Tuesday, June 30, 2009

City of your dreams

Financial Times' 2009 ranking of the Most Livable Cities in the world.  Not a single American city made into the list. Find out why by listening to this lively discussion from On Point, "What's a 'livable' city now?".

Bernanke's testimony on BoA+ML deal

This is a bit old (five days ago). One thing after listening to the testimony is the Fed helped to hide Merrill's loss, intentionally.

Lost decade for private sector jobs

Private sector jobs growth, if measured by change over the last decade, reaches almost zero.

More from Business Week.

Monday, June 29, 2009

Commodity Supercycle

We are in a commodity super cycle.

China's industrialization is certainly one of the main contributing factors. And if the current cycle is coupled with high inflation, if not hyperinflation, where investors find investing in both bonds and equities become much less attractive, the super cycle will be pushed to a newer level.

Watch this video analysis from FT:

(click to watch the video)

Chinese Yuan back to hard peg to the dollar

An analysis of recent development of Chinese currency Yuan.

(click to watch the video; source: FT)

Sunday, June 28, 2009

The sharp rising personal savings rate

The latest reading was 6.9%, a 16-year high. Are we witnessing a fundamental shift in American consumption??

(click to enlarge; source: St. Louis Fed)

Wednesday, June 24, 2009

Alan Blinder on inflation vs. deflation

Alan Blinder, former Fed vice chairman, on inflation and when to expect the Fed will hike the rate. His main message: inflation is not the danger.

Tuesday, June 23, 2009

Inflaiton debate continues

Economists and policy makers are divided over whether we will have a surge in inflation, and when the monetary policy should be tightened after inflation appears.

Uncertainties in government's attitude and actions toward inflation will certainly make inflation-hedge investment strategies look even more attractive.

Saturday, June 20, 2009

Obama's plan to revamp America's regulation

Will China lead the world out of recession?

The short answer is no ---interview of Stephen Roach, Morgan Stanley Asia Chairman.

206 years versus 12 months

A nice chart on the sheer magnitude of government bailout during this financial crisis ---206 years versus 12 months. Total cost: ~$15 trillion and counting . . .

(click to enlarge; graph courtesy of Big Picture)

Note: I am not sure the graph has taken inflation into account. But in any case, the current government bailout is enormous.

Frontline: Breaking the bank

Inside story of the two banks at the heart of the current financial crisis: Merrill Lynch and Bank of America, from my favorite Frontline of PBS. Highly recommend.

Credit crunch in historical perspective

With credit crunch over (I assume), it's time to review what we have been through:

(click to enlarge; source: Gluskin Sheff)

Wednesday, June 17, 2009

Obama's big health care push

On Point discussion on Obama's big health care push that aims to overhaul America's health care system.

Not your average-Joe recession

Albeit the recent positive signs in the economy, the current recession is far more severe than all postwar recessions. Here is another research piece that looks at the current recession in historical context from Council of Foreign Relations.  It came with a lot of nice graphs.

Link to the research

Tuesday, June 16, 2009

Shiller: Home prices may keep falling for years

Bob Shiller explains why he thinks home prices may take years to fall.  In economics, house prices are often used as an example to demonstrate the 'sticky prices'. (Source: NYT)

HOME prices in the United States have been falling for nearly three years, and the decline may well continue for some time.

Even the federal government has projected price decreases through 2010. As a baseline, the stress tests recently performed on big banks included a total fall in housing prices of 41 percent from 2006 through 2010. Their "more adverse" forecast projected a drop of 48 percent — suggesting that important housing ratios, like price to rent, and price to construction cost — would fall to their lowest levels in 20 years.

Such long, steady housing price declines seem to defy both common sense and the traditional laws of economics, which assume that people act rationally and that markets are efficient. Why would a sensible person watch the value of his home fall for years, only to sell for a big loss? Why not sell early in the cycle? If people acted as the efficient-market theory says they should, prices would come down right away, not gradually over years, and these cycles would be much shorter.

But something is definitely different about real estate. Long declines do happen with some regularity. And despite the uptick last week in pending home sales and recent improvement in consumer confidence, we still appear to be in a continuing price decline.

There are many historical examples. After the bursting of the Japanese housing bubble in 1991, land prices in Japan's major cities fell every single year for 15 consecutive years.

Why does this happen? One could easily believe that people are a little slower to sell their homes than, say, their stocks. But years slower?

Several factors can explain the snail-like behavior of the real estate market. An important one is that sales of existing homes are mainly by people who are planning to buy other homes. So even if sellers think that home prices are in decline, most have no reason to hurry because they are not really leaving the market.

Furthermore, few homeowners consider exiting the housing market for purely speculative reasons. First, many owners don't have a speculator's sense of urgency. And they don't like shifting from being owners to renters, a process entailing lifestyle changes that can take years to effect.

Among couples sharing a house, for example, any decision to sell and switch to a rental requires the assent of both partners. Even growing children, who may resent being shifted to another school district and placed in a rental apartment, are likely to have some veto power.

In fact, most decisions to exit the market in favor of renting are not market-timing moves. Instead, they reflect the growing pressures of economic necessity. This may involve foreclosure or just difficulty paying bills, or gradual changes in opinion about how to live in an economic downturn.

This dynamic helps to explain why, at a time of high unemployment, declines in home prices may be long-lasting and predictable.

