Something Snazzy

About Facebook

2011-09-30T15:36:00.000-07:00

Watching Facebook 'co-founder' Mark Zuckerberg last week stand and explain to an audience his company's latest software developments at their annual f8 conference (in an odd attempt to imitate Steve Jobs unveiling the next iPhone), a thought came to my mind: has the purpose of Facebook changed so much from the original intent that its best years are now behind it?

To try and answer this question, we need to go back to understand why Facebook came about in the first place.

Growing up in the early 1990s, I was part of a generation yearning for a greater connection with the world outside the four walls of my bedroom. The difference between my generation and that preceding it was that now we finally had the tools (i.e. the Internet) to actually do something about it.

Now in an era of ubiquitous Internet, social media has become the 'great enabler' to people young and old; it has allowed us to interact with people in ways that were previously impossible.

To what extent the introduction of social media websites, especially Facebook, has on balance made the world a better place, would seem a moot point. Surely the opportunity to make more connections and spread our personal network across the globe can only make us better off?

In theory yes, but in practice, maybe not.

For social media (the way of meeting and interacting with other people) to be based 'online' and not 'offline', a fundamental question needs to be answered: how much can you trust someone who you have never met in person?

Ask anyone with more experience offline and you get a frank reply: not that much. Certainly not enough to tell them your entire life story. How someone can effectively make this judgment themselves after spending most of their childhood online is a troubling question.

However, there is one potentially self-correcting mechanism in place: people, especially young people, get bored. They want to try new things. After a while, no matter how much fun anything is, everyone wants to try something new. This is why Facebook is trying to change into something else, to keep up with the times.

Unfortunately, this need to adapt to the changing needs of its consumers may ultimately sow the seeds of its own demise.

For Facebook to continue to grow at the breakneck speed it has done so far, it will have to give people the opportunity to do something new. Something different. The latest innovation offers users an easy way to show people everything about their life in one continuous page. An open book, if you will.

Does anyone see a problem with somebody showing everything about themselves to the rest of the world? If you had asked someone this question growing up in the 1990s (or any decade before for that matter), they might look at you in a slightly odd way. Why would I want to do something like that??

Why indeed.

After giving anyone and everyone the opportunity to meet and interact with whoever, however they like, Facebook now has to go a step further in the quest to keep consumers interested. Unfortunately, this may be a step too far for some and may signal a point in time when the seemingly neverending growth of Facebook may be past its peak. Logging off is not that hard to do.

The idle investor

2009-04-09T08:38:00.000-07:00

I've recently started reading a book called How to be Idle. The title should be enough to ensure its success as more and more people have unemployment thrust upon them.

However, the main idea behind the book - that doing less is more - is extremely pertinent for anyone now thinking of dipping their toe in the stock market.

Over eight weeks ago I recommended buying stocks and selling bonds. It just so happens the US stock market is at exactly the same level today as it was then.

In between the S&P 500 fell by 20% and then rose by 25% (unfortunate rule of investing: things need to rise by more than they fall to get back to where they started).

If you were caught out by this sudden fall and rapid recovery in the stock market, don't worry, you weren't alone.

In fact you were in very good company indeed.

Most, if not all, of the the greatest living (and still active) investors have remained confident throughout the past 18 months, and especially at the end of last year, that the stock market was past the worst.

While most of us are fed up watching the stock market fall (and the rest just don't want to look at the stock market at all) there is something very interesting happening at the moment: a turning point.

Turning points are the hardest things to predict and almost impossible to identify in real time. This is why the current situation is so favourable to the investor who is willing to wait. In other words, be an idle investor.

By doing less, you will earn more.

Find a market you like and leave your money there for a year.

You will be amazed at how productive doing nothing can become.

Investment recommendation: buy stocks, sell bonds

2009-02-04T09:08:00.000-08:00

Whenever you see anyone on TV or in the press offering free investment advice, three questions should come to your mind:

1) What are they selling?
2) What is their past performance?
3) Why are they giving away free advice?

Firstly, I am not selling anything. I was working for an investment bank but now have enough time on my hands to be able to sit and home and write this blog, without any fear of conflict of interest between myself and my employer.

Secondly, I have not invested my own money in any financial market for months. Since last summer I have been invested in either cash or bonds and most recently, entirely in cash.

Thirdly, I am giving this advice away for free as I have nothing to lose in doing so and everything to gain, in terms of reputation.

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There are a number of reasons why now is the best time to buy equities and sell government bonds. Apart from the obvious fact that this is what the current direction of both markets are suggesting (the most common reason why people recommend what they do), there are a number of very compelling reasons for doing so:

- We now know that global equity markets halved in value months before the start of the global recession.
- Global equity markets always rise before the end of a recession
- As global equity markets become more and more attractive, global bond markets will become less and less attractive.
- The strength of every downward trend is always followed by an upward trend that is equally as strong.

The only way is up (in the long-run) for equities...

Government bond yields are unlikely to go much lower

It is important not to underestimate the length and depth of the sell-off in global markets for risk. This has accompanied a process of deleveraging that has recently taken the most visual form: job cuts.

Unemployment is the last resort for any company and almost every company in the world has been forced into taking this decision.

Borrowing money from the government is one option, drawing down inventory is another, but once workers are made redundant either they never come back or new workers require training to do the job. This is a very expensive process which is weighed against the benefit of saving money from not paying wages. This process cannot and will not last forever.

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Before any good news arrives on the economy, equity markets will have to rise.

Time is running out before the appetite for risk returns.

The fact that the "safety" of government bonds has disappeared makes risky assets look the most attractive in a decade (and more importantly, than throughout this entire financial crisis).

The question of whether interest rates are low enough and when a strong recovery in equity markets will take place this year is less important for long-term investors. The most important decision is that something is done sooner rather than too late.

Barak Obama's alternate inauguration speech

2009-01-20T15:17:00.000-08:00

My fellow citizens:

Thank you so much for coming out today, many of you waiting for hours in the freezing cold, to hear me deliver this, the forty-forth Presidential inauguration speech in American history.

Today is a very special day for many of you, especially those with African-American families. With you, I share in what has been a most historic of victories. With so many, including myself four years ago, not expecting me to even run for office, the fact that I stand here today ready to take on the most powerful job in the world must seem like a fairytale.

And indeed it is a story that will be told to children up and down this great land for generations to come. How one man stood up to all those who were ready to do everything in their power to prevent him from achieving his dream. It should, and will, inspire many to do the same in future.

My life is a shining example of why you should never stop working to achieve you dreams. Dreams are there to be realised one day, not to wonder what it might be like if they came true. Dreams can come true. Look at me, standing here in front of millions of people and billions watching on their televisions at home all over the world. Hello to everyone out there. We are here and we are ready to do business with you. AMERICA IS OPEN FOR BUSINESS!

Now, many of you may be asking, what do I have planned for the coming weeks, months and years. Well, let me tell you first off, everything is on the table. I will rule nothing out. The only thing I will insist on is that anything we do is affordable.

These words may not sound inspiring but they will make a difference to this country in the long run. Yes, my fellow Americans, the next few years will be painful, they will involve tremendous sacrifice. Jimmy may have to wait for his new train set and Sally will not be going to summer camp this year. And Bob, you will have to see about that new car you've had your eye on for months. It's all gotta be put aside for now. From now we will be prudent!

Can we prudent with the public finances? YES WE CAN!

When we start to learn about what it means to live within our means, then it will be possible to re-build this great nation upon the value which made it so great: innnovation, education and affordable healthcare!

I think you will come to understand that government finances are important, just as your own finances are important. If you want to borrow money to buy something, then from now on you will have to borrow directly from government-owned banks!

This is an exciting time for our country, the country we all hold dear. We will not be indebted to the Chinese for the rest of our lives and depend upon the Saudi's to ship us oil each day. Oh no, those days are numbered, and from today I will make it one of my (many) top priorities to see to it that we will not make the same mistakes that so many of my predecessors have made. BELIEVE IT OR NOT, IT WILL BE DIFFERENT THIS TIME!!

I bless you and bless America.

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My Worldle:

Barak Obama's wordle:

Open letter to the Financial Times

2009-01-12T14:56:00.000-08:00

Even though the Financial Times has seen fit not to publish my letter, sent (e-mailed) on January 5th, the beauty of the internet means that I get to post it on my blog whenever I want!

Below is the original letter.

(N.B. Since Janaury 5th, the US stock market has fallen by 7%.)

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From Mr. Wesley Fogel

Sir, Anthony Bolton appears to have had his "Buy American, I am" moment in his column last weekend "How to spot the market’s turning point" (January 3).

Just as fellow-veteran investor Warren Buffett, who endorsed buying American stocks in October only to see the S&P 500 fall a further 20%, Mr. Bolton still has faith in his ability to do what nobody else can: identify a turning point in the market.

However, the three factors which Mr. Bolton uses to determine such a turning point and the one he does not should reveal why his advice will prove at best unhelpful and at worst damaging to investors in 2009. Contrary to his argument, it will be improved visibility on the state of the economy and not the performance of markets relative to the long run or some other technical factors that will help define a turning point. Whilst it may seem foolhardy to challenge the views of either Mr. Bolton or Mr. Buffett, neither gentleman would be at odds with the principle that past performance is no indication of future returns. Now is not the time to see who is right and who is wrong, just who is solvent. The same rules apply to them as they do to us.

Wesley Fogel,London SE10, UK

Sterling goes Loonie

2008-12-15T10:21:00.000-08:00

It's been another year to forget for Queen Elizabeth II.

Not only has she had to rein in extravagances as the family budget was squeezed but her face has been on the front of two currencies that have massively depreciated, namely the British pound and the Canadian dollar (commonly called Loonie).

But there is more in common between Canada and the UK than a monarch.

Both countries also export large amounts of crude oil. This has resulted in each currency closely tracking the price of oil as well as each other.

The close correlation between the Loonie and Sterling is an inconvenient fact for those who believe that government failure is at the heart of the pound's weakness.

To guage whether the collapse of the pound or the Loonie will continue, it would be worthwhile to monitor the direction of both over the coming days and weeks. Should there be any deviation between the two, it might signal a move in either direction.

Of course, you could just look at the price of oil, since that will determine where both are going. My guess is up, but maybe not immediately.

Either way, the Queen should have a better year in 2009.

Greenspan's monster eats Goldman's BRICs

2008-11-17T12:51:00.000-08:00

The business cycle, as we have so vociferously been reminded, is not dead.

Not only is it alive, but it's now bigger and stronger than ever!

For over a decade, it had become conventional wisdom to assume that rapid growth among the developing economies of, inter alia, Brazil, Russia, China and India (or BRICs, as Goldman Sachs coined them) had become a permanent feature of the global landscape and would be strong enough to compensate for any slowdown that might occur in advanced economies.

Not only would a slowdown in, say, Germany or the US be mitigated by growth overseas in India or Brazil but that such a period would bring with it a redistribution of wealth from rich to poor (i.e. if one group of economies is growing while others are shrinking then a rebalancing of wealth would follow).

And up until the middle of this year everything was going according to plan.

Then oil stopped rising and everything went into reverse, especially among the BRICs.

Two questions now arise (to which you will struggle to find anyone capable of providing a clear and convincing answer):

1) Why did oil prices rise to $150/barrel?
2) Why did oil prices then more than halve in four months?

A third question, to which it's always fun to see people attempt to provide an answer which they can believe:

3) Where will oil prices go from here?

While it would be tempting to try and predict where oil prices will go or explain why they have risen and fallen in such dramatic fashion, it's more important to realise what just happened in the context of oil's gyrations, since much of this backdrop helps to explain why movements in oil and other financial assets follow the paths they do. This will also explain the meaning that's hiding behind the title of this post.

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In 2001, Goldman Sachs economist Jim O'Neill predicted that the BRICs would be among the world's most dominant economies by 2050.

This ambitious prognostication helped create one of the largest proverbial bandwagons in history.

The number of people searching for the term "BRIC" on Google has grown every year. With a growing intellectual curiosity came a growing financial interest. The smart money started going South and East.

Then the stupid money followed.

At the same time as money was flowing into emerging markets, the US was facing the prospect of deflation (falling prices everywhere), something it hadn't seen since the Great Depression.

As now Fed Chairman Ben Bernanke, said at the time, interest rates could and should fall more rapidly than in normal times to avoid such a thing from happening.

And that's exaclty what they did. Until mid-2004, US interest rates remained at 1%.

What then Fed Chairman Alan Greenspan didn't realise what that investors would use the money they could borrow so cheaply to invest in emerging markets, which Jim O' Neil had predicted would offer sustained economic growth for at least the next generation.

Greenspan was creating a monster, and it's color would be green.

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With the volatility we are now seeing in financial markets it has become a fruitless endevour to bet on the next move, up or down.

However, it's important to not lose sight of the fact that we are seeing something no different to the bursting of any bubble gone before.

What caused the bubble in oil and emerging markets was a combination of a low cost of borrowing and gullible investors.

While all bubbles teach a different lesson, they all result in the same thing: the search for a new bubble. But you can't burst the same bubble twice. And oil prices and emerging markets have both now clearly burst.

Only time will tell what Bernanke's monster will destroy...

Be careful what you hope for

2008-11-04T16:41:00.000-08:00

Hope can quickly turn into hopelessness.

The very act of hope brings with it an expectation that things can and will get better.

Each passing day that hope fails to deliver is one step closer to losing hope.

Can President Obama, with his promise of hope, make things better?

If it was 1982, perhaps. If it was 1992, perhaps. If it was 2002, perhaps.

It isn't. It's 2008 and things can and will only get worse.

Unfortunately, the situation will get worse for precisely the people to whom Barak Obama has offered his special brand of hope: the black, working class.

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Obama's key pledge to the US electorate was to cut taxes for 95% of working Americans.

The key word here is working.

US jobs are currently being lost at a faster rate each month and are likely to continue to fall faster.

The greatest cause of poverty in any economy is not low wages or high taxes but unemployment.

The current environment is particularly severe as those people most at risk of losing their jobs have already lost, or are very likely to, lose their homes too.

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In the coming months what we could see is the type of humanitarian disaster created by Hurricane Katrina but on a national (indeed international) scale.

How bad would an African-American President look if this occured on US soil?

Bad enough to lose the election in 2012.

The only question remaining is which lucky politician will inherit a situation in 2012 similar to that in 1982, 1992 or 2002? That's someone who Barak Obama can only hope to be.

Timing is everything after all...

Prologue of a crash

2008-11-03T16:20:00.000-08:00

It was over 18 months ago that I made the following prediction:

"The US economic cycle has reached the stage where a sharp slowdown is not only inevitable but likely. While the timing of such a slowdown remains uncertain, it is likely that any investor who remains heavily exposed to equities for the next 2-3 years is unlikely to see any gains over the period."

On that day (April 9th 2007) the S&P 500 closed at 1450. The market then rose by a further 7% to close at 1550 on July 9th.

It then fell and fell and fell.

The market's most recent low point of 850 on October 27th was 40% below where it was when I made my prediction last year and 45% below the high point on July 9th.

You're welcome.

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If history were the perfect guide then we would all be justified in piling everything we own into the equity market.

Some professional investors, like Warren Buffett, believe that American companies offer the most compelling valuation at this most difficult of times.

Of course, with global equity markets so highly correlated it shouldn't really matter which one you pick; they all go in the same direction sooner or later!

Unfortunately, there is only one direction in which equity markets will be going in the foreseeable future: down. Why?

For the same reasons I predicted last year and more, namely:

1) Uncertainty about how much lower US interest rates will go;
2) Uncertainty about how deep and how long the US (and global) recession will last;
3) Uncertainty about how much further the US housing market will deteriorate.

If there is one thing that financial markets hate it is uncertainty and the longer it takes for these issues to be resolved the harder it will be to justify rising equity markets.

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Willem Buiter, former member the Bank of England's Monetery Policy Committee and London School of Economics professor was quoted in today's Financial Times as saying of people who for months have been pessimistic about the economy:

"Hindsight is useless. One has to look at the information available at the time and the arguments used at the time."

I guess it might be helpful if he read this blog and my posting 18 months ago.

Watch this space, Willem!

A crisis of biblical proportions!

2008-10-28T17:50:00.000-07:00

One group of people who should do very well as a result of the current financial crisis are people who write finance textbooks.

While there's been no shortage of new books/blogs/news stories, attempting to explain the ubiquitous "credit crunch" in plain English, entire courses at universities around the world will need to be re-written.

