Tuesday, April 29, 2008

Bagehot's lesson for the Fed

McKinnon of Stanford makes a good case for the Fed to raise interest rate.

Why the oil price is so high?

It's the falling dollar, stupid!

Monday, April 28, 2008

The smartest guys in the room: Where's the economy going?


Sunday, April 27, 2008

A solution to counterparty risk

Wall street is working on a new mechanism to reduce the couterparty risk (illustrated by graph below), reported by WSJ.

Saturday, April 26, 2008

Peter Bernstein is worried

Peter Bernstein WSJ interview.  He thinks the current crisis will last longer than most people thought.

WSJ: How long do you think this whole process will take, before we get back to normal?

Mr. Bernstein: Longer than people think. The people who think we will have turned in 2009 are wrong. There has to be a respite along the way. Nothing goes in one direction forever. But it will take longer than people think. If that weren't the case, I would be talking entirely differently. I would be saying, "What an opportunity we have got." And I just can't believe that the opportunity is here yet. There is too much to unwind.

Market volatility and uptick rule

WSJ reports that market volatility increased when the "uptick" rule was removed last summer. I guess this has more to do with the credit crisis since last August than with the removal of the rule. It just happened to be case that the timing of the removal coincided with the credit crisis. Nonetheless, the debate itself is quite interesting.


Thursday, April 24, 2008

Oil: the mother of all bubbles?

Reported by WSJ:

Benchmark crude futures have registered an electric performance so far this year and now -- near $117 a barrel -- hover well above some of the highest near-term forecasts. The speed of the ascent has caught many market participants off guard and forced banks and brokerages to repeatedly revise their oil-price outlook upward.


"I personally think this is the mother of all bubbles," said Michael Lynch, president of Strategic Energy & Economic Research Inc., a consulting firm in Amherst, Mass. He expects prices to pull back to $80 a barrel by late June, and in the long run step down to $50 as pent-up supply in Iraq, Nigeria, Venezuela and other underproducing exporters starts to flow.

[Crude-Oil Futures]

The case for lower oil prices is straightforward: The prospect of a deep U.S. recession or even a marked period of slower economic growth in the world's top energy consumer making a dent in energy consumption. Year to date, oil demand in the U.S. is down 1.9% compared with the same period in 2007, and high prices and a weak economy should knock down U.S. oil consumption by 90,000 barrels a day this year, according to the federal Energy Information Administration.

Mr. Lynch at Strategic Energy argues the dynamics of supply and demand justify a price of $30-$40 a barrel, while jitters in unstable exporting regions might reasonably double that price.

"But $114? I mean, the run-up in price we're seeing in the last six weeks or so has happened while the fundamentals have, generally speaking, gotten bearish," he said.

Another era of global inflation?

Modest inflation in the US and EU may eventually come down, but not in emerging markets, where central bankers are much less experienced in fighting inflation and their capacity is limited...adding to the trouble is the fact that the share of food in total consumption in developing countries' is much higher than developed economies. For example, Chinese spend about 1/3 of their income on food.  
with sharp rising food prices worldwide, be ready for another era of global inflation, and potentially more currency upheavals. 
(courtesy of wsj)

Fortune Interview of Warren Buffett

What Warren thinks...

The scenario you're describing suggests we're a long way from turning a corner.

I think so. I mean, it seems everybody says it'll be short and shallow, but it looks like it's just the opposite. You know, deleveraging by its nature takes a lot of time, a lot of pain. And the consequences kind of roll through in different ways. Now, I don't invest a dime based on macro forecasts, so I don't think people should sell stocks because of that. I also don't think they should buy stocks because of that.

Wednesday, April 23, 2008

Measuring National Happiness

Research find people are happier when:
meeting friends, eating out, exercising, giving money away, more conservative...
For men, the trough of happiness is age 44.

Libor or NYbor?

reported by WSJ.

Proposed New Version Of Rate Might Help Cut Americans' Costs

The troubles of banks in Europe are pushing up an interest rate widely used in the U.S., prompting the idea of a U.S.-based alternative to that rate, known as the London interbank offered rate, or Libor.


