Inequality

Chris Dillow has identified some data that shows the evolution of inequality across the income spectrum.  It comes from the ONS and  shows that there is a substantial increase in inequality between 1977 and 1993.  After that clear peak, it becomes a little more messy.  For the top decile relative to the lowest, the original income ratio fell to 25.69 from 30.53 between 2010-11 and 1993.  However, disposable income (after tax and benefit adjustments) rose to 9.95 from 9.23.  For the 6th decile (the middle) the same figures were 10.77 and 7.96 for original income and 3.25 and 3.86 for disposable income.

Cross Discipline

"The Great Inflation of the 2010s: Hoisted from Niall Ferguson's Archives from Two Years Ago" 

Link

A reminder of the limits of disciplines. There are probably numerous inflationary cases that appeared through history.  What of the cases where budget deficits increased but there was no inflation?  It is clear that economists ignored economic history but this appears to be a case of a historian without economic knowledge.

John Maynard Keynes, The end of laissez-faire (1926)

Worthwhile for having the whole paper.

John Maynard Keynes, The end of laissez-faire (1926): "The maxim laissez-nous faire is traditionally attributed to the merchant Legendre addressing Colbert some time towards the end of the seventeenth century.

('Que faut-il faire pour vous aider?' asked Colbert. 'Nous laisser faire' answered Legendre)."

Productivity and potential market

Dan Liu and Christopher Meissner Market Potential and the Rise of US Productivity Leadership:

 "The US advantage in per capita output, apparent from the late 19th century, is frequently attributed to its relatively large domestic market. We construct market potential measures for the US and 26 other countries between 1880 and 1913 based on a general equilibrium model of production and trade. When compared to other leading economies in 1900, the year around which the US overtakes Britain in productivity leadership, the US does not have the overwhelming lead in market potential that it has in GDP per capita. Still, market potential is positively related to the cross-country distribution of income per capita, but the impact of market potential is likely to be very heterogeneous. We illustrate this in a quantitative calculation of the welfare gains from removing international borders in 1900 within a parsimonious general equilibrium trade model. While there are gains from trade for all nations, the largest European countries do not close their per capita income gaps with the US after this hypothetical rise in market potential. On the other hand, many small countries could have done so."

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Fake it!

Amy Cuddy: Your body language shapes who you are 

TED : http://on.ted.com/q1MN

Peak Oil

Brad DeLong : Liveblogging World War II: February 3, 1943:

A caveat to the predictions of economic collapse as a consequence of 'peak oil'.

"It needs to be said, of course, that the dire predictions of Hitler and his economic advisers in 1941 and 1942 about the certain collapse of the German war machine if no new sources of oil were obtained proved to be exaggerated. The German war effort did not grind to a halt when the campaign to capture the Caucasus oilfields failed. Although Germany's oil situation remained acute, and became desperate after the Allied air offensive against its synthetic fuel plants and the Rumanian oilfields began, the Reich continued fighting until May 1945."

There are alternatives.  They may not be sustainable themselves, but..
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The Allais Paradox

The Allais Paradox | Wired Science | Wired.com:

There is some explanation of the Allais Paradox here in Wired.com.  The is a tendency to value certainty but once this is gone, there is a tendency to take risk. For speculation, this means that the positive skew to returns are very attractive but the negative skew does not have very much influence.

"But why was certainty so attractive? Kahneman and Tversky wanted to understand the psychology behind the paradox. Their breakthrough came by accident. Kahneman had been reading a textbook on economic utility functions, and was puzzled by the way economists explained a particular aspect of our behavior. When evaluating a gamble—like betting on a hand of poker, or investing in a specific stock—economists assumed that we made the decision by taking into account our wealth as a whole. (Being rational requires factoring in all the relevant information.) But Kahneman realized that this isn’t how we think. Gamblers in Las Vegas don’t sit around the card table contemplating their complete financial portfolio. Instead, they make quick decisions that depend entirely upon the immediate terms of the gamble. If there is a $100 wager, and you’re trying to decide whether or not to ante in with a pair of aces, you probably aren’t thinking about the recent performance of your mutual fund, or the value of your home."

This may mean that fat tails are attractive as the possibility of large gains draws attention while the possibility of large losses is given less weight than it should.  There is loss aversion.  If there are large potential losses, losses should be cut swiftly, but there is a tendency to hand on a hope - with potentially catastrophic results.

A guide to bootstrapping

Bootstrapping and Subsampling: Part I « Normal Deviate:

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Compartments and belief

The Mind’s Compartments Create Conflicting Beliefs: Scientific American: An overview of the idea that the mind contains compartments that may contain conflicting ideas.  The key thought that when there is conflict, there is more agitation and people are more likely to shout or try to assert their belief.

"Cognitive dissonance may also be at work in the compartmentalization of beliefs. In the 2010 article “When in Doubt, Shout!” in Psychological Science, Northwestern University researchers David Gal and Derek Rucker found that when subjects' closely held beliefs were shaken, they “engaged in more advocacy of their beliefs ... than did people whose confidence was not undermined.” Further, they concluded that enthusiastic evangelists of a belief may in fact be “boiling over with doubt,” and thus their persistent proselytizing may be a signal that the belief warrants skepticism."

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Rajiv Sethi: Risk and Reward in High Frequency Trading

Rajiv Sethi: Risk and Reward in High Frequency Trading: "These are interesting findings, but there is a serious problem with this interpretation of risk-adjusted performance. The authors are observing only a partial portfolio for each firm, and cannot therefore determine the firm's overall risk exposure. It is extremely likely that these firms are trading simultaneously in many markets, in which case their exposure to risk in one market may be amplified or offset by their exposures elsewhere. The Sharpe ratio is meaningful only when applied to a firm's entire portfolio, not to any of its individual components. For instance, it is possible to construct a low risk portfolio with a high Sharpe ratio that is composed of several high risk components, each of which has a low Sharpe ratio."

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Knight, Risk, Uncertainty, and Profit, Part III, Chapter X | Library of Economics and Liberty

Knight, Risk, Uncertainty, and Profit, Part III, Chapter X   Profit is the return for having belief in the ability to forecast the future.  Of course this is self-fulfilling if luck ensures success and increased profits increase confidence.

 "The receipt of profit in a particular case may be argued to be the result of superior judgment. But it is judgment of judgment, especially one's own judgment, and in an individual case there is no way of telling good judgment from good luck, and a succession of cases sufficient to evaluate the judgment or determine its probable value transforms the profit into a wage."

However, the build up of confidence, profits and positions that are based on luck rather than ability to forececast the future could increase risk, particularly if risk is identified as a risk of reversal or crash.

The New Physiocrats - NYTimes.com

The New Physiocrats - NYTimes.com: "What’s really going on here, as far as I can tell, is a modern version of the 18th century physiocratic notion that only agriculture is real, that everything else is fluff on top. And we really shouldn’t be seeing a rebirth of that sort of nonsense in the 21st century. If you believe that we should have fewer schoolteachers and firefighters — or that education should be privatized — make that case. Don’t try to hide your prejudices under a mystical doctrine in which important, productive jobs somehow don’t count if they come from a place with a .gov email address."

We could also point to the idea that manufacturing is all powerful and useful while services are to be avoided.
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Another side of the credit crunch

Gillian Tett assesses the fall in credit card debt and use of plastic. It should not be a great surprise given the increase in the savings rate.

