Yesterday word came that the last French veteran of World War I died at the age of 110. Less than a handful remain in the rest of the world, with only one in the US, 107-year old Frank Buckles of West Virginia. So, the last memory of the Great War is about to die out.
My point here is not to glorify it all, far from it. That war was a horror, if not as deadly as its successor, WW II. The literature inspired by it is one of horror and alienation: A Farewell to Arms, All Quiet on the Western Front, and even the more depressing war scenes from The Lord of the Rings (Tolkien served in the trenches of France then). My point is that we should fear that the consciousness of how horrible war is and has become should not fade, even as those who experience it die off.
Friday, March 14, 2008
HUH?
by the Sandwichman
"'The situation is very bad, the situation is getting worse, and the risks are that it could get very bad,' Feldstein said in a speech at the Futures Industry Association meeting in Boca Raton, Florida."
"'The situation is very bad, the situation is getting worse, and the risks are that it could get very bad,' Feldstein said in a speech at the Futures Industry Association meeting in Boca Raton, Florida."
New York Times Financial Columnist Explains Why Runs are Impossible
Says Steven Weisman in today’s NYT: “The fear of some economists is that, as the dollar declines, there could be a panic sell-off. But most experts doubt such a panic would occur, because it would be in nobody’s interest, least of all investors who are holding dollar-based investments.” Someone should tell him that it is never in the interest of investors or depositors for there to be a run on a currency or a bank. But it is in their individual interest to get out ahead of everyone else. This is not to say that there will be a run on the dollar, but you might want to find a better reason than the notion that bad things cannot happen in capitalism because capitalists don’t want them to happen.
bubblicious gold!
Awhile back, I asked what the next bubble would be. The answer from Harper's magazine (thanks, Louis!) was clean energy investments. That may be true (or may not -- since it hasn't happened yet). But it's possible that we'll see a bubble before that eventuality -- in gold. This might be financed by the Fed's expansionary monetary policies (the efforts to save the U.S. credit markets) while spurred by fears of inflation.
Assume that a gold bubble has started, i.e., that recent price upsurges do not just represent a short-term blip. If anyone wants to wants to buy and hold gold for long periods as a hedge against inflation, it's then too late, since prices are too high.
The exception to this outrageous assertion would be if the end of the "long period" is (by coincidence) either at the peak of the bubble or some time after the bubble pops when gold prices start rising again. (Gold prices should be measured in real terms, corrected for the ability of gold to buy actual goods & services, by the way. It's only when real gold prices rise that they're a successful investment.) As the bubble grows, the "too late" verdict will become more and more true.
On the other hand, if anyone wants to speculate by buying now (when prices are low compared to the future peak) and selling right before or at the peak price, that actually encourages the bubble, by increasing demand.
We can tell if a bubble is actually happening if we start hearing about how "gold is a perfect hedge" or "you can't lose by investing in gold" or "gold prices have nowhere to go but up." These kinds of statements reflect the hopes of the aforementioned speculators -- and their later efforts to ensure that their speculation pays off by driving up gold prices further.
Of course, it's a big gambling game. The gold-bugs who win at the peak (buying low and then selling high) have to find others who are willing to buy at the high price. (These are called the "greater fools.") Note that the winners' loot corresponds to the losses of those left holding the bag: as the bubble pops, the sellers drive prices down, imposing capital losses on the late buyers.
(In addition, the "house" wins to the extent that there are brokerage fees in the gold market.)
Of course, gold pays no interest or dividends. That makes the popping worse, since the only way to win in a bubble is to grab for all the capital gains one can.
J.M. Keynes's "betting on a beauty contest" theory of bubbles doesn't add anything to this discussion (because, unlike corporate stocks & bonds, gold is a well-known asset). But his "snap" analogy does say something. It's more familiar to U.S. residents as the "musical chairs" analogy.
As people begin to think that the bubble is reaching its peak size, their fear that the music will stop heightens. However, because everyone wants to avoid sitting down until a second before the music stops, they hold on to their gold. Then, for some reason -- the scary sight of an advertisment for beer projected on the Moon? -- some people start sitting down. This causes a panicked rush to the chairs. In other words, everyone tries to sell, driving gold prices down steeply.
