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Thursday, June 30, 2005

The real smart guys

Jim Simons and Renaissance want to raise a $100B fund! And why not, they're the best in the hedge fund business. In an earlier post I compared them to Long Term Capital Management. Let's see, two economics Nobelists (Merton and Scholes) who invented options pricing and a bunch of overconfident Salomon traders, versus a bunch of physics and math PhDs. I know who I'd bet on!

WSJ:

Renaissance's Man: James Simons Does The Math on Fund
By GREGORY ZUCKERMAN
Staff Reporter of THE WALL STREET JOURNAL
July 1, 2005; Page C1

It is getting harder for hedge-fund managers to generate above-average returns when their funds grow too big, right?

Tell that to James Simons.

Mr. Simons, a world-class mathematician who runs Renaissance Technologies Corp., is creating a buzz in the hedge-fund world because he is about to launch a fund that he claims could handle $100 billion -- about 10% of all assets managed by hedge funds today. It will have a minimum investment of $20 million, and is aimed at institutional investors, according to early marketing materials.

Mr. Simons, whose net worth has been estimated at $2.5 billion, has seen Renaissance's $5 billion flagship Medallion hedge fund earn an average of 34% annually since it began in 1988, making it the most successful fund during the period. These returns, which are audited, come even after fees that now are -- get this -- 5% of assets and 44% of all investment gains. That is more than double what other hedge funds typically charge.

So far this year, Medallion is up about 12%, amid losses for the overall market. Mr. Simons has done it with computer-driven, short-term trading in various markets. The firm won't divulge details of its strategy, even to its own investors. Other funds use the same strategy but are far less successful.

The new fund will take a different approach: focusing on the U.S. stock market and holding investments for more than a year.

Medallion hasn't been open to new investors for 12 years, and Mr. Simons, 67 years old, has been returning money to existing investors, convinced that returns would suffer if the fund got too big. In fact, the firm is expected to return outside investors' remaining money at year's end, leaving Mr. Simons and his employees as Medallion's sole investors and the fund about as large as it is now. Dealing with few investors has helped the publicity-shy Mr. Simons stay below the radar screen.

Mr. Simons declined requests for comment. A Renaissance spokesman wouldn't comment on the new fund, which will be called the Renaissance Institutional Equities Fund.

The latest effort -- even if it never reaches the $100 billion mark -- would seem to run up against Renaissance's instincts to keep a lid on assets. Indeed, many managers have found that more money under management can put a crimp on results. Investors briefed on the new fund say it will differ from the existing Medallion hedge fund by aiming for tamer returns that would enable it to handle the greater sums.

The new fund marks the latest encroachment of hedge funds into the lucrative market of investing money for pension plans and other institutional investors, turf that traditional money-management firms like mutual funds have clung to. The fund will use complex quantitative models, developed by the 60 or so mathematics and physics Ph.D.s on staff. The fund will aim to beat the returns of the Standard & Poor's 500-stock index but with lower volatility.

Though Mr. Simons isn't well known, even on Wall Street, his track record likely will spur strong interest in the fund, investors say. Renaissance's 34% annual average returns since 1988 top every other hedge fund in that time period, according to Antoine Bernheim, who publishes the U.S. Offshore Funds Directory, which tracks over 1,000 hedge funds. By comparison, George Soros's Quantum Fund has climbed about 22% annually since 1988, while the Standard & Poor's 500 rose 9.6% annually.

Medallion, which hasn't had a down month in the past two years, according to one investor, has distributed so much money to its investors over the years that they haven't been able to reinvest these gains to take advantage of the big returns -- likely whetting investor appetite for the new fund.

Though prior performance doesn't guarantee the new fund's success, it will share Medallion's scientific approach, and is based on Medallion's "technology," according to the marketing materials.

"Renaissance's returns are 10 percentage points higher than legendary investors such as [Bruce] Kovner, Soros, Paul Tudor Jones, [Louis] Bacon and [Mark] Kingdon," Mr. Bernheim says. "He's in a different class from everyone else."

But while Mr. Simons will levy lower fees, such as about 2% of assets, to attract interest in his new fund, he also may have to disclose more details about trades than he is accustomed to. That is because pension plans, and their consultants, usually require a full briefing about strategies of firms they invest with.

