The Awesome Science of Chinonomics

Closer to the Clouds

2012-06-20T16:40:00.000-05:00

Are we all lazy creatures? Some would say we always look for shortcuts to obtain what we want --even in the most disciplined version of ourselves. The path of least resistance defines our every move. The behavior goes deeper than what we see in our penchant to become couch potatoes. The brain also is always looking for ways to do the same tasks in the most efficient (effortless) way possible. Amblyopia is an example of the brain turning off the visual signal in one eye, choosing to overdevelop the other to compensate the loss of vision in the first one. There have been reported cases of people losing hearing in one ear without any apparent reason while at the same time overdeveloping the other ear. When the brain realizes that it can accomplish the same task with less resources, it appears it decides to shut down redundancies.

But what happens when a redundancy in the brain is created by an external agent? Some discovery -fire-, some tool -utensils-, some technology created for the convenience of humans, and a brain skill is rendered redundant, shut down and put to rest. Examples: the written word lightened the brain's memory burden. Calculators made the need of mentally calculating arithmetic operations almost disappear. Kids nowadays lack handwriting skills thanks to texting. Wikipedia killed the need to peruse volumes upon volumes for hours to find what we wanted. There has been a marked concern about the way Google creates brain skill redundancies. The immediacy of information reach, coupled with the model of internet monetization (where a plethora of ads compete in the screen for the reader's attention to get the much-coveted "click") has hindered the ability of the brain to achieve profound, prolonged levels concentration. ADD is fomented by the way we process information in our daily lives, some argue.

Is the waning of a brain skill caused by an app, gadget, or any other form of mental crutch creating a new generation of good-for-nothing neophytes doomed to failure by its mental laziness? If the storage and processing of information in our brains can be outsourced to the clouds, where is the need to really learn anything? Are Universities becoming eventually extinct? Could we get to a point where all we would need is a handheld device connected to the clouds, and someone to ask Google a question and follow/implement the clouds’ indications to solve any problem? Does the internet foment irreversible mental atrophy?

The answer is no. The brain is not getting dumber by the mental redundancies created by technology. Improvements in living standards would have stagnated decades ago had that been the case. If anything, brain skill redundancies created by technology free up human capacity to focus on more specific discoveries. Think of it in terms of comparative advantage theory: When a nation (person) is able to produce something (solve a problem) at a lower opportunity cost (foregoing less of other product), that nation (person) should specialize and import (outsource from others) that what it (he/she) is not competitive at.

And this happens because knowledge is a non-rivalrous public good. Because it has no opportunity cost (nothing is sacrificed to use it) and because it shows no diminishing returns the way capital goods do (every additional unit of labor combined with the technology in question yields the same incremental output). More to the point: thanks to the internet, knowledge is becoming increasingly non-excludable (to a point where it affects property rights). This is a powerful, paradigm-shifting phenomenon. The internet agglutinates every single discovery ever achieved by mankind throughout history, and it is available in fractions of a second. For free. Think about what that means. Of course this molds brain skills. It creates Otaku people. Instantaneous (or "fake”, as some bemoan) experts. Socrates in his time disdained the written word for creating people who would falsely appear as erudite, or "filled with the conceit of wisdom instead of real wisdom". He would definitely be turning over in his grave now.

With all the respect that deserves who is arguably the biggest philosopher humankind has ever seen, Socrates was wrong to think that way. Change should not be feared. The written word served as a revolutionary way to spread knowledge. The printing press then catapulted it. Every iteration of knowledge dispersion technology has led to human progress. The internet is just the latest one. Any incremental improvement/discovery in human knowledge is added to the internet and immediately shared with the rest of the world. Ready to be used by someone else and be taken to higher levels. To the clouds. Literally (well, kind of).

As Delicate as a Butterfly

2012-04-23T21:50:00.001-05:00

We live in an unstable world. The probability of what used to be thought as improbable is becoming more and more likely. The old definition of a statistical outlier as a "1 in a 100 years" event has morphed into the now famous "Black Swan" event. Using Didier Sornette's term, "Dragon Kings" are now becoming more likely.

Put it probability distribution terms, the distribution of all possible outcomes is becoming more bimodal (tails are "fatter", as shown in the graph below). It appears that reality is abandoning the familiar Normal probability distribution shape, depriving us of the standard tools we used to rely on to estimate the future. The comfort of saying that there is a 95% probability that an event will be within 2 standard deviations from its mean is gone, leaving analysts and futurologists clueless.


Sornette (2011): Scaled Distribution of Runs of Gains (Right) / Losses (Losses) for 30 major US stocks. Notice the fat tails of the distribution

"Dragon Kings" are crises which are exacerbated due to the combination of a series of elements that reinforce each other, creating a singularity that cannot be explained by the parameters of past events. Think of the potential energy contained in a mass of snow until a tipping point is combined with gravity, mountain inclination, and absence of vegetation to create a huge avalanche; or the epileptic attack, where a neuron firing barrage is unleashed when the inhibitory and excitatory mechanisms in the human brain fall out of balance. The shocking magnitude is caused by the interaction of amplifier forces built in their own system. Real life examples: the flash crash of May 2010 was the result of high frequency trading algorithms combined with stop orders; the Venezuela megaflood of December 1999 was the consequence of persistent orographic winds blowing from a relatively warm ocean surface meeting the coast.

Notice the importance of the meeting of the reinforcing elements. Without the interconnection of these elements, amplification doesn't occur. In human systems, interconnection amongst people allows imitative (herding) behavior that helps reinforce an event. We have all been witnesses of the effect of interconnectedness on social causes, like The Arab Revolutions. Here, potentially reinforcing elements (people willing to do something about a common problem) are interconnected thanks to a platform (the social networks) that exacerbate an event (social discontent) to create a "Dragon King" (simultaneous revolutions that have overthrown decades-old regimes). Once social discontent reaches a tipping point, all it takes is a trigger (Mohamed Bouazizi setting himself on fire) and interconnectedness fuels the fire.

Are we headed for a Dragon King in the global financial markets?

If we are looking for the orographic winds or the critical mass of snow in the global economy, by now it should be clear (thanks to the hyper-coverage in the media) that they are in the banks' high levels of leverage. Specifically, in the assets denominated in USD held by foreign banks (see graph below). Yes, those at the very center of the European debt crisis [gasp]. The critical mass for the snow avalanche or the orographic conditions for a Venezuelan flood are silently setting in.

