1. Eric Falkenstein finds another person who agrees with his view that risk is not related to return (or expected returns). 2. How China shapes their news. They have gotten more sophisticated over time. Key quote: "“He’s basically telling these students that journalism in China is a big show, it’s fabricated, but in the end it’s all justified for the higher purpose of stability,” Mr. Xiao said." (HT: Anthony)3. Encouraging embedded allies to become Dilberts (Or more accurately, Wally and the pointy haired boss) to defeat our enemies from within. 4. The EIA's latest forecasts basically admit that oil production over the next few years has peaked. It is even worse when you look at projected production excluding non-oil liquids such as biofuels.
New York Magazine has an article up about Madoff's life in jail. I was most interested in the part where he revealed how he started.
Madoff said. He insisted that he’d been “a good trader” with a solid strategy, explaining that he’d stumbled into trouble because of his success. Hedge funds—“just marketers,” he said with evident disgust—pushed cash on him. He overcommitted, got behind, and generated a few imaginary trades, figuring he’d make it up—and never did.
It seems that a lot of these fraudsters initially thought "I just need to buy myself time to make back my losses."
Robin Hansen has been writing a lot about the purpose of school. The main thrust of his theory is that "school functions in part to help folks accept workplace domination"
I was thinking about this framework when I read an article on the four day school week (HT: Anthony). The author found that many rural schools have had to shorten their school weeks to save money. The twist is that after moving to a 4 day school week, academic scores do not actually suffer. In certain cases, test scores, attendance and the graduation rate all improved. If schooling is more about teaching students to accept status differentials as opposed to the school's stated purpose of imparting knowledge, attending school probably requires a substantial amount of willpower from the students. This is likely stressful for students, so lowering the days spent in school could leave enough residual willpower for many of the marginal students to focus on the actual school work rather than merely avoiding discipline.
This is not a win-win scenario for everyone. Many teachers would not like a shorter work week if they had to take a lower salary, parents would have to find babysitters and the children of ambitious parents would probably have extra structured activities similar to school on that free day. Still, it would be interesting to see what would happen if a shorter school week became more common.
I thought that I would put yesterday's China convergence comment in some context.
I was thinking about a very good Scott Sumner post* where he looks at whether or not China can be called a free market success. He discusses how China moved from a communist system towards a mixed system, and in countries with Confucian cultures the level of involvement of State Owned Enterprises (SOEs that are monopolies, not SOEs that compete on the open market like many of Singapore's) is correlated to their absolute wealth. Within China, the prevalence of SOEs in a region is correlated with that region's growth.
China is converging to a certain level of wealth which is limited both by how free its economy is and the amount of resources available. If Beijing is already 2/3rds as rich as South Korea (and Seoul itself) on a PPP basis**, there is reason to think that the level of convergence might soon slow down as China is closer to reaching its equilibrium convergence level than people think. Of course, Matthew Yglesias points out, if people continue migrating from less free areas of rural China (where the prevalence of more SOEs mean that the natural convergence level is even lower) into China's richer cities where they will work in industry and services instead of agriculture, then the impact of slower growth in the richest areas might not impact the overall economy too much.
China's future growth path is very important because if they aren't growing fast enough in normal times it will be more difficult to deal with the inevitable volatility. China's current policy is generating a lot of loans that many people think will turn into nonperforming loans. These NPLs could be less significant if China grows enough, since there are less bad loans in a well performing economy and the bad loans that do exist will be smaller relative to the economy. If China's growth slows down because it is closer to convergence than people think (and because their working age population is no longer growing and the market for their exports might not expand as quickly as it has in the past), then the resulting NPLs could end up being a very serious issue.
All of this suggests that there are a few things that are very important to track when figuring out China.
1. Some measure of how mixed an economy they are relative to comparable economies. In the heritage index China is closer to Vietnam than South Korea, though part of it is because of how the index is calculated.
2. A measure of China's demographics. Luckily, demographics are one of those indicators that are known far in advance so this data doesn’t need much tracking. The chart below shows the changing working age population of the BRICs countries from the UN’s World Population Prospects 2008 revision database (Medium Variant). From this perspective, India is much better positioned than China.
3. Measures of China’s internal migration. If they ever change their policy on migrant workers from rural areas, it could be a sign that the party is going to keep going for a while longer.
4. The prices of China’s property markets, to see when NPLs will become a big deal. Changes in China’s monetary policy might lead changes in the property market (which might be tracked via the relative prices on China’s commodity market), since property markets are less liquid and therefore react more slowly to changes in fundamentals. Another potentially useful indicator is the Shanghai market.
5. The state of the rest of the world, since China’s exports depend on a healthy global economy.
This list is by no means exhaustive, except I did mention “the rest of the world” as a single data point to be tracked.
