Twofish's Blog

January 18, 2009

Career advice for Ph.D.’s

Filed under: academia — Tags: , , , — twofish @ 9:46 am

Do not be picky about what you do, especially in a bad economic climate. Apply for everything you can think of, finance, non-finance, academia, etc. etc. In almost all cases, you will end up having the door closed in your face, which is why you need to knock on as many doors as you can. It doesn’t matter if a 1000 people say no, as long as one person say yes, and you have to keep knocking on doors until you get to someone that has cash to give you.

The psychological pressure can be huge. There are a lot of people in Ph.D. programs who have never had the experience of being rejected, because since kindergarten their history has been “pass the test” go to the next level, and the system they have been in has been somewhat rational in which if you don’t make it to the next level, it’s because of something “bad” you did. Once you got your Ph.D., you are no longer in the world (even if you stay in academia), and it is a huge transition to make to realize, that you are going to fail and be rejected, even if you are very, very good. In a situation in which you have to keep knocking on doors and getting rejected time and time again is new, and something that most people have to deal with is the (justified) fear of rejection, humiliation, and failure.

As far as finance goes….

This situation may change quickly or it may not. I wouldn’t be surprised if in two weeks, the word from on high is “start hiring.” Having worked in the oil industry, I also wouldn’t be surprised if the situation *never* improves. There was a massive burst of hiring in the 1980’s oil boom and no major hiring until the early-2000’s when people started retiring. (Working with a lot of programmers in their 50’s and 60’s was a very good experience, since I don’t have this fear of growing old that a lot of people in younger industries have, since I’ve seen something people in their 60’s doing cool things that I want to do when I’m 60.)

Be ready, be flexible, so that you are ready if there is a massive burst of hiring in two months or if Wall Street ends up a dying industry. One thing that this means is that it helps if you don’t have too fixed an idea of what you want to do. If you say ‘I want to be a quant” then you run into the problem in that there may be no jobs whatever this quant thing is. On the other hand, if you say “I want to do cool things with math and computers” your options vastly increase.

December 20, 2008

Sophisticated investors – aren’t

Filed under: finance — Tags: , — twofish @ 10:56 am

The question I’ve heard asked is how could so many “sophisticated investors” be duped by Madoff.  The answer is simple.  Just because you have money doesn’t mean that you are sophisticated.  You can just be used as easily fooled as some who is poor.  Perhaps more easily fooled, because a lot of poor people feel less pressure to present themselves as smart or sophisticated as rich people do.

Part of all of this is has to do with the American ideology of wealth.  There is the assumption that if you are rich in the United States somehow you did something to deserve the money.  It’s because you are smarter or faster or something else.  The problem with that view is that it isn’t true.  There is a huge amount of luck in how rich people turn out to be, and this involves what family you were born into, who you happen to meet, and a lot of different issues that you have no control over.

But the ideology that people with money somehow deserve it, leads to the idea that people with money happen to be wiser or more sophisticated than people that don’t, when in fact people with more money just have more money.

Notes on China/United States trade

Filed under: china, finance — Tags: , — twofish @ 10:47 am

bsetser: Back when the RMB was (correctly) considered a one way bet, China erected capital controls to keep American (and other) capital from speculating on its currency.

No. Capital controls were put in place during the era of central planning when the RMB was basically valued at a state fixed rate that had nothing to do with the actual market value. The official exchange rate in the 1980’s was 3 RMB to 1 dollar, which meant that there was a huge black market for dollars.

bsetser: And for most of this decade, the net outflow from China to America came not from a desire on the part of Chinese savers to hold dollars but rather from a desire of China’s government to hold the Chinese currency down against the dollar.

Because in 1993, when China moved off the old central planning system, the conventional wisdom was that emerging markets needed to peg their currency to the dollar. It wasn’t until 2002, that this started to break, and changing currency policy isn’t something you do overnight.

