The China Syndrome, Part 2

"I know the vibration was not normal."
-- Jack Godell/1979

Guess what else isn't normal? Chinese are indulging in interest rate inflation the same way we did, by bidding up housing with a flood of moolah. Since the collapse of the US bubble, the Chinese are left to create their own bubble. Good for them. One might wonder whether their quants are putting heavy thumbs on their scales, too.

Remember, this mess all started with Greenspan cratering interest rates in 2001 (not in one swell foop, of course, but the Yellow Brick Road was well paved that early). A significant impetus to move funds from "risk free" instruments such as US Treasuries to housing was simply that industrial investment has become troublesome, in the sense that, at least in silicon based companies, payback period exceeds productive life. That's been an anecdotal assertion. Finally, I found a source that admits this:

Over the past ten years, the semiconductor industry's capital requirements have grown faster than its cash operating profits. As a result, the payback period on invested capital has nearly doubled, from about 0.7 years to about 1.4 years over that same time period (Refer to Appendix for underlying methodology). Product lifecycles in the industry have remained generally unchanged at 18-24 months, however. Soon, the industry will reach a point at which investment is no longer profitable from a cash net present value (NPV) perspective: the payback period on invested capital will exceed the timeframe over which the underlying assets are productive.

In other words, it becomes impossible to actually earn a return on real investment. Oops. Absent profitable real investment, fiduciary investment has the world as its oyster. The problem, of course, is that, ultimately, fiduciary returns are only possible if the underlying payers are themselves beneficially accommodated. This lack of accommodation is why the US housing bubble burst: there wasn't rising median incomes to pay the extra vig. Oops. The Chinese will find that their moolah will be just as wasted on their condos as it was on Florida McMansions. Couldn't happen to a nicer bunch of folks.

I'll mention, again, the NPR piece, "The Giant Pool of Money". The best, and rather early, popular explanation.

I Told You So, Part 3 (I Think)

Today's Times brings an embarassment of riches. The theme for today: shared risk. Whether the Editors of the Times set out to publish on this, or any, theme is unknown to me. Of course, this theme has been on my mind since The Great Recession bloomed. Long winded, but it's been a while since I've done.


Gretchen Morgenson on the way things don't appear to change in the public-private mortgage industry. Privatize profit, while socializing costs.

That the commission recommends a taxpayer-backed solution isn't surprising, given its makeup. Six of its 22 members and consultants either hail from Fannie or Freddie or work at institutions that received major financing from the companies before they collapsed.

Asked about that composition, a commission spokeswoman said that the diverse group of experts "were not selected solely on the basis of past affiliations."

The larger issue is: what do we mean by insurance? The classical economic definition is succinct: shared risk. For-profit insurers, however, don't operate that way. They always seek to segment the market, charging the maximum to each discrete segment. Mo money dat way. What Morgenson neglects to mention is that the gold rush into housing wasn't led by Fannie and Freddie, but the private insurers. Only when they sensed that they were losing market share, did the pair start down the lemmings' road to disaster with the private insurers. So, she does ask:

Neither Fannie nor Freddie has been adept at setting an appropriate price for their guarantees -- that's why they're choking on more than $100 billion in losses. Why would a new public guarantor do the job any better?

Which begs the real question: what evidence is there that the private insurers were any better at it? They weren't.


Next, we have the Cyprus mess. Regular reader knows of my fascination with Bermuda, our local version of tax evasion nation. Andrew Higgins lays out the Russian connection. What should be obvious by now, is that an economy based on financial fiddling is fragile by definition.

Andreas Marangos, a Porsche-driving lawyer here, had just woken up when he heard the news that threatened to destroy his and Cyprus's most lucrative business: setting up shell companies and providing financial services for wealthy Russians.

This reminds me of the scene from one of the Bourne films where the Russian Secret Police agent jumps into his BMW, chasing Bourne. Don't trust those Russians. And don't base your economy on stealing from other, productive, countries.

"This is all a dirty game to create a banking collapse," fumed Yuri Pianykh of the Russian business association -- aimed, he contends, at luring Russian money out of Cyprus to other European countries. He insisted the country had better safeguards to combat money laundering than many other European states and had been the victim of a German smear campaign.

Ah, Russia fighting Germany. It was, after all, the Eastern Front (read: Russia) that doomed the Third Reich. I suspect the fear and distrust hasn't abated much. The Cuban missile crisis was motivated, little known to Americans until well after the fact, by Russian response to American missiles aimed at Russia in Turkey; just about as close as Cuba is to the US mainland.

