# Information Processing

Pessimism of the Intellect, Optimism of the Will     Archive   Favorite posts   Twitter: @steve_hsu

## Tuesday, August 30, 2005

### Gecko and Van der Waals

Apparently geckos have millions of tiny hairs on their feet (paws?) that adhere to almost any surface. As I recall, the individual hairs are actually using the Van der Waals force for adhesion. The photo is from this NYTimes article, which discusses attempts to produce artifical gecko paws for applied purposes. Imagine giant robots with sticky gecko paws :-)

I really love the third photo on the right!

### Startup update and patents

We're still in stealth mode, so no details. Our product testing is going well and the beta release on 1/1/2006 looks like a realistic target. I get to add patent filings to the list of other things I'm doing. In looking for prior art and related USPTO applications, I can't help but think that (a) academic CS research can have a really low quality threshold and (b) the software patent situation is getting out of hand.

I say (a) because of all the nutty ideas I see academics publishing that will never work in the real world. If the basic idea were deep I could see pursuing it despite impracticality. But in these papers I see obvious, trivial ideas pursued (presumably consuming significant NSF, ONR, DARPA or other funding) in great detail. On the positive side, I suppose these lame projects still serve the purpose of training students. (BTW, I am referring here specifically to applied security research, where I think real world practicality is very relevant, not something more fundamental like algorithms.)

I say (b) because of all the silly things that have been granted patents. Officially, the threshold is that an idea be "non-obvious", but many, such as the Amazon One-Click patent clearly fail that test. (Amazon has had a patent for many years now on a one-click process for online purchasing.) In security, inventors have been issued patents on ideas as vague as "method for detecting dangerous programs by matching code patterns against a database" or similar. Since companies have to protect themselves in this crazy environment, they have all become profligate submitters of applications to the USPTO. Microsoft alone has a target of 3000 patents per year! The whole system is clogged, and clogged with junk!

It is obvious why there are problems at the USPTO. It takes a very smart examiner, who keeps up with the rapid pace of technology development, to understand what is important or novel in a complex patent application. Anyone smart enough to do a good job is also smart enough to make several times as much on the other side working at an IP law firm. Also, it is not clear that there are any incentives in place to keep an examiner from having loose standards. A huge backlog of patents piling up on your desk ensures a negative merit review, but what counterbalancing mechanism is in place to discourage granting of bad patents? In rare cases, after years of litigation, a bad patent might be overturned, but are there any repercussions for the original examiner?

OK, enough ranting. As an amusing aside, this Business2.0 article lists a dozen or so ideas that VCs would like to fund. One of the ideas listed is something I previously worked on with a collaborator. We built a working prototype and shopped it to several funds before dropping it for a more promising idea (our present project). I guess we were talking to the wrong VCs! :-)

## Saturday, August 27, 2005

### Evolutionary theorist Robert Trivers

Nice Guardian profile. Trivers linked the evolution of altruism to that of an ability to detect cheaters.

...There are less dramatic examples, however, which include sharing food, helping the sick, the very young, and the old, even when we are not related to them, and sharing tools and knowledge. All these are nearly universal human habits; in fact we describe societies where they don't happen as inhuman.

This kindliness became part of human nature, Trivers argued, because kind instincts were rewarded and this happened because our ancestors lived sufficiently long lives in small stable groups to keep track of who owed whom favours. The great originality of the theory is not that it says that we are under certain circumstances naturally benevolent. Plenty of people had made that observation before. What no one had seen was that this benevolence requires a very strong sense of fairness if it is to become an established instinct. Fairness, or justice, has its roots for Trivers in the determination to see that other people are not cheating us, and taking favours without giving anything in return.

From abstract notions about the flow of genes he had come up with concrete and testable ideas about the ways our minds work; and it turned out to be demonstrably true that we find it much easier to solve logical puzzles if they are framed as if they are about cheating rather than an emotionally neutral subject, even though the two ways of putting the problem are logically equivalent.

The paper on reciprocal altruism, written before he had even gained a doctorate, has been enormously influential. Robin Dunbar, the professor of behavioural ecology at Liverpool University, says Trivers played a fundamentally important role in the development of modern evolutionary studies of behaviour and ecology. His four key early papers spawned (and continue to spawn) research in the study of both animals and humans. The importance of his contribution is beyond question. The modern field of behavioural ecology (the name under which sociobiology now travels) would simply not have been the same had he not written these papers.

### Dynamical hedging and Black-Scholes

Derman and Taleb claim that you can derive Black-Scholes without assuming instantaneous replication of the option using cash and stock. (This assumption has some practical limitations in the real world.) I always thought the replication insight very important for justifying the use of the riskless rate to discount cash flows. As the authors note, formulae equivalent to B-S were derived by others such as Samuelson, but leaving the discount rate as an unknown parameter. Once you know the option can be perfectly hedged, it becomes straightforward to price it given any model in which you can compute the expected return.

For elementary discussion, see here.

### Low returns next decade?

Barron's gives a nice analysis of historical earnings growth and P/E ratios for US equities. The inevitable conclusion? If history is any guide we are in for low returns over the next decade, with the central value for total returns at 6%, rather than the 10% we've become accustomed to. Under these assumptions, the equity risk premium will shrink considerably, and the probability that bonds beat equities becomes significant.

See earlier discussion here and here.

Earnings for the S&P 500 were $58.55 at the end of December 2004. The long-term rate of earnings growth is 6.1%. Compounding that for 10 years gives us an estimate of$105.85 in a decade. For the high and low estimates, we used the standard deviation of earnings growth of plus or minus 2.3 percentage points. Essentially, this means that two-thirds of 10-year periods will experience annual earnings growth ranging from 3.8% to 8.4%. We can then estimate that in 2014, earnings for the S&P 500 are likely to fall in the range of $85.02 to$131.17.

Over the past 55 years, the stock market has sold at an average of 16.4 times earnings, with a standard deviation of plus or minus 7.0 times earnings. This means that a reasonable range for multiples is 9.4 times to 23.4 times earnings. Using this methodology, we can estimate the likely range of values for the S&P 500 in 10 years.