Jim Devine
Assume that a gold bubble has started, i.e., that recent price upsurges do not just represent a short-term blip. If anyone wants to wants to buy and hold gold for long periods as a hedge against inflation, it's then too late, since prices are too high.
The exception to this outrageous assertion would be if the end of the "long period" is (by coincidence) either at the peak of the bubble or some time after the bubble pops when gold prices start rising again. (Gold prices should be measured in real terms, corrected for the ability of gold to buy actual goods & services, by the way. It's only when real gold prices rise that they're a successful investment.) As the bubble grows, the "too late" verdict will become more and more true.
On the other hand, if anyone wants to speculate by buying now (when prices are low compared to the future peak) and selling right before or at the peak price, that actually encourages the bubble, by increasing demand.
We can tell if a bubble is actually happening if we start hearing about how "gold is a perfect hedge" or "you can't lose by investing in gold" or "gold prices have nowhere to go but up." These kinds of statements reflect the hopes of the aforementioned speculators -- and their later efforts to ensure that their speculation pays off by driving up gold prices further.
Of course, it's a big gambling game. The gold-bugs who win at the peak (buying low and then selling high) have to find others who are willing to buy at the high price. (These are called the "greater fools.") Note that the winners' loot corresponds to the losses of those left holding the bag: as the bubble pops, the sellers drive prices down, imposing capital losses on the late buyers.
(In addition, the "house" wins to the extent that there are brokerage fees in the gold market.)
Of course, gold pays no interest or dividends. That makes the popping worse, since the only way to win in a bubble is to grab for all the capital gains one can.
J.M. Keynes's "betting on a beauty contest" theory of bubbles doesn't add anything to this discussion (because, unlike corporate stocks & bonds, gold is a well-known asset). But his "snap" analogy does say something. It's more familiar to U.S. residents as the "musical chairs" analogy.
As people begin to think that the bubble is reaching its peak size, their fear that the music will stop heightens. However, because everyone wants to avoid sitting down until a second before the music stops, they hold on to their gold. Then, for some reason -- the scary sight of an advertisment for beer projected on the Moon? -- some people start sitting down. This causes a panicked rush to the chairs. In other words, everyone tries to sell, driving gold prices down steeply.
Jim Devine
Where's my Dutch pump when I need it?
I learn from NPR this am that a penny contains 1.7 cents worth of copper. I'm stoking up the furnace as I write!
On an unrelated topic, I'm waiting to see if Krugman is playing by Obama rules. Several times in past columns he has raked Obama over the proverbial coals for using Republican-sounding talking points in criticizing Clinton's health-care proposals and in calling for a fix for social security. Of course, Obama has never implied that any Republican candidate had a health-care plan that was preferable to Clinton's. Clinton, on the other hand, has said that she and McCain (and presumably Sinbad and Cheryl Crowe) have, while Obama has not, crossed the "commander-in-chief threshold." This is really inexcusable. Don't you think, Paul?
On an unrelated topic, I'm waiting to see if Krugman is playing by Obama rules. Several times in past columns he has raked Obama over the proverbial coals for using Republican-sounding talking points in criticizing Clinton's health-care proposals and in calling for a fix for social security. Of course, Obama has never implied that any Republican candidate had a health-care plan that was preferable to Clinton's. Clinton, on the other hand, has said that she and McCain (and presumably Sinbad and Cheryl Crowe) have, while Obama has not, crossed the "commander-in-chief threshold." This is really inexcusable. Don't you think, Paul?
Thursday, March 13, 2008
An Epidemic of Administrators
The increasing bureaucratization of education has now reached the tipping point where faculty represent less than half the full-time professional staff at Title IV institutions. I have not seen any data to be able to project when more than half of faculty time will be devoted to unproductive administrative duties, but what I noticed here is that that point will not be too far off in the future.
U.S. Department of Education. 2008. Employees in Postsecondary Institutions, Fall 2006, and Salaries of Full-Time Instructional Faculty, 2006-07, NCES 2008-172 (Institute of Education Sciences National Center for Education Statistics).
http://nces.ed.gov/pubs2008/2008172.pdf
Wednesday, March 12, 2008
That Talented Mr. Dorman
In the age of Google, our main competition is with ourselves, or, more precisely, with those who share the same name. In that context, I find myself several rungs below the esteemed Peter Dorman, professor of things ancient and Egyptian at the University of Chicago. Now his fame is destined to spread further, as he accepts the presidency of the American University in Beirut. From what I can see from afar, AUB’s star will also rise from its association with this highly accomplished archaeologist. My hat (the one in the photo) is tipped to both of them.
