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Archive for July 2005

Weekend reading

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LSE professor John Gray on Thomas Friedman and globalization in NY Review of books.

Globalization has no inherent tendency to promote the free market or liberal democracy. Neither does it augur an end to nationalism or great-power rivalries Describing a long conversation with the CEO of a smal Indian game company in Bangalore, Friedman recount the entrepreneur concluding: “India is going to be superpower and we are going to rule.” Friedman replies: “Rule whom?” Friedman’s response suggests that the present phase of globalization is tending to make imbalances of power between states irrelevant. In fact what it is doing is creating new great powers, and this is one of the reasons it has been embraced in China and India

Neoliberals interpret globalization as being driven by a search for greater productivity, and view nationalism as a kind of cultural backwardness that acts mainly to slow this process. Yet the economic takeoff in both England and the US occurred against the background of a strong sense of nationality, and nationalist resistance to Western power was a powerful stimulus of economic development in Meiji Japan.

Nationalism fueled the rapid growth of capitalism in the nineteenth and early twentieth centuries,[2] and is doing the same in China and India at the present time. In both countries globalization is being embraced not only because of the prosperity it makes possible, but also for the opportunity it creates to challenge Western hegemony. As China and India become great powers they will demand recognition of their distinctive cultures and values, and international institutions will have to be reshaped to reflect the legitimacy of a variety of economic and political models. At that point the universal claims of the United States and other Western nations will be fundamentally challenged, and the global balance of power will shift.

Interview with BCA Research economist Martin Barnes on our strange and fascinating low-return macro times.

Why do you see inflation staying low? Yeah, we’ve had the almost perfect conditions for inflation in the last few years. The Fed has run a very stimulative monetary policy. We have run big budget deficits. We have driven the dollar down. To top it off, oil prices are up. We’ve had the perfect inflationary mix, and yet we haven’t really had any inflation despite that.

If you look around the world, there is no evidence of inflation at all. China is perhaps the best place to prove it. Here is a country that has been growing at 9% to 10% and effectively adopted U.S. monetary policy by pegging its currency to the dollar. Yet there is no inflation in China at all. In fact, there is deflation, and that tells you there is something very powerful going on there in terms of a supply-side boom.

In the U.S., there are tough competitive conditions. And the Internet and technology in general is still a very powerful force for disinflation. There are pockets of inflation, but the overall picture isn’t all that bad. The Fed’s view is there is still a problem. They are worried about labor costs going up. But a lot of the inflation indicators we look at are rolling over. Producer prices are easing.

If the economy was to continue growing really strongly here, at a 4% clip for the next year, of course, there would be pressures on resources and the unemployment rate would fall and wages would go up. But that’s not likely. The economy is going to do OK — but I don’t see it growing much above trend over the next year.

Would you expect to see capital expenditures stronger than they have been? The corporate sector is still in a post-bubble world after the information-technology boom. The Enron and WorldCom scandals have also shaken up the corporate world. Corporate executives are worried also about housing bubbles and trade deficits and protectionism. It is not an environment where companies feel that they want to be great heroes and strongly expansionist.

They are investing to become more efficient, but not expanding capacity in a big way. They could have invested more strongly, given how healthy cash flows have been, but they’ve been focusing more on repairing balance sheets and getting their financial house in order, taking the view that the markets are rewarding them more for stronger finances than they would for being expansionist.

That attitude might change gradually the longer the economy stays OK. Then the problem becomes slowing profit growth. It is hard to make the case for capital-spending growth to accelerate. It is probably going to weaken a bit. You end up with a decent economy, but it is not going to be growing at an inflationary pace, in my view.

Written by infoproc

July 31, 2005 at 10:29 pm

Posted in Uncategorized

China macro effects

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The Economist summarizes China’s impact on the world economy. The effective global labor force doubled in the last decade, but global capital stock did not. Therefore, one would expect reduced returns to labor relative to capital. This is in fact the case, as can be seen from US wage data:

However, the return on capital is also currently quite low, as indicated by interest rates. Again, deflationary forces due to Chinese economic integration have allowed central bankers to keep interest rates low while maintaining price stability. Here the effects are not so clear cut, as increased demand for commodities leads to price increases, while decreased labor costs lead to deflation. Insofar as the latter effects are dominant (and the current trend corresponds to “good deflation”), central bankers would be making a mistake keeping interest rates so low. In effect, they are flooding the world with cheap capital, reducing the return on capital and producing serious misallocation of resources (housing bubbles).

China’s impact on the world economy can best be understood as what economists call a “positive supply-side shock”. Richard Freeman, an economist at Harvard University, reckons that the entry into the world economy of China, India and the former Soviet Union has, in effect, doubled the global labour force (China accounts for more than half of this increase). This has increased the world’s potential growth rate, helped to hold down inflation and triggered changes in the relative prices of labour, capital, goods and assets.

The new entrants to the global economy brought with them little capital of economic value. So, with twice as many workers and little change in the size of the global capital stock, the ratio of global capital to labour has fallen by almost half in a matter of years: probably the biggest such shift in history. And, since this ratio determines the relative returns to labour and capital, it goes a long way to explain recent trends in wages and profits.

