Monday, December 31, 2007

Economic Reasons Why the Yuan Must Appreciate

The article, China Lets Currency Appreciate a Bit Faster,” was published in the New York Times on December 29, 2007.

Quote from the article:China’s currency rose steeply against the dollar this week, feeding speculation that Chinese authorities, yielding to international pressure and economic realities at home, were allowing their currency to appreciate more rapidly.”

My opinion: China is not yielding to international pressures; they can no longer maintain the peg against a basket of currencies.

The Chinese People’s Bank of China has maintained a peg to a basket of currencies, including the US dollar, since 2005. A peg is a value of the currency (the Chines yuan, also referred to as the renminbi) chosen the the central bank (in this case, the Chinese People’s Bank of China). The central bank maintains the peg by buying international currency on the open market. Since 2005, the value of the Yuan has been roughly 8.11 Yuan/U.S. dollar. Today, the value of the Yuan is 7.30 Yuan/U.S. dollar –the U.S. dollar depreciated, while the yuan appreciated.

Why might this happen? According to the NY Times, the Chinese government bowed to international pressures and allowed the yuan to appreciate in order to curb exports to countries such as the U.S. While this is likely a small part of the reason, I see three reasons that are much more prominent.

First, and foremost, the People’s Bank of China holds more than $1.2 trillion in foreign exchange reserves – a level that is very costly. The reserve stock is denominated in currencies such as the euro, British pound, South Korean won, Japanese yen, Thai bhat, Russian ruble, Australian dollar, Canadian dollar, and the Singapore dollar. The largest share of currency in the foreign exchange reserves, however, still goes to the U.S. dollar. How big is $1.2 trillion? That is more than 1/10 of China’s total GDP in 2006. What does the People’s Bank of China do with such a large stockpile of reserves? Up until now, they have been simply sitting on the reserves and earning a low or no return on the portfolio – maintaining the peg with ease. Now, they realize that it is becoming too costly to stockpile the reserves, and not seek alternative investments that yield a higher expected return. According to the McKinsey Global Institute, the People’s Bank of China is losing 1.9% of gross income annually (based on 2006 gross income) by not investing the excess currency. That is a large number for a country’s whose gross income in 2006 was $10.17 trillion (measured in U.S. dollars).

Second, China is growing quickly, incurring the costs of high inflation (percentage change of rising prices). By maintaining the peg, Chinese inflation is in double-digits; export growth is so strong that prices are beginning to rise uncontrollably. One way to curb inflation is to allow the currency to appreciate a bit. High export demand from key countries, such as the U.S. and Europe, may fall, pulling down inflation in China.

Third, China lacks the ability to control economic conditions through monetary policy; the People’s Bank of China’s only current coal is to maintain the peg, not to influence the domestic economy. An example illustrates my point using the U.S. central bank, the Federal Reserve Bank. The primary goal of the Federal Reserve Bank is to maintain stable prices and stimulate growth to its potential level. If prices are rising too quickly, then the Federal Reserve Bank has the option to raise the federal funds rate in hopes of curbing price increases. The People’s Bank of China (the monetary authority in China) cannot do this – by maintaining the peg, they essentially lose control of economic objectives such as curbing prices. Controlling economic conditions is left to the other side of the government (the fiscal sector). So, by allowing the Yuan to appreciate, China gains some control of the economy by using monetary policy. Eventually, China will need to have a completely functioning monetary sector (the People’s Bank of China) to take advantage of economic objectives, such as stable prices.

In conclusion, there are three important reasons that the People’s Bank of China is forced to allow the yuan to appreciate. They are: an ever-growing stockpile of foreign exchange reserves, inflation, and attempt to gain monetary control - not international pressures.

This is not the end in the appreciation of the yuan. Economic forces will eventually force the yuan to exhibit characteristics closer to a floating currency (such as the U.S. dollar). Don’t be surprised if this happens over the next five years!

Do you have any comments? I welcome your input. Nontruths

Thursday, December 27, 2007

Benazir Bhutto's Death Heard Around the World

This is a true tragedy. I have been following Benazir Bhutto’s return from exile and rise to power (again) during the latter-half of 2007. I heard an interview with her on NPR – she was passionate, she was rational, and most of all, she considered her democratic ideals to be Pakistan’s future.

She was willing to build alliances with Nawaz Sharif and General Musharraf in order to secure the Pakistan’s growth. Now, who knows what will happen. Sharif is a corrupt man that is rumored to have met with Osama bin Laden. If there is a person to harbor terrorists and groups fighting the Western world – Sharif is your man.

I don’t have a lot to say in this blog – just that it saddens me to hear about Bhutto’s death. This reinforces the issues surrounding terrorism and how prevalent evil really is. I thank our troops for securing Iraq and pray that they will succeed in the fight against terror; it is obvious that the fight will be long and costly.

What's the Word on Sovereign Wealth Funds?

Sovereign Wealth Funds (SWF) are saving funds consisting of mostly foreign assets that are controlled by sovereign governments. When central banks or governments accumulate a surplus of reserves (assets), often they transfer the surplus to a managed fund. The International Monetary Fund (IMF) estimates global sovereign wealth to be in excess of $2.5 trillion, which is 5 times greater than it was in 1990, and is expected to grow to $10 trillion by 2012. Many funds were developed following the oil shocks of the 70’s, such as funds in the United Arab Emirates, Singapore, Kuwait, and Canada. Ten of the twenty largest SWFs, though, have been created since 2000. The large increase in demand for commodity-based products and the large saving patterns from several key countries has focused much of the world’s excess reserves in a handful of countries. estimates global sovereign wealth to be in excess of $2.5 trillion, which is 5 times greater than it was in 1990, and is expected to grow to $10 trillion by 2012.