The Other Risk
All eyes are currently on US financial markets, where the Fed has offered to sink half its portfolio into mortgaged-based securities. And it is true that there is a risk that the spreading credit crunch could cause great economic trauma. But don’t forget about the dollar. It is now trading at over 1.55 to the Euro after another sharp bump, and no one thinks it has touched bottom. There is a second path to chaos: a potential run on the dollar. The two risks are related — the crunch could trigger a run — but not the same.
Update: Make that 1.56 to the Euro....and counting.
The nice thing about the Fed exchanging treasuries for MBS is that it is not expansionary monetary policy and need not be seen as inflationary. The not so nice thing is that $400B, the amount said to be in play, is tiny compared to the $10T or so in anticipated losses stemming from the collapse of the housing bubble. If fiddling with its portfolio is not enough and Plan B is for the Fed to flood the markets with money, expectations of inflation could be reignited, with further risks to the dollar.
So there are two abysses facing the US economy and not much policy space between them.
Update: Make that 1.56 to the Euro....and counting.
The nice thing about the Fed exchanging treasuries for MBS is that it is not expansionary monetary policy and need not be seen as inflationary. The not so nice thing is that $400B, the amount said to be in play, is tiny compared to the $10T or so in anticipated losses stemming from the collapse of the housing bubble. If fiddling with its portfolio is not enough and Plan B is for the Fed to flood the markets with money, expectations of inflation could be reignited, with further risks to the dollar.
So there are two abysses facing the US economy and not much policy space between them.
Tuesday, March 11, 2008
A Functionalist Theory of Bubbles
I’ve been reading Eric Janszen’s interesting piece in last month’s Harper’s, “The next Bubble: Priming the Markets for Tomorrow's Big Crash.” He compares the dot.com and housing bubbles as part of a general theory of why the US economy is so bubble-prone. Reading it is like sitting next to a caustically witty financial analyst at a bar; he’s had one too many and is shredding his life’s work, and for you it’s prime entertainment.
So what’s his theory? In a nutshell, he says that the US is now in the hands of its FIRE brigade — finance, insurance and real estate. They own the politicians and control economic policy. Bubbles are their stock in trade. These guys get rich and leave the rest of us with the tab. To save our economy from certain ruin in the wake of one bubble, we have to pump up the next one. This is how the housing bubble inflated after tech bubble popped. And where do we turn after housing goes bust? Janszen predicts alternative energy (including nuclear) as the new new new thing.
I like anyone who builds a worldview around bubblesome finance. Nevertheless, putting on my skeptical academic hat, I think he has slipped into the dangerous waters of functionalism, believing that social or economic events happen because they are needed to happen. There is a longstanding critique of such reasoning, but I’ll spare you. The point is that functionalist explanations don’t really explain. For instance, Janszen’s article doesn’t explain why some economies are more bubble-prone than others, nor does it offer a reason why efforts of insiders to inflate a new sector will necessarily succeed.
As my loyal legions know, I think there is a structural factor behind US asset price inflations during the last 15 years or so, capital account recycling. I’m hoping to get a few hours in the coming weeks to put this into its proper algebraic form. This is how we become convincing in my business. As Groucho almost said, “Who are you going to believe, my model or your own eyes?”
Speaking of quotes, I like this one by Janszen: “Since the early 1980s, the free-market orthodoxy of the Chicago School has driven policy on the upward slope of an economic boom, but we’re all Keynesians on the way down: rate cuts by the Federal Reserve, tax cuts by Congress, deficit spending, and dollar depreciation are deployed in heroic proportions.” Amen brother.
So what’s his theory? In a nutshell, he says that the US is now in the hands of its FIRE brigade — finance, insurance and real estate. They own the politicians and control economic policy. Bubbles are their stock in trade. These guys get rich and leave the rest of us with the tab. To save our economy from certain ruin in the wake of one bubble, we have to pump up the next one. This is how the housing bubble inflated after tech bubble popped. And where do we turn after housing goes bust? Janszen predicts alternative energy (including nuclear) as the new new new thing.
