Category Archives: Economics

More Chinese Froth

China is doing some major tinkering with fiscal policy according to today’s Wall Street Journal. To try to moderate the flow out of bank savings into their stock market, they are decreasing the tax rate on savings from 20% to 10% and increasing the savings interest rate.

This will indeed get people to save more in the banks. But it will also give them more future cash from the lower taxes and higher returns. This may make them more confident about speculating in the stock market. This means that China’s mountain of cash will continue to grow. Here’s a report that China’s savings rate is 55%.

If you think about the combination of pension products (6% to get all the 401k matching seems typical), Social Security (12.4%) and Medicare (2.9%) we are doing a good bit of forced savings. If you add in home equity, most US workers in their prime are socking away 30% if you don’t deduct the debt they’re taking on.

Our population doesn’t have a huge demographic bulge brought about by a one-child policy, industrialization and massive improvements in life expectancy. The upshot is China will have very high savings until the inverted pyramid kids (one kid who is the only kid of two parents who are each the only kids of two grand parents) get to the workforce. They can expect bequests, a healthy mortgage loan market and modern employee benefits. In the mean time, no amount of cajoling from Chinese or American treasury and central banking officials is going to curb the Chinese savings rate much.

The impact means cheap money across the board for another 20 years. According to the CIA World Factbook $180 billion of their savings is going abroad net. Since they get about $65 billion in foreign direct investment, they get to invest almost $250 billion a year abroad.

They have $1 trillion in bank reserves and gold compared to US’s $70 billion. They have about $300 billion in government debt or $1.2 trillion at purchasing power parity (PPP), compared to $10 trillion US. China has a vastly undervalued currency with gross domestic product (GDP) PPP estimated at $10 trillion at about 4 times the official exchange rate which puts their GDP at current fixed exchange rates at $2.5 trillion.

In short, with a floating exchange rate, China would have the world’s second biggest economy. And that is without the benefit of substantial deficit spending, a stock market, consumer credit, a public pension system up to western standards, a health care finance system up to western standards or any of a number of multipliers that the US already has.

In the next few years, we can look forward to China becoming an economic super power and not slowing its growth (10.7%) until it rises from $7700 per capita PPP GDP to that of Poland ($14k, 5.8%) or France ($27k, 2.1%). That is respectively twice and three and a half times what it is today. With four times as many people that’s 2-3 times as big an economy as ours in the next 40 years.

Can the US manage a peaceful decline and start playing the role of junior partner in defense alliances?

Last One Out is a Rotten Egg

The Bear Stearns bailout and failure respectively of two hedge funds with hundreds of millions (formerly) of equity and $10 billion+ of debt is causing some new soul searching among risk managers about the continuing sub prime overlending. The credit card issuer risk managers are taking the opportunity to tighten consumer credit for credit cards and probably soon other kinds of consumer credit.

By tightening credit card terms and mortgage terms, banks exacerbate the difficulty that sub prime borrowers may have making their house payment and refinancing their loans when teaser rates end. As lenders tighten terms, there will be a knock on effect of more sour loans. This is a game with a distinct first-mover advantage. Many consumers even in the sub prime market have more than one credit card. If Barclays credit cards (e.g., Juniper, US Air, Barnes&Noble, etc.) tighten their credit standards, Chase and Bank of America tighten their balance transfer requirements, banks that keep their offers open longest may be the ones that suffer in the event of a rise in consumer bankruptcy. Oddly, all of the acquisitions by Chase, Bank of America and others of competing credit card issuers means that they have internalized a higher share of the pain than in the last recession, but they are still fighting the last war.