Size of the funds

The exact worth of many SWF (a notable exception is Norway’s fund) is, for all practical purposes, unknown. The top 20 funds are estimated to be worth in excess of $10 billion each. Truman (2007) estimates the largest SWF, Abu Dhabi Investment Authority, to be $500-$875 billion. The next largest is the Singapore fund, Government of Singapore Investment Corporation, which is worth $100-$330 million. Norway’s Government Pension Fund, which is valued at around $362 billion, earns an annual real return of 4.6%. Holding all else constant, expected growth of 4.6% annually implies that the fund will be worth $724 billion in 15 years (2022). Recently, Saudi Arabia announced that it will establish a SWF and is expected to hold wealth in excess of Abu Dhabi Investment Authority’s $875 billion.

Sovereign Wealth Funds derive wealth primarily from two sources: commodity sales such as crude oil and natural gas (United Arab Emirates, Qatar, Nigeria, Russia), and high export growth and saving rates (China). In both cases, governments hold a large surplus of foreign exchange in excess of liquidity needs (to purchase goods and services by citizens and the government).

Where is the money going?

The recent SWFs’ portfolio allocation strategy has been to diversify away from the high levels of liquidity (treasury notes, currency, etc.) and toward nonliquid assets. For several economies, the U.S. Treasury monitors certain flows of assets (e.g., U.S. Treasury bonds and notes, corporate bonds, and equities), but the flow of less-liquid assets, such as commercial real estate or corporate buyouts, is not well known. Several SWF have hired external portfolio managers, such as State Street or PIMCO, but their data is subject to privacy rules and is not publicly available.

The big corporate deals, though, are represented in the media. In November, Abu Dhabi Investment Authority agreed to buy $7.5 billion stake in Citigroup. Singapore Investment Corporation paid almost $10 billion for a stake in UBS. In December, China’s SWF, China Investment Corporation, agreed to pay $5 billion for stake in Morgan Stanley. Not only are the funds moving away from liquid assets, they are buying up the struggling firms; Citigroup, UBS, and Morgan Stanley are suffering greatly due to losses derived from the sub-prime mortgage crisis. In the end, these struggling corporations welcome the flow of funds during times of distress.

Implications for world financial markets

SWFs are not unlike private hedge funds or pension funds and often compete in the same asset markets. The incentives and strategies of the SWF managers, though, may differ greatly when compared to the private funds (pension, hedge, etc.). The extreme secrecy of many of the SWFs, with the exception of Norway’s Government Pension Fund, makes it difficult to assess many SWFs’ management strategies. For example, go to the Abu Dhabi Investment Authorities’ webpage – there you will find a page with no links, let a lone management information.

First, the incentive structure of managers at a government-run SWF may be different from that at a private pension fund or hedge fund. Government employees on fixed salary often manage part or all of many SWFs. A private manager (hedge fund, pension fund) receives bonus income based on the performance of the fund. This leads to a lower cost of management on the part of the SWF, and smaller incentive for its portfolio manager to maximize expected return. Thus, the SWF may be willing to accept a smaller expected return. It is becoming more common for SWFs to hire external private managers; the incentive structure is, at best, mixed.

Second, the risk exposure that the SWF is willing to be subject to may be higher than many private hedge and pension funds due to the relative magnitudes of the funds themselves. Economic theory posits that risk aversion falls as wealth levels rise since the marginal utility of each extra unit of wealth is falling. Thus, when you compare the new Saudi SWF valued at > $900 billion to a private fund worth $50 billion, the $900 billion dollar fund is willing to incur more risk. Thus, the SWF is willing to accept higher risk exposure at a lower expected return.

Third, the SWF appear (in the media, at least) to be long-only investors. They are willing to buy up stake in struggling firms (high risk) at an undervalued price. So, if a pension fund or hedge fund is based on long positions, then it will be in the same market as the SWFs.

In the end, commodity prices are driving much of the wealth. If the price of crude oil continues to rise, the surpluses earned by a few net-saving countries may impact global economic markets. The asset markets will change, global economic investment will change, and the imbalance of global saving rates may be further exacerbated. It is hard to predict the impacts, as the SWFs’ worth are essentially unknown, the investment strategies and asset purchases are essentially unknown, so we must wait to see.

Monday, December 24, 2007

Who's Really to Blame for the Housing Bubble?

Blind into the Bubble was written by Paul Krugman and published in the New York Times on Friday, December 21, 2007.

On Tuesday, the Federal Reserve Bank proposed added regulation over lending practices to protect consumers from deceitful tactics. In his article, Paul Krugman lists reasons why the Fed’s actions are too-little-too-late. He presents a short list of candidates that are responsible for the housing boom and associated predatory practices of some mortgage lenders since 2003:

1. Alan Greenspan – then Chair of the Federal Reserve

2. Five government agencies, including James Gilleran at the Office of Thrift Supervision, in charge of supervising the financial industry.

Krugman argues that regulation is the only way; there is a failure in the mortgage industry that can only be fixed by government intervention. It was free markets that pushed the industry into a whirlwind of bad banking practices.

Krugman is not the only economist blaming Alan Greenspan. In an interview Joseph Stiglitz said, “Alan Greenspan really made a mess of things. He pushed too much liquidity at the wrong time.”

What Krugman and other economists fail to mention is that the Clinton administration (Bill, of course) propelled the consumers toward risky loans in the first place. Perhaps Greenspan and the government supervisory agencies further deepened the lending glut, but they were not the instigators; Bill Clinton was. In August 1997, Congress and Bill Clinton signed the Taxpayer Relief Act. Among other things, this act exempts married couples filing jointly from paying taxes on the profits earned by the sale of a residential home for up to $500,000. That key piece of legislature changed the incentive to buy and sell personal real estate indefinitely, pushing consumers toward riskier behavior

So, the blame is misplaced. It is one capital gains tax law (a law that I would not want repealed) that initiated the real estate boom - not the fault of free markets. The tax relief act, along with poor decisions made by persons in key positions, fired up the housing boom and launched us to where we are today.

