China is the big new bogeyman. How do we deal with China? How did we deal with Japan? Japan was going to buy up the United States. Japanese manufacturing was invincible. The Japanese worker was an incredible perfectionist machine. You could not compete with that kind of perfection. So we learnt Kaizen, JIT and a whole lot of other BS. But in the end, Japan just fizzled out. No world domination.
Why is China different? China is a communist machine. China does not play fair. The Chinese use state funding and cheap slave labor to over produce goods and flood world markets (mostly American markets). Well whose fault is that? Do we actually need to wake up at 4am and stampede over living people to get that Tom Tom GPS for an additional fifty bucks off ? Just pay the additional fifty bucks. Or better still just use the Rand Mcnally Atlas. It is a lot more fun than the GPS.
But regardless of the people’s incorrect priorities, we do have two opposite economic models selling goods in the same market. We have a Capitalist consumer that is supposed to consume the maximum amount of output (irrespective of whether they need all this junk) versus a Communist model of production where the goal is to simply produce goods without regard to profitability. The Communist machine has no shareholder Accountability, no cost of research, no payroll taxes. Nothing. All it needs to do is over produce everything and run all other competition out of business.
It is the same as letting hedge funds play in the same market as Mutual funds. One group has no rules and no restrictions and the other has so many restrictions that they can barely move. So one wins and the other loses, as the game is not fair.
So the answer we need is to level the playing field. We can continue to cry about the currency manipulation. That is not going to help, because we do not control the currency markets. So the answer is to raise tariffs on Chinese goods. Use the tariffs to subsidize our manufacturing and over produce goods to offset the drop in supply from China. Use regulation to force companies like Walmart to buy at least fifty percent of their goods from US manufacturing. This will be a temporary fix but it will give the Chinese a clear message that the US is serious about fixing the asymmetrical trade equation. Also, we can use technology to become more efficient low cost producers.
The other option is to leave things as is and wait for a natural change in Chinese consumers. As the Chinese become richer, they will consume more. This is already evident in the over-heated real estate market in Shanghai and other places. There is absolutely nothing to indicate that the Chinese consumer is any more sensible in their consumption than the US consumer. As consumption increases in China, the pro democratic and other social movements will weaken the Communist machine. So there maybe a natural end to this bogeyman. Do not panic just yet.
Friday, November 26, 2010
Why is QE (Quantitative easing) not working ?
Banks are not lending. Why are Banks not lending – because they can (not lend). Banks can afford to not lend, atleast for a while. Banks are very contra useful entities. They will lend when you do not want them to lend and they will squeeze out all access to liquidity when you need it the most. Very perverse, but that is just the nature of the beast.
Ok so to go back to basics. Banks create money. Money is not longer just the total supply of paper money. Money is the number of times this stock of money circulates. This is the infamous bank multiplier, where the bank keeps a small fraction in reserve and lends the rest of the money out. So the same stock of money expands to none or 12 times (whatever is the multiplier). So now we have the opposite problem. Banks call in their loans and keep the money, to shore up their capital. So our money supply is contracting, by several multiples. It does not matter if you reduce interest rates to zero. The banks are not going to lend. People are not going to borrow.
So now that interest rates are zero, we have to look for new tricks. The new trick is quantitative easing. The Treasury issues Bonds. The Fed prints money and buys the Bonds. This increases the stock of money. But that does nothing for the multiplier. A little extra paper money floating around is not going to offset the contraction resulting from the Banks calling back their loans. At the same time we have regulators asking the Banks to increase their cash reserves – the exact opposite of what we need the Banks to do now! As usual we bolt and lock the stable door securely after the horse is several miles away in the next town.
Basic fallacies. The President can create jobs. Why and how did we ever get this notion that the President is supposed to create jobs. Can you go back in history and point to one President has had a real impact on the economy ? Sure all of them have claimed to create jobs. But that is just political rhetoric to get elected. Nobody should take this kind of claim seriously. If any of the Republicans are going to point to their god Ronald Regan as having created jobs. Please! Ronald Regan is the man who along with Maggie Thatcher sold all your jobs to China. Sure it made his economic numbers look good, but we are all paying the price of that genius thinking.
