History, economics, politics etc.

PISA from Shanghai, part 2

2011-01-01T03:51:00.000-08:00

Standardization

How many people can make a tastier hamburger than McDonalds? How about making a million of them and guarantee every single of them Ok, not good, just Ok?

The good thing about McDonalds is whenever you walk into a McDonald restaurant in Berlin, Delhi or Beijing, and buy a big Mac, it tastes the same. The bad thing about McDonalds is whenever you walk into a McDonald restaurant in Berlin, Delhi or Beijing and buy a big Mac, well, it tastes the same. The secret of scalability in management is standardization. You can be the best hamburger maker in the world or you never put your finger on a hamburger in your life. McDonalds don't care. If you are making hamburgers for McDonalds, you have to do is to follow their standardized recipe. This is probably not the best way to make state of art hamburgers, but it’s the only way to make a large amount of hamburgers of stable quality.

Most Chinese students are using standard textbooks, studying standard curriculum and taking standard examinations. There are many advantages of this. Standard textbooks make teachers' work easier. When people do something again and again, they tend to do it better and better. Do does teaching. The whole point of specialization is that when people are specialized on something they will do a lot better than when they have to deal with a lot of things at the same time. It makes evaluations of teachers, students and principles' performances easier. It arguably makes students' competition fairer. How well you do in the examination are more important than how well you are connected or how how much those who give you scores like you. In China, the combination of standardized education, large population and limited higher education opportunities created immense pressures on schools and students to improve their performances in examinations.

In America schools, standardization seems to be something everybody wants to avoid. Education researchers don't want it, because it will leave them no space for researches. Teachers don't like it, because it means their performance will be compared with other teachers. Students don't like it because it means more homework. I'm afraind it's probably a necessary evil that nobody likes. For example, the charter schools are often considered new hopes by many. In a recent research, CMO leaders complained attaining scale with consistent quality and without standardization, a challenge(Section 5, I'd rather call it an impossibility).

There are of course many disadvantages, the most important of which, it kills innovation. What is innovation really? For individuals, innovation is all about talent, but for societies, innovation is all about diversity. Think of a thought experiment. There are two groups of people searching for something in an unknown territory. Both of them have 10 people. One group demands everybody must stay together no matter what happened. The other encourage everybody out there to do their own search. Which group is more likely to find their target? It actually depends. If no special obstacle exists, I'd bet it's the group gives its member more freedom. America is a much more diversified society than China. That's why America is a great source of all kinds of innovations from pop music to physics.

But the purpose of education, at least basic education, is not for innovation. Every now and then an American high school student will do some works that can put mose graduate students to shame, but the average standard of secondary education is something deplorable for a developed country. Kant believed education was for the mediocre. The geniuses can find their own ways. The idiots are hopeless. The target of education should be to give the horde in the middle enough knowledge for a job in the modern society. Besides, anybody really believes when given total freedom most high school students will spend their time on finding new ways of doing math? Some of them will, probably only 2-3% according to some research. For these students a standard education is a total waste of time. They have a natural desire for knowledge. It's better to leave them alone. They will turn out something amazing in time. Dragging them through a standard education only put out their natural desire for knowledge. The point is education and innovation are two different games. If you have ten researchers, one of them made breaking through contributions, it’s a great success. If you have ten grade school students, only one of them can do long divide, it’s a disaster.

PISA from Shanghai, part 1

2010-12-23T19:44:00.001-08:00

Students from Shanghai scored No.1 in PISA tests. While this result seemed to cause a sensation in other countries, it creates a wave of criticism in China. A typical online comment in China is something like, 'So Chinese are good at examinations. What's new? When will we have a Nobel prize winner(in science), or a Bill Gates or a Steve Jobs?'

This is not exactly a news for people who are familliar with China's school system. Mr. Finn was very very mistaken when he said, 'if they can do this in Shanghai in 2009, they can do it in 10 cities in 2019, and in 50 cities by 2029.'

Shanghai and Beijing students are by no means representatives of all Chinese students. They are considered underperforming 'spoiled' kids. Because of the state's policy favor, students from Shanghai and Beijing can get into colleges much easier than the rest of the country, which raised calls of unfairness every year. While Shanghai has her own examination system, Beijing students, who join the nation wide college entrance examinations, are usually outdone by students from other provinces by a margin of 50 to 100 points on a scale of 750. It might be a great underestimate to say there are at least 50 cities that can outdo Shanghai in PISA tests right now.

