Lord of Finance

Lord of Finance
Walking towards Depression

After leaving it on my bookshelf for a while I eventually took out Lord of Finance to resume reading books on my journeys. Written by Liaquat Ahamed, I bought it at one of Harris’ 20% storewide sales during a period when I was thinking about reading up more about Finance after the recent crisis. I thought it was good to beef up my knowledge of American finance since Age of Turbulence was the closest I got to reading about the financial sector of America.

The book turns out to be more than what I was expecting. Written in the style that feels very similar to Doris Kearns Goodwin’s Team of Rivals, Lord of Finance traces the little stories that demonstrated the personalities of the four most important central bankers prior to 1929. They had exerted huge influence on the economies of Europe and United States, and unintentionally engineered in the Great Depression with their policies and beliefs. It was interesting to get a peek at a world still obsessed with the almost divine quality of gold as a storekeeper of value and with poor understanding of monetary economics.

Even more intriguing is that monetary policies and innovations are being created by these people who has a nuanced view of monetary economics and poor understanding of the workings of the economy. The stories and opinions of civil servants, politicians and aristocrats in those years demonstrates the experimentation humans had gone through in order to figure out how this gigantic machinery works. Of course, this study and experimentation carries on today.

Liaquat Ahamed got really good reviews (here and here) from New York Times for this book, especially for the fact that the contents of the book chillingly echos the stories of Wall Street in the past couple of years, involving banking heros and monetary policies, speculative bubbles and a huge crash. The description of the mania and the built up to the eventual crash sounds rather familiar to me given that I just finished John Cassidy’s Dot.con a while back. Men’s penchant for not learning from History seems particularly pronounced in bouts of ‘Irrational Exuberance’.

For that, Liquat gives a brilliant analogy for the role of Central Bankers or the policies makers trying to stabilize the economy and also pushing for growth. He sees them much like Sisyphus in the Myth of Sisyphus, condemned the work hard to create the conditions fertile for economic growth only to have speculation and irrational exuberance extinguish the fruits of their labour – much like Sisyphus who have to push a boulder up a mountain knowing that when the deed is done, it’ll roll back to its original position for him to do it again. Perhaps Albert Camus is right, for the struggle probably do fill the central bankers’ hearts and the belief of their heroism keeps them happy.

Lord of Finance simply surprises me with the rich collection of anecdotes about the main characters of the story Liquat tries to tell and the manner it imparts knowledge on finance and the workings of money in the economy to the readers – subtly and not too overwhelmingly technical. As a result the book caters to a wide range of audience; students interested in economics, history, finance and perhaps just stories about great men’s mistakes.

Those interested in getting a preview before making a purchase of the book or going on a trip to the library to borrow it might like to check out New York Times.

Coercion of Free Markets

Inequality is a market failure. We do pick this up in A Levels but then there’s little discourse on that. Not only do we dwell little on the solutions – which ranges from progressive taxation to welfare handouts – we ultimately ignore how inequality undermines the ultimate roles of markets, which is the efficient allocation of resources. I’ve always grasp the idea rather intuitively but then fail to deliver it in a philosophical and economics framework. I’ve pointed out the lack of philosophical musings in today’s study of Economics when I introduced Michael Sandel’s lecture on Markets and Morals.

I’ve always pose the question to my Economics student, if a person earns $1000 a month and another who earns $1 a month both needs a glass of water. The rich guy is willing to pay $10 for the water while the poor one is willing to pay $1. The market thus allocates the water to the rich man. We all know that this allocation is problematic and it doesn’t seem efficient; how is it that, in terms of willingness to pay, a person who is only willing to part with 1% of his monthly income gets the good when another is willing to part with 100% of his monthly income for it? So what exactly is the problem of inequality?

Once again, Michael Sandel points this out in the second lecture presented in this video. You don’t exactly have to watch the lecture in order to grasp the point but the idea is that when inequality (in terms of unequal distribution of income) exists, effective demand cannot properly reflect the ideal sort of demand signal transmission that would allow the market to allocate resources efficiently. In extreme cases, free markets becomes not entirely free. In other words, people are not transacting out of their free will but coerced by their own economic circumstances. We see this very often in the case of poor people in developing countries who are forced to sell organs, resort to prostitution, act as surrogate mothers, become a runner for crack.

Gary Becker is not wrong about the rationality of these people. They’re making rational choices but it is often that their choices is very much limited. That unfeeling market processes coerce us into certain decisions is something close to the hearts of all of us. Often, however, we can’t quite work out what is so unjust about that because we believe that to a large extent, we determine our riches. Somehow, deep in our hearts we know that some other decisions that we made caused us to be in the state we are in such that we are coerced into making that next decision. The fact that this argument comes back to us shows how each and every decision made in the marketplace by us are not independent. This makes for a determinism argument in a market setting where free will is supposed to reign.

There are much wider implications of all these arguments and I shall explore them if I get the chance.

Diversity & Sophistication

Product Nodes
Just like societies...

Economics have been a subject troubled with the idea of scarcity and thinking about means of distributing resources to produce what we call ‘wealth’. Scarcity is a clear-cut notion and ‘abundance’ represents the other end of the spectrum. The problem is that we are so familiar with scarcity we cannot be quite sure what really represents abundance (infinite, in short run or long run?) and thus, we actually have a problem quantifying wealth. What constitutes richness? Money? Gold? Having the most expensive resources? Having in abundance the most useful resource? Having the most diverse resources? Having human capital?

We’ve seen that most of the rich, developed world appears to be the same, with the similar institutions, rule of law and informal market rules; most of them produce certain complex niche products while importing a variety of inputs as well as many other consumer products. On the other hand, developing economies appears more diverse. This shows that the end state of riches can probably be attained through different pathways. The Economists’ latest Economic Focus discuss how recent research shows that sophistication in the economy signals at the potential of an economy.

The Product Space map that the researchers came up with shows that an economy producing at a more centrally located product zone where it is easy to diversify into many other products would fare better than one in an isolated region. However, the isolated products often yield greater profits because they are probably rarer and so competition amongst economies leads to evolutionary forces pushing certain economies into these corners of product space possibly at the expense of potential. In any case, versatility is treasured and flexibility in production will aid economic growth.

The Story of Stuff

For something animated but no less thought-provoking for the Chinese New Year, a video clip produced by Annie Leonard about how our “stuff” (i.e. consumer goods) are produced and the dangers that have come associated with the production and consumption of these goods. I was first introduced to this video in Junior College by my Geography teacher, and I found it rather animating, enlightening and inspirational, as well as rather easy to digest yet still sufficiently thought-provoking.

The Story of Stuff is a 20 minute video that can be watched on YouTube as well as downloaded from the website for future broadcasts, as I did. Do watch because it alerts you about the behind-the-scenes situation which you have never really thought about when you do shopping. While her perspective is that of government-bashing and firm-bashing, it is still worthy of considering. It is suitable for the kids though they will probably need to be guided along to fully understand the video considering that she uses quite a bit of jargon that might be slightly inaccessible to the young.

This video probably comes too late to remind you about what you buy for Chinese New Year, but still, better late than never. Happy Lunar New Year!

State & Markets

Bihar
Now for political enlightenment...

While reading about Bihar’s Recovery, it dawned on me the importance of basic government structures in an economy. This sort of realisation had come to me while I was reading about the Haiti crisis and I really think all students of Economics should remind ourselves of the government structures working in the background implied in what we call a ‘Free Market’.

As observed from the article on Bihar, which interestingly is where the Buddha gained enlightenment (according to historical records), the state’s investment in infrastructure, maintaining order, a culture that respect the rights of all citizens (that can only be created from top down) often influenced very much by the enforcement of laws, as well as giving people freedom to pursue the market activities.

When we argue about the importance of not having government interventions in markets, and that state presence should only emerge in the case of market failures, we often neglect the notion that a government is in place in the background to honour the legal tender and anarchy is not the ruling ideology of the day. Trust in the free market is also important and it is upheld by law and order, which once again, falls on the government. As we’ve seen from the earthquake in Haiti, more room for market and less state is not always a good thing. Yet after acknowledging the need for a state we want to combat its advancement into various aspects of society that are usually governed by culture or self-organizing.

Maybe working on the margins of that would help Bihar discover this balance of state and market spaces.

When Economics clashes with (Geo)politics

First published in The New York Times on Wednesday, Thomas Friedman writes about the low likelihood of a “benign 2010” given the economic and geopolitical conditions currently brewing. I read the reprinted article on mypaper on Thursday and was rather amused by his arguments.

