recession odds

Greenspan mentioned that there is about 1/3 probability that the country will head to recession this year (2007). Can he be wrong? No. He must be right. What he is saying is there is 2/3 probability the country will not head to recession this year. Whether there is a recession oor not, he is always right, depends on 1/3 or 2/3 you emphasized.

It is very interesting the media only pay attention to the 1/3 part, did not realize the whole statement is the country is unlikely (2/3>>1/3 ) head to recession.

So, the question is not how likely, but will or will not. I tend to lean on the will side...

Invisible hand vs Monopoly II

If Mankiw is right, I would guess he thinks

Senate kills bid to import prescription drugs

is also a result of invisible hand...

Invisible hand vs Monopoly

Mankiw in his Blog advertises his textbook. Fair enough...but he mentioned:

"If you would like a copy and are not a professor eligible for a free one, you will have to rely on the invisible hand of the market to satisfy your cravings."

The price seems not driven by invisible, but visible hands: a good network between the publishers, the authors, and the high lobbying effort them to prevent price competition through imports. Simple examples are kill the second hand market every few years. Tell me why do we need a new edition of Introduction to Calculus book every few years? Tell me why you need an updated edition for many economic books? Tell me why you are able to sell at more than 50% discount for non-US edition in non-US countries but still making a profit? Tell me why most US online book store refuse to sell the non-US edition with identical contents? Tell me if you are not overpricing.

With almost perfectly inelastic textbook demand by students, the network is able to maintain high profit for long time. Poor students...

Please do you claim the price of your textbook is governed by invisible hand. It is govern by a few groups of people by exercising their monopoly power!!

What is it about Polish people and lines?

A few days ago in Steven D. Levitt Blog, He hypothesizes that one possible explanation why Poles so good/rude to cut into a line is:

"With so many years of shortages, the rewards for becoming an expert line cutter were much greater in Poland than in the U.S. So they did perfect standing in lines — perfection means being able to cut in front of people and feel no guilt."

It sounds strange to me. If the hypothesis is true, we should also expect the cost of losing the place in line is very high (again due to many years of shortages). This means those already in line will try every effort to prevent being cut into...so, two force will somehow counteract each other. It is not obvious why cutting in line is so often.

An experiment may be look at the line cutting within the tourist area (where people in line did not face shortage in the past) versus the line cutting in the local area. But two problems are 1. mostly likely, the price in the tourist area may be high enough that line may not often exists. 2. not many locals in the tourist areas.

Mexico interest rate surprise

The rate hike is surprising. The statement is to reinforce the bank's credibility.

The motivation is pretty obvious that the bank wants to reverse the inflation expectation. Currently the expectation is at the upper bound of the target. Here is a few questions we need to look at.

1. Inflation expectation is formed through many different channels. Most cases, it is formed from the inflation history. Of course, there are two ways to have inflation. Supply shock or demand shock.

A. Demand shock is the loosing monetary policy. Mostly due to fiscal pressure on the central bank financing. This was typical in EM in the past, and some EM today. In this case, the bank has an important role to convince the public that printing money to finance the fiscal deficit is not an option. That is one reason we have the inflation targeting institute or an independent central bank. Also under this case, inflation is driven by the government. As governemnt does not change every month, inflation expectation is formed as a response and tends to be sticky.

B. Supply shock on the other hand is not a direct result of policy failure. It is the weather or some global factor that the government/central bank has limited tools to counteract. In this case, inflation expectation tends to be short term and less sticky. In some sense it is more likely to be adaptive, adapted to a few month in the past. Market observes inflation yesterday tends to think it will be similar today because the transition probability for weather switch from one day to another is low. In other words, if the inflation figure drops today more than expected (due to demand slow down for example), expectation tends to adapt and adjust downward fairly quickly. Also because of that, the effect of central bank hike is smaller as the source is inflation is not from government. This seems what is expected in Mexico.

2. Anyhow, rate hike is real today. what will be next? I think the rate cycle (if there is) should be done. Inflation expectation should go down partly because of this rate hike, but more importantly, the diminishing of the supply shock. Of course, if there is another unexpected supply shock, the story will be different, but that is not the baseline.