Shin (2011). Global Banking Glut & Risk Premium.

Interconnectedness, following our framework, is in international trade. Trade synchronizes economic cycles of countries around the world (see graph below). Unfortunately, Harry Markowitz' Nobel Prize winning idea of putting your eggs in different baskets is of no use if the baskets are on a table at risk of imploding.

with world Bank Figures

Normally, "Dragon Kings" are not triggered by a shocking event. It is often an innocuous event that sets the wheels of the full system in motion and unleashes the potential energy contained in the reinforcing elements. Very much like the butterfly effect. With so many potential financial triggers lingering in the air (Spain and Italy's unsustainable yields, France's election, Holland's political crisis) any of them could unleash the next Dragon King.

Our sky is filled with butterflies, and they are flapping their wings. Hard. Which one will create the next big hurricane? Who knows. No wonder people are nervous.

Are we lost?

2012-03-01T10:11:00.000-06:00

"Greed is good.” Or is it not? Gordon Gecko’s maxim has been lately at the center of some major soul-searching by world leaders. Is Capitalism a failed system? Should it be changed or reformed? Is the inequality engendered by it so pronounced now that it endangers the stability of societies?

Increase in Gini Coefficient mid '80s to late '90s
OCDE Report, Pg. 4

The discussion is everywhere. Pundits all over the world are attempting to tackle the fundamental question: "How did we get here?", "Is the model exhausted?", "Should we change course?" Some frame the discussion about the cause of the current crisis in terms of the loss of conservative values and its decay. Good values of the past are now gone, they argue. Somehow the passage of time has allowed for the relaxation of self restraining behaviors, normally deemed conducive to a stable, healthy society. Others argue that this permanent "doom and gloom" mode is an illusion. That this is just the product of the -incorrect- perpetual perception of older generations about how easily corruptible younger generations are. Every generation thinks their successor will blow it, but in reality the young ones turn out to be just fine when it is their turn to rule the world. No need to fret, they conclude.

Bill Maudlin, Life magazine, Jan. 1950

Like viruses or hyenas, our biological goal is to thrive and seek rewarding sensations without regard to our habitat or to the effects of our actions on others, even ourselves. We are addiction-prone creatures. When we are looking to thrive economically, we look for ways to game the system, leverage on it and get rich. The self-serving behavior is not characteristic of one economic system: just like capitalism breeds inequality thanks to our love for excess, socialism is fertile ground for despotism -where only despots and their cadre succeed and thrive. Self interest will seep in every economic system, even in the ones supposedly designed to protect us from ourselves.

On a more instinctive level, we seek to feel good and obtain instant gratification with the least possible effort. This is why we accumulate mountain deficits and let our grandchildren pay for them, why we look for one-night stands (courting is so much effort), and why we obtain insider information to score big on one trade. Our excesses are usually punished by the burden of consequences (diabetes, STD's, collectors' harassment, divorce, jail), unless, of course, there is a superior benefactor with some social justification willing to foot the bill, save us from our stupidity, fix the situation for us, and put us back on square one with (hopefully) some promise or assurance that we have learned our lesson and will not relapse again.

Those who think this crisis is a sign of the end of times should think again --we have been here before. Examples of bubbles fueled by speculation date as back as the Venetian bankers of the 1300's --when they took massive long gold positions at low gold-to-silver prices, then lobbied kings for the gold standard to be adopted where silver used to be currency and pocketed astronomical profits, until relative prices collapsed-- and the early independent years of Latin America (1822-1825) --when £20,000,000 in debt was raised by the newly born nations (including £200,000 for the fictional country of Poyais by Gregor McGregor) only to default a couple of years later. The year 1947 saw simultaneous sovereign defaults in countries representing 40% of world's GDP. Anecdotes of debauchery are pervasive in ancient Greece and Rome. Moral failings on the part of religious leaders were evident 6 centuries ago in the times of the Western Schism. Proof that we love to let ourselves go into sexual excesses since the prehistoric times (including the thesis that we are not biologically monogamous) has been well documented.

But despite all of this, we are not at a stage of constant, irreversible decay. Human existence has been bound by an inter-generational self correcting mechanism, an "anti-chaos" force that brings us back to stability every time we wander astray thanks to our innate penchant to binge: a historical pendulum that acts as opposing force to human-induced entropy. Yes, maybe we're in a low point, but if history shows us something is that we are able to bounce back from our low points. The dreadful 1300's --with its 1340's financial collapse, bubonic pest and Catholic Church crisis-- gave birth to the Renaissance. WWII gave birth to the biggest cultural integration effort ever attempted. We learn from our mistakes. We correct the course. We are not lost.

Membership has its Privileges (at a cost)

2012-02-04T01:46:00.001-06:00

How important is it to feel like you belong? To many of us, very important. We are social animals that constantly feel the need to be accepted. Religion, sports teams fan clubs, political parties. All examples of groups of people that share something in common. Networks of people. The concept goes beyond human association based on interests or values. Networks are formed around the use of common instruments: languages, gadgets, credit cards. Why join a network? Because you benefit from the fact that other people belong to that very same club. As a non-native English speaker, you learn English because the world of international business speaks English, not Russian, Greek or Arabic. You get a Visa Card instead of a Discover or Diners Club because you want to have access to the biggest network of POS in the world (87% of merchants worldwide accept it). You buy a gasoline-powered vehicle instead of one using Natural Gas because you want access to the well-established network of gasoline stations -as opposed to Natural Gas or Hydrogen stations. The value of the Network increases with every additional member that is incorporated: The Network Effect.

Facebook leverages the Network Effect beautifully. It leapfrogged Myspace and Friendster by starting off with a halo of exclusivity (only Harvard's students were allowed at the onset) and then capturing a massive population (845 million and counting) of people willing to dump their personal information on the platform (date of birth, marital status, educational background, religious inclination, sexual preference, books read, favorite movies, music and even real-time consumption patterns) in exchange for the promise of other people's attention, and of course, access to the network called "Facebook". We feed the Network --and other people's Voyeurism-- with the refined online version of ourselves. But think about this: if a person knocked on your door every 6 months to ask you about your personal tastes and demographic, political, religious, and family information --the same information you publish on Facebook-- would you give it away? Probably not, or at least not as candidly as you do online. This gigantic collection of personal data poses an ethic dilemma. What does Facebook do or intend to do with it in the future? How safe is it?