"It's pretty much a black box. People that work there are sworn to secrecy; it's a proprietary trading strategy," says Jeffrey Tarrant, president and chief investment officer of Protege Partners LLC, based in New York, an investor in Renaissance.

Mr. Simons began his career as a professor of mathematics, teaching at the Massachusetts Institute of Technology and Harvard University. He helped develop a geometry theorem, called Chern-Simons, that is a critical tool for theoretical physics.

"It's startling to see such a highly successful mathematician achieve success in another field," says Edward Witten, professor of physics at the Institute for Advanced Study in Princeton, N.J., and considered by many of his peers to be the most accomplished theoretical physicist alive.

After breaking military codes for the government during the Vietnam War, Mr. Simons turned to money management. He hires specialists in applied math, quantum physics and linguistics for Renaissance's office in East Setauket on New York's Long Island. Hardly any have a Wall Street background. The firm relies on a system to make thousands of rapid-fire, short-term trades daily to take advantage of small, fleeting anomalies in various markets.

Wednesday, June 29, 2005

FX update

According to BIS figures published this week global central bank currency reserve diversification has been larger and faster than previously thought. Stories of central banks divesting their dollar holdings have been common in the past two years. However, hard evidence is difficult to come by as official data is only available on a sporadic basis in the form of the BIS and IMF annual report. The latest BIS annual report published this week, therefore, provides an important benchmark to the extent and pace of diversification. In a break from the past, this year the BIS published a series of the dollar’s share of global FX reserves in constant (2003) exchange rates. This controls for the variations in exchange rates that can depress or exaggerate a currency’s share in reserves. For example the weakness of the US dollar in the past three years would tend to deflate the dollar’s share of reserves even if the actual holdings of dollar reserves were constant.

Surprisingly, the BIS numbers are somewhat different to those published in the IMF annual report in September 2004. At the end of June 2004, the BIS estimate that 65.5% of reserves were held in US dollars. While this is not significantly different from the IMF reading of 63.8% at the end of 2003, the pace of reduction in dollar holdings is far quicker in the BIS data set. The share has fallen from 77% in 2001 (see chart for more details). The BIS also shows that the euro has been the main beneficiary of this change, with the share of euro reserves more than doubling since 1999 to 23.6%. (Source: State Street, via our correspondent)





At present the main currencies are not far from their post BW I averages in real effective terms. The NZD, GBP, TWD, SEK and SGD were the only currencies that were more than 15% off their respective averages:



Monday, June 27, 2005

Google payments

Rumors have been around for some time that Google will roll out a payment system. Company representatives have said it won't be a person to person payment system like PayPal. I suspect it will be a micropayment system that lets users pay for content out of their Google Wallet. This is a crucial component of the Internet ecosystem that has been needed for some time, and Google is one of the few entities with enough clout, eyeballs and technical capability to roll it out. It will enable Web publishers large and small to sell content, going beyond the current Google AdWords model which allows ad sales. This would allow publishers ranging from the very big (Slate, Salon, New Yorker, Time, etc.) to the very small (individual bloggers) to monetize both new and old content.

In a related development, Google is readying a platform that allows people to upload video and make it available for distribution. A natural step will be for video auteurs to charge a fee for each viewing, or for Google to split fees with content providers for footage from news, sports, movies, etc. Google has already reportedly made a lot of progress in video search.

While I'm impressed with Google's string of innovations (images, Gmail, maps, etc.) I still think the stock is overpriced at $300 :-)

Saturday, June 25, 2005

AI update

Two tidbits from the inexorable advance of artificial intelligence.

1) Two amateurs from New Hampshire (a database administrator and a soccer coach) won a recent international "freestyle" chess tournament, which included several grandmasters. Freestyle chess is team competition, including both humans and computers. The winning team (ZackS, anonymous throughout the tournament) used ordinary PCs and commercial chess software. Nevertheless, their play was so spectacular that many suspected the presence of Gary Kasparov!

The other untitled team, ZackS, is a dark horse. The identity of the people behind this team, and the method they are using, will be revealed after the tournament is over. Everybody assumes that there are one or more GMs working together with the team captain. The rumour was that Garry Kasparov was producing the extraordinary chess displayed by ZackS, but we can confirm that on the weekend of the quarter-finals Kasparov was most certainly otherwise engaged.