Also there is this underlying assumption that somehow there is a “natural” value of currency that is independent of government action, which doesn’t make any sense to me. The reason the dollar dropped in the early 2000’s was because of US government fiscal and monetary policy, and there is this odd idea that somehow US state action that resulted in a drop in currency is legitimate while Chinese state action to do otherwise is illegitimate.

bsetser: . A currency union in theory shouldn’t require that kind of government intervention to keep in balance.

That’s not true. Currency unions require massive government coordination and intervention to work. Look at how difficult it was (and is) to create the euro.

bsetser: The depreciation of the Japanese yen and Chinese yuan against most European currencies over the past several years….

This actually points out one reason why I don’t think that most of the discussion about the trade deficit with China really wasn’t about the trade deficit. What in 2003, was everyone talking about China and no one talking about Japan, which had broadly very similar policies.

Two reasons:

1) During the early 2000’s China was the new “evil empire.” China sort of became the symbol of a rising power standing for what America was against, and so the trade deficit was just part of this view of China.

2) There were also specific trade issues that were new and had yet to be resolved. In the 1990’s, Chinese manufacturing massively increased and there as a lot of adjustment to be done.

Both those factors are gone. I don’t think that the United States views China as an “evil empire” any more largely because the neo-conservative view of the world that saw China in those terms has been so thoroughly discredited by the Iraq War. The US has human right issues with China, but the US also has human right issues with Saudi Arabia, Pakistan and Singapore.

The other factor is that deals have been made. No one complains about Japanese auto imports because deals were made, and the in the main industries with Chinese imports, similar deals have also been made.


One other thing is that you have to look closely at language because the terms that people use have some deep and subtle assumptions about the way the world works.  For example the notion of “government intervention” has the assumption that the action of the government is “unusual”, “unnatural”, and “abnormal.”  I’ve never heard people talk about “market intervention in the government.”  Take a piece of text that talks about “intervention” and replace it with “regulation” and vice versa.

The interesting thing about a lot of this language is that it is designed around assumptions about how the world should work and how the world does work that have totally fallen apart.  There is this idea that there is this market that somehow acts “naturally” to distribute goods and services and that any state action to change how the market operates is bad unless proven otherwise.

Having assumptions is not a bad thing.  Thought because impossible otherwise.  But one does have to be very careful in times like this when no one has any clue what is going on that one shouldn’t be trapped by the assumptions.

December 12, 2008

Incentives in US and Chinese corporations

Filed under: china, finance — Tags: , , — twofish @ 6:18 am

RBG: This is very interesting, but I cannot quite picture what kind of incentive structure would encourage such behavior. Could you please give me some example?

That’s actually quite simple. You need to ask what situation personally benefits the managers that make decisions. With Chinese companies, the more money you have in your bank account, the higher the salary and benefits of the managers. If you have large amounts of cash in the bank, you are more able to pay yourself large salaries and give yourself a better car. It doesn’t matter to the management where the cash comes from, but as banks have tightened lending, it becomes harder to use bank loans to create large cash accounts, so the tendency has been to hoard cash from operations. Also it’s not the ratio that matters but the absolute amount of cash. You can have company with huge amounts of cash, but even larger amounts of debt.

By contrast, American managers are rewarded if they have high stock prices and you have high stock prices come from having large amounts of return on equity. This encourages American companies to borrow heavily and have as little in cash reserves as possible. Also US corporate law makes if very dangerous for a large company to have large amounts of cash because any company with huge amounts of cash is susceptible to a leveraged buyout.

The theory behind American corporate governence comes from the University of Chicago is that by rewarding companies based on profitability that you are encouraging efficient use of capital, and unencouraging people not to keep capital and encouraging people to move capital from low return uses to high return uses.

The problems with this idea are that:

1) you get high returns by boosting risk, and by boosting risk, you are putting the people you are borrowing from at risk

2) if you are highly leveraged, you are very vulnerable to economic shocks, and

3) this sort of structure encourages people to borrow short term liquid instruments to fund long term illiquid investments, once this funding runs out, you are in some serious trouble.

My belief is that Chinese companies and banks will find themselves in better shape than American companies and banks because the companies that were not shut down have large supplies of cash and hence are more shock resistant. Being shock resistant is important since it gives you time.