Second fallacy. The Fed chairman has a magic silver bullet to kill the ghost of Recessions. Alan Greenspan was a fake shaman who played to the CNBC galleries. The truth is that the Fed chairman can only do so much with monetary policy. The Fed cannot make the Banks lend. Only the Banks can create money and only the Banks can make other banks lend.
So what is the answer great one ? Will we never see the end of this economic funk and see happier times ? Of course we will. There is a natural order of things. As prices fall, they will hit a bottom. People will wake up one morning and say, the heck with it, let me go out and borrow and start buying things again. They just need confidence that the world is not ending today. Soon the banks will run out of accruals on their old loans and need to lend again. Some upstart bank will figure out they need to get on top of the rankings by lending more aggressively. And everything will work again – magic!
So Mr. Bernanke my advice to you is don’t just do something. Stand there and let things take their natural course. And Mr. Obama I know things may not come up to speed by re-election time. But there is squat you can do about it. Easier to take a step back and talk sense to the sensible part of the population. Get the fear index down. And don’t make silly promises that you will not be able to keep. You should be just fine.
Ok so to go back to basics. Banks create money. Money is not longer just the total supply of paper money. Money is the number of times this stock of money circulates. This is the infamous bank multiplier, where the bank keeps a small fraction in reserve and lends the rest of the money out. So the same stock of money expands to none or 12 times (whatever is the multiplier). So now we have the opposite problem. Banks call in their loans and keep the money, to shore up their capital. So our money supply is contracting, by several multiples. It does not matter if you reduce interest rates to zero. The banks are not going to lend. People are not going to borrow.
So now that interest rates are zero, we have to look for new tricks. The new trick is quantitative easing. The Treasury issues Bonds. The Fed prints money and buys the Bonds. This increases the stock of money. But that does nothing for the multiplier. A little extra paper money floating around is not going to offset the contraction resulting from the Banks calling back their loans. At the same time we have regulators asking the Banks to increase their cash reserves – the exact opposite of what we need the Banks to do now! As usual we bolt and lock the stable door securely after the horse is several miles away in the next town.
Basic fallacies. The President can create jobs. Why and how did we ever get this notion that the President is supposed to create jobs. Can you go back in history and point to one President has had a real impact on the economy ? Sure all of them have claimed to create jobs. But that is just political rhetoric to get elected. Nobody should take this kind of claim seriously. If any of the Republicans are going to point to their god Ronald Regan as having created jobs. Please! Ronald Regan is the man who along with Maggie Thatcher sold all your jobs to China. Sure it made his economic numbers look good, but we are all paying the price of that genius thinking.
Second fallacy. The Fed chairman has a magic silver bullet to kill the ghost of Recessions. Alan Greenspan was a fake shaman who played to the CNBC galleries. The truth is that the Fed chairman can only do so much with monetary policy. The Fed cannot make the Banks lend. Only the Banks can create money and only the Banks can make other banks lend.
So what is the answer great one ? Will we never see the end of this economic funk and see happier times ? Of course we will. There is a natural order of things. As prices fall, they will hit a bottom. People will wake up one morning and say, the heck with it, let me go out and borrow and start buying things again. They just need confidence that the world is not ending today. Soon the banks will run out of accruals on their old loans and need to lend again. Some upstart bank will figure out they need to get on top of the rankings by lending more aggressively. And everything will work again – magic!
So Mr. Bernanke my advice to you is don’t just do something. Stand there and let things take their natural course. And Mr. Obama I know things may not come up to speed by re-election time. But there is squat you can do about it. Easier to take a step back and talk sense to the sensible part of the population. Get the fear index down. And don’t make silly promises that you will not be able to keep. You should be just fine.
