Twofish's Blog

May 30, 2009

More notes on Gillam Tett’s book

Filed under: academia, finance — twofish @ 8:05 pm

I’m rather surprised that people haven’t asked her more about her fieldwork in Tajikistan.  Googling around, I found a lot of interesting and relevant things about Tajikstan that is very relevant to world affairs. You have the interaction between Soviet/post-Soviet ideology and Islam.  You have some very interesting gender issues.  Men in Tajik society were suppose to be “modern” since they had to go out and work in a Soviet system, and women “traditional” and this caused a interesting interactions when the Soviet Union fell.  You had a major and very tragic Civil War, which has some relevance to my life.

Also the fact that she was a goat herder was treated as a point of humor, but I found it interesting that no one seemed to take that seriously.  Being in banking, my first reaction was “how do people in Tajikistan make money herding goats” since that hits the second question which is “how can I make money off the people in Tajikistan herding goats.”  The only google reference that I can find is that goats are being used for cashmere, which makes me interested in the economics and social structure of goat herding.  It seemed from some of the pages that Tajiks are considered to have some special ethnic affinity to goat herding.

The other reason I was pleasant surprised by Tett’s book is that she didn’t do the standard reporter thing.  I’m afraid to talk to reporters since I often get the impression that reporters feel that their job is to make you look bad.  Reporters seem to assume that life is a battle between good and evil, and heaven help you if a reporter thinks that you are evil.

However besides some nit-picking, I think that it is useful because it addresses a big problem in that most of the public really has no idea what bankers do and how banks work.  It’s because no one really has the incentive to explain it to them.  It’s not that bankers are intrinstically evil or are hiding something out of shame or fear.  The problem is that the risks of being a public figure outweigh the benefits of public knowledge.  If there is a one in a million chance that I will be fired or publicly humiliated by something I say, then why should I take the risk, since I personally don’t get any benefit out of greater public knowledge.  And the fact that there is no shortage of people that are “out to get you” just increases those risks.

So here is some nitpicking…..

* one thing that I think Tett seems to imply from the interview is that people don’t talk about the “shadow banking system” because they are ashamed or fearful about it.  Actually bankers don’t talk about the “shadow banking system” for the same reason that people don’t talk about the clouds or the air they breath.  It’s such a nature part of the system, that people don’t think about it.  The other thing is that it’s not a matter of the banks hiding things from the regulators.  Most of the regulators in 1990-2008, where actively encouraging the development of the new banking system.  It’s also not that the regulators were hiding anything from the public, after all it was the public that voted in a series of administrations that believed in loose regulation.  It’s not also that bankers had this nasty conspiracy to defraud the public.  Most people in banking believed what they were doing was a good thing, and personally I still believe that if you properly regulate derivatives trading that you will end up with a better financial system.

* Something else that Tett also doesn’t make clear is that when she says the banks were able to use CDS to reduce their capital levels.  She is referring specifically to European (particularly German) banks.  American commercial banks aren’t allowed to do this.  This does bring up a problem in that in a global economy, you just can’t fix one countries regulations, since you can side step them.  Also, you have to view regulation as a system.  In England they drive on the left side of the road.  In the US, they drive on the right side.  What happens at the intersection.  A lot of English regulation is based on what are basically informal “gentleman agreements,” but Americans are suspicious of that sort of system and prefer impersonal rule based systems. These systems work in isolation, but you end up with Frankensteins like AIG-FP when you aren’t careful.  One thing that caused problem is that insurance in the US is primarily a state regulated system, and US states normally don’t talk directly with people in other countries, so no one ever thought of getting the New York insurance regulators and the UK FSA in the same room.

And if you have this much trouble making the US and UK financial systems compatible, just wait until you try to bring in China and Saudi Arabia.  In the case of China, this turns out to be a lot easier because of Hong Kong.

* Not that it would have helped much.  The way that derivatives were used help cause the problem, but the underlying problem was bad loans, and in that area derivatives didn’t play a huge role.  For example, Washington Mutual didn’t have much in the way of derivatives, and if you look at the dozens of banks that are failing on the FDIC website, derivatives didn’t play much of a role in their failure.