"Yes, you read that right. Although Americans are (in)famous for their addiction to credit card debt, that love affair is cooling, or being forcibly cooled. By the middle of this year, the number of credit card accounts in circulation had tumbled to 383m, 23 per cent below its 2008 peak, and fresh applications for credit were declining too. Put another way, while cards are still being flogged to consumers (and even sometimes marketed, via direct mail, to pets), not all Americans are saying “yes”."

Another way to look at this is from the supply side.  As part of the 'credit crunch' and cut back in advances to risky credits.

Skin in the game - indeed

Finance is in need of a technological revolution - FT.com: "Less than two months before the Facebook fiasco, another IPO suffered an even more shocking fate. BATS Global Markets, which operates the third-largest stock exchange in the US, went public on its own exchange. If ever an organisation had sufficient “skin in the game” to get it right, it was BATS and if ever there was a time when getting it right really mattered, it was on the day of BATS’s own IPO. So when BATS debuted at an opening price of $15.25, no one expected it to plunge to less than a tenth of a penny in a second and a half due to a software error affecting stocks whose ticker symbols began with the letter A or B. The ensuing confusion was so great that BATS suspended trading in its own stock and ultimately cancelled its IPO."

BBC News - Olympic counties: Does it matter where medal-winners come from?

Wiggins Belgium and the South African cricketer

Andy Murray's gold postbox is in Dunblane, where the tennis gold medallist grew up - although he was, in fact, born in Glasgow, moved to Barcelona to train at 15 and now lives near Wimbledon in south-west London."

Rajiv Sethi: Belief Heterogeneity

Rajiv Sethi: Belief Heterogeneity the paper described here analyses competing views.  This can be used in the model of speculation and the carry trade in particular.  The simple carry trade is successful for some time and the more successful it is, the more traders are drawn to the trade, increasing its success.  It requires a shock to burst the bubble.

"Not surprisingly, then, the presentation I found most appealing was that of Blake LeBaron. Blake is a pioneer in the development of agent-based computational models of financial markets, and the paper he presented belonged to this class. A large number of different forecasting strategies, some based on fundamental information and others on technical data analysis, compete with each other and with a traditional buy-and-hold strategy in his model. The resulting trading dynamics give rise to asset price returns that exhibit both moderate levels of short-run momentum as well as mean reversion over longer horizons. Moreover, the long run population of forecasting rules is ecologically diverse, with both passive and active strategies well represented. "

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Crowds and networds

Tim Harford highlights the work of Mark Granovetter on networks and crowds.

: "Consider the following simple model of a potential riot, based on an idea published in 1978 by the sociologist Mark Granovetter. There are 1,000 people in a crowd of protesters, and all of them have some underlying tendency to embark on a looting spree. We might reckon that an outbreak of rioting might be triggered by insensitive policing, or by the poverty of the crowd, or the opportunities for theft or for violent protest. But for simplicity let’s assume that the only thing everyone in the crowd cares about is what everyone else in the crowd is doing. Some people will start looting without much company. Others will hang back until the riot is well under way."

This can also be used, I think, to look at the way that speculation can build.  Given the information cascade that builds when valuation is difficult and that activity of others can imply some understanding that may not exist.  

Finance must escape the shadows - FT.com

Excellent.

John Kay - The parable of the ox

Interesting - though I am not sure that the Chicago model (Black-Scholes?) manages to generate a price from thin air - it needs important elements (such as the current price and the estimate of volatility).  It is also important to remember that there are people like Buffett making guesses and if the crowd is very wrong, he will be the closest.  John Kay - The parable of the ox:

"One difficulty was that sometimes there were few, or even no, guesses of the oxen’s weight. But that problem was soon overcome. Mathematicians from the University of Chicago developed models from which it was possible to estimate what, if there had actually been many guesses as to the weight of the animal, the average of these guesses would have been. No knowledge of animal husbandry was required, only a powerful computer."

Interesting, non-the-less. '

How Do You Choke Away the British Open? The Science of the Tight Collar | Wired Science | Wired.com

The explanation for why English Premier League players can be good for their club and poor for their country (outside ability of the rest of the team).

Sport psychology: "“You can’t dictate your genes,” says Stone. “But among the many identities you have, you can choose which to operate from.” Tiger Woods, for instance, has clearly forged an identity that transcends the potential vulnerabilities of his multiracial makeup. You can wallow in your most negative identity — the slow one, the overthinker, the one who doesn’t care — or you can foreground another identity, the one who is ready, the one who knows what’s coming, the one who calmly attacks the problem."

With a solution

The shocking story of how a council pursued Peter Williams

It raises the question of how different are the private and public institutions.

The shocking story of how a council pursued Peter Williams | Liberal Conspiracy: "On the 8th of February a man took his own life. Peter Williams was a gifted engineer, whose invention, still manufactured today, landed him in the Guinness World Records, but he was driven to bankruptcy and suicide by an unthinking and inhumane bureaucratic system"

Models

Krugman explains that models are tools or simplifications that are used to solve a problem.  However, the assumptions of the model cannot be used to explain the implications of the model.  That would be circular.  Gadgets Versus Fundamentals (Wonkish) - NYTimes.com:

"The point is that all this work USES Dixit-Stiglitz, but it’s not ABOUT Dixit-Stiglitz; D-S is a gadget, a tool that helps you work with the fundamental issues, but you don’t ever want to forget that it is no more than that."

George Monbiot – False Summit

George Monbiot – False Summit: "We were wrong about peak oil: there’s enough in the ground to deep-fry the plane"

It is always dangerous to make forecasts.  There is always some unsuspecting element that can crop up.

and then!

Monbiot peak oil u-turn based on bad science, worse maths

http://www.davidstrahan.com/blog/?p=1576

Oil glut forecaster Maugeri admits duff maths
http://www.davidstrahan.com/blog/?p=1570

David Strahan

Energy writer

Easter Island - people or rats?

Easter Island 

"Jared Diamond drew heavily on Flenley’s work for his assertion in Collapse, his influential 2005 book, that ancient Easter Islanders committed unintentional ecocide."
When the wood was gone and civil war began, the islanders began toppling the moai. By the 19th century none were standing. Easter Island’s landscape acquired the aura of tragedy that, in the eyes of Diamond and many others, it retains today.

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Andrew Gelman on political statistics

Andrew Gelman on How Americans Vote | FiveBooks | The Browser: "The idea is that these people know enough about us so that they can manipulate our vote. Realistically, political consultants nowadays know a lot about us, and they do try to convince us. There are two kinds of people they follow. One is people where they know who they’re going to vote for, but they’re not sure that they’re going to vote. The other is people who are very likely to vote, but you don’t know which way they’re going to vote. The first type of person they try to mobilise just to turn out and vote, and the second kind of person they try to persuade. They’re pretty good at knowing who people are. In fact, at this point, a lot of this is just a question of resources. To the extent they have resources they will go out to people and call you on the phone. If they think you’re already likely to vote for a certain candidate, they’ll try to find somebody to knock on your door and convince you that it’s an important election and it’s worth voting for. In some sense it’s not as mysterious or conspiratorial as it’s made out to be in that book."