Monday, June 14, 2010
How to fix the rising cost of college education
Ok. Here is a solution. We add four more years to the local High Schools so that now we have sixteen years of schooling. Take four years out of from class one to four and let the younger kids be home-schooled.
Sure we will lose choice among colleges and majors. This is another socialist solution. But face it - kids do not learn anything in today's colleges. It is just a glorified High school. A very expensive one at that.
Maybe you go to another state for college - just to keep it interesting. We can have SAT's and competition etc, but the state would pay for college. What do you think ?
Sure we will lose choice among colleges and majors. This is another socialist solution. But face it - kids do not learn anything in today's colleges. It is just a glorified High school. A very expensive one at that.
Maybe you go to another state for college - just to keep it interesting. We can have SAT's and competition etc, but the state would pay for college. What do you think ?
Wednesday, April 14, 2010
Risk weighted Assets
You call it WRA, I call it RWA. What does it all mean ? Risk weighted assets are a fictitious concept that is used to measure a Bank's capital. To understand what this is, let us first understand how a Bank holds capital.
Simple example. Depositors put a million in my bank, I lend out nine hundred thousand. A hundred thousand is my safety net. I take in ten such deposits and I lend out ten such loans and I am sitting on a million bucks as reserve. I am playing a game here, because as long as all ten of my depositors do not come asking for money, I am good to cover the one guy that shows up. This is the traditional banking model.
Now if I do a derivative with one counterparty, and I do an offsetting derivative with another counterparty, do I need capital ? Not at the beginning, because in the beginning the derivative has no value. But as the market moves and the derivative has value, I am effectively lending to one guy and borrowing from the other. So, similar to my above simple example, I need to hold capital. This is where RWA -risk weighted asset comes in. If the value of my derivative is 1Million today, I do not necessarily have to hold a 100 thousand in reserve for it. Depending on the derivative and some amorphous rules, I am free to come up with a black box model, that will tell me how much reserve to hold. This number could be zero, could be ten bucks or could be a million. The beauty of it is that it is entirely up to me to calculate this number. This is the RWA for this contract. So I take some vaguely estimated probability of default, and multiply it by an equally made up loss given default, and come up with a perfectly random number. The smaller this amount that I need to hold in reserve, the more profitable I will look.
So now let us look at a scenario, where we have ten large investment banks, all doing a simple product like a fixed to floating swap. Nevermind credit default swaps. They are all producing the same simple widget. It was invented a long time ago and one widget is as good as another. You cannot even pretend that a swap produced by Goldman sachs smells any sweeter than that produced by the creit union down the corner. So, the only way to be more profitable than the other guy, besides selling snake oil to unsuspecting widows, Municipalities etc (adding a few extra bps when they are not looking) is for the wizards to play with the RWA numbers. The more profits you squeeze out of less capital, the better you look. The skill is in the capital management or the number management.
And we are so shocked that these banks were so thinly capitalized during the crisis! Look at the capital they hold against trillion dollar balance sheets. My advice to regulators - Force Banks/Investment Banks to hold more capital. Dont buy their stupid Value at risk VAR nonsense. Anybody with half a brain knows that Var is not real finance. VAR is like looking for inner beauty at a Miss America Pageant . True risk management is Credit risk Management. How much due diligence did you do when you lent out the firm's money to a perfect stranger ? That is the true essence of a Banker. Good judgement and hard work done before lending out money. You dont learn that in a crash course case study at an Ivy league MBA.
And these whiners actually want to say the rating agencies made me buy all those crap securities. Only a regulator or a Bloomberg correspondent would buy that kind of BS.
The BASEL II & BASEL infinity versions are supposed to solve the RWA problem. That is laughable. They set a blind elephant to hunt down a very lithe cheetah, in a particularly dark part of the forest. No hope of them catching anything before the next crisis. It is really touching though the faith that people put in these silly charms to ward off the evil eye. Like for instance the Sarbanes Oxley controls to prevent Accounting scandals. That SOX thing really worked man - except for Lehman, Bear Stearns and the rest of them.
Simple example. Depositors put a million in my bank, I lend out nine hundred thousand. A hundred thousand is my safety net. I take in ten such deposits and I lend out ten such loans and I am sitting on a million bucks as reserve. I am playing a game here, because as long as all ten of my depositors do not come asking for money, I am good to cover the one guy that shows up. This is the traditional banking model.
Now if I do a derivative with one counterparty, and I do an offsetting derivative with another counterparty, do I need capital ? Not at the beginning, because in the beginning the derivative has no value. But as the market moves and the derivative has value, I am effectively lending to one guy and borrowing from the other. So, similar to my above simple example, I need to hold capital. This is where RWA -risk weighted asset comes in. If the value of my derivative is 1Million today, I do not necessarily have to hold a 100 thousand in reserve for it. Depending on the derivative and some amorphous rules, I am free to come up with a black box model, that will tell me how much reserve to hold. This number could be zero, could be ten bucks or could be a million. The beauty of it is that it is entirely up to me to calculate this number. This is the RWA for this contract. So I take some vaguely estimated probability of default, and multiply it by an equally made up loss given default, and come up with a perfectly random number. The smaller this amount that I need to hold in reserve, the more profitable I will look.
So now let us look at a scenario, where we have ten large investment banks, all doing a simple product like a fixed to floating swap. Nevermind credit default swaps. They are all producing the same simple widget. It was invented a long time ago and one widget is as good as another. You cannot even pretend that a swap produced by Goldman sachs smells any sweeter than that produced by the creit union down the corner. So, the only way to be more profitable than the other guy, besides selling snake oil to unsuspecting widows, Municipalities etc (adding a few extra bps when they are not looking) is for the wizards to play with the RWA numbers. The more profits you squeeze out of less capital, the better you look. The skill is in the capital management or the number management.
And we are so shocked that these banks were so thinly capitalized during the crisis! Look at the capital they hold against trillion dollar balance sheets. My advice to regulators - Force Banks/Investment Banks to hold more capital. Dont buy their stupid Value at risk VAR nonsense. Anybody with half a brain knows that Var is not real finance. VAR is like looking for inner beauty at a Miss America Pageant . True risk management is Credit risk Management. How much due diligence did you do when you lent out the firm's money to a perfect stranger ? That is the true essence of a Banker. Good judgement and hard work done before lending out money. You dont learn that in a crash course case study at an Ivy league MBA.
And these whiners actually want to say the rating agencies made me buy all those crap securities. Only a regulator or a Bloomberg correspondent would buy that kind of BS.
The BASEL II & BASEL infinity versions are supposed to solve the RWA problem. That is laughable. They set a blind elephant to hunt down a very lithe cheetah, in a particularly dark part of the forest. No hope of them catching anything before the next crisis. It is really touching though the faith that people put in these silly charms to ward off the evil eye. Like for instance the Sarbanes Oxley controls to prevent Accounting scandals. That SOX thing really worked man - except for Lehman, Bear Stearns and the rest of them.
Friday, January 15, 2010
The Euro is an impostor - the dollar is the king of the world!
We have all heard the doomsday predictions. The Chinese are unloading the dollar. The Saudis will price Oil in Euros. The anti-dollar has arrived. Bye bye American Peso.
But hang on a minute. What are they hanging their hat on ? The Euro ? A conglomeration of dysfunctional Europeans, who can barely stand each other ? The Greek tragedy that is now unfolding is just a precursor of things to come. Wait till we have some real disagreements say when the French unemployment starts peaking just when the German economy is smoking hot. How can economic policy be co-ordinated without a real political union ?
Anyone who invests their life's savings in the Euro because they do not like Obama's profligate policies, are taking a huge risk. It would make more sense to buy the Saudi Riyal. At least that is backed with Oil for some time to come. What does the Euro offer you ? A bunch of Socialists with institutionalized under-employment. There is no military might, no budding superpower, no dynamic entrepreneurship, to back its value. There is no case for the Euro.