Of course, that's assuming there will still be a demand for studying courses in finance. After all, what incentive do you currently have for studying a course with no career opportunities for the next year at least? Answer: not much.

But finance is more than just a course at university, as we are discovering each day. It actually matters to the lives of everyone.

Some of the people who graduated with a PhD in financial engineering decided to apply their skills in mathematics and computing to come up with a "new and innovative" ways to invest in financial markets. The result was a something like the vision that Joseph had of Egypt: seven years of plenty, followed by seven years of famine.

Perhaps clinging to religion might not seem like such a bad idea after all...

Dark Knight, false dawn?

2008-08-03T13:56:00.000-07:00

To quote from the latest Batman movie:

"The night is always darkest before the dawn."

And it was getting pretty dark out there for the movie business. It's been over ten years since the classic Titanic managed to get every man, woman and child excited enough to pay to see a movie at the cinema.

And now it's The Dark Knight that could pick up the mantle of being the most lucrative movie ever made.

But how, I hear you ask, can this be in an age of downloads and 500-inch digital plasma home entertainment?

Well, just as General Motors is pulling out all the stops to compete with Nissan and Toyota, the movie companies are having to put down more of their own money to ensure enough bums on seats and not couches.

But just as it may be a matter of time before people decide that buying a GM ve-hicle is just not worth it anymore, despite however many bells and whistles are added, people may eventually decide that paying to see something at the cinema, no matter how dazzling, is just not worth it either.

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Make no mistake, Warner Brothers took a huge risk with the DK. At a time when everyone is paying more at the pump, leaving less in their wallets and who-knows-what happening to their home, spending over $100 million to produce a movie is enough to keep anyone up at night.

But for now, the risk paid off, right?

Well, not quite.

The Dark Knight was more than the latest blockbuster. It was an opportunity to get people back into the cinema and remind them of the value of paying to see something rather than stay at home.

And was this enough to get people coming back for more?

I don't think so.

Two unfortunate reasons are:

1) the best actor in the film won't be in any movies ever again
but more importantly.
2) the story was ridiculously bad (for your reference, my opinion of a good story can be found in anything done by Pixar, which, yes, can be appreciated just as much on an i-phone as it can in an i-max cinema).

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Movie companies are always weighing up the risk of producing an expensive movie with the likelihood that fans are willing to make the expense of going to see it.

These days, that risk has become harder to justify, hence the recent lack of blockbusting material.

Perhaps in 10 years from now, the next big production will be targeted at the only audience that will matter: the home audience.

Minority report

2008-02-21T12:27:00.000-08:00

The race to become US President has gone from the most exciting prospect for change in America to the same old politics.

But how is this possible? Isn't Barak Obama just the "change" the country needs?

He is. Unfortunately, the majority of voting Americans won't agree that someone from a minority group can lead the way.

With John Edwards now eliminated, two truly divisive candidates remain, neither of whom can convince enough voters to 'buy in' to their view of the world.

America's nightmare continues.

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Last year I predicted that John Edwards would become the next US President. I also thought that Hillary Clinton would be his Vice President, taking the country one tolerable step closer to a female President.

Sadly, I was wrong about Edwards and I'll probably be proven wrong about Clinton.

Edwards as President was the only hope for Clinton to reach the While House. Now, with him out of the picture, she has absolutely no hope of becoming the Democratic nominee, let alone President.

This leaves Barak Obama, the candidate whose sole message can be summed up in a simple identity:

Hope=Change.

While these are two things the country has not enjoyed in a long time, they suggest nothing but empty promises. With extremely little experience in politics, Obama's message of hope will never be enough to convince enough Americans that he represents the potential for change. This will become painfully obvious in contrast to John McCain (b. 1936).

Instead, it was the message of Edwards that offered the most marketable solution to America's problems:

Change=Hope

Unfortunately for Edwards, he wasn't able to convince enough people of the need for the changes he was prepared to make.

Better luck next time.

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If you were hoping that the 2008 Presidential election would herald a sea-change in American politics, you will be sadly disappointed come January 2009.

The likelihood now is that a Republican will be in the White House and the politics of old will resume.

There is one silver lining to all of this: the odds are against John McCain to win, so you still stand to gain something from the outcome of the election!

Manias, Panics and Greenspan

2007-10-17T13:36:00.000-07:00

In case you were thinking of reading the memoirs of former US Federal Reserve Chairman, Alan Greenspan, there are three things I can recommend:

1) buy it;
2) buy it on Amazon.com;
3) also buy a copy of Manias, Panics, and Crashes: A History of Financial Crises;

thereby:

1) greatly improving your understanding of how policymakers react to economic and financial market volatility;
2) saving you some money;
3) suggesting to other people that they buy the same combination, potentially enhancing their (and your) understanding of how financial markets behave.

Reading both books will help sharpen your understanding of how financial markets and economic policy interact, helping to ensure you make more money when others are struggling to stay afloat or worse, living in fear of losing money of their own.

Luckily for you, the key messages contained within both of these books are summarised below.

For those of you with enough time to get through both books, you can stop reading here and go buy them now.

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Memoirs often give famous people the first chance in their life to "come clean", revealing facts and tidbits that had until then remained a secret.

The first half of Alan Greenspan's "The Age of Turbulence" provides an unusual amount of information that was for the most part deliberately kept from the public during a period of almost 20 years.

One of the most important confessions that Greenpan makes about many of the issues he was presumed to be all-knowing is this:

"I really had no idea."

While Greenspan would (understandably) have been extremely reluctant to make this statement while Fed Chairman, he is now all too willing to reveal many of his inadequacies.

And even though we are being told this "after the event", much of what Greenspan says offer important insights into the way his successor, Ben Bernanke, is likely to be thinking about approaching the current turmoil in the financial markets.

A good example of Greenspan in honest, frank talk-mode, comes on page 156:

"Knowing when to start tightening [monetary policy], and by how much, and most important, when to stop was a fascinating and sometimes nerve-racking intellectual challenge... it didn't feel like "Oh, let's execute a soft landing", it felt more like "Let's jump out of this sixty-story building and try to land on our feet.""

Note these remarks were made in the context of the challenges facing the Fed during 1996, when the economy was cruising along nicely. During periods of financial market crisis, this uncertainty balloons. Being able to understand the mentality of policymakers in these circumstances is critical to formulating an investment strategy at such times.

And remember, the implications for monetary policy in reaction to certain events in the financial markets can be as important as the events themselves.

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Greenspan's tenure at the Fed was marked by two distinct events, seperated by almost exactly 10 years: the 1987 stock market crash and the Asian/Russian financial crises of 1997/8.

Both of these events, as catalogued by Greenspan, both tell a story of a severe shock to the financial system coming at a time of a resilient economic expansion.

As a result, the emergency easing of monetary policy on both occassions were enough to prevent a pronounced and pervasive problem from becoming persistent. As Greenspan reflects on page 191, about the period following the Russian default in 1998:

"[the fear was growing that] after seven spectacular years... the US economic boom was coming to an end. That fear, it turned out, was premature. Once we coped with the Russian crisis, the boom would continue for another two years, until late 2000, when the business cycle finally turned."

A decade earlier, Greenspan, in his first year as Chairman, faced the biggest one-day loss ever in the stock market (-22.5%). But, as he reflects on page 110:

"Contrary to everyone's fears, the economy held firm, actually growing at a 2 percent annual rate in the first quarter of 1988 and at an accelerated 5 percent rate in the second quarter."

Two years later the cycle finally turned.

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Two things should stick out a mile:

1) financial crises occur with odd regularity;
2) these crises occur at the late (though not final) stage of the economic cycle.

What's all that about then?

Well, this is what brings me to suggest reading Manias, Panics, and Crashes in conjunction with Greenspan's memoirs.

Manias makes two key observations:

1) economic theory is incomplete and thus incapable of explaining what, why and how financial crises occur;
2) all financial market crises are similar to each other.

While 1) is more of an academic point, 2) isn't. Not only is it consistent with the pattern of many historical crises of both the 19th and 20th centuries, it also makes perfect sense. As the economic cycle matures, much of what caused asset prices (i.e. equities) to rise will inevitably reach a point of saturation or obsolescence, bringing with it a costly transition to the "next phase" of the economic cycle.

This should also suggest the following likely scenario after the financial market crisis we have just witnessed this past summer:

1) The Fed will continue to provide additional liquity to the markets, thus avoiding any sustained downturn in the stock market;
2) the economic cycle will turn in 2 years;
3) at that point, there is little the Fed can do to prevent the stock market from falling, which it will likely do in an orderly fashion.
4) Ben Bernanke will start taking a bath each morning from now on.

A winning political slogan

2007-10-04T14:02:00.000-07:00

David Cameron is trying to lead a revolution in British politics.

Unfortunately, most people see it for what it really is: a desperate bid for power.

This is why more people will continue to stay at home instead of going to the polling stations to vote.

And they'll remain there until there is a true revolution in the way politics 'works'.

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The coming weeks will probably bring with it the opportunity for British people to choose the political party of their choice.

But what choice are they being offered?

Over the past couple of weeks, both Gordon Brown and David Cameron had the opportunity to set out their respective visions for the future of Britain.

As you would expect, both men made a very compelling presentation.

Cameron managed to set out the Conservative Party's case in a most eloquent (and even unscripted) way at Blackpool this week. What his argument boils down to is this:

'Vote for the Conservative Party so we can correct the mistakes that the Labour Party made after correcting the mistakes that the Conservative Party made before them!'

However much he glosses over it, it is this message which gets through loud and clear to me as a (potential) voter.

To get me to vote, not to mention actually getting my vote, what he should have said was this.

'Vote for me so that I can quit and then transfer the power back to you.'

The choice this presents to Cameron is exactly what he offers to us: none at all.

He has no interest in giving decision-making powers back to the people and we have no interest in giving it to him.

And around and around it will go, as an ever smaller proportion of the voting population will decide who governs over the rest of us.

Eventually something will be done by someone with enough vision to make a real change, but the chances of that happening in our lifetime are extremely remote.

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Politicians are very smart people. They can absorb an enourmous amount of information, have excellent communication skills and make fantastic presentations.

Why not harness all of these skills and remove the powers they have to make decisions on our behalf?

I believe that the best role a politician can play is as a consultant to the people.

If a new law or budget is required to deal with a social problem or to build a new school, have politicans consult with people about the options available and have the public decide on which course of action to take.

This is politics that engages the public and gives the power back to them.

I'd vote for that. Wouldn't you?

Sale still on!

2007-09-17T14:23:00.000-07:00

All the scenes of panic in the UK high street will have given the public a first-hand view of a bank run.

At the same time, there is a lot of debate about whether or not the US economy will fall into a recession and what this might mean for the rest of the world.

It is tempting to think it will get much much worse before it gets any better.

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While the bad news is far from over, it would be premature at this stage to conclude that a US recession is inevitable.

But this is exactly what financial markets all over the world did in August.

Trillions of dollars were wiped off the value of financial assets on speculation that companies around the world would report weaker earnings and the world economy would stagnate.

Well it hasn't, yet. And whether it will be as bad as some would have us believe is still an open question.

What this experience should teach anyone who is actively investing their own money in the financial markets (myself included) is that the underlying strength of the global economy is what determines whether financial markets are likely to perform well or not, and not the other way around.

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In other words, when stock markets sell off out of blind panic (as they did in August), but the underlying economic data remains strong, this should present an opportunity to any investor; rather like buying clothes on sale.

And the sale is still on! The same jumper that looked a bargain a few weeks ago is still a bargain today.

But at some point the current stock will go bad and won't be as good a bargain as before.

When a US recession becomes unavoidable, it will be time to shop elsewhere. Government bonds will be all the rage then.

Watch this space!

Misleading hindsight

2007-08-15T13:18:00.000-07:00

In case you've just spent the past few weeks on a desert island (or a very exotic one), you would have missed one of the most panic-driven sell-offs in financial markets in years, if not decades.

One unfortunate aspect of the latest rout is that most experts don't seem to know how much further markets are likely to fall.

This puts not just experts, but people who rely on experts (e.g. investors), in an extremely awkward situation. Without any conviction on which way to trade, markets can at best go sideways or at worst come crashing down.

In reality, we're simpy in the midst of something the world has witnessed ever since the dawn of time: an extremely rare and unexpected event with an uncertain outcome.

While we usually get to hear about why a major event such as this occured after it occured, we now have the rare opportunity to witness how truly limited our understanding of uncertainty in financial markets has remained despite all of the advances in mathematical modelling and trading strategies.

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There's nothing new about a lurch downwards in markets, otherwise known as "corrections". They usually occur as the result of a market being "overbought", which then leads to an inevitable decline (usually around 10%) and a subsequent "bounce".

At the moment, the exact cause of the downturn is not fully understood, so making a prediction about when and how much of a bounce is likely, is more uncertain than usual.

One explanation doing the rounds is that market participants have failed to learn that they fail to learn, otherwise known as a "black swan" event. This describes how after something completely unexpected happens, we come up with an explanation that attempts to explain exactly what happened and why it was predictable after all, thus creating a false sense of certainty about future uncertainty.

This problem is compounded by people attempting to draw analogies with past events to try and guage how much worse it might get. This effectively uses a backward-looking explanation of the past to help predict what might happen in the future!

If you were to suggest, based on your experiences at the time, that the current episode is similar to the events of October 1987, most people who work in the financial industry would have to take you at your word, since they are unlikely to have been working (alive??) at the time!

The more recent the period with which you make the comparison the more people you are likely to convince. In the end, there is a story to satisfy everyone. However, every story will have one thing in common: a misleading reference to the past in an attempt the predict the future.

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We are at one of those rare times when an expert will tell you exactly what they have always known about the future: very little.

At the end of the day all you can know is what you know. While it may not always be possible to know why something is happening, it is possible to guage the ability of the global economy to weather the storms that come along.

At the moment markets are falling while the global economy is resilient. If the environment were less bouyant than at present then the current turbulence in financial markets would have much wider ramifications than they currently do.

In the meantime all we can do is sit tight and hope for the best!

If...

2007-08-05T03:18:00.000-07:00

Traders who work in the financial markets don't have time for poetry.

This is unfortunate, since there's one poem that contains a lot of helpful advice for those who have been in the red these past few weeks.

The English writer, Rudyard Kipling wrote a famous poem in 1910 entitled, If. It opens:

"If you can keep your head when all about you are losing theirs..."

In the financial world this could be taken as meaning:

"A contrarian investor has much to gain". Or more concisely:

"Buy low, sell high".

But there is also a deeper message. It stresses the importance of self-belief and, more importantly, scepticism towards what other people are saying.

If you take any message from this poem, it should be that while sometimes you may be right and sometimes you may be wrong, if you stop believing in yourself, you might as will give up and go home.

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The past two weeks have seen significant losses across equity markets around the world. At the same time there is a belief among many that not only was it coming, but it's only just begun.

If you stop and consider this for a moment you realise that anything anyone says about the financial markets will always have an implicit bias.

Anyone with an opinion about financial markets either has money, their reputation or both at stake. If someone had expected markets to fall then they are likely to say the markets have further to fall. If they hadn't expected markets to fall, they probably won't expect them to fall much further.

Who should you believe?

The first point to make is that until now a lot of people had been expecting a "correction" in the markets "at some point", so the appearance of such a move is proof to many that not only were they right, but they were right when others had not believed them. This "pride" effect takes time to subside and since pride is always expressed loudly, it tends to find its way into the mainstream media faster than Paris Hilton on her way to jail.

Then there are those who didn't expect it to happen and weren't prepared for the consequences. These people are more in shock than anything else and will be pretty much useless for providing advice until things recover completely, which could take days, weeks or months.

Finally, there are the select few who saw it coming a mile away. They knew exactly when a significant selloff would take place and positioned themselves accordingly. Unfortunately, these people rarely express their thoughts in public. Think about it, if you knew when panic would strike markets and everyone would rush for the exits at the same time, would you advertise that fact? Unlikely.

In reality, the only person whose judgement we can truly rely upon is our own. Today's winner is likely to be tomorrow's loser.

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"If you can make one heap of all your winnings and risk it on one turn of pitch-and-toss, and lose, and start again at your beginnings and never breathe a word about your loss..."

Never breathe a word about your loss. In other words: a loser never says when they losing while a winner usually tells you when when they're winning!

Everyone is wrong some of the time, so when they're right and they let you know this, be wary of not only what they are telling you, but why as well.

America awakes from its dream

2007-07-20T10:49:00.001-07:00

Around 8 out of 10 Americans don't own a passport but even those with one are unlikely to want to use it.