He started off by saying that 2009 was a pleasant surprise for being a rather peaceful year for “the world’s biggest economies” to heal without any major wars or political / geopolitical disruptions, and then asserts that 2010 would probably not be as peaceful. I do not really agree with him about the “three major struggles” we face (the banks vs President Obama, China vs Google & Iran vs the world), but he has managed to make rather substantial arguments.

Struggle 1: The banks vs President Obama
I did not quite think that this was a significant issue, but that is probably because Singapore is / was pretty sheltered from the full force of the economic breakdown in the West. At least in Singapore, the banks appear to be in rather good shape. But Singapore still bore some brunt from the crisis, thanks to our open economy. I will not go into an argument about how globalized our economy should be (suffice to say that I am for globalization, but not the “free-for-all” some Republicans seem to want) but I must agree that banking regulations need to be stiffened. President Obama has a very tough job balancing giving free rein to the banks to operate and continually grow their wealth (and hence America’s economy too) and managing expectations that as president he should be concerned more about his people who are suffering as a result of the folly of these bankers (and hence should punish the bankers). Either way, this tough balancing act is going to take much more than just “change we can believe in” or “yes we can” as President Obama promised before becoming president. His actions will have direct or indirect impact on the WHOLE world.

Struggle 2: China vs Google
Again, I never thought of this as a huge issue too, but it must certainly be one of much concern to quite a few if columnists keep writing every day about the relations between China and America and whether the trough in relations they are going through marks a change in tact or just posturing. The G2 (Group of 2 – China & America) notion aside, the assault on Google was certainly daring and bellicose. I am more inclined to side with Google and America, but you must also take into consideration the views of millions (of Chinese netizens) that the Chinese government have to assuage and calm. Many of them see the China-bashing as unwarranted and colonial bullying that is behind the times given the ascendant status of China, so I do not foresee that China and America’s retaliatory actions are going to end at just sanctions. I sure hope they do things calmly though… recall the saying “when elephants fight, the grass gets trampled”.

Struggle 3: Iran vs the World
Now this is an issue that I think people do not believe is a sufficiently major problem. Iran’s nuclear proliferation will be very dangerous to America as well as the world, and it will derail all the economic efforts put in by the world’s major economies given the potential changes it will cause to the geopolitical arena. This I think would be the most difficult struggle to resolve, given the ramifications that could spillover into the economic and social spheres (e.g. war). Unfortunately, given all the other problems that America and the world is facing now, it is inevitable for the Iran issue to be placed on the back-burner. But there must be understanding that neglecting the Iran issue and letting it fester will not make it any easier to solve.

I echo Friedman’s wishes that “cooler heads prevail” this year. Or else, as he says, “fasten your seat belts”.

Sanction no more?

Rolled Bills
No more trading!

In January 27’s The Straits Times, Susan Long writes in the Review column about why sanctions will not work in curbing Iran’s nuclear tendencies. Whether sanctions work or not has been a long debated issue, and simply googling the title of Long’s article “Why sanctions dont work now” will yield many articles that have been written on this subject, mostly arguing for the end of sanctions against “evil” countries like Iran and Cuba.

First, regarding Long’s write-up. She asserts that sanctions may not be as messy as outright fighting or war, but they harm the innocent civilians most and not the leaders and perpetrators. The poor suffer the most as they have limited access to food, medicine and daily necessities amongst other things, whereas the rich are not affected very much by economic sanctions since they already have the monetary ability to purchase high-end goods like “Swiss chocolate”. The elite will “thrive on the black market” while the poor suffer unnecessarily.

Sanctions can also backfire, such as when it unites a country against the perpetrators of the sanctions (often the United States of America together with the United Nations). Take the sanctions against Iran. Instead of isolating the Islamic regime led by Ayatollah Khamenei & President Ahmadinejad and causing displeasure towards the leaders by the populace, it could end up bringing together the forces that wanted to overthrow Khamenei & Ahmadinejad, led by the Green movement whose leader is Mir-Hossein Mousavi. This would make it even more difficult to “overthrow” the current Islamic regime should the incumbents unite with the opposition against the United States and the outside world.

Of course, sanctions are only sanctioned when the country that imposes the sanctions does not stand to lose much. And often countries that impose sanctions or threaten to do so end up revoking them out of other motivations, such as the United States’ threat to impose sanctions on Myanmar which in the end were not realised because such sanctions would have benefitted China and other rogue regimes that would increase their sphere of influence in the country.