The standard of play is very high, possibly the highest ever seen in chess at these time controls. One would scarcely expect a human player, even the best in the world, to be able to face the precision and the strategic depth of some of the participants in this event.


2) An AI program has matched the average human performance on the verbal analogies portion of the SAT. (You know, "fish is to sea as monkey is to ...?") This is far short of passing the Turing test, but still an impressive feat of extracting relations from computer analysis of a terabyte of text. The program was written by Peter D. Turney's Interactive Information Group, Institute for Information Technology of the National Research Council Canada.

Thursday, June 23, 2005

How you got here

Below are the top keyword searches that led people to this blog in the past 24 hours. Apparently my post on the time travel movie Primer is popular. Other topics of interest: China, hedge funds, globalization, financial bubbles and the occasional wormhole...

Num Perc. Search Term
10 25.00% primer movie
3 7.50% china climbing
2 5.00% single-digit millionaires
2 5.00% why not hyperinflation
2 5.00% primer/movie
1 2.50% emerging markets debt processing
1 2.50% analyzing hedge fund returns
1 2.50% information processing in brain
1 2.50% advantages and disadvantages of globalization
1 2.50% ltcm today
1 2.50% horvitz cleveland
1 2.50% daniel kahneman and amos tversky
1 2.50% jeremy grantham 2005 interview
1 2.50% john d gartner the hypomanic hedge
1 2.50% cds implied volatility
1 2.50% asness bubble logic
1 2.50% tennessee candidate issues
1 2.50% china-japan relations
1 2.50% all about wormholes
1 2.50% cdx index
1 2.50% china explaining high savings
1 2.50% price to rent ratios
1 2.50% sony vs samsung tv
1 2.50% global real interest rates
1 2.50% why long bonds
1 2.50% price to rent ratio

Tuesday, June 21, 2005

Greetings from startup land

Sorry for the lack of posts recently. I'm in the bay area right now, setting up our new offices. Commercial real estate is still a bargain here - we looked at a number of places at around $1 per sq ft, full service. For example, I happened to see a nice 2000 sq ft live-work loft near the Berkeley-Oakland border for only $2k per month. Why buy an $800k house when you can rent a nice space like that? Certainly says something about price to rent ratios here :-)

We ended up renting a place between downtown Oakland and lake Merritt (not far from Chinatown). It's an up and coming area with lots of interesting restaurants. We've filled our 2000 sq ft offices with IKEA office furniture and Dell computers (very happy to be rid of that horrible U-Haul truck). My office here is now nicer than at the university or at home... The last tenants left us a closet filled with switches and some old servers, so they were pretty sophisticated themselves. I guess every small business these days has some network plumbing in the walls.

We're pretty happy with the team we've hired. We found the majority of our guys via Stanford and Berkeley, but struck out this time at Caltech, my alma mater!

Now it's into stealth mode... look for our beta release near the end of the year :-)

Friday, June 17, 2005

Economist on global housing bubble

Informed readers are already familiar with the situation, but the Economist as usual does a wonderful job of summarizing. In the first figure, note the oscillation of price/rent about the long-term average. In the second figure, you see a possible decades-long unwinding of the bubble, as in Japan.

Robert Shiller (quoted in the article) has called this the biggest bubble of all time, and the Economist agrees. In addition, his research shows only a tiny (.4% per year) real return on US house prices over the last century, contrary to conventional wisdom.






The most compelling evidence that home prices are over-valued in many countries is the diverging relationship between house prices and rents. The ratio of prices to rents is a sort of price/earnings ratio for the housing market. Just as the price of a share should equal the discounted present value of future dividends, so the price of a house should reflect the future benefits of ownership, either as rental income for an investor or the rent saved by an owner-occupier.

Calculations by The Economist show that house prices have hit record levels in relation to rents in America, Britain, Australia, New Zealand, France, Spain, the Netherlands, Ireland and Belgium. This suggests that homes are even more over-valued than at previous peaks, from which prices typically fell in real terms. House prices are also at record levels in relation to incomes in these nine countries.