But this is not for the reason you might think (I'll leave that thought with you!).

The main reason why I believe no American would want to travel abroad this summer is because the value of the US dollar is close to the weakest it has ever been.

As I wrote over two years ago there is good reason to expect the dollar to fall further in value in coming years.

As always, people have two questions about the dollar: how much further can it fall and what does this mean for the rest of the world?

In short, it will keep falling as the Chinese yuan continues to strengthen (and when that will stop nobody knows). And it's not so much what it will mean for the rest of the world but what the rest of the world will mean for the dollar.

If there is a further diminishing appetite for US dollars by countries including China and Japan, then the dollar could fall even more rapidly, sparking a sell-off in US assets and a major crisis across global markets (fingers crossed that won't happen!).

In any case, there is the potential for people to make a LOT of money from the dollar's decline. After all, if you're going to bet, bet big.

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I made two predictions in 2005, one that turned out to be right and the other one that is turning out to be right.

The best prediction I made was to expect the British Pound to strengthen, thus providing a "safe haven" against the likely decline in the dollar.

Up, Up & Away!

Since mid-2005, the Pound has strengthened by almost 20% against the dollar as money has flown to the high yield of British assets (bonds, real estate etc.). Over the same period the FTSE 100 share index has also gained over 30%.

So for investors who had to choose between markets around the world, owning UK shares in Pounds would have been a very wise move (Britsh people have just had to sit back and watch the money roll in... and out to the high street!). For now, this looks like a good strategy to continue for the rest of the year.

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A forecast I made that is beginning to prove correct is a more rapid decline in the dollar overall.

Calm before the storm?

After I predicted a more rapid decline in the dollar in 2005, exactly the opposite proceeded to happen (perhaps some very influential contrarian investors read my blog after all!). For the first year since 2000, the dollar strengthened against the major currencies of the world.

But like most forecasts that are grounded in basic common sense, eventually it prevails and now marks the point where reality begins to "kick in".

Unfortunately, a decline in the dollar is a double-edged sword.

First is the obvious diminished purchasing power of American consumers. The second relates to China.

There has been a lot of pressure on China to strengthen the yuan. While this has happened, albeit gradually, it has come at a time when the dollar has weakened. And since the yuan is still partly pegged to the dollar, the Chinese currency has reflected this weakness, offsetting part of the strength.

So, if the dollar continues to weaken then not only will it hurt the purse of American consumers, US producers will also lose competitiveness to Chinese manufacturers. That's not to mention the fact that a weaker dollar reduces the value of US assets currently held by the Chinese government in the form of US government bonds, which adds to the incentive for the Chinese to diversify into other currencies (British pounds perhaps??). Either way, this does not bode well for the US dollar at all.

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It is not the best time to be an American citizen.

Apart from a deteriorating reputation their country has in certain regions of the world (not mentioning any names!), the value of their home is likely to be flat or declining and they can't afford to go shopping for clothes in Europe.

At some point things will improve but at the moment it's difficult to see this happening any time soon.

Learning from the past

2007-06-15T12:36:00.000-07:00

Why are economists so bad at forecasting?

As I mentioned before, economists need to make assumptions about the future in order to forecast.

Unfortunately, these assumptions tend to be wrong, as do their forecasts, which is why forecasts tend to be revised on a regular basis.

But I've come to realise that bad forecasting is also the result of looking at what happened in the past and failing to learn from it in a way that will help and not hinder predicting what could happen in the future.

While we are used to hearing that "the past is no indication of future performance", it is still possible to glean from past data critical information that will help in making a forecast more accurate and less prone to revisions.

Economists fail to take away the right information from past observations and keep making the same mistakes over and over again.

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So, how can the past help us to predict the future? It depends on how you look at what happened.

Imagine you travelled down a road at 8am and it becomes very heavily congested. Based on what you have observed, you might also expect that if you travel down the same road tomorrow at 11am then it will be congested again.

Of course, this fails to take account of the fact that before 9am the road is unusually congested, since it's in the middle of the rush hour.

Economists make a similar mistake when using past observations to help forecast the future path of the economy.

They tend to look back at what actually happened rather than at what caused it to happen. In other words, economists look back at backward-looking data to help predict the future!

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In trying to predict a recession it would be better to look at what leading indicators were doing in the run up to previous recessions and compare this to what they are doing now.

Instead, economists look at what happened to GDP, unemployment and inflation, which give no indication about the future, to predict what will happen to GDP, unemployment and inflation!

Part of the reason why economists don't use leading indicators is because they don't trust their accuracy. Currently, the OECD and Conference Board produce the most widely-followed leading indexes but these have had a poor record at predicting recessions.

Another reason why economists are sceptical about leading indexes is because they don't fully understand how to accurately construct one of their own.

A lot of work has been done in this area by my former employers at ECRI and you can follow some of their leading indexes in the press. However, since they are a private firm only a small amount of information is made public. This is unfortunate, since they have a pretty decent record at predicting turning points and in particular, the timing of recessions.

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The fact that economists make bad forecasts is not necessarily a problem (they can be useful in other ways too!). However, financial markets look to economists, either in the private sector, government or at central banks to guide expecations about the future. If these expecations prove to be inaccurate or plain wrong then stock and bond markets will be unecessarily volatile. In reality, this is what we observe.

Trying to understand what caused something to happen in the past can help predict what is likely to happen in the future.

It would be like saying that a road (economy) that becomes heavily congested (has very high gasoline prices) at 11am (when leading indicators are stronger) will be better able to deal with that congestion (avoid a recession) than a road (economy) that becomes heavily congested (has high gasoline prices) at 8am (when leading indicators are weak).

Wouldn't it be better if we could assess the future of the economy with as much clarity as congestion on the roads?

Go fishing

2007-06-10T14:57:00.000-07:00

It's not unusual to hear people complain about the rising cost of living.

Our grandparents and parents have seen a rapid increase in the cost of living throughout their lives.

But that was just the beginning. They could never have anticipated what would come next.

What was affordable to our parents is unaffordable to many of us now: buying a house, driving a car, going on holiday, even buying a cup of coffee.

What some might consider fundamental to living a 'normal' life has now gone beyond the reach of the average person.

How it became this bad has already entered the mainstream media: developing countries such as China and India have been using natural resources so intensely that it has pushed up the price of everything that developed countries use every day.

What is not often discussed is what this 'new world' will mean for the lifestyle of millions, if not billions of people all over the developed (i.e. rich) world.

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As I mentiond, a rise in the cost of living is nothing new.

The process of industrialisation and technological change has improved everyone's standard of living.

But this improvement has always come at a price.

After all, any rise in the cost of living is an inevitable by-product of an improving standard of living: we all need to want more to be willing to pay and hence justify its production.

This is simple supply and demand, as illustrated in my nifty little chart below:

The price of growth

What this chart shows is the rapid and increasing cost of living seen over the past 100 years or so.

Over that time, whenever there was an improvement in the standard of living and an accompanying rise in the cost of living, there was always an increase in demand (D,D',D''' etc.) to match the increase in supply (S, S', S'' etc.).

This process has accelerated in the past 10-20 years, especially with the rise of computer technology and globalisation. Note the chart does simplify a trend (after all, there could arguably have been a fall in the cost of living line over some periods, although the trend is certainly up), but it still manages to capture the current problem: a rise in the cost of living that has created a mis-match between supply and demand.

What this means is that the current increase in the supply of goods and services has not, and will continue to not be matched by an equivalent increase in demand. (Note: this is the case for developed countries)

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So, what does all this mean?

In reality, quite a lot.

Firstly, substitution.

Instead of buying houses, people will rent. Instead of driving cars, people will use public transport. Instead of going to Starbucks, people will bring a flask to work or just drink water (from the tap!).

Secondly, people will change their lifestyles.

In the chart, any increase in demand that matches the increase in supply has an associated "sacrifice" that must be made.

Once people decide that the necessary sacrifice is not justified, or affordable, they will opt for a different way to use their free time and spare cash.

One option might be to go fishing.

An American revolution

2007-05-10T11:39:00.000-07:00

America is currently going through a painful process known as 'change'.

Once completed, this transformation can only be to the benefit of everyone around the world.

Of course, the main people to benefit will be the American people themselves. Not least because changing the attitude of the American people (and the people they elect to government) will fundamentally alter the way the rest of the world perceives them.

After all, the attacks of September 11th 2001 happened exactly because of the negative way America was seen in the eyes of those who killed all those innocent people that day.

By electing leaders who look out to the world and not away from it can America have any hope of becoming a credible world leader again.

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So who, you might ask, are these 'new' leaders? And why are they any different from their predecessors?

Well, firstly, they won't be Republicans.

Last week, after watching the 10 candidates from each of the Republican and Democratic parties debate on live television, it became clear who was fighting for what and who was most likely to win.

On the Republican's side, the emphasis was on the "War on Terror" (WOT) and on "bringing terrorists to justice". Noble goals no doubt but, as the war in Iraq has proven so painfully, completely futile.

Terror cannot be defeated. It just keeps coming back. (The only way you could actually defeat terrorism would be to eliminate it from the dictionary!)

On the Democrat's side, there is no WOT, only HAM ("hearts and minds") that need to be won.

This line will play very well with an American public that is sick of hearing about fighting and war and terror.

That's why the US Congress is now controlled by the Democratic party and that's what will ultimately sway the American public towards a Democratic President of the United States.

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So now we know which side is likely to win, who could be sitting in the Oval Office by January 20th 2009?

A few months ago my money could have been on Barack Obama.

The 46-year old from Illinois showed a lot of promise, offering soothing words of hope to the American people. And the fact he isn't white made him (literally) stand out from the crowd!

Maybe next time?

But the more I listen to his words, the less convinced I get.

His rhetoric has turned from solving problems to falsely naming causes.

For instance, he suggests that China is taking away American jobs. Not only would this be impossible to prove, it suggests a protectionist solution that can only damage relations with the most important country in the world other than the United States. This would make for a bad President.

The alternative combination is clearer to me now than ever: John Edwards for President and Hilary Clinton for Vice President.

A winning team

It is clear because it contains the two most important elements needed in a successful candidate: success and a mandate for change.

A few years ago I predicted that Hilary Clinton would run for President. Not many people believed me, but it proved correct.

Unfortunately, while she clearly has a mandate for change (again, she sticks out a mile), she isn't likely to win over enough of the public. Change comes in steps, not giant leaps.

One step towards a female President is a female Vice President.

The President who she is most likely to serve with is John Edwards.

Most people have fresh in their minds his close defeat as Vice President nominee to Bush in 2004 and this could provide enough momentum for Edwards to carry him all the way through to a successful nomination and victory.

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If you've read any of my previous comments on politics you might think this post was something of a backtrack. As a politician might say, it is and it isn't.

I still strongly believe that electing an individual to run a country is based on the outdated notion that the voting public should only decide on a major issue affecting their lives once every four years simply because this is the most practical way of running a democracy.

This is clearly not the case, with almost 70% of the US population now connected to the internet and ready to vote on an issue that is important to them.

However, as previous elections in the US and around the world have shown, electronic voting is in its infancy and prone to error.

Of course, I remain wary of any 'efforts' made to rectify these problems since it is in the interests of those currently in government to prevent electronic voting from putting them out of jobs!

Still, given there remains a more pressing need for change in the United States, a new leadership will help take the country in the right direction.

It is better to have someone at the head of government whose goals are "eliminating poverty, fighting global warming, and providing universal healthcare" than someone hell-bent on fighting a war that only innocent people will lose.

WIll you be my friend?

2007-04-17T13:57:00.000-07:00

While we may never know the true motive of the killer, many find it convenient to attach the label of "loner" to Cho Seung-Hui.

We feel it might help us to understand just a little about how someone could do something so horrific.

But you have to wonder just how much we can ever know about a "loner" and whether he was truly lonely or not.

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When you ask someone how many friends they have the answer of course depends on who you ask and how old they are.

If you ask your grandparents they may have a list of people who they've known for a number of years, if not decades.

If you ask your parents, they will have a lot of people they've known either since childhood or over a number of years.

But if you were to ask me, I could show you a list of contacts on MSN, Skype, Yahoo, different email accounts and people I know through work. This doesn't even include the websites designed to reunite past shoolmates or online dating.

I literally have more friends than I can remember.

But I don't spend a lot of time going to parties , meeting for dinner or going to nightclubs. I tend to spend most of my time at home. You might even call me a bit of a "loner".

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While Cho Seung-Hui will forever remain a mystery to so many people, it's too convenient to attach a label and use this to help explain his motives for doing what he did.

At best it will misrepresent the life he truly led and at worst it may prevent us from ever being able to understand what truly led him to kill so many people or help prevent it from ever happening again.

Last ray of hope

2007-04-14T14:10:00.000-07:00

I hearby declare that Sunshine is the last movie I will ever pay to watch at the cinema.

I was close to making this decision after seeing Children of Men, but my latest experience left me no doubt in my mind.

A number of reasons have led me to this conclusion, most importantly:

1) The movie (like so many I've paid to see in the past) was rubbish (no doubt the book was better);
2) The people sitting behind me kept whispering audibly to each other and continuously kicked the back of my seat after arriving late;
3) The popcorn made me feel bloated;
4) I drank so much that I wanted to use the bathroom halfway through but didn't want to miss anything important, so sat in agony for the last 30 minutes;
5) I could enter the cinema and walk directly to my seat without anyone checking to see if I had a ticket.

The last point was the most telling of all. The fact that nobody checked to see if I had a ticket proves how pointless it is to pay for the experience in the first place!

I doubt you could ever walk into a concert or play without someone checking your ticket. After all, these are still valid forms of entertainment.

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My decision to stop paying to watch a movie at the cinema is of course partly explained by the fact that there two perfectly viable alternatives: waiting for a DVD release or, if you can't wait that long, downloading.

Either allows you to enjoy the movie on a widescreen TV, plasma or projector, proving a similar viewing experience with the option to eat whatever you want, whenever, without having to worry about the people behind you ruining it.

While many can argue that downloading a movie is wrong, it can now be justified on the basis that it allows you to avoid the unpleasant experience of seeing it at the cinema!

Cinemas are a relic of the past, providing a deteriorating service that has been replaced with a superior alternative at home.

It's time for these buildings to be torn down and replaced with affordable housing, just like shops on the high street, as I've argued before.

An inconvenient fact

2007-04-11T11:52:00.000-07:00

Browsing YouTube (whose slogan should be changed without delay to "Just broadcast it") I came across an ambitious attempt by one Danish economist to solve the "big problems of the world" in the most immediately beneficial order of priority.

Listen to what he has to say before I rip it apart piece by piece...

I know what you're thinking. Blue T-shirt?? Where's the grey hair and grey suit??? Surely he isn't a real economist, is he?!? Well, if he talks like one, the chances are, he is one. And he seems to have some older, greyer friends, which always helps.

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The ideal that he and every other economist aims to achieve is a system that ensures the self-motivated actions of each individual be consistent with the interests of everyone else. A good example of this would be to charge customers for plastic bags at the supermarket so that they have an incentive to re-use old ones thereby helping them save money AND the environment.

Of course, it's easier to achieve this ideal scenario on a small scale. But when you begin to try and solve 'bigger' problems you run into obstacles that ultimately prove practically impossible to overcome.

To see this you need simply to ask: why hasn't what he suggests been done already? The answer lies in the different interests of the various groups involved.

Basically, the priorities of those with the money and resources to solve the big problems of the world are very different to those without it. In other words, rich countries want to solve their problems first.

This isn't as inappropriate as it sounds. After all, rich countries can cause far bigger problems than poorer ones who currently suffer with diseases that are relatively easy to contain. While you can limit the spread of disease, you can't limit the spread of global warming or the collapse of the global financial system.

This is why the richest nations in the world poor billions of dollars each year into trying to solve their own problems.

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While it is useful to prioritise problems (or solutions) in terms of their largest short-term gain, this doesn't take full account of the potential short- (and long-) term cost of leaving other problems unsolved.

In principle it makes sense to solve the problems of poorer countries first but in practise we live in a world where solving one problem literally creates another.

Ultimately, all we can do is try and solve as many problems as possible given the resources we have available. Anything else would be aiming for the ideal and living with something far worse than it otherwise would have been.

Epilogue of a boom

2007-04-09T12:01:00.000-07:00

As I mentioned last month, the world economy is booming. In many ways, things just couldn't get any better.

If you've been investing in any stock market around the world over the past few years, you've done very nicely indeed.