Notes on Gillian Tett’s book Fools Gold

Filed under: academia, finance — twofish @ 7:19 pm

Got it on back order.  From the interview it looks like one of the best books out there…..

Something that Gillian Tett makes more clear is that most people outside of banking think that the “shadow banking system” is some secretive thing that is a small part of the system, whereas in fact that “shadow banking system” is bigger than the “non-shadow banking system.” If you get a mortgage, a credit card, auto loan, commercial business loan, or any credit at all, the money that you got came from the “shadow banking system” rather than the “non-shadow banking system.”

The “shadow banking system” needs to be regulated because it *is* the banking system, and it really can’t be shut down, because there really is no “non-shadow banking system” any more. People in banking don’t talk much about the non-shadow system not because it is some deep dark secret, but rather because it’s like the air or the clouds. You see it every day that you don’t think about it.

Part of the reason the shadow system is rather poorly regulated is that throughout the 2000’s, there was this idea that government was the problem rather than the solution, and any sort of government intervention with business was bad, so routing everything through this other banking system was a good thing. Over time, the shadow banking system would prove to be so much better than the traditional one, that the traditional system would fade away.

The fact that this just didn’t work probably became obvious the day after Lehman died. I’m willing to bet that no one at the US Treasury had the slightest idea that if Lehman died, that AIG would go under, because there was just no one keeping track of who had what risk.

Discussion on the US financial system

Filed under: china, finance, wall street — twofish @ 7:17 pm

May 15, 2009

Thoughts on the Universities and the Financial Crisis

Filed under: academia, massachusetts institute of technology — twofish @ 7:32 am

Speaking of universities.  One thing that shocks me is that universities are now facing their biggest financial crisis since the Great Depression as endowments plummet, and I’m a bit shocked at the lack of leadership and vision that is coming out of the academy.  MIT is facing a $150 million short fall in revenue over the next three years, and all they can do is create committees to study the problem, and no one is even talking about the fact that the drop in revenue may be permanent.

One reason I think that academia is in such sorry state is that anyone with any vision and determination got out of academia.

Notes on China, Keynes and employment

Filed under: china, finance — twofish @ 5:54 am–-the-argument-rages/

I really don’t think that there is very much of a “debate.” I don’t know of *any* Chinese political or economic leader that thinks that China shouldn’t move from export driven growth to internal growth or that China has much choice in the matter. I also have yet to meet anyone that doesn’t think that the Chinese economy needs structural changes. As far what people are argument about, much of it is about fine tuning the details, and I don’t see much of a division into two camps.

The main debates is a replay of the Keynes-Hayek debate.

MPettis: It is that China should stop misallocating capital in order to achieve short-term employment growth.

I simply do not understand how if the goal is to increase domestic demand and reduce precautionary savings, how increasing unemployment will make the problem better not worse. It seems to me that you want to get cash into the hands of consumers however possible, so that consumers start spending and developing domestic industries. If you create mass unemployment then you’ll never have the demand to create internal growth, and it’s also a false economy when it comes to government deficits because when your tax receipts plummet your debt is going to be worse off than before.

I just doesn’t make sense to increase unemployment. Even if people are being employed in things that are immediately non-productive, you maintain consumer spending which create productive industries. If you contract the economy, you’ll never have the mass consumer demand necessary to create productive industries and *that* is what causes lost decades.

This is the Keynes-Hayek debate all over again, and Keynes won that one. Keynes’s argument is that in an economic bust, you do anything to get people spending. He suggested paying people to bury money and dig it up again. So using Keynes’s theories, the most important thing is to spend money, what you spend the money on is less important.

Even there, it doesn’t look bad. Barry Naughton has written up a paper on the details of the stimulus package, and it seems to be to be spent on rather sensible things.


Jack P: The debate is whether the crisis should be an opportunity to force the change quickly or whether the transition should be postponed in order to limit the short-term impact of the crisis.