On the other hand, in spite of the stellar performance of Shanghai high school students, most Chinese seem to be underwhelmed. Some education researchers go as far as to say the high scores are a testimony of China's education reform failure. China's high schools have been long criticized for being too examination oriented and neglecting overall development of students. An example often cited is the IMO, International Mathematical Olympiad. Chinese high school students have been dominating IMO since joining the competition in 1985, with 15 team championships and more than 100 gold medals. While in developed countries, many of those young IMO gold medalists have become ground breaking mathematicians and scientists, including 2 Nobel price winners and 7 Fields price(often called Nobel in math) winners, few of China's gold medalists can brag even a moderate academic achievement so far. In fact, many of them are not in even in the field of science and math anymore. When Terence Tao, an Australian Chinese and also a former IMO gold medalist, won the Fields price three years ago, the question was raised again: What's wrong with China's school system?

Well, I think China is probably being blessed and cursed by the same thing, standardization. But before we move on to the controversial topic of standardization in education, I want to address a commonly held misconception, at least in elementary level math.

Understanding is overrated

Von Neumann, the inventor of modern computer, once said 'in mathematics, you don't understand things, you just get used to them.'

After all, what's the meaning of understanding? People use abstract concepts to understand specific concepts, not the other way around. When someone tells me something like 'three apples', I must have these abstract concepts like, three and apple ready in my mind to understand what he's saying. The point is you use abstract concepts like 'three' to understand more specific concepts like 'three apples'. You don't use more specific concepts like 'three apples' to understand abstract concepts like 'three'. It is said some native Australians don't have concepts of numbers above three. If you take away 1 stone out of 5 behind them they would notice there are less stones, but they wouldn't know how much less.

Understanding abstract concepts is difficult. That's why math is difficult. It took human thousands of years to abstract the concept of three away from 'three apples', 'three stones' or 'three xxx'. Every small step towards a higher level of generalization in mathematics took human hundreds of years or hundreds of mathematicians' work. You might wonder how difficult it is to invent concepts like zero and negative numbers. The truth is most great Greek mathematicians didn't understand them. How difficult can it be to understand an equation can be made of alphabets not numbers? Well, the lack of algebra, which is invented by Arabians, is considered one of the most important reasons why calculus didn't develop in China. Adults use these concepts like numbers, multiply and divide freely, but we shouldn't forget how hard it was when we were kids, trying to learn them. (Well, most of us.)

The objective of elementary school math should be to hard wire these abstract concepts into children's head until they can use them freely without much effort. The only way to do that is through a large amount of repetition. Call it rote learning if you want to. It is the method used by most people in history and it works. In fact, it's the only method of learning fundamental skills in almost every field. I remember a football coach once said, 'Football is all about fundamentals and hard work.' Now try to tell a football coach he shouldn't let his players do too much passing or footwork or a basketball coach he shouldn't let his players do too much shooting, because that's rote learning!

Of all reasons often cited for the decline of math education in America, I think the lack of training intensity is the most direct one. Teachers and parents are important, but do you really need a college math degree to teach long divide? All a kid needs is a disciplined classroom and some homework time without TVs and video games. Sometimes, I can't help to think American schools can probably do a better job if they let their football coaches to teach math classes, seriously.

SCIENCE & ISLAM 1/6 | The language of science العلم والإسلام

2010-12-10T20:23:00.000-08:00

Islamic Science

2010-12-10T20:18:00.000-08:00

I'm reposting an old post from CHF here.
This is a 3 episode BBC documentary on Islamic science between 8th and 14th century. It's available on youtube now. I'm not someone total blind to the great scientific development of this time period, but there are still plenty of eye openers.

The first on Islamic contribution of arithmetic and algebra, esp the contribution of al-Khwarizmi. 'The common perception of the period of 1000 years or so between the ancient Greeks and the European Renaissance is that little happened in the world of mathematics except that some Arabic translations of Greek texts were made which preserved the Greek learning so that it was available to the Europeans at the beginning of the sixteenth century.' Few mathematical historians hold that view now. If one really wants to appreciate the importance of arithmetic and Arabian numbers, he just has to do 132 * 154 in Roman numerals for once. It's not fun! But more importantly, al-Khwarizmi and his followers systematically apply arithmetic to algebra, algebra to arithmetic, both to trigonometry, algebra to the Euclidean theory of numbers, algebra to geometry, and geometry to algebra. Thus started many mathematical research directions that later continued in Europe.
http://www-history.mcs.st-and.ac.uk/HistTopics/Arabic_mathematics.html

It's only by comparing the development of mathematics in China, that we can fully appreciate why these Islamic contributions were critical.

The second was about medicine and physics. Ibn al-Haytham and his Book of Optics were the star. He was the first person to apply mathematics to physics research and verify his theory with systematic repeatable experiments. I think Ibn al-Haytham should be called the first scientist in every sense of the word.