Of course, if you're a long-run investor or aware that there is a business cycle (or even better, both!) then you've done very nicely over the past few decades and no doubt will continue to do so.

However, you're still only as good as your last investment. After all it can only take a few days or weeks to wipe out an entire year's worth of gains.

Now is one of those times when you really have to wonder if it's the time to sell.

I'm not saying this as an economist or as an investor, but as an observer of three simple facts.

These facts help explain why now is one of the riskiest times to be actively investing in the stock market.

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Fact #1: There is a bizarre range of opinions about whether the US Federal Reserve is about to raise or cut interest rates.

Some economists believe a further hike is still a distinct possiblity while others are adamant that the next move will be down either within the next few months or at the latest by year-end.

Of course all of these economists have at some time or another been wrong about the Fed's next move(s), so their opinion (or difference of it) is not something to take too seriously.

What should be taken seriously is the prospect of the Fed actually having to cut interest rates at some point in the near future.

History is not usually the best guide for the future, especially in the stock market.

However, when it comes to the relationship between when the Fed cuts interest rates and the subsequent performance of the stock market, it's all we have.

US interest rates (red) and stock market growth (blue)

1950-1996...

... 1996-2007

As both charts show, whenever the Fed has had to cut interest rates (and even when it hasn't) the stock market has fallen sharply.

One thing we often hear about is how interest rates are "historically low". From the first chart it's clear to see how low the red line has fallen and still remains in the second. This is why some economists still believe there is further room for a further hike or two.

At the end of the day, when the Fed does start cutting, it will already be too late if you're exposed to the stock market. As the second chart shows, the stock market (blue line) falls before the Fed starts cutting in anticipation of a slowing economy.

Fact #2: There is an even more bizarre range of opinions about whether the US economy will experience a recession either this year or next.

Most (in)famously, former Fed Chairman Alan Greenspan said recently that he saw a 30% chance of a US recession in 2007. As always, his comments have helped to sharpen the debate among other economists about the probability and timing of the next recession.

Given their poor record at predicting the direction of interest rates, it's not surprising that any forecast of a recession should be treated with more skepticism than respect. If they can't predict the actions of 12 people sitting around a table (deciding the direction of interest rates) it's unlikely they can forecast the consequnces of the actions of millions of people and thousands of businesses.

But again, given the frequency of past recessions in the US (shown by the shaded red areas in the charts above), we're due one soon.

Fact #3: Nobody seems to know if the US housing market will continue to deteriorate.

The consequences of a sharp correction in the US housing market for the rest of the world are extremely severe for one simple reason: if US real estate valuations fall further, US consumers will stop spending and the world economy loses one of its engines of growth.

I say "one of" because these days China and India are also fuelling global growth at an unprecedented rate.

Still, it's US consumers who still remain the biggeset spenders out there and what they do will be as important, if not the most important, determinant of global growth for years to come.

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What these three facts all have in common, is that they reflect the fact that the US economic cycle has reached the stage where a sharp slowdown is not only inevitable but likely.

While the timing of such a slowdown remains uncertain, it is likely that any investor who remains heavily exposed to equities for the next 2-3 years is unlikely to see any gains over the period.

There are two choices that remain: sell soon or sell now.

Truth: a false frontier

2007-04-07T14:26:00.000-07:00

Research is considered by some to be worthless if it isn't cutting edge, pathbreaking or on the frontier.

But how much do we understand about this so-called 'frontier'? And when do we know we're on it? And why does it matter whether we're on the frontier or not?

Recently, while having dinner with a friend who works as an academic economist, these and other thoughts crossed my mind.

I realise now, looking back on my decision to leave academia and go and work in the private sector, that pursuing 'pathbreaking' research is no longer an option.

So where I am now relative to this frontier? Have I been getting further away from it every year since I left the academic world? And does this mean that my research is worthless?

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Research is the act of collecting facts in pursuit of the truth.

The more facts gathered, the closer we get to the truth and the more we understand.

So, 'frontier' research could be considered that which gets us closest to the 'truth'.

However, there is still very little we can say we know for certain.

So, is it possible that we may never know the 'truth', but rather only get as close as possible to it?

If this is the case, then frontier research would be the only research that mattered. Anything else would be a step backwards, right?

But what if frontier research actually took us a step backwards in our understanding? What if the product of frontier research turned out to be at best misleading or at worse just plain wrong? Worse still, what if what we thought was 'wrong' was actually right, but that we couldn't identify it as 'right' because we didn't know what 'right' was!?

***********************

In reality, there is no 'right' or 'wrong'. There is simply the addition to our pre-existing understanding. Anything we didn't know before but know now is considered a contribution, or 'on the frontier'.

In reality, anyone is capable of making such a contribution, because there are an infinite amount of things we don't know. Maybe this blog just helped improve your understanding, unless you knew all this already...

**AFTERTHOUGHT**

Apparently, over 60% of academic research is the 'regurgitation' of previous work. This is worthwhile in either proving or disproving ideas and for suggesting further areas of work. Whether this is worthy of being considered 'frontier' research is of course debatable.

Blue screen of death

2007-04-05T13:07:00.000-07:00

Microsoft can claim to be one of the greatest achievements of all time... and one of the greatest disappointments.

Soon after it was founded in 1975, Microsoft's mission was to have "a computer on every desk and in every home, running Microsoft software".

Mission (near enough) accomplished.

So why the great disappointment?

It's not because of the infamous blue screen of death that frustrated users of Windows will see every time their system crashes.

It's because a company with more than $40 bln in revenue has failed to set itself a new mission.

This provides a lesson for companies like Google, which is currently riding the wave of success that Microsoft enjoyed over 20 year ago.

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Watching the share price of a company tells you almost everything you need to know about it.

The stock of Microsoft charts both its great success and recent failures.

Going nowhere fast

Microsoft would seem to represent a typical company that has reached the "mature" stage of development, where growth is a thing of the past and its potential has already been fullfilled.

Not so fast.

Does it really make sense for a company that develops and manufactures computer software to already be past its prime when the 'information age' has only just begun?

I used to doubt it.

I thought, if Microsoft would change its mission to something like "a television in every home, running Microsoft software", then it would stand a chance.

But it never changed.

And then it was 1998 and Google arrived on the scene.

Now that it's competing with the likes of Google (not to mention Apple) it's become a lot more difficult for Microsoft to profitably branch out (e.g. Xbox flop), while preserving the core business.

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Google is a company with more than $10 bln in revenue (thank you Microsoft!)

Google's mission is "to organize the world's information and make it universally accessible and useful."

Perhaps intentially, this mission is not much different to Microsoft's.

Perhaps not surprisingly, Google's share price has also taken off in a similar way to Microsoft in its early days.

Look familiar?

Everyone is very excited about Google. After all, it's a great achievement. A dissapointment sometimes perhaps (it doesn't always find what I'm looking for, but hey), but not as great a disappointment as Microsoft... yet!

If Google fails to change its mission as times change then it too will die a "blue screen of death", just like its ancestor.

The boom that keeps on giving... and taking away

2007-03-08T13:07:00.000-08:00

It's funny how the simplest of things in life can help us understand the most complex of problems.

When we go shopping, the amount we pay for a loaf of bread or the cost to fill the tank of our car allows us to realise what is happening in the world around us.

In case you hadn't noticed, both of the above have been getting rather expensive lately.

This is because a booming world economy just keeps on booming.

Consequently, any decline or "popping of the bubble" can only offer temporary relief from an unprecedented increase in the cost of living that doesn't look like losing momentum any time soon.

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A few years ago I wrote on my blog that oil prices had risen so rapidly that it was a sure sign of a bubble.

That was in 2004, when oil prices rose from $30 per barrel to $50 within less than a year.

I expected a sharp downward correction to follow, and sure enough by the end of 2004 oil had fallen back down to $40. All well and good.

Until what happened next.

Oil prices then went on to almost double to nearly $80 within 18 months! Since then, they have fallen back down to $60.

Gyrations in the price of oil might seem like the movements you would expect to see in any financial market. But very few markets are as important as the one for oil and as difficult to predict.

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It has taken many years for economists to understand the impact that China, India and other developing economies have had on the rest of the developed world. In fact, this understanding remains patchy at best.

China is especially tricky.

What has now become the biggest producing nation is the least accountable. We just don't know what's going on over there.

However, what we can measure is the effect that China's economy is having on the rest of the world. In particular, through an increase in the price of commodities, most importantly oil.

Which brings us back to our loaf of bread.

The next time you see higher prices at the supermarket or read about the rising cost of living, remember that much of this increase can be attributed by what is happening elsewhere in the world, particularly in China.

Whilst countries like China are helping to keep the world economy booming, they have also left a rather large bill for the rest of us to pay.

The third desire

2007-02-15T11:21:00.000-08:00

There are three things we need each day to survive: food, sleep and... information.

While the way we consume the first two hasn't changed much over time, our way of receiving the latter has been revolutionised.

Unlike food or sleep, there is an insatiable appetite for information.

With each passing day our demand for information grows. We just can't seem to get enough of it.

Luckily, people are being more generous with information of their own (personal web-sites, blogs, online chatting, online dating, free newspapers, reports etc.)

You give a little, you get a lot.

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Together with a surge in the supply of information has come the call for greater transparency.

We don't just want to have more information, we want to know information we weren't allowed to know before.

While there is no limit to the information we want, there will always be a limit to the information we are given.

This disparity has shrunk over the past quarter of a century, mainly due to the spread of the internet.

But the more things have changed, the more they have stayed the same.

Much like other freedoms we haven't done anything to earn, it's not immediately clear exactly how we should use this new information.

It's like telling a farmer in the 19th century about the internet. He wouldn't neither be able, nor know how best, to use it.

******************************

When I read about a leaked government memo or the minutes of a central bank meeting there is information contained in those reports that would never have been made available to the public 50 years ago.

It is easy to forget that the actions of our not-so-distant past generations have had such a profound effect on the way we live our lives today

It is difficult for someone who is 20 years old to understand why they are able to read something their parents' generation never had the right to do and more importantly how best to use this additional information.

The cost of free healthcare

2007-01-28T03:49:00.000-08:00

British people are proud of their National Health Service, and so they should be.

Having free health care at the point of entry is something envied by people around the world. (Others would need to see it to believe it!)

When you consider that almost 50 million people in the US (equivalent to almost the entire British population) don't have the necessary health insurance required to pay for medical treatment, you realise how lucky people in the UK really are.

Not surprisingly however, the NHS is constantly underfunded.

Of course by definition, if you provide a service for free, the potential demand will be infinite!

Clearly the NHS will always be underfunded.

The question will always remain, by how much and where should any additional funding be coming from?

The answer goes to the very heart of the issue of how the political system currently works.

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As a way to move the NHS forwards, the British government has recently imposed a series of 'targets' to help ensure an improving service is being provided to all patients.

The result has been enormous pressure being placed on staff and management to achieve these targets in order to 'stay in business'.

Overall, there have been improvements but even though targets are a good idea, what the NHS really needs now is more money.

The problems of more expensive technology, an ageing population and higher expectations are not going to be solved by setting targets alone. Someone has to pay for this and that someone is...

... You!

But at the moment no political party has the incentive to raise taxes to pay for improved public services. Why?

Because people don't want to pay higher taxes for improved public services.

Consider that statement for a moment...

People... don't want... to pay... higher taxes... for improved public services.

First, ask yourself if you agree with the premise of this argument? Second, are you one of those people?

I believe your answers to each of these questions are most likely to be 'yes' and 'probably not'.

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The current state of British (and any other) politics is to essentially offer the choice of either higher or lower taxes.

This puts the voter in a conveniently awkward situation: they can vote for lower taxes, knowing they will be better off, at the expense of others.

What's worse, the decreasing voter turnout in British elections means that 40% of the British popualation (myself included) never get their voices heard.

Is it really fair for 30% of the population to be represented by people offering the false hope of a 'low tax' economy, when this leads to the situation of a increasingly underfunded NHS?

Once the 40% silent minority becomes 51%, it will signal a time for change in British politics. Maybe this could usher in a new generation of politics that stands for what people truly want.

Economists have learnt to subtract

2007-01-08T07:59:00.000-08:00

There is one subject that economists love to talk about: growth.

Growth in home prices, growth in consumer spending, growth in the economy etc.

The basic question they are paid to answer is: "how are we doing compared to last year?"

But isn't looking at growth of data like GDP going to miss the damaging effects of global warming and the depletion of natural resources?

Not really. Unless there's likely to be a major change in the rate of depletion over the next 12 months (the economist's usual time horizon).

*****************************

As highlighted in the movie An Inconvenient Truth, the monthly average carbon dioxide concentration has been steadily rising for over half a century.

Note the level of CO2 has been rising steadily, not at an increasing rate.

Going up

If we use this chart as a some kind of benchmark for the destruction of natural resources, we might conclude that until now, this destruction has occured at a constant rate.

So what is the incentive for economists to "factor in" the effects of depleting natural resources if their main concern is the growth rate of the global economy over the next 12 months?

Not very high.

Spot the difference

It's not that economists don't care about the depletion of natural resources. It's just not their job.

Central banks and governments can barely keep their own economies under control for a year, let alone limit the emission of CO2.

Of course, once the depletion of natural resouces starts to have a material effect on major cities (by drowning them), then economists will start to be concerned, but only if it cuts the growth rate of GDP!

Paris: a higher calorie Tokyo

2007-01-01T11:53:00.000-08:00

Japanese are famous for taking something and improving on it. They did it with Paris.

And now I know why.

So many details of Paris are replicated in Tokyo, only with a (sometimes not so) slight improvement.

Below are a some examples:

-- Tokyo's underground is designed similarly to Paris, only much more modern; there is no English version for the French announcer, no information about where you can change at the next station;

-- Tokyo's 'Champs Elysees' is smaller, so made to look more exclusive;

-- Japanese people are as proud of their culture, only less arrogant!;

-- Japanese food is just as tasty, only much healthier!

To visit Paris you understand what inspired many of the details you find in Tokyo.

So if you ever decide to visit Tokyo, visit Paris first.

The next generation of bloggers

2006-11-10T03:31:00.000-08:00

Are you writing a blog yet?

I say yet because blogs are a growing trend and inevitably you will get tempted.

What will your blog be about? Music? Books? Sex??

Whatever it will be about, apart from a few close friends, very few people are ever likely to read it.

That isn't such a shame, since mankind won't be so worse off for not having ever read it.

What is a great shame, is the potential of blogs that is going untapped every day.

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As I have written before (including below), blogs can be a powerful weapon of democracy.

They give people a voice they never had before. A voice that can be heard anywhere, everywhere, anytime.

But nobody is reading. Why?

Volume.

There has always been too much material on the web for people to know what to read and what not.

As I said, this is a shame and it is also a problem.

But like all problems, it can be solved.

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The chances are that today you will visit at least one of the following websites:

Google;
The New York Times;
Yahoo;
Myspace;
Blogger;
MSN
or Youtube

What is common to each of these websites is that they are all an expression of someone's voice.

And we go to listen.

Unfortunately, there are too many voices to hear.

Fortunately, there are more voices than ever that want to be heard.

All we need to do is listen. But how can we listen to them all?

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This week over 40% of the US population had their voices heard.

As we saw in the newspaper (or in other words, at one of the websites listed above), the election was a "referendum on the war in Iraq".

Was it?

What have people done to change anything about the situation in Iraq? More importantly, what are they going to do about it?

Surely, the election wasn't the only time the people of America had their say about Iraq?

Of course, it wasn't.

People have been standing outside Congress and other government buildings across the country and around the world each day, expressing their disagreement over the war in Iraq.

But nobody was listening.

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Google has changed the way we use the web. How?

It has managed to break down a virtually unlimited amount of information into something that people can use.

Previously, much of what Google can find went unseen and unused.

But times are changing.

People demand more information and they now have a way to get it.

But what are they going to do with all this newfound information?

Hopefully, they will use it to form an opinion.

The next step will be to find some way of expressing this opinion in a way that people can hear.

At the moment, this happens when a polician goes on television or is interviewed by a newspaper. We can all hear what they have to say.

Now it's our turn.

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While electronic voting is still in its infancy, it offers the way forward.

Eventually, everyone will vote electronically. Eventually, everything will be done electronically.

Once we have all entered the electronic age of voting, the opportunity for people to express their opinion about something will be huge.

Consider a substantial issue (e.g. going to war, raising taxes, changes to education policy) about which you have an opinion. You will either agree, disagree or be undecided.