I don’t think that is the debate, and if that is the debate, it is a very silly one since the degree to which China can rely on exports is something that totally out of China’s control. Everyone I’ve seen wants change. The question is “change to what?” A lot of discussions end up with you have one group that portrays themselves as “progressive reformers” and the other group as “evil regression people that want to turn the clock back to the past.” It usually doesn’t describe what people are actually arguing about. Everyone wants to move things forward, the trouble is that people disagree as to the direction.

Jack P: Japan in the early 1990s showed just how misguided and risky policies aimed at misallocating capital in order to maintain employment can be.

And I think people draw the wrong lessons from Japan. Japan (and for that matter the Soviet Union) “stagnated” at standards of living far, far beyond those of anything China is likely to see in the next three decades. Japanese stagnation existed largely because of lack of productivity growth because in an industrialized economy, the only way of generating growth is through productivity increases. If you have a non-industrialized economy, there are other, easier ways of generating economic growth, and the cost of “capital misallocation” are far smaller.

Japan’s experience may be relevant to China in 2030, but applying it to China in 2010 leads to totally incorrect policies, since Japanese stagnation is a much higher standard of living than Chinese growth. If someone comes up with an economic policy that leads to ten years of stagnation at Japanese standards of living, that a wonderful policy that we need to adopt, because it puts China at a higher standard of living than anything that anyone has proposed.

In any case, if it is choice between Japan-1990 and US-1930, I go with Japan-1990.

Pettis: I suspect you may be wedded to a version of Say’s Law.

I’m a Keynesian. Say believed that production naturally creates its own demand, and I certainly don’t believe that. Suppose you have aluminum workers that are producing too much aluminum. They should really stop producing aluminum. That’s fine. The trouble is that if you have them stop producing aluminum and then leave the factory with income, they stop consuming anything, at which point you have this

unemployment -> reduced demand -> unemployment -> reduced demand -> unemployment

spiral that led to the Great Depression, and it’s not a matter of hitting bottom and bouncing back, you don’t bounce back.

So here are the policy options in order of preference.

1) Your best situation is if you get them to stop producing aluminum and pay them to start producing something useful.

2) Your second best situation is to get them to stop producing aluminum and pay them to do nothing.

3) Your third best situation is to pay them and keep producing aluminum.

4) The worst thing you can do is to shut the factory down and put them out of work, because at that point you end up with a domino effect, that you are not going to get out of.

Pettis: Getting people to spend is certainly an important part of any solution, but only if it creates net demand.

How is putting people out of work going to create net demand? If you put the aluminum workers out of work, yes you stop producing aluminum, but you have this domino effect as the workers no longer purchase goods and services which puts more people out of work.

You can see this in the trade data. Chinese net exports has *increased* over the last few months, but growth is going down. Why? Because when you put a migrant worker out of work, you end up putting five other people out of work. Now that migrant worker is just no going back to the export factory. So have them build a school or hospital.

Pettis: If the only way to keep people employed is by creating additional capacity greater than the ability of the newly-employed to absorb it, in a world of excess capacity there are likely to be one of two consequences.

If that is the problem then employ people generating things that don’t produce new capacity. If we have too many steel mills then employ people to demolish them and replace them with parks and hospitals. Employ people to build lots of tanks and aircraft, and the put them in the middle of the desert and blow them up. That’s what got us out of the Great Depression.

Pettis: In April for example there were indications that aluminum production in China rose by around 10%, even though the world is seeing a glut of aluminum production. This certainly helps employ aluminum workers, but it cannot magically resolve the unemployment problem except by pushing it abroad.

If you can’t think of anything better to do, then take all of of that aluminum, put it in the middle of the south China sea and then sink that ship. That is what happened in World War II except that no one has to die.

That’s assuming that you can’t think of anything better to do, and I can think of a dozen things.

If you have lots of cheap aluminum, then give people coupons to buy refrigerators that use that cheap aluminum.

What I find very odd is that the problem of idle hands and overcapacity is not a new one. It existed throughout the 19th century, and some of the best economic minds of the late 19th and early 20th century thought deeply about what to do. Some of the answers they came up with were wrong (say hi to Karl Marx), but it seems very strange that after dealing with the problem of overproduction and unemployment for a century and a half we are having this debate as if this is a new and original problem, and I’d appreciate it if someone would explain what the big problem is with the solution that Keynes suggested 70 years ago.