The most interesting discovery of the third episode was Copernicus owed a lot of his revolutionary idea to the Arabian astronomers. De Revolutionibus Orbium Celestium gavve outward reference to Al-Battani's observational data in his Book of Stars. There are also clues that Copernicus also used other Arabian resources, like the Tusi couples. The diagram in Revolutionibus was almost identical to another diagram in Al-Tusi's Tadhkirah Al-Hay Fi'ilm Sl-hay'ah. The similarity was down to letters, like both used D at the center of circle. His idea about planetary motion was also remarkably similar to that of a 14th century Syrian called Ibn Al-Shatir. Ibn al-Haytham was also the first to doubt Ptolemy's equant idea. It's fair to say Copernicus' work was built on several centuries work of Arabian astronomers.

One of the reasons of the great development of Islamic science was their geological location. The Arabian Empire was in a unique position to be adjacent to all major civilizations of the time. That includes Greece, India, Persia and China. So the Islamic scientists were in a unique position to integrate and generalize the scientific knowledge of these civilizations. There are still debates about whether these developments should be called a scientific revolution. First of all, I don't think it was proper to divide science development as pre and post scientific revolution. Which invention was more revolutionary? Calculus, algebra, or digital numbers? It's difficult to say. Second, I don't think there is a scientific method. It was more a matter of money IMO. Many Chinese physics students studied theoretical physics or mathematics in China but became experimental physicist after they went to the States. Is it because they couldn't have the ideas when they were back in China? I think more likely after they went to the states they got the physical conditions necessary.

Political economy and globalization

2010-11-23T06:11:00.000-08:00

Before we continue to talk about the economics, let’s first talk about politics. Politics and economics are never separated in the real world, because making more money is only half of the economy. How to divide the money is the other half, and that’s decided by politics.

This was supposed to be obvious by classical economists like Adam Smith and Ricardo, but somehow this connection was forgotten by neoclassical economists. Just another example the neoclassical economists liked to throw out everything that doesn’t suit their mathematical models, even though their use of mathematics often made Newton and Leibniz turned in their graves.

For example, economists generally believe globalization is good for American economy. But talk to anybody on the street, it’s difficult to find somebody still pro-globalization now. What’s the best way to understand what’s happening in America now? The rise of Tea Party, the anti-globalization movement, the currency and trade conflicts with China etc. I said in another post a while ago, that this is all about employment. I’m sorry. I made a mistake. This is not even about employment anymore. American voters are so angry, they just want to slash the fat cats until they know better now.

Globalization is about making a bigger pie, but it doesn’t guarantee everybody getting a bigger piece of it. That’s what happened in America. American economy has grown 60% since 1990s, but the income of the middle and lower half of the population remained stagnant. In other words, the social contract for Americans as a whole to focus on the economic growth has been broken. The focus is now on how to divide the pie more equally. The best way to describe this is probably an old Ricardo and Marx style ‘class struggle’. And Marx is right about in a ‘class struggle’, those who seek compromise will be left in the middle and cross fired, even when it’s the best place for the whole.

If you have been following my discussion with brightness, you are probably familiar with my description of this kind of collaboration break-down as deadlocks. A deadlock is a situation wherein two or more competing parties are each waiting for the other to give in, and thus neither ever does. To continue the imaginary scene, Alice and Bob are having a dinner. Unfortunately, Alice has only a knife and Bob has only a fork. Neither of them can eat until one of them gives up what he/she has, but neither of them will, because once he/she gives up what he posses to the other the other (Alice gives her knife to Bob!), the other one(Bob) will eat all the food. That’s the best strategy for both of them because even though they don’t get to eat anything, at least the other party won’t get anything either. But if a stranger comes by at the time and threatens to eat the dinner, or at least they think so, the game will be changed, the no-lose strategy becomes a strategy of no win. I think that’s why you saw a rare bipartisanship in passing a bill targeting China’s currency policy.

Some economy analysts still think a trade war is impossible because it’s not good for anybody. I think they are too economy centric. Most Americans believe only big corporations benefit from the globalization now. American voters will continue to bash the big corporate fat cats until they spit out some profits. I anticipate America to close up quite a bit in the next decade or two and won’t open up again until this internal conflict resolved.

Development of bureaucracy in America

2010-11-16T06:21:00.000-08:00

"It is hard to imagine today, but a hundred years ago bureaucracy meant something positive. It connoted a rational, efficient method of organization – something to take the place of the arbitrary exercise of power by authoritarian regimes. Bureaucracy brought the same logic to government work that the assembly line brought to the factory. With the hierarchical authority and functional a specialization, they made possible the efficient undertaking of large complex tasks."

--- From "Reinventing Government : How the Entrepreneurial Spirit is Transforming the Public Sector."

This is why I like history and Wikipedia. You can engage in a theoretical debate for a million years without a conclusion. All you have to do is to turn around and do some historical research, which wiki is often the first place you go because it's written for people to read easily, everything becomes just crystal clear.