But hang on a minute. What are they hanging their hat on ? The Euro ? A conglomeration of dysfunctional Europeans, who can barely stand each other ? The Greek tragedy that is now unfolding is just a precursor of things to come. Wait till we have some real disagreements say when the French unemployment starts peaking just when the German economy is smoking hot. How can economic policy be co-ordinated without a real political union ?
Anyone who invests their life's savings in the Euro because they do not like Obama's profligate policies, are taking a huge risk. It would make more sense to buy the Saudi Riyal. At least that is backed with Oil for some time to come. What does the Euro offer you ? A bunch of Socialists with institutionalized under-employment. There is no military might, no budding superpower, no dynamic entrepreneurship, to back its value. There is no case for the Euro.
DMO's have a great business model
I called my DMO the other day. I was terribly upset with my Dentist. Instead of charging me 40% of the total cost she had charged me 60%, in error. Now she refused to give me back my 20%, saying that there were some additional costs that had not been included in the original charge. I felt terribly scammed. She was keeping my 20%.
So I called my DMO. The friendly representative on the other line explained to me all the details of my plan. He also went off on a side discourse about tooth numbers. Did you know that tooth numbers 1 thru 6 have a different insurance coverage from the rest of the crowd ?
Anyway, the guy assured me that my dentist should waste no time in sending in her claim ..btw ..forgot to mention - this was for a crown replacement. Anyway, this guy impressed on me that it was absolutely imperative that my dentist send in her claim soon. They would not process a claim if it was later than two years. When I conveyed this to my dentist, she was amused. I realised why when I saw the amount the DMO had paid her - a princely sum of $15.
Now we all know that Dentists make a sinful amount of money, working just four days a week. So how does this scam really work ? The way it works is that the DMO is just a roll of customers - like a marketing database. We are actually paying a $1000 + bucks a year to be part of a customer database. The two cleanings a year is all that is covered by this plan. Once the Dentist gets you on the client list, the only way for them tomake money is by crown replacements, tooth extractions and other high value ( probably unnecessary treatments). It is like taking your car to the local mechanic - not the honest one. The one with gambling debts.
And all those percentages, 60% or 40%. To quote Newman from Seinfeld about zipcodes - the secret is that they are meaningless! Theoretically, the dentist could double your cost and then give you a 50% discount,because you are a preferred customer from the DMO.
Well that was my rant for the day. Maybe, everyone else already knows this scam and I am the last one in on it.
So I called my DMO. The friendly representative on the other line explained to me all the details of my plan. He also went off on a side discourse about tooth numbers. Did you know that tooth numbers 1 thru 6 have a different insurance coverage from the rest of the crowd ?
Anyway, the guy assured me that my dentist should waste no time in sending in her claim ..btw ..forgot to mention - this was for a crown replacement. Anyway, this guy impressed on me that it was absolutely imperative that my dentist send in her claim soon. They would not process a claim if it was later than two years. When I conveyed this to my dentist, she was amused. I realised why when I saw the amount the DMO had paid her - a princely sum of $15.
Now we all know that Dentists make a sinful amount of money, working just four days a week. So how does this scam really work ? The way it works is that the DMO is just a roll of customers - like a marketing database. We are actually paying a $1000 + bucks a year to be part of a customer database. The two cleanings a year is all that is covered by this plan. Once the Dentist gets you on the client list, the only way for them tomake money is by crown replacements, tooth extractions and other high value ( probably unnecessary treatments). It is like taking your car to the local mechanic - not the honest one. The one with gambling debts.
And all those percentages, 60% or 40%. To quote Newman from Seinfeld about zipcodes - the secret is that they are meaningless! Theoretically, the dentist could double your cost and then give you a 50% discount,because you are a preferred customer from the DMO.
Well that was my rant for the day. Maybe, everyone else already knows this scam and I am the last one in on it.
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