  1. Quote: The US has a long history of bailing out the car industry, and the most recent moves are very far from indicating a major slide into the command economy.

    And the first moves toward a market economy that China took in 1977 were just minor corrections. Now that the US government has crossed the Rubicon, events are going to take on a life of their own.

    What is different is that the default assumptions have changed. Two years ago, you could argue that private companies were better run than state-owned ones and people would generally agree. You now have to argue the point.

    Quote: China wants to be a high-end manufacturer, but on the flip side it needs to encourage massive low-end consumption.

    Which is why the immediate future of China requires massive creation of low-end service jobs. You build a refrigerator, and you create jobs for truck drivers, refrigerator salesman, refrigerator repairmen, interior decorators, restaurants for refrigerator workers, ice cream parlors, day care providers, etc. etc.

    The interesting thing about the structure of Chinese employment is that the number of people employed in manufacturing hasn’t increased in the last twenty years, whereas the main change are fewer people in agriculture and a lot more people in services.

    One big problem with the Chinese financial system is that it is biased toward large lenders, whereas the big engine of growth in the Chinese economy are small mom-and-pop enterprises. Part of my disagree with a lot of economists is that people have this misguided notion that if you cut credit to large enterprise, you end up with more credit to the SME’s that you want to support. Except that I’ve never seen a case when this has actually happened.

    If you cut credit, then what happens is that if you contract credit, banks will preferentially lend to well known, high capital deep pocketed customers with quasi-official backing which pushes the economy away from the direction that it should go. What you want is to expand credit so that money goes through the infrastructure projects to the SME’s that really need the capital. How do you get the Bank of China to lend money to a dim-sum stand and beauty salon? You don’t. You have BOC lend money to the shipyard that is being built next to the dim-sum stand and beauty salon.

    I’d argue that if you count the service jobs that you create around the shipyard, you end up with far, far more wealth creation than the loses that you create from the shipyard. Now once everyone is employed in dim-sum stands and beauty salons, money that you pour into shipyards becomes a dead loss. Which is why China is different from South Korea or Mexico, and why growth in Southeast Asia stalled in 1990, and why the economic policies I proposal will cause Chinese growth to eventually stall if they aren’t changed.

    This model also explains why the Soviet model stopped working, they were just pumping money into shipyards, and not letting people start dim-sum stands and beauty salons next to the shipyard. Latin America failed when the owners of the food stands, weren’t able to reinvest their money to create new dim-sum stands.

    I agree with most of the criticism of the Chinese and banking financial system, but I cannot understand how most of the policies that are being suggested by some of these critics don’t make the problems far worse.

  2. One problem with these discussions is that any time an argument becomes A versus B, you end up missing something important. Are you in favor of a Japanese bailout or not, is a loaded question, because the assumption is that if you are against what Japan did in the early 1990’s, then you must be in favor of this other policy, which isn’t the case.
  3. In the case of Japan, one problem is that you ended up with “living dead companies”. That the Japanese government did just enough to keep the companies barely alive, but no more. One could argue that the Japanese government should have let the companies collapse, or one could also argue that the Japanese government should have taken the opposite approach of flooding the companies with enough cash so that they had clean balance sheets, which is what China basically did with its SOE’s.

    Also one assumption is that pain and pleasure are balanced and you have to have some pain to get something good. The universe doesn’t always work this way, and (as Mao demonstrated) sometimes you can endure a great deal of pain and get nothing. Given the experience with the Great Leap Forward, you are really going to have to argue the point, if you are arguing that a lot of pain right now is worth it, and I really do not see how widespread unemployment is going to help fix the structural problems in the Chinese economy, and someone needs to explain this to me.

Pain and Gain

Filed under: china, finance — twofish @ 5:44 am

WStroupe: Far too many people here and most everywhere evidently fail to see this crisis in its correct fundamental perspective, namely, the crash of the asset-based model itself.

I’m not seeing it because I don’t think it is true.  You’ve had asset booms and busts happening for the last 200 years, and I’m not seeing anything in this bust that is fundamentally different from what happened in the 1920’s.