*Yes, again. If he is going to keep being relevant I’m going to have to keep linking to his posts.
**If GDP counted construction activity by migrant workers and the official population numbers of Beijing excluded them, then Beijing might have a long way to go before their PPP GDP per capita approaches South Korea’s level.
Beijing's 2009 GDP (PPP) per capita: $17,063
South Korea's 2009 GDP (PPP) per capita: $27,978*
People always assume that China is converging to the United States and Beijing is converging to the major metropolitan areas around the world. If South Korea is a better model, China might be closer to finishing convergence than most people think.
*Both of these numbers are from Wikipedia, and the IMF in the case of South Korea's. A more apples to apples comparison would use Seoul's GDP per capita, but this number has been difficult to find. Calculating it using the assumption that Seoul is almost 22% of the Korean economy leads to a very similar number, about $28,500 (PPP).
Michael Pettis recently posted an interesting piece on the Shanghai market. He makes the following points.
- In markets, there are fundamental or value investors, arbitrage traders and speculators. Speculators react to information about supply and demand, as well as the expected short term impact of fundamental information. Value investors buy assets in order to capture the profits generated by these assets over a longer time frame.
- In the Shanghai market, transaction costs are too high for more relative value traders. Trustworthy fundamental information is too scarce, predicting government action is too important [This isn’t too different from the US market over the past crisis] and valuations are usually too high for fundamental or value investors to participate. This means that speculators dominate the market.
- Without value investors buying when the market is cheap and selling when the market is expensive, the market will be more volatile.
After giving many examples of how the Shanghai market trades on non-economic information, he concludes:
“A market driven almost exclusively by speculators, and with little to no participation by fundamental or value investors, is not a market that pays much attention to long-term growth prospects. It is driven largely by fads, technical factors, liquidity shifts, and government signaling.
So what does this year’s crash in the Shanghai stock market tell us? It might be saying something about the impact of the European crisis on export earnings. It might suggest that liquidity in the system is being driven into real estate rather than into stocks. It may reflect contagion and nervousness about the fall of stock markets abroad.
But we should be cautious about reading too much into it. In fact attempts by Beijing to hammer down real estate bubbles in the primary cities without addressing underlying liquidity expansion may simply push asset price bubbles elsewhere, and this could easily cause a surge in the Shanghai stock markets. But this should not then be interpreted as signaling a surge in the economy.
Shanghai’s markets will go up and down, but they are not driven by investor evaluation of long-term growth prospects. China does not yet posses the tools to make such evaluation useful, so be careful about reading too much into the stock market numbers.”
This does not mean that the Shanghai composite is useless. It means that it is a combined measure of liquidity and government intervention. If the fund managers who speculate on government policy or liquidity are successful in making money, then the market is giving useful information. The information may be slightly different from other markets (although even developed world markets are more focused on the next few quarterly earnings than on growth prospects 5 to 10 ears out), but it is still important. It is particularly important for those who think that China’s recent growth during the downturn is unsustainable because it is built on real estate speculation and government spending without a clear way to transition back to a more normal convergence style growth. A sharp fall in equity prices is one of the indicators of a tighter monetary policy (or that a tighter monetary policy is finally having an impact), and further extreme moves could be signs of an actual deflationary unwind. Any stock market move has many causes, but it definitely gives us useful information.
A – H share premium on top, Shanghai A Shares normalized to Jan 3rd, 2010 on bottom. The premium of the Shanghai A shares over the foreign traded H shares is another measure of the relative excess liquidity in China’s market compared to the rest of the world. Source: Palantir.
After Katrina and 9/11, some people thought that higher GDP from rebuilding what was broken could be a silver lining. Since the accident and subsequent spill obviously had a negative effect on the wealth of our economy, it will be interesting to see if anyone is insane enough to suggest that the GDP impact of cleanup and containment spending (already totally around a billion dollars) is a silver lining to the spill. Broken window fallacies are popular, but in this case the negative impact of the spill on other industries such as fishing, tourism and other deepwater oil drilling projects might obviously outweigh the supposed benefits.
Analyzing the market capitalization movements of a certain company (which will remain nameless for legal reasons) suspected to be liable for clean up costs and economic claims, adjusting for the market capitalization change in their entire sector (which shall also remain nameless, I’m counting on my readers to figure out which company and which sector I am talking about here), suggests that the liability and clean up costs may total about $40 billion dollars. Of course, there are a few caveats to this calculation. For one thing, a lot of the market cap drop is probably related to potential sanctions or damage to their brand image and investors not wanting to hold a stock that is no longer a simple {insert sector} company. For another, the market might be pricing in a high chance of relatively contained costs and a small chance of very large clean up costs. Still, 40 billion dollars is a reasonable cap so the “positive” GDP impact is at most 0.3% of GDP.