I am thankful that there is a newspaper out there (the Wall Street Journal) that includes this piece of information in the time-line of the housing bubble.

Do you have any comments?

Friday, December 21, 2007

The Economics of Christmas

The Economics of Christmas

Not much going on in the world of politics. Congress is completing its task of quickly spending money before the year end by passing a bill that blocks the alternative minimum tax (AMT), Richardson is reminiscing the olden days - smoking cigars in Japan as a U.S. Ambassador, poor Giuliani is getting over the flu , and Barak Obama is on the toy war path; he proposes a full ban of imported toys from China.

As I read the Obama article, I thought: what will Moms and Dads buy their children for Christmas? According to the Wall Street Journal, China supplies the U.S. market with about 85% of the Christmas toys. Then I started thinking about Santa Claus – from where will he get his toys to spread the Christmas joy? No, Santa is not subject to sub-par standards in China - he makes his own toys. Then, I thought about the economic meaning of Santa delivering presents and spreading the Christmas joy – Santa is a social planner!

From a theoretical point of view, the secular representation of Christmas is that of a social planner problem. In theory, there are two types of models: the social planner model (very much like its political connotation) and the competitive equilibrium model (again, very much like its political connotation). The social planner seeks to maximize the welfare (happiness) of all agents in the economy. The competitive equilibrium model allows for markets to determine the allocation of goods. In theory, and if certain conditions hold, both models yield the highest and same amount of welfare.

Theoretically, Santa Claus is in charge of gift giving and not the markets – he is the social planner. He allocates goods (presents and coal) according to who has been good and who has been bad. Those who have been good are blessed with many presents, while those who have been bad are given coal. The economy of Christmas is full of many individual economic agents (the children). Each child writes Santa Claus a note indicating the presents that he/she desires; the presents that give each child joy. This represents a utility function in economics, where utility (joy) is dependent on the consumption of goods and services (each child’s choice of presents). Finally, the total welfare of Christmas is the spread of Christmas joy.

Santa’s economic problem: Santa is a social planner that chooses the allocation of presents and coal in order to maximize the joint Christmas joy of all the children, given several constraints.

Constraint 1: There is a goodness level for each child that is dependent on the child’s behavior over the past year; this level may be positive or negative.

Constraint 2: Each child specifies only those presents that give him/her joy.

Constraint 3: The total amount of presents demanded by the children cannot exceed the amount that Santa Claus has on his sleigh.

Constraint 4: Santa’s workshop is subject to an availability of resources: elves (labor), toy-building machines (capital), blueprints for toys, coal, etc.

Constraint 5: Santa’s workshop is subject to the available technology (they cannot make hover-craft skateboards yet) and the type of toy production in the workshop (perhaps the elves work in an assembly line).

Constraint 6: The toy-building machines may be used this year or next year and are subject to a rate of depreciation (older machines are slower and less-efficient at toy production).

Constraint 7: Santa only has 12 hours of delivery time on a magic sleigh.

Solution to the problem: The optimal allocation of presents and coal is delivered across the world in 12 quick hours. The globe is spread with the highest amount of Christmas joy.

And that is how Santa does it!

I welcome any comments that you may have. Nontruths

Friday, December 14, 2007

U.S. Inflation Numbers and the Mortgage Market.

The article, “Consumer Price Up 0.8% in November,” was published in the New York Times online on December 14, 2007.

Quotes from the article:

  1. “The worry is that the jump in energy costs will leave consumers with less money to spend on other items, worsening the slowdown in economic growth that is already happening.”
  2. “The 0.8 percent rise in consumer prices was worse than the 0.6 percent advance that economists had expected. With one month to go, inflation in 2007 is rising at an annual rate of 4.2 percent, far above the 2.5 percent increase in 2006.”

My opinion:

  1. Economic theory tells us that this is not a problem with inflation.
  2. This may be a positive sign for those of us with a fixed rate in the mortgage market.

Economic theory clearly states that falling purchasing power - rising prices reduces the number of goods and services bought by a typical consumer – is not a cost of inflation. Why? Many other monetary variables, such as salaries and wages, are tied to inflation. If prices rise by 4.2%, then the average salary also rises by 4.2%; there is no change in the number of goods and services bought by the consumer. The only reduction in purchasing power associated with the jump in energy prices is short-lived; there is a time during which the other monetary variables, such as salaries and wages, adjust.

Negative economic growth (which hasn't happened yet) and rising inflation are two separate entities with different economic costs. Falling growth will result in a loss of jobs; rising unemployment is one cost of falling income. Rising inflation results in several economic costs – one being a redistribution of wealth from the loan entity (bank) to the borrower (agent that takes out the loan).

Those of us who locked in a mortgage rate stand to gain from the higher than expected inflation rate! Banks make decisions about mortgage interest rates based on current and expected market conditions. If banks expect a rate of inflation of 3% (for example), then the interest rate must be at least 3% to tie the loan with inflation (keep the value of the loan payments the same).

Wages are indexed annually for inflation, while the many mortgage rates are fixed at a predetermined interest rate. If inflation is higher than expected (4.2%, for example), then it is easier for the borrower to pay back the loan. This is the redistribution of wealth from the loaner to the borrower. Borrowers with fixed mortgage rates actually welcome higher inflation!