The likely range for the S&P 500 Index in 2014 would be 761.59 to 3069.14. This equates to an average return of minus 1.7% per year to plus 12.2% per year. The base case scenario calls for the S&P 500 Index to be at 1735.94, a yearly 4.1% rate of appreciation. Adding dividend income of 1.9% to the appreciation yields a total return of 6.0% per year -- something between minus 1.7% and plus 12.2% a year.

## Tuesday, August 23, 2005

### Foreign investors support US housing bubble

...through their purchases of mortgage-backed securities. Note the Bank of China trader thinks the Fed will keep the bubble going for at least a few more (five?) years!

WSJ: Strong demand for mortgage-backed securities from investors world-wide is allowing American lenders to make more loans -- and riskier ones -- in a way that is helping prolong the boom in U.S. house prices.

The cash pouring in -- not only from U.S. investors but increasingly from Europe and Asia -- keeps stoking the housing market even as the Federal Reserve Board continues to raise interest rates, normally something that damps home prices. The market has shown a few signs of slowing recently, and talk of a bubble has grown louder, but prices continue to rise or remain at lofty levels as investors continue to gobble up mortgage-backed securities and banks keep lending.

"As the Fed has tightened, lenders have eased" terms for borrowers, says Mark Zandi, chief economist at Economy.com, a forecasting firm in West Chester, Pa.

Investment banks and other firms have been buying mortgage loans from lenders and packaging them into securities for sale to investors since the 1980s. But investor demand has surged in recent years, largely because in an era of low returns, mortgage-backed securities offer yield-starved investors much higher returns than government bonds.

U.S. lenders will make about $2.8 trillion in home-mortgage loans this year, according to the Mortgage Bankers Association. The MBA estimates that about 80% of these loans will end up in mortgage-backed securities. Mortgage-backed securities outstanding at the end of the first quarter totaled$4.61 trillion, up 61% since the end of 2000. In the same period, total Treasury securities outstanding grew 35% to $4.54 trillion. Investors' strong demand for mortgage debt, besides allowing lenders to offer many borrowers better terms, has also made it easier to offer mortgages to borrowers who might not easily qualify for a loan. The growth of the mortgage markets spreads the risks around. But some mortgage-industry analysts say lenders have become less stringent in their loan terms because they can sell almost any type of loan to those who package mortgage securities for investors. "Loose lending standards are probably the single biggest thing fueling the speculative fever we have today" in housing, says Kenneth Rosen, an economist who is chairman of the Fisher Center for Real Estate at the University of California at Berkeley. In a world of low interest rates, the market for mortgage securities is simply too big and profitable for many investors to ignore. Investors can earn about 5.5% on mortgage securities whose payments are guaranteed by Fannie Mae or Freddie Mac, government-sponsored companies. Those who can stomach greater risk can buy subprime mortgage securities, which come with no guarantee but can yield as much as 15%, according to Bear Stearns. By contrast, 10-year U.S. Treasurys yield about 4.2%; the equivalent government securities in Germany yield about 3.2% and in Japan 1.5%. The buyers of mortgage-backed securities include U.S. pension funds, hedge funds and insurance companies. But overseas investors are the fastest-growing source of demand. The trade publication Inside MBS & ABS estimates that foreigners held$280 billion of U.S. mortgage securities at the end of 2004, or 6% of the total outstanding. The foreigners' holdings rose 26% last year and have continued to bound ahead so far this year, Inside MBS & ABS says.

"There's this insatiable appetite for mortgage-backed securities world-wide," says Andrew Sciandra, a senior vice president at IndyMac Bancorp, a California thrift, who heads a team that creates those securities. In the past year, Mr. Sciandra has met with investors from places like Germany, France and Abu Dhabi. Asian investors now account for roughly 10% to 20% of mortgage securities sold by IndyMac.

For homeowners, the growing international demand for mortgages means it's increasingly likely that the money they borrow to buy a home or refinance their mortgage is coming ultimately from outside the U.S. When Claude Gaty, a chef and co-owner of a bistro in Las Vegas, recently refinanced the mortgage on his four-bedroom Las Vegas home, the lender was IndyMac. But the bulk of the money came from investors in Asia.

IndyMac pooled Mr. Gaty's loan with about 3,000 other mortgages that carry a fixed rate for the first three, five or seven years. Mr. Gaty is paying both principal and interest on his loan, but most of the loans in the pool are interest-only mortgages, which allow borrowers to pay no principal in the early years. When the $650 million offering of triple-A rated bonds backed by these mortgages came to market in June, it drew more than a dozen investors from Europe, Asia and the U.S., according to Deutsche Bank, which handled the deal. Such bonds typically yield 0.75 to 1.15 percentage point more than Treasurys, Deutsche Bank says. The most recent entrant to the market is China. Its banks are rich with deposits from Chinese companies that earn dollars exporting to the U.S. Dollars have also been handed to some banks by the government in Beijing as part of its efforts to strengthen their balance sheets. Until a few years ago, Chinese investors restricted U.S. investment mostly to Treasurys. Now, to boost their yields and because they consider the market safe, bankers from a number of institutions say they are devoting more of their portfolios to mortgage securities. Some bankers say their goal is to have 40% of their U.S. dollars in asset-backed securities. China's government also is testing U.S. mortgage investment. The country's Bank of Communications, the only bank with a mandate to help manage China's$700 billion of foreign-exchange reserves, has recently put a sliver of those reserves into mortgage-backed issues, according to a banker there. The State Administration of Foreign Exchange, the government agency in charge of the reserves, declined to comment.

Zhu Kai, who helps manage U.S. dollar investments at Bank of China, says in a rare interview that his mortgage-backed portfolio has "plenty of room to grow." Mr. Zhu expresses confidence in the U.S. dollar and the health of the U.S. home market. Housing is so vital to the U.S. economy, Mr. Zhu and some of his counterparts at other Chinese banks reason, that U.S. authorities will prevent a bust.

Even the recent decision by the Chinese government to raise the value of its currency by about 2% isn't likely to lead Chinese banks to shift their plans. "The timing may be a little bit surprising but we will not change our investment portfolio," Mr. Zhu says.

