Twofish's Blog

November 22, 2007

I just don’t know

Filed under: Career, china, finance — twofish @ 8:10 am

One thing about economic statistic measures is that once you dig into them, you find out that are extremely messy and complex, and every economic statistic that I can think of has dozens of assumptions and guesses associated with them. This is true for CPI, GDP, PPP, profit, loss, assets, liabilities, export revenues whatever…..

This means that it is very easy to get into a situation in which you pick apart a statistic if it doesn’t agree with you, but you let it stand if it doesn’t. Because every economic statistic is so fuzzy, it’s very easy to find a reason to ignore it if it doesn’t fit your view of the world. It’s also dangerous to do that.

What I try to do is not to rely on specific statistics, but to get as many numbers as I can in order to put together a general picture. It’s harder to fudge 200 numbers than it is one, and one number is just not enough information to figure out what is going on.

Also, it’s useful to just talk to people. Finally, it’s useful to have someone with a different view of how things work look at a number and find out what it means to them. One thing that I find amazing is that a number that is *bad* to one person can be a *good* to someone else.

One thing I like about finance is the brutal honesty that real money forces on you. For example, if I say that the Shanghai stock market is going to crash or the US is going to go into recession, this is perfectly and totally useless for making money. In order to make any real money, I need to say *exactly when* the Shanghai market will crash, and exactly when the US goes into recession, how deep, and how long the recession will be. Once someone makes that predictions, you can see how much they really believe it by seeing how much of their money they put on the prediction.

One of the nice things is that it avoids some of the biases that crop up. People tend to remember the predictions they get right and forget the ones they get wrong, but bank accounts are less forgetful. Also pundits lose nothing for being wrong, but people with real money do. If I knew with certainty which way the SP500 or interest rates would go in the next year, I would be fabulously wealthy, but what leaves me wealthy if I’m right can bankrupt me if I’m wrong. This gives a big incentive to say……

I don’t know………

November 16, 2007

Comments on economic education

Filed under: austrian economics, economics — twofish @ 5:29 am

One thing that often surprises people is the degree to which people working in Wall Street investment banks tend to not be “economic conservatives.” Investment banks are huge bureaucracies, and the people in them are generally not allergic to working in large bureaucracies. Also people who work on the raw edge of markets everyday see some of the limitations of said markets. Lots of Rubin Democrats in the banks.

People like George Soros and Warren Buffet have warned against market fundamentalism, and I don’t recall anyone out of a major Wall Street investment bank that has recently called for unfettered capitalism. (Hedge funds are different.)

One of the funny ironies involves sitting at a trading desk at the center of global capitalism, and going through a maddening socialist central-planning bureaucracy trying to get a phone installed.

November 12, 2007

A brief history of recent US finance

Filed under: austrian economics, economics, finance — twofish @ 4:16 pm

50 Cent: Really? Explain how US banks were able to offer fixed rate mortgages before the 1980s without a liquid market for derivatives.

Simple. Between 1933 and 1980, the Federal Reserve set interest rates. Under regulation Q, all retail savings rates in the United States were set at 5.25% and checking account interest was set at zero. Once retail savings were fixed, then the government through FHA set the lending rates at below market rates, making it easy for people to finance home purchases.

It was a massive successful system that worked for about 50 years, but ended up being unsustainable. One thing that killed it was the inflation of the 1970’s. Once you had inflation, people were no longer willing to save at 5.25% when inflation was at 10%, and people invented clever things like money market accounts and certificate of deposits to circumvent Regulation Q. Another thing the fact that the government couldn’t increase interest rates meant that it didn’t have a way of controlling the inflation of the 1970’s. Also, the US government could pretty easily set interest rates and do whatever it wanted domestically in 1933 to 1965 when US markets were the only game in town. In 1948, if you didn’t like the lousy interest that the US government was setting for you, you pretty much were stuck since there was no where else in the world you could move your money to. This stopped being true in the 1960’s which was one reason the system broke done. Another was Vietnam and the Great Society. Have a major war and not increasing taxes means that the wealth has got to come from somewhere………..

So finally in 1980. the US government gave up, deregulated interest rates. This quickly lead to a huge set of banks making stupid loans creating an early savings and loan crisis in the US. It also very quickly lead to the formation of a derivatives market in the mid-1980’s. By the early-1990’s, there was a demand for people who could calculate the value of those derivatives, which led to lots of physics Ph.D.’s being hired on Wall Street.