...To bring the ratio of prices to rents back to some sort of fair value, either rents must rise sharply or prices must fall. After many previous house-price booms most of the adjustment came through inflation pushing up rents and incomes, while home prices stayed broadly flat. But today, with inflation much lower, a similar process would take years. For example, if rents rise by an annual 2.5%, house prices would need to remain flat for 12 years to bring America's ratio of house prices to rents back to its long-term norm. Elsewhere it would take even longer. It seems more likely, then, that prices will fall.

A common objection to this analysis is that low interest rates make buying a home cheaper and so justify higher prices in relation to rents. But this argument is incorrectly based on nominal, not real, interest rates and so ignores the impact of inflation in eroding the real burden of mortgage debt. If real interest rates are permanently lower, this could indeed justify higher prices in relation to rents or income. For example, real rates in Ireland and Spain were reduced significantly by these countries' membership of Europe's single currency—though not by enough to explain all of the surge in house prices. But in America and Britain, real after-tax interest rates are not especially low by historical standards.

...Another mantra of housing bulls in America is that national average house prices have never fallen for a full year since modern statistics began. Yet outside America, many countries have at some time experienced a drop in average house prices, such as Britain and Sweden in the early 1990s and Japan over the past decade. So why should America be immune? Alan Greenspan, chairman of America's Federal Reserve, accepts that there are some local bubbles, but dismisses the idea of a national housing bubble that could harm the whole economy if it bursts. America has in the past seen sharp regional price declines, for example in Boston, Manhattan and San Francisco in the early 1990s. This time, with prices looking overvalued in more states than ever in the past, average American prices may well fall for the first time since the Great Depression.

But even if prices in America do dip, insist the optimists, they will quickly resume their rising trend, because real house prices always rise strongly in the long term. Robert Shiller, a Yale economist, who has just updated his book “Irrational Exuberance” (first published on the eve of the stockmarket collapse in 2000), disagrees. He estimates that house prices in America rose by an annual average of only 0.4% in real terms between 1890 and 2004. And if the current boom is stripped out of the figures, along with the period after the second world war when the government offered subsidies for returning soldiers, artificially inflating prices, real house prices have been flat or falling most of the time. Another sobering warning is that after British house prices fell in the early 1990s, it took at least a decade before they returned to their previous peak, after adjusting for inflation.

Thursday, June 16, 2005

Asian-Americans hurt by affirmative action

From Gene Expression, results of a new Princeton study showing that if affirmative action were eliminated at elite universities, 80% of the previously reserved slots would go to Asian Americans. I predict little or no protest from model-minority Asians over this. The paper can be found here, but you need a subscription to Social Science Quarterly to read it.

The researchers' results seem to be in agreement with what happened at Berkeley after UC was forced to drop affirmative action - the main effect was a drop in the numbers of black and hispanic students, a big increase in the number of Asians and little effect on the white population.

Why wouldn't white and Asian-American applicants benefit equally if admission were purely by merit? It sounds suspiciously like the quota system imposed on Jews early in the 20th century. Previous research by these authors showed that being Asian was statistically equivalent to a penalty of 50 points on SAT score. (Probably due to preference awarded to "legacies", who are predominantly white.)

Disregarding race in college admissions would cause sharp drops in the number of black and Hispanic students at elite institutions, according to a new study by two researchers at Princeton University. The study, described in an article published in the June issue of Social Science Quarterly, also found that eliminating affirmative action would significantly raise the number of Asian-American students, while having little effect on white students.

If affirmative action were eliminated, the acceptance rates for black applicants would fall to 12.2 percent from 33.7 percent, while the acceptance rates for Hispanic applicants would drop to 12.9 percent from 26.8 percent, according to the study. Asian-American students would fill nearly 80 percent of the spaces not taken by black and Hispanic students, the researchers found, while the acceptance rate for white students would increase by less than 1 percent.

The researchers who conducted the study -- Thomas J. Espenshade, a professor of sociology, and Chang Y. Chung, a statistical programmer at Princeton's Office of Population Research -- looked at the race, sex, SAT scores, and legacy status, among other characteristics, of more than 124,000 applicants to elite colleges.

Tuesday, June 14, 2005

US High-Tech Economy Slipping

Here are some specific data on US high-tech competitiveness from Physics Today. (See related post here.)