In America, Europe and Japan, the pace of growth in real wages has been unusually weak in recent years. Indeed, measured by the growth in income from employment, this is America’s weakest recovery for decades. According to Stephen Roach, an economist at Morgan Stanley, American private-sector workers’ total compensation (wages plus benefits) has risen by only 11% in real terms since November 2001, the trough of the recession, compared with an average gain of 17% over the equivalent period of the five previous recoveries (see chart 3). In most developed countries, average real wages have lagged well behind productivity gains.

The entry of China’s vast army of cheap workers into the international system of production and trade has reduced the bargaining power of workers in developed economies. Although the absolute number of jobs outsourced from developed countries to China remains small, the threat that firms could produce offshore helps to keep a lid on wages. In most developed countries, wages as a proportion of total national income are currently close to their lowest level for decades.

The flip side is that profits are grabbing a bigger slice of the cake (see chart 4). Last year, America’s after-tax profits rose to their highest as a proportion of GDP for 75 years; the shares of profit in the euro area and Japan are also close to their highest for at least 25 years. This is exactly what economic theory would predict. China’s emergence into the world economy has made labour relatively abundant and capital relatively scarce, and so the relative return to capital has risen. It is ironic that western capitalists can thank the world’s biggest communist country for their good fortune.

China’s main impact on the world economy is to change relative prices and incomes. Not only are the prices of the goods that China exports falling; the prices of the goods that it imports are rising, notably oil and other raw materials. China is already the world’s biggest consumer of many commodities, such as aluminium, steel, copper and coal, and the second-biggest consumer of oil, so changes in Chinese demand have a big impact on world prices.

China has accounted for one-third of the increase in global oil demand since 2000 and so must bear some of the blame for higher oil prices. Likewise, if China’s economy stumbles, then so will oil prices. However, with China’s oil consumption per person still only one-fifteenth of that in America, it is inevitable that China’s energy demands will grow over the years in step with its income.

There is currently only one car for every 70 people in China, against one car for every two Americans. That implies a huge increase in oil demand, which could keep prices high for the foreseeable future, because of scarce global spare capacity. China’s consumption per person of raw materials, such as copper and aluminium, is also still low, so rising demand will continue to support commodity prices.

Cheap money
Overall, the upward pressure that Chinese imports of raw materials have put on the prices of oil and other commodities has been more than offset by the downward pressure of Chinese manufactured exports. As a result, another important aspect of the China effect is low inflation.

Central bankers like to take all the credit for the defeat of inflation, but China has given them a big helping hand in recent years. China’s ability to produce more cheaply has pushed down the prices of many goods worldwide, as well as restraining wage pressures in developed economies. For instance, the average prices of shoes and clothing in America have fallen by 10% over the past ten years—a drop of 35% in real terms.

A study by Dresdner Kleinwort Wasserstein reckons that China has knocked almost a full percentage-point off America’s inflation rate in recent years. The recent 2% revaluation of the yuan will probably be absorbed by Chinese manufacturers trimming their profit margins and so will not be passed on into export prices. But Americans calling for a 25-30% revaluation may come to regret it: the result would almost certainly be faster inflation.

As it is, China’s reduction of inflationary pressures has allowed central banks to hold interest rates lower than they otherwise would be. Three and a half years into its recovery, America’s real short-term interest rates are only 0.7%, almost two percentage-points below their average at the equivalent stage in previous recoveries since 1960. This is good news for borrowers, but some economists worry that the entry of China and other emerging countries into the global economy may have affected monetary policy in ways that central banks do not fully understand.

In its latest annual report, the Bank for International Settlements (BIS) asks whether it is really desirable to maintain positive inflation rates when China is boosting the world’s productive potential so dramatically and thus reducing the prices of so many goods. In other words, are central banks targeting too high a rate of inflation now that China has joined the global market economy?

During the late 19th-century era of rapid globalisation, falling average prices were quite common. This “good deflation”, which was accompanied by robust growth, is very different to the bad deflation experienced in the 1930s depression. Today, we would again have had “good deflation”—but central banks have instead held interest rates low in order to meet their inflation targets. The BIS frets that this has encouraged excessive credit growth.

This echoes a fierce debate in the 1920s. At that time, a similar jump in the world’s productive potential (then caused by technology-driven productivity growth) was reducing manufacturing costs. Some economists suggested that, in such circumstances, overall price stability might be the wrong policy goal. Instead, they argued, average prices should be allowed to fall to pass the productivity gains on to workers and consumers as higher real incomes. But just like today, monetary policy prevented prices from falling. And an overly loose policy then inflated the late-1920s stockmarket bubble.

The Austrian school of economics offers perhaps the best framework to understand what is going on. The entry of China’s army of cheap labour into the global economy has increased the worldwide return on capital. That, in turn, should imply an increase in the equilibrium level of real interest rates. But, instead, central banks are holding real rates at historically low levels. The result is a misallocation of capital, most obviously displayed at present in the shape of excessive mortgage borrowing and housing investment. If this analysis is correct, central banks, not China, are to blame for the excesses, but China’s emergence is the root cause of the problem.

Not only has China’s disinflationary impact caused low short-term interest rates, but China is also partly responsible for the low level of long-term bond yields. To keep its exchange rate pegged to the dollar, China was the biggest buyer of American Treasury bonds over the past year. In the first six months of 2005, its foreign-exchange reserves increased by more than $100 billion, to $711 billion, of which about three-quarters are in dollars. This has also kept capital costs artificially low.