Now if we look at the history of the development of bureaucracy in U.S. The answer of the question why bureaucracy is necessary for modern government become obvious.

"Spoil system ... derived from the phrase "'to the victor belong the spoils" by New York Senator William L. Marcy.

Similar spoils systems are common in other nations that are struggling to transcend systemic clientage based on tribal organization or other kinship groups and localism in general.
...
Jackson supporters had been lavished with promises of positions in return for political support. These promises were honored by an astonishing number of removals after Jackson assumed power. Fully 919 officials were removed from government positions, amounting to near 10 percent of all government postings.
...
The hardest hit organization within the federal government proved to be the post office. The post office was the largest department in the federal government, and had even more personnel than the war department. In one year 423 postmasters were deprived of their positions, most with extensive records of good service. The new emphasis on loyalty rather than competence would have a long term negative effect on the efficiency and effectiveness of the federal government.
...
Presidents after President Andrew Jackson continued the use of the spoils system to encourage others to vote for them.
...
After the assassination of James A. Garfield by a rejected office-seeker in 1881, the calls for civil service reform intensified. The end of the spoils system at the federal level came with the passage of the Pendleton Act in 1883, which created a bipartisan Civil Service Commission to evaluate job candidates on a nonpartisan merit basis. "

This is the best explanation why corruption and cronyism wide spread in democratic countries like India, Philipine and Latin America, which sometimes called 'failed democracies'. Their failures are rather the result of lacking a civil service, which means "a branch of governmental service in which individuals are employed on the basis of professional merit as proven by competitive examinations", than democracy itself. This would also help to explain east Asian countries' economic success after WWII, but that would worth another post's content.

The still coming trade war and the game of who to blame

2010-11-14T02:32:00.000-08:00

The prospect of a currency war is overshadowing that of a trade war. The bad news is, I believe, they are both coming. Two kinds of blames are being thrown between the world's major economies. One is America, Germany, Japan blaming China for keeping Yuan artificially low. The other is China, Germany, Russia blaming America for printing too much money. I think they both duely deserve it. The bad news is, there are not much people can do about it. And this, I believe, is a result of lack of a global monetary authority.

Ever since the end of gold standard, governments have been printing money badly. I guess you can say a currency war had been going on for a while and it's just getting more attention in a bad situation. Why people want to do things bad for them. Well, while most economists agree too much liquidity is bad for the world economy as a whole. They also agree that depreciating currency will bring some recognized advantages, like encouraging exports or easing debt burden. Hence lies the dilemma, what's good for each country is bad for the world. In a situation like this, the natural tendency is for every country to pursue their best interest at others' cost, the Nash equilibrium. In fact, the Nash equilibrium is so often the solution that everybody behaves most selfishly and most shortsightedly, I'm beginning to suspect there is some kind of mathematical fact behind it.

In this post, let's concentrate on American part of the equation.

I'm not a fan of printing money to shore up the economy in the time of a recession. The recession is here for a reason and printing money generally speaking exacerbate those reasons. Not say the debts. Most Americans now, except a few die hard Keynsians, fear the bond market might collapse and 'all the dollars will fall back on us(Paul Volcker)', just like the poor Greek. But Greece is not America. They don't have oversea military bases and navies. They don't have the best universities and R&D labs. They don't have clout in international organizations like IMF. The GDP of Greece is not 1/4 of the world. For short, Greece is not the superpower and their currency is not the reserve currency. America is. Hence there is a chance that America can actually print the way out of this debt hole.

(Warning! The content of the following paragraph of this post is highly dangerous. Do not try it at home! All information provided is provided for the purpose of information only. The author makes no gurantees of any kind.)

When a person is head over heel in debt, he usually has only two choices. He can declare bankruptcy or he can start working hard to save money to pay off the debt. That's when he doesn't have a money printing machine. In the current situation, it would only be foolish if America don't print as much money as can get aways with. Surely, it's bad for the world esp for the creditor countries, but what the hell, America is in a strange situation right now. What's bad for the world is good for America and what's good for the world is bad for America. If the prospect of the world is bad, investers will flock to the treasury bond which is the only safe haven in a sinking world economy. Even if they know the dollar is also sinking, they can at least have the comfort of having each other. And this is the most important factor to keep bond interest rates low. If the world thaw, Euro will go up, commodities will go up, stock will go up. Investors will leave bond and the bond interest rate will rise. Luckily, or unluckily, this is not gonna happen any time soon.

A more practical problem, right now for America, is not if printing money is good but printing how much and how to spend it. Well, I'm not finished yet, but the time is up. See you next time!