Education
* Undergraduate science and engineering degrees are being awarded in the US at a lower rate than in other countries. The ratio of college undergraduate degrees in the natural sciences is only 5.7 per 100 college students in the US, while Finland, France, Ireland, Spain, Sweden, and the UK award between 8 and 13 degrees per 100 students. In Asia, Japan awards 8 per 100, and Taiwan and South Korea each award about 11 per 100.
* The US has a smaller share of the worldwide total of science and engineering doctoral degrees awarded each year than either Asia or Europe. In 2000, about 89 000 of the 114 000 doctoral degrees given in science and engineering were earned outside the US.

Workforce
* From 1994 to 1998, the number of Chinese, South Korean, and Taiwanese students who chose to pursue PhDs in their own countries nearly doubled. By contrast, over that same period, the number of students from those countries pursuing PhDs at US universities dropped 19%, from 4982 to 4029.
* Since 1980, the number of science and engineering positions in the US has grown at almost five times the rate of the US civilian workforce as a whole.

Knowledge creation
* The US share of science and engineering papers worldwide declined from 38% in 1988 to 31% in 2001. Europe and Asia are responsible for the bulk of the growth in scientific papers in recent years.
* From 1988 to 2001, the US increased its number of published science and engineering articles by only 13%, while Western Europe increased its article output by 59%, Japan by 67%, and East Asia by 492%. Though both Japan and East Asia started from a far smaller base in 1988 and still do not publish as many articles as the US, their dramatic growth rates are striking.

R&D investment
* From 1995 through 2001, China, South Korea, and Taiwan collectively increased their gross R&D investments by about 140%, while the US increased its by 34%.
* US federal funding of basic research in engineering and physical sciences has experienced little to no growth over the last 30 years. As a percentage of gross domestic product, funding for physical sciences has been in a 30-year decline.

High-technology economy
* From 1980 to 2001, the US share of worldwide high-tech exports fell from 31% to 18%. At the same time, the global share for China, South Korea, and other emerging Asian economies increased from 7% to 25%.
* During the 1990s, the US maintained a trade surplus for high-tech products even as the trade balance for other goods plummeted. But since 2001, even the trade balance for high-tech goods has fallen into deficit.

The benchmarks note that even in nanotechnology, a heavily supported US research priority, Japan and China may have already surpassed the US. While the US is "supplying 25% of the global federal funding for nanotechnology," the benchmarks say, "Japan makes certain that its national nanotechnology initiative meets or exceeds the funding levels approved in the US. The European community is doing the same."

Monday, June 13, 2005

Financial Times on global savings glut

A strong endorsement of Bernanke's views. This article is long, but gives a fairly accurate picture of where we are and how we got here.


The paradox of thrift

Financial Times, Monday, June 13, 2005

Strange things are happening in the world economy: falling interest rates on long-term securities, declining spreads between returns on safe and riskier assets, large fiscal deficits and huge global current account "imbalances" should not, in normal circumstances, coincide. So what is going on?

Alan Greenspan, chairman of the Federal Reserve, admits that he is puzzled. He has referred to the decline in interest rates on long-term bonds at a time of rising short-term rates as a "conundrum". He returned to the issue last week when he remarked that "the unusual behaviour ofl ong-term rates first became apparent almost a year ago." Markets tried to push long-term rates up early last summer and again in March this year, but in both cases "forces came into play to make those increases short-lived. But what," continued Mr Greenspan, "are those forces? Clearly, they are not operating solely in the United States."

Mr Greenspan is correct. The changes are global. So, then, must be the forces at work. What are they? The answer, in a nutshell, is a global excess of desired savings against the background of weak investment, low inflation and ever more integrated economies.

Mr Greenspan's former colleague, Ben Bernanke, has already referred directly to excessive savings in explaining the explosive growth in the US current account deficit. In doing so, he took issue "with the common view that the recent deterioration in the US current account primarily reflects economic policies and other economic developments within the United States itself". Instead, hed eveloped what he called an "unconventional" perspective that seeks the explanation in the emergence of a "global savings glut". He was right to do so.

To understand the present we need to go back to the 1930s. The "paradox of thrift" was the most counterintuitive and, to the classically trained economist, morally, theoretically and practically objectionable idea in John MaynardK eynes' General Theory of Employment, Interest and Money, published in 1936, in response to the Great Depression. It is possible, he argued, for the private sector to want to save more than it wishes to invest. That is the paradox: what is good for individuals can be bad for an economy.T oday, at the beginning of a new millennium, Keynes' warning is again apposite.

Unfortunately, in certain circumstances, even lower interest rates may fail to clear the market for investible funds. This is particularly likely if inflation is low - and still more likely if it is negative, as has been the case in Japan for many years. Large fiscal deficits may then be needed to mop up the excess savings, as has also been the case in Japan. Otherwise, the economy may fall into a slump.

We are living once again in such a Keynesian world. How then does the argument work? What is the evidence to support it? What are the consequent dangers for the world economy? And what needs to be done?

Let us start with the economic argument. One likely outcome of a world of excessd esired private sector savings will be high fiscal deficits. These emerge partly in response to cyclical weaknesses and partly to "kick start" sluggish economies. In these circumstances, however, fiscal deficits will not crowd out private spending, but rather crowd it in, by sustaining current income and expenditures.

Another likely outcome will be "reaching for yield". High desired savings will lower real rates of interest, and so real return on capital, below "normal" levels. In response investors are likely to move towards riskiera ssets. If the riskiness of previously high-risk investments is also believed to be lower, perhaps because of success in stabilising inflation at low levels this tendency will be strengthened.

Again, if high desired private sector savings are not offset by monetary or fiscal policy action, current account surpluses will emerge in some economies. Attempts to keep the exchange rate down will support this outcome. These are, in the language of the 1930s, Some trading partners will then need to tolerate offsetting deficits. In effect, deficit countries act as spenders of last resort in the world economy.

Now turn to our second big question: how well does the evidence fit the story? Remarkably well, is the answer.

We can identify only realised, rather than desired, savings. Yet we can note that the global savings rate ran at the exceptionally high level of 25 per cent of global output last year. The striking features are the extraordinarily high, and rising, savings rate of the emerging market economies and the low, and falling, savings rates of the US (and the UK).

The private sectors of the eurozone and Japan, which generate one-third of world gross domestic product at market prices between them (22 per cent from the eurozone and 11 per cent from Japan), are running substantial surpluses of income over expenditure.

In both, the principal offset to high private sector financial surpluses has been government deficits. Japan's fiscal deficit absorbed just over 60 per cent of the country's private sector surplus in 2004 (with the rest going into the current account), while the eurozone's fiscal deficits absorbed over 80 per cent of the private sector surplus.

Despite the fiscal deficits, rough and ready estimates suggest that real long-term interest rates are below 2 per cent in Japan and Germany. But real interest rates are low worldwide. According to the International Monetary Fund's latest World Economic Outlook, they have not been this low since the 1970s . Then, real interest rates were low because of unexpected inflation. This time, however, low real interest rates are expected: US and UK government index-linked government bonds are yielding only 1½ per cent, which is less than half their level prior to the late 1990s. Moreover, inflation risk premiums have fallen since the late 1990s in both the US and UK.

Default risk premiums on emerging market and riskier corporate debt have also declined. Since October 2002, spreads over US treasuries of emerging market debt have fallen by 600 basis points, according to the JPMorgan index. This reflects not only the reaching for yield, but also an understandable perception of greater stability in thesee conomies: inflation is down, balance of payments positions are stronger, as we shall see, and the last worldwide emerging market financial crisis ended some six years ago.

Finally, there are those notorious external imbalances. As Maurice Obstfeld of the University of California at Berkeley and Kenneth Rogoff of Harvard point out, "incredibly, the US current account deficit is currently soaking up about 75 per cent of the combined current account surpluses of Germany, Japan, China and all the world's surplus countries". Meanwhile, the rest of the world is running a surplus of savings over domestic investment of around one-eighth of its gross savings.

...Particularly striking has been the shift for the emerging market economies as a group. Prior to 1997, they ran sizeable current account deficits, financed by private capital inflows. Since then they have moved into enormous current account surpluses, combined with huge private capital inflows.

Why has this turnround happened? The most important explanation was the financial crises of the late 1990s, which made everyone more cautious. Two-thirds of the Asian emerging market economies' swing from current account deficits to huge surplus occurred between 1996 and 1998 alone. Thec rises have cast long shadows. Also significant, however, have been the recent oil price rises: the Middle East's current account surplus jumped from $29bn in 2002 to $113bn in 2004.

The US has been accommodating the excess savings of the rest of the world, while attempting to run its economy in line with potential. One way of thinking about this is that in a global economy with no global government, the most important regional power - the US - has been following the Keynesian recommendation by offsetting excess desired savingse lsewhere. The US authorities did not intend to do that. But that is what they have had to do to generate a decent recovery at home.

Foreign governments have, more over, played a huge part in sustaining their domestic excess savings. According to statistics on the US balance of payments, 42 per cent of the net funding of the US currenta ccount deficits between 2002 and 2004 came from official sources. But these flows are the result of official intervention, combined with sufficiently tight monetary and fiscal policies - and direct intervention in credit markets - to sustain the domestic savings that are the counterpart of the official flows. In other words, the excess savings are in part a policy choice, except in Japan, where they are happening more naturally.

Yet another way of seeing the same thing is in accumulations of foreign currency reserves. In just the three years from 2002 to 2004, foreign currency reserves rose by $1,680bn to reach a total of $3,730bn.

...It cannot make sense for these relatively poor countries to devolve the task of borrowing and spending on to the vastly richer US. If the people of emerging economies are to lend on a vast scale to any governments, it should surely be to their own governments, which should be able to find better use for the funds now being poured into foreign currency reserves. As the rest of the world starts to shrink its excess savings, the US should expand its savings as well, largely by reducing the structural fiscal deficit.

...Large exchange rate changes will also be needed, to facilitate the adjustment process. All academic analyses of global balance of payments adjustment conclude that this will require large changes in relative prices or, to put it morep recisely, in real exchange rates. Under plausible assumptions, the required adjustment is two times larger than the real depreciation of the dollar that has occurred so far. Some estimates are much larger still. Precisely how much of a depreciation will be needed depends on how large a US current account deficit and net liability position proves sustainable.

Friday, June 10, 2005

Monkey money

Steve Levitt (my former colleague in the Society of Fellows at Harvard, now a famous economist and author of the bestseller Freakonomics) writes on Yale professor Keith Chen's research on monkey economics (Times magazine). Apparently capuchins can be taught to use metal slugs as a unit of exchange. Chen has already observed theft, prostitution and loss aversion among the little fellows. Perhaps Chen can stimulate an investment bubble in grapes by lowering interest rates? :-)

See here for video and pictures of Chen, his Yale capuchins (they understand money), and Harvard tamarins (they play prisoner's dilemma).


"It is sometimes unclear, even to Chen himself, exactly what he is working on. When he and Santos, his psychologist collaborator, began to teach the Yale capuchins to use money, he had no pressing research theme. The essential idea was to give a monkey a dollar and see what it did with it. The currency Chen settled on was a silver disc, one inch in diameter, with a hole in the middle -- ''kind of like Chinese money,'' he says. It took several months of rudimentary repetition to teach the monkeys that these tokens were valuable as a means of exchange for a treat and would be similarly valuable the next day. Having gained that understanding, a capuchin would then be presented with 12 tokens on a tray and have to decide how many to surrender for, say, Jell-O cubes versus grapes. This first step allowed each capuchin to reveal its preferences and to grasp the concept of budgeting.

...But these facts remain: When taught to use money, a group of capuchin monkeys responded quite rationally to simple incentives; responded irrationally to risky gambles; failed to save; stole when they could; used money for food and, on occasion, sex. In other words, they behaved a good bit like the creature that most of Chen's more traditional colleagues study: Homo sapiens."

Wednesday, June 08, 2005

Thought police slipping...

I was amazed to find this Economist article, discussing a possible evolutionary explanation of high intelligence (and high incidence of genetic diseases) in the Ashkenazi Jewish population. The Times also covered the story (although not as well), and the research paper is available here. See here for lengthy discussion, including comments by the authors of the paper, and here for a critique of the paper from a historical perspective.

We can easily count the number of violations of political correctness in the article:
0) the authors assume the existence of a general human characteristic called "intelligence"
1) the authors assume intelligence is (at least somewhat) heritable
2) the authors assume IQ tests have something to do with intelligence
3) the authors discuss a particular ethnic group and the distribution of genes in that population
4) the authors assume that variation in the environment in which natural selection takes place might lead to different distributions of genes in different ethnic groups.