Written by infoproc

July 29, 2005 at 5:07 pm

Posted in finance, globalization

The future of US scientific leadership

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NBER working paper by Harvard economist R. Freeman: Does Globalization of the Scientific/Engineering Workforce Threaten US Economic Leadership?

Some basic observations: fewer and fewer Americans want to be scientists and engineers (S&E). US S&E compensation growth has lagged that of doctors, lawyers and other professionals in the last ten years. Other nations, particularly in Asia, are catching up, with Asia now producing more S&E PhDs per year than the US, and China to surpass the US in PhDs per year in 2010. Freeman points out that lack of interest in S&E by native-born US students is rational – their career prospects are diminished by foreign (outsourcing) and foreign-born (immigration) competition.

Note Freeman’s Proposition 2: Despite perennial concerns over shortages of scientific and engineering specialists, the job market in most S&E specialties is too weak to attract increasing numbers of US students. Nevertheless, US S&E pay rates are still high enough to attract talented foreigners. This competition further reduces the attractiveness of S&E careers to US students.

For related commentary, see my previous posts Don’t become a scientist!, history repeats, brain drain slowdown and Tale of two geeks.

Abstract: This paper develops four propositions that show that changes in the global job market for science and engineering (S&E) workers are eroding US dominance in S&E, which diminishes comparative advantage in high tech production and creates problems for American industry and workers: (1) The U.S. share of the world’s science and engineering graduates is declining rapidly as European and Asian universities, particularly from China, have increased S&E degrees while US degree production has stagnated. 2) The job market has worsened for young workers in S&E fields relative to many other high-level occupations, which discourages US students from going on in S&E, but which still has sufficient rewards to attract large immigrant flows, particularly from developing countries. 3) Populous low income countries such as China and India can compete with the US in high tech by having many S&E specialists although those workers are a small proportion of their work forces. This threatens to undo the “North-South” pattern of trade in which advanced countries dominate high tech while developing countries specialize in less skilled manufacturing. 4) Diminished comparative advantage in high-tech will create a long period of adjustment for US workers, of which the off-shoring of IT jobs to India, growth of high-tech production in China, and multinational R&D facilities in developing countries, are harbingers. To ease the adjustment to a less dominant position in science and engineering, the US will have to develop new labor market and R&D policies that build on existing strengths and develop new ways of benefitting from scientific and technological advances in other countries.

From the paper:

Enrollments in college or university per person aged 20-24 and/or the ratio of degrees granted per 24 year old and in several OECD countries (Australia, New Zealand, Netherlands, Norway, Finland, the United Kingdom, and France) exceeded that in the US. 5 In 2001-2002, UNCESCO data show that the US enrolled just 14% of tertiary level students – less than half the US share 30 years earlier. 6 In most countries, moreover, a larger proportion of college students studied science and engineering than in the US, so that the US share of students in those fields was considerably lower than the US share overall. In 2000, 17% of all university bachelor’s degrees in the US were in the natural sciences and engineering compared to a world average of 27% of degrees, and to 52% of degrees in China.

…Overall, the U.S. share of world S&E PhDs will fall to about 15% by 2010. Within the US, moreover, international students have come to earn an increasing proportion of S&E PhDs. In 1966, US-born males accounted for 71% of science and engineering PhDs awarded; 6% were awarded to US-born females; and 23% were awarded to the foreign-born. In 2000, 36% of S&E PhDs went to U.S.-born males, 25% to U.S.-born females and 39% to the foreign-born. 8 Looking among the S&E fields, in 2002, international students received 19.5% of all doctorates awarded in the social and behavioral sciences, 18.0% in the life sciences, 35.4% in the physical sciences, and 58.7% in engineering. 9

…Whichever indicator one examines, the evidence suggests that the job market for most scientists and engineers in the US has fallen short of the job markets in competitive high level occupations. Exhibit 3 records levels of pay and rates of change in pay from the Census of Population. It shows that scientists and engineers earn less than law and medical school graduate, and that rates of increase in earnings for science and engineering in the 1990’s fell short of the rates of increase for doctors and lawyers and for persons with bachelor’s degrees. The Census comparisons of the income between S&E doctorates and persons obtaining medical or law professional degrees understate the lower income associated with the PhD trajectory. Doctoral graduate students typically spend 7-8 years earning their PhD – a quarter of their post-bachelors working life – during which they are paid stipend rates. In some disciplines, notably the life sciences, most spend 3 or so years doing postdoctoral work, again at stipend incomes that fall far below alternative salaries available to bachelors degree holders or those with professional degrees. Since postdocs work many hours, their pay is particularly low on an hourly basis for someone with their years of education. Given their lengthy training and post-doctoral work, many S&E doctorates do not enter the “real job market” until they are in their mid-30s, by which time many of their undergraduate classmates who chose other careers are well-established in their work lives. The comparison with managers with 2 years of post-bachelor’s training does not adequately reflect the payoff to MBAs since the post-bachelor’s education refers to any sort of further education, not to that degree.

…In 1973, roughly 73% of new PhDs obtained faculty jobs within three years of earning their degrees. By 1999, just 37% of new PhDs obtained faculty jobs within three years of earning their degrees.

