China: Exchange rates, productivity and inflation

Pettis writes today:

China is faced with a difficult policy choice. It can maintain an undervalued exchange rate, it can run the risk of inflation, or it can increase the domestic costs of financial repression. How Beijing balances these separate forces will determine the pace and form of its necessary rebalancing.

Which is much along the lines of what I wrote a couple of weeks ago. As always, I highly recommend reading all of Pettis' blog, which is very informative. What I found most interesting this time around was his discussion in inflation. In a closed economy, a rise in productivity increases the amount of goods provided, leading to price decreases as the number of good rises and the amount of money stays the same. In this scenario productivity increases and money supply growth can coexist and maintain price levels stable, even if a small amount of money is being printed.

2004-2007 Redux: Crisis officially wasted, history on schedule to repeat

Revealed: The home loan that could save you a fortune:

ING Direct, Australia's fifth largest lender, is preparing to sell loans that have no fixed term and no requirement to repay any capital along the way.
...
Repayments would be kept to a minimum, allowing borrowers to benefit from capital growth in their property.
"People are needlessly being denied the chance to buy a property while prices spiral rapidly out of their reach" ING Direct CEO Don Koch said.
"There is an urgent need to provide more affordable options and borrowers should be able to choose whether they want to repay the capital, or not."
Mr Koch wants to position the bank as a "mortgage partner for life", with borrowers carrying the same interest-only loan from property to property for as long as they wish, accumulating equity from rising house prices as they go.

Remember how well this worked for us? For what it's worth, the correct way to never have to repay capital is to rent. This sounds more like indentured servitude than progress. Next thing you know we'll be voting-in feudalism. This is totally going to end in tears.

California is a Third-World State

On March 22, 2010 Mercury news published an article detailing some tax changes in the state of California:

The deal reached Monday provides $200 million in new tax credits for homebuyers, to be split evenly among those buying a home for the first time and anyone buying a newly constructed home. Anyone qualified who makes a purchase between this May and August 2011 will receive a credit for 5 percent of the home's purchase price, up to $10,000 over three years. (MB: This is in addition to federal tax credits)

It is no secret that CA has had it's share of budget woes. From the issuing of IOUs, to the $20 billion deficit, it hasn't been easy for CA to get it's finances in order. That's why this measure seemed a little backward to me at the time, especially considering the low efficacy of the federal program and the record-high unemployment rate of 12.6% and associated fiscal woes CA was facing. I understand the government wants to stimulate demand for housing, but as Bill at Calculated Risk said, they should have really focused on stimulating house-hold creation, preferably via jobs which create additional tax revenue as well. This short-lived scheme will only help to accelerate the turning of renters into buyers, depressing rents and leading to lessened demand for investment properties. Rather than trying to revive a housing boom that isn't coming back, the government should have focused on helping unemployed workers gain new skills so that when the economy recovers they are ready to get back to work, because it looks like they are going to need it.

Because you can't spend your way out of a debt problem, California's budget problems persist. Today, the Governator proposed violent cuts to welfare programs, including welfare-to-work, child-care, and medical aid for the elderly. I would be surprised if these cuts weren't just empty threats like "give us bailout or we'll just have to fire all the teachers," but it outlines the bigger problem at hand: California is suffering from some delusion of entitlement and refuses to live within its budget. It is simply unconscionable that they are getting $3.2 billion from the federal government and giving away $200 million of it as a de-facto stimulus payment to the people doing well enough to buy a house while trying to cut child-care programs. Naturally, the Democrats are now calling for increased taxes because nobody wants to take the unpopular action of cutting anything. The pain must be shared, though. You won't attract employers by raising taxes and taxing the workers will just reduce the attractiveness of the state. If they are going to be successful in getting their budget under control, it will have to be a balance of increases in taxes, decreases in social programs, cuts in wages and benefits, an end to wasteful giveaways and an investment in the human capital of the state. If it's in the cards, the future pensioners should share in the pain too, but I don't see that happening.

In my opinion, the Governator is just kicking the can down the road and delaying the problem, hoping that the feds come in at the last second and save the day with a California bailout but, considering the resistance we've seen from Washington to take-on the state's liabilities, I wouldn't plan on it. There is easy things in life and there is hard things; this is a hard thing, and there's just no way around it.

Why I can't stand Nassim Taleb

I am fucking done with Taleb. I read The Black Swan and Fooled by Randomness and I liked them. I didn't necessarily like his tone, but I liked some of his ideas and, while I felt a little bit condescended on, it did get me to think about certain things I hadn't thought about before. Then I read The Aftermath of War, The (Mis)Behavior of Markets and some assorted Karl Popper and realized that Taleb is just a gigantic douche that kind of misses the point of all these great philosophers he claims to be so enamored with. The fact that he is some gigantic show-off that talks his book and brags about his good plays--while never, ever mentioning the bad ones--doesn't really bother me. He used to be a trader, what can you expect from him? What really kills me though, is that he has so much influence on people. It's easy to get caught up in his little stories, but, once you bring them to the real world, they just don't hold. Newcomers like his simple no-nonsense approach that traders are stupid and you can make a ton of money by just being less stupid--it makes them feel empowered--but the reality is there is no easy money.

While his points regarding the failure of statisticians to accept that sometimes markets can't be modeled and trying to do so is futile makes total sense to me, his talk of using OTM options to profit from fat-tail events is nothing new, and completely ignores how options are actually priced. You'd think the author of Dynamic Hedging (a great way to learn options, actually) would understand the volatility frown/smile and skew. If his thesis was really right you could just buy highly levered front and back spreads simultaneously (a "W" shape R/R profile) and let play those forever, hoping to eventually cash in on a tail event. I'll save you the trouble, the back tests (post '87 crash, when fat tails began being priced in) don't exactly show this one to be a big winner. You'd also think a statistician would understand (less than) zero-sum games. Finally, you'd would hope someone with that much education in financial markets to have at least some vague inkling of the concept of value and value creation/extraction/destruction. He could learn a thing or two about that Pettis article I linked yesterday.

Then there is his wanna-be philosopher, Roubini-humping act; it's getting really old. The reality of it is that he's a washed-up trader working in academics and trying to ride Roubini's coat-tails. I may find Roubini insufferable, but he's a smart man that makes great, insightful points, even if I disagree sometimes. Roubini is also trying to, in addition to making money, make a difference and point-out problems, purportedly so we can fix them. What the fuck does Taleb bring to the table? He's just another asshole trying to make a dollar off of your labor. Go on SSRN and search his name and see what you come up with. Look at his twitter, where he tests out his "aphorisms/epigrams." and then try to figure out where he's adding value to the chain. Just look at these examples:

BusinessBookReaders with my prose are like deaf persons in a Puccini opera: they may like a thing or two while wondering "what's the point?"

The characteristic feature of the loser is to bemoan mankind's flaws, biases, & irrationality --without exploiting them for fun and profit.

Stimulus w/ deficit, even if effective, is as immoral as borrowing from your grandchildren (without asking them) to repay your gambling debt

You will be civilized the day you can spend time doing nothing, learning nothing, & improving nothing, without feeling slightest guilt.

Real philosophers require only long walks to figure out what mere people need crises, accidents, serial bailouts, & calamities to understand

Aha! How witty, that philosophical truth! C'mon. Taleb is a philosopher in the same way the drunk sophomore at some college bar trying to diagnose you is a psychologist. The difference being that the drunk girl intents to actually continue her education and will one day probably be a real psychologist. Taleb will never be a philosopher, he's just a philistine looking for money and attention. You know how it's just so-easy to roll your eyes at The Tipping Point and think "congratulations on learning about exponential growth curves"? Nassim Taleb is basically the Malcom Gladwell of his genre--which gets a little circular when you consider Outliers is just a rehash of the same ideas in The Black Swan, which is basically just a really long "Accept the possibility that what you know may be wrong and or incomplete."

Finally, I'm just going to quote Falkenstein, who's risk/return paper should should have read at least three times by now:

Gee, someone should write a book about blow-hard traders who misrepresent their track records and take excessive risk with other-people's money, all due to cognitive biases they are too shallow to notice in themselves. Oh yeah, Taleb has done that! I guess his insider status gives him better insight.

Look, I could go on about how insufferable I find this man for another 500 words, but I'll summarize it: He's a man that doesn't give a fuck about progress; therefore I no longer give a fuck what he has to say.

This thing that looks like that thing: Greek bailout Edition (UPDATE-1)

A little over a week ago, Peter and Simon over at the Baseline Scenario wrote the following:

To restore confidence in buying Spanish and other major European nation bonds, it would surely help to have clear signals that President Obama himself, and the Federal Reserve, are taking an active stance now on making sure this does not spread to become another threat to global financial stability. A broader wall of preventive financing must now be put in place – after all, this is exactly why (in principle) the IMF was recapitalized this time last year.

Then Greece got a bailout of EUR 110MMM, but there was still trouble and John Mauldin wrote:

...30% of the Greek financing will come from the IMF ... and since 40% of the IMF is funded by US taxpayers, and that debt will be JUNIOR to current bond holders ... US tax payers will be giving money to Greece who will use a lot of it to roll over old bonds, letting European banks  and funds reduce their exposure to Greece while tax-payers all over the world who fund the IMF assume that risk. And does anyone really think that Greece will pay that debt back?

As if it wasn't enough that the ECB went back on their word and is allowing GGB to be repoed for liquidity regardless of the rating--this is the part where the ECB engineers a super-steep yield curve to transfer depositors money to bank balance sheets--now they are going to monetize the Euro debts.

I told you they were going to take your money. Let's file this one under, "this is not progress," shall we?

UPDATE-1: The WSJ reports that the US share of this is actually more like 17% and so we are only on the hook for $3MMM or so.

On Health-care Pt. 2.7: Reform is not inherently evil

Health-care reform has been a BigDeal(tm) lately, and I wanted to express some thoughts about it, the way it works and my general gripes about what is decidedly not real progress in my mind. In this series I will explore the benefits and failures of the current path of health-care reform in the United States. I will talk about insurance companies and risk pools; the difference between moral, political and economic decisions; and (in)efficiencies of scale in different levels of the industry.

On the April 17th, 2010 edition of The Economist, packed between an article about how we shouldn't eat our vegetables (seriously) and something about that slowly disintegrating Mediterranean economy, there was an article about dialysis. Most of the content matter was nothing new. Dialysis is expensive, sometimes up to $80,000 per person per year; many people die; the drugs and equipment are expensive. Basically, the same old "is it worth $x to keep this person alive?" question that is guaranteed to get everyone to scream over each other and not much else. But, while cruising through snooze-ville, I came across these little gems:

... running dialysis clinics and administering drugs, which account for 80% of the cost of dialysis. The two biggest operators of dialysis clinics are Fresenius and DaVita ...  Each of them runs almost a third of America’s dialysis clinics.

American dialysis clinics are paid on a “cost-plus” basis for the drugs they use ... American clinics used to favour an injected drug costing $4,100 a year over an identical oral one which was introduced to the market at a cost of $450 a year. After languishing unused, the oral drug now costs more than the injected one.

In case you didn't follow, here's how I understand this: Some pharma company came up with a drug that could be administered orally instead of intravenously and cost 11% of the original drug. Wow, that seems both convenient and economical! The maker couldn't sell this new, cheaper substitute because what clinics are paid is based on the cost of the drugs, therefore cheaper drugs meant less profits. In order to sell their new drug, the drug maker increased the price to a level above the injected substitute and the clinics, lured by higher profits, switched to it too. Clinics were able to do this because they could just bill it to the insurers. Patients didn't care because they were too worried about not dying, and because the insurer is paying anyways. This is big money! The government alone spends "$24 billion a year," and private insurers spend even more, although no exact figure was given. In any case, that's $48+ billion.

That, my (few) readers, is what we call "negative price elasticity of demand," resulting from the presence of a "perverse incentive."

Your friendly neighborhood tea-partier might be pointing to this as proof that the evil socialist health-care reform is going to bankrupt this once-great, once-capitalist nation, but he/she would be wrong:

The reforms will introduce a “bundled price”, whereby clinics receive a set rate for providing treatment. Analysts expect drug costs to fall by at least 10% soon after the change, as clinics use fewer or cheaper drugs.

Take that reactionaries!

On Healthcare Pt. 2.5: Demographics of the Uninsured (UPDATE-1)

Health-care reform has been a BigDeal(tm) lately, and I wanted to express some thoughts about it, the way it works and my general gripes about what is decidedly not real progress in my mind. In this series I will explore the benefits and failures of the current path of health-care reform in the United States. I will talk about insurance companies and risk pools; the difference between moral, political and economic decisions; and (in)efficiencies of scale in different levels of the industry.

Last week, I ranted about risk pools. This week I continue, since the rest of my work on the next post is not ready. See, I have this work thing that I have to do if I want to get paid. I was perusing through a report on the uninsured from the CDC and stumbled upon this interesting chart (click for full version). The chart focuses only on people under 65 because anyone older than 65 is covered by Medicare.

This is really interesting! The younger groups are less likely to be covered.  If we make the (admittedly big)  assumption that older people need more treatment, what we are seeing is a rational economic choice by the younger population to stay uninsured. I have no hard statistics on this, but from anecdotal evidence--I am in my mid 20s--younger people often will go without health insurance if they are short on money or in order to free-lance or work part-time; the price elasticity of demand for health insurance in this group is larger. I know many, many young people who go without health insurance, some because they can't afford it, and some because they are taking their chances because of the cost of coverage. Of the group that "can't afford" it, all of them could, they just refuse to reduce their standard of living for it. It makes sense if the healthy younger population gets sick less; they may not need enough coverage to justify the premiums. This means that the younger population is not subsidizing the older population, making the rising costs of insurance a self-fulfilling prophecy (remember the cost of coverage has to be less than or equal to the premiums paid plus the return on float for the system to be sustainable). If you knew the cost of your insurance was priced to subsidize someone else's, you might elect not to buy, and therefore drive the cost up for the remaining participants. By forcing everyone to participate in the risk pool, we are introducing a large set of young people, bringing down the median age of the risk pool, reducing the cost-per-particpant, and hopefully reducing the cost of participation too.

Before anyone thinks I am saying that young people going increasingly uninsured is responsible for a rise in premiums, let me clear it up: I am not. The uninsured as a percentage of the population has largely remained steady over the last couple of 20+ years, as you can see below. What I am saying is that making participation compulsory will create an implicit transfer payment system that will allow us to smooth out the changes in cost of care over the life of the participant. We are paying a little more now so we have to pay less in the future. The young can bitch about this now, but they'll probably have to pay this no matter what. If the old people can't afford health-care, the government will chip in and guess who will end up paying the government? Yup, that's right, the young. If the old can pay, but end up severely draining their wealth reserves, guess who's going to either inherit less or have to help them more? Yup, the young.

Now look at the other half of the graph (full version linked)

What is most obvious here is that blacks and hispanics are disproportionally less insured. Supporting a system where there is such huge disparities by race is definitely not progress. One could argue that this is because black and hispanics are more likely to be poor, but the really poor have Medicaid. It's the  marginally less-poor that are more likely to be uninsured:

Lack of access to health insurance could be holding back this not-so-poor segment of the population. Say it with me: This is not progress.

UPDATE-1: Got another nifty little piece of data, thanks to my sister. According to this report from the census, uninsured individuals by households income level break down like this (click image for full-size):

• < $25,000: 24.5%
• $25,000 - $49,999: 21.4%
• $50,000 - $74,999: 14%
• > $75,000: 8.2%

I am looking for more data as far as value of coverage utilized by age group and premium levels by age group so I can see if my theory checks out. Please shoot me an email if you have access to any of this data or know where I can find it.

On Health-care Pt. 2: Risk Pools

Health-care reform has been a BigDeal(tm) lately, and I wanted to express some thoughts about it, the way it works and my general gripes about what is decidedly not real progress in my mind. In this series I will explore the benefits and failures of the current path of health-care reform in the United States. I will talk about insurance companies and risk pools; the difference between moral, political and economic decisions; and (in)efficiencies of scale in different levels of the industry.

Let's start with the basics.  The reforms so far cover the following problems:

• The exclusion of individuals with "pre-existing conditions"
• Lifetime caps on coverage
• The availability of coverage for those who may not be able to afford it

As The Economist describes it:

Some 32m of the country’s 49m or so uninsured (most of those left out of the new scheme are undocumented aliens) would, starting in 2014, be required to take out insurance. The working poor and uninsured earning up to $88,000 a year get subsidies on a sliding scale so that they can afford to buy coverage; the poorest of all will be added to the rolls of Medicaid.

This effectively means that almost every American will have some sort of coverage, barring those who elect to forgo coverage and instead pay the fine. By my very basic calculations (34 AVG weekly hours x 22.47AVG hourly wage x 52 weeks [BLS]) there is probably a good chunk of the population that will benefit from the subsidy. I will put something more detailed together once I can get better data as to the distributions of these earners (I suspect a both a positive skew and fatter tails) and adjust for employer-provided benefits.

Insurance typically works by having covered individuals pay premiums to the insurance company, who is in charge of disbursing money to care providers for covered procedures and using their size to bargain for better deals. The care providers have an incentive to negotiate with insurers because they benefit from a single counter-party who is, in theory, more creditworthy and easier to deal with than hundreds of thousands of individuals. In addition, there may be economies of scale created by streamlining payments and the associated operational work. The cash held by insurance companies between when premiums are paid and payments for coverage are disbursed is called a "float," and insurance companies typically make money by investing the float in return-generating instruments. If aggregate premiums and the return from their investment exceed the payments made to care providers, there is an accounting profit for the insurer; therefore it is in the best interest of the insurer to make sure their policy holders are healthy, or at least healthier than the mean. This is why you often see things like gym-memberships, smoking cessation and nutritional assessment covered by health insurance. The healthier you are, the less the more profitable they are.

Unfortunately, the quest to have a healthier pool of insured participants often results in discrimination, which is what current legislation hopes to rectify. Insurance companies can be at a comparative advantage to others by improving their policy-holder pools, creating more efficient systems and negotiating harder with care providers. This too, unfortunately sometimes leads to unethical behavior. Insurers can become more profitable by finding ways to avoid disbursing monies for procedures, what is commonly known as the "pre-existing condition" problem.

Now that the risk pool is effectively the entire population, we are looking at a serious problem with this system: If the wealthy are more likely to be healthy, and the poor are more likely to be covered under the government program, private insurers are getting a comparatively better pool of participants, meaning they will inevitably be able to run a lower-cost operation than Medicaid. Not because the private sector is necessarily more efficient, although that may be the case, but because they have a healthier pool of policy-holders. What this system is effectively doing is privatizing gains and socializing losses, also known as the "heads I win, tails you lose," problem. Additionally, this will continue to reinforce the idea that the insurance companies are value creators, even if they may not be. There is no doubt in my mind that this amounts to an unequivocal give-away to the insurers. This is on top of the subsidized premiums from new policy holders that they are receiving.

Of course, this is not the only inequity in the system. Medicaid is backed by the full faith and credit of the US Government, so their cost of capital is the riskless rate. Additionally, they don't need to build a capital base since they can cover their costs from the general fund, where the additional taxes (hopefully) levied to cover these expenses will end up anyway. What this means is that private insurers must collect money ahead of expected payouts, the difference being a profit or loss. The government, on the other hand, is paying for this just-in-time, and letting the gains or losses affect the deficit/surplus. This puts them at an unfair advantage to the private operators in terms of costs of capital, which the insurers will surely whine about in an attempt to extract a tax credit.

For the following part, we will be focusing only on the federally mandated, minimum level of coverage.Of course expensive plans will cover things like private rooms while Medicaid might only covered a shared room, but let's focus on the bare-minimum care that we are all going to get. Just like schools, you always have the option of paying for a private one, but you are always allowed access to at least the same public one your neighbor's kids might go to.

You may be asking yourself, "Why is this all relevant?" The answer to that is that once the risk pool equals the population, the amount of federally-mandated coverage provided should be a constant, excluding the positive or negative effects of incentive programs from private-label insurers. This means that we are going to provide the same amount of coverage and it has to be paid for, no matter what. If the quality of care for the federally-mandated coverage is constant across the Medicaid and private-label risk-pools--which it should be since the providers are independent--the only difference is who pays for what share of the total. In the end it all must be paid for by premiums and subsidies. Following that logic, the minimum that you will pay, either through premiums or taxes, must at least equal the cost of coverage or else the insurers lose money or the government adds to the deficit, which the public taxes will eventually pay for anyway. Notice the "at least," which is important because if insurers lose money, they will simply raise rates or demand subsidies to make up for it, lest they go out of business and we all end up on the government risk pool anyways. However, if the insurers make money, they get to keep it. well, at least until we can negotiate lower premiums, but I wouldn't hold my breath. What this all amounts to is insurers taking a call option on care. If they don't make money, we make up the short-fall one way or another, if they make a profit, it's ka-ching! time for them. If you ask me, this looks less like evil socialism and more like shameless giveaways to big business.

Finally, if you were paying attention, you voiced a loud "ugh!" after reading "If the quality of care for the federally-mandated coverage is constant across the Medicaid and private-label risk-pools." Everyone knows that some coverage is better than others because some providers are better than others. The trend is toward equality, but that doesn't mean we are anywhere near it. If that is the case, it would imply multi-tiered care quality for basic care depending on your insurer. Does that sound progressive to you? Does segregating the poor and rich in the emergency room sound like that evil socialism slowly killing this great capitalist nation to you? The finer points of fairness here fall under economic, moral and ethical view points I don't feel like arguing, but I will say this:


From where I'm looking, this is definitely not progress.

On the next segment, I will cover more of the economic problems, unavoidable inefficiencies, and misalignment of interests in this system, as well elaborate on the argument for why I think is the smallest-government option for universal health-care is actually--spoiler alert!--a single risk-pool system.

This is not Progress: Transaction Taxes

There have been many calls for a transaction tax. I oppose all of them. I am not a free-market fundamentalist, but intervention here will help nobody. I understand the desire to tax speculator's trading activities, they can often be seen as value extracting instead of value creating activities, but at the end of the day, they do add liquidity and lead to tighter spreads, even if the liquidity is of low quality. The problem here is regulatory arbitrage, the transaction tax can easily be circumvented by moving transactions off-shore. I understand that is not trivial, but all the large  operations, the ones that can really affect the financial system, are big enough to be able to move the taxable operations because the cost of moving the operation will be less than the cost of paying the tax. Meanwhile, all the smaller players will be stuck paying the tax.

There is a lot of legitimate transactions that would end up burdened by the tax, from a small airline hedging fuel costs to a farming operation locking-in a price on a harvest, to a municipal water company hedging their energy costs (you'd be surprised at how much electricity those pumps need). The media has called it a "Robin Hood" tax and the politicians are throwing numbers like "0.25 percent" around. They just don't get it. First of all, this would mean bye-bye to the money market mutual fund industry and it's associated returns for holders of cash. Secondly, it would wreak havoc in the Fx markets and inevitably lead small money-changers to go into the black market since the tax would be bigger than the current bid-ask spreads. Finally, the tax would just end up being paid by consumers in the form of higher prices. I won't even touch the subject of market makers, whether official or de facto.
We need to fix problems, not symptoms! This is not progress.

1.) http://www.guardian.co.uk/business/2010/feb/09/tobin-tax-nighy-curtis-film
2.) http://www.bloomberg.com/apps/news?pid=20601103&sid=anYlPWIEm6gE
3.) http://www.lexology.com/library/detail.aspx?g=de4f41cb-2d89-410b-88ed-696853e482ec