Netting out the Gross Analysis

The investment commentaries from Bill Gross are always interesting and worth reading. This month’s investment outlook focuses on the greater public indebtedness that follows financial crisis and the relative abilities of the respective governments to absorb this increase in debt.

These examples tend to confirm that banking crises are followed by a deleveraging of the private sector accompanied by a substitution and escalation of government debt, which in turn slows economic growth and (PIMCO’s thesis) lowers returns on investment and financial assets. The most vulnerable countries in 2010 are shown in PIMCO’s chart “The Ring of Fire.” These red zone countries are ones with the potential for public debt to exceed 90% of GDP within a few years’ time, which would slow GDP by 1% or more. The yellow and green areas are considered to be the most conservative and potentially most solvent, with the potential for higher growth.

 They then show the following chart:

Source: PIMCO

This chart uses gross data for debt, while the net debt is a much better indicator of their ability to service debt. The rich man who has debt equal to his annual income is not said to be poor if he also owns enough assets. He may have to sell some of those assets to make good on his debts, but the debt holder should be much more worried about the man who is deep in debt without off setting assets.  The underlying structural deficit is used instead of the public sector debt to give us a better idea of whether a country is paying for past mistakes (already measured in net financial liabilities) or its current mistakes. The chart below uses 2010 projections from OECD Economic Outlook No. 86, with adjustments to Greece’s data.

Under net analysis, a few things stand out. Norway’s position is much better than any other country, especially when considering that their financial balance on the year is actually positive when petroleum activities are included.  Italy also looks like it is at least in the process of getting its house in order as they already have a underling structural surplus. Though still in the danger zone, Japan’s net debt position isn’t nearly as bad as its gross debt first appears.

The BIS presentation mentioned yesterday contains a chart on slide 7 which shows that Italy, France and Japan have policies that limit the fiscal impact of their aging population compared to other countries.

Net or gross, either approach is better than an investor believing that the efficient market will take care of things and all developed countries should be viewed equally from an asset allocation perspective.

Fun with DOJ Charts

The previous post was a bit light on data, so this post is going to make up for that by giving the reader an overview of the data

The previous post was a bit light on data, so this post is going to make up for that by giving the reader an overview of the data.  The DOJ has a lot of interesting crime related statistics and is the source of these charts.

Imprisonment rate has been going up, but it decelerated recently.


Motor vehicle theft is down.


Property crimes have been steadily declining:


Homicide rates have been dropping recently, but they are not back toe their 1900 levels.


Nonfatal firearm related violent crime has also been going down:


Public order crime (which include weapons and immigration) and drug crimes have been on the rise.


 With the recent drop in crime, the police have become more efficient in terms of making more arrests per crime committed.


The elephant in the room/jail cell

There are certain ideas that are politically incorrect as well as too simple for it to be a respected opinion.  A great example of an idea that is true and that people don’t like to think about is that one of the biggest reasons for crime's decline is more people in prison.

In his book why crime rates fell, Tufts University sociologist John Conklin concluded that up to half of the improvement was due to a single factor: more people in prison. The U.S. prison population grew by more than half a million during the 1990s and continued to grow, although more slowly, in the next decade. Go back half a century: as sentencing became more lenient in the 1960s and '70s, the crime rate started to rise. When lawmakers responded to the crime wave by building prisons and mandating tough sentences, the number of prisoners increased and the number of crimes fell.
Common sense, you might think. But this is not a popular conclusion among criminologists, according to Conklin. "There is a tendency, perhaps for ideological reasons, not to want to see the connection," he says. Incarceration is to crime what amputation is to gangrene--it can work, but a humane physician would rather find a way to prevent wounds and cure infections before the saw is necessary. Prison is expensive, demoralizing and deadening. "Increased sentencing in some communities has removed entire generations of young men" from some minority communities, says San Francisco police chief George Gascón. "Has that been a factor in lowering crime? I think it probably has. I think it also probably has had a detrimental effect on those communities."
Contrast this with the treatment generally gets in intellectual circles. Malcolm Gladwell prefers to focus on how tipping point type policies decreased crime in New York and Steven Levitt is willing to be politically incorrect with his abortion theory, as long as he is being politically incorrect in an impressively roundabout manner. The prisoners per capita coefficient in Levitt and Donohue’s paper was larger for property crime and murder, with subsequent research shower that it and not the abortion measure maintained its significance when per capita crime instead of total crime was measured.  This type of straightforward analysis of “More people likely to commit crimes in prison means less crime is committed” doesn't get much play in the popular press because being both politically incorrect and simple; it isn't a very high status point of view. The only time the idea gets play is when the prison population needs to be reduced and citizens worry what this might mean for crime.

Recognizing a fact is not the same thing as applauding all of its implications.  The drug war, which is in large part responsible for the increase in prisoners, is also responsible for a large increase in drug related property and violent crime.

Has the US been short changing education spending?