If you are highly leveraged, you could go from seemingly healthy to dead in a few days (see Bear-Stearns and Lehman Brothers) and if you have an economy which is highly leveraged you run the risk of a domino effect that can bring down the entire financial system. By contrast, if you have a lot of cash, and something bad happens, you have a few weeks, months, or in some cases years, to do something about it.

The contrast here is Chinese banks which were far more insolvent than Bear, but in which the government had a decade to deal with the problem, because unlike Lehman and Bear, they had huge cash reserves. Another contrast is between GM and Toyota. Both of them are seeing extremely large declines in sales and both of them are seeing huge losses. The difference is that Toyota has cash reserves whereas GM does not.

I’m feeling fine about the economy next year. We are going to see a very nasty recession with massive job losses and deleveraging. The reason this makes me feel fine is that two months ago, we were on the brink of something much, much worse in which rapid uncontrolled deleveraging was close to destroying the entire world financial system (and I mean this literally). One way of making you feel alright about something bad, it to show you something much, much worse, and we’ve already had enough deleveraging to avoid total meltdown.

Also, I do not think that trade will be a big issue next year. You will see a lot of bailouts, currency games, and capital protection, but I don’t think that either the US or China will call for anything that would require leaving WTO. The reason is that most jobs in the US are dependent on the world trade system being intact, and anything that destroys trade will kill jobs in the US. Things would have been very, very different had things completely self-destructed in September, in which case there would have been no interest in keeping existing jobs, because all of them would have disappeared.

This is also why I think GDP and import projections are bogus since this quantity depend on unforeseen and perhaps unforseeable events. It was a funny moment when the rating agencies downgraded Lehman’s rating from investment grade, several hours after the default.

December 4, 2008

Brave New World – The Paradox of RMB exchange rates

Filed under: china, finance — Tags: , — twofish @ 2:36 am

I think there is a basic problem here in that the US wants China to do two contradictory things. The US wants China to boost domestic consumption, while at the same time lowering the trade deficit, and absent action by the US, can’t do both.

Either China expands its money supply or it contracts its money supply. If it wants people to spend, then it expands it money supply, but if it expands it money supply the RMB goes down, and you increase the trade deficit. If China contracts the money supply, then you decrease the trade deficit, but you also encourage domestic savings. Without action by the United States, there is just no way of getting to the desired state of affairs.

The basic problem is that anything that China does to encourage China to spend money on Chinese products also encourages Americans to spend money on Chinese products, and there is a one-way trap because Americans can use dollars to buy Chinese goods whereas Chinese can’t use RMB to buy US goods, and the People’s Bank of China can’t print dollars.

If China tries to reduce its US currency reserves, the only supply of RMB is in China.

Import barriers aren’t going to solve the problem because if you reduce the amount of Chinese goods entering the US, you reduce the dollars that Chinese can use to buy American goods. Having the PBC sell dollars and buy euro isn’t going to change the fundamental problem, it just shifts it from the US to Europe.

The only way I can see to get the desired goal of boosting Chinese consumption *and* shrinking the trade deficit is for China to expand the money supply to encourage spending, and for the US to expand it’s money supply enough more so that spending gets done on American goods.

The standard “beggar my neighbor” scenarios assume two mutually exchangeable currencies neither of which is a reserve currency, and I don’t think that they work in this situation where you have one non-convertible currency and the other which is a reserve currency.

What this means is that the US and China need to coordinate fiscal and monetary policies if the US gets what it wants, which means that we are really living in a brave new world.

December 3, 2008

About Obama, China and trade

Filed under: china, finance — Tags: , , — twofish @ 7:28 am

lark: I have never heard ANYONE say that without trade with China, they would lose their job. I have MANY times heard resentment about manufacturing gone to China, poor quality products, tainted food, etc. Not a week goes by that I don’t hear such complaints.

Well then we know different people then.  It will be interesting when push comes to shove and we start counting votes.  The people I know are people in finance in NYC, software developers in Texas, and semiconductor designers in California.  This opinions never make it to the press, they are lunch time conversations.  Part of the reason people aren’t loud about being pro-China trade is that there is no point in complaining when you are winning.