While Asian investors have largely focused on triple-A-rated bonds, other investors are buying lower-rated debt. These bonds, which are created when bankers carve up pools of mortgages, offer higher yields, but also bear the first risk of losses should borrowers default. Investors who buy these bonds in effect set the standards for which mortgages are made by deciding how much extra yield they need to compensate for the added risks of lower-quality loans. They include real-estate investment trusts, hedge funds and investors from Europe.

Strong investor interest has also made loans available to borrowers with poor credit and many other people who might otherwise have trouble getting a mortgage. Subprime loans included in mortgage securities totaled $401.5 billion last year, nearly double the total for 2003, according to Standard & Poor's. Meanwhile, loans with less than full documentation of the borrower's income and assets accounted for 70% of mortgage securities rated by Standard & Poor's in this year's first half, double the level recorded in 2000. "There's no question that [lending] standards have loosened over the past couple of years," says Arthur Frank, director of mortgage research at Nomura Securities International in New York. If house prices fall, "you may well have some pretty serious credit problems," hurting holders of the lower-rated mortgage securities. Mr. Zhu, the Chinese fund manager, is sanguine, for now. The U.S. housing market is "maybe losing a bit of steam," Mr. Zhu says. "I think the monetary authorities, they don't want this housing market to burst. I don't think it is a bubble. But if things go on like this for another five years, it's a different story." On a related note, the Economist can't figure out why financial markets aren't punishing economies for budget deficits. It is amazing how low real interest rates are now relative to the last 20-30 years. ...a more efficient international capital market is supposed to ensure that capital is allocated to the most productive use. Yet much of the recent inflow of foreign money into America is not financing productive investment, but a housing bubble and a consumer binge. ...The inevitable correction, when it comes, is likely to be all the more painful. When financial conditions tighten, investors are sure to become more discriminating. Sooner or later, the traffic lights will turn red. ### Man versus machine No, we're not talking about Kasparov vs. Deep Blue, or the Turing test. We're talking about bots invading online poker games! While bots have been used to play the optimal strategy in other online card games, like blackjack, poker is a different animal. The biggest obstacles lie in the amount of information unavailable to the player and the need for the program to be able to employ a variety of strategies at different times, such as bluffing and laying traps for opponents, explained Billings, a doctoral student and master poker player. “With chess – I don’t want to trivialize it – but it’s just a matter of calculation,” he said. “With poker, you really need to write a program that can think about the game and reason.” The solution, in the case of the Vex Bot, was adding a layer of artificial intelligence over its ability to calculate probabilities. “It will show you things that no human player has ever shown you before,” Billings said of the latest incarnation of the bot, which also has the ability to model its opponent’s behavior. “… One of the biggest advantages that programs have is that they have no fear, no shame. Humans can be intimidated. They will back off in the face of a very aggressive player. A bot will not. It has no compunction about doing whatever it will take to win. It will raise you with any two cards if it thinks that it has a very slight advantage based on your history. And it can induce a lot of anger and emotional upset. These things are ‘tilt monsters.’” Rao, who served as one of the testers of Vex Bot, attests to its skills. “It was a formidable foe,” he said of his initial encounter with the bot, before the addition of its new feature. “I can see that (the improved) bot, given enough hands, will become an absolute world beater.” While the Vex Bot is undeniably at the head of its class, the mere existence of bots is a sensitive subject for operators of poker sites, all of which appear to have policies prohibiting their use. ...“If you’ve got a bot that can play 25 casinos, two tables apiece, even if you’re playing a (mid-level)$10/$20 game … that’s$1,000 an hour,” he said.

And if such a bot is created, how long will its author be able to keep it secret?

“It’s only a matter of time before a talented poker player who also happens to be a good developer decides she or he wants to be remembered as the author of the first bot that changed online poker forever,” an author who goes by the screen name “loic” lamented recently in the Twoplustwo.com poker forum.

More insidious, teams of bots playing at the same table and using out-of-band communication have an even stronger advantage. Even if most online games are not yet bots vs. humans, I imagine a lot of players are using poker software for strategy while playing online. (This is called "freestyle" play in chess.)

See related Wired article.

## Saturday, August 20, 2005

### Shiller index

Robert Shiller, Yale economist and author of Irrational Exuberance, is profiled in this Times article. Shiller called the Nasdaq bubble, and has been warning recently of the current real estate bubble.

In the last post I noted that real estate has not been a particularly good long-term investment, except in the hottest markets, and even there has lagged the S&P500 over the last 25 years. In his research, Shiller has constructed an index based on repeated sales of the same house. The index shows that over very long periods of time (like 50-100 years) housing barely outperforms inflation - house prices do not even keep pace with average income growth (i.e., GDP growth), let alone share prices of companies. Although this is contrary to conventional wisdom, it is what one might expect for an inert asset in a place like the US where population densities are still low. Otherwise, families would be forced over time to spend larger and larger fractions of their incomes on shelter.

But Mr. Shiller has unearthed some rare historical housing data for other countries. Using old classified advertisements, he was then able to fashion a chart for the United States that goes back to the 19th century.

It all points to an unavoidable truth, he says. Every housing boom of the last few centuries has been followed by decades in which home values fell relative to inflation. Over the long term, the portion of income that families spend on their shelter stays about the same.

Builders become more efficient, as they are doing today. Places that were once sleepy hinterlands, like the counties south of San Francisco or a patch of desert in southern Nevada, turn into bustling centers that take pressure off prices elsewhere. Even now, the United States remains a mostly empty nation.

"This is the biggest boom we've ever had," said Mr. Shiller, who bought into the boom himself in 2002, with a vacation home near one of Connecticut's Thimble Islands. "So a very plausible scenario is that home-price increases continue for a couple more years, and then we might have a recession and they continue down into negative territory and languish for a decade.

"It doesn't even attract that much attention," he continued. "There will be many people thinking it was a soft landing even though prices may have gone down in real terms by 40 percent."

## Thursday, August 18, 2005

### Equities vs real estate

It is well known among professionals that historical equity returns beat real estate returns by quite a margin. Successful companies generate innovation and create real economic value, so it would be surprising if equities didn't outperform an inert asset like housing over the long run. (On a risk-adjusted or tax and leverage-adjusted basis housing might be competitive, though.) We're nowhere near running out of space in this country, despite what housing bubble speculators might think. See previous posts, here and here.

NYTimes: When Marti and Ray Jacobs sold the five-bedroom colonial house in Harrington Park, N.J., where they had lived since 1970, they made what looked like a typically impressive profit. They had paid $110,000 to have the house built and sold it in July for$900,000.

But the truth is that much of the gain came from simple price inflation, the same force that has made a gallon of milk more expensive today than it was three decades ago. The Jacobses also invested tens of thousands of dollars in a new master bathroom, with marble floors, a Jacuzzi bathtub and vanity cabinets.

Add it all up, and they ended up making an inflation-adjusted profit of less than 10 percent over the 35 years.

That return does not come close to the gains of the stock market over the same period. The Standard & Poor's 500-stock index has increased almost 200 percent since 1970, even after accounting for inflation.

## Tuesday, August 16, 2005

### Brain cells from stem cells

Can we please have sensible science policy in the US before it is too late? Why are we allowing the UK and S. Korea to race ahead in this important area of research? (See previous post on therapeutic cloning by Seoul National University researchers.)

Guardian: British scientists create first pure brain stem cells

Scientists have made the world's first pure batch of brain stem cells from human stem cells. The breakthrough is important in the fight against neuro-degenerative diseases such as Alzheimer's and Parkinson's and could also reduce the number of animals used in medical research.
Stem cells can change into any type of cell in the body. How they change, a process known as differentiation, remains a mystery but scientists think certain chemical and environmental signals must trigger it.

Austin Smith of Edinburgh University's institute for stem cell research bathed stem cells taken from mouse embryos with two proteins called epidermal growth factor and fibroblast growth factor, both of which are known to be involved in the normal development of the embryonic brain. After his team had shown the process turned embryonic mouse stem cells into brain stem cells, they repeated the experiment on human embryonic stem cells.

Brain stem cells have been grown before but the results have been impure. "You end up with a mixed culture at the end which has not just neural stem cells, it has a lot of contaminating embryonic stem cells," said Steve Pollard, one of Professor Smith's colleagues and a co-author of the results, published yesterday in the journal PLoS Biology.

The work comes three months after scientists at Newcastle University cloned a human embryo using donated eggs and genetic material from stem cells. Human embryos were first cloned last year by South Korean scientists.

In the short term, the technique will allow scientists to develop cell cultures for their research. "We'll use them in the basic biology sense to try to understand how stem cells work," Professor Pollard said. "It's a good opportunity to understand what the difference is between an embryonic stem cell, which can make anything, and a brain stem cell, which can just make brain."

Through genetic modification, scientists will also use the technique to mimic brain diseases.

Tim Allsopp, the chief scientific officer of Stem Cell Science, the company given an exclusive licence to commercialise the research, said: "The remarkable stability and purity of the cells is something unique in the field of tissue stem cells and a great step forward. We have already had a number of approaches from pharmaceutical companies interested in using these cells to test and develop new drugs, and are looking forward to working with them to further develop and license the technology."

In the longer term the technology raises hopes of growing cells to replace damaged parts of the brain. But Professor Smith said there was a long way to go: "We know these cells can survive if we put them back in the brain but whether they can do anything useful is a much more complicated question."

## Sunday, August 14, 2005

### Lee Kuan Yew interview

DER SPIEGEL INTERVIEW WITH SINGAPORE'S LEE KUAN YEW

"It's Stupid to be Afraid"

Singapore's first-ever prime minister, long-time government head and current political mentor Lee Kuan Yew talks about Asia's rise to economic power, China's ambitions and the West's chances of staying competitive.

SPIEGEL: The political and economic center of gravity is moving from the West towards the East. Is Asia becoming the dominant political and economic force in this century?

Mr. Lee: I wouldn't say it's the dominant force. What is gradually happening is the restoration of the world balance to what it was in the early 19th century or late 18th century when China and India together were responsible for more than 40 percent of world GDP. With those two countries becoming part of the globalized trading world, they are going to go back to approximately the level of world GDP that they previously occupied. But that doesn't make them the superpowers of the world.

SPIEGEL: Their leading politicians have publicly discussed the so-called "Asian Century".

Mr. Lee: Yes, economically, there will be a shift to the Pacific from the Atlantic Ocean and you can already see that in the shipping volumes of Chinese ports. Every shipping line is trying to get into association with a Chinese container port. India is slower because their infrastructure is still to be completed. But I think they will join in the race, build roads, bridges, airports, container ports and they'll become a manufacturing hub. Raw materials go in, finished goods go out.

SPIEGEL: You've been the leader of a very successful state for a long time. Returning from your time in China, are you afraid for Singapore's future?

Mr. Lee: I saw it coming from the late 1980s. Deng Xiaoping started this in 1978. He visited Bangkok, Kuala Lumpur and Singapore in November 1978. I think that visit shocked him because he expected three backward cities. Instead he saw three modern cities and he knew that communism -- the politics of the iron rice bowl -- did not work. So, at the end of December, he announced his open door policy. He started free trade zones and from there, they extended it and extended it. Now they have joined the WTO and the whole country is a free trade zone.

SPIEGEL: But has China's success not become dangerous for Singapore?

Mr. Lee: We have watched this transformation and the speed at which it is happening. As many of my people tell me, it's scary. They learn so fast. Our people set up businesses in Shanghai or Suzhou and they employ Chinese at lower wages than Singapore Chinese. After three years, they say: "Look, I can do that work, I want the same pay." So it is a very serious challenge for us to move aside and not collide with them. We have to move to areas where they cannot move.

SPIEGEL: Such as?

Mr. Lee: Such as where the rule of law, intellectual property and security of production systems are required, because for them to establish that, it will take 20 to 30 years. We are concentrating on bio medicine, pharmaceuticals and all products requiring protection of intellectual property rights. No pharmaceutical company is going to go have its precious patents disclosed. So that is why they are here in Singapore and not in China.

SPIEGEL: But the Chinese are moving too. They bought parts of IBM and are trying to take over the American oil company Unocal.

Mr. Lee: They are learning. They have learnt takeovers and mergers from the Americans. They know that if they try to sell their computers with a Chinese brand it will take them decades in America, but if they buy IBM, they can inject their technology and low cost into IBM's brand name, and they will gain access to the market much faster.

SPIEGEL: But how afraid should the West be?

Mr. Lee: It's stupid to be afraid. It's going to happen. I console myself this way. Suppose, China had never gone communist in 1949, suppose the Nationalist government had worked with the Americans -- China would be the great power in Asia -- not Japan, not Korea, not Hong Kong, not Singapore. Because China isolated itself, development took place on the periphery of Asia first.

SPIEGEL: Such a consolation won't be enough for the future.

Mr. Lee: Right. In 50 years I see China, Korea and Japan at the high-tech end of the value chain. Look at the numbers and quality of the engineers and scientists they produce and you know that this is where the R&D will be done. The Chinese have a space programme, they're going to put a man on the Moon and nobody sold them that technology. We have to face that. But you should not be afraid of that. You are leading in many fields which they cannot catch up with for many years, many decades. In pharmaceuticals, I don't see them catching up with the Germans for a long time.

SPIEGEL: That wouldn't feed anybody who works for Opel, would it?

Mr. Lee: A motor car is a commodity -- four wheels, a chassis, a motor. You can have modifications up and down, but it remains a commodity, and the Chinese can do commodities.

SPIEGEL: When you look to Western Europe, do you see a possible collapse of the society because of the overwhelming forces of globalization?

Mr. Lee: No. I see ten bitter years. In the end, the workers, whether they like it or not, will realize, that the cosy European world which they created after the war has come to an end.

SPIEGEL: How so?

Mr. Lee: The social contract that led to workers sitting on the boards of companies and everybody being happy rested on this condition: I work hard, I restore Germany's prosperity, and you, the state, you have to look after me. I'm entitled to go to Baden Baden for spa recuperation one month every year. This old system was gone in the blink of an eye when two to three billion people joined the race -- one billion in China, one billion in India and over half-a-billion in Eastern Europe and the former Soviet Union.

SPIEGEL: The question is: How do you answer that challenge?

Mr. Lee: Chancellor Kohl tried to do it. He did it halfway then he had to pause. Schroeder tried to do it, now he's in a jam and has called an election. Merkel will go in and push, then she will get hammered before she can finish the job, but each time, they will push the restructuring a bit forward.

SPIEGEL: You think it's too slow?

Mr. Lee: It is painful because it is so slow. If your workers were rational they would say, yes, this is going to happen anyway, let's do the necessary things in one go. Instead of one month at the spa, take one week at the spa, work harder and longer for the same pay, compete with the East Europeans, invent in new technology, put more money into your R&D, keep ahead of the Chinese and the Indians.

SPIEGEL: You have seen yourself how hard it is to implement such strategies.

Mr. Lee: I faced this problem myself. Every year, our unions and the Labour Department subsidize trips to China and India. We tell the participants: Don't just look at the Great Wall but go to the factories and ask, "What are you paid?" What hours do you work?" And they come back shell-shocked. The Chinese had perestroika first, then glasnost. That's where the Russians made their mistake.

SPIEGEL: The Chinese Government is promoting the peaceful rise of China. Do you believe them?

Mr. Lee: Yes, I do, with one reservation. I think they have calculated that they need 30 to 40 -- maybe 50 years of peace and quiet to catch up, to build up their system, change it from the communist system to the market system. They must avoid the mistakes made by Germany and Japan. Their competition for power, influence and resources led in the last century to two terrible wars.

SPIEGEL: What should the Chinese do differently?

Mr. Lee: They will trade, they will not demand, "This is my sphere of influence, you keep out". America goes to South America and they also go to South America. Brazil has now put aside an area as big as the state of Massachusetts to grow soya beans for China. They are going to Sudan and Venezuela for oil because the Venezuelan President doesn't like America. They are going to Iran for oil and gas. So, they are not asking for a military contest for power, but for an economic competition.

SPIEGEL: But would anybody take them really seriously without military power?

Mr. Lee: About eight years ago, I met Liu Huaqing, the man who built the Chinese Navy. Mao personally sent him to Leningrad to learn to build ships. I said to him, "The Russians made very rough, crude weapons". He replied, "You are wrong. They made first-class weapons, equal to the Americans." The Russian mistake was that they put so much into military expenditure and so little into civilian technology. So their economy collapsed. I believe the Chinese leadership have learnt: If you compete with America in armaments, you will lose. You will bankrupt yourself. So, avoid it, keep your head down, and smile, for 40 or 50 years.

SPIEGEL: What are your reservations?

Mr. Lee: I don't know whether the next generation will stay on this course. After 15 or 20 years they may feel their muscles are very powerful. We know the mind of the leaders but the mood of the people on the ground is another matter. Because there's no more communist ideology to hold the people together, the ground is now galvanised by Chinese patriotism and nationalism. Look at the anti-Japanese demonstrations.

SPIEGEL: How do you explain that China is spending billions on military modernisation right now?

Mr. Lee: Their modernisation is just a drop in the ocean. Their objective is to raise the level of damage they can deliver to the Americans if they intervene in Taiwan. Their objective is not to defeat the Americans, which they cannot do. They know they will be defeated. They want to weaken the American resolve to intervene. That is their objective, but they do not want to attack Taiwan.

SPIEGEL: Really? They have just passed the aggressive anti-secession law and a general has threatened to use the nuclear bomb.

Mr. Lee: I think they have put themselves into a position internationally that if Taiwan declares independence, they must react and if Beijing's leadership doesn't, they would be finished, they would be a paper tiger and they know that. So, they passed the anti-secession law to tell the Taiwanese and the Americans and the Japanese, "I do not want to fight, but if you allow Taiwan to go for independence, I will have to fight." I think the anti-secession law is a law to preserve the status quo.

SPIEGEL: Another critical point in Asia is the growing rivalry between China and Japan.

Mr. Lee: It's been dormant all this while, right? But I think several things happened that upped the ante. They possibly coincide with the policy of Japanese Prime Minister Junichiro Koizumi. There is this return to "we want to be a normal country." They are sending ships to Afghanistan to support the Americans, they sent a battalion to Iraq, they reclaimed the Senkaku islands, and most recently, they joined the Americans in declaring that Taiwan is a strategic interest of Japan and America. That raises all the historical memories of the Japanese taking away Taiwan in 1895. Then they're applying to be a permanent member of the Security Council. So, I think the Chinese decided that this is too much. So, they have openly said they will object to Japan becoming a member of the Security Council.

SPIEGEL: Well, the United States said the same to Germany.

Mr. Lee: Exactly. So, the whole process is trying to define the position for the next round, maybe in 10 to 15 years, by which time the world will be a different place.

SPIEGEL: Can the Chinese convince their North Korean ally Kim Jong-Il to get rid of his nuclear program?

Mr. Lee: North Korea is a riddle wrapped up in an enigma. The leaders in North Korea believe that their survival depends upon having a bomb -- at least one nuclear bomb. Otherwise, sooner or later, they will collapse and the leaders will be put on trial like Milosevic for all the crimes that they have committed. And they have no intention of letting that happen.

SPIEGEL: Who can stop them? The Americans?

Mr. Lee: Yes, but at a price, a heavy price.

SPIEGEL: Could the Chinese do it?

Mr. Lee: Possibly. By denying food, denying fuel, so they would implode. But will the Chinese benefit from an imploded North Korea? That brings the South into the North. That brings the Americans to the Yalu River. So, the North Koreans have also done their calculations and know that there are limits.

SPIEGEL: So Kim is in a strong position?

Mr. Lee: If I were Kim I would freeze the programme, tell the Americans you can inspect, but if you attack me, I will use it. That leaves the Americans with the problem of checking and verifying and intercepting ships, aircraft, endless problems.

SPIEGEL: Would that save Kim's regime?

Mr. Lee: In the long run I think they will implode sooner or later because their system cannot survive. They can see China, they can see Russia and Vietnam, all opening up. If they open up, their system of control of the people will break down. So they must go.

SPIEGEL: If the six party talks fail, do you foresee an arms race in Eastern Asia?

Mr. Lee: If the nuclear program is frozen, there won't be an arms race. Eventually, it is not in China's interests to have an erratic Korea nuclear-armed and a Japan nuclear-armed. That reduces China's position.

SPIEGEL: Many Americans fear that China and the US are bound to become strategic rivals. Will this become the great rivalry of the 21st century?

Mr. Lee: Rivals, yes, but not necessarily enemies. The Chinese have spent a lot of energy and time to make sure that their periphery is friendly to them. So, they settled with Russia, they have settled with India. They're going to have a free trade agreement with India -- they're learning from each other. Instead of quarrelling with the Philippines and the Vietnamese over oil in the South China Sea, they have agreed on joint exploration and sharing. They've agreed on a strategic agreement with Indonesia for bilateral trade and technology.

SPIEGEL: But the Americans are trying to encircle China. They have won new bases in Central Asia.

Mr. Lee: The Chinese are very conscious of being encircled by allies of America. But they are very good in countering those moves. South Korea today has the largest number of foreign students in China. They see their future in China. So, the only country that's openly on America's side is Japan. All the others are either neutral or friendly to China.

SPIEGEL: During your career, you have kept your distance from Western style democracy. Are you still convinced that an authoritarian system is the future for Asia?

Mr. Lee: Why should I be against democracy? The British came here, never gave me democracy, except when they were about to leave. But I cannot run my system based on their rules. I have to amend it to fit my people's position. In multiracial societies, you don't vote in accordance with your economic interests and social interests, you vote in accordance with race and religion. Supposing I'd run their system here, Malays would vote for Muslims, Indians would vote for Indians, Chinese would vote for Chinese. I would have a constant clash in my Parliament which cannot be resolved because the Chinese majority would always overrule them. So I found a formula that changes that...

SPIEGEL: ... and that turned Singapore de facto into a one party state. Critics say that Singapore resembles a Lee Family Enterprise. Your son is the Prime Minister, your daughter-in-law heads the powerful Development Agency...

Mr. Lee: ... and my other son is CEO of Singapore Telecoms, my daughter is head of the National Institute for Neurology. This is a very small community of 4 million people. We run a meritocracy. If the Lee Family set an example of nepotism, that system would collapse. If I were not the prime minister, my son could have become Prime Minister several years earlier. It is against my interest to allow any family member who's incompetent to hold an important job because that would be a disaster for Singapore and my legacy. That cannot be allowed.

The interview was conducted by editors Hans Hoyng and Andreas Lorenz.

Translated from the German by Christoper Sultan

## Saturday, August 13, 2005

### Linux kernel development

If you have any interest in Linux kernel development or software development in general, I recommend this podcast of a talk by Andrew Morton, lead maintainer of the Linux kernel (I believe he shares this duty with Linus Torvalds; both are employed through the Open Source Development Lab (OSDL) in Portland, OR). Morton, a deeply thoughtful guy, gives a nice overview of the current organization and process of Linux development.

A few interesting things I learned from the talk:

1) The majority of code contributors are now employed by companies in positions where contributing to the Linux kernel is part of their job description. This is quite a contrast to the early days of Linux, when it was mostly the work of enthusiasts. Morton describes the economic and GPL licensing factors which make it attractive for corporations (even large ones, like IBM or HP) to contribute to the kernel code base.

2) More than 50% of the code is contributed by 20 or so individuals (this is out of thousands or more who have participated). Morton is restrained, but can't help characterizing these people as off-scale coders who are far beyond the level of typical professionals. Does this say something about the distribution of talents in programming, and the relative productivity of exceptional versus average developers?

3) Product testing (as opposed to coding) is still largely dominated by true volunteers and hobbyists. Tens of thousands download each new image of the kernel to see whether it will run on all manner of obscure hardware.

## Thursday, August 11, 2005

### Returns to capital

In recent posts I noted that returns to labor are going to be suppressed by the effective doubling of the labor pool since the end of the cold war. Economist Brad Setser (see comments) noted that returns to capital (as evidenced by interest rates or market returns) have been poor of late as well. The Economist tries to explain this conundrum, using Investment-Savings (IS) and Liquidity-Money (LM) demand curves. Bernanke (our next Fed Chairman?) has argued that low returns are due to a global glut of savings. The Economist asserts that central banks bear most of the responsibility: low rates have triggered a liquidity glut, which is not the same as a savings glut.

Economist: Bond yields are low largely because central banks have created too much liquidity. Despite rising short-term interest rates in America, monetary policy is still unusually expansionary. Average short-term rates in America, Europe and Japan have remained below nominal GDP growth for the longest period since the 1970s. In addition, America's loose policy has been amplified by the build-up in foreign-exchange reserves and domestic liquidity in countries that have tied their currencies to the dollar, notably China and the rest of Asia. As a result, over the past couple of years, global liquidity has expanded at its fastest pace for three decades. If you flood the world with money, it has to go somewhere, and some of it has gone into bonds, resulting in lower yields. Or, more strictly, bond prices have been bid up until yields are so low that people are happy to hold the increased supply of money. In its latest annual report, the Bank for International Settlements suggests that the fact that the prices of all non-monetary assets (including bonds) have risen could indeed reflect an effort by investors to get rid of excess liquidity.

In fact, the two theories are not mutually exclusive. Too much saving relative to investment may well have gone hand in hand with excess liquidity, ie, both the IS and LM curves have shifted downwards. Central banks' monetary easing was, after all, partly in response to a fall in investment after share prices slumped. However, the current rapid pace of global growth suggests that excess liquidity is the prime cause of low bond yields. The snag is that central banks will eventually have to mop up the overhang of liquidity and bond yields will then rise.

Why isn't excess liquidity generating inflation? The basic IS-LM model assumed that the price level was fixed, and thus its inability to explain high inflation rates in the 1970s and 1980s hastened its fall from grace. If an economy is at full employment, an increase in money leads to higher prices, not lower bond yields. Today, however, the model may be more relevant because the entry into the world economy of cheap labour in China and other emerging economies is helping to hold down inflation. In a world of low inflation, IS-LM rides again.

## Wednesday, August 10, 2005

### MBAs head to India

The NY Times reports that India has become a hot destination for MBA interns from top schools in the US. Widespread use of English means the students can function well at Indian companies such as Infosys or Wipro. It should be obvious from the article that Indian companies are gearing up to apply formidable local brainpower to outsourceable jobs well beyond call centers and software development. The next frontier is business services such as accounting and investment banking research.

Among the Infosys interns is Caton Burwell, 28, from the Stanford Graduate School of Business. "India has come to symbolize globalization and I wanted to participate in the workings of the global economy," he said. "Besides, it would look great on my résumé."

Mr. Burwell said that, since arriving in India, he had developed a better grasp of the workings of the global economy and the logic behind the choices companies and countries make. "Being here is a powerful experience; it is impossible not to think differently," he said.

Also, his attitude toward outsourcing has changed since meeting Indian employees, who he said work very hard and care a great deal about the quality of their work. "To come here, meet these people, and to return home and turn your back on outsourcing is hard," he said.

Jeffrey Anders, 29, from the Sloan School of Management at M.I.T., is similarly stirred. Mr. Anders is halfway through his internship at the business process outsourcing division of Hewlett-Packard India in Bangalore.

"I can't help but feel that I am witnessing the creation of a new global economic order, a new reality that most people back home don't realize is coming," said Mr. Anders.

After a meeting with the recruiting head of Hewlett-Packard India's back-office unit at a conference at M.I.T., Mr. Anders came to India to help build a group of Indian economists and statisticians to perform complex analytics and predictive modeling for Western multinationals. "These highly educated and qualified people are not stopping at call centers and back-office work," he said. "They are getting ready to compete for every job."

## Tuesday, August 09, 2005

### Returns to labor in the rustbelt

Not only are GM and Ford hurting, but huge parts supplier Delphi is threatening bankruptcy (WSJ) if their US labor costs cannot be adjusted downwards. Recall that one of the main consequences of this era of globalization will be reduced returns to labor relative to capital...

WSJ: Delphi Corp. Chairman and Chief Executive Officer Robert S. "Steve" Miller said the automotive supplier is in discussions with former parent General Motors Corp. and the United Auto Workers about a comprehensive restructuring of Delphi's unprofitable U.S. operations aimed at avoiding bankruptcy reorganization.

Mr. Miller, a veteran leader of large-scale corporate restructurings, said discussions with GM and the union "are very constructive and give me hope that we can restructure out of court." But Mr. Miller said that if Delphi can't reach agreements with GM and the UAW that substantially cut its U.S. labor costs and allow for restructuring or sale of unprofitable businesses, the company can't continue on its current course until September 2007, when its current UAW contract expires.

TROY -- General Motors Corp.'s top purchasing executive Wednesday urged the automaker's suppliers to consider building parts in China in order to remain competitive. The automaker also reinforced the need for suppliers to meet aggressive cost-cutting goals and help it dramatically reduce warranty costs.

The meeting in Troy between GM and 380 executives from suppliers comes as the automaker is under pressure to cut its $85 billion global purchasing bill and other costs to help restore profits, particularly in North America. GM expects to report an$850 million first-quarter loss and has warned that 2005 earnings will be about 80 percent below earlier forecasts.

GM is consolidating its global automotive operations and has expanded the responsibilities of several top executives who oversee purchasing, product development and engineering worldwide... GM told suppliers it's not backing off a goal to cut material costs by 20 percent between 2003 and 2005, but did not demand further price cuts.

...The Detroit News spoke to several people who attended the meeting and obtained a 13-page slide presentation Andersson gave to suppliers.

GM spokesman Tom Wickham said the message GM's purchasing team delivered during the two-hour session was "we're a global company, we need a global supply base, a competitive supply base and we do need to work together." To meet GM's global needs and remain competitive, suppliers should consider building plants closer to growth markets, in particular, China, GM officials said. "Location is important for logistical reasons," said Wickham, "but it's really going to be the supplier call on what works better for them.

...While he didn't specifically demand that suppliers move production to China, Andersson's slide presentation made the message clear: "The footprint is shifting ...Will it be driven by the consumer, competition, or you?" The presentation also quoted from news stories that discussed rival Toyota Motor Corp.'s move to source parts in China and asserted that American suppliers are missing out on growth opportunities in China. A so-called global purchase price that GM and other companies seek is the lowest price available anywhere, said John Henke, president of Planning Perspectives Inc. and marketing professor at Oakland University. Getting a global purchase price on labor intensive components often requires dealing with suppliers located outside the United States, he said. "Simply because of wage structures around the world, you'll go to places like Mexico, China and India to get the best price on anything," Henke said.

The exodus of parts suppliers to countries where labor costs are cheaper is well underway and not likely to abate before the end of the decade. North American auto suppliers will close plants and move as much as 20 percent of their production to lower-cost regions by 2010, according to a survey conducted last year by Roland Berger Strategy Consultants in Troy. Some parts can be produced 20 to 40 percent cheaper in China and other low-cost regions than they can North America, experts say.

Troy-based Delphi Corp., GM's biggest supplier, has invested more than $400 million to open 11 factories in China since 1991 and is building a$15 million research and development center in Shanghai. Still, GM imports only one-tenth of 1 percent of the parts used in its U.S. assembly plants from China (Michigan factories supply 14 percent). But the company expects to increase its auto part purchases from China 20-fold in six years -- from $200 million in 2003 to$4 billion in 2009.

During Wednesday's meeting, company executives reiterated that only those suppliers who are competitive on quality, service, technology and price would win or retain GM's business. Andersson told the suppliers they must continue to play an important role in reducing GM's warranty costs, which have dropped from $35.56 per vehicle after six months in service, to$24.90 in 2004. GM's target for 2005 is $22.05 per vehicle. DeKoker acknowledged it's in the suppliers' best interest to play ball with GM as it struggles through a tough year. "We want GM to be successful," he said, "because you can't sell parts to something that doesn't exist." Meanwhile, GM's joint venture in China is producing a bestselling mini-minivan that sells for$5k and gets 43 mpg.

## Saturday, August 06, 2005

### V.S. Naipaul in NY Times

Nice profile and interview. I highly recommend his non-fiction work on India (A Wounded Civilization, A Million Mutinies Now).

Naipaul understands that what is happening with Islam and terrorism is merely a sideshow to real world-changing developments in Asia. US leaders should not be distracted from more important long term issues like economic and technological competitiveness.

From the audio interview:
"The economic development of India -- and China -- will completely alter the world... nothing that's happening in the Arab world has that capacity... mischief, just mischief, whereas what is happening in India and China will bend the world.''

## Friday, August 05, 2005

### Is Hilbert space discrete?

New paper, to appear on arxiv.org on Tuesday.

Paper: hep-th/0508039
From: Stephen D. H. Hsu
Date: Sat, 6 Aug 2005 03:15:50 GMT (21kb)

Title: Is Hilbert space discrete?
Authors: R. Buniy, S. Hsu and A. Zee
Comments: 4 pages, revtex, 1 figure

We show that discretization of spacetime naturally suggests discretization of Hilbert space itself. Specifically, in a universe with a minimal length (for example, due to quantum gravity), no experiment can exclude the possibility that Hilbert space is discrete. We give some simple examples involving qubits and the Schrodinger wavefunction, and discuss implications for quantum information and quantum gravity.

Figure 1: A possible discretization of the Bloch sphere (qubit Hilbert space). Points on each disc (of size $\epsilon$) are identified. Points between discs can be assigned to the nearest disc.

## Wednesday, August 03, 2005

### MRI machines from China?

Most people will be shocked at how fast they are climbing the value chain. From this article (excerpted from Ted Fishman's book) in Inc. magazine:

Given how quickly China is climbing the industrial ladder, perhaps the next question is whether any commercial technology is beyond an imminent challenge from China. Gal Dymant, an American Israeli venture capitalist in Beijing, believes the answer is that few will be. One of the companies Dymant works with, a database publisher named Asia Direct, produces an annual China Hi-Tech Directory. Tracking the directory's updates year to year gives Dymant an informal measure of the shifts in Chinese industry.

The first thing one notices about the directories, he says, is how much thicker they grow every year, particularly in industries where there have been large foreign investments. In 2003, Asia Direct's volume grew considerably fatter in the sections devoted to China's domestic mobile-phone manufacturers and suppliers, broadband communications, and in companies establishing themselves in cities outside of China's eastern powerhouses. The manufacture and sale of integrated chips is also soaring, along with healthy gains in China's software and information-services markets. Then again, every section in the directory has grown, including biotechnology, semiconductors, and Internet development, areas in which Chinese firms have newly established themselves, many now in partnership with the world's leading technology-driven companies.

For his part, Dymant is putting together an investor group to build a Chinese version of one of the world's most advanced and costly medical devices, the magnetic resonance imaging (MRI) machine. "The talent is here to build anything," Dymant says. "We think we can develop MRIs for about 60% of the price they are built for in the U.S."

## Monday, August 01, 2005

### The terrifying beauty of exponential growth

Via Gene Expression:

The dark-blue plot indicates Kurzweil/Moore's Law: it describes the doubling of computer instructions per second per US dollar (IPS/US $) that has been occurring approximately every 18 months since 1900. The magenta plot indicates an exponential growth in the number of base pairs of accurate DNA sequence per unit cost (bp/US$) as a function of time. To some extent, the doubling time for DNA mimics the IPS/US \$ curve because it is dependent on it. An even steeper segment occurs in the orange curve; this depicts the number of web sites (doubling time of four months) and shows how quickly a technology can explode when a protocol that can be shared spreads through an existing infrastructure. The turquoise plot is an 'Open Source' case study of 'FLUORESCENT IN SITU SEQUENCING' with polonies (see main text for details of this DNA-sequencing technology) in bp/min on simple test templates (doubling time of one month).