People is going nuts about Facebook's IPO. It is going to go public valued at 26.5x revenue --almost double the ratio of Linkedin's (14.5x) and almost 3x that of Google (10x). The markets are obsessing about its growth rate, about how it can make its ads more effective, about how Zinga represents 12% of its revenue, about how it has no presence in China, and about how Zuckerberg holds 57% of the controlling vote. No one seems to focus on the real issue, which is that of privacy. No one has questioned how Facebook uses our personal information. Well, according to the company (from the S-1 filing):

As our users maintain and expand their authentic identity on Facebook, they are increasingly choosing to share their interests and preferences regarding products and services. We use this information to improve our ability to deliver relevant ads that we believe are more interesting and compelling for each user.

Harmless, right? Not so fast. They actually use your name to push ads to your "FB friends" (which in many cases are people you have met once) as a form of endorsement, like this:

Still comfortable? What about when you "check-in" at a restaurant, coffee shop or deli?

...when a user posts on Facebook that he or she has “checked in” to a Starbucks store, this check-in creates a story that can be shown in the user’s friends’ News Feeds...Starbucks can purchase sponsored stories to significantly increase the reach, frequency of distribution, and prominence of this story to the user’s friends.

You are actually doing the job of advertising for the company, and your post will populate more people's News Feed than you think if Starbucks paid Facebook to push your "check-in" status harder.

No one has questioned how secure is our personal information either. For example, no one has actually mentioned that they have been investigated and disciplined by the FTC for doing a bad job at keeping our information safe, as stated in the S-1:

...in 2011, we reached agreement with the Federal Trade Commission (FTC) to resolve an investigation into various practices by entering into a 20-year settlement agreement that, among other things, requires us to establish and refine certain practices with respect to treatment of user data and privacy settings and also requires that we complete bi-annual independent privacy audits.

But most importantly, no one has asked Zuckerberg how his company will use that information in the future. Now as a public company, Facebook is going to be under huge pressure from the markets to keep growing like it did in its infant years (close to 100%/yr). How is the company going to monetize our personal information to keep growing? What new initiatives will roll out, or what advertising techniques will it create in order to keep it growing? These are important questions we need to be vigilant about. In a world where the rights of internet users are becoming more and more important, this is an issue we have put pressure on. Yes, Networks are beneficial for every one of its members, but we need to understand well what are the costs of entry (implicit or explicit). We know that "Membership has its Privileges", but we need to make sure the privileges do not come at an unreasonable cost.

The Matrix has you

2012-01-18T17:10:00.000-06:00

We hear it all the time: the Internet is becoming more and more important in our lives. We read news on it, we socialize, shop, bank, and get an increasing share of our entertainment from it. A whole parallel cyber-universe coexists with the brick-and-mortar (often more boring) reality we brave every morning we step out of our beds. The Wachowsky brothers were not that crazy after all. We choose to live in a computer-generated reality -- a "Matrix" called Internet. Our Facebook self is nothing but our own residual self image --the "Neo" version of ourselves. One would think the parallelisms between cyberspace and real life should extend to many more areas. If there is a marketplace in cyberspace -where you can get anywhere from a prostitute to a Bentley- and a bunch of social networks where humans interact -some even find their soul mates-, the same natural/legal rights and social institutions that underpin growth and stability in the brick-and-mortar world (like monetary mechanisms, property rights, privacy rights, freedom of expression, markets, etc) have a bizarro counterpart in the internet "Matrix".

With online retail sales exponentially growing, online property rights become paramount (just as property rights are the foundation for the brick-and-mortar world). But with security breaches being more and more frequent, a huge threat rears its ugly head. The total obliteration of knowledge-based companies like Stratfor only reminds us of how vulnerable anyone can be if we do business in the internet. Think about how critical this will become if more and more people become dependent on the internet for day to day transactions. The preservation of confidence that you can go to the internet to buy/sell products and services without the threat of being stripped of your identity or bank account is fundamental if the world is to keep relying on the internet as a platform for economic growth into the future.

Government, in its position of enforcer of property rights, has clumsily attempted to remedy this threat -- as usual, not very cleverly. Web piracy, a prime example of property rights infringement, is currently at the forefront of a discussion that has pushed politicians to scramble to propose a piece of legislation that basically threatens another natural right for those of us living in the "Matrix": freedom of expression. With the pretext of blocking web-piracy, the SOPA/PIPA could have potentially been used to censor internet content, putting the US in the same camp as other known internet-censor-states like Iran, China, Ben Ahly's Tunisia or Mubarak's Egypt. A piece of legislation that hurts personal freedoms with the pretext of fighting a threat (did someone mention the Patriot act?).

The internet is dynamic. That much we know. It has replicated a reality online that has evolved so rapidly and chaotically that people trying to develop the rules of engagement for that game are struggling to keep up. Granted, we have a template for that "Matrix" reality in the brick-and-mortar world, so politicians should be able to apply and adapt rules from the real world to the world of the "Matrix". Unfortunately, politicians are not known to be tech savvy, and the adaptation process can be dangerously flawed. They will have to rely on geek brainpower and the collaboration of internet users if they are to shape legislation that: a) effectively strengthens the digital rule of law b) protects our natural and legal rights in the "Matrix" world and c) keeps the heavy influence of special interests and lobbyist at bay. Not easy, right? The journey is about to begin, or to quote Mr. Anderson:

"I didn't come here to tell you how this is going to end. I came here to tell you how it's going to begin."

Home sweet home

2011-12-28T22:19:00.004-06:00

"Work hard and you will get the reward". That is a tenet any good parent would like to teach their children. The idea rests on the basic principle (assumed to be true) that whatever reward you get will not be snatched from you by someone else. The principle in question: Property Rights.

Property rights are a keystone of human civilization. When we discovered farming, the primitive farmer had to make sure whatever he was growing was not going to be stolen by any passing nomad tribe that "didn't get the memo" that a farmer was growing something for his own consumption or benefit and that it could not just be taken. Imagine how difficult it was to go from communal to private property. Enforcement of property rights became one of the primal functions of proto-States and other central authority entities created in the beginnings of civilization. The difficulty of enforcement of property rights even shapes human culture. The "culture of honor" displayed in the rugged terrains of the U.S. Appalachians -which was the cause for multiple family feuds and killings between 1860 and 1930- was a consequence of a lack of proper property rights enforcement.