David Officer, a sociologist at the University of Nicosia, said Cyprus had indeed enacted tough legislation to fight dirty money, "but the problem is implementation." He said that "a culture of secrecy" allows billions of dollars from abroad to slosh through the financial services and real estate industries with little supervision.

Sound kind of familiar? Yet another bevy of toothless laws and regulations.


Next up: Roger Lowenstein tells the tale of FDIC. As with Fannie and Freddie discussed above, the issue boils down to defining what we mean by "insurance". If we really mean shared risk, then the private, for-profit, corporation ought not to be the vehicle. Private insurers only make real money when they concoct contracts which never pay out. Or, at least rarely and for substantially less than actual loss. In the case of financial services, encompassing more than just store front banks, we need to consider what function they should play in the economy. Fundamentally, their only distinct value is marrying savers with borrowers. The cost of doing this is virtually zero, and so profit in financial services by this definition and with a truly free market, will be just a notch above nada.

Yet, Western (read: "post industrial") economies forged toward financial services rather than production over the post WWII period. Extracting extraordinary profit from arbitrating between savers and borrowers depends on trickery of law and lax enforcement of what laws and regulations do exist. The rat in the woodpile is that economies based on non-productive uses of both labour and capital have to enforce draconian monetary policies on their entire economies (read: all those other folks who don't work in financial services) in order to maintain "the value of the currency". This is, stated or overt, the reason such post-industrial economic decision makers get so batshit over the least whiff of inflation.

In a producing, domestic economy, inflation (modulo true hyper-inflation, which isn't in the US's cards) is a spur to production, since hoarding of currency is discouraged. Consumer demand stays robust as the stock of money is spent on *widgets which are produced in situ*. Such was the state of the USofA from the end of WWII into the early 1970s. The proximate cause of distress was the Arab/OPEC oil embargo, but the seeds of our current state of affairs had already been planted. Now that we have a much diminished producing economy, and more like Bermuda and Cyprus, we depend on imports to satisfy consumer demand for widgets. In such a situation, the economy's commodity is its currency. Since currency is the blood of the commonweal's body, all parts of the body are impacted when the bloodflow is managed to support just the left foot. This also means that both fiscal and monetary policy levers are much less powerful; an economy, in the very short term, can rise out of recession only be re-employing those made redundant by the recession. In the case of the USofA, that's housing and finance, the quicksands that sucked us down in the first place. It took decades to dismantle production across the economy, and that course won't be reversed in two presidential terms (even if Obambi understood the real issue, and sought to fix it).

Forman's insight was that banks were vulnerable to chain-reaction panics. As he put it -- in a line unearthed by the Harvard Business School historian David Moss -- "banks constitute a system, being peculiarly sensitive to one another's operations, and not a mere aggregate of free agents."

He opens his article thus:

FOR all the criticism of bailouts since the financial crisis struck, virtually no one has suggested that depositors in banks be made to suffer along with their investors, employees and customers. Until this week, when the euro zone proposed that, in return for a bailout of the failing banking system in Cyprus, depositors pay a "tax" of 6.75 percent of their deposits -- 9.9 percent for deposits above 100,000 euros.

He fails to mention that, by all we can see, the reason for this is the EU's foment to punish Russia. See above. But the demand from the EU raises, once again, the definition of both insurance and a United Europe. Just as the Red states suck off the teats of the Blue states, southern, dark, swarthy Europeans will do the same to the Aryan nations. If there is to be a United Europe. Interesting factoid: 50% of Germany's GDP is from exports. Germany is taking a meat cleaver to its nose; and doesn't even have a clue it's doing so.

Oddly, what I didn't recall, FDR was opposed to insuring deposits:

When bank failures reached epidemic proportions in the Great Depression, the idea was revived. Again, the industry opposed it -- as did Franklin D. Roosevelt, who said insurance "would lead to laxity in bank management and carelessness on the part of both banker and depositor." Insurance was to be financed by premiums from banks. Still, because it was guaranteed by the government, Roosevelt feared that it could bankrupt the Treasury.

And, as always, the issue comes down to equity and responsibility. For industries which aren't analogous to blood, failure by stupidity harms only the shareholders and employees. If the economy consists of millions of ten or twenty person firms (no corporations), along the presumed ideal of the real Adam Smith, then it's a bubbling pot of stew, which re-blends itself as needed. But that's not the real world, and wasn't in 1776 when Smith's book was published.

To critics, the S.& L. fiasco proved that insurance was a flawed concept. The problem wasn't insurance per se, but that premiums weren't high enough -- nor were they adjusted according to the risk presented by individual banks. (By the same principle, any rational auto insurer will charge a higher premium for an 18-year-old with a D.U.I.)