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Greece’s ailing economy grinds to a halt - FT.com

The FT.com looks at the effect that a lack of credit is having on the Greek economy.

"But after thinking it over, Yannis Stamos, the company’s co-founder, turned the customer away. Filling the order would have meant reaching into Medical Service’s own pockets to cover the €35,000 cost of such a machine, since Greek banks have stopped lending and the company’s German suppliers now demand pre-payment in cash."

Bond market liquidity

FT.com: discusses the lack of liquidity in the corporate bond market.  A combination of risk-aversion, Volcker rule and capital costs seem to have combined to encourage banks to hold less inventory.  

 "Data from the Federal Reserve on Thursday showed corporate bond holdings among the largest dealers fell last week to $45bn. These inventories reached highs of more than $200bn in 2007 before falling to $90bn a year ago.
Asset managers are concerned that reduced liquidity will make it harder to move in and out of large positions, particularly at times of market stress.
“The buyside is looking for an answer on how to fix this,” said one of the dealer participants."'

Declining liquidity makes the market more of one where deals are worked over time and ultimately increases the cost of borrowing as final investors know that there is limited possibility of a swift sale.

Social network vs critics

The Guardian: reports on a Harvard business school study that compares Amazon book reviews to critics and finds that evaluation is similar, though the reviews are swift to find new authors.

 "Amazon reviewers were more likely to give a favourable review to a debut author, which the Harvard academics said suggested that "one drawback of expert reviews is that they may be slower to learn about new and unknown books".
Professional critics were more positive about prizewinning authors, and "more favourable to authors who have garnered other attention in the press (as measured by number of media mentions outside of the review)"."

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Collateral and rating

A good overview of the effect of rating downgrade and increased risk aversion on the profitability of investment banks and, inevitably, the liquidity of financial markets.

M Stanley reassesses downgrade impact - FT.com: "The additional collateral needed could reduce Morgan Stanley’s fixed income derivatives revenues by almost a third, analysts at AllianceBernstein estimated in a recent note. In addition to having to stump up extra collateral to its trading partners, Morgan Stanley could also face a higher cost of funding, the analysts said."

This also gives some indication of the importance of the economies of scale in investment banking.

International holding of bonds and capital

International holding of government bonds.

Bank adequacy: weight and see - FT.com: "But what would be the effect of removing the zero weighting on banks’ domestic sovereign debt holdings? In its latest stability report, the IMF takes a stab at estimating the “correct” risk weightings to use, via default rates embedded in sovereign credit default swap spreads. Doing this lowers the average capital adequacy ratios across banks in emerging countries by 2-3 percentage points – no small sum. Ratios for European banks fall by less, between 0.5-2 percentage points. The reduction for US lenders is smaller still. Even so, more capital would be needed."

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Funds move directly into loan market

If funds cannot If funds cannot get access to loans via structured products, can they go into the market themselves by making loans?  M&G are in £266m property financing deal - FT.com  

"It is the second time this week a UK insurer has provided debt finance for a property deal, with Legal & General issuing its maiden property loan on Tuesday.

The relationship between the two sectors is deepening rapidly as insurers snap up opportunities created by the shortage of bank lending."

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German banks rein in exposure to Spain - FT.com

German banks rein in exposure to Spain - FT.com: "Will Spain – where house prices have fallen more than 22 per cent from their peak, with analysts expecting worse to come – bring more pain? Figures published this month by the Bank for International Settlements show that German banks had $146bn of exposure to Spain at the end of 2011 – more than the banks of any other country. Some $53bn of the exposure is to Spanish banks, while a further $68bn is to the rest of the private sector"

End-December 2011
           Denmark France     Germany     Greece     Ireland      Italy       Japan       Mexico
Spain   1,951      115,162   146,096        292       4,696       26,939    21,691       540 ...

http://www.bis.org/statistics/r_qa1206_anx9b.pdf

FX Momentum trades

Forex momentum trade yields long-term gains - FT.com: "Currency momentum strategies that buy or sell currencies according to whether they have risen or fallen over the previous month yielded annual returns of nearly 10 per cent between 1976 and 2010, according to the Cass study, which analysed 48 currencies against the US dollar. The paper, “Currency Momentum Strategies”, is due to be published in the Journal of Financial Economics."

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Investment Bank Leverage

The FT reports on the rise in capital at investment bank Goldman.

Goldman Sachs: then and now - FT.com: "Spookily, it is as if nothing has changed for six long years. But a financial crisis has come and gone since then and regulators are now throwing everything at banks. Of course, there is one huge difference between the two periods, but it is not to be found in the profit and loss account. Flip to the balance sheet and be astounded to remember that in 2006 Goldman was running on just $27bn of common shareholders’ equity. With exactly the same earnings today, that number is now two and a half times higher."

Hedge funds and leverage

Hedge funds keep a lid on leverage - FT.com: "According to the UK’s Financial Services Authority, which in February published its annual survey of the global hedge fund industry, the average hedge fund currently uses leverage of about 2.5 times its capital – as it has done for the past three years.
Indeed, unlike prop desks, most hedge funds have to grapple with all too finite liquidity and financing – issues no manager has been able to ignore since 2008."

How the leverage has been reduced as pro trading transfers from investment banks to hedge funds.

The BBK seeks insurance against EMU break-up

The Bundesbank has no right at all to be baffled - FT.com:

"It also tells us something else: by seeking insurance against a collapse of the euro, the Bundesbank tells us it no longer regards the demise of the euro as a zero-probability event. If the Bundesbank seeks insurance, so should everybody else."

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Are Credit Ratings Massively Overrated? | Economics Intelligence

The informational content of credit rating agencies seems to be minimal - worse than a simple indicator that can be constructed.

Are Credit Ratings Massively Overrated? | Economics Intelligence:

"Hilscher and Wilson reply that they do not claim that ratings have no informational content whatsoever. Having a S&P rating was certainly better than no information at all, stresses Hilscher"

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Do hedge funds offer value for their fees? No - FT.com

Not surprising if the absolute returns are from finding inefficiencies. Given an absolute amount of inefficiencies, these are shared over more funds.

Do hedge funds offer value for their fees? No - FT.com:

"Just as individual hedge funds tend to do better when they are small, so too, his analysis shows, the industry as a whole performed better when it was a largely unknown $200bn business, rather than the high profile $1.9tn industry it had grown to become, before the financial crisis in 2008 so dramatically exposed some of its shortcomings. The comforting compounded rates of return reported in hedge fund indices give a misleading impression of the actual cash returns achieved by hedge fund investors. Most of the client money that has flowed in since the industry began to be institutionalised has not achieved anything like the returns the long-term headline index figures suggest.
"

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Delete rows from R data frame « Heuristic Andrew

Use for getting rid of rows of data where there is no response. For instance, the missing values in a large dataframe can be removed in this way with simplicity.

Delete rows from R data frame « Heuristic Andrew:

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Friedman and Krugman

New Frontiers in Economic Barbarism - NYTimes.com: "Quite. What Matt may not know, however, is that this is a classic argument in international macro, and the person who made it best was …. drumroll … Milton Friedman. Here’s a snip from Friedman’s 1953 essay “The case for flexible exchange rates”:


Is it really possible that people at the University of Chicago have unlearned not only Keynes but Friedman? Alas, yes."