3. The real concern is if the real economy response to the interest hike. The economy is cooling down. The uncertainty between the weak US growth and Mexico economy is high. If Mexico faces external sector slow down, and if domestic economy response negative to the rate hike, the effect will not be pleasant. This paves the way for interest rate adjustment.

Rising threat of Protectionism

What will be the impact of rising impact of protectionism?

I think that we need to go back a step to ask why there is a dollar weakness. We agree that is driven by current account deficit, which I personally think is internally driven as a reflection of private and public negative savings. The private and public negative savings are made in the US. In some sense the monetary policy in the private sector and the fiscal policy in the public sector. Global liquidity effect on paper assets also plays a role. The dollar has been supported by capital inflow which by definition is external driven.

The thought process of trade protectionism is how this may affect the link mentioned.

There is no reason that protectionism will have any significant impact on public saving. It is very hard to imagine the tariff collected from import will be significant in any measure.

On private saving, there are two things to think about. One is the overall level, the other is the substitution. With tariff and if the price actually rose, it is a matter of elasticity whether the US consumers will spend more or less. Indeed, I tend to believe that private business is able to adjust their productions to pass the tariff barrier. Unless there is a global protectionism, I would guess the level impact will not be large. One example is the US has placed a high tariff on wood imported from China for a while. What we see is that a number of furniture firms have switched from wood to leather or metals. The substitution effect may be more important from buying imported goods to domestic goods. I am not sure how big the effect will be, but it is very hard for me to imagine the US has competitive advantage in most consumer goods nowadays. In this sense, the impact on the public and private saving sides will not large.

The other side of the coin is the capital inflow financing. Capital inflow financing is a function of investor’s confidence on the US (yield and investment environment) and the foreign countries’ domestic concern. Protectionism will not be positive on the US investment environment. In the 1980s, when the trade tension between the US and Japan, we saw Japanese companies has put FDI in the US to smooth the relationship. In that sense, it is positive to the dollar. Do we expect this will happen again today when every low labor cost countries are opening up? I could guess the impact will not be as big as in the past decades. By the end, the portfolio flow is much larger than the FDI. For example, net foreign-owned assets in the US in 2006 were 1.76 trillion, while net foreign FDI inflows were $183.6bil, or less than 10% of total capital inflow. (BEA data)

The last thing is what will be the reaction of foreign countries? One reason why the foreign government continues to buy the US treasury is to support domestic employment, as the US government claims it is the exchange rate subsidy. Now, if the tariff is effective to switch employment from EM back to US, what is the motivation to continue buying the treasury? What this implies is that if tariff is effective, trade deficit will be improved, a positive to the dollar. At the same time, capital inflow will slow down, a negative to the dollar. Of course, there is the timing problem. If trade is improving but foreign governments do not act, it will be positive to $, and vice versa. One thing to bear in mind is the foreign governments consist of many players, that they do not coordinate their policies. If the US put a tariff on buy treasury buyers like China, China’s action can affect the market easily, but not the case if the tariff is on Costa Rica for example. So, if tariff is effective in affecting the trade flow, it is likely that the capital account will respond accordingly. Again, this case seems not likely as it is hard to see the competitive advantage of domestic US industry in consumer goods.

The worst case will be the broad protectionism creates a rise in risk aversion, but I am not sure this will benefit the US economy. This will be a loss-loss situation for all.

Latin America Trip

I have been in Latin America in the past two weeks. My first destination was Chile, followed by Argentina, Brazil, Peru and Colombia. The trip is very fruitful, but very exhausted. Two weeks have passed in a flash. I am now on the way back home.

Different countries have different economic development. The impression from the trip is that all countries are booming. All countries, to a different extent, are able to maintain their fiscal discipline. Argentina, Brazil, Peru and Chile all have primary fiscal surplus. Colombia is a bit behind with manageable deficit. This is a big contrast in the 1980s when the government spending is highly correlated with external environment.

Another important observation is that the growth is not limited to a small subset of economic sectors. Chile, Peru and Colombia, for example, the growth is quite diversified, from their traditional commodity export to retail, manufacturing, telecommunication, etc. This seems the current favorable external environment somehow passes through into domestic economy. One explanation is that the world really has a lot of liquidity. With economies are driven largely by private sector, high liquidity is channeled to the productive sectors. The government spending restraint also minimizes the crowding out effect.