Imagine a young couple now renting an apartment. A few years ago, they were toying with the idea of buying a house, but seeing unemployment all around them and the turmoil in the housing market, they have changed their thinking: they have decided to remain renters. They may not revisit that decision for some years. It is settled in their minds for now.

On the other hand, an elderly couple who during the boom were holding out against selling their home and moving to a continuing-care retirement community have decided that it's finally the time to do so. It may take them a year or two to sort through a lifetime of belongings and prepare for the move, but they may never revisit their decision again.

As a result, we will have a seller and no buyer, and there will be that much less demand relative to supply — and one more reason that prices may continue to fall, or stagnate, in 2010 or 2011.

All of these people could be made to change their plans if a sharp improvement in the economy got their attention. The young couple could change their minds and decide to buy next year, and the elderly couple could decide to further postpone their selling. That would leave us with a buyer and no seller, providing an upward kick to the market price.

For this reason, not all economists agree that home price declines are really predictable. Ray Fair, my colleague at Yale, for one, warns that any trend up or down may suddenly be reversed if there is an economic "regime change" — a shift big enough to make people change their thinking.

But market changes that big don't occur every day. And when they do, there is a coordination problem: people won't all change their views about homeownership at once. Some will focus on recent price declines, which may seem to belie any improvement in the economy, reinforcing negative attitudes about the housing market.

Even if there is a quick end to the recession, the housing market's poor performance may linger. After the last home price boom, which ended about the time of the 1990-91 recession, home prices did not start moving upward, even incrementally, until 1997.

Robert J. Shiller is professor of economics and finance at Yale and co-founder and chief economist of MacroMarkets LLC.

Paul Samuelson warns against the US Dollar

The great economist Paul Samuelson warns against being too complacent about the economic outlook, and he predicts "some day -- maybe even soon -- China will turn pessimistic on the U.S. dollar".

Henry Ford said, "History is bunk." Even more cynically, Napoleon said, "History is a set of fables agreed upon."

Both had a point.

But back in the early 1930s, during the Great Depression, President John F. Kennedy's father, Old Joe Kennedy, made two fortunes betting that stocks would keep falling and unemployment would keep growing.

He disbelieved in early New Deal recoveries.

By contrast, the leading U.S. economist at Yale, Professor Irving Fisher, after (1) marrying a fortune; and (2) earning a second fortune by inventing a profitable visual filing system, nevertheless ended up losing no less than three fortunes!

The story of these two opposites illustrates how and why economics can never be an exact science.

Joseph Kennedy Sr. was a tough and crafty speculator. Apparently he sold stocks short from 1929 to, say, 1931 or 1932.

Professor Fisher early on first lost his own fortune when the stocks he bought went bust. So he restudied the Wall Street and Main Street statistics.

Admitting that he had been too optimistic, Fisher wrote a new book. In it he admitted his previous error. But his new book said: The stock market is now a bargain.

Alas, his heiress wife's assets collapsed under this guidance. Stubborn Fisher persisted in his optimism. He went on to advise his sister-in-law, the president (I believe) of Wellesley College, to stay with stocks! This time she balked and fired him as investment adviser.

While Fisher was going broke, Joe Kennedy persevered by selling short the stocks that still were falling. No paradox.

However, as the New Deal recovery program finally began to succeed, Kennedy Sr. left the stock market and bought the Chicago Merchandise Mart Building -- the biggest structure in the world at that time.

Which speculator was right? And which was wrong between these two well-informed giants? No sage can answer that question.

Today, Federal Reserve Gov. Ben Bernanke glimpses a possible recovery by year's end.

He is a cautious scholar, backed by the best forecasters in the world at the Federal Reserve Board.

I would be a rash fool to quarrel with this official's quasi-optimistic view that by year's end some stability will occur.

You and I should hope that there will indeed be a glimmer of light at the end of the tunnel ahead.

But shift our vision now to the future.


Even if the short run prospect for a 2009-2010 recovery turns out to be good, I must warn once again that the long-run outlook for the U.S. dollar is hazardous.

China is the new important factor.

Up until now, China has been willing to hold her recycled resources in the form of lowest-yield U.S. Treasury bills. That's still good news. But almost certainly it cannot and will not last.

Some day -- maybe even soon -- China will turn pessimistic on the U.S. dollar.

That means lethal troubles for the future U.S. economy.

When a disorderly run against the dollar occurs, I believe a truly global financial panic is to be feared. China, Japan and Korea now hold dollars not because they think dollars will stay safe.

Why then? They do this primarily because that is a way that can prolong their export-led growth.

I am not alone in this paranoid future balance-of-payment fear.

Warren Buffett, for one, has turned protectionist. Alas, protectionism may well soon become more maligned.

President Obama struggles to support free trade. But as a canny centrist president, he will be very pressed to compromise.

And he will be under new chronic pressures. His experts should right now be making plans for America to become subordinate to China where world economic leadership is concerned.

The Obama team is a good one.

But will they act prudently to adjust to America's becoming the secondary global society?

In the chess game of geopolitics between now and 2050, much stormy weather will take place. Now is the time to prepare for what the future will likely be.