Written by infoproc

July 27, 2005 at 4:48 am

Portrait of a mathematical geneticist

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An interesting PLoS interview with Neil Risch (via the blog Gene Expression.)

Neil Risch (Caltech BS in math; PhD in biomathematics from UCLA) is the Lamond Distinguished Professor in Human Genetics and Director of the Center for Human Genetics at the University of California, San Francisco, California, United States. He has held faculty appointments at Columbia, Yale, and Stanford Universities.

I have a strong problem with the way politicians use this information. [Former President] Clinton, for example, when the first draft of the human genome sequence came out, made a statement about how all people in the world, in terms of their genetic makeup, are 99.9% the same. His intent—to reduce conflict among peoples—is noble. People on the left, anthropologists and sociologists, do the same thing. They use the 99.9% figure as an argument for social equality. But the truth is that people do differ by that remaining 0.1% and that people do cluster according to their ancestry. The problem is that others could use that information to create division.

From NYT, March 20, 2003:

A view widespread among many social scientists, endorsed in official statements by the American Sociological Association and the American Anthropological Association, is that race is not a valid biological concept. But biologists, particularly the population geneticists who study genetic variation, have found that there is a structure in the human population. The structure is a family tree showing separate branches for Africans, Caucasians (Europe, the Middle East and the Indian subcontinent), East Asians, Pacific Islanders and American Indians.

Biologists, too, have often been reluctant to use the term “race.” But this taboo was broken last year by Dr. Neil Risch, a leading population geneticist at Stanford University. Vexed by an editorial in The New England Journal that declared that race was “biologically meaningless,” Dr. Risch argued in the electronic journal Genome Biology that self-identified race was useful in understanding ethnic differences in disease and in the response to drugs.

Race corresponded broadly to continental ancestry and hence to the branches on the human family tree described by geneticists, he said. Expanding this argument today, Dr. Risch and nine co-authors say that ignoring race will ‘retard progress in biomedical research.’ Racial differences have arisen, they say, because after the ancestral human population in Africa spread throughout the world 40,000 years ago, geographical barriers prevented interbreeding. On each continent, under the influence of natural selection and the random change between generations known as genetic drift, people would have diverged away from the common ancestral population, creating the major races. Within each race, religious, cultural and geographical barriers fostered other endogamous, or inbreeding, populations that led to the ethnic groups.

Written by infoproc

July 26, 2005 at 4:10 am

Posted in genetics

WSJ on leadup to revaluation

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WSJ on the leadup to revaluation. Careful preprations began two years ago, but the Senate tariff threat determined the timing. Treasury officials were on the ball.

Behind Yuan Move, Open Debate and Closed Doors
Two-Year Saga Included Secret and Staged Meetings, Weeks of Quiet Diplomacy
By JAMES T. AREDDY in Shanghai, NEIL KING JR. in Washington, MARY KISSEL in Hong Kong and JASON DEAN in Beijing
July 25, 2005; Page A1

Last Thursday morning, several key foreign banks were asked to send a representative to the headquarters of the People’s Bank of China, the central bank. The topic wasn’t clear.

The meeting began around the time China’s foreign-exchange market was closing for the day at 3:30 p.m. As a central-bank official began to talk, the doors were shut and locked.

“They started talking about something that wasn’t very useful and then started to collect mobile phones and BlackBerrys,” said a banker who was briefed later. The Chinese then distributed a four-point statement: Beijing was unlinking the yuan from the U.S. dollar effective immediately.

Then another surprise: The bankers were told they would have to cool their heels until an official statement was read nearly three hours later on China’s government-controlled 7 p.m. news program.

That last-minute combination of surprise and secrecy was in keeping with the long-running drama over the yuan. It is a saga whose twists and turns included secret trips to Beijing by a U.S. envoy, debates among Chinese ministries about how much to revalue, and a seaside conference in China that featured American economists debating before an audience of high-level Chinese officials whether or not revaluation made sense.

According to U.S. and Chinese officials, China began thinking about allowing the yuan to rise in value against the U.S. dollar in 2003 with the accession to power of a younger, reform-minded generation of Chinese leaders led by President Hu Jintao and Prime Minister Wen Jiabao. Leading the push for change was the newly appointed head of the central bank, the scholarly, English-speaking Zhou Xiaochuan.

Foreign bankers consider Mr. Zhou one of the best of a new breed of senior Chinese officials familiar with the intricacies of global economics and market economies. Before running the central bank, Mr. Zhou spent 20 months as China’s top stock-market regulator, but his credibility stemmed from top central-banking positions through the 1990s.

Proponents of a change in the yuan argued that more countries were moving toward flexible exchange-rate systems and that blindly tying the yuan to the value of the dollar kept China’s financial system dangerously closed, hobbling the development of needed overhauls like market interest rates.

Opponents feared the impact a change would have on China’s booming exports. A stronger yuan would tend to make China’s exports more expensive relative to other countries’ exports. And some were chafing at what was already becoming a drumbeat of American criticism of China’s currency policy.

People were saying, ” ‘Why should we have to listen to what America says,’ ” said a Chinese official familiar with the yuan debate. Yet, similar debates about the currency policy were taking place among Chinese leaders, their views emerging through ministry-linked think tanks and reported prominently in the nation’s financial media.