Lazy for too long

2010-11-07T21:21:00.000-08:00

Ok. This blog has been idle for a long time. For my defense, I've been really busy recently. I have a lot in mind but little time. The third part of the RMB problem; A more organized version of the social evolution theory; The true story of Casanova, who is really someone unlike anything you heard of him; Li Yu's poems; The abyss America got into that's called health care; HSR etc etc.

Corruption and Cronyism in the Greek Crisis

2010-04-24T08:30:00.000-07:00

A report from WSJ. Tragic Flaw: Graft Feeds Greek Crisis

Some comments from the readers are real interesting too.
"As an American living in Greece, this is the first article that really sheds a light on how bad it is here with bribery and corruption! When you try and fight back or refuse to "cheat" you are labeled a coward or an idiot for not doing everything like everyone else! You are so stupid, you pay taxes, etc..."

"...Modern Greece suffers from a completely corrupt political and governance system that has been inherited and preserved from the days of the Ottoman rule. Public servants at various positions and levels (e.g. ministers, mayors, tax collectors, planning officers, doctors ... you name it) create dubious and unnecessary needs and then demand to be paid in order to fulfil them. They act as the local chief, the pasha, to whom one has to go and ask for a favour in return for a hefty price, a cash payment (yes, please use an envelope). Rousfeti: word that I believe has Turkish origins. That behaviour coupled with a naive and desperate customer and an absent legal system makes up for a lethal mix in the long run.

At some point, a brave visionary with European ideas tried to change all that but he was killed by those local chiefs and that was the end of it all.

Now, all these peculiar behaviours have solidified in a local culture as the article points out so well. The absence of an efficient legal authority has allowed for a propensity towards corruption and the creation of a warped sense of right and wrong. Politicians are sitting at the top of this enjoying complete legal immunity, endorsed by the Constitution. Do you need anything more to destroy a country?"

Instead, it's corruption that's the trouble, but this article focuses on all the ways that Greece avoids taxes. Even that is not as significant since it is only 6% more tax avoidance than other Western countries, and the IMF has helped Greece to institute plans to stop some of it. Guess what the estimate for cutting tax avoidance is? 2%. That's it. But that's not how the deficit was built...."

"...Greece needs to stop taking on huge projects and charging the credit card for them. So many public works projects, and the Olympics, and military buying planes, subs and tanks. Debt is bloated because of high value purchases that have yielded no economic returns... "

I think the lesson is an independent effective legal system is as important as democracy for the health of a society.

A Social Evolution Theory

2010-03-31T19:42:00.000-07:00

“When a rule is extremely complex, what is in conformity with it passes for irregular. Thus, one can say, in whatever manner God might have created the world, it would always have been regular and in accordance with a certain general order. But God has chosen the most perfect world, that is, the one which is at the same time the simplest in hypotheses and the richest in phenomena, as might be a line in geometry whose construction is easy and whose properties and effects are extremely remarkable and widespread."
---Leibniz, Discourse on Metaphysics, 1686.

Why should we study history? I mean, history is hopeless as a science, even more hopeless than economics. There are things very predictable in the economics. For example, you can never predict what someone will take for lunch tomorrow. Even if you get it right, it’s just pure luck unless you know him/her extremely well or tomorrow is thanksgiving. Yet it’s very easy to predict how much beef Americans will consume tomorrow. It’s something statistically stable.

History is something totally different. It can’t be put into mathematical frameworks. Nobody even tried as far as I know. Most of the time, a history theory is just an interpretation of existing resources and archeological discoveries. The most frustrating thing is whatever generalization one tried to make, there are always exceptions. In that sense, history is a science the same way zoology is a science. The purpose of studying history might be, I suppose, to find the simplest and most elegant way of interpreting historical evidences. We put things into categories and make generalizations. There are always exceptions, but we live with it when there are not better explanations.

I’m extremely fascinated by Sanders and Price’s hypothesis that agricultural productivity decides sociopolitical structure of a society. It’s a theory that societies have evolved over 6 or 7 stages: band, tribe, chiefdom, (city) state, nation, and probably civilization. Of course, the first 4 stages came from Sanders and Price’s work Mesoamerica: The Evolution of a Civilization. I added in the last three stages. It’s a social evolutionism theory. It’s a very powerful theory to explain many phenomena of Europe and Chinese history, probably Japanese history too, but when one tries to get into the details to figure out the mechanism that’s driving behind. The complexities simply exploded. I will just write down some random thoughts in this one and coming blogs, since I’m also exploring the field. Of course, you are welcome to tell me your ideas, esp if you are familiar with Indian or Middle East history.