Monday, June 15, 2009

"Trust me", says the Fed

I wish to trust Richard Fisher, the Dallas Fed President, because he is a well-known inflation hawk. But I am not convinced the Fed knows when is the exact right time to rein in the massive liquidity (we know monetary policy works with more than 12 months lag), and whether they could be able to do it given the almost certain prospect of double digit unemployment rate, and the political pressure they are about to face.

Watch this interview of Richard Fisher on inflation and the Fed.

College towns are recession proof: the Euro version

College towns are relatively recession-proof in the United States. This recent Deutsche Bank research says this is true also in Europe:

The recession is also affecting the European real estate sector. True, many German housing markets are regarded as relatively stable. However, differentiation is called for, since regional differences, as in other countries, are considerable in Germany as well. Two simple criteria are good indications of price dynamics of housing investments: for one thing, the share of students in a city, and for another, the share of the manufacturing sector.

The economic crisis has unsettled many investors. Currently, they are looking less for risky products with high yield potential but rather for low-risk investments with a stable return. This is precisely why many people are turning to residential property: they are interested either in owner-occupied housing or in buying rented property. Is this a sound assumption? Although no housing bubble for residential markets has occurred in Germany yet, the low financing rates currently also make residential property an interesting investment. Thus, an investment in German residential property currently offers potential.

It should be kept in mind, however, that investments in residential property per se are not risk-free. In particular, investors should always be aware of the location risk of housing investments. But what makes a good location in housing? No doubt, good utility connections and the proximity to infrastructure systems are among the key criteria. In particular, such micro factors require a case-by-case examination of properties, i.e. very good market knowledge, though. Before starting the selection, the quality of a region, that is its macroeconomic factors, should be checked. What are the prospects for the economic structure? How good is the location with regard to transport links? For these factors have a decisive influence on the future demographic and income situation and thus the development of house prices.

In a thorough location analysis, forecasts have to be made of a very large number of macro factors. This is a very demanding task, especially as various factors have reciprocal effects, and some variables can change quickly, e.g. the registered office of a major company. Thus, factors subject to only minor fluctuations are particularly useful indicators for risk-averse real-estate investors. This can be illustrated by two selected factors: the share of students and the share of employees in the manufacturing sector. To show the influence of these two factors, the average price development of new owner-occupied housing units in over 100 German cities over the last ten years has been analysed.


This shows the 20 cities which post the best gains do not only include the usual suspects like Munich and Hamburg but also smaller cities such as Marburg, Heidelberg, Trier, Wuerzburg and Muenster. These five cities are marked by a very high share of students in the residential population. The value development in typical university towns was more favourable all in all than in towns without a sizeable share of college students. In the last ten years, the average value increase of new condominium apartments in university cities, i.e. towns with a share of college students of at least 15% in the population, rose by roughly 0.75 percentage points more than the increase in house prices in towns with very few students or no students, respectively – annualised, that is. This applies to both east and west Germany. At first glance it may come as a surprise that the value of residential property – and even more so, condominiums – in university towns has increased disproportionately well, for the disposable incomes of college students are of course by no means above average. The correlation is plausible, though: first, universities serve as large employers, and many jobs in university towns are not influenced by the economic cycle. Second, many college students stay in their college town after graduation as they still find their university town so attractive. The incomes of these graduates usually exceed that of people without a college degree. University towns therefore – also in times of crisis – are a safe haven for housing investments.


Risk-conscious investors should currently act cautiously with regard to typical industry locations. Average house prices in highly industrialized towns (with a share of employees in manufacturing of over 30%) were about 0.50 percentage point per year below price levels in towns with very small industrial bases. Even though the number of manufacturing employees increased strongly in the latest upswing, the gap reflects Germany's continuing structural change towards a service society, especially wage moderation in many segments of manufacturing. As in the current recession manufacturing is severely battered by the decline in exports, it is plausible that towns with a strong industrial base in this crisis will be hit even harder than in the last ten years. Thus, investors considering towns such as Ludwigshafen, Schweinfurt, Ingolstadt and Salzgitter as locations for an investment will probably have to pay a higher risk premium at present.

Investors should be aware of the fact that these two correlations are stable and statistically verified. It should be kept in mind, however, that these are only two individual criteria. Not every university town can guarantee value, and the risks among industrial towns do vary. In particular, the microeconomic factors mentioned above always play a major role. What is more, attention must also be paid to the change in value retention and the yield. For example, Wolfsburg and Ludwigshafen are the beneficiaries of a relatively favourable multiplier while the ratios for Freiburg and Bamberg are rather unfavourable.

Milton Friedman: Don't rely on the 'right man'

Who said Friedman's ideas were out of date? Watch this video you will know exactly why his ideas are as refreshing as it was 30-40 years ago.

One lesson to take away: don't rely too much on the Fed's exit strategy and its promise to get inflation under control. Smart investors should protect themselves ahead of the curve. There is probably 80% chance that inflation will NOT get out of control if the right man, Ben Bernanke, acts wisely; but if the 20% chance prevails, you want to make sure you have inflation-hedge in your portfolio.

(video haptip: TMGM)

No need to say Friedman's idea also has important implications to different political systems we are living in. Think China vs. the US ---with the former relying too much on the 'right man' to make the right decisions.

Sunday, June 14, 2009

How serious is America's budget deficit?

Charlie Rose ---A conversation about the growing fiscal deficit with Alan Blinder, Professor of Economics at Princeton University and Director of Princeton's Center for Economic Policy Studies, David Leonhardt of "The New York Times" and Alan J. Auerbach, Professor of Economics and Law, Director of the Burch Center for Tax Policy and Public Finance, University of California, Berkeley.