In the spring of 2003, the People’s Bank stepped up its study of China’s peg to the dollar and whether the government should make a change. It held staff seminars on exchange-rate and macroeconomic management, and invited leading U.S. economists to Beijing to present their views. The central bank also sent officials to the Hong Kong Monetary Authority, the city’s central bank, and the U.S. Federal Reserve for training.

Aware of the research taking place inside the central bank, economists at investment banks in Hong Kong and China began confidently predicting that China would scrap its peg to the dollar. That accelerated a guessing game in the financial markets about the yuan that would last for the better part of two years.

Meanwhile, in Washington, criticism of China swelled as the U.S. trade deficit with China widened. In 1998, U.S. officials had praised China for sticking with its fixed peg to the dollar during the 1997 Asian financial crisis. But now the U.S. and many European countries charged that the yuan was grossly undervalued and gave China an unfair advantage selling its products overseas.

Hoping to deflate the issue, U.S. Treasury Secretary John Snow flew to Beijing in early September 2003 to meet with Mr. Zhou and Chinese Finance Minister Jin Renjing. The Chinese adopted what became a very familiar line: They might one day move to a more-flexible exchange rate, but never under U.S. pressure.

Three times in 2004 Mr. Snow met with his Chinese counterparts to seek some sign of progress on the currency issue, each time coming away with little to show to increasingly vocal critics back home. China, in the meantime, was quietly stepping up its meetings with officials at the Monetary Authority of Singapore, the city-state’s central bank.

Singapore was one of the most successful adherents to a managed floating exchange-rate system, presiding over an expanding economy and keeping inflation in check for several decades. China’s central bankers sent midlevel staff for extended visits to Singapore’s central bank to learn how it managed its exchange-rate regime.

In May 2004, China hosted a two-day conference in the seaside town of Dalian. Beijing-based officials, including Mr. Zhou and his deputy, listened to presentations on exchange-rate management from top American economists. Stanford University’s Ronald McKinnon and Columbia University’s Nobel Prize-winning Robert Mundell didn’t support a change to China’s peg to the dollar. Harvard University’s Jeffrey Frankel and Morris Goldstein of the Institute for International Economics in Washington did. One big risk they saw to adjusting the exchange rate was that too small a change could prompt speculators to demand more, a situation China may now face.

At the end of the conference, a senior Chinese bank official stood up and said China planned to follow Mr. Mundell’s advice in the short term and Mr. Goldstein’s advice in the long term, “only we’re not going to tell you how long the short term will be.”

In Washington, congressional anger over the yuan came to a boil this spring. On April 6, Sen. Charles Schumer, a New York Democrat, and Sen. Lindsay Graham, a South Carolina Republican, pushed an amendment to the annual State Department spending bill that would impose 27.5% duties on all Chinese imports if Beijing didn’t agree to revalue its currency. A vote to reject the amendment was defeated, 67-33. It was an overwhelming vote of support for the anti-China legislation — especially coming from a chamber not known for its protectionist passions — and it surprised the Bush administration.

Within the Treasury Department, the tone shifted markedly. “There was a sense of exhaustion over defending the Chinese,” said a Treasury official. “There was a general sense of being tired.”

On May 19, Mr. Snow appointed a special envoy to China on the currency issue, Olin Wethington, a longtime Treasury official who had just brokered a huge settlement for much of Iraq’s international debt. Mr. Wethington left the next day on the first of what became three unpublicized, weeklong trips to Beijing during the next three months. “We made a judgment that…there was ample room for a quiet discreet effort out of the limelight,” said another Treasury official. “But we realized we needed to broaden the dialogue within the regime and to reach into other parts of the government and to raise the issue much higher in the hierarchy.”

During the next seven weeks, Mr. Wethington and his team met with political and business leaders in China, including officials in the Foreign Ministry, the president’s office, the central bank and the upper ranks of the Communist Party. Mr. Wethington told the Chinese that if they didn’t give significant flexibility to their exchange rate, there could be adverse consequences on the U.S. side.

By May, according to officials with the International Monetary Fund, it was becoming clear the Chinese were preparing to value the yuan against a basket of currencies and were spending a great deal of time with monetary authorities in Singapore to see how their system worked. The IMF had been pushing Beijing for several years to adopt the basket-of-currencies approach.

Inside China, people who deal with the central bank say, the bank was pushing for an initial 5% revaluation of the yuan against the dollar. But under pressure from other ministries that feared the impact on China’s exports, China’s State Council, or cabinet, decided instead on 2.1%.

On his final trip to China, late last month, Mr. Wethington picked up strong signals that the Chinese were ready to move on the yuan. But they also made clear that they would do nothing under direct pressure from the Bush administration or Congress. So on June 30, in a highly visible move, Fed Chairman Alan Greenspan and Mr. Snow went up to Capitol Hill for a highly staged closed-door session with Sens. Schumer and Graham.

The Chinese were ready to budge, the senators were told, but only if the Senate put aside its tariff threat. The senators emerged from the meeting and announced that they were delaying any vote on the amendment until after the August recess.

Late Wednesday, hours before the rest of the world heard of China’s decision, the Bush administration received official word from Beijing that China was ready to alter its exchange rate and adopt what the central bank calls a managed floating-exchange rate that includes reference to a basket of unnamed currencies. Hong Kong was also told in advance, said a person with knowledge of the situation.