If enough people can express their view about something then the chances of the outcome being alligned with the interests of the country are significantly increased.

It shouldn't have to be much more complicated than this:

Step 1: Read as many blogs that discuss a particular subject
Step 2: Engage in a dialogue with other people to try and find common ground
Step 3: Go to a (government) website and vote.
Step 4: If enough people (i.e. a majority) support the idea, you could vote for an alternative proposition.

Step 1 has been partly solved by Google Blog Search. Step 2 is already popular among bloggers and non-bloggers alike. Step 3 and 4 are still unavailable.

It's 2006. What are we waiting for?

Down for maintenence

2006-10-25T13:52:00.000-07:00

I was going to call this posting Lazy voters get what they vote for, but blogger was unavailable for one hour during routine maintenence, so I couldn't publish until now.

This inspired me to change the title.

There is lots of attention on what will happen in next month's US midterm elections.

Will you be voting?

The chances are you won't.

Luckily (or not) for you, it would't make a difference even if you did.

The fact is, one vote every two years won't lead to something worth voting for.

What we need is for the voting system to go down for maintenence while changes take place that will make a difference.

**********************

Think about something you don't like, for example, fatty foods.

If one day you decide you don't like fatty foods and would prefer a low-fat diet, you will stop eating fatty foods and start eating more fruit and vegetables. What happens to producers of fatty foods?

Either they change or go out of business.

But what if we only decided to change our diet every year or two, or even four?

A lot of companies making fatty foods stay in business and we get fatter and unhappier.

Does this sound familiar? Well not in the real world.

In that world, people vote with their minds and their feet every day and this is the driving force behind much of the social changes we see take shape around us.

The fact that more and more people are eating healthier foods shows what sending messages to food companies can do. What a difference people can make.

**********************

While midterm elections are an opportunity for people to express their frustrations with their elected leaders it is not enough to affect what those elected leaders actually do on a daily basis.

At best, they are a chance for someone else to take their place and cause an equal or perhaps larger number of frustrations among the electorate.

The electorate are just like consumers and if they are not heard every day then what they say or do every two years or more will make absolutely no difference whatsoever.

And making no difference is becoming more risky as the stakes get higher.

Make a difference today and be heard.

Vote for blog!!

India: the land where time stood still but everything changed

2006-09-07T21:28:00.000-07:00

Time travel or intergalactic flight has always been the stuff of science fiction.

But in many ways, a machine that transports people across space and time has already been invented. It's called an aeroplane.

When I stepped off a flight to Bangalore, India it felt as though I had landed in both a different world and a different time.

If you ask someone on a street in India what year it is they would respond 2006, but they wouldn't think it was 2006. And neither would you.

When people talk about India, they usually mention its population of over a billion and that many of them now form an integral part of the way companies work around the world.

What people don't describe, or perhaps appreciate, is what it is actually like to live in the country.

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If you consider India from the perspective of an average Indian, your perception of it would change considerably.

The values and way of life of the people don't seem to have changed for over half a century.

While Indian people are still courteous in public, the streets are utterly chaotic. As one local described to me, it must seem like a scene Charles Dickens would have witnessed in late nineteenth century England.

And while much of the British legacy remains it has failed to develop in the way Britain did.

Part of this is because of the late stage India joined in the race for economic development. Because of this, it feels the need to move at the currently hectic pace just to keep up with the rest of the world.

Another hurdle is the lack of effective and organised management of public systems. As mentioned, the streets are in complete dissaray, the air during rush hour in Bangalore is heavy with smog and most of the roads are filled with potholes or in many cases incomplete.

This is not the country or the city you imagine when you are told of an "IT hub" or the "next global superpower".

********************

While India has much to be proud of it has equally much to be concerned about.

All of the achievements of the past 50, and especially 15, years are what India has to lose if it continues to fail to provide the necessary infrastructure necessary for a country to develop sustainably.

Put bluntly, before another shopping mall or office block goes up, roads and water mains should be put down. Without this, India will forever remain stuck in the past.

Painting by numbers

2006-08-17T14:14:00.000-07:00

Many 18-year old students in the UK will today be contemplating their future.

They have found out if they can go to university to study the subject of their choosing.

They may think that this is the most important day of their life.

In fact, the most important day of their life has already passed.

It was the day they made a choice. The consequences of that choice are already being realised.

Whether they can go to university or not is out of their control. Whether they can afford to go and study is also out of their control.

Economists understand this distinction between an action and the consequences of that action.

So, why not choose to study economics?

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Economists have a great job. Let me explain why.

When you ask someone for advice, you usually do this because there is something you want to do but aren't exactly sure what that might be. So you seek the opinion of an expert.

In the case of medicine, the person you will ask has studied biology or chemistry and a number of years of medicine to be in a position to offer a suitable suggestion.

With legal matters you will ask someone who understands the legal system and how it affects your individual rights.

In both of these cases you seek an objective solution to a problem. There is a right and wrong response. The right response will lead to a healthy or just outcome. The wrong answer will lead to ill health or worse.

When you ask an economist for advice, you are not going to get a right or wrong answer. You will get a logical argument that helps you to understand more about the question you are asking in the first place.

An economist can't tell you how to make money. That's what investors do. However, an economist can give advice to an investor.

If an investor wants to know if the economy will deteriorate next year, an economist can explain why this might happen or why it might not. It is up to the investor to choose which of these arguments are the most convincing to them. After all, everyone sees a painting in a different way.

An economist paints the picture and others observe it.

Painting by numbers. How many other professions let you do that all day long?

Do current account deficits still matter?

2006-07-14T00:03:00.000-07:00

Recently I attended a debate in London hosted by Reuters with the above title as the point of contention.

Not that there was much contention.

No direct answer to the question was offered by either participant.

This reflected both an unwillingness to address, and distint lack of understanding of, the issues underlining this misguided question.

It is not the deficits themselves that 'matter'. It's the debts they have spawned, in this case within the US household sector, that will eventually force through an outcome.

********************

One attempt at a solution was offered: a 40% real reduction in the dollar.

Apparently, in the past few years we have already seen half of this decline and "all we need is for the US current account data to reflect this."

Uh-huh.

So, all we need is for the dollar to weaken and this will make US households spend less and reduce the current account deficit?

If only.

It's not the dollar that has gotten us into this situation and it isn't the dollar that's going to get us out of it.

The answer lies in Asia.

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On the flip side of US profligacy is Asian thrift.

This counterparty to US excessive consumer spending is what has kept the whole party going for the past decade or more.

The party is over.

No longer are Asian central banks providing a free lunch to the US in the form of low interest debt. The bill has arrived. And it's called inflation.

Inflation is what has led interest rates in the US to rise to the level they are now. And it's these interest rates that will push US consumers into a level of indebtedness they haven't seen in years.

Once US consumers stop spending it will slow US growth to such an extent that the US current account deficit falls.

It's not the deficit that matters, but how it corrects.

In fact it won't take long before the US current account could be in surplus. An explanation of how that happens will be for another day.

The final act

2006-01-03T14:21:00.000-08:00

Comedy often turns into tragedy, right around the final act of the play.

2006 will bring the last few scenes of the US Federal Reserve's Comedy of Hikes.

Will a new hero step in to save the day or will he arrive too late?

Time's up.

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The bond market is literally bending over backwards to get the Fed's attention.

The yield curve is inverted.

This means that investing in a government bond for 2 years earns you a higher rate of interest than investing for 10 years.

Strange, huh?

Yes.

Not funny

Before the yield curve inverted, the Fed relentlessly increased interest rates at a painfully slow rate. A quarter point here, a quarter point there.

No end was in sight.

But as is becoming commonplace in today's damn the future society, the light at the end of the tunnel was a truck heading straight for us.

It won't be easy to turn around in time and avoid the crash.

As the chart shows, when the yield curve has inverted, the stock market gets edgy.

What's worse, the economy either contracts or slows considerably.

********************

Either a recession or a slowdown of the US economy now look inevitable. The latter much more than the former.

Of course, if that truck were to be carrying a load of explosives we might be in for even more trouble!

(English translation: the US economy is now more vulnerable to a recession following a terrorist attack than at any time since 2001).

Breaking news

2006-01-03T13:48:00.000-08:00

It could have been so beautiful.

24-hour news: there whenever you needed it.

News on Demand.

The concept seems so old now. And tired.

News is broken.

It's time to fix it.

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Humans have an insatiable appetite for news (especially bad news).

We read a newspaper everyday. Why?

To learn more about the world around us.

We want to learn about the world us.

We expect news every day.

Bad news: there isn't news every day!

Hold the presses, please!

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Can you imagine a day when there isn't any news?

How would you know?

You wouldn't.

News can be whatever news companies want it to be.

Whatever sells is news. And we buy it, every single day.

This is wrong. This will stop.

When?

When we stop buying news.

If you are paying for the news you receive it's like adding fuel to the fire.

The more money you pay to receive the news the more money news organisations receive to produce more news!

Thanks to all the 24-hour news that's been shoved down our throats over the years we've learnt the difference between information we need to know and news.

In a true "Information Age", we choose what news we want to read. And we don't pay anyone for it. (e.g. Google News).

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When we look back on changes they make sense.

It's even more interesting to look at those changes while they're taking place (hint: this can be a great way to make a lot of money).

The past few years has seen news broken and bridges gapped.

The bridge is between ignorance and knowledge.

Thanks to 24-hour news, we know so much more about the world around us.

This education has been the raison dêtre of 24-hours news. For that we are thankful.

But it's come at a price.

Now that it's served it's purpose, 24-hour news can stop and we, the masses, can move on to the next stage of enlightenment...

Who is the 'US consumer'?

2005-11-08T08:42:00.000-08:00

A lot of talk these days focuses around valiant US consumers (USC's).

These non-mythical creatures are supposedly helping to fuel world economic growth.

But who are they? What are they?

They're wealthy.

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You might think you've seen a USC walking around the streets of America.

But a lot of these people look quite poor; surely they aren't the USC's you read about...

They aren't.

They're poor.

The USC's you've heard about are probably doing their shopping from home, on the internet.

Sharing the American pie

The fact is over two-thirds of the US population is doing quite nicely.

They probably have a good job and live in a nice home.

In the past these USC's have caved in to the pressures of standing to lose both.

These days they only have to worry about one of those problems, if at all.

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Unusually low real interest rates in the US over the past few years (see next piece) have put USC's minds at rest.

They can sleep easily in their beds and shop happily on their computers.

The Federal Reserve has been studying these USC's for a while now and knows exactly what they need to do in order to save them from extinction.

Spending begins at home

The chart above shows US home prices over the past 50 years. The shaded ares are recessions.

For the first time over that period home prices have continued to grow while the economy shrank.

Why?

Negative real interest rates.

People have been able to borrow money at such a low rate of interest that makes it look like a sure bet.

While there's no free lunch, the bill doesn't necessarily have to come at the end of the meal.

The cost of buying a home isn't fully realized until it's finally paid off.

This depends on what happens to interest rates.

At the moment interest rates are still low and look likely to remain so.

**************************

Gradually rising interest rates won't hurt USC's.

Rapidly rising rates will.

The Fed knows this.

It will do everything in it's power to prevent it from shooting itself and USC's in the foot.

Go USC!

Follow the money: part 2

2005-10-11T13:11:00.000-07:00

15 months ago, I explained why the Japanese economy wasn't worth getting excited about.

For the same reasons, it still isn't.

However, given Japan's recent upturn, it may be tempting to at least start getting excited.

This week, The Economist succumbed to just that temptation.

Just like the magazine, I didn't buy it.

Did you?

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One key piece of economic data that I look to for any sign of confidence in an economy is its money supply (the first column on the left shows the growth rate tending lower in 2005).

This represents the blood flowing through the veins.

If it doesn't circulate well, there's something wrong.

Judging by Japan's money supply, there's still something wrong with their economy.

Really?

It's only when Japanese individuals and companies are ready to use money, intead of putting it away for a rainy day, that brighter days will come.

Unfortunately, this is a self-fulfilling prophecy: the less confidence Japanese have in their economy, the worse it will continue to perform.

************************************

The recent strategy of Japan's central bank has been much like its over-prescribing doctors: pumping the patient (economy) with excessive amounts of drugs (liquidity).

While Japan has been drugged up with money, China has raced ahead and now poses a greater threat than ever.

Japanese firms are right to be cautious about investing their money. Only when that money gets put to use will Japan be ready to take on China, Korea and the rest of the world.

Until then, the light at the end of the tunnel will remain the headlights of China and others heading straight for it.

Why economists shouldn't forecast

2005-09-21T15:29:00.000-07:00

Hindsight provides an opportunity to learn from our mistakes.

Ideally, we learn enough about our mistakes never to repeat them again.

Economists who make forecasts disagree: The past is in the past. The future is different and uncertain. It's hard to disagree with that. After all, economists know what they're doing, right?

Not quite.

***********************

Over a year ago I wrote about the assumptions economists need to make. The International Monetary Fund has just published its World Economic Outlook, with it's regular section on assumptions (pdf, p.viii).

In 2004, the IMF made the following assumptions about oil prices:

"... the average price of oil will be $30.00 a barrel in 2004 and $27.00 a barrel in 2005, and remain unchanged in real terms over the medium term." (viii)

These levels were clearly way off course, as were their forecasts for economic growth.

In 2005, they now assume the following for crude oil prices:

"... the average price of oil will be $54.23 a barrel in 2005 and $61.75 a barrel in 2006 (viii)

Naturally, these forecasts are wrong as are their forecasts for economic growth.

***********************

The moral of this story?

(1) Always consider the assumptions behind an economist's forecast;
(2) Never trust an economist's forecast;
(3) Economists shouldn't make forecasts.

and

(4) Your forecast is as good as an economist's!

A real dilemma

2005-09-18T12:19:00.000-07:00

If you're one of those people who expects the U.S. Federal Reserve to stop raising interest rates next week then you probably don't look at enough charts.

If you were to look at the charts the Fed looks at then you would understand why to stop raising interest rates now would defeat the purpose of the past 12 months of rate hikes.

One piece of data the Fed takes very seriously is the real interest rate; the interest earned on overnight deposits after taking account of inflation (i.e. higher inflation means lower real interest).

Going up

What the chart shows is that real interest rates are currently zero. Putting $1 in your bank account today will earn no interest in real terms. Your dollar today buys you less tomorrow. That's not going to help anyone, including those who survived the hurricane.

What the Fed is aiming towards is a neutral real interest rate. Judging from the past that means we should expect at least another 2% of interest rate hikes by the Fed (measured, not stirred).

****************

Nothing can stand in the way of the Fed on a mission, not even a hurricane. When the time is right, interest rates will stop going higher. If history is anything to go by, that usually means they're ready to head in the opposite direction.

Conundrum is Greenspan's legacy

2005-08-07T00:16:00.000-07:00

Ben Bernanke sure has his work cut out for him.

Once he replaces Alan Greenspan next year, it's uphill all the way. Or should I say downhill...

Until now the U.S. Federal Reserve has been raising interest rates in an attempt to regain 'neutral' ground.

Near-zero interest rates were a recipe for disaster (i.e. Japan) so there was only one way interest could go.

Unfortunately, they haven't gone there quick enough.

**********************

Under Alan Greenspan's tentative guidance, the Fed looks like a driver lost in the dark. It knows it has somewhere to go, but it doesn't know exactly how to get there. So it takes it one small step at a time.

One problem with this is the ferrari behind (the bond market) is in a hurry to get where it wants to go!

The Fed is supposed to act as the "guiding light" for the bond market, dictating the future trend of interest rates.

Lately, the Fed has been a poor guide; the ferrari is ready to go it alone.

**********************

It's important not to forget how far the Fed has come.

As U.S. politicians continuously remind the public, interest rates are still at a 40-year low. And they got there pretty fast.

The black line indicates the Federal Reserve's overnight interest rate. The red bars are the interest rates on 10-year Treasuries. The Fed sure seemed to know where it was going 2 years ago!

When the Fed set out in a new direction at the end of 2004, the reasons weren't clearly laid out. The only clear fact was that interest rates were too low. The light, it assured the market, was at the end of the tunnel.

The ferrari didn't buy it.

Over the past year the Fed has lost credibility with the public and with the market (something that can only be earned through transparency , a point I made before the Fed started raising interest rates).

The market continues to buy bonds and the public continues to borrow money and purchase homes. The Fed should take a lot of credit for this (no pun intended).

**********************

When Alan Greenspan labelled the continuted fall in bond market yields this year a conundrum, it was like a driver scambling to find his current place on the map.