Grantham on value investing and China

Jeremy Gratham of GMO talks about value investing: high growth does not mean high return to capital; it all depends on your entry point. He applies this classic investment philosophy to China. (source: Morngingstar Investment Conference, May 2009)

Saturday, June 13, 2009

A fun talk on whether Americans should start saving

Peter Schiff on Daily Show:

The Daily Show With Jon StewartMon - Thurs 11p / 10c
Peter Schiff
Daily Show
Full Episodes
Political HumorNewt Gingrich Unedited Interview

Update: Has housing reached the bottom?

The short answer is NO. Here is another interview of Susan Watcher of Wharton Business School following my previous post on predicting the housing bottom. (source: Bloomberg)

Larry Summers on the current state of the economy

Larry Summers speaks to the Council of Foreign Relations. He explains government's intervention was out of 'necessity' not 'choices'.

Thursday, June 11, 2009

Can banks grow without removing toxic assets?

David Wessel discusses whether banks can lend and grow without removing toxic asset on their books. (Source: WSJ)

Eight months ago, in the worst moments of the Great Panic of '08, then-Treasury Secretary Henry Paulson persuaded Congress to provide $700 billion for what he said was the crucial task of buying lousy real-estate loans and securities, the "toxic assets," from the nation's banks.

Four months ago, Treasury Secretary Timothy Geithner proposed to leverage some of that money with private money to buy as much as $1 trillion in what he delicately dubbed "legacy assets" from the banks to repair their balance sheets and get them lending again.

The government has yet to buy any of these assets. Instead, it bought about $200 billion worth of shares in the banks, and this week it allowed 10 big banks to repay $68.3 billion of that taxpayer money. The key: Big banks have raised about $65 billion in private capital in the past several weeks, an accomplishment that seemed unimaginable just a few months ago.

So is it no longer necessary for the government to get toxic assets off banks' books to get credit flowing again? Is bolstering banks' capital a substitute for ridding them of smelly loans and securities?

We're about to find out. Until this historic episode, the internationally accepted recipe for fixing a banking crisis had three ingredients: take bad assets off bank books, temporarily guarantee their debts and deposits, recapitalize the banks. The notion was that removing toxic assets usually was necessary before a bank could attract new capital or a buyer and get on with the business of making loans.

Banks need capital to absorb losses when borrowers don't repay their loans. If a bank's capital cushion is large enough, it can absorb all the losses it faces and remain solvent. (Say a bank is carrying a loan at 80 cents on the dollar, but it's really worth 50 cents. Investors don't want to lend that bank money or, if they do, they charge a lot. That makes it hard for the bank to lend readily. With a fat enough capital cushion, the bank's solvency is assured even if it has to mark the loan down to 50 cents.)

The very stressful stress tests conducted by the regulators were intended to calibrate how much capital the big banks needed in a terrible, though not worst-case, economy. Arithmetically, if banks raise enough capital, then there's no need for the government to buy the toxic assets. And we all live happily ever after.

Perhaps. But ridding toxic assets accomplishes two other things. First, it removes any doubt about looming undisclosed losses. As long as toxic assets remain on bank books, there's uncertainty about whether they've been marked down enough to reflect reality. If they're gone, it doesn't matter.

Second, it removes a huge distraction for management, which may be prerequisite to focusing on making new loans, the objective of all these efforts.

Michael Bleier, a banking lawyer at Reed Smith in Pittsburgh who spent 14 years as general counsel at Mellon Bank, says this is a big deal. In 1988, Mellon created a "bad bank" to hold and sell $1.4 billion worth of bad real-estate and energy loans that were then worth 47 cents on the dollar. "One of the key reasons we did this was that management's time and attention was being taken up with questions like: What are you going to do with this stuff?" Mr. Bleier said. "By not getting rid of the assets, management attention is somewhat diverted."

The bad bank was a success at its sole mission: It sold the assets and closed its doors in 1995. And the good bank, Mellon, was healthy enough to be making acquisitions in late 1989 (and was later acquired by Bank of New York.)

Mr. Geithner's Public Private Investment Program to buy toxic loans is going nowhere; the PPIP to buy securities may yet materialize. If markets and banks deem all this no longer necessary because the financial system has pulled back from the abyss and banks have raised more capital than expected, that's good.

That's not the only possible explanation. Bankers always will be reluctant to sell if they have to mark down loans; they'd rather wait and hope for better times. But the Treasury offered investors a sweet deal here -- and found few takers amid much anxiety about whether participating would subject investors to congressional scrutiny and limits on executive pay. If the lack of appetite for these deals instead reflects Wall Street worries about the political risk of doing business with the U.S. government, that's not so good.

At a Senate hearing this week, Mr. Geithner said lack of interest in toxic-asset sales reflects elements of both explanations. And he isn't ready to abandon the effort. If the economy takes a bad turn, or attitudes toward banks change -- particularly toward banks that weren't deemed healthy enough to give back taxpayer capital -- a mechanism for removing toxic assets may yet prove essential to reaching a happy ending.

Monday, June 08, 2009

Replay of 2008 oil bubble?