The problem: Payments on trillions of dollars in U.S. corporate and mortgage loans are set according to dollar Libor, but only three of the 16 banks that contribute their borrowing costs to calculate the rate are based in the U.S. That means the financial difficulties of European banks are having an outsized effect on U.S. borrowing costs, and could complicate the Federal Reserve's efforts to bring those borrowing costs down.

European banks' "demand for dollar funding is likely to raise dollar Libor and result in higher borrowing costs for everyone from [General Electric Co.] to the average homeowner, even as the Fed is lowering the fed-funds rate further," says Scott Peng, an interest-rate strategist at Citigroup Inc. In a recent report, Mr. Peng proposed the creation of a "NYbor" index, which would track the borrowing costs of U.S. banks only.

A significant gap between borrowing rates reported by European and U.S. banks has opened up since last week, when many banks started raising their reported Libor rates. The banks' moves came as the British Bankers' Association, which oversees Libor, said it was investigating bankers' concerns that their rivals were understating their actual borrowing costs to avoid looking desperate for cash.

John Ewan, who manages the Libor program at the BBA, said Tuesday the association's Foreign Exchange and Money Market committee is reviewing the way Libor is calculated.

On Friday, the gap between three-month dollar Libor and the average three-month borrowing rates for U.S. banks in the 16-bank Libor dollar panel reached 0.04 percentage point, its highest level since the financial crisis began in August. If sustained, that would represent an added $2.8 billion in annual interest costs on some $6.9 trillion in U.S. corporate and subprime-mortgage debt tied to Libor. It has since fallen, but analysts said it ultimately could increase to 0.10 percentage point as European banks' difficulties become fully reflected in their Libor quotes.

Analysts attribute the sharper rise in European banks' borrowing rates to the fact that they're scrambling for dollars to pay off dollar-denominated debts. Pressure is particularly acute in Europe in part because it lacks analogs to such U.S. institutions as Fannie Mae, Freddie Mac and the Federal Home Loan Banks, which provide U.S. banks with access to additional funding.

Tuesday, April 22, 2008

Wasserstein: What We've Learned From the Market Mess

Bruce Wasserstein of Lazard discusses what caused today's chaos in financial market and how to fix it.

inflation indexed capital gain tax

When inflation is rising, the effective capital gain tax also rises, which hurts investment and economy. Here is a piece from WSJ advocating inflation indexed capital gain tax.

[The Inflation Threat to Capital Formation]

click to enlarge

Sunday, April 20, 2008

An update on debate over trade and wage inequality

Economist analyzes Paul Krugman's recent paper on trade and wage inequality:

Krugamn, "It's no longer safe to assert that trade's impact on the income distribution in wealthy countries is fairly minor...There's a good case that it is big and getting bigger." ....two reasons why. First, more of America's trade is with poor countries, such as China. Second, the growing fragmentation of production means more tasks have become tradable, increasing the universe of labour-intensive jobs in which Chinese workers compete with Americans.


It is possible that globalisation is becoming a bigger cause of American wage inequality. But contrary to the tone of the political debate, and the thrust of Mr Krugman's commentary, the evidence is inconclusive. "How can we quantify the actual effect of rising trade on wages?" Mr Krugman asked at the end of his paper. "The answer, given the current state of the data, is that we can't."

Saturday, April 19, 2008

Bubble Burst in China

China's stock market index was down 4% on Friday.  The Shanghai composite now is close to 3000 milestone.  The index has fallen almost 50% since its peak 6 months ago. The decline has wiped out nearly $2.5 trillion of wealth.
[Stock Plunge]

Battle of ideas is not over

In a time of crisis, people have urge to turn to government for help, and for more regulations.  The battle of ideas is way from over.  NY Times reports, "A Fresh Look at the Apostle of Free Markets".
(courtesy of NYT)

Friday, April 18, 2008

Feldstein: Enough Interest Rate cuts

Martin Feldstein wrote on WSJ that the Fed should end cutting interest rate soon.

Enough With the Interest Rate Cuts


It's time for the Federal Reserve to stop reducing the federal funds rate, because the likely benefit is small compared to the potential damage.