So who do you know?  Let’s count votes.

lark: What part of that is due to globalization, offshore outsourcing, China particularly, may never be quantifiable. But it doesn’t need to be.

Actually it does, because you need go convince people that the problems are due to globalization if you want to go China-bashing.  I don’t think that the problem is globalization.  I personally think that the problem is that the benefits of globalization have been unequally shared, and that government needs to be heavily involved to make sure that the economic gains from globalization get equally shared.  This means low tariffs and high taxes on the super-wealthy.

lark: The fact is Obama doesn’t owe his election to the economic actors who have profited from the China trade.

Yes he does.  You look at the groups of people that I just mentioned.  Obama won in large part because he was able to out-technology McCain because of help from Silicon Valley and massively outspend McCain because of contributions from Wall Street.  Those are the two most “pro-China” groups in the United States.

Also if you look at organized labor, two of the most active and vital unions in the US right now happens to be Pacific longshoremen and Teamsters.  Think about that.

I voted for Obama because I was sick and tired of Bush era incompetence, I’m worried about keeping my own job, and because McCain came across as an economic idiot.  The interesting thing is that now that Obama is in power, he really has to define “change” rather than just talk about it and that is going to lead to some interesting conflicts.

lark: They will be parties at the table but they will not determine policy.

Yes they will (or rather yes *we* will).  Look at who Obama is naming to his cabinet.  One thing that is interesting about Obama’s election is that it marks the ascent to power of political forces that have been dormant.

Google/Goldman-Sachs/MIT/Teamsters.  This is the new governing coalition that Obama put together.  Strange bedfellows, but that’s politics.

lark: More important, in my view, will be the stressed American workforce.

Sure.  But the workforce isn’t what it was in 1985.  You have investment bankers, software developers, and auto workers that are afraid of losing jobs.  McCain’s strategy of “Joe the Plumber” and “bash Wall Street” failed very badly because he didn’t realize how the workforce has changed.  Citicorp employs more people than GM.

It’s odd to see an investment banker as a “worker” but good politicians listen carefully and see beyond stereotypes.  So rather than bashing bankers and mid-level managers, Obama was able to tap into this feeling in a way that McCain was not.

By the way, most Wall Street investment bankers don’t make multi-million dollar bonuses, and if you want to bash *upper* management and talk about more regulation, then you’ll get a lot of support.

lark: I’m sure his team will try to solve these problems without destructive protectionist measures but I don’t think that means status quo for China. It doesn’t even mean that protectionist measures are impossible or even unlikely.

But the type of protectionist measure is important.  If Obama and the United Auto Workers thinks that tariffs on auto parts and textiles will help save American jobs, then sure I’ll go along with that.  We are on the same team, and we need to be nice to each other.  However, I *haven’t* heard the UAW or GM suggest that tariffs would be useful, and it’s likely to be the reverse since China is the only place in the world that buys Buick.

However, if Obama starts sounding like Lou Dobbs, then I (and a lot of other people) will turn against him in a big way.

The beauty of the internet is that you get to meet different people, and I’m just saying what things look like from my neck of the woods.

December 2, 2008

Trade riddle

Filed under: china, finance — Tags: , — twofish @ 6:42 am

One other characteristic of the post-BW I system was that, there was a lot of ad hoc evolution. I don’t think that anyone in 1970 could have really predicted what the world system looked like in 1985, and right now we are also sailing into the unknown. There is a limit to which you can design system, and most complex systems are more the result of ad-hoc evolution than intelligent design.

One important criterion for any workable system is “political viability.” You have to have some reason that the major actors go along with the system, and that reason could be either persuasion or coercion. The major actors are so interlinked that coercion for the most part is not an option. Coercion in the global economy is like threatening to push someone you are chained to off a cliff, and there are limits that you can threaten someone before you hurt yourself.

So you have to use persuasion, but then you run into the problem that people have different interests.