The first thing came into mind is how it is related to the evolution of tool making materials. The traditional stone, bronze, iron, three-age system is already widely accepted. I believe we have to add two another ages or sub ages, steel and mechanization. This is more problematic than it seemed to be at a first glance. By all means, the tool making material was used implying a degree of technological sophistication. Bronze-age should have more sophisticated tools than the stone-age. Iron-age should have more sophisticated tools than the bronze-age, doesn’t it? Gee, not that simple. The bronze weapons excavated from the first emperor’s tomb was so sophisticated, many believe they were the reason of Qin’s military success over other states in spite they already had steel weapons. Though some believe the bronze was used in the tomb only because they don’t decay like the iron. I think there’s probably another reason. I think the reason might be that bronze weapons were easier to mass produce at the time. Bronze were cheaper than the iron, this might be suggested by the fact that coins were made of iron before Qin in China. Bronze metallurgy was also more mature than iron too. Maybe only bronze arrows can achieve the precision Qin army required.

Another blog about the RMB crisis

2010-02-28T20:55:00.000-08:00

The sparring around RMB is kicking into a high gear, as the US Treasury Department will have to decide whether to label China a currency manipulator and 130 US law makers are pressing for action. Maybe it’s time for me to say something more in this blog.

First of all, let’s take a look at where the problem came from. Among many reasons that caused the current economic crisis, three of them are probably the most important. These are imbalance, imbalance and imbalance.

The first imbalance is created by the Berlin Wall. The Berlin Wall kept a large part of the world resource and almost 3 billion labors out of the global market. After it fell, the capital and technology flew to these places to utilize the resources and labor there. It brings a great improvement of productivity and living stand on both sides of the. This is a long process. I don’t think we have seen half of it yet. It is believed that one of the effects of this process was the decline of American manufacturing as American manufacturing factories being outsourced to Asian countries, but I think it is more a result of the second imbalance, the one created by the fall of Bretton-Woods System.

The fall of Berlin Wall unleashed 3 billion labors in the socialist world. The fall of Bretton-Woods System unleashed money printing machines in the capitalist world. Because US dollar is the sole international reserve currency, Fed effectively had become the defacto central bank of the world. As the process of printing money is also the process of wealth redistribution, America enjoyed an unprecedented level of prosperity since the 80s even though American manufacturing had been in decline since the 70s. The productivity growth of the 90s brought by the information revolution was real, but this productivity growth was largely offset by the rising cost of health care. The dollars kept by foreigners eventually become explicit or implicit debts for America. As a result, the U.S. national debt now exceeds $12 trillion and growing fast; That doesn’t include the state and municipal government debts, which California alone was $500 billion; That also doesn’t include the personal debts either. The mortgages, car loans, student loans, credit card debts may well exceeded $10,000 per person.

The continued capital infusion into a country on this scale and over a long period will inevitably change the capital structure of the country and have many other effects. 1) The American economy became more and more centered around spending these money rather than making stuff. America continued to run a large double trade and current account deficit. The financial engineering or flipping hamburgers replaced the traditional engineering; 2) The asset bubble; 3) Strong expansion of American international corporations, because they can get capital much easier than competitor from other countries. 4) Students began to shun away from the traditional engineering jobs, because their paying expectation is simply not that good enough, at least compared to the amount of work needed. And this of course reduces the quality of math and science education. Why would a kid wants to study math and science if he/she doesn’t want to be a scientist or an engineer. And this in turn exacerbated America’s manufacturing competitive position.

All these effects happened along with the Kondratiev wave or what I called three-generation cycle and their effects emphasize each other. You can blame the greedy bankers or big corporations, but the law makers wouldn’t loosen the fiscal discipline to such a degree 30 or 40 years ago and common consumers wouldn’t borrow so much either. It’s also tempting to blame the decline of American manufacturing on China. Aren’t American factories being packed and shifted offshore to China? Not really. I like to use an analogy that there are two leagues in the manufacturing world now. Team America is playing in the major league. Players in the Major League, like Japan, Germany, South Korea, Taiwan etc, compete with things like technological innovation, brand recognition etc. Team China, on the other hand, is still playing in the Minor League in spite of all the hype. The players in the minor league, like Vietnam, Indonesia, Mexico etc, compete only for one thing, the labor cost. Team America is accusing team China for breaking the rules and they are right. Team China is playing ‘burger thy neighbor’ on other teams, in fact I think it’s more like ‘burger thyself’, but it’s not the reason team America just had a bad season, because you know what, they are not playing in the same league. China keeps an artificially low exchange rate mostly because of inner reasons, which is the third imbalance, the one created by China’s double track system.