In fact, I would argue that the big mistake that people made was the notion that the economy fundamentally had changed, when in fact it had not.

WStroupe: It’s about switching back to a more traditional income-based model. That will be a gut-wrenching process entailing far more pain and suffering than the U.S. has experienced so far, and it only gets worse the longer U.S. leaders waste precious time and money trying to revive the asset-based corpse.

I really don’t think so.  What the US has to do is to boost savings and cut consumption.

Annoying yes, but not the end of the world.  What happens when you boost savings, is that you increase productivity so the amount that you save comes back to you in higher wages.  OK, people go from -2% savings to 5%.  Moderately annoying, but no one is going to starve, and that money is going to come back to you.  You save 5%, a factory gets built, you get a higher paying job.

Take your 401(k), people were assuming 10% growth, now assume 3-5%.  The numbers that come out are somewhat ugly, but they aren’t disastrous.  What will cause massive financial disasters to most people is if they lose their jobs for an extended period of time.  If you are typical and the return on your pension goes from 10% to 5%, it’s ugly, but not the end of the world.

For most people under 55, if you are out of work for a year, then it is the financial end of the world.  Imagine what happens to you if you lose your job for three years.  You are never going to bounce back, so this is why it’s vital to get people back to work, because most people under 55 people have personal financial situations in which even if you have a massive boom after three years of unemployment, it’s not going to be of any help to you.

And God help you if you get sick during those three years.  Without fundamental changes in the social system, if you get hit by a car while unemployed, you are going to be in poverty for the rest of your life.

I don’t see anyone trying to revive the corpse.  If you disagree, go to a bank and try to get a subprime mortgage today.  The money and effort being spent involves burying the corpse, which can be frightfully expensive.

There is this very popular notion that in order to get something you have to undergo a lot of pain.  What that ignores is that you can undergo a lot of pain, and still get nothing.  I’m extremely skeptical of the idea that just because an idea is painful, you end up getting some benefit out of it.  It has something to do with Stalin, Mao, and the Great Leap Forward.  In the 1950’s, Chinese were told that if they sacrificed for the common good, there would be a few years of pain and then this economic boom.  So there was a lot of pain and then nothing.

So when someone says “you have to go through this pain to get to the boom” I’m really skeptical because I’ve heard that before.  There is also the early-1990’s when you had large number of people saying that Russia would boom and China would stagnant because Russia was taking strong medicine whereas China was not.  Things didn’t work out that way.  The first thing I ask, is “is this pain *really* necessary and if it is then what are the ways that we can reduce the pain?”

Also if you talk about getting rid of the old system and going for this wonderful new system, I keep thinking “wasn’t that what Mao and Stalin promised?”  OK, you claim you are different.  That’s fine.  Explain to me how you’ll end up with a boom, and give me numbers.  How much needs to be sacrifices, for how long, and at what point do you throw up your hands and say, well maybe I was wrong about what the problem is, and we need to do something different.

If what you propose will have me accept a 5% return on my 401(k) and a 5-10% tax increase if I hit the jackpot and make more than $250K, that’s fine.  Annoying, yes, but survivable.

If what you propose has me out of work for two years, at which point I lose my house and savings, and have no insurance, then this will not work because I’m busted even if the economy comes roaring back, and if you multiply me by fifty million, I don’t see how the economy is *ever* going to recover.

Also, this plan has another big, big problem.  If I lose my job for two years, I’m wiped out.  The ex-CEO’s of Bear Stearns, Lehman Brothers, General Motors, AIG, Citigroup, and Enron all can survive two years without a job or health insurance.  If you blow up the economy for two years and then you have a massive boom, I’m going to be in poverty for the rest of my life.  They aren’t, because they have enough money in the bank so that two years without work or health insurance is a vacation, and so a bust then boom is going to benefit them, not me.

If the choice is between is between two years of hell followed by a boom, and Japanese style zero-growth economic stagnation then I vote for zero-growth stagnation, and so will most people.  If this doesn’t work for you (and it doesn’t work for me), then come up with another choice.

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