Property rights are also a key determinant of economic activity. The better developed property rights are, the most advanced a country is (the highest-ranked countries by property rights protection: Norway, Netherlands, Denmark, Sweden, New Zealand, U.K. Germany, Australia. The U.S. ranks 14th along with Canada & Ireland). Entrepreneurs' investment decisions will be greatly dependent on whether or not they will be able to enjoy the fruit of their effort, and this also applies to savings and possessions. Why owning anything if it can be snatched away from you in the blink of an eye? Property rights are, thus, the very foundation of Capitalism and of economic development in a country.

Out of all the possessions anyone can have, your home is the most important one. It is the ultimate fruit of your labor, the place where you raise your family and the one asset that can even provide –some would argue- emotional stability. The house stock of the U.S. is $16 trillion -- more than 1x one year's GDP of the country -- representing the biggest asset of households. The system that supports and regulates real estate ownership has traditionally been based on physical records kept in Title Rooms and County Courthouses administering them. Land and Property records have been paramount in the determination of who owns what property in this country.

But then MERS happened.

Created by the biggest mortgage banks, it is the black box where property titles that collateralize mortgages are transferred every time a mortgage is sold to another bank, or packaged as a pass-through security, or wrapped in a MBS, or re-packaged CMO. It was a financial innovation -or workaround, really- to enable easy exchange and transferability of a title that otherwise would have required a person going to the Title Room, peruse over hundreds of records, finding the title in question and go through the Courthouse paperwork to change the beneficiary in the Lien. One huge problem created by MERS: mortgages change hands so many times they simply lose track of who is the legal beneficiary in the Deed of Trust.

People are realizing that legally challenging their lender to produce the title is a winning strategy: banks that can't prove they have the title have to give up the claim and let the homeowner get the house back."Quiet-title actions" are proliferating and organizations are starting to foment these types of legal challenges. The implications for the legal system and the banks' profits could be huge. No wonder bank stocks are in the tank (BofA Price-to-book is 0.26x) while they keep getting hit by more and more lawsuits.

We are talking about property valued in the Trillions (in 2007 MERS registered two thirds of all mortgages in the US) that cannot be traced back to the real beneficiary. We are talking about homeowners diligently paying their mortgage for decades only to find out after all those years that they cannot get their title back because the nominal "owner" of the mortgage cannot produce the title. We are talking about the biggest, most important asset in the U.S. economy being thrown into legal limbo. This is a major blow to the backbone of property rights, and serious threat to the very foundation of Capitalism itself.

Pick up that penny

2011-12-04T11:31:00.001-06:00

If you found a penny in the ground, would you pick it up? Most people would not. In fact many believe they should be discontinued. They argue that pennies are not commonly accepted, that they are worth more for their metal content than for their monetary (fiat) value, that they are impractical to carry around, and that they are an inefficient store of value (breaking 2 out of 3 qualities money must have: medium of exchange, store of value and unit of account). In sum, the penny is a vestigial remnant of an era long gone that has no purpose anymore - much like the appendix or the wisdom teeth in the human body.

Does this mean that pennies are really worthless?

Fiat money is a very funny thing. It is worth something because we are told so by decree and because we expect (or believe) that someone else will also expect (or believe) it will be worth something when they take it from us in exchange for a good or a service. Enter the key word: "expectations". We hear often about "expectations" from Central Bankers when they manipulate the value of their currency. Inflation (the change in the level of prices) will happen to a great extent if people expect it will. It is the task of central bankers to gauge those expectations and adapt policy making decisions to the population psychological mindset.

But what determines inflation expectations? Some argue expectations are determined by inflation of past periods. Some other even argue that people form inflation expectations considering every piece of information in the economy to reach their expected inflation level (the "rational expectations" assumption).

What if people's expectations were heavily determined by the level of prices instead? What if, in forming future price expectations, it made a difference to have bread prices in the billions as opposed to a couple of dollars? People have a tendency to like stronger currencies. Germans in the 1920's were excited when they could buy a tin bread bin for 1 Rentenmark after paying trillions of Marks for it. The moment the Germans believed they had a strong currency (the new Rentenmark), hyperinflation disappeared. Their inflation expectations were reset because of the existence of fractional money (i.e. pennies).

If the price level was not important in setting inflation expectations, countries with hyperinflation problems would never "reform" their currencies (like China's 1948 3-million-to-1 re-denomination or Brazil's multiple attempts in the early 90's) in order to allow its citizens to pay unitary and fractional prices for basic necessities. Clearly, they sought to establish (with different degrees of success) a perception of currency strength in order to change inflation expectations. In the Brazilian case (see graph below: tip of the hat to Keith Houston/B. Malamud), each time a new currency entered the economy, inflation plunged.

Fractional money is worth something more than the metal it is made with. It is a psychological anchor that helps keep mass perception that cents are still needed and that a currency is strong. Without them (and considering the current insane level of money printing in these times of crisis) inflation could spiral out of control. So, the next time you find a penny in the ground, think about its more subtle value and give the little Lincoln some respect.

Don’t call me a chicken!

2011-11-18T17:38:00.007-06:00

Being called a chicken is never a good thing. You get called that in the schoolyard and the most likely thing to happen next is to hear humiliating laughs of the other mean kids. A movie character loses a game of “chicken”, and he is most likely losing the girl. That game has even been studied by game and signaling theory.

The whole mess in Europe could be reduced to a game of chicken. Here, there are two cars being driven against each other, challenging each other not to veer to the side. One car is driven by Mario Draghi, the other one by the bond vigilantes (or speculators, as Europe’s politicians like to call them).

Signaling is paramount. Mario Draghi resists to monetize, and signals that the ECB will not openly use its balance sheet without restrictions to push sovereign rates down. The reason? The ECB –always mindful of its standing as a hawkish institution known as protector of the value of the Euro - risks denting its reputation of independence, which for any central bank that issues fiat currency is the most important intangible asset they have.

Draghi (under heavy skepticism) faces a lot of pressure from Germany not to monetize, also. The Germans know first hand how destructive hyperinflation can be, hence their uncompromising position against anything that could lead to the loss of confidence in the value of their currency. There are also the legal arguments of the ECB’s impossibility of buying sovereign paper (although this can be easily bypassed by a) making local banks swallow sovereign auctions and pledging the paper as collateral, or b) using the IMF as conduit --both of which mean monetization in the end). Finally, another reason to resist monetization is the political argument. Not ceding is an excellent way to push Italian/Greek/Spanish politicians to get serious about passing long overdue reforms to spur growth and reduce deficits.