It’s a myth that China after 30 years of reform had become a largely capitalist country. No, it’s not true. The Chinese economy is still largely state owned. The state own all the land, natural resources and 80% of the financial resources. The state owned enterprises and banks, even though often public listed now, are still hopelessly inefficient and incompetent. Some of them are making big profits, but that’s mostly because of their monopoly status sanctioned by the state. Most importantly they contribute very little to the employment compared to the private enterprises. The result of this imbalance is the glut of savings in the state owned sector and the financial repression in the private sector. It’s another myth that Chinese are saving too much. The house hold saving rate of China is 20%, which is even lower than India. The overall saving rate of China is nearly 40% and it mostly comes from the state owned enterprises. They saved too much because they don’t have much channel to invest. The private business can’t increase employment because they are starving for capital and can not enter some markets because of the government policy. The common consumers can’t spend because they don’t have much money; they need to save to buy the super expensive houses and they are afraid they might lose their jobs or get sick someday. It’s this deadlock within China that makes export the only option to increase the employment even though it’s doing Chinese economy overall a big disservice.

Sorry for this long diversion. Now back to the topic: Will the RMB appreciation help U.S. to increase employment? Not much, 1% max probably, because even if RMB appreciate 40%, America still has to import from other minor league countries. Will China raise RMB value? No way. Will the law makers in U.S. take actions no matter the Department of Commerce label China a currency manipulator(I think the chance is above 50%) or not? Yes, if not an overall tariff at least tariffs on case by case basis, which is even worse, because things will spin out of control easier that way.

The financial crisis is surely one of the most unfortunate events in a long time, since many people are suffering the financial pain of it. Yet, like they said, even the darkest thing has a bright side. From the pure economics point of view, IMO, if things continue to unravel this way, we might be going to have a once in a century opportunity to put the fundamentals(esp the interest rate) of Keynesianism to test, because it was invented to save a big crisis exactly like this 80 years ago. In fact, I believe it has been proven wrong in the 70s’ by the stagflation, but anyway, let’s make another try.

Traditionally, interest rate is considered the price of capital. Like all other prices, the price of capital is decided by its relative abundance, which is decided by saving rate. What Keynes brought into the picture is the concept of liquidity preference, which is people’s preference to hold money instead of assets like bonds. So the interest rate is not the price of capital but the price of money, which is decided by people’s liquidity preference. From here, Keynes derived conclusions dramatically different from the traditional view. 1) Saving is bad, because it reduces consumption. 2) To encourage investment, you have cut interest rate. This is the theoretical base of central banks cutting interest rate today. It’s dramatically different from the traditional view because the traditional views hold that 1) Saving is good, because it’s the source of all investment; 2) To increase investment, you have to increase interest rate because it will encourage saving.

Which theory is correct? The traditional one, I believe. The capital a society invests can come only from two resources, saving or borrowing. Ultimately, only one resource, because the money one borrows has to come from another one’s saving. Cutting interest rate, in the modern fractional reserve banking system, is just a better covered way of printing money, which is just a better covered way of taxing. Ultimately, it’s just a way of spending the savings of a society, which in turn will hurt investment and consumption.

In fact, even Keynes himself acknowledged that cutting interest rate will cause inflation in the long run, but he argued, ‘In the long run, we are all dead.’ So an important problem is how long is it exactly ‘in the long run’? We already had many examples of countries cutting interest rate to stimulate the economy, but the effects were always obfuscated by many other factors. For example, Japan had a near zero interest rate in the 90s, but they also had a high saving rate and a continued deflation. China also progressively cut interest rate in the last decade, but China also had a high saving rate and high growth rate. That’s why the American economy will be the perfect test of Keynes theory. America now has a zero saving rate, near zero interest rate and a stable CPI. That’s possible only because the continued pouring in of foreign capital mostly in the form of treasury bonds. It means, if the Fed interest rate stays stable, there will be a direct relationship between foreign capital and inflation in the U.S. If the pouring in of foreign capital stops or slow down dramatically for some reasons, the inflation will respond very fast, if not immediately. If that happens, as far as I’m concerned, the Keynes theory won’t be able to explain the phenomenon.

The tricky part is if or when will the foreign capital stop coming to America. That would bring us back to the RMB problem. Since China is the biggest buyer of treasury bonds, all other buyers are speculating what China is going to do. If China stops buying, the demand of U.S. assets will drop. As long as China is running a big trade surplus with America, China will have no other place to put the dollars. Diversification is not much a choice for China. Euro is not much better an option than the dollar. There is simply not another big enough market for all the dollars China hold. Whatever China buys, its price will immediately go off the roof. For short, China is stucked. Another concern is whether the market will lose confidence in America’s ability to compensate the bonds. I actually don’t think that’s a problem because America is functioning more like the Bank of World than a traditional sovereign debtor. It sounds incredible but it’s how the fractional reserve banking works, isn’t it? You know as a fact the bank doesn’t have enough money to pay everybody back, but it doesn’t bother you as long as there is not a bank run. If the bank is managed well enough, they can even make a profit. Even a bank run indeed happened, I’m sure governments and IMF will find a way to bail America out, because America is too big to fail for the world economy. The risk of China dumping dollars is very small too IMO, because if China really tries to do that, Chinese government will find America has much more cards to play in this game. As they said, if I owe someone a thousand dollars, I have a big problem. If I owe someone a million dollars, he has a big problem. America has the upper hand in this game. The real risk comes from if Uncle Sam will overdeal his hand. If the tariffs U.S. put on Chinese products is so high, it effectively reduces import from China. I think that’s when the inflation will start. Fed then will face the most difficult choices, to raise the interest rate or ignore the inflation. I will continue to discuss this in the next blog, because this one is getting way too long.