In 2008, we had a huge oil bubble. The crude oil shot up to $147 per barrel. Now with crude up 99% in 75 trading days, are we going to have another oil bubble?


(graph via Bespoke Investments)

WSJ compares the similarities and differences between the current oil runup and the spike in 2008.

The rapid rise in the price of crude-oil futures, which touched $70 on Friday, is sparking fears of a repeat of last year's energy rollercoaster.

Crude oil futures on the New York Mercantile Exchange on Friday hit $70.32 before closing down 37 cents at $68.44. Prices remain well below what they were a year ago, when oil was selling for more than $125 a barrel, but the climb in recent months has been even steeper than last year's.

Prices have more than doubled since closing at $33.98 on Feb. 12, the recent low. They're up more than 50% since the start of 2009, compared to a 33% rise during the same period last year.

[oil prices]

What China has become

China ---impressive economic growth with increasing censorship on information. What China has become?  I am afraid this is really what scares people in the West.  Chinese leaders may soon realize block of free information flow and ideas will eventually haunt them and hamper China's future long-term growth.

WSJ reports:

China plans to require that all personal computers sold in the country as of July 1 be shipped with software that blocks access to certain Web sites, a move that could give government censors unprecedented control over how Chinese users access the Internet.

The government, which has told global PC makers of the requirement but has yet to announce it to the public, says the effort is aimed at protecting young people from "harmful" content. The primary target is pornography, says the main developer of the software, a company that has ties to China's security ministry and military.

Where are the jobs?

Again, the stable job growth happens in small and midsized towns that concentrate on technology, healthcare and are near universities.

Sunday, June 07, 2009

Rethinking Efficient Market Hypothesis

New York Times has some nice discussions on the Efficient Market Hypothesis and how the current financial crises helped to revamp the once-orthodoxy financial theory:

For some months now, Jeremy Grantham, a respected market strategist with GMO, an institutional asset management company, has been railing about — of all things — the efficient market hypothesis.

You know what the efficient market hypothesis is, don't you? It's a theory that grew out of the University of Chicago's finance department, and long held sway in academic circles, that the stock market can't be beaten on any consistent basis because all available information is already built into stock prices. The stock market, in other words, is rational.

In the last decade, the efficient market hypothesis, which had been near dogma since the early 1970s, has taken some serious body blows. First came the rise of the behavioral economists, like Richard H. Thaler at the University of Chicago and Robert J. Shiller at Yale, who convincingly showed that mass psychology, herd behavior and the like can have an enormous effect on stock prices — meaning that perhaps the market isn't quite so efficient after all. Then came a bit more tangible proof: the dot-com bubble, quickly followed by the housing bubble. Quod erat demonstrandum.

These days, you would be hard-pressed to find anybody, even on the University of Chicago campus, who would claim that the market is perfectly efficient. Yet Mr. Grantham, who was a critic of the efficient market hypothesis long before such criticism was in vogue, has hardly been mollified by its decline. In his view, it did a lot of damage in its heyday — damage that we're still dealing with. How much damage? In Mr. Grantham's view, the efficient market hypothesis is more or less directly responsible for the financial crisis.

"In their desire for mathematical order and elegant models," he wrote in his firm's quarterly letter to clients earlier this year, "the economic establishment played down the role of bad behavior" — not to mention "flat-out bursts of irrationality."

He continued: "The incredibly inaccurate efficient market theory was believed in totality by many of our financial leaders, and believed in part by almost all. It left our economic and government establishment sitting by confidently, even as a lethally dangerous combination of asset bubbles, lax controls, pernicious incentives and wickedly complicated instruments led to our current plight. 'Surely, none of this could be happening in a rational, efficient world,' they seemed to be thinking. And the absolutely worst part of this belief set was that it led to a chronic underestimation of the dangers of asset bubbles breaking."

(Mr. Grantham concluded: "Well, it's nice to get that off my chest again!")

I couldn't help thinking about Mr. Grantham's screed as I was reading Justin Fox's new book, "The Myth of The Rational Market," an engaging history of what might be called the rise and fall of the efficient market hypothesis.

Mr. Fox is a business columnist for Time magazine (and a former colleague of mine) who has long been interested in academic finance. His thesis, essentially, is that the efficient marketeers were originally on to a good idea. But sealed off in their academic cocoons — and writing papers in their mathematical jargon — they developed an internal logic quite divorced from market realities. It took a new group of young economists, the behavioralists, to nudge the profession back toward reality.

Mr. Fox argues, echoing Mr. Grantham, that the efficient market hypothesis played an outsize role in shaping how the country thought and acted in the last 30-plus years. But Mr. Fox parts company with him by also arguing that the effect wasn't necessarily all bad. As for the question of whether an academic theory hatched in Chicago led to the financial crisis, suffice it to say that some questions can never be answered definitively. Which isn't to say they shouldn't be asked.

"There are no easy ways to beat the market," Mr. Fox said when I spoke to him a few days ago. If you want to point to the single best thing the efficient market hypothesis taught us, that is the lesson: we can't beat the market. Indeed, the vast majority of professional money managers can't beat the market either, at least not on a regular basis.

As Mr. Fox describes it, much of the early academic work that led to the efficient market theory was aimed at simply showing that most predictive stock charts were glorified voodoo — just because a pattern had developed didn't mean it would continue, or even that it had any real meaning. Dissertations were written showing how 20 randomly chosen stocks outperformed actively managed mutual funds. (Hence the phrase "random walk," to connote the near impossibility of beating the market regularly.) Mr. Thaler, the Chicago behavioralist, says that evidence on this point — "the no free lunch principle," he calls it — is clear and convincing.