A new study has gotten some people excited about how the internet is not as ideologically segregated as many people think.
We find that ideological segregation of online news consumption is low in absolute terms, higher than the segregation of most offline news consumption, and significantly lower than the segregation of face-to-face interactions with neighbors, co-workers, or family members.
The paper calculated an isolation index, which is basically how much people are exposed to a point of view that is similar to their own. An internet where conservatives only read fox news and liberals only read the new york times would have a very high isolation index score. However, because conservative blogs link to the New York Times and liberal blogs link to foxnews.com, that paper finds that the internet has a lower isolation index than national newspapers and the people we interact with everyday.
The problem with this line of thinking is mentioned as a caveat in the paper:
We conclude with an important caveat: none of the evidence here speaks to the way people translate the content they encounter into beliefs. People with different ideologies see similar content, but both Bayesian and non-Bayesian mechanisms may lead people with divergent political views to interpret the same information differently.
This caveat been vastly underrated by most people looking at this research. When reddit.com or the huffingtonpost.com links to a conservative site such as foxnews.com, it is most likely for one of the following reasons:
1. To tell their readers about the lies Fox News is telling their readers
2. To make a liberal point, highlighted with "even Fox News admits..."
3. To make counter arguments to the views expressed, so when the reader visits the website they are inoculated against any of the arguments made.
4. To show their readers that those who disagree are them stupid/racist/misogynous/etc.
As the authors mention, a liberal isn't likely to trust data from a known conservative website in the first place. The same point extends for conservatives linking to liberal websites. A conservative reader who visits an article on nytimes.com because he followed a story about their media bias is still isolated from the liberal point of view.
The paper itself is very interesting, but readers should be wary of drawing the wrong conclusion from this research.
A lot of the basic market indicators have been flashing panic signs recently. One example of this panic is the VIX, a measure of expected S&P 500 volatility over the next month, has spiked up from just over 15 to over 35 today (It hit 45 last week) in a little over a month. When the VIX is purified for recent price action in the S&P 500, the recent volatility spike suggests that people should be buying the market. However, there is increasing pressure in the financial system and buying against a panicky market while the financial system’s pressure is accelerating can be very risky.
There are a few measures that can be used to measure financial system pressure. Equity prices and volatility, the former going down and the latter going up, are one sign. Another is credit default swaps (CDS). CDS for the average major American banks rose between 50 to 100 basis points over the past month. A less volatile measure of market stability is the LIBOR-OIS spread. This is the spread between the rate banks lend to each other on the interbank market and the effective federal funds rate. Not only does this spread indicate stress, but according to research published by the St. Louis Fed “the LIBOR-OIS spread has been the summary indicator showing the “illiquidity waves” that severely impaired money markets in 2007 and 2008.” This time the illiquidity stress is coming from European banks exposed to sovereign risk, as well as other financial institutions that are exposed to distressed European banks (The flight to quality towards Switzerland banks caused short term interest rates there to briefly go negative, hitting -0.25% on May 25th).
The chart bellow shows the LIBOR-OIS, which fell through most of 2009, has rose over 20 basis points in the past month.
Via Arnold Kling, I found this interesting question/answer from Matt Ridley:
6. What interesting question didn’t I ask that I should have? And please answer it!
You did not ask me why intellectuals are all such pessimists. And my answer is that pessimism gets attention – from funders, from the media, from governments. Also, for reasons I do not fully understand, it sounds wiser than optimism.
Some people might think that optimists ask this question when they don't know how to respond to the pessimist's concerns directly. However, there are a few reasons beyond attention why being pessimism might be the intellectual's preferred approach.
1. Intellectuals are more likely to stick to ideas than to get their hands dirty executing their ideas in the real world. The optimistic intellectual might be tempted to leave the ivory tower for opportunities elsewhere, leaving the intellectual profession full of pessimists.
2. There are always flaws to any plan/idea/project, so it is often easier to point out the flaws than help make it work.
3. There is a fine line between being optimistic on a subject and being a cheerleader, so it is easier to avoid the fine line completely and be a critic.
4. A continuation of the status quo or "these trends will continue" is often a rather boring point. Intellectuals need to be interesting in order to for people to pay attention to them.
5. Optimists who believe that a problem will be solved but who aren't quite sure how sound a lot less impressive than a pessimist who can give you the reasons why a problem is important and why each attempt to solve it will most likely fail.
6. Discussing why something won't work gives the intellectual the chance to raise his status relative to the people he is critiquing. Discussing why a certain group is going to do amazing things would lower his status.
What am I leaving out?