On the other hand, you have the vigilantes/shorters/speculators (however you want to call them). Shorters will benefit from falls in prices which in turn precipitates the forced sale of sovereign papers by banks that need to clean their balance sheets in light of the new capitalization rules agreed to under the October Greek restructure deal. They have leverage, since their heavy selling makes their perception of sovereign bankruptcy a reality, which becomes self fulfilling, and that is a pretty powerful tool to make their position not to cede (to keep shorting) credible –of course, we know what happens to them if they fail and there’s a short squeeze.

Notwithstanding the structural, long term problems of the Eurozone, the short term problem is simply: Will Draghi finally cede and monetize? Or will he remain stoic about defending the Euro’s value and use shorters’ strength in his favor to force politicians to fix their budgets? Game theory says the game of chicken has 2 Nash equilibria (one cedes and the other one doesn’t and viceversa). So hypothetically, if no player knows what the other is going to play the outcome cannot be known. But, if one party knows the strategy the other is playing, that party chooses a strategy that maximizes its outcome. Here, Draghi has a disadvantage: this game already happened, and we know what each player chose to do in that game. Iterations in the game of chicken allow players to better guess what their counterpart will choose to play. Remember 2008? Paulson played the same game when he refused to bailout Lehman after having bailed out Bear Stearns in an attempt to make his threat credible. The result? Two rounds of QE, 310% increase in the size of the FED balance sheet ($7.7 trillion at its peak according to Bloomberg), and a long list whiners claiming that they have been hurt by the Dollar’s depreciation. Who wants some Pollo?

___________
4/5/12 Update:
With the introduction of the LTRO by the ECB, the winner of this game is now obvious. Like Paulson in 2008, Mr. Draghi has ceded.

A new baby is being born -- call the doctor

2011-11-16T17:18:00.003-06:00

Giving birth is supposed to hurt, and with nations it is no different. The labor pains of a nation's birth do not end, however, with the toppling of the dictator, the expulsion of the invaders/conquerors, or the signature of an armistice treaty. The next step in a nation's life is the most crucial one: The Foundation of the State. Europe is currently in the labor pains stage. Its current travails show a marked parallel with the origins of the United States as a Nation: Jefferson (read Merkel) did not want the U.S. to assume the debts of some profligate former colonies (read Greece/Ireland/Portugal/Spain/Italy) and issue U.S. Federal Bonds (read Pan-European Bonds). Hamilton (read Barroso, and to some degree Sarkozy) pushed for the single issue and fiscal integration. The result: Jefferson ceded and the U.S. assumed the debts of less frugal states in exchange for picking a location for the new nation's capital near his home state of Virginia. Integration triumphed. The baby was born healthy.

Will integration win for Europe? Robert Mundell won the 1999 Economics Nobel Prize for explaining precisely what is needed in order to have an "optimum currency area" -or what is needed to integrate several formerly independent economies with different currencies into one single market economy. However -for a reason ~~I still do not understand~~ that might have to do with his reputation-, no one has ever mentioned his findings in the mainstream media. Mundell states that in order for a Optimum Currency Area to work, it must:

Have Labor Mobility within its boundaries. If you quit your job you easily get hired somewhere else.
Have Capital Mobility. So investment decisions are not influenced by which region within the country one is doing business other than the risks inherent in the project per se.
Share a Central Fiscal Revenue collection agency, so taxes are levied on prosperous regions to subsidy and eventually develop less rich areas.

Labor mobility is something Europe definitely lacks. Spain's 20% unemployment rate (44% among youths) is due in great part because -ironically- people don't get fired. It's very expensive for Spain bosses to fire employees -despite the government's lukewarm efforts to liberalize its labor market. Unions there have succeeded in restricting labor supply, making wages artificially expensive. In Italy the government still controls the supply of labor by issuing permits for certain professions -a practice Milton Friedman derides as a way to restrict economic freedom and limit economic development. Then you have the cultural barrier - imagine that moving from Texas to Oklahoma you had to speak a different language to be able to get a job.

Capital mobility is something that Europe scores better, though. One needs only to see the footprint of European transnationals within the continent to know that they have easily established operations in different regions of the Euro area. Santander, Deutsche Telekom, Vodafone, are good examples of companies that have harnessed well the ease of capital mobility within the Eurozone. The very fact that Germany exports 60% to the other Eurozone countries is also good. Although trade by itself is not strictly capital mobility as Mundell defines it -it is the mobility of capital goods' end products-, trade is a precursor that can lead to capital mobility.

And as far as sharing fiscal revenues, well, that's definitely an area Europe has not succeeded. I don't need to extend much here. They don't have a joint tax collector, and every state has responsibility to combat its own evasion. Frugal, efficient tax-collector states (Germany) wince at the thought of subsidizing so-called squandering nations.

Out of 3 conditions, Europe fails on 2. Notice that these 3 factors in Mundell's Optimum Currency Area are preconditions for it to work. You have to have them, and then issue the single currency. Europe did it backwards. The Maastricht Treaty was supposed to lay the ground for those conditions to be met, not by creating a unified European fiscal revenue agency, but by simply "inviting" its member to abide to the 3% of GDP deficit rule. Not exactly the best way to enforce fiscal frugality.

So, we have arrived here. The European nations (plural) are suffering from labor pains, struggling to give birth to the new European nation (singular). Will the baby survive? If they don't give him the right medicine, (liberalizing labor markets and implementing fiscal integration) chances are he will not. Somebody call the Doctor!

----
Update 2-11-12:
I now have a theory about why Mundell´s model has not been quoted during this whole European Debt debacle. Maybe -just maybe- it has to do with the Canadian's damaged reputation after his participation in Olympus' board and its epic corporate scandal.

Financial Totalitarianism

2011-11-14T19:10:00.002-06:00

Trying to make sense of this financial world through traditional stock fundamental measures is futile these days. Playing the money game has become a binary flip of a coin on the last dollar: either you invest in assets (all in) or in cash (all out). This duality simplifies the plethora of alternatives that normally overwhelm the investor. "Correlation-One" Markets that rise and fall at unison. The value of your investments is determined by the latest decision of a policy figure.