There are welfare considerations of higher inflation on the mortgage market. Holding constant the negative effects of any reduction in economic growth, those consumers with fixed rates benefit from higher-than-expected inflation rates. On the other hand, those consumers with variable rates, at the very minimum, are not hurt since wages rise with the inflation rate. This will create a growing disparity between the wealth of consumers in the mortgage market. The fixed rate consumers become less and less indebted, while the variable rate consumers become perhaps more and more indebted. This is a real economic cost, as bankruptcy and foreclosure rates start to rise.

Ben Bernanke gives a speech regarding inflation expectations and inflation forecasting at the Federal Reserve Bank. The Fed can predict well prices for individual goods for up to two quarters, but uses larger macroeconomic models to predict longer timespans. Overall, he argues that the forecasts (which are not revealed to us) have been rather successful. Forecasting, however, is a difficult science, and subject to unforeseen events. Let’s assume that the Fed has the expected inflation forecast in check, and that the inflation numbers are not as bad as the New York Times would have you believe.

Thursday, December 13, 2007

The Social Costs of Riding the Bus

Today was an interesting day for me in public transportation; I realized that there is a serious failure in the market for public transportation. Every time I ride the bus, there is always that person claiming that he/she “doesn’t have their wallet,” or “can’t find their monthly card.” At first I thought, “I purchase a monthly pass in order to ride the bus to work, why can’t they?” Well, it’s not just about their lack of fare – there is a social cost that we all pay.

Different from the train, the bus driver has discretion regarding fares. The bus drive may simply say, “Okay, but bring it next time” upon hearing the excuse. I overheard a passenger in conversation with another passenger about how this passenger never pays the fare because he can always sweet-talk the bus driver. This is a problem that creates a social cost for all of us who ride the bus.

Let’s see – the government (regulators of public transportation) must know that the bus drivers often allow non-fare riders to take public transportation. The price-setter of the public transportation authority takes this fact into account when setting fares and sets a higher fares on average. The non-fare riders cause higher fares for all of the passengers in order to pay for the average cost of transportation. Simply said, you and I pay for the non-fare passengers. In Economics, this is a social cost – a cost paid by society for a market transaction, impacting others besides the buyer and seller of the good. The market transaction is between the bus driver (seller) and the non-fare rider (buyer). The social cost is the bus space used by the non-fare rider (which can be large during rush hour) and the higher average fare.

London, England understands this social cost. As you see in the photo, the bus driver is in a small room/cab surrounded by Plexiglas. During rush hour, he (photo here is a he) simply closes the Plexiglas, and nobody can sweet-talk him into allowing non-fare riders to enter the bus. The social cost associated with those passengers that do not pay is zero.

Do you have any thoughts? I welcome your comments. Best, Nonthruths

Tuesday, December 11, 2007

The Airline Industry is in Shambles: Anticompetitive is Good!

The article, "In the Crowded Sky, Change is Approaching," was published in the New York Times on December 11, 2007.

Quote from article: “I couldn’t get it through their heads that passengers are probably not interested in solving the delayed flights problem by having flights that cost twice as much, or having half the number of flights available to book on,” he [Mr. Stempler, a lawyer with Air Travelers Association] said.

My opinion: I will gladly pay the higher prices if that results in a more comfortable flying experience. Let the airlines declare bankruptcy to free up some market space.

The airline industry is a classic example of an industry with significant barriers to entry. In order to run an airline, one must purchase planes, hire pilots and flight attendants, and acquire landing rights at a limited supply of airports. These strong barriers lead to just a handful of airlines flying most of the passengers. Recently, low-cost carriers, such as JetBlue or Southwest, have emerged in force. They have driven prices down by creating competition and increasing the supply of available flights. On a positive note, consumers face a greater availability of flights and lower ticket prices. Producers suffer; competition drives the price closer to cost, reducing the profit margin. Currently, fuel costs are rising, reducing further the profit margin faced by airlines.

Today, with greater competition, planes are smaller and uncomfortable, airports are crowded, takeoff and landing slots are filled, and flights are delayed. In an unprecedented move during the Thanksgiving Holiday, President Bush declared that “business as usual is not good enough for American travelers.” The Pentagon opened up airspace to allow for the high traffic over the Thanksgiving weekend. Delays and crowded airports are the result of an over-crowded industry with too much competition.

So, what should the industry do?

First, consider regulation, where the government determines the price charged and the airlines that fly the routes. We already tried this, and it did not work. In the 1970’s, the Civil Aeronautics Board (CAB) controlled ticket prices and regulated routes; airlines were subject to long delays when attempting to add a route. It was argued that regulation led to inefficiencies and higher costs, resulting in the Airline Deregulation Act of 1978. Clearly, regulation is not the answer.

Second, consider status quo, with no change in the industry. The high competition results in many plane delays, overcrowded airports, and congested flights. This is not sustainable due to rising fuel prices, increasing consumer demand, and a relatively fixed supply of planes. Eventually something has to change.

Third, allow for airline mergers and a movement toward an less competitive industry. Mr. Stempler (quote above) certainly does not speak for every consumer. I would gladly pay the higher price associated with lower competition; I say allow the firms to merge. In order to avoid violation of the Sherman Antitrust Act and the Clayton Act, this must be done carefully. I suggest that the Department of Justice outline explicitly the allowable limits of concentration in the industry. Airlines, like Delta and United, are free to merge without all of the sunk costs associated with the approval process. In reducing the costs (both economic and monetary), the industry will converge more easily to a more highly concentrated industry (less competition).

With fewer firms (airlines) out there, the shortage of landing space and plane space will be alleviated. That Boeing 737 will not seem quite as crowded, and perhaps, all of those families with screaming babies will choose not to fly.
See, rising prices are not bad in all circumstances; those passengers no willing to pay the higher price are pushed out of the market. As long as prices are not too high, then those who want to fly will be able to comfortably.