I like anyone who builds a worldview around bubblesome finance. Nevertheless, putting on my skeptical academic hat, I think he has slipped into the dangerous waters of functionalism, believing that social or economic events happen because they are needed to happen. There is a longstanding critique of such reasoning, but I’ll spare you. The point is that functionalist explanations don’t really explain. For instance, Janszen’s article doesn’t explain why some economies are more bubble-prone than others, nor does it offer a reason why efforts of insiders to inflate a new sector will necessarily succeed.
As my loyal legions know, I think there is a structural factor behind US asset price inflations during the last 15 years or so, capital account recycling. I’m hoping to get a few hours in the coming weeks to put this into its proper algebraic form. This is how we become convincing in my business. As Groucho almost said, “Who are you going to believe, my model or your own eyes?”
Speaking of quotes, I like this one by Janszen: “Since the early 1980s, the free-market orthodoxy of the Chicago School has driven policy on the upward slope of an economic boom, but we’re all Keynesians on the way down: rate cuts by the Federal Reserve, tax cuts by Congress, deficit spending, and dollar depreciation are deployed in heroic proportions.” Amen brother.
Monday, March 10, 2008
The Ultimate Bailout, Round 2
Round 1 has seen the world’s central banks picking up the slack from private investors and keeping the dollar afloat in the face unrelenting US current account deficits. Now we are hearing the first murmurs of Round 2, a coordinated move by some or all these same players to backstop crumbling US credit markets.
In very broad outlines, here is how Round 1 looks: Over the course the 1990s the US began to run increasingly large current account deficits, which then further swelled during the Bush years, peaking at nearly 7% of GDP in 2006 before falling back a percent or so.
Financing the deficit was not difficult during the go-go years of the ‘90s bull market, as private investment poured in from around the world. In the wake of the dot.com collapse of 2000-01, however, it became increasingly difficult to recycle dollars through private channels. Central banks, and to a lesser extent sovereign wealth funds, stepped forward to do the job. These entities now finance essentially the entire payments gap, largely by using their dollar accumulations to purchase US treasury bills. Acquisition of other assets, as when China tries to acquire an oil company or Dubai goes in for a money center bank, attracts headlines but as yet account for a small fraction of this recycling.
The willingness of these public entities (it may be a stretch to call funds under the control of Gulf monarchies “public”, but economic language is not especially nuanced) to hold dollar assets prevents the dollar from falling even faster, and more broadly, than it has and serves to keep US interest rates far lower than they would be otherwise. The growth in foreign dollar reserves alone last year was approximately $900B, in excess of the entire US financing requirement. It would be going too far to claim that this extraordinary level of support is motivated by a desire to sustain the US economy; certainly other interests are at play, but the effect has been to enable US consumption to exceed production by a substantial margin, year after year. Given the scale of the enterprise, you might call this not a bailout but an international payments sump pump.
Now we face a new crisis: because of large developing writedowns in the housing market and the opacity of investment instruments that bundled low-value mortgages in ostensibly high-value securities, a credit crunch is enveloping US markets. Banks and equity funds, desperate to safeguard what remains of their capital base, are pulling out of markets for a variety of loans: for business investment, for certain forms of municipal investment finance, for college students borrowing to pay tuition. This credit retrenchment, according to Larry Summers, constitutes “the most serious....economic and financial stresses that the US has faced in at least a generation, and possibly much longer.” (Thanks to Brad Setser for this.)
The Federal Reserve has created a term auction facility (TAF) which will extend up to $200B to banks, while accepting mortgage-backed securities as collateral. Effectively, this represents an infusion of $200B in demand for the most troubled assets. Dean Baker thinks this simply socializes the losses of the rich after years in which their profits were hoarded by an elite few. Even so, the biggest fear has been that the Fed intervention will prove to be too small relative to the size of the markets to make a difference. This is precisely Paul Krugman’s point, seconded by Setser. So does this mean that there is no defense against a financial meltdown?