The next day, shortly before 7 p.m., Chinese officials delivered the government’s official statement to the chief editor of China’s main evening news program with directions that it be read at the top of the news. The statement was also placed on the Web sites of China’s central bank and the official Xinhua news agency, both of which crashed under an avalanche of Internet hits.

Written by infoproc

July 25, 2005 at 4:57 am

Posted in finance, globalization

Revaluation and reactions

with one comment

Below are two enlightening comments which appeared on Brad Setser’s blog, discussing the revaluation and related macro topics.

CSFB has the right perspective, think of it as transferring two percentage points of purchasing power from a country (USA!) with a low personal savings rate to a country with a high PSR 😀

then, keep in mind that ~2/3 of the PRC’s pop. still resides in the ‘countryside’/local villages whose average wage is 45 cents/hr…

then note the revaluation of capital that globalisation has wrought relative to labor…

“Harvard economist, Richard Freeman, has calculated that the global workforce has doubled since the fall of the Iron and Bamboo Curtains as a result of the effective addition of workers from China, India and the former Soviet Union. According to Freeman, the capital/labor ratio has been lowered to 55%-60% of what it would be otherwise, thereby reducing the return to labor and increasing the return to capital. As Freeman said, “A decline in the global capital/labor ratio shifts the balance of power in markets toward capital as more workers compete for working with that capital.” Based on Freeman’s calculations, thirty years will need to elapse before the global economy returns to the capital ratio that existed when the Iron Curtain fell. If true, this implies an extended period of low inflation.”


…lex goes on to note that this arrangement will continue to invite speculation and bubbles, but i would just note that this unstable equilibrium continues to be in the best interest of both parties, at least over the near-term, and as long as ‘measured’ steps — so as not to destabilise the unstable equilibrium — are being take to reduce imbalances in the long-run, then the longer this arrangement can last and eventually (hopefully) morph into something more stable 😀


…There is an enormous flow of capital and money out of the industrialized world. Some of it does return in terms of profits and salaries, but a good percentage of those profits never find their way into public coffers. The rich get very rich. There is no way longer any way of really getting a slice of those profits to pay the national bills. In addition, downward pressure on average wages continues.

Cheap labor has been substituted for investment. Credit is cheap. With profits and cheap labor at these quantities, who needs credit? I do not see this as a conundrum. The pump has been primed from every conceivable direction: tax incentives and cheap labor abroad, tax cuts at home.

Ten million Chinese work for a foreign enterprise. The size of that cheap labor force is staggering. And it is only a tip of the Chinese iceberg. And we have yet to touch India. We are living through a boom economy, except the boom is not really heard here. We are paying for it. The dimensions of that boom cause Chinese entrepreneurs to open fake off-shore businesses, pose as foreign investors, and then be eligible for all the goodies–roundtrip investors, they are called. With credit like this, is there any wonder that capital returns cannot be measured by real interest rates? Hell, I should start such a business. Bet doing so is dirt cheap. No loans required. And, you do not needed real investment in automation or equipment when labor is dirt cheap. Look at what the Egyptians did with the pyramids, or the Chinese with the Great Wall.

Normal Keynsian economics was not prepared for anything like globalization of this magnitude or style. There is a glut of capital and credit and labor. And it is coming at the American taxpayer’s expense. The average American consumer is going deeper and deeper into debt. Average credit card debt in the U.S. is over $9000. And the interest rates are hefty there! And then place that number against the median wage: credit card debt then becomes one-fourth of the median wage. Some are living on a knife’s edge here.

When the bubble does burst, who will pay the bills, personal and national?

The knot that has been tied is Gordian, as Volcker says. There is no easy way out of this one. We cannot wait until China becomes a “consumer society”– a ten or fifteen year pipe dream. After China, there is India. After India, who knows.

Written by infoproc

July 25, 2005 at 2:25 am

Posted in globalization

Revaluation really was imminent

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Wow, the yuan-dollar peg is now a moving yuan-basket peg. Only a 2% move for now, but stay tuned for further developments. The 10 yr yield is up to 4.28 today, so 10y treasuries lost about 2.5% in value in a single day. For some historical perspective, see here for a graph of dollar-yen in the wake of the Plaza Accord — the dollar dropped by more than a factor of 2-3 against the yen in the following decade.

BEIJING, July 21 – Following months of political pressure, China today revalued the yuan to 8.11 for every dollar, scrapping a decade-long peg to the currency in favor of a more flexible band using a “basket of currencies.”

China’s announcement, which has been anticipated and debated by economists and government leaders for months, is the first time in a decade that China has raised the value of its currency, also known as the renminbi, effectively making the yuan and exports more expensive against the United States dollar.

The move represents China’s first step toward the more flexible exchange rate that the United States, Europe and many other countries have called for in recently. Until the announcement, the yuan sold for 8.27 for every dollar, a rate that has remain unchanged since 1998.

The change falls far short of the 10 percent to 15 percent revaluation demanded by many in Washington, where the Bush Administration and Congressional leaders have been calling for a higher yuan, in part to alleviate America’s growing trade deficit with China.