Unfortunately, it's too late for him to do anything about it, other than just vent.

With Bernanke at the wheel, the Fed may regain some credibility with the market and perhaps start leading the way.

Do you feel safe yet?

2005-07-07T18:46:00.000-07:00

It takes a human tragedy to make people realize just how vulnerable they are.

It takes a human tragedy for elected officials to reveal to the public this vulnerability.

New York Mayor, Mike Bloomberg, explained this morning how security measures have been "stepped up" in the subways, on the railways and at the ports in response to the bombings in London.

It doesn't seem the safest way to proceed if, in reaction to an attack that had no warning, that temporary measures are taken, aimed at improving national security. Surely we should have been at this state of preparedness all along?

This raises the question of just how prepared are we for another terrorist attack.

The answer is, it depends on what our elected officials are doing about it!

Today's tragedy helped to reveal just how vulnerable we are, thanks to the insufficient measures being taken by the people we elected for exactly that purpose!

** Afterthought **

I'm not the only one who lacks faith in the government's ability to prevent another terrorist attack. It's the stock market too. The U.S. stock market, and hence the global stock market, has learnt to live with the fact that another attack is coming and it won't be prevented, just reacted to.

Alan Greenspan raised interest rates today. Did you notice?

2005-04-21T09:21:00.000-07:00

Talk is cheap, right?

Not when the chairman of the Federal Reserve is talking.

If he's concerned then financial markets are concerned.

If markets are concerned, then you pay the price.

What did I say?

This morning, Alan Greenspan told congress:

"The federal budget is on an unsustainable path, in which large deficits result in rising interest rates."

So, "unless major deficit-reducing actions are taken" interest rates are more likely to go up than down.

Investors got nervous, thinking this might actually signal higher interest rates (since the person talking sets the target for the overnight interest rate). They sold bonds, pushing yields higher.

As I have discussed before the bond market is what essentially sets mortgage rates. If bond yields go up then your mortgage bill goes higher too.

****************************

It's important to remember that for policymakers, words are just as important as actions. Anything they say can be taken to imply something they may do.

Markets are always thinking about the future.

If you think like the market thinks, you can avoid getting hurt by it every single day.

It's the stupid Economy!

2005-04-09T21:30:00.000-07:00

It's very easy to criticize other people.

It's extremely easy to criticize economists.

These dismal scientists are given the thankless task by government to solve problems for which there are a number of different solutions, each with different costs associated with them.

Every solution will come with a cost.

No pain, no gain.

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Some economists including, Friedrich August von Hayek , believe that government is the problem.

This is a very convincing argument given the history of evidence stacked against government policies over the recent past.

It seems as if every time the government tries to fix a problem they create another, larger problem in the process.

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Of course, different views on any subject represent different parts of the political spectrum, so none will provide the kind of balanced judgement that might convince everyone.

In the current political system, it is only the majority of the voting public that needs to be convinced (every 4 years) in order to choose between (usually 2) competing (and often extreme) alternatives.

The dollar's drop cometh

2005-03-22T14:34:00.000-08:00

Every day we move a step closer to a dramatic fall in the value of the U.S. dollar.

The pull of gravity is getting stronger by the day.

Until now this pull has been mitigated by a number of forces working in the opposite direction. Unfortunately they cannot hold out for much longer.

There are three major forces waiting to take hold (in increasing order of likelihood):

1. The effects of U.S. statements in favor of a weaker dollar.
2. Reduced dollar holdings by U.S. and international investors.
3. A continually growing U.S. trade deficit.

************************

A record trade deficit is a symptom of a problem that has no solution.

You won't hear the U.S. government say:

"To cut the trade deficit, we are going to..."

A weaker dollar is supposed to help reduce the U.S. trade deficit by making exports cheaper.

Unfortunately, this doesn't get to the cause of the problem: the U.S. imports more than it exports.

It's understandable why the U.S. imports so much.

I often think to myself, as I wonder through a one-dollar-shop, how this is what it felt like 50 years ago. I can buy clothes and groceries using dollar bills and still have change left for the bus ride home (which now costs 3 dollars...).

Of course every country in the world is under the spell of cheap Chinese imports.

However, only the U.S. represents 250 million consumers that use greenbacks to purchase all these goodies.

************************

One thing you do hear the U.S. government say is:

"China needs to revalue it's currency."

A stronger Chinese currency would of course make Chinese imports more expensive. However, the U.S won't say that this will help reduce the trade deficit.

A deficit is not caused or solved by the value of a currency.

If anything it's the other way around: a weaker currency is the result of a weaker economy that imports less.

************************

So, what can you do?

Well, the first thing is insure against a further (and no doubt faster) drop in the dollar.

If you hold dollars, move into something else. You have two realistic options: the Swiss Franc (commonly considered a safe haven) or the British Pound.

Of course, if you live in the U.S., you could stop buying Chinese imports or imports in general. If this doesn't appeal or seems downright impossible then you will understand why the dollar can only go in one direction and you should act accordingly.

Behind the Times

2005-03-14T15:30:00.000-08:00

People who sit behind a Times on their way to work are stuck in the past and stuck in their ways.

This is not good for them. But they do it anyway. Why?

Human nature is consistent with people choosing not just an inferior product but one that also costs more than the better alternative.

Perhaps people are paying for the convenience. After all, time is more precious than money. This would explain why fast food has always remained popular despite being so unhealthy. (No coinicidence then that in England, fish and chips are traditionally wrapped in a newspaper, since both are bad for you in different ways!)

So consumers, while driven by their own self interest, do not always act in their best interest.

*******************

Newspapers are moving to publish in electronic form only. Once that process is complete, it will be tomorrow's news, not yesterday's, that we are going to have to pay for, whether we want to or not.

Once people become more informed about the world around them the better that world will be.

I guess this was one cheer for the free market...!

How's the service? Terrible?

2005-02-28T19:56:00.000-08:00

Service is bad at the best of times. Bad news: it's about to get much much worse. Why?

The internet.

The internet is migrating all of the services we once had to travel somewhere to use. You want to buy clothes? No need to ask you helpful sales assistant about their latest special offers. Just point and click.

But what becomes of the helpful sales assistant? Well, the first thing is, they become a whole lot less helpful. They get trained less and, worse, less motivated to compete with their dot.com colleague.

***********************

While human sales assistants are a dying breed, it's the services industry that has been the main driver of economic growth for a large number of the major advanced economies in recent decades.

If a significant (and in recent years, growing) part of the workforce that lies behind a growing economy deteriorates on a mass scale then it signals a major deterioration in a large proportion of the labor force.

Ultimately, it will be the frustration of shoppers in department stores and people on line in Starbucks that will accelerate the complete migration of shoppers from the high street to the internet.

***********************

As with all social change, a lot of the change can only be brought about by social forces moving in the direction of that change. The ever-more sloppy sales assistant may well be the last straw.

Or they could just stand up straight, look fast and pretend to be professional!

**Afterthought**

All of this clearly begs the question, what becomes of all these sales people? This also raises the issue of what to do with all space currently taken by retail outlets.

One possible scenario would be for these buildings to become residential. This would help provide homes where they are most needed: in the inner cities. This might help initiate a new industrial architectural revolution. Such a revolution would resuscitate the manufacturing industry, bringing full circle the changes seen in the 20th century.

Perhaps the hands that serve us in the stores will be those helping to build the homes of the future in the not-too-distant future.

Goodbye Greenspan, hello inflation target?

2005-02-17T20:22:00.000-08:00

In June last year, I explained why the bond market was important.

I'm back to explain why again and also predict what will happen to U.S. interest rates after Alan Greenspan retires from the best job on earth.

********************

In case you hadn't already noticed it's daily movements in the bond market that actually determine the mortgage rates your bank offers you on a daily basis.

If you don't believe me, look at the chart below that shows the 10-year government bond yield (set by the bond market every day) against the 30-year mortgage rate (set by the banks every day).

(Red: 30-year mortgage rate. White: 10-year bond yield)

Most people might think it's the central bank who directly (or even indirectly) set mortgage rates, with retail banks following suit. This isn't how it works.

Firstly, central banks only change interest rates on a monthly basis, if at all. However, banks change the rates they offer to lenders all the time. You might wonder how they can do this if the central bank hasn't changed the "interest rate".

The reason is simple: banks settle their books at the end of every working day by borrowing money at a rate of interest that is being set by the bond market. The bond market sets the interest rate according to expectations of future inflation.

If inflation is expected to increase then interest rates will have to rise in order to compensate bondholders who will see the value of their investment fall in real terms.

********************

As I also mentioned before, the past 2 decades has seen a major crackdown on inflation. This has meant lower interest rates across many countries.

The U.S. is one of the few countries that does not directly target the inflation rate, simply because the person in charge of monetary policy does not want to use a target.

Since Alan Greenspan is expected to leave his post in the near future this raises the possibility that the Federal Reserve will adopt an inflation target as well. This will be very good news for the bond market and more importantly, great news for mortgage holders.

An inflation target means the bond market expects low inflation. Low inflation expectations means low bond market yields. Low bond market yields means low overnight interest rates and this means low mortgage rates.

3 cheers for Alan Greenspan. More cheers for the inflation target!

Tax rant cont.

2005-02-11T10:19:00.000-08:00

Three things are certain: death, taxes and more taxes.

The closer you get to death the more in taxes you are going to pay.

As I outlined before, if your income doubles you are going to pay about double the amount of tax.

This is the society's definition of fair since taxes act to redistribute money from one group of society to another; i.e. from the rich to the poor.

*********************

As I also outlined before, America has a major problem with saving. The government and the citizens it represents don't like doing it.

If an individual is short of savings they go to a bank to borrow money.

The government goes to the public, by way of taxation. The more money the government needs, the higher taxes go.

The problem facing the U.S. government is an increasing need to fund expenditure by way of taxation. This means taxes will need to rise further.

*********************

A commonly heard argument is that people with higher incomes (let's call them 'companies') should be taxed more than those with lower incomes.

This is considered a fairer way to raise the extra money the government needs.

However, since it's companies that hire people on lower incomes, then taxing the rich indirectly taxes the poor.

A company that loses a higher share of it's income to the government will have less left over to hire more people.

You can only go to the well so many times before it eventually runs dry.

*********************

The economy runs in a circle: companies make things, people work for companies, people spend money on things companies make.

If one part of this cycle is taxed more than another then it takes away from all other parts as well.

If the government needs to raise more money by increasing taxes it does not benefit any part of society by focusing those increases on certain groups.

**Afterthought**

In light of the comments to this blog, perhpas this is the best 3D representation of how wealth is distributed amongst various groupings of the economy..

The trouble with jdate

2005-01-11T13:36:00.000-08:00

These days one Jew isn't expected to marry another.

This is a freedom of choice past generations never had.

However, like most freedoms it isn't one most people today have had to earn. It's the result of years of struggle between parents and children at a time of social change.

Consequently, when one Jew enters into a relationship with another it carries with it a sense of being something special.

**************************

JDate gives Jews the 'freedom' to choose from thousands of available people who share the same religion.

It makes it easier for Jewish people to enter into a relationship with one other.

The fact that both people are Jewish can even help sustain the relationship; it can start to feel like eating chocolate without gaining the pounds.

However, this heightened sense attraction to each another can turn out to be illusory:

"What did I ever see in him?"
"He was Jewish?"
"Oh, yeah."

**************************

Meeting the right person doesn't always have to be an impossible task. But by making it easier to start a relationship with someone on the basis that they share the same religion is a very sandy beach on which to build the family home.

Too often the relationship will escalate too quickly and then everything comes tumbling down.

Dollar may keep falling, reality says

2004-12-23T17:40:00.000-08:00

Two facts explain why the dollar will keep falling for another generation at least.

Americans don't like saving. Japanese like saving.

This is cultural. This won't change.

If anything, this cultural gap will widen over the next 50 years as the Japanese population ages terribly and becomes even more thrifty.

But what does American indulgence have to do with the dollar?

A currency is like a reality check. It's one of the few things the government can't influence directly (unless they do something to influnce it directly).

Every time Americans swipe their credit cards at the cashier they're chipping away at their nation's credibility with overseas investors.

The only way to make up the monthly payments is to attract foreign money and this attraction rises when the dollar becomes cheaper.

And so the market bids down the dollar, every day.

********************************

The dollar should only weaken as a last resort. After all, it's the currency most people use around the world to facilitate transactions and a weaker dollar is reducing the incomes of people around the world.

This is bad for the world, by the way.

There is no feasible solution to the problem other than to impose upon Americans the idea that by spending more than they earn will hurt them, their friends, family and future generations.

The odd frown shown upon those who spend too much would be a cracking start...

You've seen one bubble...

2004-12-09T11:57:00.000-08:00

Two months ago I predicted that oil prices would eventually drop. It turns out I was right... for the wrong reason.

I thought that a recession in the U.S. economy would be the cause of slowing demand and falling oil prices.

It turns out that a speculative rise in prices was cut short by speculation that prices wouldn't rise any more.

Another bubble bites the dust.

************

Everyone touts the benefits of a free market without truly understanding the consequences of what they endorse.

They emphasise the positives without weighing them with all the possible negatives.

Quite often negatives are not actually seen as negatives.

Bubbles in stock prices, home prices or any prices are seen as a way of letting the market breathe.

Until greed is permanently eliminated from the English language, too much freedom will always be a very dangerous thing.

Why Kerry won't win

2004-10-29T13:08:00.000-07:00

Polls are quite useless, but they're not completely useless.

The most useful message they provide is one of voter apathy.

In large, this isn't apathy towards George W. Bush, but towards John Kerry.

After all, Kerry is the one who has the mountain to climb. He's the one trying to dislodge the incumbent.

If there were even the slightest indication that Kerry were about to become the next U.S. president, you would expect the polls to have caught some whiff of it. They haven't.

What the polls are telling us is that a lot of people do not see John Kerry as someone for whom it's worth taking an hour out of their working day to go and vote. (Note: why does this election have to fall on a Tuesday? When an election is this close it makes sense for the largest number of potential voters to have the chance to go and cast their vote.)

********************

Politicians thrive on momentum.

John Kerry needs more time to build enough momentum to win.

For John Kerry time is running out.

Only a miracle can save him now...

Oil & the bigger picture

2004-10-12T05:09:00.000-07:00

In case you were wondering, oil prices will stop rising... eventually.

Now more than ever it's looking like only one thing can stop this uncontrollable rally.

A recession in the U.S. economy.

While this is not likely to happen soon, it will become an ever-growing reality by early 2005.

A global economic slowdown has been in the works since the start of 2004.

Rising oil prices will likely be the last straw.

*******************************

The idea of a confluence of factors giving rise to the recent surge in oil prices is a very worryng predicament.

You would think the world has managed to figure out how to prevent oil prices from rising too rapidly.

It hasn't.

It seems we're just as vulnerable now as we were 10 or even 30 years ago.

Good intentions

2004-09-26T15:25:00.000-07:00

When religious leaders speak passionately about something their very show of emotion is sometimes enough to prompt a reaction by those listening.

The Rabbi's Yom Kippur sermon got me thinking.

He got me considering doing things I hadn't thought of doing before; such as attending a protest march in the street.

What I realized is that he got me thinking of doing things I neither wanted to do nor had ever thought of doing before.

This concerned me.

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While someone living a comfortable life has no strong incentive to correct the inequalites of the world, someone who is far less well off is very easy to convince of the need to take some form of 'action'.

What shape and form this action might take is left up to listeners.

Sitting in a New York church, I wasn't amongst a crowd of people likely to engage in any form of violence protest.

However, if transplanted into the Middle East or any other place where violence and poverty are far more widespread, I might expect a different response.

In a region where religion and religious beliefs are enbedded in everyday life, religious leaders have far more reponsibility.

This means they need a game-plan. If they don't then their good intentions could result in an even more violent world.

Addicted to debt

2004-09-07T13:01:00.000-07:00

Everybody has something they are prone to liking too much for their own good.

For the government, debt falls very neatly into this category. Given the opportunity they just can't get enough of it.

For people in power only a short period of time, going deeper into debt is a win-win situation. The more they spend, the more popular they get, at the expense of people they aren't accountable to.

But all is not lost, right? The U.S. economy will grow faster, making the government finances healthier?

Wrong. For two big reasons: the war on terror and baby boombers.

These are two problems that can't be fixed and have huge costs associated with them.

Add to that modest economic growth not capable of generating the types of tax revenues enjoyed in past upturns and you get a very nasty surprise ahead.

