Saturday, May 31, 2008

What is the way out for the US airlines

BusinessWeek article "You Think Flying Is Bad Now..."  reports: 

To fully appreciate the impact that soaring oil prices have had on the nation's beleaguered airline industry, consider that U.S. carriers will likely spend $60 billion on jet fuel this year—nearly four times what they paid in 2000. Because of the spike in fuel costs, airlines now lose roughly $60 on every round-trip passenger, a slow bleed that puts the industry on pace to lose $7.2 billion this year, the largest yearly loss ever.

Not surprisingly, Wall Street has become so dour about the industry's prospects—can you say federal bailout?—that the combined market capitalization for the six major legacy carriers and Southwest Airlines has fallen to just over $17 billion. That's about what ExxonMobil (XOM) books in revenues every two weeks. "The U.S. airline industry, as it is constituted today, was not built for $125-per-barrel oil," Gerard Arpey, the chief executive of American Airlines parent AMR (AMR), told shareholders on May 21.

Vietnam's inflation crisis

Vietnam is in an inflation crisis (source: wsj). The government said this week the inflation rate in May was 25.2% on an annual basis, up from 21.4% in April and 14.1% in January. What happened in Vietnam today reminds me of the two great inflation in China: one in 1988, which partly led to the Tian'anmen Square incident of 1989, and the other one during mid 1990s, which ended up with deflation near the millennium. 
With soaring food and energy prices, I am not so much worried about inflation in G7 countries.  But I am truly worried about inflation in those emerging economies, where governments/central banks have little experience fighting inflation and the evil of inflation is often played down as a byproduct of high growth or the so called structural inflation.  Well, every country should learn the lesson by themselves. I hope China's policy makers are better prepared this time.

Friday, May 30, 2008

New wave of African aid (aka grabbing natural resources)

Afraid of being left behind, Japan, a resources-scare country, is following China and India, is set to offer more aid to African countries, this time with no strings attached. The strings, advocated by Europeans and Americans, require good governance and human rights.
This is a troublesome development. 
This new wave of African aid, with sole purpose of competing and grabbing for more natural resources may leave African people with more income to spend. But aid without improving governance and institutions in general could end up hurting these poorest countries in the world in the very long run.

Thursday, May 29, 2008

A look at Q1 GDP revision

The 1st revision is out: GDP in Q1 was revised up from 0.6% to 0.9%.  Jeff Frankel, member of NBER business cycle committee, talks about how he views the new revised number.
It is hard to say that we entered a recession in the first quarter, without a single negative growth quarter, let alone two of them.   Even so, three minor qualifications to that 0.9% remain: 
1)      The number will be revised again, and could move in either direction.
2)      A bit of the measured growth consisted of an increased rate of inventory investment, which was almost certainly not desired by firms and is likely to reverse in the 2nd quarter
3)      As Martin
Feldstein has pointed out, the QI growth number is defined as the change for the quarter as a whole relative to QIV of 2007;  within QI, the information currently available suggests that GDP fell from January to February to March.

The economy is a four-engine airplane flying at stall speed, skimming along the top of the waves without yet going down.   Real gross domestic purchases increased only 0.1 percent in the first quarter.   But exports provided an important source of demand for US products, and are likely to remain a positive engine of growth in the future.   The same is true of the fiscal policy engine, as consumers receive and spend their tax cuts in the 2nd and 3rd quarters.   On the other wing, the investment engine has been knocked out;  inventory investment is likely to fall and residential construction will remain negative for sometime.   The big question mark is the consumption engine.   Is the long-spending American household taking a hard look at its diminished net worth and taking steps to raise its saving rate above the very low levels of recent years?

We are already clearly in a "growth recession...

Behind Bear Stearns' fallout

A fascinating story behind the fallout of Bear Stearns, featured on WSJ.

Part One
Part Two
Part Three

Wednesday, May 28, 2008

Ditch dollar peg?

Much unlike currency attacks in 90s, this time investors are betting currencies in dollar-pegging countries will appreciate and possibly break away from the peg. Policy makers in these countries feel compelled to do so as expansionary monetary policy in the US adds too much pressure on domestic inflation.

(source: wsj)

Lehman economist says oil in 'asset bubble'

Edward Morse, chief energy economist at Lehman Brothers says high oil prices constitute an ``asset bubble,'' and discusses U.S and Chinese strategic petroleum reserves. This is audio clip. (source: Bloomberg) 

Sunday, May 25, 2008

Hamilton: understanding crude oil prices

Jim Hamilton, the renowned econometrician and an expert on oil price prediction came out with this research paper. I recommend all who are interested in the issue should read the whole paper.

He listed three theories for current high oil prices:

1. storage arbitrage (the investory story)
2. index future speculators (the speculation story)
3. the recent feature of scarcity (the limited supply story)

Here are some really nice charts from his research (click to enlarge, hat tip to Jim Hamilton):

The US is less reliant on oil.

How much will be the impact?

Not very promising on the supply side:

Commodity index speculators

The graph says it all.

(click to enlarge. source: Michael Masters' congress testimony)

Saturday, May 24, 2008

Inflation mugger is back

Inflation is back. Developing countries without tightly anchored inflation expectations will suffer most from the inflation serial killer. Developed countries with better monetary policy shouldn't feel too complacent, either.  While wage is not likely to rise in America where labor unions have much less negotiation power than 70s, Europe could face a tough fight. 
Ultimately, to fight inflation, central banks in developing countries will have to raise their interest rate significantly.  And this raises the question of how to control the flow of hot money: the diverging interest rate policies in the US and developing world, thus the increasing interest differentials, will likely dramatically increase hot money flows out of the United States.
Read more on the issues at
RONALD REAGAN once described inflation as being "as violent as a mugger, as frightening as an armed robber and as deadly as a hit-man".
In countries such as China, India, Indonesia and Saudi Arabia even the often dodgy official statistics show prices have risen by 8-10% over the past year; in Russia the rate is over 14%; in Argentina the true figure is 23% and in Venezuela it is 29%. If you measure the numbers correctly, two-thirds of the world's population will probably suffer double-digit rates of inflation this summer.

Friday, May 23, 2008

Pension funds and commodity speculation

"[Commodities] are experiencing demand shock from a new category of speculators: institutional investors like corporate and government pension funds, university endowments, and sovereign wealth funds," said Michael Masters, managing member of Masters Capital Management, a Virgin Islands-based hedge fund. "Index speculators are the primary cause of the recent price spikes in commodities."

...Masters distinguished between traditional speculators and what he calls index speculators, or passive investors who enter the commodities markets as a long-term hedge against inflation. Commodities exchanges limit the number of positions an investor can take in the market, but Masters says the Commodity Futures Trading Commission has allowed unlimited speculation in these markets through a loophole.

Speculative activity in commodity markets has grown dramatically over the last several years. In the past decade, the share of long interests—positions that benefit when prices rise—held by financial speculators has grown from one-quarter to two-thirds of the commodity market. In only five years, from 2003 to 2008, investment in index funds tied to commodities has grown twentyfold, from $13 billion to $260 billion.