Think again about where the financial clout now lies. After years of accumulating treasuries, foreign central banks now have a far larger stash of securities than the Fed. (The Fed’s holdings of treasuries stand at about $800B, less than a year’s accumulation abroad.) The Fed can play with its portfolio, selling some treasuries and effectively buying mortgages, but between them the dollar-soaked central banks of China, Japan, the Gulf states, Brazil et al. have an even larger portfolio to deal from. Hence the potential for these entities to step into the market and buy assets at risk.
Will this be Round 2? If it is true that the Fed is no longer big enough for the job, it’s hard to see an alternative. The US, even in financial tatters, is too big to fail, and it is not difficult to imagine that rescue discussions are already under way. It’s not a sure thing, but a coordinated global move could restore enough demand to keep mortgage and other bubbly assets afloat yet a few more quarters or even years into the future. This would buy more time for the adjustments needed to address the true underlying problem, massive ongoing US current account deficits. I could even imagine a quid pro quo in which support for US markets is tied to a set of policies to rebalance the US position, although it would not likely take a public or transparent form. (Whether those policies would actually do the job is another matter, of course.)
We are in highly speculative territory here, and I could be way off the mark. But maybe not, and if the second phase of the global bailout begins to take form in the next few weeks, tell everyone you heard it here first.
In very broad outlines, here is how Round 1 looks: Over the course the 1990s the US began to run increasingly large current account deficits, which then further swelled during the Bush years, peaking at nearly 7% of GDP in 2006 before falling back a percent or so.
Financing the deficit was not difficult during the go-go years of the ‘90s bull market, as private investment poured in from around the world. In the wake of the dot.com collapse of 2000-01, however, it became increasingly difficult to recycle dollars through private channels. Central banks, and to a lesser extent sovereign wealth funds, stepped forward to do the job. These entities now finance essentially the entire payments gap, largely by using their dollar accumulations to purchase US treasury bills. Acquisition of other assets, as when China tries to acquire an oil company or Dubai goes in for a money center bank, attracts headlines but as yet account for a small fraction of this recycling.
The willingness of these public entities (it may be a stretch to call funds under the control of Gulf monarchies “public”, but economic language is not especially nuanced) to hold dollar assets prevents the dollar from falling even faster, and more broadly, than it has and serves to keep US interest rates far lower than they would be otherwise. The growth in foreign dollar reserves alone last year was approximately $900B, in excess of the entire US financing requirement. It would be going too far to claim that this extraordinary level of support is motivated by a desire to sustain the US economy; certainly other interests are at play, but the effect has been to enable US consumption to exceed production by a substantial margin, year after year. Given the scale of the enterprise, you might call this not a bailout but an international payments sump pump.
Now we face a new crisis: because of large developing writedowns in the housing market and the opacity of investment instruments that bundled low-value mortgages in ostensibly high-value securities, a credit crunch is enveloping US markets. Banks and equity funds, desperate to safeguard what remains of their capital base, are pulling out of markets for a variety of loans: for business investment, for certain forms of municipal investment finance, for college students borrowing to pay tuition. This credit retrenchment, according to Larry Summers, constitutes “the most serious....economic and financial stresses that the US has faced in at least a generation, and possibly much longer.” (Thanks to Brad Setser for this.)
The Federal Reserve has created a term auction facility (TAF) which will extend up to $200B to banks, while accepting mortgage-backed securities as collateral. Effectively, this represents an infusion of $200B in demand for the most troubled assets. Dean Baker thinks this simply socializes the losses of the rich after years in which their profits were hoarded by an elite few. Even so, the biggest fear has been that the Fed intervention will prove to be too small relative to the size of the markets to make a difference. This is precisely Paul Krugman’s point, seconded by Setser. So does this mean that there is no defense against a financial meltdown?
Think again about where the financial clout now lies. After years of accumulating treasuries, foreign central banks now have a far larger stash of securities than the Fed. (The Fed’s holdings of treasuries stand at about $800B, less than a year’s accumulation abroad.) The Fed can play with its portfolio, selling some treasuries and effectively buying mortgages, but between them the dollar-soaked central banks of China, Japan, the Gulf states, Brazil et al. have an even larger portfolio to deal from. Hence the potential for these entities to step into the market and buy assets at risk.