************************

At the moment we are enjoying low interest rates, mainly because of low inflation. However, this has only made it easier for the government to get it's fix of debt without anyone noticing.

Until now.

Record government deficits have made headline news but they're still not that interesting to most people. That's mainly because it doesn't affect the majority of us.

This is going to change, fast.

The first thing we are going to notice is that the government's huge borrowing requirment isn't going to go away as quickly as it did in the past.

Then we are going to notice higher taxes and this is going to make things a lot worse.

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You know things have gotten really bad when the government starts raising taxes. It's something they are loath to do and usually end up regretting (i.e. they get the boot, first chance people get).

This is going to happen in the very near future. When it does people are going to blame the government and they should. Only thing is, it's not the present leaders they should pin the blame on but those from the past.

** Afterthought **

An absurd moment at today's testimony by Fed Chairman Alan Greenspan to the U.S. Senate had certain politicians lauding "His Excellency" for bringing with him the solutions to all the future debt problems: Pay as You Go.

This scheme, whereby the working population funds the retirement costs for the present elderly, is a very leaky boat.

The debate is a debate and not a problem with a unique solution. There are a number of solutions to the problem.

The first unambiguously positive step is to get people more active and eduacated about investing. Once people understand that they are responsible for their future wealth they can go ahead and ensure they have enough of it.

Rising oil prices give central bankers a lift

2004-08-23T18:12:00.000-07:00

While many of us look on in despair at the rising price of oil, Alan Greenspan and his friends are enjoying every minute.

Why?

Because rising oil prices are doing the job most central banks need to do but resent doing: raise interest rates and damp rising demand.

The dilemma for most central banks is how to achieve price stability while not jeopardizing economic growth. This is not an easy task and more often than not entails sacrificing one for the other, making central banks very unpopular when the situation gets nasty.

In the past year central banks around the world have been on tightening mode. Global economic growth was getting to the point where it might generate more inflation than necessary. Things needed to be kept under control. So central banks, armed with their interest rates, starting raising.

Higher interest rates always make central banks unpopular. After all, most people need to borrow money to buy a home, a car or whatever. Savers always look to alternative means of outperforming the saving rates a bank offers, so they aren't going to complain too much either way so long as the stock market is given a chance to provide them with a decent return.

The issue for central banks is how to keep everyone happy. How to make everyone better off.

The rising price of oil is a convenient scapegoat for everyone and this includes the central banks.

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It's important to remember that rising oil prices are not the same as rising inflation.

Accelerating inflation usually happens when the economy is growing out of control, not when oil prices rise (the 1970's was an exception to this rule).

Global inflation picked up in the past year, making central banks nervous.

Rising oil prices have come just at the right time. Why?

Higher oil prices will help cool demand and keep the economy from generating too much inflation.

It's easy to forget that a large part of the reason why oil prices have risen this far is because of increased demand from China, not to mention the summer driving season in the U.S.

Higher fuel costs will act to correct the pickup in demand, without causing central banks to break a sweat.

**********************

We don't live in the 1970's anymore.

We are't experiencing the type of oil price shock that will tip the global economy into recession.

What we are seeing, however, is a convenient way for central banks to get out of doing their least favorite job: raising interest rates.

Investing 301

2004-08-14T20:36:00.000-07:00

Investors are getting smarter.

They're still pretty stupid, but they're getting smarter nonetheless.

There used to be a time when investors would lose money when stock prices fell. That doesn't always happen now.

Some investors still complain about the low value of the stock market.

That's because their methods of investing haven't changed in decades. They need to catch up or forever lack the wealth they need to survive into old age.

Some people never get the chance to learn about how to invest and that's a shame. It's a shame because they will live their lives without job security and a sufficiently large pension.

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Investing isn't just about the stock market.

Investing is about stocks, bonds and currencies (in ascending order of importance). When you invest in the stock market you need to be aware of what's happening in the other two since all three interact with each other on a daily basis.

Investing is about the future and being able to correctly predict where all of these prices are going to go.

The majority of investors hope prices will move in one direction, and that's up.

Unfortuntaely for them, prices also go down.

The way around this is to trade derivatives.

The derivatives market started in the 1970's, became big in the 1980's, got even bigger in the 1990's and keeps getting bigger. So what's it all about?

Essentially, trading in derivatives allows you to benefit when prices rise or fall.

Not everyone expects prices to move in the same direction.

If you expect the price of apples to fall you would want to agree to sell apples to someone at a certain point in the future at today's price. If that person expects the price of apples to remain the same as today or to go higher then they will happily enter this agreement with you.

Of course you don't need to trade with someone else directly. You can sit at home at trade on the web.

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Investors today understand the importance of reading the financial press to understand when is the right time to buy and sell stocks.

If they broadened their knowledge of how the financial markets work they can avoid getting burned when stock prices (inevitably) fall.

One way to be wise of events on the horizon is to monitor leading indicators! But that lesson is for another day...

The writing on the wall

2004-07-29T18:30:00.000-07:00

People write a lot of things on the walls of a public lavatory. Some consider this to be vandalism. To me it's occasionally a source of inspiration.

This morning, while in a sedentary position at our office's facilities, I came across the following message:

Think about the future

I'm not sure what the person was thinking when they wrote it, but it got me thinking about a lot of things.

Firstly, how often we think about our future really depends on our age.

If you're in your 20's you probably don't think too much about your future; you're too busy spending money to worry about not having enough of it once you get older.

If you're in your 30's you're probably thinking about nothing but your future; who you're going to be with and how much money you're going to need.

Once you're in your 40's what you do tomorrow is as important as what you're doing today.

In your 50's the future is now.

In your 60's the past has caught up with you.

Above 70 and you're enjoying the moment like you were 21 again.

You're probably going to live a very long life; at least until you're 70, hopefully longer.

You don't know exactly when you're going to die and that's a problem.

It's a problem because you don't know how much you're going to need to see you through. Given this dilemma people tend to overcompensate and put a 'little extra' away. How much extra is determined a great deal by your culture.

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After reading the message on the wall I also though about how much we should be thinking about the future.

Should we always be thinking about the future? Probably not.

Should we never think about the future? Not unless you're over 70.

What if we don't think about the future enough? What then?

I know I don't think about the future as much as I should. But how do I know that? When is it enough?

I fear that it will never be enough. It's hard enough to manage my life right now, let alone my future as well.

***************************

My future is becoming increasingly important as each day passes and so the less I think about the future each day the more costly it's becoming.

I should probably do something about it. Maybe tomorrow...

Tax rant

2004-07-27T06:06:00.000-07:00

A quick back of the envelope calculation:

-- A single person earning $110,000 loses about $27,000 to taxes.
-- A single person earning $52,000 loses about $10,000 to taxes.

-- A couple earning a combined $185,000 lose about $47,000 to taxes.
-- A couple earning a combined $130,000 lose about $30,000 to taxes.

-- Anyone earning above $288,350 loses 38.6% of each dollar to taxes.

Do these numbers make sense? Do you see a problem here?

John Kerry does. Why?

The thrust of his argument goes something like this:

"The U.S. economy is being undermined by a rising budget deficit, the prospect of ballooning interest rates, unfairly high taxes on the poor and unfairly low taxes on the rich."

His solution: tax the rich more and tax the poor less. Put the proceeds into public healthcare and education. There will be plenty to go around. Share the wealth!

Firstly, why is the budget deficit rising? Didn't Clinton sign a balanced budget not long ago?

The point here is that in 2001 the economy went into a tailspin for the first time since Clinton was in power. The stock market lost a lot of ground and the 9/11 terrorist attack left investors gob-smacked. Is it any wonder why the fundamentals of the U.S. economy are so out of sync?

What is easy to forget is that when an economy is performing badly the government is the first to suffer. The less people earn, the less they spend and the less the government receives in tax revenues. The upshot is a rising budget deficit. The government is borrowing to cover it's spending commitments; commitments made when the economy was doing a lot better than it is now.

The irony of all this is that the economy is being run by people who remain in office for a short period of time. This is usually part of the problem, not the solution. What we have now is a situation where things look bad and will probably get better. They will get better irrespective of who is in power. Anyone who thinks otherwise is kidding themselves.

The only lasting difference those in power can make is in the distribution of income. Some might say this is government getting in the way. Others might say it's the government righting wrongs. The truth of the matter is, as always, somewhere in between.

**********************

What is crucial is that government not intefere excessively.

What I see when I look at the calculations above is a situation where a moderate redistribution of wealth is taking place already.

Financial market truisms

2004-07-21T18:45:00.000-07:00

On average, the following are true (corrolory in italics):

Stock prices move up and down for all the wrong reasons.
You can't anticipate the reason why a stock price will move next.

With currencies, all you know is what just happened.
You can't predict the direction in which a currency will move next.

Bonds and stocks are being traded by the same dumb people.
All traders are not as smart as they should be.

Tomorrow's news is today's news.
Don't trade on news you read in the printed press.

Taking risk is inevitable.
Don't expect to see your initial investment again.

Time is the hardest thing to buy.
Use all of the time you have to your advantage.

The only information that matters is private.
Don't trade on something you read about in the public domain.

Always confirm what your instincts tell you, never trust them.
Think, then act!

Read all the news, even the made-up stuff.
Be aware of what everyone else knows.

Don't do the same thing you did yesterday.
Avoid making systematic errors.

Vote for Blog!!

2004-07-19T17:39:00.000-07:00

I'm going to try and make this point as concisely as I can. It's a point I think needs to be made and it's a point that might seem obvious once it's been made.

My point is this: we no longer need a single political leader to run our country. In fact, we no longer need politicians. We can govern ourselves. How?

We will be (self-)run by Bloggers. The collection of thoughts and writings of people around the world will help shape the society in which we live.

Blogs will be organized into specialized communities. Each community will comprise individuals who specialize in a particular field. They will decide and vote on laws. The debate and the final vote will rest on each seperate individual, not on individuals who represent the interests of others.

What I'm trying to say is this: it's become easier for us to go online and be involved in a debate that we will finally vote on than have someone do it for us. This gives us a far greater incentive to get involved in the debate than to just sit on the sidelines and let others decide for us. Apathy is not an option.

Doctors, teachers, police will all be organized by experts in their field. Changes to the way they are run can be debated and decided upon by an all-inclusive discussion and final vote.

**************************

There needn't be a reluctant choice for President, Prime Minister or Mayor. They are someone who we don't entirely trust.

We are capable of running our own society, determining our own future. This is something that most people are willing to work towards.

Change is now really possible.

Imaginary trivia about Wesley Fogel, successful Hollywood actor

2004-07-10T20:02:00.000-07:00

Married to Marisa Tomei, 13 years his senior. They don't have any children.

His birthday is on December 8th.

Likes to go scuba diving in the pacific.

Bought the basketball court on University Plaza and 10th street in Manhattan.

Has apartments in London, Tokyo and New York.

Is afraid of heights.

Only buys champagne that costs at least $1,000 a bottle.

Doesn't like going to parties.

Invited Steven Spielberg to his apartment in Tokyo to talk about making a movie there.

Always wakes at 7am in the morning.

Wants to fly to the moon one day.

Lacks any strong religious beliefs.

Works out 2 hours a day in the gym.

Always eats at the same restaurant when he's in Tokyo. It's called 'Qahwa'

Has had corrective laser surgery three times.

Never had plastic surgery.

Has his teeth whitened once a month.

His favorite color is magenta.

Doesn't like dogs. Loves cats. He has no pets.

His best friend is Brad Pitt.

Buys all his shoes from Prada.

Follow the money

2004-07-08T18:51:00.000-07:00

"Don't get too excited about the Japanese economy just yet."

Who said that?

Was it you? A billionaire investor? The government??

None of the above.

It was... the money supply (the red line).

"What's that??"

Who said that? Was that you? I thought so...

*************************************

The money supply is the blood pumping through the veins; the lifeblood of the economy. Without good blood circulation the body withers and dies.

Japan's economy has been suffering from bad circulation for a while now. Money isn't working it's way through the system as it's supposed to. Much of this is down to structural problems; banks have been so heavily indebted that paying off their dues has distracted them from getting on with what they do best: making money.

How does a bank make money?

Easy. It creates loans or 'promises.' The more that people promise to pay back the bank in the future the more money that is being spent today. That's how money is created, literally out of thin air.

*************************************

The trouble with Japan has been a lack of confidence. People don't have the confidence to go up to the bank and say "gimme as much as I can carry and I will be back this time next year with that and more, much more." Instead, they shy away from the risk, choosing to hide what they have under the pillow.

This won't do.

The Bank of Japan can only do so much to help. Much like a drip being applied to a patient, it's not enough to get the body on it's feet again. It requires not just other methods of treatment but also belief on the part of the patient that a recovery is truly on the way.

I'm optimistic but not yet convinced.

Look at the growth of the money supply again. When it takes off you'll know the patient will have found it's feet again.

** Afterthought **

If you were to compare with a chart for the United States you will see an example of a much healthier economy. This patient is well on the road to recovery. All of the cheap money the Fed has been supplying the U.S. economy is finally being used for the purpose it was originally intended: the creation and circulation of more money. Long may this blood lust last!

A pointless exercise in money-making

2004-07-06T17:03:00.000-07:00

If this were a financial market report you would probably stop believing everything that's being said right about now, since at this point the story is supposed to give a reason for why the market is moving in a particular direction.

I use the present continuous form 'moving' since market reports are written during active trading.

Markets trade continuously. When one market closes another opens. The money never stops flowing. Neither does information. But information can lose it's value as quickly as it was gained. The person who finds the information first can make money from it. Other traders are left guessing and sometimes their instincts can be as reliable as the information itself.

So where does the journalist fit into all of this?

A journalist is supposed to report the facts. These facts are supposed to help explain why prices rise and fall. Better still, they may help to explain why prices may rise or fall in the future. But prices move on information. Where is this information coming from?

Remember, a journalist is not supposed to trade. They must remain neutral observers to the market. This means they won't have ready access to the type of information market participants do. So how can someone who is not in the market know what's moving the market? They ask someone who's in the market. This is where the problems start.

Any single individual in the market, no matter their size, will make darn sure not to reveal their information to other traders. Most important of all, THEY DON'T TELL JOURNALISTS! What they do tell journalists is 1) what they want to tell the journalist and 2) what the journalist wants to hear, i.e. something believable. This is why market reports should not be believed and certainly not traded on.

Summer: time for ice-cream

2004-06-15T06:45:00.000-07:00

It's tough to sell ice-cream.

Not only is it a highly competitive market, but you are also competing with the toughest competitor of all: Mother Nature.

Ice-cream sellers are at the mercy of the seasons.

The demand for ice-cream waxes and wanes with the months of the year.

So does the price.

To try and get people to eat ice-cream when they otherwise wouldn't, you need to make it cheaper; everyone has a price.

Market forces can overcome the forces of nature. The poor ice-cream seller, however, is at the mercy of both.

*****************************

To the casual observer, the price of ice-creams might seem to be very predictable. In the summer, prices will rise. In the winter, prices will fall. Not too complicated.

Now take the entire economy and you get a very complicated picture indeed.

Every market is affected by the seasons. Not all of them to the extent of the ice-cream seller, but the seasons play an important role in explaining why prices rise and fall.

It's important for policymakers to distinguish between factors that are seasonal and those which reflect a more fundamental shift in the economy.

*****************************

A lot of emphasis is put on the price of fuel. Anyone who owns a car needs to buy fuel. When more people want to drive in the summer, the price of fuel is going to rise. Like in the case of ice-cream, this is soley due to the fact that temperatures are rising and everyone is hitting the road. Like the demand for ice-cream, this won't last.

When making a decision on interest rates, policymakers need to be able to consider the current strength of the economy compared to any other stage of the business cycle. Seasonal changes should not be allowed to influence this decision.

Like the ice-cream seller in the winter, things can and will improve without the help of anyone else.

The price of ice-cream that doesn't include seasonal variation is the only way to guage the true strength of the market. This applies to the whole economy too.

Inflation is our friend

2004-06-09T14:36:00.000-07:00

Inflation has gotten a lot of bad press lately.

It's as if we would all be better off if it would just go away. Then we wouldn't have to worry about rising interest rates, right?

Wrong.

Looking at the inflation rate of a country is a good way to guage it's economic health.

Assuming a country isn't engaged in war or some other political turmoil, inflation is one of the best ways to know when the economy is strong and when it's weak.

************************

Every economy is capable of producing more each year. At the same time, consumers demand more and more. They always want a newer TV, car or house. This is what causes prices to rise.