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Cross Validation

A number of related ideas about the cross validation of models:

Arlot paper on cross validation

Rob Hyndman

R code for comparison

Why Only Germany Can Fix the Euro | Foreign Affairs

At the heart of the Euro area crisis.

Why Only Germany Can Fix the Euro | Foreign Affairs:

" According to Eurostat, Germany's trade surplus with the rest of the EU grew from 46.4 billion euro in 2000 to 126.5 billion in 2007. The evolution of Germany's bilateral trade surpluses with the Mediterranean countries is especially revealing. Between 2000 and 2007, Greece's annual trade deficit with Germany grew from 3 billion euro to 5.5 billion, Italy's doubled, from 9.6 billion to 19.6 billion, Spain's almost tripled, from 11 billion to 27.2 billion, and Portugal's quadrupled, from 1 billion to 4.2 billion. Between 2001 and 2009, moreover, Germany saw its final total consumption fall from 78.5 percent of GDP to 74.5 percent. Its gross savings rate increased from less than 19 percent of GDP to almost 26 percent over the same period."

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Unintended consequences

The unintended consequences of trying to reduce the Greek debt burden while preventing the triggering of CDS has the unintended consequence of making all bond positions look vulnerable (even when there was a previous CDS protection. The FT quotes Commerzbank chief a:

"Mr Blessing criticised the Greek agreement since investors that insured Greek bonds using CDS had not received a pay-out because the voluntary agreement was not deemed to be a so-called “credit event” and thus did not trigger CDS payments."

This can lead to other bond holders selling the bonds because they find that they are not protected from default.

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Michael Lewis on Prospect Theory

Prospect Theory and MoneyBall

"The moment the psychologists uncover some new kink in the human mind, they bestow a strange and forbidding name on it (“the availability heuristic”). In their most cited paper, cryptically titled “Prospect Theory,” they convinced a lot of people that human beings are best understood as being risk-averse when making a decision that offers hope of a gain but risk-seeking when making a decision that will lead to a certain loss. In a stroke they provided a framework to understand all sorts of human behavior that economists, athletic coaches, and other “experts” have trouble explaining: why people who play the lottery also buy insurance; why people are less likely to sell their houses and their stock portfolios in falling markets; why, most sensationally, professional golfers become better putters when they’re trying to save par (avoid losing a stroke) than when they’re trying to make a birdie (and gain a stroke)"

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Unintended consequences

Unintended consequences: "In the UK, the “Merton Rule” – it originated in the Borough of Merton and has been widely emulated – demands that substantial new developments include the capacity to generate 10 per cent of the building’s energy needs through renewable sources, on site.

Alas, such a rule is hopelessly slack for an out-of-town supermarket – an environmental disaster because of all the driving it encourages, yet with plenty of real estate for solar panels. Meanwhile it is too challenging for a city-centre skyscraper, which is naturally a low-energy building because of its compactness and proximity to public transport."

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The evolution of overconfidence

A paper in Nature makes the case for the positive aspect of over-confidence: it encourages action and decisive response; it is generally successful or adaptive; when it goes wrong, it goes very wrong.

The evolution of overconfidence : Nature : Nature Publishing Group:

This would be consistent with the behaviour that is mirrored in financial markets. The carry trade is such a confident trait. There is the belief that the exit can be achieved before the shock. This is generally successful, certainly more successful than the alternative strategy that would hold back and worry about the risk of a funding currency appreciation. Those who embark on the strategy make years of gains. Those who stay on the sidelines, lose out. When the hit happens, it is a shock that is explained away by specific circumstances. The over-confident are not blamed and the cautious and not proved 'right' in most cases.

The price of protection - FT.com

The price of protection - FT.com: "However, most banks expect the biggest impact to be felt by corporate customers, particularly mid-sized companies that rely heavily on bank debt. Analysts believe these businesses will sit outside the ringfence, alongside the investment bank activities – the part most at risk of a sharp rise in wholesale funding costs. Creditors generally give higher ratings to banks with retail and investment banking under one roof as they believe they are more stable. Remove that benefit and ratings are likely to fall, making it harder and more expensive to access funds."

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The Social Responsibility of Business is to Increase its Profits, by Milton Friedman

The Social Responsibility of Business is to Increase its Profits, by Milton Friedman: "The New York Times Magazine, September 13, 1970. Copyright @ 1970 by The New York Times Company.

When I hear businessmen speak eloquently about the "social responsibilities of business in a free-enterprise system," I am reminded of the wonderful line about the Frenchman who discovered at the age of 70 that he had been speaking prose all his life. The businessmen believe that they are defending free en­terprise when they declaim that business is not concerned "merely" with profit but also with promoting desirable "social" ends; that business has a "social conscience" and takes seriously its responsibilities for providing em­ployment, eliminating discrimination, avoid­ing pollution and whatever else may be the catchwords of the contemporary crop of re­formers. In fact they are–or would be if they or anyone else took them seriously–preach­ing pure and unadulterated socialism. Busi­nessmen who talk this way are unwitting pup­pets of the intellectual forces that have been undermining the basis of a free society these past decades."

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Technology Can't Save Us From Math Mishaps - WSJ.com

Nice

Technology Can't Save Us From Math Mishaps - WSJ.com: Mr. Clarke, the economist, suggests that we go easy on statisticians. "Everyone makes spreadsheet mistakes," he says. He repeats advice he received from his best man at his wedding: "The best way to remember your wedding anniversary is to forget it once."

Profits from ETF

FT.com: "Why are ETFs so profitable when they appear to be so cheap? Annual management fees have been driven down by price wars, which have been particularly fierce in the US. Synthetic ETFs obviously offer scope for profitable derivative trading and collateral management, but the opportunity to extract revenue is less obvious with physical ETFs, being mainly confined to securities lending. Perhaps running an ETF business is at least in part a means of running a securities lending operation, in which case providers should reveal what proportion of stocks in a portfolio are lent, as the associated counterparty risks are material to investors."

2011 World’s Most Ethical Companies | Ethisphere™ Institute

Useful for the selection of 'ethical companies'.

2011 World’s Most Ethical Companies | Ethisphere™ Institute: "The World’s Most Ethical Companies designation recognizes companies that truly go beyond making statements about doing business “ethically” and translate those words into action. WME honorees demonstrate real and sustained ethical leadership within their industries, putting into real business practice the Institute’s credo of “Good. Smart. Business. Profit.”"

Bond market liquidity

The reduction in bond market liquidity due to the decline in bank risk appetite and increased capital requirement.

Lack of liquidity bad for big bond funds - FT.com: "In 2007 bond fund managers were able to trade bonds at bid/offer spreads of 0.25 per cent. That widened to 2-3 per cent at the height of the crisis from September 2008 to March 2009. Trading spreads subsequently fell back to 0.4-0.5 per cent but have since crept up again to about 1 per cent on fears of the European sovereign debt crisis. Mr Davidson says: “It’s clear the banks don’t want any credit instruments on their books, especially given everything that’s going on in peripheral Europe.”

As a result, he adds, anyone managing a bond fund with assets of £1bn ($1.6bn) or more – with individual holdings of £10m plus – has their hands pretty much tied, “unless they resort to the euro market for greater cash liquidity or the CDS [credit default swap] market for greater active liquidity – but they’d be giving away yield in both cases. It is taking people a long time to trade out of an accumulated position of over £100m in a single, not very liquid bond.”"