Do you have any thoughts? I welcome your comments. Best, Nonthruths

Saturday, December 8, 2007

Quotes From Our Top Democratic Candidates

Some Quotes from the Top Democratic Candidates

Hilary Clinton: "Wall Street not only enabled, but often encouraged, reckless lending."Boston

My opinion: In this article, Hillary is threatening to pursue legislation if “Wall Street” does not enact voluntary measures to suspend foreclosures for at least 90 days.

Mortgage-backed securities (MBS) are widely traded assets on Wall Street. The mortgages at a bank are sold at a price that is determined by default risk and current interest rate. Now, having sold the mortgages to Wall Street, the mortgage banks are free to make further loans. This is not reckless lending; it occurs for all types of loans, sub-prime or prime. If Hillary is successful in claiming that Wall Street encouraged this problem and pursues legislation against this monetizing of debt, then future loanable funds may be in jeopardy.

Hilary Clinton: “I think it is a mistake for Democrats to be throwing these ideas out when we know that we can’t do anything unless Democrats and Republicans hold hands and jump together.”

My opinion: I would like to see Hillary happy about anything besides mopping the floor with her opponents. Barack Obama initiated a website to monitor Hillary’s aggressive behavior and attacks. Such an aggressive candidate would not be successful in putting on the bipartisan hat.

Barack Obamba: "We are in a defining moment in our history," he says. "Our nation is at war. The planet is in peril. The dream that so many generations fought for feels as if it's slowly slipping away.
"And that is why the same old Washington textbook campaigns just won't do."

My opinion: The situation in America is not as bleak as Barack describes. The figure below illustrates real per-capita income since 1960. Notice that average income has increased over 100% since 1960 and that it has not trended downward since Bush took office. I know that this does not well represent the distribution of income, but this means that our citizens are better off. We have access to better education, a rich variety of goods and services, technology, and overall, a better quality of life than in 1960. Compared to some countries, we are living in economic prosperity.

Nigeria, for example, is experiencing an increase of wealth derived from the crude oil market. Nigerian citizens, however, remain impoverished and living in shanty towns, while a few political leaders soak in the revenues and growth.

Sometimes politics really forgets to mention how well-off American citizens are.

John Edwards: "This system is corrupt. And it's rigged. And it's rigged against you," he says. "And we can say as long as we get Democrats in, everything's gonna be OK. "It's a lie. It is not the truth. Do you really believe if we replace a crowd of corporate Republicans with a crowd of corporate Democrats that anything meaningful's gonna change? This has to stop. It's that simple."

My opinion: John Edwards was a trial lawyer before he became involved in politics. According to CNN, he is worth millions, making $1.2 million in 2006. I just don’t see how this level of wealth differentiates John Edwards from his affluent democratic and republican predecessors.

Bill Richardson: "Is the plan I told you messy?" Richardson said, explaining his support for the concepts in the failed immigration bill. "Yes. ... Is somebody in Washington going to find a way to mess it up? Probably. But it's far better than doing nothing, and it's far better than deportation."

My opinion: Immigration reform is an interesting topic - one that Bill tackles with On the Issues. Bill Richardson wants to give illegal immigrants driver’s licenses, increase the number of H-1B visas, enhance border patrol with technology, and…include same-sex couples in binational sponsorships! Further, and part of a longer list, he will build a stronger relationship with Mexico and Central America to create jobs so that the immigration flow to the U.S. slows. This is not feasible. Perhaps this may work for the agricultural industry, but the service-sector professionals are not going to find appropriate jobs in Mexico. The job flows will always be inward (to the U.S.), and no relationship is going to change that economic fact.

Do you have any thoughts? I welcome your comments. Best, Nonthruths

Tuesday, December 4, 2007

Pelosi Should Rethink Her Energy Bill

These are published remarks by Nancy Pelosi on February 25, 2004 that can be found at the House of Representative’s website.

One of her many remarks: "As we all know, since President Bush took office, manufacturing jobs are hemorrhaging. The President has already lost 2.8 million good paying manufacturing jobs and continues to lose more every single month.”

My opinion: She has a very short-term memory. This energy bill that congress wants to pass will have strong repercussions in the manufacturing industry!

The democrats (Nancy Pelosi) go on and on about the jobs lost in manufacturing to larger trading partners such as China. This article is not going to be a debate about industry destruction and suffering of the manufacturing industry. It should be noted, though, that I do believe in the evolution of production, and that the long-run transition from goods-based production (manufacturing) to service-based production (banking or health care) creates economic growth.

There are obvious inconsistencies across Congress’ current energy bill and their fight for manufacturing jobs. Congress’ version of the energy bill requires that all auto manufacturing firms produce cars, truck, and SUV’s with an across-fleet fuel efficiency average of 35 miles/gallon by 2020. This sounds great on paper, but unless I am unaware of some major redefinitions of what constitutes manufacturing, production of motor vehicle parts, body, and motor vehicles are considered manufacturing. By placing such strong fuel efficiency measures on the production of motor vehicles, the Democratic Congress is destroying manufacturing jobs. Yup, those precious jobs in Detroit……gone!

I see this occurring in two respects: direct and indirect. First, the direct effect is higher costs associated with the production of fuel-efficient vehicles that require new technologies. As costs rise, firm labor demand falls, and unemployment results. Second, the indirect effect is the falling demand on other sectors, such as steel, rubber, plastic, glass, and other basic materials. As demand falls, revenues to the firms in these industries fall, and firms fire workers.

It is simply ironic that Congress cannot see past the high cost of gasoline. The plan is laughable when considering the number of years they have appealed to the “American Manufacturer.”

Saturday, December 1, 2007

Wall Street and Borrowers with Low Credit Ratings Have Been Bad

The article, “Wall St. Sees Silver Lining in Economy,” was published in the New York Times on December 1, 2007.