The Chinese financial system looks in some ways like the US financial system of 1965, but there are lots of pressures for floating interest and currency rates. It’s not that floating interest or currency rates are morally better or worse, it’s that like the US in the late-1970’s, China is finding that it *must* to certain things in order to avoid chaos. What I find fascinating about the history of US finance from 1970 to 1990 is that pretty much *none* of it was planned.

The other thing is that among the financial innovations that people found scary in the late 1970’s were money market funds and certificate of deposits. Money market funds turn out to be a great thing since it means that you can basically have a checking account that pays interest, which is a hellishly difficult thing to create.

Also, one curious thing is that the US retail derivatives market is not nearly as well developed as the Asian or European markets. In the US, you can’t go into a bank, and buy a complex structured note, and there are dozens of legal, cultural,. and regulatory reasons why not. In the UK, you can.

November 10, 2007

Meet the new boss, same as the old boss

Filed under: china, finance, politics — twofish @ 4:41 pm

Events in Georgia illustrate why I’m not so eager to overthrow the Communist Party of China.  To recap, in 2003, there was a Rose Revolution that overthrew the old regime ushering in a new age of democracy lead by someone who is now breaking up demonstrations.

And in Chinese history, the Kuomintang overthrew the emperor, and the Communists overthrew the Kuomintang, and in each case you had people that behaved as badly if not worse, and you spend a lot of effort with a useless revolution that also destroyed institutions that you needed to run a government.  People wonder how can I not oppose the Communist Party given the blood that it has on its hands from the Great Leap Forward and Cultural Revolution, and then answer is that if you have an other revolution, you’ll go through exactly the same process all over again.  Power corrupts, which means that if you have a wonderful moral revolutionary and give them power, they will be corrupted by it.  Today’s idealistic revolutionary young person is tomorrows party boss.

What keeps things working are laws, processes, and institutions.  The US government works as well as it does not because the people in charge are more moral or smarter than people in the rest of the world, but it is because it has laws, processes, and institutions that keep people from doing damage.  Put Dick Cheney or Alberto Gonzales in situations where they are unconstrained by things like courts and legislatures, and they will do exactly what people in third world countries will do in those situations.  Put you or me in that situation and given time, you or I will behave just as badly.

In the case of China, you now have functioning courts and legislatures, and you have processes and procedures that make sure that the person on top changes every ten years.  Hu Jintao and Wen Jiabao are going to retire in 2012, and be replaced by fresh new faces, and changing the person in charge from time to time in a regular orderly manner is important.  New people have new ideas, and they can quietly blame the last person (fairly or unfairly) for some of the problems that they want to fix.  Someone who is 50-60 is just going to have a bit more energy to run things than someone who is 90.  Also the way that the Chinese system works, ultimate power is distributed among about 20 people in the Politburo who have to answer to a “selectorate” of about 2000 people.  That keeps one person from going totally nuts.

Laws, processes, and institutions usually don’t fair well in revolutions.  Sometimes it is necessary when there are no other options, but China is nowhere near that point.

Follow the money

Filed under: china, finance — twofish @ 4:19 pm

There are two arguments which suggest that China can withstand a US recession.

1) Export/GDP figures vastly overstate the importance of exports to China. You put together two widgets worth 50 cents to one spocket that is worth $1.10 which is then exported. This gets count in export revenue as $1.10 but just contributes to 10 cents to GDP. If you then calculate export/GDP you get a figure that overstates the importance of the export.

2) The second is historical. Since 1978, the Chinese economy has been unaffected by US recessions, including most recently the 2001 recession which hit a lot of other East Asian countries hard.

As far as jobs, I don’t see it to be particularly difficult to redirect export production inward if this is necessary. Most of the exports to the US are consumer goods, which Chinese would want if the US doesn’t take them. Also, most of the new jobs in China produced in the last 25 years aren’t in manufacturing. They are in services. What happens is that as productivity increases and as people have fatter paychecks, they want to get their hair done, remodel the apartment, eat in nicer restaurants etc. etc.

Unemployment can be dealt with through public works projects. Tension between rich and poor may be less destablizing then one imagines. The really, really poor are too busy trying to survive to fight the system. The less poor are able to fight the system, but they are more interested in using it to get rich. IMHO, banks are in much less bad shape than some people think, and certainly in much better shape than the last US recession in 2001.

The reason global imbalances aren’t talked about much any more is that the reason they were talked about in 2004 was that certain interest groups in the US wanted certain specific things, and talking about RMB revaluation and global imbalances was a way of uniting the groups. No one cares about it much any more because those groups basically got what they really wanted. Textiles manufacturers got an extension to the multi-fiber agreement, and Wall Street has gotten a lot of financial service liberalization.