One should point out that one reason that Bretton Woods I cam into being was that after World War II, the United States was the only major power left standing and could dictate global economy rules. Bretton Woods I ended when this was no longer the case, and you had Europe and Japan with different interests.

Something similar happened with Bretton Woods II. For a brief moment in history, the United States could reshape the world in its image, but that moment is fast fading.


This is one big reason I don’t think that the current situation in which everyone is doing what seems to be in their interests is necessarily a bad one. You can come up with a system in which a Lenin or Mao comes to power and forces people to do the “right” things, but there is no assurance that those things are right after all.

Ying: Unfortunately politicians and businessman are too obsessed with zero-sum gain sort of thinking that they can’t get out of it.

Business and politics is all about making agreements that are positive for the people making it. You give me X, I give you Y, we both benefit. Figuring out what X and Y is quite tricky sometimes.

The trouble is that sometimes (and in fact quite often) you do end up with zero-sum or negative-sum situations. If it is positive sum, then it’s easy, you get people in a room and shake hands and make deals. But sometimes it isn’t. Or sometimes you have a deal that’s positive sum for the people in the room, but negative for people outside. Or sometimes you have a deal that is short term positive but long term negative, or you can have something that is short term negative but long term positive.


The other thing that I don’t understand is why people assume that the “optimal situation” between US and China is one in which you have zero trade deficits when no insists that this is the optimal situation between New York and New Jersey or even between France and Germany. My guess is that if you use some simple comparative advantage arguments, you’ll end up finding that impose an international trade constraint actually reduces total wealth generation. (This also nicely explains why there was such huge trade friction with Japan in the 1980’s. Since Japan and the US have similar economies, there is no extra wealth generated by comparative advantage so things do become zero-sum.)

I propose this as the solution to the riddle that if global balance is such as great thing, why are there so few people interested in having it.

November 23, 2008

Notes on fiscal stimulus

Filed under: china, finance — Tags: , — twofish @ 8:16 pm

Pettis: At the same time, Washington desperately needs Beijing to keep buying American bonds, so that the U.S. government can run up a deficit and launch its own fiscal stimulus.

No they don’t. Right now short term Treasuries are near zero interest. The flight to liquidity and from risk means that there is no shortage of buyers for US debt. Everyone in the world wants Treasuries, so there is no need to focus on China as the main buyer of US debt, and one reason that a massive stimulus package is essential is to “push out” the massive purchases of US Treasuries. Without a fiscal stimulus the end state will be everyone having non-productive US Treasuries in their mattresses and no investment in anything that isn’t a US Treasury.

Also, to clarify the main source of disagreement between you and Setser on the one hand, and me and the other:

1) I don’t think that China is or was overproducing
2) I don’t think that the United States is or was overconsuming

The basic problem with the US economy was that the productivity gains of technology and globalization ended up in low interest rates rather than in increasing wages, and that there was massive misinvestment in non-productive goods rather than in productive ones. Less money for houses, more money for universities.

Had the US government spent more on public goods such as infrastructure, health and education this would have provided in increase in wages and interest rates, and would have reduced the amount of leveraging that took place.

The other missing piece here is productivity. If you take out a loan and spend it on inner city education or better subways, you end up boosting productivity which is going to help you pay back those loans.

Pettis: By the way the view that the Chinese authorities will have an easier time in this crisis than the US because “They have options, we don’t” is not, fortunately in my opinion, universally held among Chinese authorities.

Chinese authorities to have an easier time in one respect and that is the issue of “time” and “administrative bandwidth.” In politics, time is critical, and it helps a lot if you have time to argue and think about what is going on. If you aren’t faced with a crisis that has to be resolved in the next few hours, then this gives you time to think and debate about what happens next, and to rollback changes if they turn out to be wrong. If all you are doing to trying to deal with the next explosion, then you don’t have the time or energy to think and argue about long term consequences.

November 22, 2008

Notes on Chinese trade policy

Filed under: china, finance — Tags: , — twofish @ 7:17 am

  1. China can go fiscal while doing tax rebates. Personally, I don’t think that the tax rebates are going to do more than band-aid the situation since taxes on nothing are nothing.