The credit card and mortgage defaults may, in turn, dry up some sources of liquidity for hedge funds that buy credit card and mortgage backed securities and other consumer debt. There is still plenty of money gushing into the global financial system (China’s government and consumers are socking away a lot of money in anticipation of a labor shortage when they retire and no trillion dollar social security program to help them and expect India, Pakistan and Indonesia to join them as their demographic bulge matures coincident with speedy growth). So unwinding the sub prime fiasco will just increase the appetite for return and dollar denominated assets in other sectors of the world economy. But that’s small consolation for the millions of people caught in a credit crunch. A politician cleaning up bad credit is going to lose votes when voters find out the alternative is no credit.

My proposal is for there to be a federal car loan program and a federal health care loan program.

Continue reading Last One Out is a Rotten Egg

Who’s Ahead?

On Intrade, here’s the standings for the 2008 election (security pays 100 if individual is elected):

  1. 32.7 Clinton
  2. 17.4 Obama
  3. 16.0 Thompson
  4. 13.2 Giuliani
  5. 9.5 Romney
  6. 7.6 Gore
  7. 4.7 McCain
  8. 3.1 Edwards
  9. 1.2 Bloomberg

Adds up to 105. Could some partisans be trying to raise their favorite’s numbers?

Who’s Ahead?

On Intrade, here’s the standings for the 2008 election (security pays 100 if individual is elected):

  1. 32.7 Clinton
  2. 17.4 Obama
  3. 16.0 Thompson
  4. 13.2 Giuliani
  5. 9.5 Romney
  6. 7.6 Gore
  7. 4.7 McCain
  8. 3.1 Edwards
  9. 1.2 Bloomberg

Adds up to 105. Could some partisans be trying to raise their favorite’s numbers?

Who’s Ahead?

On Intrade, here’s the standings for the 2008 election (security pays 100 if individual is elected):

  1. 32.7 Clinton
  2. 17.4 Obama
  3. 16.0 Thompson
  4. 13.2 Giuliani
  5. 9.5 Romney
  6. 7.6 Gore
  7. 4.7 McCain
  8. 3.1 Edwards
  9. 1.2 Bloomberg

Adds up to 105. Could some partisans be trying to raise their favorite’s numbers?

Economists Agree?!

Economics is the only subject where two economists can share a Nobel Prize saying opposing things.
Roberto Alazar

But all the big names (25 all told including a bevy of Nobel winners) agree on this:

Prediction markets are markets for contracts that yield payments based on the outcome of an uncertain future event, such as a presidential election. Using these markets as forecasting tools could substantially improve decision making in the private and public sectors.

We argue that U.S. regulators should lower barriers to the creation and design of prediction markets by creating a safe harbor for certain types of small stakes markets. We believe our proposed change has the potential to stimulate innovation in the design and use of prediction markets throughout the economy, and in the process to provide information that will benefit the private sector and government alike.

Amen. Too late for Poindexter.

Fixed And Variable Costs

These kinds of complaints betray an ignorance of business economics. One would expect that from Congress, but it would be nice to think that the American people are smarter (sadly, what with the clamor for “anti-gouging laws” and the like, there’s little evidence of it on the ground).

As Peter Suderman points out, the problem is that the cost of adding a cable channel is extremely low relative to providing the service in the first place. Like him (and no doubt many others) I am paying for many channels that I never watch, and will never watch, and wish that I could dump them for a lower satellite bill. But that’s not how the business model works.

It’s similar to the restaurant problem (which to my mind is one of the causes of the “obesity epidemic” among Americans, to the degree that it exists). The bulk of the cost of eating in a restaurant (unless it’s serving larks’ tongue pie and pan-fried snail darter) is overhead: rent, lighting, environmental control, power for cooking and refrigerating, wages, benefits, etc. I’m not sufficiently familiar with the business to know the exact numbers, but it wouldn’t surprise me if the cost of a meal, at least in a small place, was sixty to seventy percent overhead, with the rest going to the cost of the food itself. Say that it’s three quarters. That means that if you provide twice as much food, you only increase the cost of the meal by twenty-five percent (and the converse is that if you provided no food at all, but merely the ambiance and pleasure of having people wait on you, the price of a twenty-dollar meal would still be fifteen bucks).