Take the value of your money, for example. The value of your money measured in assets (or how many barrels of oil, bars of gold, pairs of Nike shoes or heads of lettuce can you buy with a fixed amount of green stamps called "money") is established by its relative abundance (or at least its perceived abundance), which in normal times is determined by the decision of a counsel of elders in which we have trusted our savings (the central bank). We never think of it this way, but our wealth is defined to a great extent by "royal" (or totalitarian, if you will) decree every time Draghi or Bernanke gather in their respective conclaves and spew out white smoke to declare before hoards of financial reporters crammed in a room: your green stamps will buy 2-3% less lettuce the following year. The population abides to the royal decree (depending of course on the credibility of the elders in question) and adjust their expectations accordingly. It is indeed a very well choreographed dance. One party leads with its cue and the counterpart harmoniously follows fulfilling the inflationary prophecy of its monetary central planner.

So our wealth is determined every time a policy figure opens his mouth. Interesting. I don’t know about you, but that is pretty much the definition of Political Risk. This is akin to the risk a transnational company faces when they decide to invest in Venezuela or Bolivia and Hugo Chavez or Evo Morales declares that he will expropriate their Venezuelan plants and give them 30% of the value of the assets they installed in his personal backyard, err, country. You might ask: Why investing in a politically risky environment with the contingency of value-confiscation by the local autocrat (be it the current Dictator or the MIT-trained PhD in charge of the central bank)? Well, as long as the investor has confidence the return will compensate for the confiscation, that is ok.

Notice the Key word: Confidence.

Normally, the conclaves’ ever-ending short selling of their respective currencies would create the incentive (via punishment of cash holders) for the population to always want to hold anything other than cash. One problem arises in times of "Correlation-One" Markets though: there is no Confidence investments will compensate for the confiscation rate the local autocrat imposes. The same psyche prevalent in a bank run is prevalent here: the return of your capital precedes over the return on your capital. Everyone prefers cash to assets. Everybody races to hoard that currency which stores value the best, because they want to keep the amount of lettuce they can buy as stable as possible. Problem is, that hoarding urge sends everyone running for the usual suspects creating bubbles: Gold, Swiss Franc, US dollar... and that hoarding affects precisely the variable the monetary planners want to regulate: the relative abundance of money. So in a confidence crunch, the paradox of thrift renders the bank multiplier useless -in fact detrimental-, and the money’s relative abundance goes down sending its value higher. The incentive to own assets instead of cash is no more and deflation ensues. Economic activity plunges. The counsel of elders’ effort to punish the cash holders is nullified by the frantic search for cover. Suddenly, people is so scared they don't care their money buys more lettuce -they never use it to stock up. All they want is cash, cash, cash -an irrational behavior, considering you can't cook bills.

We are in a Crisis of Confidence. And with good reason. Italy owes the world €1,900,000,000,000 (€1.9 Trillion) and if that sovereign paper "Greeks-out" (and we apply a 60% haircut the way SocGen & BNP did) we will have have created a €1,140,000,000,000 (€1.14 Trillion) hole in the Europe's banks. That capital whole would wipe out Europe's biggest bank (Spain's Santander) 16.7 times. With Italy's 10yr at 7.23%, we are awfully close to sovereign debt market shutdown for Italy.

The monetary planners are fighting this by inflating their balance sheets and selling their currency in one huge massive push to make investors own anything but cash. The ECB, traditionally very vigilant of its reputation as guardian of the Euro's value, finally ceded and has spewed out its latest decree: "you will buy less lettuce with your Euros". That change in music in Europe is more than welcome. The lady has changed dance partner, and the new partner has sent his cue.

There are a lot of things that need to happen for confidence to come back, but at least the first one is there. Papademos' good reputation in Greece and Monti's succession of Berlusconi definitely help.

These days, our wealth is determined every time a policy figure opens his mouth or takes a decision. We live in the days of Financial Totalitarianism. One unilateral decision, one decree, and you wealth decreases immediately. Forget about P/E's.

The Great Cycle of Human Stupidity

2011-11-14T18:35:00.001-06:00

Humans are unpredictably predictable. When circumstances surrounding us are overwhelming and pressing, we try to change them. Sometimes aggressively (with revolutions) some other times more passively (quitting your job). Interestingly, this also applies to love life: after a long run of dating people with characteristic "X", the next person you look for is someone with the opposite characteristic, because you now know the disadvantages of that personal trait. The pendulum metaphor is at work. In societies, the metaphor applies to politics, and of course also to matters of economic policy. Totalitarian societies (like Pinochet's Chile or Franco's Spain) topple regimes looking for the longed freedom they did not have before. Societies that reach economic freedom (the U.S.A.) realize that opening their borders to trade allows other nations to get in and "steal" profits from domestic businesses via price undercutting and fierce competition and look to revert this with protectionist movements.

It is always a traumatic event which causes the change in trajectory and a reset of a political journey with a new destination - a destination that often a past generation of men already visited. The new generation cannot hear the voice of wisdom and warning of the past one simply because they are not here with us anymore. And so, the new generation will again prove to itself why this "new" destination, so far located from the place where they currently are, is no panacea. Ignoring and not heeding the wisdom written in history books in an arrogant -maybe desperate- attempt to solve current overwhelming, pressing circumstances only to end up where past generations ended up at is, frankly, a clear example of historic myopia that touches stupidity. It is The Great Cycle of Human Stupidity.

How traumatic does the event have to be in order to push the current generation to change course? Let us hope not as traumatic as the darkest episode registered in modern human history. I am referring to the event that gave genesis to the biggest, boldest pacific intercultural integration effort humans have ever attempted.

Europe's impressive laboratory (mosaic) of human diversity and forced coexistence provides us with the best experiment to prove human self-destructive behavior, but also of humanity's ability to learn from past generations' mistakes. It seems that Otto Von Bismarck 1860's brilliance in juggling with the ego of other European leaders while preventing Europe's implosion -and keeping Prusia's integrity intact- delayed genocide some 80 years. Europeans had to live the horror of utter destruction with WWII to understand that nature's "decision" to give them a shared, crowded continent meant for them to see each other as a permanent neighbor who will simply not go away and will not be just "conquered", and that the alternative of tolerance is simply less costly that the alternative of extermination.

The effort of European integration initiated from WWII is at the brink of collapse, pushed by current overwhelming, pressing circumstances. The pendulum seems to reset its trajectory in reverse, marking the possible commencement of The Great Cycle of Human Stupidity. Let us hope the event that gave genesis to Europe's integration effort lingers in Europe's physique forever and it's not lost in time, and that Bismarck's contemporary colleagues understand the historic importance of the role they are playing these days.