When people talk about education in the US, the one idea that receives almost unanimous support is that we need to spend more money on education.  Historical data from the BEA and the UN World Population Prospects Database show that educational investment has been rising at the same time the student age population has been shrinking relative to the working age population.

When looking at per pupil aged growth rates, the change was rather extreme in 60’s and 70’s when more women and minorities started getting access to college and has since evened out with the spending per pupil increasing at the rate of GDP.  Considering that the population is growing, this means that education spending is rising faster than GDP.

The increased investment has increase the size of the population with Bachelor degrees and high school diplomas as these charts from the US Census show:


Part of the increase is from higher current educational attainment, while part of the increase is from the older less educated population dying off. This is demonstrated by a snapshot of the Census’s 2008 data:

Education spending has held up over time, with the amount spent on the student aged population rising with GDP.  Whether or not more education spending is needed depends on whether education spending is growing aggregate human capital or if the marginal education spending is more related to signaling and status.  

Interesting charts has some collected some rather interesting data.  Here are a few charts, presented without comment:

Check out the site, and try not to be too amused by some of the spurious correlations.

Time to go back to school?

So you are a confused college student who is having a hard time finding a job in the aftermath of the great economic recession. Should you go back to school for your Ph.D. in order to hide out until the job market gets better?  Thomas H Benton has an interesting article addressing this question for those interested in the humanities Ph.D.'s but who aren't sure that they want to go into academia.
The ranks of new Ph.D.'s and adjuncts these days are mainly composed of people from below the upper-middle class: people who believe from infancy that more education equals more opportunity. They see the professions as a path to security and status.

Again and again, the people who wrote to me said things like "Nobody told me" and "Now what do I do?" "Everybody keeps saying my doctorate gives me all kinds of transferable skills, but I can't get a second interview, even outside of academe." "What's wrong with me?"

Well, the job markets sees a few things wrong with the typical Ph.D. student compared to someone who has similar levels of IQ, openness and conscientiousness but managed to avoid getting sidetracked in graduate school.

1. They are signaling that they are not the type of person who wants to deal with the real world outside of the bubble of academia.

2. For graduate students in technical fields, they are demonstrating that they prefer prestige status over monetary opportunities. There is also the potential for status clashes with superiors in the workplace.

3. In younger Ph.D. students, the Ph.D. track is often chosen because no other track was readily apparent.  Choosing this track only to go into the workforce later on suggests that they don't really think about how the world works beyond one or two steps.

4. They spent all of their time learning how to become a professor, gave up on that, and are now competing with peers who have put the time into figuring out how to create value in the market. 

The Ph.D. drop out is much better positioned than the student who delays entering the real world by finishing their thesis. However, there are some positions such as in biochemistry where in order to have influence in the real world an advanced degree is more beneficial than harmful.

Tyler Cowen has some additional thoughts on why people get Ph.D's in the humanities.

Charting out the Greek Tragedy

First, here is the OECD data and projections on the PIIGS with revised Greece levels:

Here is the same things with some other potentially troubled countries:

It is obvious that the problem children are Japan, Italy and Greece. Greece went from being the third highest debt/GDP country to the worst of the OECD. This move occurred not as a natural progression, but with the unveiling of their past lies/bad statistics/fraud. To look at their situation going forward, the government’s underlying primary balance, the amount of money it is spending or saving before interest payments, is quite informative.

Italy is fine; it is Greece and Japan who are in trouble.  This is before including the effect of higher interest rates on the Greek budget. Every time Greece has to issue or roll over their debt at higher interest rates their actual budget deficit gets worse. Greece is planning on increasing their underlying government balance as a percent of GDP at a rate faster than any OECD country has since Denmark in 1982. Of course, when Denmark increased their underlying primary balance they had a much higher inflation rate which meant they didn’t need to make the nominal cuts that Greece is now making. Japan’s situation looks in many ways similar to Greece, but since they have control of their own monetary policy they are in a much better position.

Greece's Impact on the Euro

Greece has been in the news recently.  Greece’s economy is only 2.6% of the Euro according to 2008 data from the World Bank, so it is interesting to see its effect on the monetary zone’s currency.

The top chart shows the 5 year CDS on Greek bonds and the bottom chart is the Euro versus the dollar. The cost of protection for Greek bonds started going up at about the same time as the Euro started weakening.

However, the specifics of the currency market do not seem that panicked. Below is a chart of 1 month and 3 month EURUSD volatility. If a crisis is expected, the one month volatility will often be higher than the three month volatility.  This is not currently the case, and despite there being a problem with the Euro the market is much calmer than it was in late 2008.

The same goes for other currency crosses, with the one month volatilities of EURCHF and EURGBP crosses relatively suppressed:

The put call skew for the Euro is similarly neutral relative to past levels, so there are no more people than usual making extreme bets against the Euro or hedging their Euro exposure with out of the money options.  What is happening to Greece isn’t the problem; it is what this implies about the future and stability of the Euro.  There are a few drastic possibilities that the market might be worried about, but right now the impact of Greece on wider markets is disproportionate relative to its impact on the headlines.