Looking at a country like Japan, where prices are falling, you might think people there are enjoying lower prices each year. Unfortunately, they're not.

Much like a sick patient, where the temperature is dropping, Japan's economy is also sick.

The best way to cure the disease and is to get people spending and spending more each year. To get people wanting to spend their income on new and improved products, instead of sticking with the old TV and saving their money for a rainy day.

Japan backs off

2004-06-09T05:45:00.000-07:00

Japan hasn't weakened the yen in April or May. Why?

They haven't needed to. Why?

The market has weakened the yen all by itself. Why?

The answer depends on who you ask.

An investor might say expectations of rising US interest rates make Japanese assets less attractive.

An analysts might say the yen was overbought, and did not reflect economic fundamentals. After all, Japan's economic growth was always expected to slow over the course of the year.

Of course it's a combination of factors that influence the currency market in the short-term, since currencies move up and down (and up again) all in one minute!

The Japanese government says as little as possible, knowing their every word is being watched by everyone in the market, eagerly waiting to know where to next place their bets.

Still, it's comments by government officials that are responsible for the large part of short-term currency market moves. The market makes money on what the government says. That's how it works.

************************

Japan's decision to back away from the currency market means fewer purchases of US assets with the money used to intervene in the market. So far this has not created too much cause for concern.

But markets are always looking for ways to make money. It's a sure bet the Japanese government won't allow the yen to strengthen too far against the dollar. Many traders prepare to benefit from short-selling the yen as Japan prepares to get back in the market.

Let's talk Japanese

2004-06-08T14:19:00.000-07:00

Speaking is the easiest thing to do.

Speaking in a different language can seem the hardest thing in the world.

It really depends on the person; in particular, their application and motivation to learn and use the language.

Some people learn a new language quicker than others. This can come with a stronger motivation to learn the language or a better ability to apply the language to their way of life.

In any case, the more practice the better.

**********************

I've been 'exposed' to the Japanese language for the past 5 years. While I have fallen short in application, my motivation to learn the language has remained strong. It's a fun language to learn. It's more fun to use. It's just harder to use a language than it is to learn.

It never ceases to amaze me how easy it can be to translate a simple sentence from one language to the other but how difficult it can be to do this in a conversation.

When speaking in a different language it's best to listen, think and speak in that language. I often find myself thinking in English, translating this into Japanese and then speaking in Japanese. This makes me look slow and can often disrupt the flow of a conversation. Many kind people have patiently suffered my lacklustre conversations.

Everyone's talking about the Fed

2004-06-07T15:34:00.000-07:00

For many months now anyone and everyone has had an opinion on what the US Federal Reserve will do next and when.

We all talk about it but nobody knows exactly what to expect.

It's possibly the most interesting monetary policy in the world right now and that's a problem. Why?

If investors aren't sure what policymakers have planned for us, they can't make well-informed savings and investment decisions.

While the Fed has come a long way in making it's policy decisions more transparent, the heated debate over the past couple of years has highlighted a significant shortcoming in US monetary policy.

Bank of England Governor Mervyn King prides himself on making monetary policy boring (i.e. predictable). This is important if a central bank is going to gain any credibility among investors.

Fed chairman Alan Greenspan still has a long way to go, no matter how eloquent his cryptic remarks may seem.

********************

The possiblity of further US interest rate cuts virtually disappeared when the inflation rate stopped slowing in 2003.

There seems to be no doubt in people's minds that the Fed's overnight rate will double by the end of 2004. In fact, it is now become the obligation of the Fed to do just that.

If you take a second look at the chart above you'll notice that by historical standards, today's pickup in inflation is very modest to say the least. This is mostly due to (implicit) inflation targeting on the part of the US central bank over the past 10-15 years.

The key question to ask is this: how concerned is the Fed about inflation right now?

If the Fed knew the answer to this question they would have made their next move on interest rates a long time ago.

If the Fed made it's inflation target more explicit, investors would have anticipated this move a long time ago too!

********************

Since the start of 2003 what we've had is a prolonged situation where both investors and the Fed alike have never been sure when the next move in interest rates would come. Until the Fed makes its policy target clear for all to see, people will not stop talking about it. This only adds to the uncertainty investors face every day. It's the job of policymakers to eliminate uncertainties, not create them.

Jargon-English translation

2004-06-07T07:18:00.000-07:00

Here is a line-by-line translation of a recent bond market commentary:

Treasuries have now settled in slightly lower on the day.

Bond market investors have modestly sold bonds today. They have seen something that gives cause for concern that inflation and interest rates might be rising, but nothing to get serious about just yet.

Bonds were higher following the jobs report but are now lower.

Investors had bought bonds in reaction to an earlier economic report, since the data didn't provide any convincing evidence of higher inflation.

It looks like the initial spike was short covering on fears of a blowout number in excess of 300,000 new jobs last month.

In particular, the initial buying was by investors who had earlier sold bonds in anticipation of stronger evidence of inflation.

Prices, particularly in the short and intermediate part of the yield curve are lower and deferred Fed funds futures yields are up 2 to 4 basis points after the data.

Investors have mostly sold bonds with a shorter maturity: 6-months to 3 years. This points to higher interest rates as investors sell those bonds most sensitive to imminent interest rates moves by the central bank.

In the cash market, twos are down 1/8th at 2.68% and tens are off 5 ticks at 4.74%.

The price of 2-year bonds have fallen, pushing the yield slightly higher to 2.69%. The yield on 10-year bonds has risen slightly to 4.74%.

December Fed funds are currently at 2.17%. Futures are off with June bonds down 3 ticks and municipals up 5/32nds.

Investors bet the US central bank will set the overnight rate on bond sales among banks to 2.17% by December.

***************************

Which version makes more sense?

Treasuries have now settled in slightly lower on the day. Bonds were higher following the jobs report but are now lower. It looks like the initial spike was short covering on fears of a blowout number in excess of 300,000 new jobs last month. Prices, particularly in the short and intermediate part of the yield curve are lower and deferred Fed funds futures yields are up 2 to 4 basis points after the data. In the cash market, twos are down 1/8th at 2.68% and tens are off 5 ticks at 4.74%. December Fed funds are currently at 2.17%. Futures are off with June bonds down 3 ticks and municipals up 5/32nds.

or

Bond market investors have modestly sold bonds today. They have seen something that gives cause for concern that inflation and interest rates might be rising, but nothing to get serious about just yet. Investors had bought bonds in reaction to an earlier economic report, since that data didn't provide any convincing evidence of higher inflation. In particular, the initial buying was by investors who had earlier sold bonds in anticipation of stronger evidence of inflation. Investors have mostly sold bonds with a shorter maturity: 6-months to 3 years. This points to higher interest rates as investors sell those bonds most sensitive to imminent interest rates moves by the central bank. Since the demand for bonds fell today, this pushed the price of 2-year bonds lower, pushing the yield slightly higher to 2.69% (to offer a greater incentive to purchase the lower priced assets). The yield on 10-year bonds has risen slightly to 4.74%. Investors bet the US central bank will set the overnight rate on bond sales among banks to 2.17% by December.

***************************

All financial market reports should be written in terms both the professional and layman can understand and appreciate. Anything else just isn't good enough.

The bond market and you

2004-06-07T04:09:00.000-07:00

Bonds are complicated.

The mention of the word bonds is enough to send most people to sleep. Why?

Most people hate thinking about matters (especially complex ones) that don't have a direct impact on their everyday lives.

Unfortunately, they do.

If I say the word mortgage you might sit up and take an interest (no pun intended).

Understanding the bond market will make you more aware of the risks facing you as a potential (or present) mortgage-holder.

*********************

The biggest obstacle most people face when trying to figure out the bond market is the concept of price and yield.

Yields and interest rates are very closely related:

Interest rates are the price of loans;
Yields are the returns paid to bondholders.

Banks lend to their customers;
Bondholders buy the debt of an institution.

Interest rates in banks rise and fall;
Yields on bonds rise and fall.

The biggest concern for mortgage holders is the interest they are paying each month;
The biggest concern for bondholders is the return they are receiving each quarter, year etc.

The bond market is a market for debt. This debt carries with it a price.
The mortgage market is a market for debt. This debt also carries with it a price.

As a mortgage holder you are subject to the ups and downs of interest rates. Higher interest rates means a bigger bill at the end of the month. Similarly, for bondholders, a higher yield means a higher return on their investment.

The bond market is the best (and probably only) way to predict the next move in interest rates. Why?

Bondholders want to eliminate risk from their investment. If they are government bondholders (where rerturn on the initial investment is fixed) they are sensitive to just one risk: inflation.

Inflation purges the value of any investment. Bonds are particularly vulnerable to higher inflation because the rate of return on the initial investment is fixed.

So how does the bond market help predict interest rates?

Since bondholders are extremely sensitive to inflation, even the slightest hint of rising prices will send bondholders running for the hills.

When bondholders get nervous and start to sell, bond prices fall. Since the interest rate on bonds are fixed, the investor buying this bond will enjoy a higher yield.

The yield on bonds is so important, not least since it helps set mortgage rates. Why?

The bond market is huge. The US bond market is almost 1.5 times the size of the country's GDP. The global bond market is 95% the size of world GDP! This makes the bond market important and credible. People are seriously putting their money where their mouths are. If investors who are responsible for this much money flag concerns over future inflation, the government is forced to sit up and take notice. Banks take even more notice.

In the past 10-15 years, central banks and governments around the world have made it their sole mandate to target (or at least very closely watch) the inflation rate. Should the inflation rate exceed a certain target level or get out of control, there was a strong probability that interest rates would rise.

*********************

People wise to the bond market will be even wiser to the mortgage market since they will be the first to anticipate higher rates in the future and can take steps to avoid being hurt in the process.

What you assume is what you get.

2004-06-06T07:12:00.000-07:00

Economists need to make assumptions.

This is part of the reason why all economic models are wrong.

This is not the same as saying all models are useless. I was always taught to think of economic modelling in terms of modelling an aeroplane. Each model captures an important aspect of the thing you are modelling. Doing this enables you to isolate possible causes of failure or to think of better ways to improve the final design.

Economists have some favorite assumptions. These include the following:

- complete information;
- perfect foresight;
- no uncertainty;
- prices adjust;
- rational expectations.

These assumptions are clearly unrealistic. So why assume them in the model?

Because it's a model! More importantly, it's a 'baseline' model. The model can be made more complicated but the modeller knows that each time a further complication is added, it takes away from the elegance of the model and, in the end, it's usefulness.

The most complicated model will be that which is closest to the thing you are modelling, which is far from ideal.

The best models balance simplicity and realism.

Economists are playing a delicate balancing act where modelling is concerned. The most precarious part of an economist's job lies in the assumptions being made; this is where art and science combine.

The difference between two perfectly good economic models can simply be the assumptions underlying each.

What determines these assumptions?

The dissatisfying answer is the whim of the economist.

Unfortunately, the economist might not have any choice but to make restrictive assumptions on the grounds that without them the model could not produce any meaningful results.

**************************

Economics is often considered a science; mathematics can explain economic concepts.

The big difference is that in science any idea can be proven or disproven by experimentation.

Economists only have secondary statistics: numbers not generated from any experiment. An economist cannot impose the assumptions of a model onto the real world.

Then why bother?

To help us understand.

Economists seldom provide clear-cut answers; instead they help improve our understanding.

**************************

The strength of an economist's argument lies in their assumptions.

The International Monetary Fund makes an interesting assumption about oil prices in their latest World Economic Outlook:

"... the average price of oil will be $30.00 a barrel in 2004 and $27.00 a barrel in 2005, and remain unchanged in real terms over the medium term." (viii)

You might think this assumption will need to be revised at some point in the future. You'd be right.

All economists need to make assumptions. A perfectly good economic model can be undone by it's assumptions. This is why economists are so notoriously bad at forecasting.

**************************

So, whenever you hear an economist make a forecast don't accept what they are saying without knowing what they are assuming. If you disagree with any of their assumptions, then you shouldn't agree with the forecast they are making.

The grass is still greener in England!

2004-06-01T08:56:00.000-07:00

Reports of grouchy U.S. drivers having to suffer higher prices at the pumps always irritates me as a Brit. Prices in the U.K. have always been twice as high this side of the pond.

Taxes account for a larger proportion of the final UK retail price of fuel when compared to Asia and the US. This acts to buffer the effect of changing oil prices. Since the British government can decide when and by how much to raise taxes on fuel, the retail prices is less exposed to the volatile market price.

The next time you hear a reporter talk of 'higher oil prices threatening to fuel inflation and derail the U.S. economic recovery' suggest they take a look at the stable inflation rate and strong economy in the UK and see what kind of reaction you get.

Which comes first: rising oil prices or faster inflation?

2004-06-01T06:54:00.000-07:00

Rising oil prices contribute to higher inflation. No doubt about it. After all they form part of the inflation rate as measured by the Consumer Price Index.

What is easy to forget is that the inflation rate is determined by a lot more than just oil prices.

More importantly, the inflation rate itself chips away at the value of oil and the earnings of oil producers.

Charting oil prices that are adjusted for the inflation rate next to the rate of inflation might lead you to conclude that oil prices have pretty much determined the U.S. inflation rate since the first oil price shock of the 1970s.

What I see when I look at that chart is the oil industry (essentialy OPEC, a group of oil producers who stabilize the price of oil) attempting to keep track with inflation.

If oil prices were to rise FASTER than the rate of inflation then I would be convinced that it is higher oil prices that cause higher inflation, and that will probably only come with the next REAL oil price shock.

To see why we aren't even close to this type of shock at the moment, read on...

It's real easy

2004-06-01T04:57:00.000-07:00

In 1950 a mars bar cost 3 cents.

In 2004 a mars bar costs 30 cents.

In NOMINAL terms the price of a mars bar has risen by 10-fold (1000%!!) oh my goodness, what a crazy world we live in.

*********************

In 1950 a mars bar cost 30 cents in 2004 prices.

In 2004 a mars bar cost 30 cents in 2004 prices.

In REAL terms the price of a mars bar is UNCHANGED (0%) oh my goodness, what a... *boring* world we live in!!! BAD TV!!!

*********************

look at the 2 charts on this web-page:

http://www.zealllc.com/2004/goldoil3.htm

on the first chart you will see that NOMINAL crude oil prices are far far higher today than they were in 1975.

on the second chart you will see that REAL crude oil prices are EXACTLY the same as they were in 1975.

In other words,
the nominal price of goods (such as oil and mars bars) has been rising year-on-year. At the same time, the real price of goods (such as oil and mars bars) has remained the same.

In some other words:
the intrinsic value (the scarcity, the quality, the perceived value) of goods (such as oil and mars bars) doesn't change.

**********************

REAL prices matter.
NOMINAL prices don't matter.

People don't understand REAL prices.
People do understand NOMINAL prices.

Why?

If you pay for something you want to know HOW MUCH to pay for it; how much to take from your wallet or bank account or credit card. if the price of something is rising you think you are paying more for it.

Every day the newspapers and tv talk about rising prices. The price of oil is rising, the price of mars bars is going up, the price of a car is going up etc. etc. It is far more complicated for people to calculate the proportion of their annual income they spend on something, especially mars bars and oil. Cars, maybe.

**********************

So as long as NOMINAL prices will matter to people and REAL prices won't, the confusion and concerns over RISING PRICES will persist and all the understanding we have of these concepts will go to waste.

**********************

My story so far...Who am I...?

2004-05-27T07:15:00.000-07:00

I guess it's fair to say that things really got started in York (the one in North England!). It was there I found my feet in the Economics field. Immeditely after completing my masters degree I went to work at Cambridge University's Economics Department as a research assistant. Six months later I decided to try something completely different. So I left England to go and find work in Japan!

After a few months of searching I found out about an internship with Bloomberg. I decided to snap up the opportunity. So I spent 6 months learning about the financial media (and how much respect Economists get from Journalists!).

Instead of jumping on the next plane back to England I decided to stick it out a bit longer and waited for a full-time vacancy to become available with Bloomberg. In the meantime my Japanese language skills were coming along (and the vast sum of money I put into my Japanese education started paying off!).

Once a full-time position did become available I spent the next 2 years as a reporter for Bloomberg News. I learnt a lot more about the financial markets than I did as an intern, which gave me more of a reason to pursue a career outside of the academic world.

So I am now about to start a new job in New York with The Economic Cycle Research Institute.

Most important of all, I am optimistic about working in a vibrant city along side people who can teach me what I need to know.

Stay tuned for more details...