Foreign intervention and democracy

Do superpower interventions to install and prop up political leaders in other countries subsequently result in more or less democracy, and does this effect vary depending on whether the intervening superpower is democratic or authoritarian? While democracy may be expected to decline contemporaneously with superpower interference, the effect on democracy after a few years is far from obvious. The absence of reliable information on covert interventions has hitherto served as an obstacle to seriously addressing these questions.

The recent declassification of Cold War CIA and KGB documents now makes it possible to systematically address these questions in the Cold War context. We thus develop a new panel dataset of superpower interventions during the Cold War. We find that superpower interventions are followed by significant declines in democracy, and that the substantive effects are large. Perhaps surprisingly, once endogeneity is addressed, US and Soviet interventions have equally detrimental effects on the subsequent level of democracy; both decrease democracy by about 33%. Our findings thus suggest that one should not expect significant differences in the adverse institutional consequences of superpower interventions based on whether the intervening superpower is a democracy or a dictatorship.



Thursday, May 22, 2008

Unemployment and Recession: initial claims vs. continuing claims

Today's initial unemployment claim came out with a benign number: 365k, well below the historical average required for recession: 375k-400k. So what's going on? Are we not in recession?

Barry Ritholtz thinks we may need to shift our focus to the continuing claims and he presented a convincing graph to show that we are already in recession.

"Observe the CUIC (continuing unemployment insurance claims), YoY, 4 Week MA:
Every time this has moved above 10%, we have been in a recession. If you want a margin of safety, use 15%. The current reading: 19.5% -- is deep into recessionary levels -- despite INITIAL CLAIMS being below 400k".

(click to enlarge)

Theory linking Hepatitis to China's 'missing women' invalidated

This woman (Emily Oster) stirred the academia with her intriguing finding that attributes China's skewed male-female birth ratio to the high Hepatitis-B rate in China. Now the theory is being invalidated, by herself.

Fed's gloomier outlook

From yesterday's Fed minutes: slower growth and higher inflation
[Weaker Outlook]

How much is RMB undervalued? A reconsideration

RMB (Chinese Yuan) was estimated by various studies undervalued by over 40%.  But the estimation was based on an obsolete World Bank PPP conversion number in 1980s. Several months ago, World Bank finally got their hands on the issue and revised the PPP number for China.  Now new estimates show RMB is only undervalued by 10%.  Read this analysis here.
What does this imply?
Chinese government finally got their revenge: I told you so, Paulson, we were not manipulating our currency!  The implication for the currency market is this: anyone who expects Yuan's appreciation will go on forever had better change their bet.

China: currency appreciation and inflation

Stephen Jen has a very interesting piece on currency appreciation and inflation. Normally, people would think appreciating currency would bring down import prices thus help to bring down inflation. In China's case, rising Chinese Yuan (CNY) also discourages export, thus keeps fast rising current account surplus at bay, reducing the need for sterilization by central bank and slow down money supply growth in the domestic market. Both tend to ease inflation pressure eventually.

In his piece, Jen hypothesizes another possibility that rising expectations of future currency appreciation attracts large capital inflows (I think he meant hot money) thus dampens central bank's hope that currency appreciation would reduce inflation pressure through the balance-of-payments channel.

One of the key structural forces of inflation in China, as is widely agreed, is the persistent and large rise in its official reserves, roughly half of which have, in recent years, been sterilised. What makes China's case rather remarkable is that China not only runs a large C/A surplus (which averaged 7.4% of GDP during 2005-07), but it has also received very large capital inflows. Official reserves grew sharply from 2002 (US$286 billion) to 2005 (US$819 billion), but really accelerated in 2007 (reserves increased by US$461 billion). What is perhaps even more remarkable is that, while China's C/A surplus has continued to expand, the growth (my emphasis) in net capital inflows in 2007 accounted for 59% of the total increase in reserves. To spell this out, China's massive C/A surplus last year of US$206 billion accounted for 'only' 41% of the increase in official reserves. We argue that much of these large capital inflows may have been motivated by the general expectation that the CNY would continue to appreciate against the dollar at a rapid pace, and that having a short USD/CNY exposure was a high-yield zero-risk investment. Thus, rather perversely, while Beijing's ultimate objective of bringing the value of the CNY more in line with the economic fundamentals should eventually lead to a more sustainable BoP position, the process of getting there is inflationary. In sum, while many have argued that the stronger CNY has helped China to contain inflation, we believe that precisely the opposite is the case.

Theoretically, the only way around this dilemma confronted by China is to have a maxi-revaluation in the CNY against the dollar of a size so large that few investors would believe that the CNY can appreciate further. This is the only effective way to halt the speculative capital inflows into China. The practical obstacle, however, is that it is not clear how big such a move in USD/CNY would have to be. Related to this question are the concepts of the 'fair value' and the 'equilibrium value' of USD/CNY. The former is the value of USD/CNY that is consistent with the underlying economic fundamentals (e.g., productivity, terms of trade, etc.), while the latter is the value of USD/CNY that will help to close China's BoP surplus. We believe that the current spot USD/CNY is already close to the 'fair value'. However, to close China's BoP surplus, USD/CNY would probably need to decline by a massive (50%?) amount. Would Beijing feel comfortable implementing a step revaluation in CNY from 7.00 to 3.50 in one go? We doubt it.

Jen's analysis captures largely what is happening in China. I reckon that this could be a plausible explanation of why Chinese government's inflation-control measures so far have been largely fruitless.

However, there are several issues with his analysis I'd like to point out:

First, he did not differentiate FDI with hot money in the net capital inflows. I suspect a large chunk of the capital inflows would be long-term foreign investment. But arguably, a lot of hot money can also enter under FDI camouflage.

Second, Jen thinks the only solution to the inflation problem is a large one-time currency reevaluation. But there are many other policy possibilities.

1. Tighten up capital control on hot money inflow. This is arguably not the best solution but can be improved at margin.

2. PBoC (China's central bank) allows an even bigger chunk of $ revenue from export be retained at enterprise level. This reduces the pressure of converting $ to CNY immediately thus will not increase domestic money supply.

3. Relax the regulation on domestic US $ conversion and allow one-way free currency exchange without cap (or with a very generous cap). This is to say, Chinese enterprises and individuals are encouraged to freely exchange US $ with CNY, but US $ is not allowed to be converted to CNY within certain time-frame. Be reminded free conversion does not equal lift of capital control but can be the first step towards it.

4. Finally, if Chinese government is really serious about inflation control, they should raise interest rate to an even higher level. Tweaking with bank reserve requirement is not good enough. Currently the real interest rate in China is negative (with inflation adjusted), and the monetary policy is still expansionary. Administrative control or command orders have been ineffective. Only by increasing cost of capital and disincentivize investment can inflation be controlled.

Berner: muddle-through or darker clouds ahead?

The recent market rally since mid March spurred a lot of discussion on market outlook. Here is another one.  Richard Berner, Chief Economist of Morgan Stanley, discusses market risk and in his view the downside risks outweigh those positives.