Pension fund exposure

Two interesting aspects of this FT report: The decline in equity share and the increase in alternative assets.

Reductions in equity exposure to continue - FT.com: "UK pension funds have been gradually reducing their allocation to equities in the past decade from 74 per cent in 2000 to 55 per cent in 2010, according to Towers Watson. The equity exposure of UK funds remains the highest of all the large markets; compared with 49 per cent in the US, 37 per cent in Japan, 33 per cent in the Netherlands and 28 per cent in Switzerland. But a decline in equity allocations is common, with the net overall allocation across the largest pension fund

markets down by 13 per cent in the past five years, as pension funds diversify into alternative asset classes, which now account for 19 per cent of all portfolios."

Smell like team spirit

When it comes to taking most of the profits, the top investment banks do not compare with football clubs. The money flows to the talent.

Sports franchises: smell like team spirit - FT.com:

"Ditto Stateside. The headline grabbing $400m Platinum Equity supposedly paid for the Detroit Pistons this month is equivalent in size to Stein Mart, 468th in the S&P 600 small cap index. (And the retailer makes 10 times the revenues.) Sports profitability is worse. Why? Wages. Incredibly, the market cap of Juventus FC is only 30 times the annual salary of its best paid player. Goldman Sachs’s market cap is 5,000 times its boss’s last pay packet."

Pencil full of lead

BBC - Scotland - Sunday at RockNess 2011

Beware the tottering Greek domino

Good overview of market sentiment and its measurement.

FT.com / Markets - Beware the tottering Greek domino

FT video.

How I Failed, Failed, and Finally Succeeded at Learning How to Code - James Somers - Technology - The Atlantic

How I Failed, Failed, and Finally Succeeded at Learning How to Code - James Somers - Technology - The Atlantic

‘National mania’ blamed for Irish crisis

The FT.com on the report about Irish banks. The national speculation seems to be a feature of all such financial crises. It is obvious in retrospect. At the time, everyone is part of it and after none will take responsibility.

"Mr Nyberg said the attendant risks went undetected or were seriously misjudged by regulatory authorities “whose actions and warnings were modest and insufficient”.

A “happy go lucky” attitude prevailed during the period, including among the bondholders that lent to Irish banks.

“When it all ended, suddenly and inexplicably, participants had difficulty accepting their appropriate share of the blame for something in which so many others were also involved and that seemed reasonable at the time,” the report states"

Economist's View: Empirical and Historical Validation of Macroeconomic Models

Economist's View looks at the failure of the Bernanke type economic accelerator model to explain much of the deviation in output. However, this is rather the same as the failure of the short period of housing data to show the possibility of a simultaneous fall in house prices across the country.

"That was a mistake, but what is the lesson? One is that we should not necessarily ignore something just because it cannot be found in the data. Much of the empirical work prior to the crisis involved data from the early 1980s to the present (due to an assumption of structural change around that time), sometimes the data goes back to 1959 (when standard series on money end), and occasionally empirical work will use data starting in 1947. So important, infrequent events like the great Depression are rarely even in the data we use to test our models. Things that help to explain this episode may not seem important in limited data sets, but we ignore these possibilities at our own peril."

Spanish rates and the ECB

FT.com / "Almost all Spanish mortgages are based on the one-year Euribor money market rate, which is now close to 2 per cent, and rising"

What will people do for money?

What will people do for money?: "In the hypothetical scenario, 64 percent of participants said they would never administer a shock to someone else for money. However, in the real world that number changed, and in a big way. When faced with real money, 96 percent chose to shock the person in the other room for money."

Fixed income hedge funds

The FT looks at fixed income and some of the key players and strategies in the market:

"The resources and infrastructure required means that yield curve hedge funds tend to exist inside banks and the largest asset management firms. In Europe, well-known credit exponents include Trafalgar Asset Managers and BlueBay Asset Management, while yield curve funds include Brevan Howard, Moore Capital, Comac Capital and Prologue Capital."

ESM and seniority

FT.com / Capital Markets - Eurozone bonds face boycott by investors: "Standard & Poor’s, the US credit ratings agency, warned earlier this month that any country borrowing from the ESM could face further ratings downgrades because of the seniority issue."

Global credit gaUge

The FT.com reports on international measures to increase required capital ratios if credit growth breaches a threashold.

"The agreement drew strong support from around the world despite predictions that regulators would be unable to come up with a common definition for bubbles. The deal uses the ratio of credit-to-GDP as its basic measure. But regulators can use other metrics, provided they make their reasoning public"

Merrill and the CDOs

How Merrill Lynch Traders Helped Blow Up Their Own Firm - ProPublica: "By the middle of 2006, the Merrill traders who bought mortgage securities were often clashing with the powerful division, run by Harin De Silva and Ken Margolis, which created and sold the CDOs. At least three traders began to refuse to buy CDO pieces created by De Silva and Margolis' division, according to several former Merrill employees. (De Silva and Margolis didn't respond to requests for comment.)"

John Maynard Keynes - A great investor

John Maynard Keynes - A great investor:

"John Maynard Keynes started off as a currency trader, moving to commodities a bit later on. He attempted to invest based on macroeconomic predictions—keep in mind that he was an economist—and it didn't exactly work out in the short run. I didn't quote the rest of the article but Keynes appears to have broke even later on but this was definitely a painful start."

Transaction banking

The FT looks at transaction banking:

"Few universal banks split out their transaction banking performance. But Deutsche Bank, for example, recorded transaction banking pre-tax profits of €1.1bn in 2008, up 17 per cent and equivalent to an ROE of 108 per cent. Though the number slipped back – to €776m – in 2009, that relatively stable performance contrasts with the investment banking result, which was €7.4bn in the red in 2008, thanks to the toxic asset fall-out from the financial crisis, and then €4.3bn in the black again last year."

UK Irish exposure

Ireland: a danger zone for banks:

"Settlements estimates that UK lenders account for almost 30 per cent of European banks’ total $509bn exposure to Ireland. RBS and Lloyds, both partially state-owned, have taken the most Irish pain, falling by about 8 and 9 per cent respectively over the past week before regaining some ground on Tuesday"

Negative basis in Ireland

FT Alphaville looks at the movement of Irish bonds vs CDS. In this case the bond market is leading the CDS as selling of bonds (to raise, or prevent the need to post, collateral at LCH) has been the main factor behind the move. Usually, it is the more liquid CDS that makes the move.

"Ireland joined Greece this week in the negative basis club. That is, the five-year asset swap spread for Ireland outpaced movement in equivalent credit default swaps. So (in basic terms) spreads in the CDS market were trading lower than in the cash market for Ireland."

German banks and Basel 2

FT.com "It is also a somewhat disturbing paradox that such a successful manufacturing economy remains reliant on such a fragile banking sector. Indeed, of the 44 European banks that have had recourse to state support in the latest crisis, by far the biggest number have been based in Germany, with 13 banks, followed by the UK and Belgium with five cases each"

Allocation of education

Stefan Collini discusses education reform. The bottom line, he says, is

"We can have the money for a national system of higher education distributed either in accordance with the tastes of 18-year-olds or in accordance with the tastes of a group of older people in London: there’s no other way to do it."

but does not propose an alternative. How else can education be allocated?