He repeats, almost verbatim, what Morgenson had to say about premium setting by Fannie, Freddie, and their possible replacement. Who copied from whom? Just kidding. It's an obvious conclusion. Which brings the nasty bit:

After recovery from the S.& L. crisis, Congress, lulled by an improving climate, succumbed to bankers who called the F.D.I.C. overfinanced. Premiums were cut to zero for banks judged to be well capitalized.

I bet you didn't know that? Nor do I recall it. Wouldn't it be useful to know which, if any, of the bailed out banksters were on the zero premium plan? Lowenstein doesn't say.


Next up: Robert Frank takes on soda. Bloomberg's attempt to end the 32 ounce variety. While he doesn't mention it, there was recent reporting from the medical community that diabetes isn't a result of weight, per se, but rather sugar itself. Juvenile and adolescent sugar consumption is the trigger, not adult weight. Bloomberg is on solid scientific grounds, even if he didn't (and from the reporting I've seen, he didn't) know the exact connection at the time.

Frank makes the analogy between sugary drinks and tobacco. Who should pay the external costs of either? And given that such costs exist, and with sugar apparently the higher of the two, should we not, as a society and economy discourage behaviour which damages most of us indirectly? Do we really want a pure Darwinian country? Only those with stronger endocrine systems, able to withstand the onslaught of juvenile sucrose, be allowed to live? Makes for more palatable kiddies; rather Swiftian, what?

Imagine a society like the United States before 1964, where unregulated individual choices produced high percentages of smokers in the population -- more than 50 percent among adult men. Not even the staunchest libertarians should deny that their children would be more likely to become smokers in such an environment.

Smokers harm not only themselves and those who inhale secondhand smoke but also those who simply want their children to grow up to be nonsmokers. People can urge their children to ignore peer influences, of course, but that's often a losing battle.
...
Just as few smokers are glad that they smoke, few people go to their graves wishing that they and their loved ones had drunk more sugary soft drinks. Evidence suggests that the current high volume of soft-drink consumption has generated enormous social costs. So to those who have lobbied successfully against a soda tax, I pose a simple question: How do the benefits of your right to drink tax-free sodas outweigh the substantial costs of defending it?

Next up: cancer. C-SPAN2/BookTV has been running a talk by Ben Goldacre, where he blurbs his new book. I've not been able to see it straight through, but he's got it in for Big Pharma.

Along similar lines Ezekiel Emanuel takes on Pharma in the context of oncology. If you've been following the healthcare sector of the stock market over the last few years, you've seen the transformation from developing widely useful compounds to those which aid the few. The proximate cause, as I see it, was the Orphan Drug Act of 1983 (and the later, 2002, Rare Diseases Act), which allows drug companies to spend all they want and charge what they want for drugs aimed at small populations. And they've done so with gusto. Not only that, their "efforts" (if one wishes to be kind) tilt toward Medicare folks. You know, that terrible waste of money. Oh wait!! It's Pharma's bread and butter.

This year, more than 1.6 million Americans -- 0.5 percent of the population -- will receive a diagnosis of cancer. Their treatment will consume at least 5 percent of the country's health care spending, at a cost that is growing faster than all other areas of medicine.

And it ain't cheap:

Of the 13 anticancer drugs the Food and Drug Administration approved in 2012, only one may extend life by more than a median of six months. Two extended life for only four to six weeks. All cost more than $5,900 per month of treatment.

What's even more stupid, is that robots were sold as the way to be more efficient and more effective.

For instance, while more than 800,000 robotic surgeries, mostly for cancer, have been performed in the last two years, there is no reliable evidence that the robots either improve survival or reduce side effects -- despite the fact that they cost more than traditional surgery. Once interventions are paid for, the incentive for research disappears.

Post-approval research was a major part of the segments of Goldacre's talk that I've seen. Simply put: clinical trials involve, with rare exceptions, at most a few hundred individuals. From a statistical point of view, if what you're studying is well enough understood with regard to how its distribution looks, a few hundred is a lot. But that's true only if the real difference between the New Way is sufficiently better than the Old Way. When the difference is small, then it's harder to prove. And if the difference is small, what's the point of wasting society's resources?

Today, 60 percent of cancer diagnoses are made in patients who are eligible for medicare. By 2030, that number will rise to over 70 percent.

To put it bluntly: what's the point of spending $1 billion (rough estimate from Pharma) to create a drug which gives an 85 year old cancer patient an extra month of living in a hospice? Does that make much sense? Since Nixon (remember him) initiated the War on Cancer, the standard response is along the lines of, "we're making progress, albeit slowly with each new drug, to finding The Cure for cancer". Proponents of the status quo are making the implicit promise that the billions of dollars spent annually on development and treatments, which provide minuscule benefit to patients (but enormous profits to Pharma), are the beneficial side effects of this quest. Never mind that we've only discovered that there's really no Cancer, in a monolithic sense of a single disease like tuberculosis. And there's no chance that there'll be a Cure.

Shared risk? A few patients get a few more weeks of sentience, while widely deadly or debilitating (or both) diseases get little to no research. We're all paying for Granny's extra week. If it's my Granny, or if I'm Granny, I probably think that's a good deal. But it's not.


Finally, Maggie Koerth-Baker takes on we're living longer meme. Alas, this is in the Magazine, and the Times, in its rapacious ways, won't link to the entire piece, just an abstract. Go to the library during the week. In sum: humans aren't really living all that much longer, once adulthood is passed. Currently, expectancy at 25 in the US is 79, and has been for a long time. However, where we were 9th in the world in 1950, we're now 51st. For all that we spend on orphan drugs and elective surgery, public health skids to the gutter.

Stop Having So Many Kids

Among my favorite authors is Paul Theroux, but only his travel stuff; not so much his fiction. C-SPAN2/BookTV cover many, if not all, book festivals, generally live (thence repeated). Within the last year or so, he appeared at one such festival, blurbing a book I suppose; I don't recall because the most important thing he had to say, in response to a question from the audience, was: "stop having so many kids!". It might even have been, "damn many".

It is an article of faith, and data, among economists that as a group/society/country moves up the development pyramid, breeding recedes. The typical explanation, based on US experience at least, is that as farming transitioned from subsistence farming to commercial family plots to industrial farming on mega-acreage, fewer kids were needed to provide both child and, later, adult labor. One might also note that the migration from farm to city reduced the *need* for kids; modulo welfare gaming, if you believe in the existence of such. I don't, but that's another episode.

An R builder, Markus Gesmann, has been working googleVis for some time now, and has just released another version. googleVis is an R package that enables motion charts with Google Chart Tools from R in the browser. A link to googleVis proper is in the posting.

If you toddle off to his blog, you'll see his demo. As it happens, the data he uses is fertility and life expectancy (the latter a common surrogate for development). QED.

How Many Shoes Does a Centipede Have? [update]

Well, yes, the centipede drops another shoe. Today's Times has an evaluation of the Levin committee's report on JP Morgan's whale watch. Here's the report. One wonders whether Google is in league with The Banksters, since the report doesn't appear in the results. (The Times piece does have a direct link, though.) I had to follow many links to get to it. For future reference, this is the URL for that subcommittee.

The report runs over 300 pages, so I'll (for now; there may be updates to the missive as I work through) drop some cute quotes from Morgenson's piece.

BE afraid.
That's the takeaway for both investors and taxpayers in the 307-page Senate report detailing last year's $6.2 billion trading fiasco at JPMorgan Chase. The financial system, thanks to dissembling traders and bumbling regulators, is at greater risk than you know.

What we care about here is to what extent the quants were either co-opted or active participants in the shenanigans. Defenders will assert, as expected, that the quants were either just following orders or were kept in the dark.

... risk limits created by the bank to protect itself were exceeded routinely ...

Morgenson goes on to re-state the obvious

Remember that this is a report examining JPMorgan Chase, the bank that enjoys the best reputation among its peers. One can only wonder: if JPMorgan Chase traders think nothing of misrepresenting the value of their trades to minimize losses, what are the financial world's lesser players up to?

Dimon was particularly trenchant in defending himself and his bank during The Great Crash. From some years ago:

Instead of simply trusting his traders, Dimon put himself through a tutorial, so that he would understand the complex trades the bank was exposed to. And rather than run its mortgage machine at full throttle for as long as possible, Dimon reined in lending earlier than did others and warned his shareholders of looming trouble.

May be he didn't really? Could be. He certainly didn't do an Ahab imitation this time.

So, we have this later from the report:

Hoping to understand JPMorgan's practice of relaxing its valuation method on the troubled investment portfolio, Mr. Levin asked of Mr. Braunstein: "Is it common for JPMorgan to change its pricing practices when losses start to pile up in order to minimize the losses?"

After a bit of back and forth, Mr. Braunstein said: "No, that is not acceptable practice."

Here's where it gets a bit mathy. Risk assessment in the bankster crowd relies on gauging tomorrow's chance of collapse based on historic fluctuations in whatever sector/industry/company/etc. under review. Which is a perfectly acceptable stat methodology when the object of investigation is some natural process. With natural processes, barring events such as asteroids taking out most of the Yucatan, there's so much going on in the environment around the process we're interested in, that the causes of fluctuations in the process under review have all been blended into the historic data. Think: Brownian motion (financial quants have been known to invoke BM in their work; if only they had a brain). Human driven processes, where events are the result of specific human decisions, just don't work that way.

Since they say they're doing quant, rather than policy, they look for a number to quantify risk. Turns out, they use a measure of variability in the historic data. It's an attempt.

Normal practice at the bank and across the industry is to value these kinds of derivatives at the midpoint between the bid and offer prices available in the market. But in early 2012, as it became apparent that JPMorgan's big trades at the chief investment office were going bad, the bank began valuing the portfolio well outside the midpoint. This reduced its losses.

In other words, just as a butcher who doesn't know you (or does, and still hates you) puts his thumb on his side of the scale, Morgan leaned full force on the scale. The losses weren't really reduced, only the reporting said so.

In March, however, all 18 deviated, and 16 were at the outer bounds of price ranges. In every case, the prices used by the bank understated its losses.
...
Then, in April 2012 alone, risk limits were exceeded 160 times.

That's one angry butcher. Sweeney Todd on meth.

Levin goes in for the kill. Morgan had done its own investigation:

"You just told us that shifting pricing practices to minimize losses is not acceptable," Mr. Levin said. "Did you say that in your report? Did you say that's what happened?"

"I don't believe we called that out in the report," Mr. Cavanagh answered.

Here's why all this matters.

JPMorgan, don't forget, is the largest derivatives dealer in the world. Trillions of dollars in such instruments sit on its and other big banks' balance sheets. The ease with which the bank hid losses and fiddled with valuations should be a major concern to investors.

Mama, don't let your boys grow up to be quants.

[update]
From page 94 of the report:

Step by step, the bank's high paid credit derivative experts built a derivatives portfolio that encompassed hundreds of billions of dollars in notional holdings and generated billions of dollars in losses that no one predicted or could stop. Far from reducing or hedging the bank's risk, the CIO's Synthetic Credit Portfolio functioned instead as a high risk proprietary trading operation that had no place at a federally insured bank.

From page 155 of the report:

The CIO's lead quantitative analyst also pressed the bank's quantitative analysts to help the CIO set up a system to categorize the SCP's trades for risk measurement purposes in a way designed to produce the "optimal" -- meaning lowest -- Risk Weighted Asset total. The CIO analyst who pressed for that system was cautioned against writing about it in emails, but received sustained analytical support in his attempt to construct the system and artificially lower the SCP's risk profile.

From page 168 of the report (quoting Morgan documentation):

"The Firm calculates VaR to estimate possible economic outcomes for its current positions using historical simulation, which measures risk across instruments and portfolios in a consistent, comparable way. The simulation is based on data for the previous 12 months. This approach assumes that historical changes in market values are representative of the distribution of potential outcomes in the immediate future. VaR is calculated using a one day time horizon and an expected tail-loss methodology, and approximates a 95% confidence level. .. "

In other words: "we expect today to be just like yesterday".

Here's where it gets interesting (and sounds familiar?). The Whale Pod decided that the risk model used by Morgan was too pessimistic, so they'd do their own, but

Although Mr. Stephan [an experienced quant having built VaR models for Morgan] remained employed by the CIO in a risk management capacity, he was not the primary developer of the new VaR model; instead, that task was assigned to Patrick Hagan, the CIO's senior quantitative analyst who worked with the CIO traders. Mr. Hagan had never previously designed a VaR model.

So, sing the bridge again:
Mama, don't let your boys grow up to be quants.

Rope a Dope [update]

For those who can't be bothered to engage in word play, the previous post's title was a lexical meta-syllogism equivalent to today's. And today, I'm happy to report that those reporting on the ground, in Vatican City and Buenos Aires, confirm the conclusion.

"Snub of Reformers' Choice Seen Before Pope's Anointing" (the title in the dead trees version is a bit different) explains the course of events, beginning with:

The choice of Cardinal Jorge Mario Bergoglio as pope was so surprising, the Italian bishops sent out an e-mail congratulating the wrong man.

Dewey and Truman? Dewey, Cheatem, and Howe? A roar comes from the crowd! The forward leaning Americans and Europeans were told to go shove it.

... the Vatican-based cardinals protective of their bureaucracy snubbed the presumptive front-runner, and a favored candidate of reformers, Cardinal Angelo Scola.

Reform? More like repression.

Cardinal Scola went into the conclave with a solid block of votes, including many of the Americans and Europeans, who saw in him an Italian who was nevertheless at a distance from the intrigues of the Vatican. But it quickly became apparent this was not going to be enough, particularly given what news reports said was the opposition of Cardinal Tarcisio Bertone, the powerful secretary of state under Benedict.

Let's not go too far, folks. Let's keep 'em poor, stupid, and breeding. And, we'll have another chance soon enough, without the pressure (most likely) of needing a Pope immediately for Easter.

Cardinal Bergoglio's age may have cut both ways, said Mr. Ingrao, the Vatican expert for Panorama. Reformers may have believed it would motivate him to act quickly, while cardinals favoring the status quo may have hoped his papacy would be too short to effect much change.

There remains the conspiracy theory that John Paul I was offed by the Vatican Mafia just because he wanted to bring the church into the modern world. Franky best watch his step, if he's been a liberal in wolf's clothing all this time.

And folks in Argentina aren't all happy with the dude.

One of the most biting reactions to Francis came in a statement from the Mothers of the Plaza de Mayo, the association of women whose children were disappeared during Argentina's military dictatorship, from 1976 to 1983. The group contrasted Francis, who has long been criticized for not confronting the dictatorship, with the 150 or so other priests who were killed during the so-called Dirty War.

"About this pope they named, we have only to say, 'Amen,' " Hebe de Bonafini, the group's president and a longstanding critic of the incoming pope, said in a statement steeped in irony.

[update]
That didn't take long.

Rope a Pope :: Pope a Dope

Let's consider what happen today. The Catholics (at least, the dudes who run the show) doubled-down on Fascism. The Retired Pope was a Hitler Youth in the land of Nazis, the New Pope ran the Church in the retirement community for Nazis. I watched on MSNBC (of course), and Chris Matthews was among those chattering in the background as we all waited for the announcement. To listen to him talk about the Church needing to listen to the West! I turned to tennis after the unveiling, so I didn't hear him lament, if he did.

So, either the far Right Wingnuts have thoroughly taken over (my guess), or Bergoglio is a short-timer (not such a bad guess). Ratzo had to know that by bailing just before Easter, he forced the Conclave to make a swift appointment. Since Bergy is, rumoured, the second choice to Ratzo in the first place, well, there you are.

There is, however, a deeper evil afoot here. Rome is counting on the Third World countries to restore it to power. First World, aka The West, countries are populated by folks who've (by and large, Appalachia excepted) figured out that upward mobility from subsistence existence is powered by restricted breeding. With industrial productivity continuing to grow, popping out mewlers like bad colds just expands the workforce and lowers wages. If, on the other hand, you're in a Third World country, then breeding out of control is what subsistence agrarian demands. All the bull from 2,000 years ago sounds sensible, since you're living about the same way as folks did back then.

So, off to the lands of stupid, poor, breeders. As they will be forever.

False Hope

What makes for a contrarian? It seems that there are two species: those that disagree for the sheer shits and grins of it, and those that disagree based on logic and/or data. I fall into the latter group. One of my current pet peeves is that drumbeat of increased education as the cure for the hollowing of the middle class. "If only we educated ourselves, more of us would be in the middle class".

Poppycock. Of course, that response is pure logic, which goes like this. In the 1950s and 1960s the education level of Americans was substantially lower than now, yet, it is believed, the middle class was larger and more prosperous (in a relative sense; everybody had pretty much the same sort of phone then, and so forth) 60 years ago. It would be nice if there were income by education data, from a unified source, from 1950 to 2010, but I haven't found it.

What I did find is an article which references some data on education from 1950 to 2010 here, but there's nothing at the link.

But I did find a a census report, which does have an interesting graph (figure 1). I think that says it all.

Creation, and preservation, of a dominating middle class (in opposition to the 1% domination) is a product of policy, not data. In the aftermath of WWII, with a residual collectivist ethos (anti-Communism and McCarthyism notwithstanding) supporting unionism and domestic economics, (re-)distributional decisions made the blue collar middle class possible. Educating all of us to an undergraduate degree can't do anything but devalue the B.A., due to over-supply. One might well argue that is exactly what is happening. A robust middle class can only be attained through express policy decisions.

Good News, Bad News

It's the nature of (semi-)democratic politics for those parties out of power to complain that Good News isn't really (for some conspiracy that *they* would never engage in) so Good, and that Bad News (ditto) is really worse. And so it is today. The monthly jobs report was released earlier today. If not already, certainly by the end of the day, the Republicans/Libertarians/Free Market Capitalists will be crying foul.

Let's have a look at some numbers.

The headline grabber is that the "official" unemployment rate for February was 7.7%, which was last the case just before Obama was inaugurated: December, 2008. Non-farm payrolls were up more than predicted, 165-170K predicted with 236K reported. So, all is good, yes? Well, may be not.

As stated a few times here: these numbers come from sample surveys, not censuses, and the "official" unemployment rate has been, and continues to be, criticized as too positive. The "official" number is called U-3, and it is down .6 point YoY. U-6, the most encompassing measure is down from 15.0 to 14.3, .7 point, but a much lower percentage improvement. The ratio of employed to population (an arguably more accurate measure) is the same at 58.6%. So, how did the rate go down? The measured labor force decreased by about 2,000,000. Ain't algebra fun?

You can peruse Table B-1 for clues to where the jobs are growing (hint: it ain't those who live in 90210 land). The right wingers should be happy. Hated Gummint employment is down, again.

Is the situation any better? The global numbers say no. Wall Street has been hogging the trough of QE money, with little effect on Main Street. Those with a Left Wing agenda, and those who've seen the movie before, said from the outset that Obama's stint in the White House wouldn't help much if the only lever used was monetary policy. Monetarism, when it isn't used to actively punish Main Street, ends up punishing Main Street anyway, since it is a matter of pushing a string. That can't work. As the Prosperity Through Austerity folks in Europe are demonstrating, efforts to force the victims of the Great Recession to suffer even larger losses only leads to greater concentration of wealth, and thus power.

The numbers tell the story. And the story is that those out of power have managed, in part because those in power are feckless, to increase the pressure on the necks of the 99%. Makes one wonder whether quants have devolved to being mouthpieces, just as economists did some decades ago.

Kung Fu Panda

To recap: Friday was the release of a report from China's State Council (not yet known to me) that recommended a 20% capital gains tax on home sales; Sunday "60 Minutes" runs a piece which both details a woman real estate billionaire (only commercial buildings), and miles upon miles of developments and whole cities of empty high rise residential building; finally, today a report in the NY Times referencing the report. After the "60 Minutes" piece, I considered typing up something, once again emphasizing the wastefulness (from a macro-investment point of view) of "investing" in residential building. But, that seemed too much like beating a dead horse.

Until today. Investment, particularly according to the Supply Side Phanatics, is the key to growth. They're both deluded and lying, of course. Laffer makes occasional forays out from his burrow, but the notion that capitalists will buy new plant and machinery just for the hell of it, and flood the market with larger amounts of cheaper goods, absent unmet demand, is just a lie. Real investment happens only when real returns are expected. The problem we face is a slackening of endogenous demand. Both the Germans and the Chinese, or any export dependent economy, are mostly in the business of exporting poverty. It's not that exporters are necessarily smarter producers, but that they're able to enforce poverty in their labour force.

In order for exporters to make money on their capital, they need for their currencies to devalue labour. It works like this, if Adam Smith had it right (he didn't): the purpose of exchange rates is to level the playing field. What really happens is countries with sufficient juice game rates. Since capital has always been without-borders, and is completely so now, there's no way for sovereigns acting alone, to punish rapacious capital. In fact, given the love capital has for Fascism, capital migrates to sovereigns that are most repressive. After all, profit can only come out of wages if capital is fully fungible. That last bit means: high return uses of capital can't hide, thus fiduciary capital will always migrate to sectors of high return. As the migration progresses, returns (due to increased supply of capital) drop. The only way to maintain the initial level of profit is to squeeze out wages. Thus, exporters are just exporting poverty to other nations. In due time, no one can afford to pay the price needed to generate outsized real returns to capital. But given the asymmetric nature of the war twixt labour and capital, "due time" can be quite long, and generally happens with real warfare.

Thus, the reason, not too often admitted, is that the average daily wage in China is on the order of $2/day. Now, in the cities which support the export sectors, it's a bit higher. But living conditions aren't a whole lot better; thus the suicides at Foxconn.

The odd part of the story, for those who haven't been singing along, is that the housing bubble in China exists for much the same (although more extreme) reason as it has here: wages are poor, nominal returns to savings are poor, and access to other fiduciary assets is largely non-existent (more extreme than the US).

With loans readily available again, there are signs now that rising real estate prices might be back. The National Statistics Bureau reported that prices jumped in 54 of the 70 cities tracked by the government in January. In Shanghai, for example, average property prices were up as much as 40 percent in the first two months of the year, compared to the same time last year.

According to the "60 Minutes" piece, these empty developments and cities are "owned" by individuals. Unoccupied, but owned; in what sense I'm not sure. The piece indicated that people were buying up multiple units, anticipating flipping at some point. What wasn't described is the fiduciary element: are the buyers plunking down cash on the barrel head, or mortgaging as in the US? A collapse has more immediate effects in the former than in the latter case. Long term, six of one ...