This does not mean the countries are totally insulated from shock. One very clear problem in my mind is all their currencies are undervalued. Government intervention is the norm everywhere. There are two problems. One is sterilization is not complete, which means sooner or later, inflation will show up in the domestic economy. If this happens, the most affected group will be the poor, as most of them are not able to hedge the inflation risk. This is particularly important as history tells us that social unrest has been a hidden bomb in the Latin region. Last year’s Peru experience is still in our mind.

On the other side of the same coin, huge rise in international reserve expose the central bank on exchange rate valuation effect. If the world continues to be smooth and if the US continues to be fiscally irresponsible, the continuation of dollar depreciation is inevitable. If dollar in one day lost its attractiveness as a vehicle currency, these countries’ assets will be greatly affected. In some sense, the US now having a free lunch; or precisely the cost of the free lunch is paid by other countries.

The second problem I think is even more worrisome is all countries is very protective to their export sector. This suggests that they are not confident on the domestic economy. Every developing country wants to move to the developed world. Every developed economy is driven by domestic component, and most likely letting its currency floats freely. I don’t see this is the case in any of the Latin economy. The typical argument from the central bank or the ministry of finance is they concern their export sectors, or in short the Dutch Disease. Theoretically sound, but seems not practically right. The Dutch Disease argument relies on high entry barrier. This seems not too important for Latin’s manufacturing industries. But the end, the undervalued currency hinders the transformation to a high value added sectors. This is quite a bad thing in the long run.

In the sense, the government should spell a clear message that FX intervention is transitional, including the intervention magnitude over time. It seems so far there is no clear message out there. The market may think that is transitional not because of the government commitment, but the government capacity. Although the eventual outcome may be FX appreciation, the dynamic is very different. Under the first case, the market will have full information on the FX trend, and export sector are able to plan its transformation in an orderly fashion. Rational expectation suggests that volatility will tend to low. In the second case, market needs to estimate the capacity of the central bank, from inflation data, from interest rate data, etc. export sector will put more efforts on lobbying the government. Speculation will be high, and so is the FX volatility.

I recalled there are a number of countries in the past are able to move from pegged regime to floating regime without triggering a crisis. More importantly, all of them switched their regimes under the good time. This is the time for the Latin America. Making it overvalued or undervalued will eventually be problematic. It is important to let the FX go before the end of the good times. Today, with the exception of Argentina, all countries are doing well. Private sector is moving forward, and business confidence is high. Hyperinflation is a history.

With high international reserves, with fiscal balance and with favorable monetary condition, it is time to let it float. Let the market determine which industry should stay, which should let go. Let the financial market develops under the market condition. Most of those countries are not small open economy, they need their domestic demand determines the economy, not the export sector.

Cafe in Chile

very interesting and attractive...I love the cafe though I don't drink coffee

Working hour flexibility

Many suggestions has been thrown out how to tracke the global warming problem: tax on gasoline, biofuel, tax through insurance on driving, etc.

I have another suggestion. I think a large portion of driving are devoted to work commute. In many cases, people do not drive as much as during the weekend. Unlike work commute, people has more flexibility in their driving decision in the weekend. If we can reduce our working day from 5 days a week to 4 days a week. Think about a typical hours of work in a typical weekday: 8-5pm from Monday to Friday. If we can squeeze it into 4 days from 7am to 6pm, the total number of hours will increase from 45 hours per week to 44 hours. We can cut lunch time for the new scheme from 1 hour to 45 minutes to make the 1 hour up.

I think many workers will like to have this new arrangement. If government worries that people may drive even more in the "long" weekend, the government can make it Wednesday break instead of Monday or Friday.

I think indeed some international institution has this practice, probably for a different resaon. IMF for example, employees there can take every other Friday off. We do not see there is any significant problem for the fund's operation. Of course we can also be more flexible in this new scheme, instead of everyone off on Wednesday, some take Wed, some take Thur, and so on. The company can continue to funcation 5 days a week.

This is probably be good for the earth and for the employees. Is that a win win situation?

Yen

Shall we buy yen? Yes

The reason, in additional to the Japanese domestic economy, is that the govt/central bank is also debating the delink between US and the rest of the world/ asia I particular. Evidence is it is possible. If we have a delink, weaken or moderating US economy will discourage money flow into the US markets. Those extra money has to go somewhere. From currency prospective, Yen is the only outlier in the developed world. From geographical prospective, the delink is beneficial to Japan as its trade with Asia is highly connected. Both encourage the capital inflow to Japan. From the rest of the world prospective, reserve accumulation is slowing down. The major buyers in the past are either diversifiying or slowing down its rate of accumulation. I don't know how the global inflation and domestic US economy will play out in the US interest rate dynamic, but the long end of the US treasury will eventually feel the pressure from external.

The only problem is the Japanese policy makers are not 100% certain that delink will be the case. At this point, they are conservative because if delink has not yet be confirmed, earlier rate hike will be harmful to the economy. It will not materialize until the day it comes. Given the current oil price is highly uncertain, It looks like the bank wants to confirm the delink hypothesis before acting (which of course the mirror image of domestic economy pick-up).

Yes. It is expensive today. It will become cheap once the delink hypothesis is confirmed.

Housing market

A while ago I mentioned that I am not as bullish as the market regarding the housing stabilization. I argued that in most market, price and quantity are both needed to adjust when there is a drop in demand. In some sense, the short run supply of house is relatively inelastic. Price adjustment will follow the sales adjustment.

Here is a bit of thought on the economy as a whole. So far, the weak housing market did not (yet) spilled over into other components of the economy. Private consumption remains high. One explanation is that housing market is quite localized. The collapse in sales in Florida will not cause much private consumption impact in the Bay Area. But when the government measures private consumption for the country, it looks at both Florida and the Bay Area. The impact of housing market collapse will not be one to one to the overall private consumption.

Now, the problem seems different. Thanks to our financial engineering technology, the securitization of mortgage loan makes every part of the country exposes to the housing market. Investors everywhere in the country are now able to expose to the risk of the local housing market through the exposure of stock market. Our private consumption is fine as long as stock markets hold up.

I would guess this is the reason why Greenspan mentioned that spill over is possible until recently.

Remittance and housing

From 2003 Jan to 2007 Jan, year over year growth between US housing starts and Mexico remittance has some unsurprising relationship:

Mexico Remittance: Only 7 out of the past 49 months are below or at 10%yoy growth. 5 out of those 7 happened since August 2006.

US housing starts: 20 out of the past 49 moths are below or at 0% yoy growth. 11 out of those 20 happened since 2006.

In terms of overlapping, 6 out of the 7months below 10% yoy remittance growth are associated with below 0% yoy growth of housing starts. The remaining 1 months was on Jan 2004 when Housing starts was also low at 3.13%yoy (Jan 2003 housing starts was 9.1%yoy, Jan 2005 housing starts was 11.8%.)

So, what will be the remittance going forward, what what will be the impact on the Mexican families live in Mexico?

HMO Coordination

I did a surgery last Wednesday. My spine disc was displaced and pressed the nerves. I could not stand and walk in the past weeks. Laying on the bed is the only way to make my pain away.

I joined the Healthnet HMO. I have my family doctor. Here is the procedure from the time my leg was really hurt to the day of surgery.

Day 1: I need to see the family doctor. He briefly examined my leg. and referred me to took an X-ray on my leg and back. In the mean time, he gave me some pain reliever pills.

Day 2: I did the X-ray and took the medicine. Well...the medication was not working. The pain was there without any imporvement. The X-ray result could not detect anything abnormal.

Day 3: I came back to my family doctor and told him the situation. He decided to write a report to the insurance that I need an MRI (another advance type of X-ray that can see through your nerves). Another strong set of pain killer as well.

Day 4: The insurance approved the MRI. I did the MRI in that evening.

Day 5: The MRI result was out showing that my disc in my spine was displaced. I came back to the family doctor to get his referral to the specialist.

Day 6: I went to the specialist with the MRI films. I was lucky that at the time when I brought my film to the specialist. The doctor just arrived the office and read the films. (usually I need another appointment which will be a nother day or two). He was nice enough to handle my situation immediately. (I guess my situation is already too worst to wait...). He said I need an surgery, but need to get the insurance approval.

Day 7: I eventually got the insurance approval for the surgery. However, I still need to get confirmation from the hospital for room availability.

Day 8: eventaully, the hospital confirmed as well.

Day 9: Surgery in the afternoon

Day 10: rest at home

Day 11: back to work.

This is the coordination problem...I suffer from miserable pain for more than 2 weeks. Remember from day 1 to day 11, there are two weekends in between, and one of the weekend was the President days - a long weekend...

Is there any way to may that more efficient? for example, can the insurance, hospital, family doctor, specialist netowrk connect together? rather than waiting for an verbal confirmation form one another?

Can the drug prescription service available at the family doctor or specialist office? rather than go to Walgreen or Longs Drug? All these should not cost much extra. Are we protecting the drug company or are we protecting the one who needs the care?

Central bank’s job

The more I study the job of a central bank, the more thought I have. In most central bank nowadays, the main responsibility of the central bank is to maintain price stability. The policy is inflation targeting. There are many different form of inflation targeting. From a strict targeting like UK and New Zealand, to a more flexible inflation targeting like Mexico and Brazil. The whole point for this policy is to make sure that inflation is in the target range.

Investors often project the central bank’s policy stance, by looking at the latest inflation/cpi number. When it is above the market expectation or when it is close to the upper bound, the market expects a rate hike and vice versa. This sounds to me a very wrong interpretation.

Here is why: we all know that from interest rate hike to money supply to investment to domestic demand takes time. Or from interest rate hike to credit contraction to less money in the market to less liquidity takes time. We also know that the latest inflation/CPI number is mostly a month old. So, from the inflation number released to the interest rate hike, and from the interest rate hike to the real effect on inflation will probably take more than 2 months, not to mention that a lot of economies do not have a smooth monetary transmission. So, this time lag will basically make the monetary policy ineffective.

So, what is the point to have a monetary policy? Because of this time lag, the only propose of the monetary policy is to stabilize inflation expectation. Nowadays, inflation survey has been released in many of the countries. The expectation is mostly available a few weeks before the realized figure. Does that make sense for the central bank to put more weigh on the deviation between inflation expectation and the inflation target, rather than the deviation between realized headline inflation and the inflation target.

So, what is the point on that? We are having inflation hyper in Mexico these days. Latest bi-weekly Inflation is downtrend, same as the core cpi. Inflation expectation in 2007 and 2008 (also implied by the wage negotiation settlement) are not out of line from the central bank. So, why need hike rate? May it better for the bank to talk more aggressively to stabilize inflation expectation and act only when the expectation is against the bank’s view? I would guess this is what the bank did this morning. It states:

“the Board will remain attentive that core inflation is complying with its own forecasted trajectory (both monthly and annual) consistent with a decline by March. If not, the Board will tighten monetary policy."

Yield compression

In the past days when my productivity is low, I was thinking about some global issue. Thanks to the global liquidity, the current situation is that emerging markets are in general is doing great. Yield differential across the globe has compressed to historical low level. Buying a Peru or Philippines local bond is more or less the same as buying a comparable US treasury bill. To look at a summary comparison, I pulled out some random number of local bonds: Colombia 2010: 9.2%, Indonesia 2010: 9.97%, Peru 2010: 5.6, Philippines 2010: 5.6%, Thailand: 2010: 4.45%, and finally US treasury: about 5%.

This is a large compression. Why? There are two reasons. But have conflicting implications. The first reason is investors now believe that investing in $ asset is not safe. Current account deficit, fiscal deficit, over-relying on consumption, weak export and housing bubble. Lots of indicators suggest the only support relies on the strong labor market, and business investment. There are recently some signs of weakening business investment. The fundamental points to the weakening of the weakening of the US market, either soft or hard landing. One the other side of the globe, emerging countries takes advantage of the global saving to invest into the US treasury bills, commodity resources, and fixing/restructuring their own balance sheet. Macroeconomic policies are now in place in most of the countries. In some sense, it is a good bet that the emerging countries will not face a massive crisis as we observed in the 1990s.

Under this situation, putting money into the emerging markets is a good investment, both as a hedging the moderation of the US, and take advantage of the EM growth dynamics. Yield differential is compressed as a result.

The second reason for this yield compression is the investors made mistakes. Investors with too much cash in hand has no where to invest. As a result, their risk appetite rose, and look for the high yield bond without fully taking into account its bond and currency volatility. This becomes a herding behavior or more precisely a bubble, that as everyone else believes the rest of the investors will continue the process, bandwagon effect continue until there is a trigger. Before the trigger, we continue to have a good yield compression.

The trigger can start from a mini crisis like we observe in the mid 2006. One of the many emerging countries fell into trouble, and then spread to the rest of the EM world. The problem of this type is it is hard to detect in advance. We do not know exactly the linkage between/across different region. How can we realize the Russia crisis will spread to Latin America in 1998? Even worse, it is highly possible that the leverage is concentrated in a group of diversified hedge funds. Our knowledge on hedge fund institution is minimal. What we learn is that they are “sophisticated” that allow them to make a most efficient decision. But as a matter of fact, this presumption has never been verified. To be honest, we don’t know. Also because of those hedge funds, their herding behavior will cause large market volatility without much advance notice. It is like a hot potato move around from one fund to another and eventually the chain will take the toll.

So, what will be the consequence under each case. Back to the first, where investors have “rational expectation” that on average, they are correct. The fundamental/trend of US is declining, while the opposite happens in the rest of the world. Since their expectation is realized, the yield compression converges to the US asset yield. The safe heaven/US market liquidity is offset by the local currency appreciation. $ will depreciate which offset the advantage of liquidity $ market. The yield differential converges, and the risk adjusted return between the US and EM will be at equilibrium.

With this first scenario, $ depreciates, the rest of EM currencies appreciates. Export to the US drop while EM domestic demand picks up. The large EM international reserve will be in use to stimulate the domestic demand. The rebalance will switch from US domestic consumption/EM export to US export/EM domestic consumption. The safe heaven hypothesis will switch from $ to Euro, Swiss Franc, pound and Yen. Those currencies will be moving in the same direction as the major EM against the $.

The big concern under this scenario is that if US successfully switches from domestic consumption to export, it requires two components. One is $ depreciation, Two is domestic stagnation. Uncovered interest parity implies the US long term yield will rise, while the fed policy implies the yield will drop. Most likely the curve will be steeper. The impact will not be too strong in the EM curve, as money flows into the EM currencies. EM appreciation will offset the expected loss in interest differential.

The second case is a bit worrisome for me at least in the short run. If investors are miscalculated the risk of investing in the EM markets, any minor wakeup call can reversed the trend. There are a number of things are likely to happen. First, money will shift back to the safe heaven, namely, the US, Euro, etc. $ will strengthen at the expense of the EM currencies. The strengthening of $ will have adverse impact on the trade balance. The valuation effect as we mentioned many times in the past will accelerate the worsening of the current account. On the other side of the globe, gradual EM currencies depreciation will be welcomed by several countries like Brazil, China, Colombia, but too much and too fast deprecation will guarantee the central bank intervention.

Regarding to the bond yield, this miscalculating will widen the yield differential, as seen in the mid 2006. Together with their currencies depreciation, there is a potential rise in inflation which will force the central bank to raise the interest rate further.

Which case is more likely? I don’t know, but if I am asked to put a probability, I would put a higher probability on the first scenario. Why?

One: nowadays, investors are at least partially able to distinguish bad countries from good ones. A mini crisis in a bad country (for example, Venezuela) may not have a systemic effect on the rest of the region, not to mention the rest of the EM universe.

Two: most EM countries now have the capacity to buffer from external shock (change in investor’s sentiment). External debt has been declining, international reserve has been rising. Central banks have become more credible. Their balance sheets have been improved.

Three: Trade openness has been more liberated than in the past. With more open economy, exchange rate adjustment has to be smaller to accommodate a given amount of external shock. Exchange rate movement can be spread over many countries.

Four: in many EM countries, especially in Asia, the governments have capacity to increase their spending to stimulate their domestic demand to buffet the export contraction.

Our housing market

A quick thought on our housing market:

We have been told that our housing market has stabilized from its bottom. Existing home sales and new home sales are “rebounding” from its lowest level since late 2006. The latest housing start statistics, on the other hand, drop again after a few rises in the past months. Vacancy rate remains very high. Finally, both existing and new house median price remain more or less intact since we claimed the housing market collapse.

So, the first question we need to ask is what defines as housing market stabilization. Should we look at sales volume, housing starts statistics, price, or some kind of weighed measures? If price is the main component of the definition, our housing market has never collapse. The problem I can see in determining the housing market situation with a set of indicators. All these indicators are dynamically linked, especially price and quantity.

Here is what I believe. At the beginning of the “market slowdown”, sales volumes dropped. Sellers, especially those investors/speculators are uncertain about whether the slowdown is real or not. And more importantly, they do not know the slowdown duration. They are willing to wait for a few months without triggering the price adjustment. It is also easy to use seasonality as scapegoat. Winter is the non-peak housing season. Indeed, they have every incentive maintain price rigidity as a way to persuade buyers that there is no slow down at all. Of course, there are some random sellers are really to sell at a lower price, but not the big real estate companies. If their strategy achieved, they should expect buyers will come back to the market in the summer. Sales volume and price will rebound.

From the buyers’ prospective, there are two major concerns. One is will the price dropped in the near future? Two is will the quantity house supply drop too fast? At this moment, seem the first concern dominates. What they are observing now is quantity supply is high, with non-dropping price. What they are waiting to see is if the market rebounds in this coming summer. If the sellers’ strategy wins, buyers are persuaded that there is a “structurally upward shift”. The past few years price jump is permanent. However, if the sales volume did not rebound in the summer, it is very likely that buyers in general believe the house market is indeed in bubble. Seller lost the seasonality scapegoat. The only way sellers can do is to lower the price to liquidate their inventories.

In other words, this summer is the critical moment. Price, if adjusts, should start in this summer.

Can we claim at this moment that housing market has stabilized? I don’t know, but I really don’t think so. In most markets, we do not often see either price or quantity adjustment. It is likely both adjust, just a matter of dynamic behavior.

Rent Seeking

I really need to spell out how greedy our textbook publishers and their monopoly networks are. A textbook in the US can cost more than $100. Most of the times, student use that for only 1 semester/quarter. Student's textbook demand elasticity is almost perfectly inelastic. Whenever the teacher assigned a textbook, no matter how expensive it is, student will continue to buy.

The problem is those textbook publishers and textbook authors are coordinated to form the monopoly. The authors, mostly teachers as well, require their students to buy their own textbook. They at the same time, coordinate with the publishers to publish a new edition every few years ( and/or publish a "updated edition" after a few months) to kill off the used book market. The publishers, at the same time, create different edition (hardcover, paperback, US edition, Australia edition, Asia edition, etc.) for the same book. They even lobby the congress to make the arbitrage among different editions illegal (so far unsuccessful, but it is just a matter of time, as most politicans can be bought out). What a shame for all these people! they claim their role to to educate the next generation. But they screw up the public by creating this monopoly.

I recall when I was a student in an big economic class a few years ago (econ 100a intermediate microeconomics at a good public school in the Bay Area CA). The textbook was written by the instructor. In the first lecture, one student asked if it is okay to use the international edition textbook, which is basically the same content as the US edition. The teacher (the author) replied that "you are not supposed to get the book in this country". Well...He basically did not answer the question. He knows it is much cheaper, and he knows the content is the same, but he refuse to say okay.

The government put more money on education by increasing grant, low interest student loan, etc. all the additional money goes to the publishers, authors and book stores as they raise the textbook price accordingly. Many politicans are benefited as they are being bought out by those people. I really want to know if anyone does any empirical study on the relationship between textook price and governmnet education grant.

Folk Theorem

In Brazil, the dynamic of the central bank behavior is a function of inflation dynamic, which in turn is a function of government policy dynamic. In some sense, from the central bank of view, the rate decision is taking the expected government policy as given. On the other hand, the government policy in Brazil is also a function of the central bank’s policy. Given the primary budget target and public debt constraint, the government’s projection must be in line with the central bank rate decision. In some sense, both are facing a non-cooperative dilemma.

The recent program by the government suggests that government expenditure will rise in the next few years. This is feasible only if the central bank’s rate dynamic is in line with the government projection. It is particularly important for the government since its debt dynamic depends on the interest rate dynamics. As the central bank said that debt/GDP ratio will be lower in 2007 mainly because of the decline in interest rate. From the prospect of the government, if government expenditure continues to increase, together with the continuation of rate decline, economic growth will rise, while the debt dynamic will be improved. This is the objective of the government. Of course, the government also needs luck from the benign external environment. Currently, more than 30% of total debt are fixed rate fixed, with average of maturity of about 1 year. Roll over risk is a concern.

From the prospect of the central bank, it takes the government policy as given. Its objective is stable inflation. As mentioned previously, they care mostly on money supply and inflation expectation. Rising government spending will increase the credit growth, hence M2/M3. It also increases inflation expectation. Both lead the bank be more cautious in rate cut. This is the objective of the central bank.

They face a dilemma. By construction, these two institutions are independent. Their jobs are inflation and employment/growth respectively. The government prefers the central bank to be more aggressive in cutting rate. The central bank prefers the government to be less aggressive in government spending. Since this is a repeated game, we should expect some signaling between the two parties over time. One clear signal by the central bank is the last week’s 25 bp, instead of 50bp, cut. It provides a signal to the government that if the government acts irresponsibly, all the fiscal stimulus will be counter balanced by contractionary monetary policy. The net result will be worsening debt sustainability without growth. Similarly, by announcing publicly that the improving debt dynamic and economic growth requires interest rate cut. The government signals the bank that the bank will face a lot of pressures if it is too conservative.

These signals are simply to show both parties that if either one of the party deviates from the feasible strategies, the other party will trigger a “revenge”. Of course, the feasible strategies should be somewhere in the middle. The government is not too aggressive in public spending, which will not drive too much inflationary pressure. The central bank continues to cut rate, but in a gradual pace.

If you remember in your game theory 101, there is a “folk theorem” that captures the essence of the above story.

From Wikipedia, “all of the players of the game first must have a certain feasible outcome in mind. Then the players need only adhere to an almost grim trigger strategy under which any deviation from the strategy which will bring about the intended outcome is punished to a degree such that any gains made by the deviator on account of the deviation are exactly cancelled out. Thus, there is no advantage to any player for deviating from the course which will bring out the intended, and arbitrary outcome, and the game will proceed in exactly the manner to bring about that outcome.”

Who should we blame?

An article talked about the increasing foreclosure these days due to the declining hosuing market, and suggesting that the government regulator may want to step up to strengthen its regulations on commerical banks. It implicitly (or explicitly) saying we should blame the mortgage lenders for their aggressiveness. I am not sure I agree with him with 100% confidence.

I think in this case, regulator has a role to prevent those agressive loan program banks offered. But more importantly, it is the problem of individual investors that did not face the reality. They know how much they make, they know how much they have to pay for the mortgage payment, they know how those aggressive loan programs work. They always have the right to NOT buying the house. They always have the right not to take those loan. They still take the risk. they have to pay for their mistakes.

The role of the regulator should strengthen the transparency of the mortgage contract's contents. The role of the regulator should provide full information on the impact of declining housing market on investors. I believe individual commerical bank should has its own discretion to tailor its mortgage program to fit its goals.

We should remember any trade involves two parties. It is quite inappropriate to blam solely on the sellers. the buyers should be blamed as well if they are true speculators, which I think many of them are.

The people really suffers are those who can afford the house at the "normal" price (that price follows the historical trend), but not the "bubbled" price. They have to rent an apartment, or moved to far away places to survive.

btw, I am not in this industry, there is no conflict of interest in shaping my opinion.

market for health care

Milton Friedman argues that the government should not be involved in to health care market. Private sector should take full control. Market competition will drive the bad firms from the market. Good firms will stay. Good ending. But I disagree.

What I disagree is who will be willing to risk his life in this process. To find out who is bad, Someone has to be involved in the bad firms. By construction, he will not have good medical care, and as a result, suffers. What the possible outcomes are:

1. There are only a few medical providing firms that are able to establish thier reputations. New firms are hard to enter the market unless they charge sufficiently lower price to attract customers. This may lead to a naturel monopoly or oligopoly outcome. We need the government to handle that.

2. When new firm tries to enter the market, they have to charge low price, but under this oligopoly situation, it is highly likely those big firms may undercut the price whenever there is potential entry. This treat may prevent new firm at the beginning. We again need government to handle.

What I think is important is that the government should establish a min standard for qualification for the medical profession. Then develop a transparent system in rating from the users. It looks like many online sellers that they develop their reputation through customer ratings, but need to fullfil the min requirement outlined by the web platform.

I think in academica, it is natural to distinguish into the pro market or pro government camps. It is natural because this is the way to establish your stance. But in reality, we know both market and the government have important roles. It is a matter of under what situations.