Private equity

Malcolm Gladwell looks at private equity and the the rescue of General Motors : The New Yorker:

"That seems about right: car companies stand or fall, ultimately, on the strength of their product, and teaching a giant company how to build a quality car again is something that can’t be done on the private-equity timetable. The problem is that no private-equity manager wants to be thought of as a mere financial engineer."

You can't buck the market

The FT Alphaville looks at the real appreciation of the Chinese currency from the increase in inflation rather than the nominal appreciation. This is a forgotten channel and one that is exacerbated by the intervention to hold the rate stable. There may be ways of sterilising in a controlled economy but it is likely that the underlying pressure will emerge in some way.

"We’ll quickly note that the Fed’s expected QE2 measures will, if successful in bringing about inflationary pressures, further add to the pressure on China to appreciate."

Alphavile argues that these inflationary pressures will increase the pressure on the Chinese authorities.

Marginal Revolution: Classical economics reading list

Marginal Revolution: Classical economics reading list:

1) Smith

2) Hume

3) Ricardo

4) Early marginalists

5) Malthus

6) Edinburgh Review

7) Mill

8) Marx

The Economist: Junk Bonds

Drexel Burnham Lambert's legacy: Stars of the junkyard | The Economist: "Junk bonds, once despised, are now mainstream. “Milken and Drexel took high-yield bonds from a cottage industry to one of the cornerstones of the financial industry,” says Howard Marks, one of Mr Milken’s early customers and now chairman of Oaktree, a Los Angeles firm that manages around $75 billion in funds, much of it in high-yield bonds and related investments."

Before the bank

Pepy's Diary 10th October 1667. Trying to find the gold that he buried at his father's house in the country.

And he being gone, and what company there was, my father and I, with a dark lantern; it being now night, into the garden with my wife, and there went about our great work to dig up my gold. But, Lord! what a tosse I was for some time in, that they could not justly tell where it was; that I begun heartily to sweat, and be angry, that they should not agree better upon the place, and at last to fear that it was gone but by and by poking with a spit, we found it, and then begun with a spudd to lift up the ground. But, good God! to see how sillily they did it, not half a foot under ground, and in the sight of the world from a hundred places, if any body by accident were near hand, and within sight of a neighbour’s window, and their hearing also, being close by: only my father says that he saw them all gone to church before he begun the work, when he laid the money, but that do not excuse it to me. But I was out of my wits almost, and the more from that, upon my lifting up the earth with the spudd, I did discern that I had scattered the pieces of gold round about the ground among the grass and loose earth; and taking up the iron head-pieces wherein they were put, I perceive the earth was got among the gold, and wet, so that the bags were all rotten, and all the notes, that I could not tell what in the world to say to it, not knowing how to judge what was wanting, or what had been lost by Gibson in his coming down: which, all put together, did make me mad; and at last was forced to take up the head-pieces, dirt and all, and as many of the scattered pieces as I could with the dirt discern by the candlelight, and carry them up into my brother’s chamber, and there locke them up till I had eat a little supper: and then, all people going to bed, W. Hewer and I did all alone, with several pails of water and basins, at last wash the dirt off of the pieces, and parted the pieces and the dirt, and then begun to tell [them]; and by a note which I had of the value of the whole in my pocket, do find that there was short above a hundred pieces, which did make me mad; and considering that the neighbour’s house was so near that we could not suppose we could speak one to another in the garden at the place where the gold lay — especially my father being deaf — but they must know what we had been doing on, I feared that they might in the night come and gather some pieces and prevent us the next morning; so W. Hewer and I out again about midnight, for it was now grown so late, and there by candlelight did make shift to gather forty-five pieces more. And so in, and to cleanse them: and by this time it was past two in the morning; and so to bed, with my mind pretty quiet to think that I have recovered so many. And then to bed, and I lay in the trundle-bed, the girl being gone to bed to my wife, and there lay in some disquiet all night, telling of the clock till it was daylight.

Internalising

FT Alphaville discusses the internalising of equity market in large investment banks. This means that the bank nets the buy and sell orders and sends the balance to the exchange.

"As for the proportion of trading conducted this way? According to the last stats seen by FT Alphaville, something like 31 per cent of all US equity orders were being internalised as of January, 2010."

Networks and liquidity

David Warsh points us to Paul David and an essay on the "flash crash". The end to open outcry may have some effects that allow the transmission of shock or 'catastrophe beyond what would previously have been the case. It is a story of fragmented liquidity and an end to face-to-face dealing.

Still, if it’s the crash itself that is of interest, you’ll do better reading the SEC report. It is the larger dimension of the signal that interests David. He invokes the work of French mathematician René Thom, inventor in the 1970s of a formal mathematics of sudden shifts, of qualitative breaks or discontinuities, that he called catastrophes. “To appreciate that quality it is helpful to start from the mathematical rather than the ordinary language meanings conveyed the term,” David writes.

A commonplace physical illustration of a “catastrophic event” – in this formal sense of the term — may be experienced by letting your finger trace the surface of a draped fabric until it reaches a point where the surface (the “manifold” as mathematicians would speak of the shawl or cloak’s three-dimensional surface) has folded under itself; there gravity will cause your finger’s point of contact to drop precipitously from the surface along which it was traveling smoothly – to land upon the lower level of the drapery beyond the fold. That little passage is the “catastrophe.” In the present context, what is especially relevant about this conceptualization of the “event” experienced by your finger is its generic nature: catastrophes thus conceived are not phenomena belonging to a category delimited by some size dimension of the system in which they occur, or according to the severity of their sequelae; nor are they to be uniquely associated with processes that that operate only in one or another range of temporal velocities (whether slow, or fast). Instead, the catastrophes to which this essay’s title refers are fractal, possessing the property of self-similarity.

Similar to what? He compares the conditions that led to the May 6 price break to the phenomenon known as “flaming.” One party breaks off a previously civil exchange with hostile abusive comment. Instead of turning it aside, others sometimes reciprocate. Anonymity is the key part of the process; isolation seems to remove inhibitions that would brake the process if the exchanges took place face to face. Silence ensues, or, worse yet, digital versions of what long ago were called “slam books” – compendia of the faults of others, sufficient to fragment the conversation once and for all. (This is the problem with Glen Beck and much of the rest of Fox News.)

Humans evolved to recognize from infancy the effect of their actions on others – facial expressions, body language, tone of voice, he notes. On the Internet, however, no one knows when they may come across as a flame-throwing tank. It is why humor is so risky on the Web.

Exchange traded fx products

FT.com discusses the lack of growth in ETP in the FX space. However, there is an interesting product from Deutsche Bank that tries to combine three basic strategies. One case study could try to set the rules for such a product.

"For investors who do not want to take simple long/short positions, an alternative tactical approach to foreign exchange markets is offered by Deutsche Bank and its db x-trackers currency returns ETF. This combines three strategies widely used by traders in currency markets: carry, momentum and valuation. Like a quantitative hedge fund, it uses a rules-based process to take long and short positions in G10 currencies with regular rebalancing of the components."

Market or command

A comparison of social network and command as a means of organisation.