In another worrying trend for the Chinese government, the flood of credit in the last few months has failed to cause a sharp uptick in sectors other than real estate; instead, the Chinese economy seems to be settling into a slower long-term growth rate even when receiving strong monetary stimulus.

While our Right Wingnuts bray that The Gummint is stealing capital from business (it isn't), it's been the siphoning of capital to un-productive building. Only in China, it's much, much worse.

Among the major challenges Beijing's new leaders face is how to cope with a widening income gap and how to address inflation and the high cost of housing for ordinary Chinese.
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A popular comparison among recent college graduates is that their typical paycheck of $500 a month means that in an entire year, they could save only enough to buy two square meters, or 21.5 square feet, of an apartment in a large coastal city, and then only if they spent nothing on food or anything else. Buying an 800-square-foot apartment could take the paychecks of an entire career, by that calculation.

When I was living in DC, at an age when most of my colleagues were marrying, breeding, and moving into mortgaged McMansions in Northern Virgina, the daily refrain from them was, "We're house poor".

Housing capital gains gaming is a pure Ponzi scheme. It only works when mortgage holders, en masse, have rising real incomes. Rising (aggregate) house prices are merely an aftereffect of a rising tide lifting all boats. As we've seen here in the US, and the Chinese for similar and more corrupt reasons, absent real median income rising, the only way to generate outsized capital gain on housing is corruption in the system. That's all folks.

Seeing the Trees for the Forest

A three-peat of grist for both the quant and macro-policy mills, all in today's NY Times (that's a surprise). Both versions of this endeavor have mentioned the importance of the Bretton Woods agreement to both the growth of the US economy, and thence its collapse post-OPEC oil embargoes. That's covered in a book review relating how Bretton Woods got done.

America was unscathed at home and far stronger in 1945 than in 1941. Owner of the bulk of the world's gold bullion, a stunning 20,000 metric tons, the United States wanted to emerge from World War II with fixed conversion rates assured by a dollar tied to gold. And it went without saying that it was bent on becoming the globe's financial capital.

In other words: the USofA ran international finance. One effect was to create a blue collar middle class, never seen before in human history, which supported not only production domestically, but provided a market for the rebuilding economies of both the Allies and the Axis Powers. We gave with one hand (Marshall Plan), and taketh away with the other (Bretton Woods).

Although America's global dominance has long since melted away, no substitute is yet strong enough to shove the dollar aside, in part because of Bretton Woods.

Next, The Great Divide, a continuing series muses on the notion of consumption versus capital. I don't agree with much of the argument, but it's impossible to ignore this:

A consumption bias, economists argue, is not a bad thing, as it leads to cheaper goods for Americans. And after all, someone has to do the consuming -- otherwise, whom would the Germans and Chinese export to?

Of course, no one.

Which leads to Friedman's take on a climate change report. I've been unable to track down reporting I read ages ago, which asserted that the dissolution of the USSR wasn't Gorbachev's policy, but rather a rebellion driven by extended crop failures. This always made more sense. Now, we have reporting that crop failures motivated revolts in Arabia.

The numbers tell the story: "Bread provides one-third of the caloric intake in Egypt, a country where 38 percent of income is spent on food," notes Sternberg. "The doubling of global wheat prices -- from $157/metric ton in June 2010 to $326/metric ton in February 2011 -- thus significantly impacted the country's food supply and availability." Global food prices peaked at an all-time high in March 2011, shortly after President Hosni Mubarak was toppled in Egypt.

Consider this: The world's top nine wheat-importers are in the Middle East: "Seven had political protests resulting in civilian deaths in 2011," said Sternberg. "Households in the countries that experience political unrest spend, on average, more than 35 percent of their income on food supplies," compared with less than 10 percent in developed countries.

Everything is linked: Chinese drought and Russian bushfires produced wheat shortages leading to higher bread prices fueling protests in Tahrir Square. Sternberg calls it the globalization of "hazard."

For the macro-policy folks: it's the distribution. For the quants: policy trumps data every time; more specifically policy responses to bad things happening in the world. Whether climate change is a perpetual Black Swan herd (yes, I just looked it up) or not, quants need look out the window to know what's going on.

Or not. Phil Factor relates:

I remember when a 'rocket scientist' friend of mine in the City of London worked out, a while ago, that the price of sugar futures contracts correlated directly with the weather in Chicago.
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Why? Chicago was the center of the bulk of sugar futures trading, at the time. The traders merely looked out of the windows and reacted instinctively.

There be dragons.