Some other articles that disbelieve in sanctions can be found online as well. Nicholas Kristof of The New York Times has similar views to Long, published in the Global Policy Forum. David Henderson of Hoover Institution in Hoover Digest even goes as far as to propose that free trade with “rogue” nations would help to engineer collapses in these regimes when the people open their eyes to the world out there and what is on offer. Dursun Peksen in Foreign Policy names other plausible alternatives such as “engagement / dialogue” and even economic incentives like foreign aid.

In essence, the idea seems to be that should the stick fail, the carrot might be the only way out. In a globalized world such as ours, penalties like sanctions have a high chance of backfiring.

The Bigger Brother

Monster
Not so cute...

A search query on Wikipedia for ‘Big Brother‘ offers a disambiguation page that offers a link to their ‘Authoritarian personality‘ article. Today, we sometimes allude to the concept of ‘Big Brother’ when we talk about our governments but we hardly picture the government being authoritarian, perhaps just more of nannying. Today’s problem for the world, however, is that our Big Brothers are getting too big, as Leader of The Economist this week pointed out.

The cover of The Economist features a big fat monstrous lump attempting to devour a corporate executive reflecting their perception of how appallingly huge and scary governments have become. As a matter of fact, developed world governments might have taken up to much of economic breathing space because of the recent events and will need to scale down their footprint more. It’s always easy to get involved in many activities in the economy but difficult to pull out. The Briefing talks about state spending ballooning and makes a fierce assault on the weaknesses of government.

One of the case mentioned was their failure to make good use of management consultants, who ends up being portrayed as conman treating “the public sector as dumping grounds for airy-fairy ideas”. Oh well, in a crisis everyone suffers, even the management consultants themselves are not doing well.

Free Market Madness

Free Market Madness
Market for Sanity

I was looking for George Arkelof and Robert Shiller’s Animal Spirits in the library but it was on loan so I decided to look for something else in the Call Number 330 (which some library-goers might note is the ‘Economics’ section) area. I stumbled on ‘Free Market Madness‘ by Peter Ubel.

Ubel’s book is a pretty simple and short one, I took only one and a half day of on-and-off reading to finish it, one of my fastest timing for a non-fiction. Admittedly, the text and paragraph spacings are pretty wide and the book is thin for a hard-cover one. It is largely about behavioural economics, a topic which I hardly have a hard time understanding so the speed by which I finished the book didn’t really surprise me. Nevertheless, I hardly consider Ubel’s Free Market Madness to be that good a book.

For a start, I understand that Ubel is trying to make a case for government intervention in the economy for markets where consumers are ill-placed to make wise choices and where market imperfections like the inadequacy of useful information and the apparent misalignment of producer’s interests and consumer’s interests are significant. He focuses on the case of junk food causing obesity though he touched on other cases such as insufficient retirement funding and overspending on branded drugs. Unfortunately, while he makes a good case for the fact that humans are not entirely rational (something we all know at least implicitly), based mainly on the study of other behavioural scientists and economists, he didn’t give very outstanding or original proposals on how to get around this problems. Even then, he fails to make a good connection with how the conflict between the short-term-self and long-term-self can be resolved by the governments; the question of what sort of happiness/well-being (long term or short term) the ‘Big Brother’ he is advocating should maximize it left to speculation by the reader.

The little technical issues in the examples he cited in his book is by and large criticized by David Gordon, senior fellow of the Mises Institute. Austrian School economists probably think that no one can be innocently obese; it takes two hands to clap and producers and consumers must agree on the transaction for it to take place. In other words, people are obese through a process of attempting to maximize utility within their own accounting. On the other hand, Ubel thinks that the faculty accounting on the part of the consumers need to be rectified – in other words, internalities need to be addressed. The problem is we cannot exactly agree on which accounting is correct; after all, if one’s belief in the goodness of a product can provide additional positive experience in consuming it, the faculty accounting can have such a self-fulfilling effect. I believe I have the tendency to agree with the ordinary economists that humans would have a fair degree of foresight and self-control and in an event where they lack such discipline and ability, the market punishes them very much in the way evolution eliminates those who lack the fitness.

His proposals are rather unoriginal, citing stuff like fat taxes once mentioned in The Economist, default options, persuasion campaigns (largely moral suasion) and possibly outright ban. He did discuss implications on liberty and such but doesn’t dwell much on it – often it seems to me like he’s saying ‘I just want everything to be good and right, I don’t care how’.