November 8, 2007

Non story – Chen Siwei and the sky falling

Filed under: china, economics, finance — twofish @ 4:02 am

The sky is falling. China is going to dump dollars for Euros. The sky is falling!!!

After googling a bit, I found what Chen Siwei really said, and it wasn’t quite what was reported

Translating the third paragraphs….

Chen Siwei said that improving liquidity could allow for the adjustment of foreign exchange reserves. He proposed that from a strategic and tactical viewpoint it would be appropriate to relax restrictions controls on individuals and enterprises, and so “save the reserves among the people.” In this currency system, stronger currencies would rise and balance the fall in weaker currencies.

Thanks to the magic of sensationalist journalism, this became CHINESE GOVERNMENT ABOUT TO DUMP DOLLARS!!!!!

Also it seems to be a big conference with lots of papers with lots of different points of view, and it seems that the reporters just went through the dozens and dozens of speakers and papers to find the bits that would make nice headlines.

What annoys me is the shoddy journalism in the internet age. Not one newspaper that I’ve seen gave a hyperlink to the talk, nor did anyone think of just translating the whole speech or even a paragraph versions. What’s more, once one newspaper came up with a quote, every other newspaper, did a “me too” and repeated exactly the same set of quotes with some extra exclamation marks to it.

It wasn’t a huge amount of effort for me to find out what Chen Siwei actually said. I just googled for financial conferences in Beijing in November 2007 and looked for Chen Siwei.

November 4, 2007

Comments on the RMB reval

Filed under: china — twofish @ 3:05 am

The way people sometimes describes things, you’d think that Hu Jintao reads the newspaper in the morning and immediately picks up the phone and immediate orders people around to do things. That’s just not how things work in big organizations. Major policy changes take months of negotiation and bargaining to implement, since they usually involve a large amount of coordination between different agencies.

What most likely happened was that the Politburo decided to revalue the currency sharply in the summer, and the delay was to have the 17th party congress finish and everyone in their new places before doing anything. There are several major initatives going on right now QDII and CIC being two important ones, and all of these initiatives are interlinked and require quite a bit of coordination. In particular, I don’t see how the government can push forward with a massive QDII program or the linkages between the Shanghai and Hong Kong stock markets without freeing up the currency. Also what ever inflows there are, they are likely to be dwarfed by the massive outflows that are coming in the QDII program and CIC’s strategic investments.

November 2, 2007

Conspiracy theory fodder

Filed under: china, finance, quantitative finance — twofish @ 1:46 am 

One other bit of data is that I was at the Chinese Financial Association conference over the weekend in which Chinese mutual managers were actively trying to recruit Wall Street professionals to come back home and manage portfolios. In the short run, there is a huge demand for all sorts of people to manage QDII transactions. In the long run, one fund mentioned that they were looking for people with experience investing in emerging markets.

The other thing that I got from the conference was how close the cooperation is between Hong Kong and mainland markets. One of the medium term goals of the PRC government seems to be to have Hong Kong displace Tokyo as the center for finance in the “third time zone” as well as to tap into the financial expertise that exists there. One interesting part of this is that one of the goals of Hong Kong appears to be to become a center for Islamic finance which ties into a lot of the themes in this post.

About currency revaluation….. There was a mid-level official from the PRC who gave a talk. He didn’t answer any questions about currency valuation directly, but he did say to read Hu Jintao’s remarks at the party congress in the original Chinese, and that “interesting things are about to happen.”

It was also curious to hear a talk from someone that worked in the Treasury during the mid-1990’s and to hear first hand what they said happened and the relevance to China. Far from trying to destroy East Asian economies, that person said that Treasury and the IMF were trying hard to pump money into the southeast Asia during the crisis, but they were just overwhelmed by the scale of the capital flows.

The final thing about the conference was that it would have been a playground for conspiracy theorists. You had people from the Council of Foreign Relations, Wall Street bankers, ex-officials from the US Treasury Department, officials from the Chinese government, and the heads of some of the Chinese mutual funds all in one room. One point that the PRC official made was that he travelled all the way from China to give a twenty minute talk because the people in the audience, who were a sample of Chinese people who work in Wall Street finance were the precisely people who are going to be making the big decisions in the future.

Yes there is a vast conspiracy. I’ve seen it. I’m actually part of it. Care to join in?

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