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July 21, 2005 at 4:09 pm

Posted in Uncategorized

Risk aversion, brain damage and gambling

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WSJ: Brain damage which impairs emotional response might actually make you a better investor or gambler! Note that in this study the odds are specified with mathematical precision. In real markets gauging the psychology and emotions of others is very important. What is needed is an emotionless automaton with insight into the human condition 🙂

Lessons From The Brain-Damaged Investor Unusual Study Explores Links
Between Emotion and Results; ‘Neuroeconomics’ on Wall Street

People with certain kinds of brain damage may make better investment decisions. That is the conclusion of a new study offering some compelling evidence that mixing emotion with investing can lead to bad outcomes.

By linking brain science to investment behavior, researchers concluded that people with an impaired ability to experience emotions could actually make better financial decisions than other people under certain circumstances. The research is part of a fast-growing interdisciplinary field called “neuroeconomics” that explores the role biology plays in economic decision making, by combining insights from cognitive neuroscience, psychology and economics. The study was published last month in the journal Psychological Science, and was conducted by a team of researchers from Carnegie Mellon University, the Stanford Graduate School of Business and the University of Iowa.


A new study shows people with brain damage that impaired their ability to experience emotions such as fear outperformed other people in an investment game.
• The brain-damaged participants were more willing to take risks that yielded high payoffs.

• They were less likely to react emotionally to losses.

• They finished the game with 13% more money than other players.

The 15 brain-damaged participants that were the focus of the study had normal IQs, and the areas of their brains responsible for logic and cognitive reasoning were intact. But they had lesions in the region of the brain that controls emotions, which inhibited their ability to experience basic feelings such as fear or anxiety. The lesions were due to a range of causes, including stroke and disease, but they impaired the participants’ emotional functioning in a similar manner.

The study suggests the participants’ lack of emotional responsiveness actually gave them an advantage when they played a simple investment game. The emotionally impaired players were more willing to take gambles that had high payoffs because they lacked fear. Players with undamaged brain wiring, however, were more cautious and reactive during the game, and wound up with less money at the end.

Some neuroscientists believe good investors may be exceptionally skilled at suppressing emotional reactions. “It’s possible that people who are high-risk takers or good investors may have what you call a functional psychopathy,” says Antoine Bechara, an associate professor of neurology at the University of Iowa, and a co-author of the study. “They don’t react emotionally to things. Good investors can learn to control their emotions in certain ways to become like those people.”

…In the late 1990s, when the links between psychology and neurobiology were firmly established, behavioral economists began turning to neuroscientists, in addition to psychologists, for help explaining human behavior. The idea was that if brain chemistry could explain phenomena such as depression or attention deficit disorder, it might also help explain more mundane psychological functions, such as how people reach financial decisions.

Behavioral economists, like Princeton’s Daniel Kahneman, who won the Nobel Prize for Economics in 2002, began teaming up with neuroscientists, like Peter Shizgal at Concordia University in Montreal. In one study, the pair used gambling games and neuroimaging techniques to look what part of the brain is triggered when people anticipate winning money. They found that monetary rewards trigger the same brain activity as good tastes, pleasant music or addictive drugs.

The 41 participants in the new study included people with and without brain damage, including a control group of participants with brain damage that didn’t affect their emotional processing. Players were given $20 and asked to play a simple gambling game that involved 20 rounds of coin tosses. If they won a coin toss, they earned $2.50. If they lost the toss, they had to give up a dollar. They could choose not to play in any given round, in which case they kept their dollar.

Logic indicates that the best strategy was to take the gamble in every round of the game, since the return on a win was much higher than the potential loss, and the risk in each round was 50-50. The players with emotion-related brain damage took a more logical strategy, investing in 84% of rounds, while the nonbrain-damaged players invested in just 58% of the rounds. Emotionally impaired participants outperformed the nonbrain-damaged participants, winding up with an average of $25.70 versus $22.80 at the end of the game.

The researchers believe fear had a lot to do with the poor performance of nonbrain-damaged participants. “If you just observe these people, they know the right thing to do is invest in every single round,” says Baba Shiv, an associate professor of marketing at the Stanford business school and a co-author of the study. “But when they actually get into the game, they start reacting to the outcomes of the previous rounds.”

Yet emotions may play a useful role in financial decision making. While the brain-damaged players did well in the specific game in the study, they didn’t generally perform well when it came to making financial decisions in the real world. Three of four of the brain-damaged players had experienced personal bankruptcy. Their inability to experience fear led to risk-seeking behavior, and their lack of emotional judgment sometimes led them to get tangled up with people who took advantage of them. Their life experience suggests emotions can play an important role in protecting our interests, even if they sometimes interfere with rational decision making.

Humans developed this fear response as a survival mechanism to protect against predators. But in a world where predators aren’t lurking around every corner, this fear system can be over-sensitive, reacting to dangers that don’t actually exist and pushing us toward illogical choices.

“There was no such thing as stock in the Pleistocene era,” says George Loewenstein, a professor of economics at Carnegie Mellon University, and a co-author of the study. “But human beings are pathologically risk averse. A lot of the mechanisms that drive our emotions aren’t really that well adapted to modern life.”

Written by infoproc

July 21, 2005 at 5:21 am

Posted in Uncategorized

Instant companies

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This excellent article (PDF) from Business2.0 discusses the drastically reduced barriers to entry for designing, manufacturing, marketing and distributing new products. The combination of Web collaboration platforms, outsourced design and outsourced manufacturing (typically in China) are changing the landscape dramatically.