There are various ways to compete in the restaurant industry, including branding, food quality, atmosphere, service, but one that’s of value to a lot of people is food quantity. Based on the economics described above, the latter is one of the cheapest things to increase, and much less costly than hiring better chefs, or classier waitpeople, or investing in a branding. This is particularly the case when you increase the quantities of really cheap food, such as starches and sugar. The fast food industry figured this out a while ago, with “biggie drinks” and “supersizing.” Giving the customer an extra potato’s worth of fries, or another spoon of corn sugar with flavored water added only pennies to the meal cost, but seemed to many customers to provide a bargain.

This is in fact why Mexican restaurants have such high profit margins relative to other cuisines. You rarely get good-quality meat (and if you do, you pay a lot more for the dish). It’s usually bits of chicken parts, shredded beef or pork, or (in some of the less reputable places) “meat”…, disguised in a hot sauce, and wrapped in a flat unrisen bread made of corn or wheat, combined with rice and beans. You can get stuffed with unhealthy high-glycemic carbs. Not to mention, of course, filling you up pre-meal on sectioned deep-fried corn tortillas and a chopped tomato sauce. It used to be that Mexican meals were cheap, relative to others, but once it became trendy, they started to make a killing, particularly the chains, charging as much for this low-cost meal as other restaurants do for meat that you can actually identify (at least as regards to species).

What’s worse is that these are exactly the kinds of excess calories that we don’t need. If they upped the protein, it would be much healthier for us, but that would cost much more (though even there, they’ve managed it, with double and triple burgers, but you’ll notice that there’s a much bigger price jump for these, since the meat and cheese are the most expensive parts of a burger). I’ve often wished that I could get a cheaper, smaller meal, but like the case of the bundled cable or satellite channels, the economics militate against it.

By the way, it should also be noted that misunderstandings of the difference between fixed and variable costs also lies at the root of many people’s ignorance about the source of high space launch costs, even among professionals in the space industry.

Is There an Eco in Here?

I landed at the Ft. Lauderdale airport yesterday and there was a sign that said that to decrease water use, the airport has changed its thermostat from 74 to 78. Call me hopelessly brown, but it seems to me that they can attract more money to pay for more water via tourism if their airport is comfortable rather than politically correct. Water can be recycled, pulled out of the ocean and the air. The economic value of the savings is summarized by the market price for more water which is still measured in hundreds of dollars per acre foot. An acre foot is enough water to cover an acre one foot deep, or 325,851, gallons putting the price of water in gallons per cent. Skimping on use is pain for no gain. Or is masochism the main point of being Green?

Hungry for Ethanol

Food prices are up as corn prices have doubled to $4.50/bushel with the $0.51/gallon of ethanol subsidy. As the US is (soon to be was) a huge corn exporter, this is causing higher prices worldwide. Foreign Affairs in the May/June issue says that could lead to doubling the world hungry from 600 million to 1.2 billion. They hope that

relying more on sugar cane to produce ethanol in tropical countries would be more efficient than using corn and would not involve using a staple crop.

No, if sugar cane is more profitable than corn, it will also outcompete staples for land and labor until the price of staples is hungry high.

Scientific American makes the same mistake in the June issue:

[Jatropha, an oil crop] favors hot, dry conditions and hence an unlikely threat to rain forests. There is no trade-off between food and fuel either, because the oil is poisonous.

No, Jatropha will pull away farm equipment, labor and land from other crops driving up the price of every other crop.

Ethanol is an OK energy delivery system to convert solar energy, but if biofuels stay competitive with petroleum (via subsidies for now), all arable land will be converted to corn and other energy crops until the food crop prices are driven up enough to be competitive with the energy crops.

The only way to bring the corn price down is to either bring a multiple of the current acreage under cultivation (all US arable land devoted to corn would get us 12% of petroleum consumption) or reducing the corn/ethanol subsidy.