It's all about the employment.

2010-02-11T18:42:00.000-08:00

I remember discussing this with a friend before, that there is a big chance the US Congress will do something to China's currency this year, as long as the overhaul of the health care come to a temporary stop. President Obama had expressed his will to have 'Serious Negotiation' with China on currency.

With all these pressure, will China raise the RMB value? I'm afraid not. Not this year, not in this political climate, not even 5%. First, it's not clear what's gonna happen if China raise the RMB value. In China, most consider it a bad thing, at least in the short run. Second, political decisions are made to maximize political interests and minimize political cost. What's the benefits of a decision like appreciating RMB value at this point? If it turns out well, it's only an admission that they made a mistake in the past. If it turns out bad, that's a lot of risk. Third, the RMB problem has become so sensitive, even a 5 - 10% appreciation will signal a major policy change. I don't think they want to add expectations to this hot topic right now and I don't think any major policy change can happen in China before 2012, the 'election' year of China. Unfortunately, something has to happen for the States before 2012.

You might wonder, 'what's going on?' Isn't the cheap products from China supposedly help to keep the inflation in the States in control, and the cheap credit from China help to finance the federal deficit? Yet this isn't a problem of money anymore. This is all about the employment, for both China and US.

The unemployment rate in US had declined unexpectedly from 10% to 9.7% in January, but jobless claims rose unexpectedly last week. Honestly, this shouldn't be a surprise at all. The up and downs in the job market are the late responses to the up and downs in the treasury market. As the US has a service economy, the new jobs mostly come from government employment and service sector expansion and they are both closely related to the sales of treasury bonds.

How's the employment in China? If you believe in the State Statistics Bureau, it's 4%(It's always 4-5%), but the Chinese Academy of Social Science put it at 10% for urban unemployment. The national unemployment rate is difficult to estimate because of the surplus labor in the country. Asian Development Bank put it above 30%.

So the China-US really makes a real interesting pair. They both have a gargantuan domestic structural imbalance. They both have severe unemployment problems. China exports too much. US imports too much. And both countries see export as the most important way of job creation! Is export really the best way of job creation? Not necessarily, but it's indeed the best way without going through the painful domestic structural reform.

What will happen, if, say the US Congress pass a tariff bill on all things made in China and it also pass through the senate and White House. Will the bill have a positive effect on US employment rate? It's a tricky problem. It might depend on how high the tariff. I actually believe a 20% tariff is very favorable to US. Not that factories will move back to the States. Even a 200% tariff won't have that kind of effect. It's good simply because that's a lot of money for the federal government.

The China-America trade system is so established, a 20% tariff can't break it. If fact, though I don't have the stats, but from some stories and personal experiences, the same products sold in US is already cheaper than in China now. This probably means the system has the potential to consume a 20% tariff. Walmart's profit might drop a little. Chinese factories will work even harder. Chinese government will subsidize export even harder or even depreciate the RMB. It will have some negative effects on US economy, like the rise of living cost, but the general effect will be good. The bottom line is if somebody is willing to pay for my bills why not let them pay more.

But if the tariff is 40-50% as many demanded now. The effect might be totally the reverse they wanted. The China-America trade pair will have to decouple. An often made, but not outspoken, yet misguided comparison of the current situation was Yen problem in the 80s and the Plaza Accord. For short, when Yen doubled its value, Japanese factories moved to other Asian countries, but if US put a 40-50% tariff on China, Chinese factories will sell things in the domestic market. Depends on what the Chinese government will do, it can be a good news for Chinese economy. After all, China already has $2 trillion. What's the point keep selling more products for dollars?

The effect on US economy might be bad as the cheap products and cheap credits from oversea are the key for the current service/consumption economy to work. Unemployment rate might go up to 20% and stay there for a rather long time. If that happens, it would be like the 1930s all over again. Bank robbers will make the head line of NY Times. Organized crimes will spring up. Above all, the danger of a hyperinflation. Just like most damage of a storm is not done by the storm itself but the Tsunami follows it. The worst damage of a financial storm is often its political consequences.

So mark my word, guys. 2012 won't be the end of the world but it might be the end of the world trade as we know now.