In a new book called “The Dragonfly Effect: Quick, Effective, and Powerful Ways to Use Social Media to Drive Social Change,” the business consultant Andy Smith and the Stanford Business School professor Jennifer Aaker tell the story of Sameer Bhatia, a young Silicon Valley entrepreneur who came down with acute myelogenous leukemia. It’s a perfect illustration of social media’s strengths. Bhatia needed a bone-marrow transplant, but he could not find a match among his relatives and friends. The odds were best with a donor of his ethnicity, and there were few South Asians in the national bone-marrow database. So Bhatia’s business partner sent out an e-mail explaining Bhatia’s plight to more than four hundred of their acquaintances, who forwarded the e-mail to their personal contacts; Facebook pages and YouTube videos were devoted to the Help Sameer campaign. Eventually, nearly twenty-five thousand new people were registered in the bone-marrow database, and Bhatia found a match.

The broad theme is that command is necessary for real, serious, important and difficult tasks; social networks are broader, more creative and more trivial.

Commodity fund

All About Alpha investigates commodity funds.

Because of the capital costs of holding commodities directly, investing is almost exclusively done using futures (exceptions include commodity producers, consumers, etc.) Commodity indices, ETFs, ETNs and mutual funds manage their portfolios very similarly when using futures contracts. For the most part, they construct the portfolio by purchasing near-dated futures contracts. As the contracts near maturity, they sell the contract at or near the spot price of the commodity and purchase new near-dated contracts and the process repeats itself. The frequency and magnitude of this roll leads to the importance of the yield it generates.

Unfortunately, investing in commodity futures contracts can be complicated since total returns are comprised of three return components:

• Collateral Yield: Futures contracts require very little collateralization (~10%). The remainder is frequently invested in high-quality, short-term instruments such as a 90-Day T-Bill. The yield from these investments is often very small relative to the total return and is known as the collateral yield.

• Spot Price Change/Yield: This represents the price change in the underlying commodity contract and is often quoted during a discussion of a commodity’s return. Investors are usually seeking exposure to these returns when choosing to invest in commodities.

• Roll Yield: This component of return is the focal point of the recent articles and is a little more complicated. Commodity investors (e.g. indices, funds, etc.) tend to buy near-dated contracts (e.g. 1-month from expiration) and sell them just prior to settlement. The revenue generated is immediately used to purchase another near-dated contract to maintain exposure to the commodity. This process continues indefinitely and represents the roll yield (sale price less purchase price). If the subsequent purchase cost is less than the revenue gained from the sale, then the roll yield is positive; if the sale prices is less than the purchase price the roll yield is negative. A positive roll yield is referred to as backwardation while a negative yield is called contango.

Information

Ben Bernanke looks at what the financial crisis means for economics. In the middle of this there is an overview of information and expectations under uncertainty.

Most fundamentally, and perhaps most challenging for researchers, the crisis should motivate economists to think further about their modeling of human behavior. Most economic researchers continue to work within the classical paradigm that assumes rational, self-interested behavior and the maximization of "expected utility"--a framework based on a formal description of risky situations and a theory of individual choice that has been very useful through its integration of economics, statistics, and decision theory.⁹ An important assumption of that framework is that, in making decisions under uncertainty, economic agents can assign meaningful probabilities to alternative outcomes. However, during the worst phase of the financial crisis, many economic actors--including investors, employers, and consumers--metaphorically threw up their hands and admitted that, given the extreme and, in some ways, unprecedented nature of the crisis, they did not know what they did not know. Or, as Donald Rumsfeld might have put it, there were too many "unknown unknowns." The profound uncertainty associated with the "unknown unknowns" during the crisis resulted in panicky selling by investors, sharp cuts in payrolls by employers, and significant increases in households' precautionary saving.

The idea that, at certain times, decisionmakers simply cannot assign meaningful probabilities to alternative outcomes--indeed, cannot even think of all the possible outcomes--is known as Knightian uncertainty, after the economist Frank Knight who discussed the idea in the 1920s. Although economists and psychologists have long recognized the challenges such ambiguity presents and have analyzed the distinction between risk aversion and ambiguity aversion, much of this work has been abstract and relatively little progress has been made in describing and predicting the behavior of human beings under circumstances in which their knowledge and experience provide little useful information.¹⁰ Research in this area could aid our understanding of crises and other extreme situations. I suspect that progress will require careful empirical research with attention to psychological as well as economic factors.

This can be tied to the modelling of expectations in the UIP model. There may be a non-linear model that is distributed with a negative skew and kurtosis in regular times and collapses into something binary in a crisis.

Not poisoned but starved

Gary Wenk speaks about "brain food" and the way that the shared ancestory of ourselves and plants makes components of our food most effective in affecting our bodies and minds. Amidst this:

No, he does not die, because his species and that of the creature on this foreign planet do not share an evolutionary past or a common ancestor. Although they may both be made of proteins formed from amino acids, their independent evolutionary paths should made it highly improbable that they use similar neurotransmitter molecules within their respective brains and bodies. Every spaceman from Flash Gordon to Captain Kirk to Luke Skywalker should feel safe walking around any planet (except their own) with impunity from animal and plant toxins. For this same reason, the intoxicating drinks and powerful medicines that always seem to be popular in these foreign worlds in science fiction movies would also have totally different effects, if any effects at all, on the brains of our plucky spaceman. Eating otherworldly foods might be the most disappointing and distressing experience of all: Even if they were filling and somehow tasted delicious, as products of utterly alien biochemistries they would probably prove devoid of nourishment for our Earthly bodies. Thus, starvation might be the greatest threat to any future explorers of alien biospheres. Unless, perhaps, they’d brought along a large supply of chocolate.

Risk

Another look at the nature of risk in the coverage of EMH in the FT.

Second is the pro-cyclical nature of value-at-risk, a measure of the risk of loss. Recent high market volatility is sharpening attention towards risk and the need to measure and manage it. At the same time, rapid financial innovation has increased the ability to monitor and control risks, allowing measures like Var to gain further ground. This would all be good news, if the markets were using the right type of Var for establishing the risk limits.

Generally, when prices move down, Var goes up, eventually triggering the risk limits and thus enlarging the troops of sellers. Symmetrically, the reduction of Var in good times encourages traders and fund managers to pile on risk, increasing their risk exposures when prices are already high and while demand is thriving. This can compound the positive feedback mentioned earlier.

The interesting thing here is the way that a period of low volatility will provide a sample of low volatility and increased risk taking. Increased volatility leads to less risk taking. Can we model this?

Mobile phone and microfinance

Amidst a discussion of mobile phones in Kenya in the Guardian, the possibility that microfinance improvements may also be seen.

Besides enabling millions of people to easily communicate over distance for the first time, the mobile phone has spurred a host of other life-improving innovations, including a money transfer service that allows people to send cash instantly across the country via text message.

Washington Consensus

Interesting! I had never seen this before.

From Ronald McKinnon.

John Williamson (1990) did all a great favor by writing down the rules for what he called “The Washington Consensus” for developing countries to follow to absorb aid efficiently:

1. Fiscal policy discipline.
2. Redirection of public spending from subsidies (“especially in discriminate subsidies” toward broad-based provision of key pro-growth, pro-poor services like primary education, primary health care, and infrastructure;
3. Tax Reform—broadening the tax base and adopting moderate marginal tax rates:
4. Interest rates that are market determined and positive (but moderate) in real terms;
5. Competitive exchange rates;
6. Trade liberalization—with particular emphasis on the elimination of quantitative restrictions; any trade protection to be provided by low and relatively uniform tariffs;
7. Liberalization of inward foreign direct investment;
8. Privatization of state enterprises;
9. Deregulation—abolish regulations that impede market entry or restrict competition, except for those justified on safety, environmental and consumer protection grounds, and prudent oversight of financial institutions.
10. Legal security for property rights.

To provide perspective on these ten rules, the year 1990, when Williamson wrote, is important. It was just after the fall of the Berlin Wall and the complete collapse of confidence in Soviet-style socialism. The rules reflect the hegemonic confidence that most people then had in liberal market-oriented capitalism—think Ronald Reagan and Margaret Thatcher. But, 20 years later, should the meteoric rise of socialist China—both in its own remarkable growth in living standards, and in the effectiveness of its foreign “aid” to developing countries, undermine our confidence in Williamson’s Washington Consensus?

Copyright and competition

De Spiegel discusses work by Wolfgang Menzel that suggests that an absence of copy right in Germany was responsible for a flourishing of ideas. In contrast to England, where copyright laws kept monopoly power over ideas and prevented competition, in Germany there was an outpouring of non-fiction publishing. German publishers reacted to their inability to enforce their rights by using price discrimination to cover the market.

In Germany during the same period, publishers had plagiarizers -- who could reprint each new publication and sell it cheaply without fear of punishment -- breathing down their necks. Successful publishers were the ones who took a sophisticated approach in reaction to these copycats and devised a form of publication still common today, issuing fancy editions for their wealthy customers and low-priced paperbacks for the masses.

European money markets

Some interesting comments on the state of the money market in Europe. It appears that things remain very tight and that collateral is increasingly demanded.

What Comotto emphasises, however, is that while that trend may have begun as far back as the 1990s, the recent European crisis has now nearly completely vaporised what little unsecured interbank lending was left in the market. What’s more, the demand for tri-party transactions — where collateral is managed by a custodian rather than bilaterally — has almost doubled from less than 25 per cent before the Lehman crisis to almost 50 per cent since.

This is from Richard Comotto of the European repo market, quoted in the FT's Alphaville. There is a lot more interesting information on the repo and money markets. //

Power law and SMEs

More evidence of a power law.

The National Endowment for Science, Technology and the Arts, an independent trade body, calculates that just 6 per cent of the highest growth businesses generated 54 per cent of new jobs over the last decade.

This is important because it means that it is a few high quality SME creations that generate all the social benefit as well as the profit. More from the Financial Times Lex column,

Changes in microsctures

Raijiv Sethi raises the idea that increased focus on algorithmic trading is removing the support for smaller size capitalisation and reducing the number of public limited companies.

In addition, stock market structure today is geared for large‐capitalization stocks with typically symmetrical order books but disastrous for the vast majority of small‐capitalization stocks with asymmetrical order books (where there is not naturally an offsetting buy order to match against a sell order and vice versa)... The “Flash Crash” was an example of where even normally liquid securities went to a state of “asymmetry” and price discovery broke down...

[Until] all trades, quotes and other messages in all interrelated markets are tagged and traceable to the trading venue, broker and ultimate investor, and disclosed to the market, markets will not be perceived as fair... With full tagging, tracking and reporting and the application of posttrade analysis and test bed techniques such as Agent‐Based Models, regulators and market participants will... once and for all be in a position to judge the impact of other participants and to regulate and plan accordingly...

Liquidity Preference

Keynes:

Because... our desire to hold Money as a store of wealth is a barometer of the degree of our distrust of our own calculations and conventions concerning the future.... The significance of this characteristic of money has usually been overlooked; and in so far as it has been noticed, the essential nature of the phenomenon has been misdescribed. For what has attracted attention has been the quantity of money which has been hoarded... supposed to have a direct proportionate effect on the price level through affecting the velocity of circulation. But the quantity of hoards can only be altered either if the total quantity of money is changed or if the quantity of current money income (I speak broadly) is changed; whereas fluctuations in the degree of confidence are capable of... modifying... the premium which has to be offered to induce people not to hoard. And changes in... liquidity preference... affect, not [consumer] prices, but the rate of interest.

Keynes and uncertainty

Keynes in the 1937 Journal of Economics take another look at uncertainty.

By ‘uncertain’ knowledge, let me explain, I do not mean merely to distinguish what is known for certain from what is only probable. The game of roulette is not subject, in this sense, to uncertainty; nor is the prospect of a Victory bond being drawn. Or, again, the expectation of life is only slightly uncertain.... The sense in which I am using the term is that in which the prospect of an European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolescence of a new invention, or the position of private wealth-owners in the social system in 1970. About these matters their is no scientific basis on which to form any calculable probability whatever. We simply do not know. Nevertheless, the necessity for action and for decision compels us as practical men to do our best to overlook this awkward fact and to behave exactly as we should if we had behind us a good Benthamite calculation.... How do we manage?... (1) We assume that the present is a much more serviceable guide to the future than a candid examination of past experience would show it.... (2) We assume that the existing state of opinion as expressed in prices and the character of existing output is based on a correct summing up of future prospects.... (3) Knowing that our individual judgment is worthless, we endeavour to fall back on the judgment of the rest of the world which is perhaps better informed....

The key here seems to be a vague and embryonic outline of some of the ideas of behavioural finance. How do we deal with uncertainty when there is no basis to make an estimate of probabilities? What short-cuts can the mind use to deal with these issues? One of the things that Keynes suggests here and the The General Theory is the idea that we assume that things will be rather similar to how they have been in the past. This is probably a reasonable starting point. It is conservatism. Another thing that Keynes suggests is that we look to the opinion of others. Here we get the basis for a social construction of belief.

Market making or trading

There is a lot post on the FT's Alphaville looking at the position of Jerome Kerviel. There is a blurring of the distinction between market-maker and proprietary trader. The fact that cash positions were carried over from one day to the next is taken as a sign that there was more than just market-making going on.

Run on the bank

Pepy's diary 13th June 1667, in the wake of the Dutch attack on Chatam:

I presently resolved of my father’s and wife’s going into the country; and, at two hours’ warning, they did go by the coach this day, with about 1300l.in gold in their night-bag. Pray God give them good passage, and good care to hide it when they come home! but my heart is full of fear: They gone, I continued in fright and fear what to do with the rest. W. Hewer hath been at the banker’s, and hath got 500l. out of Backewell’s hands of his own money; but they are so called upon that they will be all broke, hundreds coming to them for money: and their answer is, “It is payable at twenty days — when the days are out, we will pay you;” and those that are not so, they make tell over their money, and make their bags false, on purpose to give cause to retell it, and so spend time. I cannot have my 200 pieces of gold again for silver, all being bought up last night that were to be had, and sold for 24 and 25s. a-piece.

Power law

O2 indicate that the use of bandwidth is partly determined by a power law.

More here from the Guardian.

Instead, it said that a tiny number – just 1% 0.1% (corrected: incorrect figure given by O2 initially) of smartphone users – are using 36% of its total mobile data traffic, and that they needed to be encouraged to change their behaviour.

Identity economics

George Akerlof and Rachel Kranton's identity economics is reviewed by Whimsley.