In time, this insight led to the rise of passive index funds that simply matched the market instead of trying to beat it. Unless you're Warren Buffett, an index fund is where you should put your money. Even people who don't follow that advice know they should.

As it turns out, Mr. Grantham was an early advocate of index funds, mainly for unsophisticated investors who have no hope of beating the market. But he also believes that professionals should do better precisely because, as he puts it, "the market is full of major league inefficiencies."

"There are incredible aberrations," he told me over lunch not long ago. "The U.S. housing market in 2007. Japan in the 1980s. Nasdaq. In 2000, growth stocks were three times their fair value. We were quoted in The Economist in 2000 saying that the Nasdaq would drop by 75 percent. In an efficient world, you wouldn't have that in a lifetime. If the market were truly efficient, it would mean that growth stocks had become permanently more valuable."

As Mr. Grantham sees it, if professional investors had been willing to acknowledge these aberrations — and trade on the fact that the market was out of whack — they should have been able to beat the market. But thanks to the efficient market hypothesis, no one was willing to call a bubble a bubble — because, after all, stock prices were rational.

"It helped mold the 'this time it's different' mentality," he said. Indeed, professional money managers who tried to buck the tide wound up losing their jobs — because everybody else was making money by riding the bubble for all it was worth. Meanwhile, government officials, starting with Alan Greenspan, were unwilling to burst the bubble precisely because they were unwilling to even judge that it was a bubble. "Our default reflex is that the world knows what it is doing, and that is extravagant nonsense," Mr. Grantham said.

But as much as I've admired Mr. Grantham's writings over the years, I think the truth, in this case, is a little more subtle. Given the long history of bubbles, I suspect this crisis would have taken place with or without the aid of the efficient market hypothesis. People thought "it's different this time" in the 1920s, long before anyone was writing about efficient markets. And over the course of history, professional money managers have been just as fearful of bucking the trend as they were during the Internet bubble.

Mr. Fox sees it somewhat differently. On the one hand, he says, the efficient market theoreticians always assumed that smart market participants would force stock prices to become rational. How? By doing exactly what they don't do in real life: take the other side of trades if prices get out of whack. Their ivory tower view reflected an idealized market that simply doesn't exist.

On the other hand, Mr. Fox says, what was truly pernicious about the efficient market hypothesis is the way it allowed us to put asset prices on a pedestal that they never deserved. Stock options — supposedly based on a rational price — became prevalent in part because higher stock prices were supposed to be the rational reward for good performance.

Or take the modern emphasis on market capitalization. "At some point in the early 1990s (or maybe it was in the late 1980s), market capitalization became accepted as the best measure of a company's importance," Mr. Fox wrote me in an e-mail message. "Before then it was usually profits or revenue. I think that's a classic example of the way efficient market theory seeped into popular discourse and shaped how we perceived the world. It wasn't entirely stupid — profits and revenue are flawed, limited measures, and market value does tell you something useful about a company. But it was another one of the ways in which asset prices came to rule the world, which eventually turned out to be a bad thing."

A few days ago, I called Burton G. Malkiel, the Princeton economist, to ask him what he thought of Mr. Grantham's theories. Mr. Malkiel is the author of "A Random Walk Down Wall Street," surely one of the greatest popularizers of any academic theory that's ever been written.

"It's ridiculous" to blame the financial crisis on the efficient market hypothesis, Mr. Malkiel said. "If you are leveraged 33-1, and you're holding long-term securities and using short-term indebtedness, and then there's a run on the bank — which is what happened to Bear Stearns — how can you blame that on efficient market theory?"

But then we started talking about bubbles. "I do think bubbles exist," he said. "The problem with bubbles is that you cannot recognize them in advance. We now know that stock prices were crazy in March of 2000. We know that condo prices were nuts."

I thought to myself: if a smart guy like Burton Malkiel had to wait for the Internet bubble to end to realize we had been in one, then maybe Mr. Grantham has a point after all.

Comedy on GM (for biG Mess)

Taxpayers have every right to be angry:

The Daily Show With Jon StewartM - Th 11p / 10c
BiG Mess
Daily Show
Full Episodes
Political HumorEconomic Crisis

Are inflation concerns inflated?

Too much output gap in the economy, why should we worry about inflation?

David Wessel of WSJ outlines the possible reasons that inflation can be a worry down the road. Among those he listed, I think inflation expectations matter most. As I mentioned many times before, we may end up with a 70s-like stagflation scenario.

What's new this time around is that most emerging economies are forecast to grow much faster than the developed world even you exclude exports to the US. And most of these countries are resources-energy intensive.

Geithner exclusive interview on China

CNBC exclusive interview of Treasury secretary, Tim Geithner. Geithner received a warm welcome in China as he was an exchange student in China about 30 years ago. But China's domestic media seems to think Geithner's speech was boring and he had a tendency to speak too fast to give people enough confidence.

Saturday, June 06, 2009

China's one-child policy and runaway brides

Partly due to the one child policy, China now has one of the highest male-to-female ratios in the world. When these men reach marriageable age, nowhere in the world they could find a bride.

In a highly competitive marriage market where women are in hot pursuit, and with potential of huge 'profits', scam naturally rises. Here is some interesting excerpts from WSJ's article on China's runaway brides.

With no eligible women in his village, Zhou Pin, 27 years old, thought he was lucky to find a pretty bride whom he met and married within a week, following the custom in rural China.

Ten days later, Cai Niucuo vanished, leaving behind her clothes and identity papers. She did not, however, leave behind her bride price: 38,000 yuan, or about $5,500, which Mr. Zhou and his family had scrimped and borrowed to put together.

When Mr. Zhou reported his missing spouse to authorities, he found his situation wasn't unique. In the first two months of this year, Hanzhong town saw a record number of scams designed to extract high bride prices in a region with an oversupply of bachelors.

The fleeing Mrs. Zhou was one of 11 runaway brides -- hardly the isolated case or two that the town had seen in years past. The local phenomenon has fueled broader speculation among officials that the fast-footed wives may be part of a larger criminal ring.

"She called me soon after she left," says Mr. Zhou, a slight man with a tentative smile. He says she asked how he was doing, and apologized for the hardship she had caused. "I told her, 'I will see you again one day.' "

Thanks to its 30-year-old population-planning policy and customary preference for boys, China has one of the largest male-to-female ratios in the world. Using data from the 2005 China census -- the most recent -- a study published in last month's British Journal of Medicine estimates there was a surplus of 32 million males under the age of 20 at the time the census was taken. That's roughly the size of Canada's population.

Now some of these men have reached marriageable age, resulting in intense competition for spouses, especially in rural areas. It also appears to have caused a sharp spike in bride prices and betrothal gifts. The higher prices are even found in big cities such as Tianjin.

A study by Columbia University economist Shang-Jin Wei found that some areas in China with a high proportion of males have an above-average savings rate, even after accounting for factors such as education levels, income and life-expectancy rates. Areas with more men than women, the study notes, also have low spending rates -- suggesting that many rural Chinese may be saving up for bride prices.

How easy money feuled another round of commmodities speculation

WSJ reports:

With oil inventories high and demand down year on year, yet prices surging, "fundamentalists" are puzzled. Market participants, however, always have an eye on the future and locking in a profit.

Recently, commodities bulls have been aided by the Federal Reserve keeping rates low and banks' short-term funding flowing. This facilitates commodities trading and stokes fears of inflation. As cash flows into oil futures, their prices rise relative to spot prices. That makes it profitable to buy physical oil, store it and sell it forward.

Energy economist Phil Verleger demonstrates how lucrative this can be. On March 1, the cash price of light, sweet crude was $40.15 a barrel, while the 12-month forward contract sold for $50.26. Assume an investor bought the physical barrel borrowing 80% of the money at a rate of 3%, sold it forward, and paid 50 cents a month for storage. The resulting profit of $3.15 a barrel equates to a 39% return on investment.

[crude oil chart]

In reality, financing and storage costs aren't static. As spot prices have risen faster than futures, the spread has narrowed and the volatile trade recently turned unprofitable: On Friday, the return was zero.

Rapid liquidation of inventories could crash prices. Financial-services provider GaveKal puts global commercial inventories at six billion barrels. Crudely calculated, that is more than $400 billion of precious working capital tied up.

Yet oil has held up. Inflation fears aside, the "green shoots" thesis also lends support, although this is self-reinforcing: The more optimism on the economy, the more oil prices rise, fueling more optimism. On that reading, last July's $145 a barrel should have betokened eternal prosperity.


More here

Friday, June 05, 2009

Unemployment rate surges to 9.4%

The double digit unemployment rate is sure to follow. Implication: the economy may be in a recovery, but businesses will continue to shed jobs. Any economic recovery will be slow and shallow, if any at all.

In historical perspective:

(click to enlarge; graph courtesy of calculatedrisk)

Thursday, June 04, 2009

Decoupling is NOT dead

Th decoupling is not dead. China may well lead the world out of this severe downturn, for the first time. Watch this short analysis from FT:

China buys Hummer: Simply stupid!

I don't know what's the drive behind the purchase. But unless the Chinese company can make Hummer gas efficient and clean in the already very polluted country, the purchase was simply stupid.  I hope Chinese government won't let the deal pass.

Comments from Wall Street Journal:

A Rough Drive With the Hummer

The idea of an obscure Chinese heavy equipment maker buying up Hummer is entertainingly left field for most onlookers.

Chinese government officials will likely be tearing their hair out.

For sure, Beijing is keen for Chinese companies to expand overseas. But they're also hoping for some common sense.

Vice Premier Wang Qishan recently railed against Chinese acquisitions made by managements with little overseas experience, in markets where they don't understand labor relations or even the language.

Yet here is Sichuan Tengzhong Heavy Industrial Machinery – a company whose key overseas markets are Vietnam, Pakistan, and Bangladesh, and whose management speaks little English – venturing to turn around a struggling American icon.

Having a Chinese company bid for the mother of all gas-guzzling car manufacturers isn't exactly a snug fit with Beijing's efforts to promote a more environmentally friendly image for the country.

Those familiar with the so-far unheralded Sichuan Tengzhong point to its decent track record in manufacturing a variety of industrial products, having steadily accumulated businesses in China.