Let's put aside the contentious issue of whether the theory is correct in what it says about Ashkenzim (it does make testable predictions, so we can wait and see). One interesting thing I learned from background reading on this subject is that there are specific genes that are known to correlate with above-average IQ. How long until we start "overclocking" humans via genetic or chemical engineering for higher intelligence?

Sunday, June 05, 2005

Portrait of a quant

Here is a nice profile (NYT Sunday magazine) of hedge fund manager Cliff Asness. Some time ago, we discussed his research on a modified Fed model for equity valuation. Asness has a PhD from Chicago, and a quantitative style of investing. The article does a good job of explaining how hedge funds caught on with university endowments as alternative investment classes with (potentially) low correlation to the overall market, and good risk-return characteristics. Schools like Yale and Harvard led the way, with spectacular results.

Of being super rich, Asness says "Well, it doesn't suck." For a description of how the Bush tax policies favor the super rich, see here. (Those earning more than $10 million a year now pay a smaller share of their income in taxes than those making $100,000 to $200,000. So much for progressive taxation!)

Saturday, June 04, 2005

Working class heroes

The Times Sunday magazine has a nice article on the plight of the millionaire serial entrepreneur in Silicon Valley...

NYTimes:
Every community has its haves and its have-nots, but in Silicon Valley, it's the additional deep divisions and steep hierarchies among the haves that is unique: the haves and the have-everythings. It is this subtle class system among the haves that delights industry veterans like Avram Miller, a former Intel executive who is now semiretired and lives on an estate in the Northern California wine country. Miller, who has the gray, steel-wool locks of a mad scientist, casts single-digit millionaires as the working class of Silicon Valley, working stiffs lucky enough to have been part of a successful company in the 1990's but still putting in grueling hours, cranking out code, crunching numbers, devising marketing plans. They are the ones most likely to drive a car sporting the bumper sticker you occasionally see on the streets of Palo Alto or Mountain View: ''Please God, Just One More Bubble.''

Double-digit millionaires make up the area's middle class, financially independent but still striving to keep pace. They live comfortably but not ostentatiously, at least by local standards. Keeping up with the Joneses takes on a whole new meaning when your next-door neighbor drives a 660-horsepower Ferrari that starts at $643,000 and the guy down the street owns a $38 million Gulfstream V. Even a used Cessna Citation X private jet costs in the neighborhood of $12 million, plus more than half a million a year for upkeep. And the price for a modest vineyard in Napa County? If you have to ask. . .

Finally, there are the true have-everythings, the area's centimillionaires. ''To feel truly rich in Silicon Valley,'' Miller says, ''you have to be worth in the three-digit millions.''

Thursday, June 02, 2005

Greying of the professoriate

This Chronicle of Higher Ed article discusses the advancing average age of the professoriate. I can't say that I haven't noticed this trend in my own department, but at least we are doing better than the NC State econ department described in the article, which has only one professor under 40 and two thirds over 55!

"In the 16-campus University of North Carolina system, the proportion of tenured and tenure-track faculty members age 50 or older jumped from about a third in 1984 to more than half in 2001. In 1984 there were only two tenured faculty members over the age of 69. By 2001 the system had 90 such professors.

Other colleges face a similar demographic shift. A decade ago, at the University of Arizona, less than 17 percent of the tenured and tenure-track faculty members were 60 or older. Now, almost one in four professors is that old. At Wichita State University, 29 percent of the faculty were 55 or older a decade ago, and 41 percent are that old now. Nearly one out of 10 professors there is 65 or older. At private colleges, experts say, the situation is compounded: The type of pension plans that most private institutions offer tend to reward professors for working longer.

While the national population is aging as a whole, factors specific to academe magnify the trend. Ten years have passed since Congress ended mandatory retirement, a policy that had allowed colleges to require faculty members to retire at age 70. Many professors hired during the great expansion of academe in the 1960s and 70s are now reaching their golden years. And, because many people are living longer -- and need financial resources to do so comfortably -- more and more professors are delaying retirement, some of them indefinitely."

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