I do agree with Ubel, that humans in our age needs more self-control and the public’s awareness of the ills of the markets, the ills of different products that are so ubiquitous in our world today needs to be improved. This self-improvement in discipline and improvement of public knowledge can come from bottom-up rather than top-down. After all, given the circumstances today, it is likely that the group with better knowledge of the markets, those making wiser market decisions and the ones who have better self-control is going to thrive. Parents will have to recognize that and respond accordingly (not too much to hope for given the limited rationality of humans I hope) when educating their children and developing them. And I must have to say that in markets like healthcare and pharmaceutical products, doctors like Ubel himself will have to take the responsibility of protecting their patients from the ills of the market/industry. The imperfect information is really too serious in this market and Ubel is right to say that doctors are practically making decisions for patients – doctors’ recommendations are almost equals to patients’ choice (doctors can’t possibly give their diagnosis to patients and get them to choose medicine for themselves). The government can only do so much to protect the doctors from manipulation by the industry and thus defend the interests of the patients. Physicians themselves will have to take the big step to be responsible doctors.

On the whole, Free Market Madness gives us good idea of how behavioural economics came into being and how traditional economic analysis of indifference is difficult to apply in today’s complex world. As a result, rationality of human beings becomes undermined today. Beyond that, it makes a good alert on the problems humans might have with markets that makes us poor economic agents – in long run we will get exploited somehow. We will need to exploit back by becoming producers of certain exploitive products ourselves or try to defend ourselves through self-restraint and aggressive self-education. Otherwise, if the book is hoping to inspire any sort of action, it might need to be much more.

Optimistic Wishes for 2010

Bully Kids
Goofing Kids...

In today’s The Straits Times, occasional columnist Tom Plate writes about ‘an optimist’s wish list for 2010‘. Tom Plate is a relatively regular columnist for The Straits Times and writes for many other newspapers in the Asia-Pacific as well. His articles also often make for interesting reading because he writes in a rather cheerful and casual (yet still professional) style, a style not exactly like Paul Krugman’s whose writings I recently referred to in my last entry for erpz.net but I enjoy his writings as much as Krugman’s.

In this article, he tries to infuse some optimism into his hopes for the coming year. Some of the wishes are really wishful thinking, but still no harm keeping your fingers crossed.

His wishes:
1. World pays more attention to South Korea, less to North Korea
Well, actually this tactic might work. North Korea is sometimes like an attention-seeking kid throwing a temper-tantrum and sometimes you need to ignore the kid for a while so that he calms down. But then again, does your kid have nuclear weapons that he can throw at his ‘friends’?

2. These bad big shots will resign: Britain’s PM Gordon Brown, Burma’s junta leader Than Shwe & North Korea’s leader Kim Jong Il
I agree on the latter two but Gordon Brown… he’s not doing a good job at all in Britain, but he’ll probably be kicked out through the elections this year. Why is Iran’s President Mahmoud Ahmadinejad not on this list? He’s a greater danger to the world than Gordon Brown is.

3. India’s Odd Couple named Time’s Man and Woman of the Year: PM Manmohan Singh & Congress party leader Sonia Gandhi
Like Plate says, US needs to pay more attention to India. It will make not ‘just a good strategic partner’ as US President Obama claims, but a staunch ally and friend not just in the War on Terror but in terms of the global economy and climate change for instance. US needs to soothe the frayed nerves of their Indian counterparts.

4. China’s President Hu opens up, gets down with Western media
This is not that hard to do on a personal perspective, but if you think about the Chinese leadership and how they go about doing things… this is pretty much like expecting Wish Number 2 to magically be granted.

5. Japan finds a successful premier: NOT Yukio Hatoyama
In all honesty, is anything so wrong with current PM Yukio Hatoyama? I think he is hamstrung by his 2 parties allied to his Democratic Party of Japan (DPJ) that are imposing many demands on him and not toeing the official alliance line. And then there’s DPJ Chairman Ichiro Ozawa who pulls strings behind the scenes… which makes the current PM’s life so difficult. Give him a chance to learn the ropes. We are so willing to give President Obama chances to make mistakes as a newly-minted leader without much experience, so why not PM Hatoyama?

He did not tackle climate change in his article as I hoped he might have, but let’s just stick to politics and economy for now. Or he probably feels pessimistic about climate change as well? We dont really know what he doesnt write, but from what he has written in his above list, if any of the wishes came true it’d make global affairs less complex and less troublesome for America at least.