The bid for Hummer, it's said, has been carefully considered, with due attention to cultural differences: The Chinese company will leave Hummer management in place, treating the deal almost like a private equity investment.

That's as it may be. But the track record of cross-border auto sector deals, especially in niche markets like the Hummer, isn't great.

Tata Motor's travails with Land Rover and Jaguar spring to mind as recent less-than-favorable examples. Hummer's market even in the U.S. is fading fast, with sales halving last year.

Sichuan Tengzhong's bet is that the market can recover: the Hummer may seem antediluvian these days, but there may be enough takers when the economy recovers.

In financial terms, this is a small deal, even at the upper end of the estimated $500 million price tag.

But it's a deal rich with symbolism. That won't have escaped the Chinese leadership – the pressure is truly on Sichuan Tengzhong to make this deal a success.

Wednesday, June 03, 2009

Bernanke on the current state of the economy

Tuesday, June 02, 2009

Top ten locations of America's high-tech economy

We all know about Silicon Valley, but where are the top places for America's high-tech industries and innovations? Look at this newest rank from Milken Institute.

(click to enlarge)

Link to the interactive map

China: America's banker

Geithner goes to China to reassure China that its assets are safe. Hear this lively discussion from On Point on the ecoomic relation between China and US --- Does China have a choice? What does it mean when the US is the one saying "PLEASE".

(pictured above is Tim Geithner holding his photos taken 28 years ago at Beijing University when he was an exchange student there).

Monday, June 01, 2009

Gary Becker: Is the world center of gravity moving to Asia???

Gary Becker thinks Asia's future looks bright:

Is the World Economic Center of Gravity Moving to Asia?

The short answer is "yes", although not immediately, and not inevitably. My reasons for an affirmative answer are partly demographic and partly economic. Asia has a large fraction of the world's population, and their biggest economies are generally experiencing rapid growth as they narrow the gap in living standards with the West. 

To start with the demographics, about 4 billion persons, or almost 60% of the world's population, live in Asia. India and China alone have about 2 ½ billion individuals. Other Asian countries with populations in excess of 100 million are Japan, Indonesia, Pakistan and Bangladesh, while Vietnam and the Philippines each have almost 100 million persons. In addition, Asia's population is growing much faster than that of either Europe or North America, so that 20 years into the future, Asians will constitute more than 2/3 of the total world population.

By contrast, the whole European Union has only about 500 million people, and the very low birth rates in almost all countries within this Union imply that its population will be falling over time, unless offset by steep levels of immigration. The United States is still growing- partly fueled by considerable immigration- but more slowly than Asia's. As a result, the populations of Europe and North America will decline over time, perhaps absolutely but surely relative to the growing numbers in the rest of the world.

Large populations alone do not have much impact on the world economy, as seen from the rather minor economic influence of both China and India prior to 1980, or the unimportance to the world economy of Sub-Sahara Africa's 800 million persons. Asia must have rapid economic growth during the coming several decades for it to become the major player in the economic world. Fortunately for them, China, India, Indonesia, Vietnam, and some of the other larger Asian countries discovered during the past 20 years many of the vital ingredients required to produce economic progress. 

These ingredients include first of all a reliance on private companies and competition, and a much smaller role for government direction of the economy. China started along this path in the late 1970s, while India began to throw off its socialist traditions in the late 1980s and early 1990s. Second in importance is the utilization of the world economy to find markets for Asian exports, and to attract foreign capital to finance its rapid industrialization, although India has lagged far behind China in using both world capital and world markets. Most Asian countries also have recognized that human capital is the foundation of modern knowledge-based economies, and they have begun to emphasize investments in education and training.

As a result of these and related policy shifts, Asia as a whole experienced rapid economic growth during the past 20 years, and has narrowed the gap in per capita incomes with the rich countries of Europe and North America. The major Asian economies are likely to continue to grow rapidly for the next decade, and perhaps well beyond that decade, given how far behind Asian per capita incomes still are, the thirst of most of its population to become rich like the West, and the momentum their economies have built up. I say "perhaps" beyond the next decade because one cannot be sure that leading Asian countries will not shift away from growth-producing policies in the more distant future.

Its rapid growth in both per capita income and population implies that Asia's importance in the world economy will increase quite rapidly. As a result, Asia will become a far more important source of consumer demand not only for products made in Asia, but also for exports from America and the EU. In addition, it is likely that researchers and companies in Japan, China, India, and elsewhere in Asia will generate an increasing share of the world's important innovations.

Greater economic dominance of Asia does not necessarily mean that the United States will not continue to be the world's leader in per capita income and innovation. The development of Asia can stimulate the US and the EU economies by providing greater opportunities for trade, including valuable imports and large markets for its exports, and other advantages from having a more developed and larger Asia. The economic threat to the West is not Asia's development, but it is government excessive interference in the performance of markets, like the automobile bailout in the US, that may choke the very competitive system that created Western wealth, and demonstrated how to become rich to countries elsewhere.

To be sure, as the economic center shifts to Asia, that continent will expect much greater influence over international institutions, like the IMF and the World Bank, ia greater role in determining common international trade policies, more say on climate policies, and on many other world economic issues. The larger Asian countries will also expect to have a more important role in determining world security and anti-terrorist policies. On security issues and possibly on climate and some other international questions, major conflicts might well emerge between countries like China and India, and the United States and the EU.