    Pettis: Calling on the US government to engage in massive fiscal expansion to replace lost private demand is crazy. It means that we should continue the current game that has led us into so much trouble, but instead of having US over-consumption and rising debt at the private level we must have it at the public level.

    First the US government is the only entity that can generate the demand that is necessary and with all of the money that is going into treasuries it has a lot of free money that it should be doing.

    Second, the problem with what the US did from 2002-2008 was not that it expanded the economy. That was good, and it got us out of the 2002. The problem with what the US did was that this investment was in non-productive goods and that the benefit to the consumer was in the form of low interest loans rather than in higher wages. The US should try to generate demand by reducing consumption and having a massive effort to increase investment in roads, factories, health, education and anything else that will generate long term returns.

    Pettis: China needs to resolve this problem by expanding fiscally, not by stimulating exports.

    China doesn’t have a big enough economy to resolve global problems. It’s going to have a tough enough time fixing internal problems.

    Quote: The world has excess production and there is a need for the US to reduce its demand and increase its savings.

    *THIS* is the crazy part. We have overproduction and the solution is to reduce demand….. Hello???? If we have overproduction then we want to increase demand by any means possible.

  2. Pettis: It is amazing to me that people like Ferguson, who have been arguing correctly for years that US consumed too much and saved too little, are now terrified of the necessary adjustment, and are arguing that it should be stopped and even reversed.

    From my point of view the implication here is that they were wrong in the first place.

    Pettis: The process cannot be stopped – US savings are too low and will rise one way or the other.

    If you have savings rates that are too low in an era of overcapacity, you can have the government print money and stuff it into people’s bank accounts. Boom. Instant savings. Take debt and print money to erase it. Boom. Instant equity. That’s actually more or less what the government has been doing.

    None of this makes sense in normal times, but if you have people without jobs, and factories that can produce stuff that aren’t producing it, and the only problem is lack of money, you can print it.

  3. One other thing is that I don’t think that trade policy is really going to make that much difference. You can issue as many tax rebates as you want, but if no one in the United States is buying then it’s not going to make much of a difference. Also, I don’t think that trade is going to be a major source of friction because what either China or the United States can do is constrained by WTO rules, and WTO provides a forum for everyone to coordinate policy.

    What is going to be more interesting is the complex interactions between trade, monetary and fiscal policy. For example, if China takes huge fiscal stimulus but the US does not, then you are going to see the RMB weaken, and this could produce a worse balance of trade with the United States unless China agrees to peg its currency to avoid devaluation. So if either China or the United States or Europe takes fiscal stimulus, this is going to require some coordination of trade and monetary policy with the other actors.

    The other thing is that very unexpected things have happened and will continue to happen and figuring out ways of reacting to them is going to make things very interesting.

November 6, 2008

Officials and the Chinese business cycle

Filed under: Uncategorized — Tags: , , — twofish @ 8:34 am

Victor Shih has written a wonderful book on the political economy of China when he points out that the business cycle in China corresponds to shaping power relationships between two groups of officials. One group consists of local officials that want more spending, and one group consists of central government finance officials that are more concerned about monetary stability. When the economy overheats, the monetary stability people come in and cool things down. When the economy goes into a slump, the local officials come in and start building things left and right. Also, you have to look at incentives, local officials love big infrastructure projects for the same reason Wall Street CEO’s love big complex financial instruments, you make lots of money personally off of them.

We agree that this is going on. He seems to think that this is a bad thing, and if the monetary hawks could stay in permanent control that we could abolish the business cycle. I disagree since I am a fan of Hyman Minsky and I don’t think the business cycle can be abolished and that the shift between these two groups of officials is that Chinese government reacting to the business cycle rather than causing it.

The other thing is that the notion that the financial system ought to be ideally independent of any government supervision is I think dead. It’s hard to fault Wen Jiabao calling up Chinese banks and says “LEND MONEY” when Paulson is basically trying to do the same thing, and the fact that Chinese banks are more willing to listen to Wen than American banks are to Paulson may not be such a bad thing.

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