Will this be Round 2? If it is true that the Fed is no longer big enough for the job, it’s hard to see an alternative. The US, even in financial tatters, is too big to fail, and it is not difficult to imagine that rescue discussions are already under way. It’s not a sure thing, but a coordinated global move could restore enough demand to keep mortgage and other bubbly assets afloat yet a few more quarters or even years into the future. This would buy more time for the adjustments needed to address the true underlying problem, massive ongoing US current account deficits. I could even imagine a quid pro quo in which support for US markets is tied to a set of policies to rebalance the US position, although it would not likely take a public or transparent form. (Whether those policies would actually do the job is another matter, of course.)
We are in highly speculative territory here, and I could be way off the mark. But maybe not, and if the second phase of the global bailout begins to take form in the next few weeks, tell everyone you heard it here first.
That Multi-Talented Ben Stein
Ben Stein, who writes a column on “economics” for the New York Times, also displays his credentials in “science” in the forthcoming film “Expelled”. Stein, we are told, interviews believers in “intelligent design” who say they have been denigrated by the scientific and educational establishment. We know that Stein has been the brunt of quite a bit of criticism, especially from Brad DeLong, but his grasp of economics is not inferior to his chops as an evolutionary biologist.
My favorite howler from this article was the following Stein quote: “there’s just a lot of people who don’t believe that big science and Darwinism should have a stranglehold on academic life....” Yes, big science is the problem. We need small, innovative start-up sciences that aren’t tied down by, you know, peer-reviewed journals and experimental protocols. Biology, geology, they’re just cruising on their legacy market share. With a good business plan and access to the right angels, a neo-biblical venture could be really competitive.
My favorite howler from this article was the following Stein quote: “there’s just a lot of people who don’t believe that big science and Darwinism should have a stranglehold on academic life....” Yes, big science is the problem. We need small, innovative start-up sciences that aren’t tied down by, you know, peer-reviewed journals and experimental protocols. Biology, geology, they’re just cruising on their legacy market share. With a good business plan and access to the right angels, a neo-biblical venture could be really competitive.
Pay Toilets Under Capitalism and Socialism
So, just back from a week in Italy I have yet again had the experience of having to pay to use toilet facilities in publicly owned entities in Europe, in this case, bus and train stations, where attendants sit at the entrance collecting the fees, but not obviously doing anything. This was also how it was in the old Soviet Union. However, toilets are universally free everywhere in the US, although I remember ones in hotels in the 1950s that one had to put coins in to get into the stalls (but not the urinals), meaning that I suppose there was gender discrimination back then (something to mention two days after International Womens' Day, celebrated big time in Italy).
So, anybody got any explanations for this curiosum?
So, anybody got any explanations for this curiosum?
Saturday, March 8, 2008
It’s Getting Worse on the Financial Front
No one has mentioned this grim report from yesterday’s New York Times, so allow me to bring it to your attention. It should be read from beginning to end to get a sense of the scale and scope of the disruption. It’s especially not a good sign that there is an uptick in the perceived risk of a U.S. government default.
For superb background reading, take a look at this paper by Greenlaw, Hatzius, Kashyap and Shin. It’s low tech; in fact much of it reads like a macro principles text of the future, after the flow of funds and balance sheet analysis will have been integrated into the core model. Some readers will note that the authors make a structural case for Minsky cycles, one that does not depend directly on psychological postulates. All of this, plus an informed (but probably conservative) estimate of the contribution the credit crunch (“deleveraging”) will make to an overall economic slowdown.
For superb background reading, take a look at this paper by Greenlaw, Hatzius, Kashyap and Shin. It’s low tech; in fact much of it reads like a macro principles text of the future, after the flow of funds and balance sheet analysis will have been integrated into the core model. Some readers will note that the authors make a structural case for Minsky cycles, one that does not depend directly on psychological postulates. All of this, plus an informed (but probably conservative) estimate of the contribution the credit crunch (“deleveraging”) will make to an overall economic slowdown.
Friday, March 7, 2008
How to Save Social Security
Do you remember when we could save Social Security by funding retirement in the stock market. Here is what the Wall Street Journal reports about the U.S. Pension Benefit Guaranty Corp.'s decision to invest in the stock market.