Statement from the article: “As Wall Street rallied this week, it seemed that investors were taking comfort in the notion that the economy had become so imperiled by the crumbling housing market that it was forcing the government to finally mount an aggressive rescue effort.”

My point of view: Wall Street and borrowers with low credit ratings (sub-prime) have been bad.

From a policy-makers point of view, the sub-prime mortgage crisis may indeed be a crisis….but not because Wall Street and Sub-Prime defaulters are suffering. The default of sub-prime mortgages creates an apprehensive banking sector. Banks become less willing to make risky loans (go figure) and hold a higher portion of deposits as reserves in their vaults. This restricts the money supply, resulting in a possible reduction in economic growth - all without the blessing of the Federal Reserve Bank. Among other things, a nervous banking sector was one primary cause of the Great Depression. The central bank did not increase the liquidity in the market enough. The money supply fell significantly, resulting in deflation and economic depression. Of course, the banking sector is not incurring a widespread panic, and the Federal Reserve does not need to increase the money supply.

There is no economic rationale for the Federal, State, or Local government to step in and appease Wall Street and sub-prime borrowers. The current solution to the sub-prime mortgage crisis (italicized to emphasize sarcasm) is to freeze interest rates on certain mortgages facing adjustable interest rates. According to the Wall Street Journal, up to $362 billion in sub-prime mortgage loans will be affected by the policy. This is a direct interference with banking decisions and private enterprise.

Banks set the mortgage rates according to variables such as alternative asset options and competing bank practices. Let’s say that the bank is holding a sub-prime mortgage at a 3% expected return, and the expected return on a 10-year treasury note is 4%. The bank must raise its rate on the riskier asset (the sub-prime mortgage) to rationalize holding the loan if the safer asset (10-year treasury note) offers a higher expected return. So it is not the mean banks that are raising rates on those poor sub-prime victims (again, italicized to emphasize sarcasm), it is just good business sense.

The sub-prime victims and Wall Street are not really victims at all. Many of the sub-prime loans went at very low rates, and families were able to purchase homes with a negligible down payment. Essentially, for a term of five years or so, these families lived in a great home for low rent. At the end of the five-year term, they default and move on – losing the negligible down payment and some foreclosure costs. Wall Street, having purchased risky assets based on the sub-prime mortgages, looses as well. The assets become worthless once these sub-prime loans default. Why are we suggesting that this behavior is acceptable?

There are high costs (some are not measurable) associated with government intervention in the sub-prime mortgage market. First, and most important, the government policy signals to Wall Street and future sub-prime lenders that the government will bail out the mortgage market, which encourages further risky behavior; we will likely see this problem again in the future. Second, the banking sector becomes regulated. Prices (the mortgage rates) are no longer determined by the market, inhibiting loans and saving even further.

Do you have any thoughts? I welcome your comments. Best, Nonthruths

Friday, November 30, 2007

A Day in the Life of a Federal Reserve Chairman

Help Wanted: Chairman of the Federal Reserve Bank


  • Must be able to predict the future
  • Demonstrate the ability to perform a balancing act between the financial system, consumers, and the global economy
  • Strong communication skills – ability to speak in public a must

The job entitled Chairman of the Federal Reserve is a tough job. Here are some of the qualifications required out of a successful Chairman of the Federal Reserve Bank.

Must be able to predict the future

This skill is essential, but the most improbable; predicting the future is impossible. We can make our best efforts to estimate the probability of events, but that is about it. The Federal Reserve Bank uses large econometric models in order to predict the future, but even these models may be wrong. The Federal Reserve Chairman must be able to react to economic shocks that were not foreseen in order to maintain economic stability.

Demonstrate the ability to perform a balancing act between the financial system, consumers, and the global economy

Generally, policy is conducted with the notion that falling interest rates stimulate domestic economic growth. First, based on economic theory, lower interest rates stimulate consumption demand (because saving is worth less in the future) and investment in housing and business capital (cost to take out a loan falls). This is good for the economy, and growth results. Second, the financial markets like lower interest rates. How often do you read, “Fed announces a lower interest rate target, markets rally”? Lower interest rates mean a higher current value of lifetime profits for firms (see an Accounting text on this, but I certainly am not going to subject you to the equation). Demand for stocks rise, pushing up stock prices (portfolio value). Faced with nervous consumers and a weary financial system in the U.S., what should Ben Bernanke do? Well, financial markets expect falling interest rates to stimulate economic growth.

This is not the whole question.

The Fed Chairman must consider global economic variables as well. For example, the value of the U.S. dollar is fundamentally dependent on forces of supply and demand. I use two simple examples for illustration. As American demand for imports rises, the demand for foreign currency to pay for those imports rises, and the U.S. dollar falls in value. Also, if interest rates in the U.S. fall (the return on U.S. treasury bonds and notes), then the international demand for U.S. bonds falls, the demand for U.S. currency falls, which again reduces the value of the U.S. dollar. Now, faced with this information, what should Ben Bernanke do? Well, in order to stabilize the value of the U.S. dollar, perhaps an increase in interest rates is the proper course of action.

In the simple examples that I have just described, a strong and imminent policy quandary has evolved. As argued in the Economist, and myself of course, the Fed should consider the international repercussions of reducing interest rates since a global economic disaster would result. Thus, policy should look to stabilizing the dollar, rather than appeasing financial markets.

Strong Communication Skills – ability to speak in public a must

A Fed Chairman’s policies are only as good as the public (consumers, firms, and the globe) believes the Fed Chairman to be. When Ben Bernanke spoke about “headwinds for the consumer in months ahead,” in a speech last Thursday, he was strategically signaling to the public that a reduction in interest rates, or an expansionary policy, may occur. He is saying that the Fed understands the economy’s current distress, and that the Fed is considering helping it along. This announcement alone (without any such policy action) can stimulate financial markets, consumer spending, and bank loans if the announcement is credible.