__________________________________________________

Translated from Spanish from my earlier note.

El Gran Ciclo De La Estupidez Humana

2011-11-14T18:29:00.001-06:00

El humano es impredeciblemente predecible. Cuando el conjunto de circunstancias que lo rodean lo agobia, busca cambiarlas. Algunas veces agresivamente (revoluciones) otras de manera pasiva (renunciando a tu trabajo). Se da hasta cuando uno busca pareja: después de que tuviste una serie de parejas de "X" característica, la siguiente la buscas con la característica opuesta porque conociste de cerca las desventajas de esa característica "X". Siempre aplica la metáfora del péndulo. En sociedades esto se da en materia de ideología política, y por supuesto que también en materia de política económica. Las sociedades tienden a zigzaguear de un extremo político al opuesto cuando sienten que la primera alternativa no les dio resultados. Sociedades que eran totalitarias (como Chile, España) derrocan regímenes buscando la ansiada libertad que no tenían. Sociedades que alcanzan la libertad económica (EEUU) se dan cuenta que el abrir sus fronteras permite a otros llevarse el pastel de utilidades por ser mas competentes/baratos y buscan revertir la apertura con movimientos proteccionistas .

Siempre es un evento traumático el que ocasiona el quiebre en dirección y el reinicio de una trayectoria cuyo destino es un lugar en donde ya estuvo otra generación de hombres, cuya voz de sabiduría y advertencia no es escuchada porque simplemente ya no están aquí. Y la nueva generación volverá a probar el porqué ese destino, tan lejano del lugar en que se encuentran actualmente, no es ninguna panacea. Desatender e ignorar la sabiduría escrita en los libros de historia en un intento arrogante (quizás desesperado, quién lo sabe con certeza) por solucionar las agobiantes circunstancias actuales para luego terminar justo donde terminaron generaciones anteriores es, francamente, un claro ejemplo de miopía histórica que raya en la estupidez. Es el Gran Ciclo De La Estupidez Humana.

¿Qué tan traumático tiene que ser el evento para revertir trayecto? Esperemos no tanto como lo fue el evento mas obscuro del que se tiene registro en la historia moderna de la humanidad, y el mismo que fue génesis del esfuerzo más grande de integración intercultural pacífica que la humanidad jamás haya intentado.

El impresionante laboratorio de diversidad humana y coexistencia forzada que se da en Europa nos proporciona la mejor prueba comportamiento autodestructivo humano, pero también nos proporciona el mejor ejemplo de la habilidad humana de aprender de los errores de las generaciones pasadas. Parece que la maestría de Otto Von Bismarck en los 1860's para lidiar y manejar el ego de otros líderes Europeos y al mismo tiempo prevenir la implosión de Europa (manteniendo la integridad de su natal Prusia en esos años) pospuso el genocidio 80 años. Los Europeos tuvieron que vivir el horror de la total destrucción en la Segunda Guerra Mundial para entender que la “decisión” de la naturaleza de darles un continente compartido era para que se vieran el uno al otro como un vecino permanente que simplemente no se va a mudar (y que tampoco puede ser “conquistado”), y que la alternativa de tolerancia es simplemente menos costosa que la alternativa de exterminio.

El esfuerzo de integración Europea surgido a raíz de la Segunda Guerra Mundial esta al borde del colapso, empujado por el “agobio” de las circunstancias económicas actuales. El péndulo parece iniciar su trayecto en reversa, marcando el posible reinicio del Gran Ciclo De La Estupidez Humana. Espero que el evento que dio génesis a este esfuerzo de integración intercultural pacífica en Europa haya quedado lo suficientemente marcado en la psicología colectiva, y que los colegas contemporáneos de Von Bismarck entiendan la importancia histórica del papel que juegan en estos momentos.

El "orgullosamente Regio" necesita actuar.

2011-11-14T18:16:00.000-06:00

He visto en muchos lados este blog post, en el cual un Chilango describe desde su visión la grandeza de Monterrey y su tristeza de dejarlo. Quisiera compartir mi sentir despues de leer ese artículo. El artículo es un homenaje que hace sentir especial a todos los que son de Monterrey, sin duda. Pero es un homenaje desafortunadamente hueco que no hace más que consolar y decir “no se preocupen, Monterrey va a salir adelante”… ¿cómo? Quién sabe.

Sentirse especial y orgulloso de dónde eres es claramente algo bueno, pero es realmente virtuoso cuando eres parte activa y constructiva de tu entorno. Cuando lo enriqueces con tus acciones, por pequeñas y rutinarias que parezcan. Ser “orgullosamente regio” porque eres Rayado/Tigre a morir, porque tienes todos los discos de los Invasores de N.L. o porque te encanta el machacado con huevo y la carne de la Ramos, o porque hablas con el acento “inimitable” de Monterrey es, francamente, algo superficial que no ayuda en mucho a sacar a la ciudad de la crisis histórica en la que se encuentra. Cuando contribuyes a la construcción de la grandeza que reclamas como tuya, entonces SÍ puedes (y tienes que) sentirte orgulloso. No tienes que convertirte en revolucionario y formar cuadrillas de activistas para poder cambiar de la noche a la mañana ese nido de ratas asesinas que a veces parece que se ha convertido Monterrey (gracias en mucha medida también al amarillismo periodístico). Es utópico pensar eso, pero cosas pequeñas ayudan. Dejar de ser corrupto y no darle mordida al tránsito y al funcionario de ventanilla es un comienzo. Exigir a las autoridades es imperativo para que una sociedad funcione, y Monterrey no es la excepción. Si el “orgullosamente Regio” tuviera una cultura de participación cívica como sí la tienen los “socialistas” del D.F., las autoridades responderían. En Francia marchan todas las semanas por temas tan triviales como las vacaciones de maternidad. Obedecer las señales de tránsito fomentaría el respeto a la ley. Tratar a los pobres como te gustaría que te trataran a ti es otra buena manera de contribuir a la unidad social. Reconocer e integrar a los pobres de Monterrey es fundamental. Porque que hay muchos, pero MUCHOS más pobres de lo que el “orgullosamente regio” quisiera admitir (1/3 de la población de N.L. vive con menos de USD$5.25/día). La marginación social de las colonias de pobreza extrema ha sido el caldo de cultivo perfecto para la germinación de nuevos reclutas adolescentes del crimen organizado. Sin un futuro, y sin nada que perder, vivir 3 meses manejando una Escalade y el poder que da una AK-47 es mejor que una vida de miseria lavando parabrisas bajo 40 grados en Ave. Colón. Ese mundo paralelo de miseria (inimaginable para el que cree que Monterrey es ciudad de primer mundo) siempre estuvo ahí, pero el “orgullosamente regio” eligió ignorarlo (incluso esconderlo, como cuando la Serie Cart de Automovilismo fue a Monterrey y el gobierno erigió una barda que tapaba la “fea” Colonia Pablo A. de la Garza para que los turistas no la vieran). Esa marginación está cobrando factura, y lo está haciendo de manera rabiosa. Para contrarrestarlo, el “orgullosamente Regio” necesita realmente solidarizarse y llevar a la acción ese “amor” por Monterrey.