Hauser's Law in taxation

Look at below graph first (h/t to wsj article, "You Can't Soak the Rich"):

I am amazed by the fact that no matter what tax rates are, tax revenue always remains at around 19.5% of GDP (post WWII). Laffer curve would help to explain this mysterious finding: when government increases tax rate, it's supposed to discourage incentives to work and invest, so GDP shrinks; when government lowers tax rate, the opposite is true and GDP increases. So on average, tax revenue as % of GDP may be quite stable, but I did not expect it's a fixed number. The 19.5% number is amazing to me.

read the full article here

Wednesday, May 21, 2008

Buiter worries about central banks losing credibility on inflation


Central bankers talk about inflation more than a teenage boy thinks about sex. Perhaps they talk about it too much. In contrast to teenage boys, for whom less action would probably be a good thing, central banks would be well advised to talk less and act more. In the US, the Euro Area and the UK, the track record of inflation during the past few years has deteriorated to the point that a material loss of credibility may well be imminent for all three central banks involved - the Fed, the ECB and the Bank of England.

more here...


Bear market rally?

The US stock market had a nice rally since mid March. Dow has surged almost 11%. Yet, we are in recession and problems in the in the financial sector are far from over and the outlook for both consumer spending and employment is quite murky, if not perssimistic. WSJ asks the question, "Is the rally for real?

[Is the Rally for Real?]

Related, market volatility as measured by VIX has been dropping sharply. Are we going to see the volatility bounce back again some time soon? Just to repeat the previous 3 (or 4) rounds? (see the graph below).


Lagging behind in the Internet

The U.S. is lagging behind other developed countries in both Internet speed and subscriptions. WSJ analyzes why this is the case.  If you consider the Internet as public goods and is likely to bring great welfare to the society, you would have no problem with public investment in this area.
[Logged On]

Corporate bailout history

Business Week has a slideshow of corporate bailout history. But it included some cases that shouldn't be considered as bailout.  I thought bailout should involve public or taxpayers' money.  It is quite confusing to say the least.  

The logic of collective action

In 1965, Mancur Olson wrote a classic book called "The Logic of Collective Action," which pointed out that large, amorphous groups are often less powerful politically than small, organized ones. He followed it up with "The Rise and Decline of Nations." In that book, Olson observed that as the number of small, organized factions in a society grows, the political culture becomes more divisive, the economy becomes more rigid and the nation loses vitality.
If you look around America today, you see the Olson logic playing out. Interest groups turn every judicial fight into an ideological war. They lobby for more spending on the elderly, even though the country is trillions of dollars short of being able to live up to its promises. They've turned environmental concern into subsidies for corn growers and energy concerns into subsidies for oil companies.
The $307 billion farm bill that rolled through Congress is a perfect example of the pattern. Farm net income is up 56 percent over the past two years, yet the farm bill plows subsidies into agribusinesses, thoroughbred breeders and the rest.

Tuesday, May 20, 2008

Taiwan New President Inaugural Speech

Ma Yingjiu inaugural speech yesterday:

I think his speech is generally positive for the across-strait relationship. But his speech dashed the hope for any immediate political solution. He advocates "no independence, no unification, no military armament".

Taiwan index was down 2.5% afterwards:

(clicke to enlarge)

Taiwan ETF is down over 3% today, but the trend is still up:

(clicke to enlarge)

EEM: MSCI emerging market index
EWT: Taiwan ETF

Fear no more

Bloomberg reports TED spread, which measures the difference in yields on three-month U.S. Treasury bills and the three-month London interbank offered rate, or Libor, dropped to nine-month low. Market confidence is coming back.

(click to enlarge, H/T: Bloomberg)

Earthquake and China

NY Times reports, in earthquake, China is beginning to develop its own robust civil society.  This can't happen without rising economic prosperity and personal wealth.  Milton Friedman's essay on the relation between economic freedom and political freedom makes more sense than ever.

Monday, May 19, 2008

Charles Engle: oil rational bubble


Recession call at ivory tower pace

BusinessWeek reports "Why So Long to Call a Recession?"

Any call, if it comes, is going to take a while. The NBER usually takes 6 to 18 months to decide when a recession starts or ends. Hall's committee didn't announce the end of the 2001 recession until a full 20 months after the fact.


Robert Hall, Chairman of Business Cycle Dating Committee

Hall says he's a hands-off manager of the process of identifying recessions. "These aren't people who can be directed," says Hall of the committee members. "These are people with a lot of expertise and awareness of what's happened in the past, but it's not a group that has a lot of disagreement." Discussion takes place by e-mail and frequently revolves around a mid-month message Hall sends to committee members containing economic data, including the monthly estimate of GDP growth, as calculated by the St. Louis consulting firm Macroeconomic Advisers.  

Lin on China's food situation

Yifu Lin, now Chief Economist at World Bank, talks about China's food situation and how to provide farmers more incentives to grow crops (a lot of land are being wasted due to young labor migrated to the east coast). The article is in Chinese.
My impression from reading the interview is that China does not seem to have a serious food problem for now. Lin emphasized that government should allow food price to increase so to offer farmer incentives return to their land. I agree. But this should be done gradually to avoid inflation spike.  In the long term, food price should be set by marketplace.  
In order to achieve that, China sooner or later will face the question of how to deal with the property rights of agricultural land. Without clearly defined property rights, people cannot sell or buy their land freely, land consolidation is thus impossible, the latter of which is the precondition for scale of economy to take place.  But this is going to take a long time, and it's closely tied to the progress of China's urbanization and labor migration.
The alternative to scale of economy solution is technology.  Increasing productivity without scale of economy is certainly possible and is probably a more realistic solution considering the fact that in China a large chunk of labor (about 50%) are still working on the agricultural sector.

Sunday, May 18, 2008

Different measurement, different stories

From, "Grossly distorted picture":

However, the single best gauge of economic performance is not growth in GDP, but GDP per person, which is a rough guide to average living standards. It tells a completely different story...

GDP growth figures flatter America's relative performance, because its population is rising much faster, by 1% a year, thanks to immigration and a higher birth rate. In contrast, the number of Japanese citizens has been shrinking since 2005. Once you take account of this, Japan's GDP per head increased at an annual rate of 2.1% in the five years to 2007, slightly faster than America's 1.9% and much better than Germany's 1.4%. In other words, contrary to the popular pessimism about Japan's economy, it has actually enjoyed the biggest gain in average income among the big three rich economies. Among all the G7 economies it ranks second only to Britain (see left-hand chart).

Related to this is my earlier post where Warren Buffett echoed the same view that if recession is measured by decline of GDP per capita growth, the U.S. was already in recession.

Malthus comes alive, again

With soaring food and oil prices worldwide, Malthus' pessimistic predictions come alive again, just like 70s. I feel fortunate I am an economist, a.k.a. an optimist.

Gasoline price and mode of transportation

Need not say more:

(click to enlarge)

Should I just ride bicycle?