So, how will the current Chair, Ben Bernanke, fare in this so-called troubled economy (see related post, U.S. Economic Outlook)? Only time will tell. He is the 14th Chair and assumed office just two years ago (February 1, 2006). The economic outcome of monetary policy is so lagged (you don’t see the effects for a long time) that we may not know of his successes/failures for years. Some economists now blame Alan Greenspan, 13th Chairman of the Federal Reserve, for the current housing slump since he allowed too much liquidity to remain in the U.S. economy for too long.

Do you have any thoughts? I welcome your comments. Best, Nonthruths

Thursday, November 29, 2007

U.S. Economic Outlook

U.S. Economy Bulldozes Market Jitters

Economic muscle

Based on recent economic data for the U.S., growth remains strong. Real GDP in the last quarter grew at a healthy rate of 3.8%. Advanced estimates for this quarter indicate another period of robust growth at 3.9%. The unemployment rate remains constant at 4.7%, indicating a tight labor market. A falling dollar, coupled with inflation woes in foreign economies, resulted in export growth last quarter. The trade balance rose in September from $-57.6 billion to $-56.5 billion. Fiscal accountability is improving; deficits as a percentage of GDP fell from -1.9% in 2006 to -1.2% in November 2007.
Annual inflation rose to 3.5% in October, up from 2.8% in September. The U.S. dollar is down against major currencies; the Trade Weighted Exchange index is 73.93 in November, down from 75.91 in October.
Monetary Policy has been expansionary, with a 0.75 basis-point reduction in the federal funds target of 4.5% in October. The M2 stock expanded 0.34% in October, down slightly from 0.43% in September.

Markets are weary

With the housing market on the fritz and consumer confidence down, apprehensive investors seek safety. The 5-year treasury note rate is down to 3.496% at the end of month from 4.014% at the beginning of the month. The 3-month treasury bill rate is down to 3.042% at the end of month from 3.797% at the beginning of the month. Consumers are also concerned. Growth in household nonfinancial debt fell to 7.1% last quarter from 7.9% the quarter before. The consumer sentiment index is down 3.0% as retail sales slump and gas prices rise 38%.

Resolving the debate

Current economic activity seems to contradict market expectations. Leading economic indicators and a new Federal Reserve action indicate a bright economic future. Businesses inventories rose to 0.12% of GDP in the last quarter, up from 0.04% the quarter before:
Average labor productivity growth is up 4.9% compared to 2.2% the quarter before; it grew at its highest level since 2003: Weekly unemployment insurance claims were down 3.2% during the week November 10 through November 17.
In an effort to become more transparent, the Federal Reserve Bank increased the frequency of published economic forecasts to four times a year. In response to this signal, the Fed gains credibility, offering hope to the weary financial markets. According to the latest publication, the Fed projects solid economic activity through 2010, with 2.5% expected growth in 2008. The labor market is expected to remain tight, with unemployment rising just 0.1% to 4.8% in 2008. The housing market slump and reduction in consumer spending reduce the expected inflation forecast from 3.0% in 2007 to 2.1% in 2008. Given that the Fed's forecast agrees with the leading economic indicators, we expect the federal funds target to fall another 0.25 basis-points, but not further.
Possible recession-causing culprits are the decline of the U.S. dollar, the sub-prime mortgage crisis, or the high cost of crude oil. Different from previous recessions, 1973-1975, 1981-1982, 1990-1991, 2001, these culprits were expected. Rational expectations and the transparency of economic shocks eased the ability of firms and consumers to react to the shocks, and the economy prepares for a soft landing.

Do you have any thoughts? I welcome your comments. Best, Nonthruths

Sources: Board of Governors, Federal Reserve Bank of St. Louis, Bureau of Economic Analysis, Bureau of Labor Statistics, the Economist, and National Bureau of Economic Research.

Tuesday, November 27, 2007

Oh, Greenpeace - What's Next?

The article, “Greenpeace Criticizes Microsoft, Nintendo,” was published in the Associated Press and can be viewed online at the New York Times on November 27, 2007.

Statement from the article:Microsoft and Nintendo are taking too long to phase out toxic chemicals from their game consoles, and TV producers Philips and Sharp have poor policies on taking back and recycling outdated products, Greenpeace said Tuesday in its latest environmental ranking of leading electronics companies.”

My opinion: Bill Gates must be shivering in his shoes now that Greenpeace has deemed his production process too toxic.

Bill Gates, the All-American entrepreneur, has failed Greenpeace’s company report card. Microsoft has made it to the bottom of the list of the most irresponsible electronics companies, those companies that must clean up their act! Greenpeace now demands that Microsoft eliminate hazardous substances and recycle their products once they become obsolete.

As I look at those firms that are “failing,” I see almost every major electronics company listed. As of September 2007, the failures were: Nokia, Sony Ericsson, Dell, Leveno, LGE, Sony, Fujitsu Siemens, Samsung, Motorola, Toshiba, Acer, Apple, Hewlett Packard, and Panasonic. Am I missing anyone – no, but Greenpeace is not, either.

According to the Microsoft website, Bill and his wife, Melinda, supported philanthropic activities in the amount of $28.8 billion in Jan. 2005. These monies support improvements in global health, technical opportunities, and education. Warren Buffet is also a large contributor to the cause.

Why does this make national news? Given the current available technologies and the low concentration of firms in the electronics market, what more can the guy do? I think that Greenpeace would be happy if the production of electronics from any of the failing firms (such as Microsoft) was forbidden. Problem – without these irresponsible firms, how would Greenpeace get the word out? I am just happy that I no longer see a Greenpeace sponsor every time that I answer the door. I say keep the electronics firms in business just to keep Greenpeace off my back!

The Hypocrisy in Europe: Genetically Modified Foods

Article, “European Official Faults Ban on Genetically Altered Feed,” was published in the New York Times on November 27, 2007.

Statements from the article: “The European agriculture commissioner, Mariann Fischer Boel, warned farm ministers on Monday that Europe’s resistance to importing genetically modified products like livestock feed was contributing to the rising cost of raising pigs and chickens and could pose a threat to the meat industry.

My opinion: The hypocrisy is overwhelming. Now that the prices in world agricultural markets are rising, the Europeans are reassessing their ethical views and standards.

For years, Europeans (Western, or course) have been contemptuous in their dealings with the producers of agricultural goods derived from genetically modified organisms (GMO). They were staunch in their principles and regard of GMO food products' negative effects on health, safety, and of course, environmental quality. In 2002, the Committee on the Environmental, Public Health and Food Safety, elected to attach a series of tariffs to products derived from GMOs. This affected the exports of U.S. corn and soybean directly.

Tariffs create an increase in the prices of the goods to the importing country. The tariff is a tax that exporters must pay upon the shipment’s arrival to the importing country (corn, for example). The exporter (U.S. corn farmer) passes the cost of the tariff on to the consumer in the importing country (France, for example) by increasing the sale price of the good in the importing market. Now, the rising cost of feed for livestock can be lowered in Europe by…………repealing the tariffs?

Even Mariann Fischer Boel admits, via her spokesman, “that the European Union’s zero-tolerance policy toward genetically modified foods comes at a ‘potential major cost.’” Go figure - perhaps Ms. Fischer Boel can even talk the Committee on the Environmental, Public Health and Food Safety to repeal the tariffs on GMO-related agricultural commodities.

Isn’t it ironic how the Europeans are willing to sacrifice their precious standards regarding food, and perhaps import GMO agricultural goods even though the goods may be related to problems with health, safety, and environment? I hope that the population survives when genetically modified food is introduced into the economy.

I am surprised that this is breaking news.

Monday, November 26, 2007

Developed World Sets Standards Too High

The article, "New York Manhole Covers, Forged Barefoot in India," was published in the New York Times on November 26, 2007.

A quote from the article: “The scene was as spectacular as it was anachronistic: flames, sweat and liquid iron mixing in the smoke like something from the Middle Ages. That’s what attracted the interest of a photographer who often works for The New York Times — images that practically radiate heat and illustrate where New York’s manhole covers are born.”

My opinion: It is not the place of the developed world to set the standards of labor for the developing nations.

Here is the picture from the article:

Here is a picture (from Bettman/Corbis) from the 1890’s of 5 chimney sweepers:

The picture from the article is not anachronistic for India (especially back to the middle ages) – perhaps for a developed economy, such as the U.S., but certainly not for a developing economy such as India. The prevalent production sectors in India are mining, textiles, transportation equipment, machinery, and agriculture (cotton). Does this sound familiar? Sure, the developed-world’s industrial revolution! The industrial revolution (late 18th century to early 19th century) marked a time of increasing labor productivity in production sectors including agriculture, transportation, and manufacturing. Labor was the primary resource, and even child labor laws were not yet developed. According to Galbi (1997), during the period of 1818-1819, 49.9% of spinners in English cotton factories were under 10 years of age when they started. In today’s standards, that is inhumane.

Long-term economic growth models explain this disparity in working conditions and production specialization between the developing (e.g., China, India, Vietnam) and developed economies (e.g., U.S., U.K., Germany). Over the last century, the United States has transitioned from an economy focused on manufacturing, textiles, and mining (products based) to one focused on investment services and banking, information, health care services, and arts and entertainment (service based). According to the Census Bureau, the service sector accounts for 55% of current economic activity in the United States. If the U.S. does not produce it, it imports the product-based production, such as textiles and agricultural and metal commodities, from economies such as India and China. These economies are behind the U.S. in terms of economic growth and technical advancement. Since production in the developing nations is roughly a century behind production in the developed nations, the labor laws are understandably behind as well.

When the United States of America was production based (mining, textiles, and manufacturing), the labor laws were not well-developed. It was not until 1938 that Franklin D. Roosevelt passed the Fair Labor Standards Act, which established a minimum wage, guaranteed overtime pay, and prohibited child labor. In 1802, the first labor law was passed in the U.K., the Fair Factory Act. Countries such as India and China will catch up – they are on a path of growth toward claiming status as developed economies, but this will take decades to occur (perhaps even another 40-50 years).

The workers in India make the choice to go to the mines and factories. According to the Penn World Tables, in 2003, average production per worker in India was: $6,724.55, and $67,865.44 in the United States. That means the average worker in the U.S. was roughly 10 times better off than his/her counterpart in India. The Indian workforce is choosing between growing opportunities to work in conditions that are deemed unacceptable to the developed world and not feeding their families. They choose to feed their families by working. It is their choice. As average production per worker rises to meet that in the U.S., higher standards for labor will be valued. At that time, the laws and conditions will change, but not before.

Admittadly, the quality of exports from the developing economies to the developed world (e.g., toys) have been under scrutiny, and affect the developed world. The developed world has much strategic power in the international markets. If world demand falls, then international toy makers will increase their standards in order to make the sale.

In conclusion, history dictates that labor laws are likely to come, but the nations such as India and China must dictate these rules, not the developed nations. The developed world learned about labor laws all on its own, and the developing world must, too. It is not the place of the developed world to regulate and judge the practices of the developing world. Give them time, and they will catch up!

Galbi, Douglas A. (1997). Child labor and the division of labor in early English cotton mills.
Journal of Population Economics 10, 1432-1475.
Photo downloaded at:

Penn World Tables at: