, so the policy uncertainty of the 50’s was probably low despite high the variability of inflation.

The high level of inflation volatility and therefore policy uncertainty can help explain why there are deficit hawks and gold bugs with nominal ten year yields at 2.6%.  Ignoring the increasing deficit, the US treasury is going to have to roll over 2.5 trillion dollars worth of debt* in the next year alone, so maybe there is something to be uncertain about.

*To look this up for yourself, go here. Download the excel file and look at marketable debt. There are over 1.7 trillion dollars worth of Treasury bills and .74 trillion worth of Treasury Notes payable in the next year. The amount of inflation adjusted notes coming due is under 40 billion and there are no long term treasury bonds coming due.