Saturday, May 17, 2008

Behavior modification

Cash-strapped drinkers are starting to switch to lower-priced beers. Since January, Miller Brewing Company has seen a shift from higher-priced, premium beers to less expensive brands such as Miller High Life and Milwaukee's Best. (source: NPR)

Friday, May 16, 2008

Fortune misinterpreted Maddison's China prediction

Fortune magazine has an interesting article titled "You have seven years to learn Mandarin", in which Geoff Colvin argues in 7 years (that's 2015), China will become a major competitor to the US in technology, finance; China will no longer relies on cheap exports. 
Colvin's argument is based on Angus Maddison's prediction that by 2015, China's GDP (in PPP term) will surpass the U.S.  The prediction itself is quite plausible, but technology and financial innovations are often tied to per capita income level and the quality of institutions, not solely on total GDP. China has 1.4 billion population, more than four times of the US, so when China's total GDP equals the US, the personal income level is just 1/4 of the American income, assuming no big change in population. Also, in just seven years, I can't imagine that China's institutions can be improved significantly.
Nonetheless, the analysis is interesting and generally shows the trend that China will regain its great world power in 21st century.

Forget cheap imports. China's rise will soon be a force on Wall Street and Main Street and in Silicon Valley.

(Fortune Magazine) -- Back in 2001 when the International Olympic Committee chose Beijing as the site of this summer's games, the event was meant to mark China's debut as a player on the global economic stage. But a recent study by the economist Angus Maddison projects that China will become the world's dominant economic superpower much sooner than expected - not in 2050, but in 2015.

While short-term investors are already cashing in on China's growth by playing the global commodities boom, smart long-term thinkers are contemplating what happens when China matures from an exporter of cheap goods to a competitor in sectors where the U.S. is dominant - technology, brand building, finance. China has almost wiped U.S. makers of low-value items like toys and socks, but by 2015 it may threaten Apple (AAPL, Fortune 500), J.P. Morgan Chase (JPM, Fortune 500), and Procter & Gamble (PG, Fortune 500). It will increasingly influence the S&P 500 and the mutual funds in our 401(k)s. So it's worth looking at how that will happen, what it means, and what anyone can do in the seven years before the baton is passed.

Just using the exchange rate to convert China's GDP into dollars isn't helpful in comparing the two economies, because China controls its exchange rate; by that method, China's economy might not pass America's for decades. Exchange rates apply only to tradable products and services; they aren't very useful in valuing nontradable goods in a country like China that is much poorer than the United States. So we need some way to compare the real value of China's economic output with America's, and economists have developed one. It is called purchasing power parity.

For example, Chinese construction workers earn a whole lot less than Americans do, yet they can still build top-quality buildings. If we used the exchange rate, the value of a new skyscraper in Shanghai would count much less toward China's GDP than an identical building in Chicago would count toward America's, which makes no sense. Purchasing power parity corrects the problem.

Will China take the crown?

Angus Maddison's forecast (which uses purchasing power parity) isn't built on outlandish assumptions. He assumes China's growth will slow way down year by year, and America's will average about 2.6% annually, which seems reasonable. But because China has grown so stupendously during the past decade, it should still be able to take the crown in just seven more years.

If that happens, America will close out a 125-year run as the No. 1 economy. We assumed the title in 1890 from - guess who. Britain? France? No. The world's largest economy until 1890 was China's. That's why Maddison says he expects China to "resume its natural role as the world's largest economy by 2015." That scenario makes sense.

China was the largest economy for centuries because everyone had the same type of economy - subsistence - and so the country with the most people would be economically biggest. Then the Industrial Revolution sent the West on a more prosperous path. Now the world is returning to a common economy, this time technology- and information-based, so once again population triumphs.

So how should we make the most of our seven-year grace period? For companies: Focus on getting better at your highest-value activities. Just because the Chinese will be fighting you in the same industries doesn't mean you'll lose. (Investors, remember that China bought $3 billion of Blackstone (BX) at the IPO price of $31 last summer, and the firm is now trading at $19.) It only means you'll have to work harder to win.

For individuals: You can avoid competition with Chinese workers by doing place-based work, which ranges in value from highly skilled (emergency-room surgery) to menial (pouring concrete). But the many people who do information-based work, which is most subject to competition, will have to get dramatically better to be worth what they cost. For government leaders: Improve U.S. education above all.

Those are the issues in China's becoming No. 1 that we most need to focus on. And as with so much else in China's recent history, we'll need to worry about them much sooner than we expected. 

A digest of asset bubbles


Bubbles emerge at times when investors profoundly disagree about the significance of a big economic development, such as the birth of the Internet. Because it's so much harder to bet on prices going down than up, the bullish investors dominate.


Manias can persist even though many smart people suspect a bubble, because no one of them has the firepower to successfully attack it. Only when skeptical investors act simultaneously -- a moment impossible to predict -- does the bubble pop.


Bubbles don't spring from nowhere. They're usually tied to a development with far-reaching effects: electricity and autos in the 1920s, the Internet in the 1990s, the growth of China and India. At the outset, a surge in the values of related businesses and goods is often justified. But then it detaches from reality.


One who believes a stock is too high can short it, borrowing shares and selling them in hopes of replacing them when they're cheaper. But this can be costly, both in the fees and in the risk of huge losses if the stock keeps rising. Many big investors rarely short stocks. When differences between bullish investors and bearish ones are extreme, many of the bears simply move to the sidelines. Then, with only optimists playing, prices go higher and higher.


At some point in a bubble, optimists' enthusiasm runs its course. Prices turn down. There's an expectation that at this point, investors who were skeptical may see prices as more reasonable and start buying. If they don't, that's a signal that prices had gotten way too high -- and then they tumble.


The insights of bearish investors "are more likely to be flushed out through the trading process when the market is falling, as opposed to when it's rising," Mr. Hong and Harvard's Jeremy Stein write. They say this explains why prices fall more rapidly than they go up. Over 60 years, nine of the 10 biggest one-day percentage moves in the S&P 500 were down.

Fed and bubbles

Greg Ip has a nice piece on wsj summarizing the ongoing heated debate whether the Fed should prick bubbles using monetary policy and whether monetary policy itself is the culprit for creating bubbles.

ECB: not the lender of last resort

William Buiter argues in the case of financial crisis that involves cross-border banking activities where reponsibilities cannot be clearly defined, ECB, lack of backing of fiscal authority of a single sovereign country, cannot function as the lender of last resort. Something needs to be done about it.

Should we have a strategic beer reserve?

Beer price is soaring, what to do about it?


Icahn's letter to Yahoo board

Dear Mr. Bostock:

It is clear to me that the board of directors of Yahoo has acted irrationally and lost the faith of shareholders and Microsoft. It is quite obvious that Microsoft's bid of $33 per share is a superior alternative to Yahoo's prospects on a standalone basis. I am perplexed by the board's actions. It is irresponsible to hide behind management's more than overly optimistic financial forecasts. It is unconscionable that you have not allowed your shareholders to choose to accept an offer that represented a 72% premium over Yahoo's closing price of $19.18 on the day before the initial Microsoft offer. I and many of your shareholders strongly believe that a combination between Yahoo and Microsoft would form a dynamic company and more importantly would be a force strong enough to compete with Google on the Internet.

During the past week, a number of shareholders have asked me to lead a proxy fight to attempt to remove the current board and to establish a new board which would attempt to negotiate a successful merger with Microsoft, something that in my opinion the current board has completely botched. I believe that a combination between Microsoft and Yahoo is by far the most sensible path for both companies. I have therefore taken the following actions: (1) during the last 10 days, I have purchased approximately 59 million shares and share-equivalents of Yahoo; (2) I have formed a 10-person slate which will stand for election against the current board; and (3) I have sought antitrust clearance from the Federal Trade Commission to acquire up to approximately $2.5 billion worth of Yahoo stock. The biographies of the members of our slate are attached to this letter. A more formal notification is being delivered today to Yahoo under separate cover.

While it is my understanding that you do not intend to enter into any transaction that would impede a Microsoft-Yahoo merger, I am concerned that in several recent press releases you stated that you intend to pursue certain "strategic alternatives". I therefore hope and trust that if there is any question that these "strategic alternatives" might in any way impede a future Microsoft merger you will at the very least allow shareholders to opine on them before embarking on such a transaction.

I sincerely hope you heed the wishes of your shareholders and move expeditiously to negotiate a merger with Microsoft, thereby making a proxy fight unnecessary.

Sincerely yours,


Food consumption as % income in the world

China       28%
US           7%
India         33%
Vietnam   40%

It Is The Bio-Fuel Policy Stupid!

(coutesy of John Mauldin)

There are three food staples in the world today which dwarf all other food ingredients in terms of importance. They are (in alphabetical order) corn, rice and wheat. They have all experienced rapid price appreciation since last summer. What is it that has driven this price explosion and what does it mean to financial markets? As with most things in life, there is no simple explanation; a number of factors have conspired to create a situation which is exceptional but also destabilising and hence dangerous.

The explanation given by most commentators is the bio-fuel policy currently being pursued by the Bush administration in Washington. The policy is driven by a desire to unlock the United States from its rising dependence on imported crude oil. The problem, as Bush and his government have been slow to recognise, is the stupidity of the policy in its current form. Let's back that claim up with some hard facts.

In the United States, corn (better known as maize over there) is the primary ingredient in ethanol production although wheat and soybeans are also used. According to a recent UN report, it takes 232 kg of corn to fill an average 50 litre car tank with ethanol - enough corn to feed a child for an entire year. It is estimated that almost 20% of total US corn production will go towards ethanol this year and the number is set to rise to 45% by 2015.

The problem with corn is that it is low on carbon hydrates, which is where the energy comes from. Instead, American ethanol producers rely heavily on fertilisers with the energy being extracted from the nitrogen in the fertiliser. This is an inefficient and very costly approach - in particular in an environment of rising energy prices because crude oil and/or natural gas are major ingredients in fertiliser production. 33,000 cubic feet of natural gas are required to produce just 1 ton of ammonia!

So what does all this mean? According to estimates from Goldman Sachs, the cost of ethanol from corn is now over $80 per barrel, it is about $145 from wheat and over $230 from soybeans. Other countries recognised this problem a long time ago and use crops with higher carbon hydrate content. In the Philippines they use coconut oil and the Brazilians use sugar cane. Goldman reckons that the cost of one barrel of ethanol based on sugar cane is about $35. So why not import sugar cane from Brazil instead of using corn? One simple answer: Brazilian farmers do not vote at American elections. Idaho farmers do.

Thursday, May 15, 2008

Roach China Interview

Stephen Roach, Chairman of Morgan Stanley Asia, talks about China's earthquake and its impact, China's economic outlook, decoupling theme, Arthur Burns, inflation and monetary policy, and China bashing in election year. (source: Bloomberg radio)

Larry Summers is being blasted

Arvind Subramanian et al. blasted Larry Summers on FT for his nationalistic argument against liberal economic tradition:

Is a liberal international economic order losing intellectual support? Should developing economies be worried? If Larry Summers is the canary in the intellectual mine, his two columns in the Financial Times (April 28 and May 5) suggest that the answers to both questions are yes.

The liberal economic order of the last several decades was premised on two assumptions. First, that the proliferation of prosperity across countries was a good thing. Second, there would be winners and losers but, on balance, a majority of people in both developing and developed countries would benefit. Mr Summers now appears to be questioning both assumptions. He has not stated outright that the proliferation of prosperity is undesirable but his ­columns do suggest that globalisation creates competition for America.

I feel sympathetic to their view. American policy makers in last several decades have been promoting around the world the liberal policies as demonstrated in Washiongton Censensus: free trade, free capital flow, competition, etc. But when the developing countries begin to widely adopt these policies, economists in the U.S. as prominent as Larry Summers are saying, "It's time to rethink, we don't want our workers to be hurt in the process".  Oh well, what about the workers in developing countries?  I smell hypocrisy, and Summers is seeking his Keynesian roots.

Carbon trade: next big thing

Carbon trade, especially the trades between developed and developing countries, which I think is one of the most brilliant ideas in mechanism design, will be the next big thing in financial innovation. A democrats president in November will only expedite the process.

(source: wsj)

Bernanke on the origin of financial meltdown

Bernanke summarizes the origin of current financial meltdown in a nice 2 min video.

(source: CNBC)

Oil speculation 101

CNN Money has a nice basic discussion on oil speculation. Be aware: speculation can drive up price for a considerable period of time (Brad DeLong had a nice piece on this), and speculation can become a huge source of "demand" in a time of euphoria. But eventually fundamentals (supply/demand) will dominate.  

Another farm bill

Congress passed another farm bill, at $290 billion. With agri-commodity soaring, the US famers enjoy the windfall at the expense of greater social welfare.
Read this opinion piece from wsj: "Who Wants to Be a Millionaire?"

Inflation, price control and earthquake rescue

In watching China's earthquake rescue, I was stunned by one interview clip in which local official complained that due to lack of diesel oil, the heavy rescue equipment could not be put into use. At every gas station, diesel is sold out.

Why is there a shortage of diesel in China? That's because Chinese government thinks price control is the way to deal with inflation. The unintended policy consequence is the suppliers (such as SINOPEC and China Petro) all cut down their supplies. This reminds me of the price and wage control in the US back in 70s under President Nixon, and the long wait line at the gas station... Politicians just don't learn their lessons.

Also, with commodities prices all time high, I think it's a good time for Chinese government to re-evaluate their policy toward auto industry: Whether public transportation should be preferred in a country with 1.4 billion population? Whether gas guzzlers like GM's Hummer shall ever be allowed to be produced in China? Yes, there are plenty of Hummers in China.

Behind the food crisis

The silent Tsunami:

(This is a 45 min video, coutesy of Bloombergy TV)
Background reading from

Fitch's optimistic write-off report

Fitch ratings says banks have already written off 80% of their subprime loss. If this indeed were true, the worst is probably over. But I strongly doubt it. Fitch assumed the total loss of $400 billion, which is much lower than IMF's estimate of $1 trillion.

Wednesday, May 14, 2008

Oil price and speculation

Reading this report from Bloomberg, I was wondering about another possible explanation for the puzzle raised many times by Paul Krugman in his NY Times column: Krugman claims if speculation is the true culprit, you will have to see a large inventory buildup of oil. However, there is no evidence for the inventory accumulation.

The new possibility is that if oil suppliers realize or fear that the current fast run-up of oil price is unlikely to last, they will not increase production capacity. Therefore on one hand, commodity futures and other financial products (such as ETFs) keep bidding up oil price higher and higher, while on the other hand there is not much increase of supply (then no inventory buildup).

Just like farmers decide not to plant more corns because they expect corn price will fall next year. Oil producers are likely to do the same thing: They don't want to get burned. Seems like rational expectations theory in application.

Martin Wolf on oil price

Martin Wolf asks you to think about oil price in a longer term (source: FT). 
His comparison with oil price hike in 70s is insightful.


Oil at $200 a barrel: that was the warning from Goldman Sachs, published last week. The real price is already at an all-time high (see chart). At $200 it would be twice as high as it was in any previous spike. Even so, it would be a mistake to focus in shock only on the short-term jump in prices. The bigger issues are longer term.

Here are three facts about oil: it is a finite resource; it drives the global transport system; and if emerging economies consumed oil as Europeans do, world consumption would jump by 150 per cent. What is happening today is an early warning of this stark reality. It is tempting to blame the prices on speculators and big bad oil companies. The reality is different.

Demand for oil grows steadily, as the vehicle fleets of the world expand. Today, the US has 250m vehicles and China just 37m. It takes no imagination to see where the Chinese fleet is headed. Other emerging countries will follow China's example.

Meanwhile, spare capacity in members of the Organisation of the Petroleum Exporting Countries is currently at exceptionally low levels, while non-Opec production has equally consistently disappointed expectations. (See charts.)

It looks increasingly hard to expand supply by the annual amount of about 1.4m barrels a day needed to meet demand. This means an extra Saudi Arabia every seven years. According to the International Energy Agency, almost two-thirds of additional capacity needed over the next eight years is required to replace declining output from existing fields. This makes the task even harder than it seems. As the latest World Economic Outlook from the International Monetary Fund adds, the fact that peak production is reached sooner, because of today's efficient technologies, also means that subsequent declines are steeper.

This is not to argue that speculation has played no role in recent rises in prices. But it is hard to believe it has been a really big one. True, the dollar price has risen sharply, but that is partly the result of the decline in the dollar's relative value (see chart). As I have argued before, if speculation were raising prices above the warranted level, one would expect to see inventories piling up rapidly, as supply exceeds the rate at which oil is burned. Yet there is no evidence of such a spike in inventories, as Goldman Sachs and the IMF point out.

Similarly, it is not even true that the investment needed to boost the constrained production capacity has been lagging. The WEO shows that nominal investment by national and international oil companies more than doubled between 2000 and 2006. But real investment hardly increased, because of a global scarcity of rigs and associated skilled labour services. Against this background, it seems far more likely that such speculation as there is has been stabilising, rather than destabilising: in other words, it is moving prices in the right direction, in order to reduce demand.

Will the high prices succeed in doing this? Certainly. Demand has to match supply for a simple reason: we cannot burn oil that does not exist.

The price spikes of the 1970s were followed by big absolute falls in demand and output (see chart). This was partly because of the recessions and partly because of rising efficiency. Both forces should work again this time, but to a much smaller extent. The slowdown in the US economy is indeed likely to be significant. Slowdowns will also occur in western Europe and Japan and even in the emerging world. But the latter will still grow rapidly. Overall, the world economy – and so world oil demand – is likely to continue to grow reasonably briskly. Similarly, the improved efficiency of use of petroleum, as people switch to more efficient vehicles, notably in north America (where the room for doing so is so large), will be offset by the rising tide of demand for motorised transport in the world's fast-growing emerging countries.

On balance, it is quite unlikely that aggregate demand for oil will collapse, as it did after the two previous price spikes, just as it is unlikely that massive net new oil supplies will come on stream in the near future. This does not mean that prices will remain as high as they are today for the indefinite future: such stability is improbable. But it means we should expect a sustained period of relatively high prices even if "peak oil" theorists are proved wrong. If proved right, this would be true in spades.

So what should be the response to these simple realities? Here are some obvious "do nots" and "dos".

First, do not blame conspiracies by speculators, oil companies or even Opec. These are the messengers. The message is one of fundamental shifts in demand and supply. If speculators push prices up in response, they are helping the adjustment. Even if Opec keeps output back, it is preserving a valuable resource for the future.

Second, do not blame the emerging countries for their growing demand. Citizens of rich countries must adjust to the higher prices of resources that the rise of the emerging countries entails. The only alternative is to attempt to destroy those hopes. That would be a blunder and a crime.

Third, understand that prices at these levels are now playing a big macroeconomic role. At $100 a barrel the annual value of world oil output would be close to $3,000bn. That is 5 per cent of world gross product. The only previous years in which it was higher than that were 1979 to 1982.

Fourth, adjust to high prices, which will play a big part in encouraging more efficient use of this finite resource and ameliorating climate change. The current shock offers a golden opportunity to set a floor on prices, by imposing taxes on oil, fossil fuels or carbon emissions.

Fifth, do try to reach global agreement on a pact on trade in oil based on the fundamental principle that producers will be allowed to sell their oil to the highest bidder. In other words, the global oil market needs to remain integrated. Nobody should use military muscle to secure a privileged position within it.

Finally, do become serious about investing in basic research into alternative technologies. Energy self-sufficiency is an implausible goal. Investing for a post-oil future is not.

We are no longer living in an age of abundant resources. It is possible that huge shifts in supply and demand will reverse this situation, as happened in the 1980s and 1990s. We can certainly hope for that happy outcome. But hope is not a policy.

The great event of our era is the spread of industrialisation to billions of people. The high prices of resources are the market's response to this transforming event. The market is saying that we must use more wisely resources that have now become more valuable. The market is right.


Fertilizer crisis

Fertilizer price is soaring, and farmers use more of it. (courtesy of NYT)

TED spread, still too high

click to enlarge

source: Yellen's presentation (05/13/08)

Tuesday, May 13, 2008

Yellen: current state of economy

Janet Yellen, President of San Fransico Fed had a wonderful presentation of current state of the economy, a lot of nice graphs. Her full speech is here.

rethinking central bank doctrines

Leijonhufvud in his piece on VOX challenges two central bank doctrines:

1. inflation targeting;
This strategy failed in the United States. The Federal Reserve lowered the federal funds rate drastically in an effort to counter the effects of the crash. In this, the Fed was successful. But it then maintained the rate at an extremely low level because inflation, measured by various variants of the CPI, stayed low and constant. In an inflation targeting regime this is taken to be feedback confirming that the interest rate is "right". In the present instance, however, US consumer goods prices were being stabilised by competition from imports and the exchange rate policies of the countries of origin of those imports. American monetary policy was far too easy and led to the build-up of a serious asset price bubble, mainly in real estate, and an associated general deterioration in the quality of credit. The problems we now face are in large part due to this policy failure.
2. independence
When monetary policy comes to involve choices of inflating or deflating, of favouring debtors or creditors, of selectively bailing out some and not others, of allowing or preventing banks to collude, no democratic country can leave these decisions to unelected technicians. The independence doctrine becomes impossible to uphold.

His argument is quite interesting.

Thaler: Framing and Nudge

Richard Thaler, one of the top-guns in behavior economics, explains how to use nudge or framing to help people make decisions. 
In his new book, "Nudge," written with University of Chicago Law School professor Cass Sunstein, he looks at how policymakers might go about doing that. He and Mr. Sunstein make an argument for policies that guide people toward making optimal decisions while not depriving them of their ability to make a choice. They call this idea "libertarian paternalism." ("Why not paternal libertarianism?" asked Nobel laureate Daniel Kahneman at a recent event. "It's no worse," Mr. Thaler replied.)

Bernanke, the Improviser

The event was a 2002 conference at the University of Chicago to celebrate the Nobel laureate Milton Friedman's 90th birthday. When Ben S. Bernanke rose to speak, he said that the Federal Reserve, of which he was then a governor, had come around to Friedman's view that the central bank's blunders were to blame for the Great Depression. "We're very sorry," Bernanke said, prompting laughter. "But thanks to you, we won't do it again."

From Bernanke's standpoint, there are two major lessons to be learned from the Fed's reaction to the market crash of 1929 that are relevant today. The first is that the Fed should lower rates, not raise them, in the face of an economic contraction. The second is that the Fed must pay careful attention to the health of financial institutions, as lending plays a big role in economic growth.

I had the same feeling: Being a Great Depression buff himself, Bernanke has been so much worried about another great depression under his reign. That partly explains his aggressive monetary policy.  History will tell whether he's right or wrong.
read more here (source: Bloomberg)

Monday, May 12, 2008

Gary Becker: The rise of price of oil

Yes, I am all hooked up with recent run-up of oil price.

Here is another piece from Gary Becker, one of my most admired economists. He thinks the predictions such as the one made by Goldman Sachs analyst, $200 per barrel crude in the near future "are not based on much analysis, and mainly just extrapolate this sharp upward trend in oil prices into the future."

Something to take away from his insightful analysis:
For the evidence is rather strong that the short run response of both the supply of and the demand for oil to price increases is rather small. The small elasticity of both the supply and demand for oil explains why the moderate reductions in world oil supply during the earlier price spikes, and the moderate increase in world demand during the current price boom, produced such large increases in price.

Frankel rebuffs White House' call on slowdown not recession

Jeff Frankel thinks by stating that the economy is not in recession but in slowdown, White House CEA Chairman Ed Lazear risks putting his reputation on the line.

It is true that the Commerce Department BEA's advanced estimate of first-quarter GDP growth was still above zero (+0.6%).     But there are three reasons not to take this number too seriously.

(1) Revisions in these numbers are usually substantial, so the final number could easily turn out to be negative — or twice as high. (my comment: revision is esp. high around turning point)

(2) Even if the +0.6% number were to hold up, it can be entirely accounted for by measured inventory investment.   In other words, real final demand fell rather than rose in the first quarter.   It is plain that this inventory accumulation was not the outcome of deliberate decisions by bullish firms to add to their inventories in anticipation of a booming economy.   Rather it was almost certainly unintended inventory accumulation, as goods sat unsold on store shelves and in warehouses.    This overhang makes it more likely that inventory accumulation will be negative in the 2nd quarter.   (Admittedly, rising exports from the weak dollar and rising consumption from the tax rebate checks could outweigh that particular factor, and we could scrape along the ground for another quarter at near-zero growth).

(3) As Martin Feldstein has been pointing out, it is a misinterpretation of the GDP statistics to say that growth remained positive in the first quarter.  Rather GDP for QI as a whole was estimated to have been 0.6% higher as compared to QIV as a whole.  The Commerce Department does not report monthly GDP estimates, but MacroAdvisers does, and these data suggest that monthly GDP has been declining since January.

Difficult time for American banks

Since I read this book about Citibank, I have always kept a close eye on the firm and banking industry in general. The restructuring plan announced by their new CEO last week received little enthusiasm by the star bank analyst Meredith Whitney. Watch this Bloomberg video and help you understand the outlook of the financials.

What lowest NYSE volume implies

A nice piece from Barry Ritholtz on today's YTD lowest NYSE volume. Lowest volume rally is a bear market rally and implies short coverage.

Alternative to buying up foreign land

This piece argues as long as countries maintain full sovereignty on their land, land investment for food production by China and other countries will not be perceived as imperialism.  So in this case, China is not to buy up foreign land but just investing with a contractual agreement on a share of crops.  Not bad an idea.
China, where self-sufficiency in food is coming under pressure as a richer population consumes more meat, is considering whether to make support for offshore land acquisition, in places such as Africa and South America, an official government policy. A private-equity group in the United Arab Emirates is buying land in Pakistan with government support, while other resource-rich but food-poor nations – oil producers such as Saudi Arabia and Libya – are looking abroad to secure their food supplies.
Foreign investment in agricultural land should not be a problem. One recent estimate is that 15 per cent of all purchases of UK agricultural land are made by foreign investors. Even more than a power station or a yoghurt producer – which have caused rows about foreign investment in recent years – farmland is a fixed asset. Foreign investors bring capital, expertise and markets; they are a good thing.

China inflation up 8.5% in April

China announced fresh monetary tightening measures on Monday after inflation data showed price rises of 8.5 per cent in April, the second highest monthly figure for 12 years.

The People’s Bank of China lifted the share of funds that commercial banks must leave on deposit with the central bank by 50 basis points to 16.5 per cent, the fourth such increase this year.


The renminbi has stalled in recent weeks against the dollar, after appreciating at an annualised rate of nearly 20 per cent in the first quarter of this year. (source: FT)

The graph below shows recent slowdown of Yuan's appreciation.

Krugman, oil nonbubble

Paul Krugman today argues in NY Times that we don't have oil bubble. His usual argument is that if this was speculation, there should be an inventory buildup. I think he's wrong and his argument is inconsistent.

First, oil demand, just like food, can be very inelastic, i.e., demand will not fall much even with rising oil price. For the same reason, with a small decrease of supply, even without much increase of demand, price can rise sharply.

Second, Krugman himself admits due to driving habit, infrastructure layout, and policies, it's very hard for people to adjust their behavior within a short period of time.

I tend to think the current runup of oil price is mainly due to falling dollar, supply constraint, and most importantly, speculation. What differs from previous times is the availability of a lot of new financial instruments for both institutional and individual investors to speculate on oil and other commodities. Yes, I have ETF in mind.

Sunday, May 11, 2008

Peter Bernstein: When Should the Fed Crash the Party?

Peter Bernstein repudiates on NY Times the view that the Fed should let market crash and sort out the excesses by itself. A lot of prominent investors, such as Jim Rogers held such view.

Bernstein thinks "today's authorities are taking risks and are going to make mistakes in managing the complex fallout from the speculative fevers of recent years. Nevertheless, I would still reject Mellon's advice and those who echo it, because the consequences would be unthinkable."

What was Mellon's advice?
In the darkest days of the Depression, Treasury Secretary Andrew W. Mellon, one of the richest men in the United States, opposed any government action to stem the tide of plunging business activity and soaring unemployment. Instead, he urged a policy of supreme indifference.

"Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate," he said.

"It will purge the rottenness out of the system," he added, and values "will be adjusted, and enterprising people will pick up the wrecks from less competent people."

Bernstein's question also echoes the debate in academia whether the Fed should prick the bubble so to avoid large market correction and economic fluctuations later on. It also goes back to the fundamental question whether the Fed can micro-manage business cycles and whether the Fed often does more harm than good in the process.

Two related readings:

Bernanke on "Asset Bubble and Monetary Policy"

Another piece on VOX, "Can Monetary Policy Be Used to Stabilize Asset Prices"

Where is 'scale of economy' in Chinese agriculture?

To follow up yesterday's post on China's food production, I think Financial Times proposed the right policy: for China to be largely self-sufficient on food, establishing scale of economy in agriculture is the key, that is, get rid of fragmented farming, improve productivity by reorganizing how agri-industry operates.

Friday, May 09, 2008

Is the Commodities Boom Driven by Speculation?

Seeing crude oil passing $125 per barrel, I want to open a fresh discussion on the titled subject. I'd like to hear what you smart guys outthere think.  But first let me start by quoting the following:
"On a slow afternoon, trader A decided to open a market for a can of sardines. Bidding started at $1. B bought it for $2 and sold it to C for $3. D and E decided to get into the act, with the result that E became the owner for $5.
E decided to open the can and discovered the sardines had gone bad. He went back to A to get his money back, protesting that the sardines were rotten. A smiled broadly, and said, " You don't understand. Those were trading sardines, not eating sardines."
This is to say: I believe the current runup is largely speculation. You may argue speculation is also one kind of demand, i.e. demand for hedging risk, demand from investment seeking abnormal return...but it's quite different from what we usually described as fundamental driven demand, for example, China and India need more energy to grow, and US consumers need gas for road trip, etc.

Stiglitz on inflation targeting

Joe Stiglitz argues it's not a good idea for developing countries to adopt inflation targeting. I agree, because food consumption accounts for a large chunk of personal disposable income in poor countries. Institutions-wise, central banks in developing countries are far from independent and have no credibility anyway. So Stiglitz shouldn't worry too much about it.  

Inflation decomposition

Play this dynamic chart to get more details about recent inflation number.  This is the US inflation.

China inflation update

Wall Street Journal reports that China's headline inflation may spread:

Within China, there are also signs that price rises, so far concentrated almost entirely in food, are now spreading to other goods and services. That could be worrisome to policy makers, who have repeatedly declared that their main goal is to prevent isolated food-price gains from turning into broader inflation. Among the risks: Inflation could weaken the consumer spending that has helped support economic growth.

The increase in China's consumer-price index excluding food accelerated to 1.8% in March, after hovering at 1% or less for almost all of 2006 and 2007, according to the National Bureau of Statistics. The acceleration likely reflects how higher wages and raw-material costs are feeding into price rises for a broader range of goods, phenomena that have global implications given China's importance as a supplier of many products.
Another contributor is higher rents, thanks to continued price rises in most urban-property markets. J.P. Morgan economists expect nonfood inflation to continue to speed up to an average 2.5% for all of 2008.

However, the report was short of providing evidence of price increases in CORE category. In any case, I am less enthusiastic about differentiating between "core" and "headline" inflation. China is a developing country and people spend more than 1/3 of their disposable income on food. So just admit it, there is an inflation problem.

China to buy up foreign land for food production

Very imprudent policy...danger of being perceived as neo-colonism. Why is this better than just importing food?

More sensible policy alternatives would be to focus on providing more incentives for Chinese farmers to upgrade their farming technology and improve productivity on China's home land.

Chinese companies will be encouraged to buy farmland abroad, particularly in Africa and South America, to help guarantee food security under a plan being considered by Beijing. A proposal drafted by the Ministry of Agriculture would make supporting offshore land acquisition by domestic agricultural companies a central government policy. Beijing already has similar policies to boost offshore investment by state-owned banks, manufacturers and oil companies, but offshore agricultural investment has so far been limited to a few small projects. (source: FT)


I am suspicious that interest rate based monetary policy will work better in China.  (source: Bank of Finland)

Increased use of SHIBOR reflects evolution of China's money markets.
At the beginning of 2007, China began quoting the Shanghai Interbank Offered Rate (SHIBOR) as part of its financial market reform programme with a view to implementing a market-based interest-rate regime. Official sources say the use of SHIBOR as a reference rate has clearly increased. However, use of SHIBOR varies significantly depending on the instrument and the matur-ity. SHIBOR rates are mainly used at present as a refer-ence rate for contracts of less than three months, which illustrates the actual thinness and underdeveloped state of Chinese financial markets.

By some estimates, use of reference rates has remained lower than hoped, which is evidenced by the grown inter-est rate spreads between different instruments. Currently, the three-month SHIBOR is about one percentage point higher than the rate for central bank bills. The situation may reflect problems in setting reference rates, or it could show that the central bank is using the opportunity to sell its own bills below established market rates. There is essentially no difference between the one-week and overnight SHIBOR and repo rates, which implies that these short-term markets function reasonably well.

The goals of reform of the interest rate regime include increased awareness of interest-rate risk among banks and deepening China's financial markets. These conditions must be met before China can shift from a monetary policy regime based on regulation of the quantity of money to an interest-rate-based system. China's long-term goal is a market-based financial system, but the central bank cur-rently imposes strict limits on bank lending and deposit-taking. The general ceiling set by the central bank today for the bank deposit rate (3-month) is 3.33 % and the low-est lending rate (6-month) is 5.91 %.

Thursday, May 08, 2008

Feldstein thinks recent GDP growth number misleading

Martin Feldstein writes in the Financial Times: Misleading growth statistics give false comfort
Prepositions matter. The recent government report that US gross domestic product increased 0.6 per cent in the first quarter was very misleading. It implied that economic activity was rising in January, February and March. But the increase actually refers to the rise from the average level in the fourth quarter of 2007 to the average level in the first quarter. Monthly data since January indicate that economic activity and GDP have been declining since the start of this year.
Although the government does not provide monthly estimates of GDP, Macroeconomic Advisers, a private forecaster, constructs them ... Although GDP declined during the first quarter, the average of the monthly figures in the first quarter ($11,711bn) is higher than the average of the monthly figures for the final quarter of 2007 ($11,675bn).

Gasoline help

With gas price near $4, websites (and programs) that help consumers find the cheapest gas station are getting popular.
[fuel tools chart]
source: wsj

Wednesday, May 07, 2008

Feldstein Recession update, again

source: Bloomberg

Gasoline tax across country comparison

Now people should think hard about alternative energy. This is one of few area I actually think higher tax actually will do good. 
source: wsj

Sunday, May 04, 2008

Is the Fed done cutting?

Bill Gross interview on the Fed and the economy (source: CNBC)

Saturday, May 03, 2008

China's Real Effective Exchange Rate

BIS calculated China's real effective exchange rate since 1994. China had a close peg with US dollars since late 90s and broke off the peg in mid 2006, and accelerated its appreciation pace.