"What an economy really wants, after all, is not more investment per se but better investment. It wants capital to flow to companies that will create value - not in the form of a rising stock price but in the form of more goods for less cost, more jobs and rising wages - by enhancing productivity." - James Surowiecki
Productivity is another interesting economic input. To create a product you need materials, a plant and labor. The number of products produced for a unit of labor is referred to as productivity. Throughout history there have been major leaps in productivity from the railroad to the Ford manufacturing methodology to the Internet. Each of these has fueled growth and created huge wealth for the innovators. Furthermore there is a body of consensus that points to increases in productivity providing job growth and wage increases, both of which are desperately needed today. So is there another productivity miracle in the works and will it be the golden spoon that pulls the global economy out of its quagmire?
Looking at the last 50 years there have been major leaps in productivity each decade other than the most recent one. This is leading economists to predict that another one is just around the corner however the problem with leaps in productivity is that you never know when it will arrive or where it will come from. Certainly there is more and more money being spent on research and development globally but it is hard to imagine that we will ever see something as impactful as what was witnessed with the creation of the Internet. That said we have witnessed the birth of three dimensional printing that is allowing companies to develop products far more quickly than ever before. On top of that as the price of the printers has dropped significantly more and more people have access to these machines and they are able to tinker away at product development in the comfort of their homes. While this is a great new technology it is hard to imagine it having the productivity impact of the Internet but it may result in the next productivity miracle being designed.
Another recent development has been Fracking. This new technique for extracting oil and gas out of rocks has drawn a lot of skepticism from the environmentalists but it is changing the economic landscape as America is suddenly becoming an energy super power. Once again though this innovation will not provide much in the way of a productivity benefit although it is having a marked impact to the employment numbers in the northern part of the United States.
So we do not know where the innovation will come from but it appears that we have not witnessed the next productivity wave we are only basing the expectation on historical data. Now while I have no doubt that productivity will continue to improve I do have a question as to whether this will have any meaningful impact on unemployment. In the past innovation that resulted in productivity gains resulted in increased employment opportunities and higher wages. As factories became more efficient market share was taken from others and the home country benefited at the expense of others. As I have mentioned before with the advent of the Internet the globe shrank metaphorically speaking as things could now easily be produced in countries with a comparative advantage (see previous blog on this topic). The result of this was an export of jobs to places like China and India. Those that managed to keep their skill set aligned with the changes benefited with higher wages but there was a large portion of the population that has since been made obsolete.
It is this portion of the population that is creating a drag on growth for the simple reason that the balance of the workforce has to make up for the lost wages and purchasing power of these individuals. My contention is that when the next wave of productivity gains appears (and it will) we could see another spike in unemployment. In fact we could be at a point in time where full employment in the United States is no longer 4% but has shifted to 6% or even 7%. Printing more and more money to try to foster employment by businesses in this scenario is pointless as no matter how much money is thrown at the problem the result is still high unemployment numbers. The only result is an ever burgeoning level of government debt and the problems that come with that.
Not that I believe that the way to get people to work is reducing productivity. What will happen over time as productivity continues to improve is that the employment market will shift and workers will adapt to the changes. This takes time and could take decades but the way to lower unemployment under this scenario is for the government to spend their money assisting people on retooling their skills to match the changes in the market place. Instead, the Federal Reserve continues to believe that throwing money at banks will result in a trickle down effect that will eventually reach the out of work sector. This is clearly not happening as improvements in productivity are giving businesses the ability to reduce their workforce while continuing to increase volume.
If the government and the Federal Reserve would take a long hard look at all the entitlements that reduce the desire to work and the stimulus and how it is being spent maybe they would see that a far better way to reduce unemployment is to spend money on innovation and retooling rather than blindly throwing money out the window.
Friday, September 27, 2013
Friday, September 20, 2013
Econometrics: The Big Disappointment
A mathematician, an accountant and an economist apply for
the same job. The interviewer calls in
the mathematician and asks "What do two plus two equal?" The
mathematician replies "Four." The interviewer asks "Four,
exactly?" The mathematician looks at the interviewer incredulously and
says "Yes, four, exactly." Then
the interviewer calls in the accountant and asks the same question "What
do two plus two equal?" The accountant says "On average, four - give
or take ten percent, but on average, four." Then the interviewer calls in the economist
and poses the same question "What do two plus two equal?" The
economist gets up, locks the door, closes the shade, sits down next to the
interviewer and says "What do you want it to equal?"
Three econometricians went out hunting, and came across a
large deer. The first econometrician fired, but missed, by a meter to the left.
The second econometrician fired, but also missed, by a meter to the right. The
third econometrician didn't fire, but shouted in triumph, "We got it! We
got it!"
A mathematician, a theoretical economist and an econometrician
are asked to find a black cat (who doesn't really exist) in a closed room with
the lights off: The mathematician gets
crazy trying to find a black cat that doesn't exist inside the darkened room
and ends up in a psychiatric hospital. The
theoretical economist is unable to catch the black cat that doesn't exist
inside the darkened room, but exits the room proudly proclaiming that he can
construct a model to describe all his movements with extreme accuracy. The econometrician walks securely into the
darkened room, spend one hour looking for the black cat that doesn't exist and
shouts from inside the room that he has it caught by the neck."
It is easy to pick on Economists as the jokes above show. Economics, in my mind, has always been an art even though it falls under the sciences at universities. In an effort to try to make it more precise Econometrics was devised whereby economists use mathematical modeling to determine the probability of certain outcomes. I remember when I was studying economics back in the early 80's this was thought to be the future of the industry that would unlock the secrets of the investment universe so that investors would be able to determine with clarity the risk of an investment and the likelihood of an unwanted economic event.
Fast forward 30 years and while the models have become more and more sophisticated so has the investment marketplace. As more and more intricate investment derivatives are created the ability of the econometric model to predict the risk of an event and more specifically the chance of a fat tail event are becoming more and more feeble. A fat tail event is an event that is not captured under the normal bell curve and therefore has fantastic or disastrous consequences on your portfolio. The fatter the tail the more likely an unknown event is to occur. Finding these fat tails is the job of econometrics but the models have for all intents and purposes failed.
So let's take a look at the two sides of a fat tail. On the one side you have the unknown event that helps you tremendously. For example a cousin's, aunt's mother tells you to dump $100K into Facebook while Zuckerberg is still in college. Little do you know it at the time but it is about to turn you into a billionaire. On the other side of the tail is the catastrophe that was 9/11. On that morning no one was to know what was about to happen and this played havoc with your investment returns, not to mention the poor people and families that were directly involved in the tragedy. This is a fat tail event that was unpredictable and has disastrous consequences.
So although mathematical models are used by economists to take a shot at predicting the future they are not able to capture the one event that haunts ever money manager. In order to protect your portfolio from these fat tail events it has to be broadly diversified. By this I do not mean just into a basket of stocks and bonds but into assets beyond those. In my recently published book How To Thrive In The Obama Economy" (available now on Amazon see link below) I explain the reasons why it is more critical than ever today to look beyond a "normal" portfolio. I encourage you to read the book as I am certain it will help your investment philosophy and your returns.
Looking further at fat tail events there is no need to look further than the returns on the stock market. Since its inception there have been on average 12,000 listed companies. Of these companies roughly 300 represent half of the total stock market capitalization. Furthermore a lot of companies go bust year after year and are replaced by new companies. What this means is that over time only a small fraction of companies have made investors any real money. Miss these companies and your portfolio will really be hurt. This is why investors buy the market using ETFs and is a reason why they are so popular however this strategy opens up the portfolio to the fat tail event. The need to protect your portfolio outside of this one allocation is more important today than ever so take heed, open your eyes and prosper.
http://www.amazon.com/Thrive-Obama-Economy-Stephen-Bick/dp/1490975128/ref=sr_1_1?s=books&ie=UTF8&qid=1379694723&sr=1-1&keywords=stephen+bick
Fast forward 30 years and while the models have become more and more sophisticated so has the investment marketplace. As more and more intricate investment derivatives are created the ability of the econometric model to predict the risk of an event and more specifically the chance of a fat tail event are becoming more and more feeble. A fat tail event is an event that is not captured under the normal bell curve and therefore has fantastic or disastrous consequences on your portfolio. The fatter the tail the more likely an unknown event is to occur. Finding these fat tails is the job of econometrics but the models have for all intents and purposes failed.
So let's take a look at the two sides of a fat tail. On the one side you have the unknown event that helps you tremendously. For example a cousin's, aunt's mother tells you to dump $100K into Facebook while Zuckerberg is still in college. Little do you know it at the time but it is about to turn you into a billionaire. On the other side of the tail is the catastrophe that was 9/11. On that morning no one was to know what was about to happen and this played havoc with your investment returns, not to mention the poor people and families that were directly involved in the tragedy. This is a fat tail event that was unpredictable and has disastrous consequences.
So although mathematical models are used by economists to take a shot at predicting the future they are not able to capture the one event that haunts ever money manager. In order to protect your portfolio from these fat tail events it has to be broadly diversified. By this I do not mean just into a basket of stocks and bonds but into assets beyond those. In my recently published book How To Thrive In The Obama Economy" (available now on Amazon see link below) I explain the reasons why it is more critical than ever today to look beyond a "normal" portfolio. I encourage you to read the book as I am certain it will help your investment philosophy and your returns.
Looking further at fat tail events there is no need to look further than the returns on the stock market. Since its inception there have been on average 12,000 listed companies. Of these companies roughly 300 represent half of the total stock market capitalization. Furthermore a lot of companies go bust year after year and are replaced by new companies. What this means is that over time only a small fraction of companies have made investors any real money. Miss these companies and your portfolio will really be hurt. This is why investors buy the market using ETFs and is a reason why they are so popular however this strategy opens up the portfolio to the fat tail event. The need to protect your portfolio outside of this one allocation is more important today than ever so take heed, open your eyes and prosper.
http://www.amazon.com/Thrive-Obama-Economy-Stephen-Bick/dp/1490975128/ref=sr_1_1?s=books&ie=UTF8&qid=1379694723&sr=1-1&keywords=stephen+bick
Friday, September 13, 2013
The World Is Shrinking
"Globalism began as a vision of a world with free trade, shared prosperity and open borders. These are good, even noble things to aim for." - Deepak Chopra
While the global economy is still trying to recover from the Great Recession global trade is surging. In 2012 world goods exports surged to just over $16 trillion from $12.5 trillion in 2009. It is interesting that this surge in trade is coming on the back of weak global economic expansion but when you look at some of the reasons behind the growth it appears that this trend will continue unabated for the foreseeable future making the world seem to be shrinking.
Basic economic theory states that goods and services will migrate to a country that has a comparative advantage over other countries. Comparative advantage refers to a country's ability to produce goods or services at a lower opportunity cost than another country. This means that even if one country can produce all goods and services at a lower cost than every other country, there is still an opportunity to increase profits by focusing on the goods and services that reduce the overall opportunity cost. So let's assume country A can produce every good and service cheaper than everyone else. Country B however is able to produce certain goods that have a low opportunity cost in country A cheaper (in opportunity cost measures) than country A. Therefore country A stops producing that good and imports this from country B. There is a benefit to both countries in doing this as their overall profit increases.
So let's explore opportunity cost. This is the cost of doing something at the expense of not doing something else. Take for example work versus play. At any given time in the day you could walk out of your office and go for a surf. Now while you are surfing you are not making any money so the opportunity cost is relatively high. That said if you value your free time more than the amount of money you would make during that hour surf session then it would be wise to go surfing. Now to take this one step further it may be that there are no waves that day in which case you would stay at work as suddenly the opportunity cost is higher at work than surfing. So you can see that opportunity costs can vary over time depending on circumstances. This is why countries can have an opportunity cost in one product for a while and then lose it a few years later for the simple reason that international trade shifts all the time.
Looking at how this landscape has changed over the years it is easy to see not only technology at work by also economies of scale. Technology is making it easier and easier to transact globally. It is relatively simple to wire money across borders, find a manufacturer in a foreign country and fly there and back for a small fee. Furthermore shipping costs are falling and with things like three dimensional printing a product can be designed on the fly, the specifications emailed across the globe in seconds and a week later the product is being shipped back to your home port.
Economies of scale are also helping drive the costs down and this too sets the stage for growth in international trade. Architects in London are used to design buildings in Australia and the main infrastructure of the building is made in Indonesia with parts shipped from China. These parts are then shipped from Indonesia to Australia where they are assembled much like Lego blocks with the finishing touches done by Australian artisans. The only way that this can be done in a cost effective manner is if each part of the equation is cheaper than doing it in the home country. Looking more carefully at this example the cost of the building is mainly made up of parts and labor. Parts are far cheaper in China and labor costs only $7 a day in Indonesia. So all that is left is to make sure that the shipping costs do not blow the budget.
To this end Maersk is building 20 Triple-E container ships. These behemoths are as long as the Empire State building and can house 18,000 containers, enough to ship 182 million i-Pads in one go. The ship itself weighs 55,000 tons. One link in the anchor chain weighs 500 pounds. If you stacked the containers end to end they would stretch over 68 miles. Fuel one way from Rotterdam to Shanghai costs around $2.5 million. The bet of course is on the continued growth of global trade but as amazing at is first appears it also is driving down the cost shipping. The reason of course is the economies of scale. Back in 1956 to ship one ton of freight across the Atlantic was $5.83. Using container ships drove this down to 15.8 cents per ton. Using the Triple - E will drive these costs even lower and that is the benefit of economies of scale.
Interestingly the boat is being built in South Korea with parts shipped in from around the globe and assembled on the docks. It is clear that with the continued advances in technology combined with economies of scale and comparative advantage, global trade will continue to flourish. This should be seen as a positive as it will draw the global closer together and should foster better relations between countries. The one fly in the ointment would be war and while one can never count this out unless Syria sparks an international divide, for the foreseeable future global trade should continue to flourish.
While the global economy is still trying to recover from the Great Recession global trade is surging. In 2012 world goods exports surged to just over $16 trillion from $12.5 trillion in 2009. It is interesting that this surge in trade is coming on the back of weak global economic expansion but when you look at some of the reasons behind the growth it appears that this trend will continue unabated for the foreseeable future making the world seem to be shrinking.
Basic economic theory states that goods and services will migrate to a country that has a comparative advantage over other countries. Comparative advantage refers to a country's ability to produce goods or services at a lower opportunity cost than another country. This means that even if one country can produce all goods and services at a lower cost than every other country, there is still an opportunity to increase profits by focusing on the goods and services that reduce the overall opportunity cost. So let's assume country A can produce every good and service cheaper than everyone else. Country B however is able to produce certain goods that have a low opportunity cost in country A cheaper (in opportunity cost measures) than country A. Therefore country A stops producing that good and imports this from country B. There is a benefit to both countries in doing this as their overall profit increases.
So let's explore opportunity cost. This is the cost of doing something at the expense of not doing something else. Take for example work versus play. At any given time in the day you could walk out of your office and go for a surf. Now while you are surfing you are not making any money so the opportunity cost is relatively high. That said if you value your free time more than the amount of money you would make during that hour surf session then it would be wise to go surfing. Now to take this one step further it may be that there are no waves that day in which case you would stay at work as suddenly the opportunity cost is higher at work than surfing. So you can see that opportunity costs can vary over time depending on circumstances. This is why countries can have an opportunity cost in one product for a while and then lose it a few years later for the simple reason that international trade shifts all the time.
Looking at how this landscape has changed over the years it is easy to see not only technology at work by also economies of scale. Technology is making it easier and easier to transact globally. It is relatively simple to wire money across borders, find a manufacturer in a foreign country and fly there and back for a small fee. Furthermore shipping costs are falling and with things like three dimensional printing a product can be designed on the fly, the specifications emailed across the globe in seconds and a week later the product is being shipped back to your home port.
Economies of scale are also helping drive the costs down and this too sets the stage for growth in international trade. Architects in London are used to design buildings in Australia and the main infrastructure of the building is made in Indonesia with parts shipped from China. These parts are then shipped from Indonesia to Australia where they are assembled much like Lego blocks with the finishing touches done by Australian artisans. The only way that this can be done in a cost effective manner is if each part of the equation is cheaper than doing it in the home country. Looking more carefully at this example the cost of the building is mainly made up of parts and labor. Parts are far cheaper in China and labor costs only $7 a day in Indonesia. So all that is left is to make sure that the shipping costs do not blow the budget.
To this end Maersk is building 20 Triple-E container ships. These behemoths are as long as the Empire State building and can house 18,000 containers, enough to ship 182 million i-Pads in one go. The ship itself weighs 55,000 tons. One link in the anchor chain weighs 500 pounds. If you stacked the containers end to end they would stretch over 68 miles. Fuel one way from Rotterdam to Shanghai costs around $2.5 million. The bet of course is on the continued growth of global trade but as amazing at is first appears it also is driving down the cost shipping. The reason of course is the economies of scale. Back in 1956 to ship one ton of freight across the Atlantic was $5.83. Using container ships drove this down to 15.8 cents per ton. Using the Triple - E will drive these costs even lower and that is the benefit of economies of scale.
Interestingly the boat is being built in South Korea with parts shipped in from around the globe and assembled on the docks. It is clear that with the continued advances in technology combined with economies of scale and comparative advantage, global trade will continue to flourish. This should be seen as a positive as it will draw the global closer together and should foster better relations between countries. The one fly in the ointment would be war and while one can never count this out unless Syria sparks an international divide, for the foreseeable future global trade should continue to flourish.
Friday, September 6, 2013
An Economic Recovery?
"People are realizing that they cannot make it in the current Wall Street dominated corporate capitalist economy. It is not designed for most people to make it. Rather it is designed for a small percentage to profit while everyone else is exploited and economically insecure." - Kevin Zeeze and Margaret Flowers
This week there were some signs of an economic recovery. There were some impressive numbers from the service sector with the US ISM non-manufacturing index jumping in August to a seven-year high of 58.6. This points potentially to an improvement in GDP growth in the third quarter. Looking deeper into the number it appears that most of the demand came from internal orders and not exports so there is hope that the local economy may be on more solid ground than previously thought. The payroll report today was not great as it appears that the level of growth in payrolls is slowing however there is still growth which is mildly encouraging.
On the European front it appears that certain of the economies are starting to recover and unemployment while still high seems to have stabilized. So with both of these economies appearing to be in recovery mode it must now be time for the Federal Reserve to exit the market, right? The issue is that as I have mentioned repeatedly, the recovery is very tentative and any sign that the safety net that is the Federal Reserve will be removed will have dire consequences on the stock and bond markets. The question is will a spike in bond yields combined with a sudden drop in the stock market unnerve the Federal Reserve and send them back to the printing presses? My guess is that it will as it has in the past and therefore there is no reason to believe that this time will be any different.
Beneath the surface of this recovery is a very tepid technology sector, weak growth in the small business market, slow growth in employment and increased expenditure coming in the form of Obamacare. Furthermore stock prices are exceptionally elevated and have baked in a far more robust recovery. Removing the stimulus will take away the fuel and the fire will die. As an example of stocks at ridiculous levels take a look at the stock of the year Tesla. Now I have seen their cars and have been told they are fantastic to drive but the stock is trading at a market capitalization of over $21 billion on earnings of negative $112 million. Sure they did report a profit this last quarter but please, the headwinds against this company are still enormous and to command such a lofty market capitalization you need to be selling cars into the mass market and not just to the rich and famous in California. At the current vehicle sticker price that is not an option.
So it will be very interesting to see at the FOMC meeting later this month whether the Federal Reserve will consider trying to taper again and how the market reacts this time. Based on previous meetings it is clear that even the Federal Reserve knows that it needs to exit this printing game but the question is how as they have shown that they have no stomach for a stock market crash. Furthermore if yields on the 10-year bond rise much higher any form of recovery in the housing market will be put to rest right as they are deciding to exit the government owned mortgage finance companies, Fannie Mae and Freddie Mac. It seems that once again the officials have timed the exit from the housing market to perfection!
This week there were some signs of an economic recovery. There were some impressive numbers from the service sector with the US ISM non-manufacturing index jumping in August to a seven-year high of 58.6. This points potentially to an improvement in GDP growth in the third quarter. Looking deeper into the number it appears that most of the demand came from internal orders and not exports so there is hope that the local economy may be on more solid ground than previously thought. The payroll report today was not great as it appears that the level of growth in payrolls is slowing however there is still growth which is mildly encouraging.
On the European front it appears that certain of the economies are starting to recover and unemployment while still high seems to have stabilized. So with both of these economies appearing to be in recovery mode it must now be time for the Federal Reserve to exit the market, right? The issue is that as I have mentioned repeatedly, the recovery is very tentative and any sign that the safety net that is the Federal Reserve will be removed will have dire consequences on the stock and bond markets. The question is will a spike in bond yields combined with a sudden drop in the stock market unnerve the Federal Reserve and send them back to the printing presses? My guess is that it will as it has in the past and therefore there is no reason to believe that this time will be any different.
Beneath the surface of this recovery is a very tepid technology sector, weak growth in the small business market, slow growth in employment and increased expenditure coming in the form of Obamacare. Furthermore stock prices are exceptionally elevated and have baked in a far more robust recovery. Removing the stimulus will take away the fuel and the fire will die. As an example of stocks at ridiculous levels take a look at the stock of the year Tesla. Now I have seen their cars and have been told they are fantastic to drive but the stock is trading at a market capitalization of over $21 billion on earnings of negative $112 million. Sure they did report a profit this last quarter but please, the headwinds against this company are still enormous and to command such a lofty market capitalization you need to be selling cars into the mass market and not just to the rich and famous in California. At the current vehicle sticker price that is not an option.
So it will be very interesting to see at the FOMC meeting later this month whether the Federal Reserve will consider trying to taper again and how the market reacts this time. Based on previous meetings it is clear that even the Federal Reserve knows that it needs to exit this printing game but the question is how as they have shown that they have no stomach for a stock market crash. Furthermore if yields on the 10-year bond rise much higher any form of recovery in the housing market will be put to rest right as they are deciding to exit the government owned mortgage finance companies, Fannie Mae and Freddie Mac. It seems that once again the officials have timed the exit from the housing market to perfection!
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