Lower interest rates could raise the already high prices of energy and food, which are already triggering riots in developing countries. In order to offset the inflationary impact of higher imported commodity prices, central banks in those countries may raise interest rates. Such contractionary policies would reduce real incomes and exacerbate political instability.

The impact of low interest rates on commodity-price inflation is different from the traditional inflationary effect of easy money. The usual concern is that lowering interest rates stimulates economic activity to a point at which labor and product markets cause wages and prices to rise. That is unlikely to happen in the U.S. in the coming year. The general weakness of the economy will keep most wages and prices from rising more rapidly.

But high unemployment and low capacity utilization would not prevent lower interest rates from driving up commodity prices. Many factors have contributed to the recent rise in the prices of oil and food, especially the increased demand from China, India and other rapidly growing countries. Lower interest rates also add to the upward pressure on these commodity prices – by making it less costly for commodity investors and commodity speculators to hold larger inventories of oil and food grains.

Lower interest rates induce investors to add commodities to their portfolios. When rates are low, portfolio investors will bid up the prices of oil and other commodities to levels at which the expected future returns are in line with the lower rates.

An interest rate-induced rise in the price of oil also contributes indirectly to higher prices of food grains. It does so by making it profitable for farmers to devote more farm land to growing corn for ethanol. The resulting reduction in acreage devoted to producing food crops causes the supply of those commodities to decline and their prices to rise.

Rising food and energy prices can contribute significantly to the inflation rate and the cost of living in the U.S. The 25% weight of food and energy in the U.S. consumer price index means that a 10% rise in the prices of food and energy adds 2.5% to the overall price level. Commodity price inflation is of particular concern now that the CPI has increased 4% in the past 12 months. Surveys indicate that households are expecting a 4.8% rise in the coming year.

In lower-income, emerging-market countries, food and energy are generally a larger part of consumer spending. A rise in these commodity prices can therefore add proportionally more to the cost of living in those countries, and therefore depress real incomes to a greater extent than in the U.S.

Government actions to dilute these effects by increased subsidies on the prices of energy and food add to the government deficits, reducing the national saving available for investment in plant and equipment that would otherwise contribute to faster economic growth.

The rise in the U.S. inflation rate, and the adverse effects in emerging market countries, might be defensible if lower interest rates could significantly stimulate demand and reduce the risk of a deep recession. But under current conditions, reducing the federal funds interest rate from the current 2.25% by 50 or 75 basis points is not likely to do much to stimulate demand.

The current conditions in the housing industry and in credit markets mean that a further lowering of interest rates will have a smaller impact on demand than in previous recessions. In previous recessions, lower rates stimulated aggregate demand by inducing increased home building. But with the massive inventory of unsold homes – up 50% from a few years ago – a further cut in the fed funds rate would have little effect on housing construction.

Moreover, lowering the fed funds rate has not brought down mortgage interest rates. While the fed funds rate is down three percentage points from this time last year, mortgage interest rates are down by less than 0.5 percentage points.

The dysfunctional state of the credit market means that many individuals and businesses are unable to get credit. Lowering interest rates will not stimulate demand for those who cannot get credit.

Economic recovery will require resolving the difficult problems of the credit markets, dealing with the millions of homeowners who may now be tempted to default on mortgages that exceed the value of their homes, and reducing the risk that the ongoing decline in house prices will push millions of additional homeowners into a vulnerable, negative equity condition. A lower fed funds rate will not solve any of those problems.

Mr. Feldstein, chairman of the Council of Economic Advisers under President Reagan, is a professor at Harvard and a member of The Wall Street Journal's board of contributors.

Saturday, April 12, 2008

Greenspan Fights Back

To defend his reputation and legacy, Greenspan fights back.
Here is a CNBC exclusive interview with Alan Greenspan.

interview video part I, part II
Was the Fed keeping interest rate too low for too long?
Greenspan: "The Fed Reserve lost control of long term interest rate probably around 2002 or 2003...and the global force began to dominate the market..."

Monday, April 07, 2008

China's SWF Pledges More Transparency

Gao Xiqing, President of China's Investment Co. (CIC) in an interview yesterday on CBS' 60 minutes, pledged more transparency. You can view this interview by clicking the image below: