Tuesday, November 30, 2004

Bretton Woods II and ASEAN summit

WSJ: Meeting on the sidelines of a regional gathering in Laos, the leaders of South Korea, Japan and China agreed on the need for exchange-rate stability, according to a statement issued by the South Korean presidential office. A separate meeting of finance-ministry officials from the three countries to discuss the dollar's decline led to an "understanding," though no agreement on any concerted action, South Korean Deputy Finance and Economy Minister Chin Dong Soo told reporters in Seoul.

...South Korean President Roh Moo Hyun met with his counterparts, Prime Minister Junichiro Koizumi of Japan and China's Mr. Wen, on the sidelines of the Asean summit yesterday. A statement from Mr. Roh's office quoted the Korean president as telling Messrs. Koizumi and Wen that "a dramatic change in exchange rates is not appropriate" and that "currency stabilization is important for the economies in this region." According to the statement, Messrs. Koizumi and Wen agreed. The statement paraphrased Mr. Koizumi as saying there should be cooperation and joint efforts among the three countries to stabilize the currencies.

See previous discussion of Bretton Woods II.

VIX and Black-Scholes

OK, humor me here as I continue to think about volatility. Looking at the CBOE white paper on VIX, I see a plot (page 13) indicating very strong correlation between movements in the SP and the implied vol. A change in the SP of about 1% causes a 4% shift in the VIX, but with the opposite sign. Now, SP500 options are widely traded and liquid. They should provide one of the best tests of options pricing theory. But in the usual Black-Scholes model the volatility of the underlying security is a fixed input parameter - it certainly isn't supposed to be path (history) dependent. The simple log normal random walk model has its limitations - for example, there is no reason the vol shouldn't change in time (hopefully slowly) - but I'm surprised to see such clear path dependence. Of course, it's possible that the actual volatility (as opposed to implied volatility) doesn't exhibit the correlations we are discussing. But if so, there is an inefficiency in the behavior of options traders that should be arbed away!

...I've been informed that these issues are addressed using more sophisticated GARCH models. (GARCH = Generalised Autoregressive Conditional Heteroskedastic!)

This paper seems to conclude that implied vol is a good predictor of realized vol, so the correlation between market movements and vol is not a behavioral quirk of options traders (indeed, it is a quirk of the market itself).

Monday, November 29, 2004

VIX thoughts

The VIX index tracks implied volatility, using a basket of options with expirations closest to +30 days to compute an implied probability distribution for values of the SP500 30 days hence. The VIX is often referred to as a "fear gauge" because it is anticorrelated with market performance: when the SP goes up the implied vol goes down, and vice versa.

To characterize the prob. dist. with a single volatility value, one fits to a Gaussian. Historically we know that outlier events are much more likely than implied by a log normal distribution. Deep out of the money options are included in the VIX computation as long as there are nonzero bids (and no intervening zero bids at more probable strikes). Looking at the current prices I see this only goes out about 2 sigma into the tail, so the distortion from mispricing of rare events is small. I know Nassim Taleb (author of Fooled By Randomness) makes his living buying mispriced deep out of the money options - I assume he has to buy these directly by calling up market makers, since the widely traded options don't go too far out on the tail.

Why is the VIX anticorrelated with market moves? I can understand why options traders might be psychologically disposed to expect more vol in a down market, but does the observed, historical vol exhibit this anticorrelation? We could check by crunching the data looking for up/down moves to see if the variation in the following 30 days is correlated with the sign of the move. To put it very simply, are downward moves of the market choppier than upward moves? If not, can't I arbitrage by selling vol when the market goes down and buying it when the market moves up?

Sunday, November 28, 2004

Inflation: goods vs services

If you break the CPI into components, you can see an interesting divergence in the behavior of goods vs services. The former have exhibited deflation over the last 4 years (exported from China?), while services costs have continued to go up. When will outsourcing become widespread enough to affect the rate of inflation in services? Evidently labor still has some pricing power.

(Graph from BusinessWeek.)

BusinessWeek on US-China trade

I picked up the latest issue of BusinessWeek on the flight home, which is largely devoted to US-China trade. The cover story is on the "China Price" that manufacturers are now forced to match.

Meanwhile, U.S. companies are no longer investing in much new capacity at home, and the ranks of U.S. engineers are thinning. In contrast, China is emerging as the most competitive manufacturing platform ever. Chief among its formidable assets is its cheap labor, from $120-a-month production workers to $2,000-a-month chip designers. Even in sophisticated electronics industries, where direct labor is less than 10% of costs, China's low wages are reflected in the entire supply chain -- components, office workers, cargo handling -- you name it.

China is also propelled by an enormous domestic market that brings economies of scale, feverish local rivalry that keeps prices low, an army of engineers that is growing by 350,000 annually, young workers and managers willing to put in 12-hour days and work weekends, an unparalleled component and material base in electronics and light industry, and an entrepreneurial zeal to do whatever it takes to please big retailers such as Wal-Mart Stores (WMT ), Target (TGT ), Best Buy (BBY ), and J.C. Penney (JCP ). "The reason practically all home furnishings are now made in China factories is that they simply are better suppliers," says Janet E. Fox, vice-president for international procurement at J.C. Penny Co. "American manufacturers aren't even in the same game."

An interesting statistic from the article: the US is still the world's largest manufacturer, and 75% of goods consumed in the US (presumably by value) are made here (this is down from 90% as late as the mid-90's). So, very roughly speaking, a 4% trade-weighted decline in the dollar would lead to a 1% increase in inflation, assuming there is no resulting substitution of goods.

Saturday, November 27, 2004

Japan, China, UK and hedge funds(?)

...are the largest holders of US Treasury debt, in order of holdings. Note Japan still dominates all others.

Is it plausible that hedge funds hold $100B in US Treasury debt? A recent JP Morgan report concludes that hedge funds currently account for $900B in capital, out of a world total capitalization of $74 Trillion in equity and fixed income. So, the notes held by secretive Caribbean entities account for only 10% of hedge fund capital.

Friday, November 26, 2004

Sino-French TTE largest producer of TVs

WSJ covers TTE, created from the takeover of French TV maker Thomson by Chinese company TCL. This may be the first example of a major western technology company and prominent brand (RCA) taken over by a Chinese firm. TTE produces 20M televisions a year, in a dozen factories worldwide (China, France, Mexico, Poland, Thailand and Vietnam).

The agreement between Thomson and TCL was highly ambitious and seemed to be clearly necessary. TCL, with just 11 years in the TV-making business at the time, produced more sets than Thomson and was profitable as well. But the company was virtually unknown outside China and had little expertise in global marketing. Thomson, keeper of the 85-year-old RCA brand, was being squeezed by cost pressures in developed markets and posting losses in North America. It also had only dabbled in China, which two years ago passed the U.S. as the world's biggest TV-set market in terms of unit sales.

One of the obvious difficulties, covered briefly in the article, is the huge salary differential between TTE employees (including top executives) in China and France.

Thursday, November 25, 2004

Kings of capital

The Economist has a nice survey on private equity funds (which include venture capital and traditional buyout funds). For those unfamiliar with the details, most funds have a "2 and 20" reward structure, taking a 2% management fee each year and 20% of profits. For example, a $1 billion fund, run by 5 partners, would split $20M per year in fees, and another $20M in "carry" assuming a 10% return on the fund. (Hedge funds work similarly.) No surprise that everyone in finance these days wants to be in private equity or at a hedge fund. Sadly for investors though, private equity and hedge funds often underperform indices like the SP500, even though they take on greater risk. Jon Moulton of Alchemy, a British private-equity firm, is puzzled: “A lot of people in the industry already make several million a year without having to perform. I can't understand why investors haven't put more pressure on fees.”

One interesting statistic is the divergence in performance by investor class: it seems that some limited partners (LPs, or investors) are much better than others at picking funds. University endowments have been particularly successful, while banks have performed dismally.

Wednesday, November 24, 2004

Minimum length and quantum gravity

There is strong evidence for a minimal length in nature: the Planck length L = 10^{-33} cm. On this scale, quantum fluctuations of the metric are large, and the meaning of spacetime breaks down.

Recently, I and two collaborators at Caltech showed that no device (not even a gedanken experiment) is capable of measuring a distance less than the Planck length. (The paper is published in Physical Review Letters.) By "measuring a distance less than the Planck length" we mean, technically, resolve the eigenvalues of the position operator to within L. (Previous work on this problem had not been very careful in defining minimum length, and to obtain a clean result we had to be a bit careful.) The only assumptions in our argument are the uncertainty principle from quantum mechanics and a dynamical criterion for gravitational collapse from classical general relativity called the hoop conjecture.

An implication of the result is that there may only be a finite number of degrees of freedom per unit volume in our universe - no true continuum of space or time. This means that there is only a finite amount of information or entropy in our universe (or at least in any finite patch of it).

One of the main problems encountered in the quantization of gravity is a proliferation of divergences coming from short distance fluctuations of the metric (or graviton). However, these divergences might only be artifacts of perturbation theory: minimum length, which is itself a non-perturbative effect, might provide a cutoff which removes the infinities. This conjecture could be verified by lattice simulations of quantum gravity (for example, in the Euclidean path integral formulation), by checking to see if they yield finite results even in the continuum limit.

Peg will hold, for now

Financial Times interview with Li Ruogu, deputy governor of the People's Bank of China, who said the country won't be pressured into revaluing the yuan and warning the U.S. not to blame others for its own problems: "Under heavy speculation, we cannot move [toward greater flexibility] and under heavy external pressure we cannot," Mr. Li was quoted as saying. "So the best environment for us to gradually move towards a more flexible exchange rate is when people don't talk about it."

University Ave, Palo Alto

I'm in the bay area for Thanksgiving right now. Today I was in Palo Alto for some meetings with venture capitalists (VCs). The density of funds near University Ave in Palo Alto is only exceeded on Sand Hill Road near the Stanford Accelerator Center (SLAC). You can't have dinner (I wanted Coppola-Niebaum but we ended up having tandoori) or go into Starbucks without overhearing deals discussed by 40ish guys wearing khaki pants, or the interview of a potential VP of sales by a CEO. Activity is still nowhere near peak bubble levels of 2000, but things have been steadily improving since the crash :-)

VIX hits low

VIX - an index computed from the implied volatility of a basket of SP500 options - is at a 9 year low (Jan 1996). Perhaps the SP hitting new highs after Bush's election has led to option selling to lock in gains - this would depress the price of volatility. If you are bullish on equities, now is the time to buy cheap call options. Interestingly, bank value at risk (VAR) is reportedly rising even though the volatility input has gone down - meaning more money at play chasing returns.

Tuesday, November 23, 2004

China climbing value chain

WSJ profiles Matsushita's (Panasonic) activities in China: ...built or invested in five high-technology product development and research centers across China, hiring hundreds of local engineers to work in areas ranging from car electronics to mobile technology, mostly for cellphones... Matsushita President Kunio Nakamura has called China the company's future "engine of growth."

...Matsushita's efforts to go upstream also are partly an attempt to win support from the Chinese government, which is eager for foreign companies to transfer more high-end operations and technology into China.

"Right now, the real competition in China is for human resources," Matsushita HR manager Mr. Nakamura says. As foreign companies engage in more sophisticated activities such as software development and product design, and local concerns try to raise their levels of expertise, companies are fighting over graduates of the top universities.

And then there is the uniquely Japanese hurdle of a reputation for low salaries, long hours and slim career prospects. A survey conducted by ChinaHR, a major online recruiter, ranked Matsushita No. 46 among the most popular companies to work for in China. U.S.-based International Business Machines Corp. and Microsoft Corp. ranked No. 2 and No. 5, respectively, while the highest-ranking Japanese concern was Sony Corp. at 26.

A related article discusses how the Korean government is actively concerned about "essential technologies" like LCD or plasma screen manufacturing finding their way to China via acquisition or industrial espionage.

As discussion usually centers around China's growth as a low-wage manufacturing base, I believe many will be surprised at the rate at which China climbs the technology value chain. Recent WSJ articles have covered Siemens moving parts of their cellphone R&D to China, as well as Vodafone's likely decision to start sourcing 3G equipment from Huawei and others. The Matsushita article makes it clear that foreign companies are under pressure to demonstrate technology transfer and R&D activities in China. Yesterday's WSJ had a piece on outsourcing pharma research to Chinese labs. Korea and Taiwan are in danger of losing their leads in key areas like LCD or semiconductor fab, and other developing countries (SE Asia, Mexico, etc.) have already been leapfrogged.

Monday, November 22, 2004

UBS FX report

Received from one of our correspondents, this UBS report is skeptical of the Bretton Woods II hypothesis. There is quite a lot of interesting data on the US balance of trade, historical FX rates, etc.

The conclusion is similar to my own view - the Asian dollar bloc will persist for a year or two at least, with the euro bearing the brunt of dollar depreciation pressure.

G20 statements and renminbi peg

They seem to be preparing the way for a gradual removal of the peg. As reported by one of our correspondents in finance:

G20 on exchnge rate:
* "We understand the importance of medium-term fiscal consolidation in the United States, continued structural reforms to boost growth in Europe and Japan, and, in emerging Asia, steps towards greater exhcnage rate flexibility, supported by continued financial sector reform, as approprate."
* "Experience has shown that countries seeking domestic monetary autonomy while substantially liberalizing their capital account should increase the degree of exchange rate flexibility accordingly."
Next G20 meeting is in Beijing

China's comments:
Mr. Zhou, the PBoC governor:
* On possibility of exchange-rate changes: "You can read October 2003 Chinese government documents that already clearly mentioned we are going to reform our exchange-rate regime and to try to set our exchange-rate at an equilibrium point and also we are going to gradually reach capital-account convertibility. This is the general direction.'' "Recently, I think, at the end of September and the beginning of October, our premier Wen Jiabao mentioned the policy orientation of that related to the exchange rate. And this is basically all the new progress so far.'' "We are reviewing all our foreign-exchange control systems." (comment: Mr. Wen's view here alluded to is that China had a more flexible currency regime before the breakout of Asian financial crisis and would consiser to have more flexibilty now that the crisis was over).

President Hu's comment after meeting President Bush at APEC meeting:
* China will "push for reform of the exchange rate while maintaining stability in the economy,'' Hu "expressed appreciation for Bush's rejections of applications of some people within the U.S.'' on the yuan exchange rate.''

Saturday, November 20, 2004

The face of battle in Falluja

Powerful writing by Dexter Filkins of the Times. Reminds me a bit of Hemingway's war correspondence.

...This intimacy of combat, this plunge into urban warfare, was new to this generation of American soldiers, but it is a kind of fighting that they will probably see again: a grinding struggle to root out guerrillas entrenched in a neighborhood, on streets marked in a language few American soldiers could comprehend.

...In eight days of fighting, Bravo Company took 36 casualties, including 6 dead, meaning that the unit's men had about a one in four chance of being either wounded or killed in little more than a week.

...For all the death about the place, one inescapable impression left by the marines was their youth. Everyone knows that soldiers are young; it is another thing to see men barely out of adolescence, many of whom were still in high school when this war began, shoot people dead.

...Like many of the young men in Bravo Company, Corporal Ritchie said he joined the Marines because he yearned for an adventure greater than his small town could offer. "The guys who stayed, they're all living with their parents, making $7 an hour," Corporal Ritchie said. "I'm not going to be one of those people who gets old and says, 'I wish I had done this. I wish I had done that.' Every once in a while, you've got to do something hard, do something you're not comfortable with. A person needs a gut check."

...Time and again through the week, Captain Omohundro kept his men from folding, if not by his resolute manner then by his calmness under fire... A little later, Captain Omohundro, a 34-year-old Texan, allowed that the strain of the battle had weighed on him, but he said that he had long ago trained himself to keep any self-doubt hidden from view. "It's not like I don't feel it," Captain Omohundro said. "But if I were to show it, the whole thing would come apart."

VOIP is here

I've been using Voice over IP for some time now. I talk to my physics collaborators in foreign countries using a free service called Skype, which runs on my laptop. The sound quality is incredibly good - often better than an international call on the telco system. The free service is only for PC to PC calls, but you also can terminate the IP connection on the old telco system to reach an ordinary phone for a small fee (about $.02 per minute for Skype, if I recall).

The economics of VOIP are a little opaque to me - some of the cost savings is due to the lack of regulatory fees on IP telephony. (When I look at my QWEST phone bill I am astonished at how much of it is taxes and regulatory fees.) But there is certainly a big advantage to using a packet-switched network instead of a circuit-switched one, once the quality issues are solved. Telephony will soon be priced like bandwidth.

I predict a huge wave of innovation around VOIP. The fundamental unit of the Internet revolution - a linux or BSD server, built from cheap hardware - can now use open source software (e.g., the Asterisk package) to perform PBX functions and voice-data manipulation. That means much of the expensive telco equipment that Alcatel or Siemens or Nortel sell is going to be commoditized in the coming years. Cisco and others are already moving aggressively into VOIP, although penetration rates in both the consumer and Enterprise markets are still very low. As always, the real innovation will come from small startups. It seems to me that the easiest way to roll out low cost Internet-related services and applications to cellphones is via VOIP, rather than depending on 3G. The user I/O is limited to voice or touch-tone, but the connectivity is already there and no special handsets are required.

Friday, November 19, 2004

Raw Data

From today's Financial Times:
...Within the US political debate, the administration often paints the current account deficit as a success story. The refrain is that the US has an excess of investment opportunities which foreigners want to use. That was true until 2000, when investment as a share of US GDP was growing. But since then the share has fallen and it does not explain the growing current account deficit. Rather, as the US government began to borrow heavily, national savings fell even faster, causing the current account to deteriorate further.

...Net capital inflows in the year to September, at $657bn, exceeded the $445bn trade deficit over the same period. But Ashraf Laidi, currency analyst at MG Financial Group in New York, points out that foreign demand for US assets has been falling. A year ago, the US was importing twice as much capital a month as it needed to cover the trade deficit. The gap has narrowed: the $63.4bn of capital imported in September compared with the $51.6bn trade deficit in that month.

Below you can compare US foreign debt levels to those of other countries during previous currency crises. It doesn't appear to me that we are near a catastrophic collapse in confidence in the dollar - the US is no Argentina, so perhaps the Sweden data point is most appropriate. That gives us a decade to get our finances in order. (On the other hand FT indicates the Norway point from 1977 - if that is a good comparator we will definitely see a crisis while W is still President.)

Generalized Turing test

I have a bet with one of my former PhD students regarding a strong version of the Turing test. Let me explain what I mean by "strong" version. Turing originally defined his test of artificial intelligence as follows: a tester communicates in some blind way (such as by typing on a terminal) with a second party; if the tester cannot tell whether the second party is a human or a computer, the computer will have passed the test and therefore exhibits AI. When I first read about the Turing test as a kid, I thought it was pretty superficial. I even wrote some silly programs which would respond to inputs, mimicking conversation. Over short periods of time, with an undiscerning tester, computers can now pass a weak version of the Turing test. However, one can define the strong version as taking place over a long period of time, and with a sophisticated tester. Were I administering the test, I would try to teach the second party something (such as quantum mechanics) and watch carefully to see whether it could learn the subject and eventually contribute something interesting or original. Any machine that could do so would, in my opinion, have to be considered intelligent.

Now consider the moment when a machine passes the Turing test. We would replicate this machine many times through mass production, and set this AI army to solving the world's problems (and making even smarter versions of themselves). Of course, not having to sleep, they would make tremendous progress, leading eventually to a type of machine intelligence that would be incomprehensible to mere humans. In science fiction this eventuality is often referred to as the "singularity" in technological development - when the rate of progress becomes so rapid we humans can't follow it anymore.

Of course the catch is getting some machine to the threshold of passing the Turing test. My former student, using Moore's law as a guide (and the related exponential growth rates in bandwidth and storage capacity), is confident that 50 years will be enough time. Rough calculations suggest we aren't more than a few decades from reaching hardware capabilities matching those of the brain. Software optimization is of course another matter, and our views differ on how hard that part of the problem will be. (The few academic CS people who I have gotten to give their opinions on this seem to agree with me, although I have no substantial sampling.)

I'd be shocked if we get there within 50 years, although it certainly would be fun :-)

FX Angst at G20 meeting

The Economist covers the upcoming meeting of G20 finance ministers and central bankers. Who will be next (after Russia) to move to a reserve basket of currencies, shifting from dollars to euros?

...For a country such as South Korea, buying dollars is both costly and possibly inflationary. The country’s excess savings, parked in low-yielding American Treasuries, would earn a higher return invested at home. And the finance ministry’s weak won policy, by making imports more expensive, has hampered its fight against rising prices. In the summer, annual inflation reached its highest rate for three years, though it has since eased.

South Korea’s growing ambivalence about its won policy may be shared by the other post-crisis countries in the region. But their freedom for manoeuvre is limited by China’s dedication to its peg against the dollar. During the financial storms of 1997 and 1998, the peg provided an important anchor for the region. Even as currencies collapsed all around it, China refused to beggar its neighbours by devaluing the yuan. But China’s peg, a bulwark against the financial crisis, is now blocking the “reversal” of the crisis that Mr Jen foresees and the dollar needs. To its neighbours, China is such an important trade partner and competitor that they dare not let their currencies strengthen too far against the yuan. Even Japan is wary.

Much of the G20, then, is now waiting for just one of its members, China, to unpeg its currency. Some speculators can wait no longer. They are already swapping their dollars for yuan, betting it will soon jump in value. To deter such speculation, Chinese banks on Thursday raised the interest they pay on dollar deposits.

Thursday, November 18, 2004

Russia moves to EUR FX basket?

OK, not quite an Asian central bank defection, but a major EurAsian one...

From a correspondent in finance:

The Nikkei news is reporting that from 2005, Russia's central bank will adopt a EUR-dominated basket peg for the RUB. The BoR does not have a formal USD/EUR basket, but has a notional basket containing a split of 70% USDs and 30% EURs which it uses when it targets trends in the RUB's REER. Its FX reserve composition tends to reflect this notional basket. The vast majority of FX intervention (roughly USD2bn a week) is conducted via the USD/RUB market given that EUR/RUB is illiquid. The BoR is believed to then convert roughly 30% of its incremental FX reserve growth into EURs. FX intervention in Russia is therefore positive for EUR/USD.

I should have bought more BEGBX!

Dollar Loses Luster in China

It isn't just the hedge funds betting against the dollar (WSJ):

...From black marketers to anxious grandmothers, Chinese have become disenchanted with the dollar. The selling has posed problems for Beijing as it tries to keep the yuan pegged to the dollar, adding to pressure China is getting from its trading partners to revalue its currency.

The selling also signals a startling shift that may have damaging implications for the dollar down the line: Many Chinese view the yuan, also called the renminbi, as the safer currency to hold.

"The U.S. dollar is weakening! The renminbi is the hard currency now!" shouts a 40-year old man after pulling $10,000 out of U.S.-dollar-denominated stocks and plunking the sum into yuan deposits. "It's the best choice," he says.

...Meanwhile, China's central bank has scrambled to buy dollars from ordinary Chinese who are selling them, to the tune of $20 billion in the first six months, according to an internal report from the State Administration of Foreign Exchange.

A member of a black-market syndicate in Shanghai, a 35-year old surnamed Lu, says he is doing a booming business converting dollars to yuan... Because Mr. Lu and his colleagues are having a difficult time reselling the dollars, they have lowered their exchange rate below what the banks are offering for the yuan.

..."Hot money," or speculative capital, coming into China is pressuring the yuan. But the return of money through legitimate channels also suggests a rush back to China to bet on a stronger yuan. China's portfolio and other capital inflows stood at $36.3 billion in the first half of the year, a little more than double that of the same period of last year. China's foreign-exchange reserves reached $514.54 billion at the end of September, increasing by about $12 billion a month.

At a closed-door meeting in Shanghai this month, banking regulators expressed concern about these developments. "The exchange rate is facing a lot of upward pressure," said Wang Zili, the deputy director at the central bank's branch in the southern city of Guangzhou, according to the minutes of the meeting. "Foreign reserves are increasing too quickly. A lot of capital is coming in through the black market betting on the yuan."

Wednesday, November 17, 2004

Wal-Mart and US-China trade

WSJ. Wal-Mart by itself accounts for more than 10% of U.S. imports from China... Wal-Mart is termed China's eighth-largest trading partner by the government-controlled mainland media and would place ahead of Russia and the United Kingdom on the top-10 list. Other published reports indicate Wal-Mart would be the fifth-largest importer of Chinese manufactured items if it were considered as a nation.

Since Wal-Mart doesn't produce anything for export, the large-scale importing contributes to the gap in U.S. trade. The U.S. is expected to run up a total trade deficit of more than $600 billion in 2004, with the deficit in its bilateral trade with China contributing $150 billion. Thanks mainly to the shortfall in merchandise trade, the U.S. current-account deficit is approaching 6% of gross national product.

According to Amy Wyatt, a spokeswoman for the Bentonville, Ark., retailer, Wal-Mart imported $15 billion in goods from China in the fiscal year that ended Jan. 31, 2004. About $7.5 billion were directly imported by Wal-Mart, the other $7.5 billion came indirectly through suppliers. In the same period, Wal-Mart's total net sales reached $256 billion, with roughly $209 billion coming from U.S. operations.

Tuesday, November 16, 2004

EU vs US labor and productivity data

Taken from WSJ. French and German workers are as productive, on a per hour basis, as US workers, although US workers tend to work more hours per year, which leads to greater GDP per worker per year. Two effects worth noting: (1) workers who work fewer hours should be more productive per hour, as one's effectiveness tends to degrade over a long workday (2) excluding less productive workers (i.e. having a higher unemployment rate, as Germany and France do at 9-10% vs 5% here) should lead to higher average productivity.

String theory and all that

I was asked to give a talk to the physics students here about string theory. Now, I'm not a string theorist, but am probably the closest thing on campus with the possible exception of a guy in the math department.

I emphasized that quantum gravity is perhaps the most conceptually interesting area in all of physics (perhaps all of science). I think I am not exaggerating here, since questions such as Why is there one time direction and three spatial dimensions? Can our universe be multiply-connected on short distances? or What is the endpoint of black hole evaporation? all involve deep and fundamental ideas.

But I also told them, half joking, that I didn't want to work on quantum gravity (at least not all the time) until someone builds a desktop accelerator that can collide particles at Planck energies or at least make small black holes. What I meant by this comment is that physics generally cannot advance by theoretical ideas or mathematics alone. There is no evidence that a single, unique mathematical structure describes our universe. Consequently, we will likely be confronted with more than one theoretical possibility, and only experimental tests can distinguish between them.

We are barely on the threshold of detailed tests of classical general relativity (e.g., using large interferomenters such as LIGO to detect gravity waves). There are no experiments on the drawing board which will test whether these waves are indeed quantized into individual gravitons, and the current generation of particle accelerators are 16 orders of magnitude away from testing the Planck energy. So, I think quantum gravity will not, in a strict sense, be a scientific endeavor for some years to come.

NYTimes on dollar

Nice overview here.

It is surprising to see how, on a trade-weighted basis, the dollar is still pretty strong by historical standards. It looks like a 20% decline would test historical lows.

Monday, November 15, 2004

Bounded rationality - case closed

Yes, there really are noise traders. I took the following from the Yahoo!Finance discussion board for MSFT. Do we really want these people managing their own social security funds?

Why is MS down to 27+
by: fira9us
11/15/04 01:00 pm
Msg: 892456 of 892462

 What happend to MS? It was closed to 30?

Message Thread [ View ]
Profanity filter is Off [ Turn On ]

MSFT and Bounded Rationality

Bounded rationality (I prefer bounded cognition) refers to the cognitive or information processing limits of participants in otherwise efficient markets. Specifically, traders or consumers who lack the time or ability to figure things out before transacting. (I will refrain from calling them monkeys or noise traders :-) I discussed this in an earlier post, noting that a lot of investors were confused about the consequences of the MSFT special dividend of $3.

It seemed a lot people were under the impression that they should buy the stock in order to get the dividend, not knowing that the price would drop after it was issued. (To be eligible for the dividend you had to own your shares by end of trading last Friday, so we are now ex-dividend.) You can judge for yourself from these graphs whether it looks like there was a runup in the stock due to the anticipated dividend. As of opening today the share price dropped $3 to just over $27, so the discontinuity was there as predicted - $27 looks suspiciously like the value before the runup!

Sunday, November 14, 2004

Quote of the Day

The most extravagant idea that can be born in the head of a political thinker is to believe that it suffices for people to enter, weapons in hand, among a foreign people and expect to have its laws and constitution embraced. It is in the nature of things that the progress of Reason is slow and no one loves armed missionaries; the first lesson of nature and prudence is to repulse them as enemies.

One can encourage freedom, never create it by an invading force.

- Maximilien Robespierre (1791)   

The part I like best (and should keep in mind) is: It is in the nature of things that the progress of Reason is slow...

Genetic basis for race

[See more recent posts on this topic here.]

The essential tension between science and political correctness on this issue is discussed in the Sunday Times.

We were told long ago that there is no scientific basis for race. Yet, it would be surprising if the distribution of individual genes were the same in all ethnic groups, with their different evolutionary histories of the last tens of thousands of years. In fact, mtDNA tests can readily identify which of a few dozen matrilineal lines any modern human belongs to. Each of these lines can in turn be traced to certain geographical regions to which early humans migrated from Africa, and correspond reasonably well to conventional racial categories.

Researchers last week described a new drug, called BiDil, that sharply reduces death from heart disease among African-Americans. ...But not everyone is cheering unreservedly. Many people, including some African-Americans, have long been uneasy with the concept of race-based medicine, in part from fear that it may legitimize less benign ideas about race.

...The emergence of BiDil, described last week in The New England Journal of Medicine, is a sharp reality test for an academic debate about race and medicine that has long occupied the pages of medical journals. Is there a biological basis for race? If there is not, as many social scientists and others argue, how can a drug like BiDil work so well in one race?

...This month, in a special issue on race published by the journal Nature Genetics, several geneticists wrote that people can generally be assigned to their continent of origin on the basis of their DNA, and that these broad geographical regions correspond to self-identified racial categories, such as African, East Asian, European and Native American. Race, in other words, does have a genetic basis, in their view.

...Some African-Americans fear that if doctors start to make diagnoses by race, then some in the public may see that as a basis for imputing behavioral traits as well. ''If you think in terms of taxonomies of race, you will make the dangerous conclusion that race will explain violence,'' says Dr. Troy Duster, a sociologist at New York University.

Saturday, November 13, 2004

Sink or Schwinn?

Bicycle maker Schwinn, unable to compete with Chinese imports, went bankrupt in 1993 and now exists only as a brand label affixed to bikes imported from Asia and sold in stores like Wal-Mart.

This Economist article discusses outsourcing's effects on European vs US firms. The rigid European labor market makes redeployment of surplus workers more difficult than in the US. The following graph, based on research from McKinsey, shows that while both Germany and the US benefit from cost savings from outsourcing, inefficiency in redeploying surplus labor keeps the overall benefit to Germany from being positive, whereas it is slightly so in the US. (Positive economic impact per dollar of outsourcing exceeds one dollar here, but not in Germany.)

Economist on Outsourcing

This week's issue surveys the situation.

As Alan Greenspan, chairman of America's Federal Reserve Bank, has pointed out, there is always likely to be anxiety about the jobs of the future, because in the long run most of them will involve producing goods and services that have not yet been invented. William Nordhaus, an economist at Yale University, has calculated that under 30% of the goods and services consumed at the end of the 20th century were variants of the goods and services produced 100 years earlier. “We travel in vehicles that were not yet invented that are powered by fuels not yet produced, communicate through devices not yet manufactured, enjoy cool air on the hottest days, are entertained by electronic wizardry that was not dreamed of and receive medical treatments that were unheard of,” writes Mr Nordhaus.

...Indeed, the definition of the sort of work that Indian outsourcing firms are good at doing remotely—repetitive and bound tightly by rules—sounds just like the sort of work that could also be delegated to machines. If offshoring is to be blamed for this “lost” work, then mechanical diggers should be blamed for usurping the work of men with shovels. In reality, shedding such lower-value tasks enables economies to redeploy the workers concerned to jobs that create more value.

My main worry is that our system doesn't do a good job of redistributing benefits from winners to losers. It seems probable that the rather sudden addition of more than a billion workers to the world labor market will, for a time, lead to a surplus of labor in certain categories or at certain skill levels. Is America's educational system really preparing surplus workers to move to "jobs that create more value"?

Bubble Trouble

Here is a nice article from the Asia Times about China's boom economy and its effect on interest rates and consumption in the US.

Why you might not want to buy property in China under current bubble conditions:
The total amount of property under construction is likely to reach 1.460 billion square meters, with a market value of about 30% of the gross domestic product (GDP) by year-end. All data suggest that the market is grossly overextended.

How deep is the pool of suicide bombers?

Judging by this account by journalist Robert X. Cringley of the Iran-Iraq war, there is no effective limit on the number of potential Al Qaeda recruits.

So I took a taxi to the front, introduced myself to the local commander, who had gone, as I recall, to Iowa State, and spent a couple days waiting for the impending human wave attack. That attack was to be conducted primarily with 11-and 12-year-old boys as troops, nearly all of them unarmed. There were several thousand kids and their job was to rise out of the trench, praising Allah, run across No Man’s Land, be killed by the Iraqi machine gunners, then go directly to Paradise, do not pass GO, do not collect 200 dinars. And that’s exactly what happened in a battle lasting less than 10 minutes. None of the kids fired a shot or made it all the way to the other side. And when I asked the purpose of this exercise, I was told it was to demoralize the cowardly Iraqi soldiers.

Now put this in a current context. What effective limit is there to the number of Islamic kids willing to blow themselves to bits? There is no limit, which means that a Bush Doctrine can’t really stand in that part of the world. But of course President Bush, who may think he pulled the switch on a couple hundred Death Row inmates in Texas, has probably never seen a combat death. He doesn’t get it and he’ll proudly NEVER get it.

Welcome to the New Morality.

Friday, November 12, 2004

Where would we be without them?

The funny thing is, I often hear from Bush supporters that deficits don't matter - after all, look how low interest rates are!

From today's WSJ article on Asian central banks and Treasury markets:

Japan's and China's purchases of Treasurys in recent years are credited with helping keep interest rates in the U.S. at historic lows. To put their role in the U.S. debt markets into perspective, Japan and China own about a quarter of Treasurys outstanding, with respective holdings of $723 billion and $172 billion.

...Foreign central banks have been big buyers of Treasurys, especially since a robust October employment report last Friday sent yields soaring. Market participants said these institutions rushed into the market as the 10-year yield approached 4.25% and put a lid on the selloff by buying government securities in large amounts, with bids Friday estimated at around $1 billion.

Some in the market speculate that the People's Bank of China led the charge that day, seeing the weakness as an opportunity to park dollars accumulated through foreign direct investment and peg maintenance into Treasurys. By some estimates within the market, the Chinese authorities have $60 billion in short-term deposits offshore that need to find an investment home.

Thursday, November 11, 2004

Phishing the next big problem?

Phishing attacks use SPAM which appears to originate from a legitimate source such as a bank or ecommerce site. The SPAM message alerts the recipient to a "problem" with their account, and links to a URL that lets them login to fix the problem. The URL is really on a Web server controlled by the phisher, who learns the victim's password and other personal information. The result might be identity theft or even direct theft of funds from the victim's account.

I don't see any easy way to defend against this attack (esp. in red states ;-), since the email and Web site can look very authentic. I have seen some very high quality EBay and Citibank phishing attacks - certainly good enough to fool most of the population.

Companies (especially banks) have been pushing consumers to use the Web to manage their accounts, as there is a tremendous cost savings. It appears that Web transactions and phishing are about to collide head on.

John Thompson, Symantec CEO, in WSJ:

The more threatening and challenging task, however, is phishing. And I don't mean fly-casting. I mean phishing for credit-card information, Social Security numbers, mothers' maiden names. Popular Web sites or popular brands are hijacked to divert unsuspecting consumers and even small businesses off to a spot where their identities can be stolen. Phishing is growing, by the latest estimates, at 110% a month -- a month.

You couple that growth rate with a 5% response rate [to e-mail sent by phishers], and you're going to see an enormous problem. It's relatively easy to do. I mean, you can cut and paste the Citigroup logo off their Web site without a whole lot of hard work. They're hijacking very, very important and powerful brands to catch your attention.

What is Google worth?

When Google was nearing its IPO the share offer price implied a valuation of about $30B for the company. Since then its market cap has skyrocketed to about $45B.

At the time I used to joke around that for $1B I could easily build a competitor to Google that had 80-90% of its capabilities. Now, with Microsoft about to launch its new search service, codenamed underdog, my assertion seems to be proved, as they spent a reported $100M and 20 months to build it.

So, does this shake your faith in Google's lofty valuation? Only time will tell.

What is clear is that online advertising has become a huge industry - about $4B per year in revenues, and growing rapidly. Interestingly, there is not a single strong competitor in the search industry outside the US (except perhaps in China, and those companies are focused primarily on Chinese-language search).

Say what you want about US competitiveness, but in this case a leading new technology is completely dominated by Americans.

Wednesday, November 10, 2004

How can the average investor hedge against the declining dollar?

Here are some funds which invest in foreign bonds, and which should do well if the dollar crashes:

BEGBX (Euro bonds, currency risk mostly unhedged)
PFUCX (PIMCO fund, completely unhedged)
IHHX (Templeton fund, foreign money funds, unhedged)

There is also Everbank.com, which sells foreign-currency denominated CDs.

I think these are better than international equity funds, since many foreign company shares will fall if their currency appreciates too much against the dollar.

Note that if the Bretton Woods II hypothesis is correct (see previous post), we may soon see the European Central Bank intervene to support the dollar. So, although macro trends point toward a dollar correction, it may not happen for years.

Bretton Woods II

My description of why Asian central banks are supporting a strong dollar and hence financing US budget and current account deficits is apparently referred to as the Bretton Woods II hypothesis in policy/econ circles. The current arrangement is reminiscent of the old Bretton Woods regime of fixed exchange rates that lasted from 1945 to 1973.

There are some important differences, though.

Europe, not being as export-driven as Japan/Korea/Taiwan, nor under the same pressure to develop (absorb excess labor) as China, is not as incentivized as Asia to support this system. Nevertheless, the European Central Bank (ECB) may soon be forced to intervene to preserve competitiveness if the Euro continues to rise, thereby joining the cartel supporting the dollar.

One event we should all be on the lookout for is the first defection of an Asian central bank from this cartel. Any one of the smaller economies could diversify its foreign reserves into Euros (hedging against a dollar crash) without driving up the dollar appreciably. However, if each of them do so, the crash would be realized. This is obviously an unstable situation - can it last?

Who are the winners and losers under this regime? The US can continue its deficit spending while keeping interest rates low, benefiting consumers and financial institutions engaged in the carry trade, but risking the creation of asset bubbles (housing). On the other hand, US manufacturing companies will be forced to move production to Asia in order to survive.

Tuesday, November 09, 2004

FT gloomy about Bush II economic policies

Executive Summary: expect a radical agenda which helps the GOP politically but may be disastrous for the dollar and deficits.

The economics of a second term
Financial Times, Tuesday, November 9, 2004, By Adam Posen

Ideological and partisan politicians know that elections are not about mandates or checking the people's will. They are about taking the reins of power and using them to realign the balance of interests in society in their favour - either by strengthening supporters' dependence on their programmes or by weakening the programmes of the opposition. The Bush administration understands this, and its radical economic agenda will move forward aggressively as a result. The "Bush II" agenda will not be constrained by bipartisanship, fiscal discipline or even economic reality, because the ultimate motivation is not economic but ideological - to shrink government and weaken Democratic opposition. The three big economic initiatives promised by Mr Bush should therefore be seen for the political thrusts they are.

First and most importantly will be the push for partial Social Security privatisation. This policy is at least as much to win over Wall Street - the one big business sector besides Hollywood that has continued contributing to Democrats as much as Republicans - by offering the fees that go with managing hundreds of billions of dollars in private accounts. For the Bush team, the political advantages of boosting asset markets temporarily and again giving those who manage money a direct stake in Republican programmes will outweigh any long-term fiscal costs (which limit government spending anyway).

On non-partisan Congressional Budget Office estimates, the transition costs of such a programme will present a budget shortfall of 1.5-2 per cent of gross domestic product a year for 10 years. Some will claim this just moves to the balance sheet an off-balance sheet liability that would be reneged on in future. Try telling that to bond markets, which will be asked to absorb another $200bn (£108bn) a year in government paper on top of today's deficits. Of course, as financial companies make money from trading volatility and sales fees and are not themselves the ultimate holders of the accumulating US government debt, the Bush strategy hopes they will be pleased at that end of the transaction too. Turning US debt into a new class of emerging market bonds may erode America's future, and its ability to fight terror, but it also offers profit opportunities to one-time political fence-sitters.

Second, the tax cuts of the Bush first term, set to be phased out in various years, will be made permanent. This result is already on course, given the Republican majorities in Congress and the Bush team's ability to claim there would be no impact on the current budget deficits. These "permanent" tax cuts will provide no short-term stimulus but will convince high-income voters that any shift away from Republican majorities will come at their expense. The cuts are also part of the multi-pronged "starve the beast" strategy to limit any future non-defence government programmes that might aid the Democrats or their voters.

The third initiative is the pursuit of tort reform that will limit medical malpractice claims, class-action suits, asbestos litigation and so on. Of all items on the Bush economic agenda, this has the most potential for some general benefit to economic efficiency and investment. Its political motivation, however, is the crassest: trial lawyers and their lobbies are the second largest contributors to the Democratic party after organised labour. Cut jury awards, and you cut funding for Democrats.

We should not, like Claude Rains' character in Casablanca, be "shocked" that politics is going on here. If Mr Bush's planned economic initiatives also promoted the general welfare, their dual use of locking in supporters would be welcome. However, the Bush administration is putting its political staying power ahead of economic responsibility - indeed it is weakening the independence of those very institutions on which Americans rely to check economic radicalism. For example, the current Republican congressional leadership is trying to override the constitutional design whereby the Senate acts as a brake on the executive branch and on the self-interest of "majority faction". Bill Frist, senate majority leader and George Allen, the Republican senate campaign committee chair, said their unprecedented direct campaign against Tom Daschle, the defeated Senate minority leader, should warn moderate Republican and Democratic senators not to be "obstructionist", even though that is precisely what the Founding Fathers intended the Senate to do.

The coming leadership change at the Federal Reserve is also being exploited to limit the Fed's room to criticise the inflationary implications of fiscal irresponsibility. The candidates to succeed Alan Greenspan as Fed chair are limited to those (Martin Feldstein and Glenn Hubbard, for example) who not only have ample qualifications, but also have explicitly supported the Bush team's Social Security and tax agenda. Even when central bankers don the Fed chairman's mantle of impartiality, these prior public statements will give the Bush team some protection from future Fed complaints.

Markets tend to assume that the US political system will prevent lasting extremist policies so, even now, observers discount the likelihood of the Bush administration fully pursuing - let alone passing - this economic agenda. If the thin blue line of Democrats and the responsible Republican moderates in the Senate bravely fulfil their constitutional role, perhaps the damage will be limited. If not, we can foresee the US economy following the path to extended decline of the British economy in the 1960s and 1970s and of Japan in the 1990s.

But, as Japan and the UK showed, once the political-economy dynamic is in motion, it takes years for the opposition to reverse it, even as its failures become obvious. That long-term preclusion of alternative policies is ultimately the goal of the Bush economic agenda.

Monday, November 08, 2004

Whither the Renminbi Peg?

This is something I posted on Brad DeLong's Econ blog about dollar-renminbi issues. Everyone should keep in mind that currency markets, although vast and deep, are subject to manipulation by central banks...

The PRC runs a big trade surplus with us, so they have a lot of dollars. It is in their interests to keep the RMB cheap (to keep exports competitive) and stable (to encourage further foreign direct investment).

The policy is definitely mercantilist in nature. Multinationals have concluded that China is the only scalable manufacturing base in the world: close to a huge pool of inexpensive but skilled labor and also close to fast growing markets (in China and the rest of Asia). The PRC government does not want to do anything to alter these beliefs, which led to $60B in FDI last year. Perhaps more important than the dollar investment figure, there is a huge transfer of technological and business knowledge in progress.

Once it is too late for Western companies to turn back, and domestic demand has grown enough that the economy is not wholly dependent on exports, they will definitely let the currency float.

This is essentially what happened with Japan: export driven growth on the back of a cheap currency, followed by eventual appreciation of the currency. It is hard for us to remember that the Yen used to be cheap in the 60's and 70's.

Another related point: the size of the PRC economy is very different when measured by nominal FX rates vs. PPP. It is clear that this differential will eventually go away as the country becomes fully integrated with the world economy. (Perhaps one could define "integrated" as no large discrepancy between PPP and FX rates, since the same bundle of goods should cost roughly the same in China as in the US, if trade is working properly. Recall the "no arbitrage" condition in efficient markets.) This will only happen if the RMB goes up substantially in value, just as the Yen did.

Note Added: Although the bilateral US-China trade deficit is large, China's balance of trade with the entire world is fairly even. They run big deficits with Japan, S. Korea and Taiwan. In some sense, the flow resembles: components imported to China from these countries, assembled there (modest value add), sold to consumers in US. Dollars flow back to China and to more advanced Asian economies.

Sunday, November 07, 2004

Whither the Dollar? A trader's view

Rumors from the financial world:

"Interesting read.   As tomorrow's FT article points out below, if the dollar doesn't rally on strong payroll #s, something fundamentally may be changing.  What is it ? Potentially foreign governments cutting exposure to US assets.   Article cites China, India, Russia and other Middle Eastern countries selling $s. Widening US budget and current account deficits can't be helping either on a 'secular' basis."

From FT: Many currency traders were taken aback on Friday when the greenback fell in spite of bullish data showing the US economy created 337,000 jobs in October. "If this can't cause the dollar to strengthen you have to tell me what will. This is a big green light to sell the dollar," said David Bloom, currency analyst at HSBC, as the greenback fell to a nine-year low in trade-weighted terms.
Speculative traders in Chicago last week racked up the highest number of long-euro, short-dollar contracts on record. Options traders have reported brisk business in euro calls - contracts to buy the euro at a pre-determined rate. However, the market has been rife with rumours that the latest wave of selling has been led by foreign governments seeking to cut their exposure to US assets.

The view of an amateur (me!):

The dollar may fall on rumors, but I doubt seriously whether the BoC (China) has really decided to abandon the dollar. For such an important decision, even were they ready to do it now, I imagine they would want to watch the new Bush administration for a while to see what is happening.

If the dollar falls too much against Asian currencies (Yen, Yuan), there will be a real problem as the J economy could slip back into recession and the growth in China would slow to the point that they are not creating enough jobs to handle the flow of migrants into the urban areas. That would lead to social unrest.

I think the RMB peg will not go away for a couple of years (certainly not fully - a wider trading range is possible, though). Recall that James Baker helped negotiate the Plaza Accord, which devalued the dollar by about 40% in the mid to late 80s, but in an orderly way. I would not be surprised if W puts together a similar deal, although I also would not be surprised if they continue their "benign neglect" of the USD and the market takes it out of their hands...


Outsourcing vs technological innovation

Imagine a new software product. A super-version of TurboTax, the software asks detailed questions via the Web and can prepare sophisticated returns - not just for individuals, but even for large corporations. The cost is a fraction of what U.S. accounting firms would charge for the service. Sounds great, right? Artificial Intelligence lowers the cost of doing business. Companies can pass the savings on to consumers. Some accountants lose their jobs, but that is the inevitable price of technological progress.

Now suppose you find out the guts of the software isn't an AI engine, but rather an office full of Indian chartered accountants in Bangalore. The cost saving is still real, and the fees now go to stimulate the developing Indian economy, rather than into the pocket of a software entrepreneur.

Why is this second outsourcing scenario any worse than the first scenario?

Rove's methodology: MoveOn's evil twin

This WashPost article describes the winning tactics of Bush's team.

A lot has been made of the Internet tactics pioneered by Dean and 527's like MoveOn. This article shows that the Republicans were not without their own effective uses for information technology. The left relied heavily on people's anger over the last election, or dislike of Bush. The RNC's methodology - which relies more on profiling techniques from consumer marketing - seems more likely to produce a stable, robust base with commonalities beyond a single issue.

...the Bush operation sniffed out potential voters with precision-guided accuracy, particularly in fast-growing counties beyond the first ring of suburbs of major cities. The campaign used computer models and demographic files to locate probable GOP voters. "They looked at what they read, what they watch, what they spend money on," a party official said.

Once those people were identified, the RNC sought to register them, and the campaign used phone calls, mail and front-porch visits -- all with a message emphasizing the issues about which they cared most -- to encourage them to turn out for Bush. "We got a homogeneous group of new registered voters and stayed on them like dogs," another official said.

Saturday, November 06, 2004

Interpreting the Election

The demographic breakdown of voting patterns is quite interesting. It appears that many groups (evangelicals, young voters, etc.) increased their turnout in absolute terms, but not relative to the total number of voters, which also increased.

So, the Republicans and Democrats were *roughly* equally successful in turning out their supporters, but the R's slightly more so.

Probably, the R's were able to use culture war issues like gay marriage to distract their people from the problems in Iraq and with the economy.

I can see two disasters on the horizon that might give the D's a chance in two or four years: Iraq is the obvious one, but a dollar crisis (see previous post; foreign creditors become reluctant to buy Treasuries, forcing a spike in interest rates, leading to a recession) is also possible.

I can't emphasize enough how strong the R's and how weak the D's are right now, by historical standards. Bush's economic performance was terrible and the war in Iraq unpopular. Yet he won a decisive victory. Imagine how hard he would have been to defeat if he hadn't gone into Iraq, or had a better economy. (On the other hand you might argue that 9/11 helped him a lot as a source of fear mongering and demagoguery.)

From David Brooks' column: (no endorsement of his usually irritating column implied)

Here are the facts. As Andrew Kohut of the Pew Research Center points out, there was no disproportionate surge in the evangelical vote this year. Evangelicals made up the same share of the electorate this year as they did in 2000. There was no increase in the percentage of voters who are pro-life. Sixteen percent of voters said abortions should be illegal in all circumstances. There was no increase in the percentage of voters who say they pray daily.

It's true that Bush did get a few more evangelicals to vote Republican, but Kohut, whose final poll nailed the election result dead-on, reminds us that public opinion on gay issues over all has been moving leftward over the years. Majorities oppose gay marriage, but in the exit polls Tuesday, 25 percent of the voters supported gay marriage and 35 percent of voters supported civil unions. There is a big middle on gay rights issues, as there is on most social issues.

Much of the misinterpretation of this election derives from a poorly worded question in the exit polls. When asked about the issue that most influenced their vote, voters were given the option of saying "moral values." But that phrase can mean anything - or nothing. Who doesn't vote on moral values? If you ask an inept question, you get a misleading result.

The reality is that this was a broad victory for the president. Bush did better this year than he did in 2000 in 45 out of the 50 states. He did better in New York, Connecticut and, amazingly, Massachusetts. That's hardly the Bible Belt. Bush, on the other hand, did not gain significantly in the 11 states with gay marriage referendums.

He won because 53 percent of voters approved of his performance as president. Fifty-eight percent of them trust Bush to fight terrorism. They had roughly equal confidence in Bush and Kerry to handle the economy. Most approved of the decision to go to war in Iraq. Most see it as part of the war on terror.

Friday, November 05, 2004

Whither the Dollar?

The conventional wisdom seems to be that the dollar is headed down. The case is made pretty clearly here in the Economist.

The U.S. current account deficit will reach about $600B this year, or about 6% of U.S. GDP. Most of this is financed by Asian central bank purchases of Treasury debt. How long will China and Japan continue to finance our profligacy? Certainly they have strategic reasons to keep their currencies cheap relative to the dollar. But someday (soon?) they'll begin to diversify their foreign reserves into Euros. When that happens, we can expect a run on the dollar and a significant increase in interest rates to keep dollar-denominated Treasuries attractive to our creditors.

How to hedge this risk? If you have any good ideas, let me know! Bonds denominated in Euros or NZ dollars or Norwegian Crowns are one option, but they've already had a big run up in recent years. (The dollar is down 14% in trade-weighted terms since 2002.)

Income Volatility

Nice article from LA Times on volatility in family income. Basically, although Americans are getting richer, the size of annual fluctuations in income has also become larger. So, although people are earning more they are also putting up with more volatility from year to year.

In finance terms, the risk-adjusted growth in income, even for high earners, is less impressive than just the growth itself.

There was a brilliant study on this recently, which showed that the top 2% of earners had substantial income growth in recent years, but that they weren't *spending* more. Further analysis showed that there was a lot of movement of families in and out of the top category, due to career and job volatility - it is not the same people in the top category from year to year! Families know this, so in good years they don't necessarily spend as if they are confident of more good years in the future. A good example of this is the sales guys at my former company. One year, they might make $200K, but they could easily be unemployed for 6 months and make much less the following year.

When we compare U.S. economic performance with other countries, we might want to adjust our per capita income growth for the additional volatility that the average American now endures. Many would rather make less money if they can enjoy more security.

Map of the future

Here is a county by county map of the USA, showing red and blue counties. A second map with population densities is also included.

hillbillies 1
knowledge workers 0


BTW, Charlie Rose last night was quite interesting. Two editors from Newsweek were talking about their special campaign issue - for which they were given special access to both campaigns, on the condition that the issue would come out after the election.

The lead editor on the story claimed that Kerry was a terrible candidate and a terrible manager. He said on several occasions the campaign staff had to take away Kerry's cellphone because he wanted to revisit every decision and micromanage. He also was a rambling and overly complex speaker until the very end, although he was able to tighten things up for the debates, thanks to extensive coaching. The campaign hired a number of expensive professional coaches to help Kerry, but to no avail.

It was claimed that the initial campaign management was terrible - until the former Clinton people arrived in Sept. Apparently, Bob Shrum did a terrible job - something that was hinted at in the New Yorker profile of him earlier in the year. On the other side, the Bush campaign was run very crisply and effectively.

Apparently, Clinton urged Kerry from his hospital bed to *come out against gay marriage* as a way to tack to the center. I think it is very persuasive that the republicans used this issue effectively against Kerry (look at the 10 or 11 states that passed anti-gay marriage measures - even Oregon). This example just shows the gap between Clinton - a successful realist - and the rest of the democrats.

I guess I agree with Clinton. Given the current situation (see map), I do not think the left has the luxury of expending a lot of resources to defend gay marriage. So many more consequential issues (foreign policy, the deficit, healthcare reform, the supreme court) are in jeopardy that the democratic party cannot allow itself to be held hostage on unpopular fringe issues that the republicans are trying to exploit.

Looting at Al Qaqaa

For those still interested, here are U.S. soldiers' eyewitness accounts of the looting of plastic explosives.

(Faith-based individuals can ignore this message - the Lord will make it OK in the end as long as we don't allow gays to marry.)

LA Times

The soldiers, who belong to two different units, described how Iraqis plundered explosives from unsecured bunkers before driving off in Toyota trucks.

The U.S. troops said there was little they could do to prevent looting of the ammunition site, 30 miles south of Baghdad.

"We were running from one side of the compound to the other side, trying to kick people out," said one senior noncommissioned officer who was at the site in late April 2003.

"On our last day there, there were at least 100 vehicles waiting at the site for us to leave" so looters could come in and take munitions.

"It was complete chaos. It was looting like L.A. during the Rodney King riots," another officer said.

Wednesday, November 03, 2004

Bounded Cognition

Months ago Microsoft (MSFT) announced a special dividend on Nov. 15 of about $3 per share. They are sitting on a huge pile of cash and don't know what to do with it other than return it to shareholders.

Now, what will happen to the price of a share of MSFT after the dividend is issued? If you go online you can find a lot of discussion and confusion about this point, by obviously very interested individual traders. I have been asked repeatedly about this by fairly sophisticated people.

The answer is that the share price will drop discontinuously by the value of the dividend once it is issued. The argument is kind of trivial: MSFT's future prospects will be the same the instant before and after the dividend, but they will have slightly less cash, so the share price should drop. (Keep in mind they announced the dividend months ago, so there is no new information from the actual payment.)

But, you can find people online discussing a strategy of buying the shares just before Nov. 15 just to get the dividend (which amounts to about 10% of the share price). Not a bad deal, except once you collect the dividend your shares will be worth less. No free lunch.

Talk about bounded cognition - this isn't a hard question like what the dollar-yen exchange rate will be in 3 years. The answer can be deduced by simple logic, but many individual investors are clueless.

Tuesday, November 02, 2004

How to Win Friends and Influence People

The all-time classic, now summarized for your convenience!

This is Dale Carnegie's summary of his book, from 1936

Table of Contents
1. Fundamental Techniques in Handling People
2. Six Ways to Make People Like You
3. How to Win People to Your Way of Thinking
4. Be a Leader: How to Change People Without Giving Offense or Arousing Resentment

Part One

Fundamental Techniques in Handling People
1. Don't criticize, condemn or complain.
2. Give honest and sincere appreciation.
3. Arouse in the other person an eager want.

Part Two

Six ways to make people like you
1. Become genuinely interested in other people.
2. Smile.
3. Remember that a person's name is to that person the sweetest and most important sound in any language.
4. Be a good listener. Encourage others to talk about themselves.
5. Talk in terms of the other person's interests.
6. Make the other person feel important - and do it sincerely.

Part Three

Win people to your way of thinking
1. The only way to get the best of an argument is to avoid it.
2. Show respect for the other person's opinions. Never say, "You're wrong."
3. If you are wrong, admit it quickly and emphatically.
4. Begin in a friendly way.
5. Get the other person saying "yes, yes" immediately.
6. Let the other person do a great deal of the talking.
7. Let the other person feel that the idea is his or hers.
8. Try honestly to see things from the other person's point of view.
9. Be sympathetic with the other person's ideas and desires.
10. Appeal to the nobler motives.
11. Dramatize your ideas.
12. Throw down a challenge.

Part Four

Be a Leader: How to Change People Without Giving Offense or Arousing Resentment
A leader's job often includes changing your people's attitudes and behavior. Some suggestions to accomplish this:
1. Begin with praise and honest appreciation.
2. Call attention to people's mistakes indirectly.
3. Talk about your own mistakes before criticizing the other person.
4. Ask questions instead of giving direct orders.
5. Let the other person save face.
6. Praise the slightest improvement and praise every improvement. Be "hearty in your approbation and lavish in your praise."
7. Give the other person a fine reputation to live up to.
8. Use encouragement. Make the fault seem easy to correct.
9. Make the other person happy about doing the thing you suggest.

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