A related phenomena is the “long tail” — as you might expect, the distribution of market sizes in a product category is a power law, with a few big niches and lots of smaller ones. Now, with efficient search and distribution using the Web, small virtual companies can profitably attack the smaller niches. The winner, of course, is the consumer, who has greater and greater access to inexpensive and innovative goods.

The first question for anyone who wants to build the next superstar widget is this: What’s it going to look like? Arriving at an answer was traditionally an arduous task, an age-old struggle between designers and manufacturing engineers to balance what’s desirable and what’s possible. But the new army of hit makers is getting it done faster and cheaper than ever before. Take Kidrobot founder Paul Budnitz, who describes himself as a “decent artist and database programmer.” Just three years after Budnitz began selling collectible dolls on the Web, sales of the figurines — inspired by hip-hop culture and Japanese anime — are on track to hit $5.5 million in 2005. There are bustling Kidrobot stores in Los Angeles, New York, and San Francisco and a TV cartoon deal in the works. Aside from salespeople in the stores, Kidrobot has only 11 employees.

To create new characters, Kidrobot’s designers first sketch them using Adobe Illustrator, the off-the-shelf drawing program that goes for $500 a copy. They produce six views of each toy, plus blowups of detailed areas like eyelashes. Then they move to Basecamp. Released less than a year ago by software maker 37signals, Basecamp is a Web-based application that links everyone who works on Kidrobot’s toys — from its New York City design team to manufacturers in China. Established toy companies spend tens of thousands of dollars shuttling designers around the world to iron out product details. Kidrobot pays about $100 per month for Basecamp.

Once Budnitz is satisfied with the initial designs, his team uses Basecamp to share Illustrator files with engineers in China who transform them into clay or wax models. One week later the models arrive in New York. With Basecamp acting as the messenger, the two sides repeat the back-and-forth until the toys meet Budnitz’s approval. The final design — along with specs for paint and form-fitting packaging – is then uploaded to Basecamp, and 30 days later finished toys march off production lines in China. “I can have as many as 40 toys in various stages of production at one time, and we can still manage all of these projects with just a few people,” Budnitz says. “It’s stupid simple.”

…Outsourced manufacturing has long been available to the big guys. But thanks to folks like Yu, it’s now an option for anybody. Born and raised in the United States, Yu is as comfortable in North America as she is flitting between her office in Taiwan, her shipping center in Hong Kong, and the Union Electric factory in southern China. In addition to Color Kinetics, Yu’s clients include Brookstone, Discovery Channel Stores, and RadioShack (RSH). She has shepherded the manufacture of singing cake cutters, golf pedometers, and scads of digital recording devices. Through her, companies tap into some of the deepest manufacturing expertise on the planet — at a third of what similar work would cost in the United States. “In the States they have such great ideas, but they don’t know how to put those ideas into production and they don’t have the infrastructure to do it,” Yu says. “We do.”

…Start with Google: Type in “China,” “manufacturer,” and your product and you’ll get a list of factories. Or look on eBay for something similar to your gizmo and research who made it.

Written by infoproc

July 19, 2005 at 4:49 pm

Posted in globalization

Hard times in Japan

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From Time magazine. Increased inequality and competition… is this our future, or are we already there?

A decade ago, 90% of Japanese considered themselves “middle-class.” In an Asia-wide survey conducted by U.T. last year, however, 60% of Japanese now rate their economic status as “below middle-class.” The public’s increasing awareness of kakusa shakai is reflected in the Japanese media’s obsession with who is up and who is down. Whether in magazines, on TV chat shows or on bookstore shelves, the domestic debate is dominated by the idea of kachigumi and makegumi (“the winning team” and the “losing team”). Fashion magazines are filled with beauty tips to marry early and avoid being a poor, single woman.

Yet, while the poor get poorer, the rich are getting richer. Last month, the national tax agency released its annual list of the country’s top 100 taxpayers. Tatsuro Kiyohara, a 46-year-old fund manager at Tower Investment Management, ranked No. 1, with a tax bill that suggested a personal income of approximately $100 million. This marked the first time a wage earner had captured the top spot, an occasion that many writers and talk-show hosts alternately hailed and lamented as a signature moment in the new, more Darwinian society—for Kiyohara’s pay is almost entirely performance-based.

Will American workers displaced from jobs in manufacturing, textiles and other industries really be able to “move up the value chain”? Younger Japanese are already facing these issues as their economy “hollows out” in the face of competition from China – Japan’s number one trading partner.

Naoki Ijiri… jobless gloom. The 25-year-old polytechnic college graduate had come to the job-placement office this spring after searching fruitlessly for work for six months—long enough to convince himself that he would never find a career to match his training as an environmental-systems engineer.

“People like me who aren’t particularly talented at anything are happier with the old system of lifetime employment and seniority-based salaries,” he says. “The supposed ‘chances and opportunities’ that a competitive economy offers is for those who are already steps ahead.” Ijiri later found work as a security guard, hardly the future he once envisioned for himself.

…Akiko Miyamoto, manager of the unemployment office that Sasamoto frequents, says she sees the same story again and again: a sense of entitlement and unrealistic expectations followed by depression and paralysis once the going gets tough. “People come in wanting to be designers or photographers or editors,” she says, “but there are very few jobs in those fields posted here.”

Written by infoproc

July 18, 2005 at 12:32 am

Posted in globalization