La dedicación del "jalador" regiomonano es un rasgo admirado por muchos. Su disciplina, tenacidad y constancia son valores que el "orgullosamente Regio" aplica para lograr el éxito individual. Ese individualismo, sin embargo, ocasiona el olvido de las necesidades de los demás, y los demás, en este caso, representan Monterrey mismo.

El "orgullosamente Regio" necesita dejar el individualismo y actuar por la ciudad por la que tanto orgullo profesa. De otro modo, Monterrey enfrenta el desmoronamiento que carcome ciudades como Ciudad Juárez y Torreón.

The Lousy, Myopic & Biased NYT views on Cleaner Energy

2011-11-14T16:53:00.001-06:00

Two days ago I was having a couple of drinks with some friends. Among the many topics over which we blew off steam, someone mentioned an article about clean energy on the NY Times by Robert Bryce stating that Gas is Greener. Since I am someone concerned with the state of the planet (we pay for wind energy, we recycle glass/paper/cans, we even use biodegradable diapers for our toddler) I was intrigued by that statement. I mean, I am open-minded. Al Gore could be all wrong and all the over-priced eco-friendly services and eco-friendly diapers we use could make no difference to improve the world we live in (although to be honest the current heat wave in the US is a nagging reminder that he might not be that crazy after all) or even worse: these so called eco-friendly energy sources could, the NYT article stated, be actually more harmful to the environment than the traditional non-eco-friendly ones.

If you have not (or do not intend to) read the above mentioned article, it basically states the following: wind turbines are massive steel structures (200 tons each) that produce 4 MW/h of electricity whereas a natural gas turbine requires only 9 tons to make and produces 43 MW/h. With this piece of info, Robert Bryce goes on to state that:

...however you crunch the numbers, the takeaway is the same: the amount of steel needed to generate a given amount of electricity from a wind turbine is greater by several orders of magnitude. Such profligate use of resources is the antithesis of the environmental ideal.

Having an article of a well-respected national newspaper confirm that you have been for years overpaying 30% for electricity that you thought was cleaner (I am reminded of this every month, believe me) when in reality it is actually more harmful to the environment, can make you feel dumb. "I am the guy who 'drank the kool aid'!", I lamented after reading the article the first time.

So I had a closer look at Mr. Bryce's numbers. It turns out, they are lousy -Incredibly lousy and incomplete, actually. Bryce utterly ignores some basic high-school arithmetic principles, such as comparing two variables in the same scale. His whole argument is "one wind turbine uses 200 tons of steel while a natural gas one uses only 9, that's a lot of energy squandered in the wind turbine" and "producing 1/6 of California's energy with solar requires solar panels covering an area the size of 70 Manhattans". That's it. No quantification of the energy resources used to make the steel for the wind turbine, no measurement of the impact of the 70 Manhattans area. And most importantly, no consideration whatsoever of the greenhouse gases that won't go into the environment by installing the wind turbines.

To have a fair comparison you have to bring the two alternatives to the same scale and then compare what's the best. So I crunched some numbers:

Producing 1 ton of steel requires 13,680Kw/h go to Table 1, Page 12 if you don't believe me.
Producing 1 Kw/h releases 2.09 pounds of CO2 according to Table 4, Page 4 of this EIA report
1 wind turbine requires 191 tons of steel more than a natural gas one.

So, to produce the extra steel necessary to make a "dirty" wind turbine, a total of 5,460,919.20 pounds of CO2 were released (13,680x191x2.09), or 2,477.03 metric tons of CO2. But wait! Installing a 1 Mw/h wind turbine avoids releasing 2,600 Metric Tons of CO2, so it's not all bad after all. CO2 is bad for the environment, right? (climate change deniers, please go along, this article is not about proving Al Gore's right, it's about how lousy this NYT op/ed is).

Thus, if 2,477 extra tons of CO2 were released to produce a wind turbine instead of a natural gas turbine, it takes a 4MW/h wind turbine only 87 operating days (2,477/10,400*365) to "pay" the "cost" of CO2 emissions of that extra steel. After day 88 the wind turbine is cleaner, while the natural gas turbine will continue releasing 111,800 tons of CO2/year (43MW x 2,600) until it's shut down or replaced with a cleaner one.

The same analysis could be done of the 70 Manhattans of solar panels. Bryce makes no attempt to measure its impact. We're not talking about chopping 70 Manhattans worth of Amazon Forest. They'd be installed in the Nevada desert, where there's only sand and life is almost non existent. He could have tried, but he makes absolutely no effort to measure its impact in any form.

So, you can still say that the wind turbine is cleaner. Phew. For moment I felt pretty silly. If you are a climate change denier and are still reading this, hat's off to you. You might have guessed by now I think we're screwing the planet so bad that I feel compelled to do something. Too bad the NYT publishes articles so ill-informed. But hey, at least it was an op/ed section. People should be able to read and judge what they're reading with their own criteria. I have mine.

--Update: 1-13-2012

Apparently somebody brought to Mr. Bryce's attention how lousy his op/ed was. Today I checked out the same article online and to my surprise, a very different (and much more convincing) article appeared under "The Gas is Greener" title. Now he takes real examples of wind farms to base his estimation of the area size that would be affected by new wind farms, including the mention of some legal obstacles to building them even in the desert.

...A vague, modest clarification in small print reads hidden at the bottom of the article:

A version of this op-ed appeared in print on June 8, 2011, on page A23 of the New York edition with the headline: The Gas Is Greener.

(A "lousy version", that is).