Silva, Lauren and Martin Hutchinson. 2008. "Pension Guarantor's Bad Bet." Wall Street Journal (21 February): p. C 14. http://online.wsj.com/article/SB120356297487082117.html?mod=todays_us_money_and_investing
"The U.S. Pension Benefit Guaranty Corp.'s decision to boost its investment in equities and alternative assets looks like poor risk management. The liabilities of this government guarantor of corporate pensions increase sharply in economic downturns, when companies file for bankruptcy and offload their under-funded pension plans onto it. So equities, which tend to fall in downturns, and alternative investments, which can become illiquid, may represent a doubling of risk for the pension agency, rather than a hedge. Pension Benefit Guaranty, established in 1974, has been funded primarily by corporate premiums. It had built up a surplus of $9.7 billion by 2000, but two factors caused it to run a deficit since 2002. First, several large bankruptcies, particularly in the airline sector, burdened it with large, unfunded pension liabilities. Second, bond yields dropped. That lowered the discount rate used to calculate the present value of its future pension obligations, meaning that from an accounting perspective, they increased rapidly."
"The agency's new investment plan -- to increase its allocation to equities to about 45% from about 25%, and allocating 10% to alternative investments -- also looks poorly timed. Making such a move after a lengthy bull market and a period of low interest rates and high speculative activity can lead to low returns, even over 20 or 30 years."
Silva, Lauren and Martin Hutchinson. 2008. "Pension Guarantor's Bad Bet." Wall Street Journal (21 February): p. C 14. http://online.wsj.com/article/SB120356297487082117.html?mod=todays_us_money_and_investing
"The U.S. Pension Benefit Guaranty Corp.'s decision to boost its investment in equities and alternative assets looks like poor risk management. The liabilities of this government guarantor of corporate pensions increase sharply in economic downturns, when companies file for bankruptcy and offload their under-funded pension plans onto it. So equities, which tend to fall in downturns, and alternative investments, which can become illiquid, may represent a doubling of risk for the pension agency, rather than a hedge. Pension Benefit Guaranty, established in 1974, has been funded primarily by corporate premiums. It had built up a surplus of $9.7 billion by 2000, but two factors caused it to run a deficit since 2002. First, several large bankruptcies, particularly in the airline sector, burdened it with large, unfunded pension liabilities. Second, bond yields dropped. That lowered the discount rate used to calculate the present value of its future pension obligations, meaning that from an accounting perspective, they increased rapidly."
"The agency's new investment plan -- to increase its allocation to equities to about 45% from about 25%, and allocating 10% to alternative investments -- also looks poorly timed. Making such a move after a lengthy bull market and a period of low interest rates and high speculative activity can lead to low returns, even over 20 or 30 years."
Thursday, March 6, 2008
The Downward Spiral of Manufacturing
This article says that a small shoe manufacturer failed because the exit of shoe manufacturers left the industry with too few suppliers for the plant to survive.
Supposedly, the most efficient businesses are supposed to survive, but that works only if there is adequate infrastructure.
Aeppel, Timothy. 2008. "U.S. Shoe Factory Finds Supplies Are Achilles' Heel." Wall Street Journal (2 March). http://online.wsj.com/article/SB120450124543206313.html
Howard Shaffer's factory for making high-end custom shoes, relied on computer imaging to fit customers from around the U.S. and Canada remotely, turning out shoes for $450 or more a pop.
"Having spent the previous decade setting up plants in China to manufacture shoes for big U.S. brands, he thought he knew how to revive the moribund U.S. footwear industry: use heavy automation run by a handful of skilled workers instead of relying on large numbers of low-paid Chinese laborers."
A trade magazine catering to the factory-automation industry pronounced him "Progressive Manufacturer of the Year" in 2005, picking tiny Otabo for an award that usually goes to a large multinational.
"But now, he is throwing in the towel on that venture, too. He closed his factory over the weekend, and is shifting the bulk of his operations to China."
"What killed his U.S. factory isn't just competition from Asia's cheap labor, he says. It is the lack of infrastructure needed to make a factory tick, a problem that has bedeviled the few remaining independent shoemakers in the U.S. Finding technicians to fly in on short notice to fix shoe machines was a constant and growing challenge, Mr. Shaffer says, because the number of U.S. companies that make and service machines has dwindled. The suppliers of shoelaces, leather, and other basic materials insisted that he buy in batches far larger than made sense for a small-scale producer."
"Consider what happened with his supplier of outsoles, which form the bottom part of the shoe. Mr. Shaffer initially found a domestic supplier to provide what he needed at a reasonable price. But a glitch developed about a year ago. One Otabo style required an outsole with two types of polyurethane sandwiched together -- a tough bottom layer that resists wear and a spongy inner layer that makes the shoes more comfortable. It is a more complex process, Mr. Shaffer says, "and so after three years of supplying us, they said they just can't do it that way anymore"."
"David Murphy, chief executive of closely held Red Wing Shoe Co. in Red Wing, Minn., an iconic American boot maker that has kept a large manufacturing operation in the U.S., says even a larger-scale company like his, with annual sales of more than $400 million, has to worry about the shoe industry's withering infrastructure."
"Almost 99% of the 2.4 billion shoes purchased in the U.S. every year are imported, 86% of them from China. The problem of obtaining components is especially acute when it comes to materials uniquely designed for shoes, as opposed to generic items such as cardboard boxes that are used by a wide array of manufacturers. This is one reason why Red Wing prepares its own shoe leather, says Mr. Murphy. Mr. Murphy notes he just got a call from a small custom shoe producer in northern Minnesota who often turns to Red Wing for supplies. "They were having trouble getting shoe laces," he says."
Supposedly, the most efficient businesses are supposed to survive, but that works only if there is adequate infrastructure.
Aeppel, Timothy. 2008. "U.S. Shoe Factory Finds Supplies Are Achilles' Heel." Wall Street Journal (2 March). http://online.wsj.com/article/SB120450124543206313.html
Howard Shaffer's factory for making high-end custom shoes, relied on computer imaging to fit customers from around the U.S. and Canada remotely, turning out shoes for $450 or more a pop.
"Having spent the previous decade setting up plants in China to manufacture shoes for big U.S. brands, he thought he knew how to revive the moribund U.S. footwear industry: use heavy automation run by a handful of skilled workers instead of relying on large numbers of low-paid Chinese laborers."
A trade magazine catering to the factory-automation industry pronounced him "Progressive Manufacturer of the Year" in 2005, picking tiny Otabo for an award that usually goes to a large multinational.
"But now, he is throwing in the towel on that venture, too. He closed his factory over the weekend, and is shifting the bulk of his operations to China."
"What killed his U.S. factory isn't just competition from Asia's cheap labor, he says. It is the lack of infrastructure needed to make a factory tick, a problem that has bedeviled the few remaining independent shoemakers in the U.S. Finding technicians to fly in on short notice to fix shoe machines was a constant and growing challenge, Mr. Shaffer says, because the number of U.S. companies that make and service machines has dwindled. The suppliers of shoelaces, leather, and other basic materials insisted that he buy in batches far larger than made sense for a small-scale producer."
"Consider what happened with his supplier of outsoles, which form the bottom part of the shoe. Mr. Shaffer initially found a domestic supplier to provide what he needed at a reasonable price. But a glitch developed about a year ago. One Otabo style required an outsole with two types of polyurethane sandwiched together -- a tough bottom layer that resists wear and a spongy inner layer that makes the shoes more comfortable. It is a more complex process, Mr. Shaffer says, "and so after three years of supplying us, they said they just can't do it that way anymore"."
"David Murphy, chief executive of closely held Red Wing Shoe Co. in Red Wing, Minn., an iconic American boot maker that has kept a large manufacturing operation in the U.S., says even a larger-scale company like his, with annual sales of more than $400 million, has to worry about the shoe industry's withering infrastructure."
"Almost 99% of the 2.4 billion shoes purchased in the U.S. every year are imported, 86% of them from China. The problem of obtaining components is especially acute when it comes to materials uniquely designed for shoes, as opposed to generic items such as cardboard boxes that are used by a wide array of manufacturers. This is one reason why Red Wing prepares its own shoe leather, says Mr. Murphy. Mr. Murphy notes he just got a call from a small custom shoe producer in northern Minnesota who often turns to Red Wing for supplies. "They were having trouble getting shoe laces," he says."
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