Fixing Global Finance by Martin Wolf

Martin Wolf is an associate editor and economics commentator for the Financial Times and a professor at the University of Nottingham. Fixing Global Finance began as a series of lectures delivered in 2006 at the Paul H. Nitze School of Advanced International Studies. It was published in 2008 but I think the majority of it was written when the stock market was at its 2007 peak. The ideas aren't new -- all of the important points can be found in Ben Bernanke's speeches and writings since 2005 -- but there's a lot of illuminating data and it's an interesting read. What follows is more of a summary than a review.

The subjects of Mr. Wolf's book are the global financial imbalances. America's $800 billion Current Account deficit and emerging economies' giant surpluses are not accidental. They are the result of export-led growth strategies in the developing world and currency market interventions. That America has been on the receiving end of these policies is due to its position as the global borrower of last resort.

The housing market collapse in the United States and the global recession are the results of these global financial imbalances. Martin Wolf has published this book at an appropriate time because some people still seem confused by what happened. President da Silva of Brazil recently blamed "white people with blue eyes" for the global crunch, and China has been pointing its finger at the US. The Chinese explanation is that greedy, stupid Americans who forgot how to save money are consuming all of the world's wealth by buying mansions and BMWs. The US is jeopardizing global stability, and 50 of its investment bankers ruined the world's economy (the only problem with blaming US consumption is that if it was "crowding out" foreign savings, we should see high real interest rates abroad. In fact we see very low real interest rates globally -- China is "crowding in" US consumption, not the other way around).

But those things were not the causes of the housing market collapse and they didn't ruin the global economy. Instead, it was the developing nations' Current Account surpluses that caused the collapse.

Think about this logically. I know that stories about liar loans are easy to understand and make sense, but picture this from China's point of view. China, as we all know, is the fastest growing country in the world. Why would China be sending its money to the US? Is the US a better investment opportunity than China? Of course not. When a nation has the investment opportunities that China has, it should be importing capital as fast as it can to grow. This isn't happening. Something is definitely wrong.

I'm not singling China out of the group; China's case can help us understand what's been going on. China has been running increasingly massive Current Account surpluses since the late 1990s. The world loves tainted milk and poisonous toys, so China exports them in bulk. Normally, when one nation runs such a large surplus, foreign investors buy the local currency and drive up the exchange rate. This makes the local goods less competitive and the surplus shrinks. The developing world has been preventing this from happening. China, Japan, developing Asia, oil-exporting nations, and the C.I.S. countries have been intervening in currency markets to keep their currencies low relative to the Dollar (this is the currency manipulation that politicians on Capitol Hill are constantly bitching about -- although they seem to single out China, who is only part of the problem). So, a manufacturer in China makes a wonderful piece of crap like these glasses, and ships it to Los Angeles County. Someone from Wal-Mart pays for it, and it winds up on a shelf in Framingham, Massachusetts. The Chinese manufacturer takes those Dollars (the Yuan is not an international currency -- this will change) back to China, where the People's Bank buys them from the manufacturer for Yuan (Chinese citizens are not allowed to own foreign assets anyway). The bank then sits on massive foreign currency reserves, and buys more Dollars on the open market to offset foreign investment in China. The Yuan stays weak, Chinese exports stay competitive, and occasionally the People's Bank needs to stockpile more Dollars to keep the Yuan down. Evidence that this is happening is easy to find. Since 2002 the Dollar has been losing value against almost all major currencies. Those nations with currencies that have not appreciated against the Dollar, and have simultaneously run up major foreign currency reserves, are the culprits. Like I said before, these guys are China, Japan, developing Asia, oil-exporting nations, and the C.I.S. countries. The oil-exporting nations were running surpluses thanks to high oil prices, but they're falling now.

How does this affect the US? This is the "global savings glut" that we keep hearing about. An artificially strong US Dollar hurts domestic manufacturing (we had the lowest Current Account deficit in the 4th Quarter of 2008 since 2003 thanks to a falling Dollar). This would result in high unemployment, but the Federal Reserve under President Bush pursued an expansionary monetary policy (interest rates fell to 1%) to create excess demand. This is what is meant by calling the US the "borrower of last resort." This excess demand consumes the surplus coming from Asia. If the Federal Reserve hadn't pursued this policy, it would have stalled the manufacturing sector in Asia and reduced the surpluses. We weren't being malevolent -- it would have also caused higher unemployment in the US. This policy of inflating consumer demand helped create the housing bubble and shrank our savings rate (does anyone want to keep their money in a Bank of America savings account paying 0.20% interest?). I emailed the author of the book, Martin Wolf, and he told me as much. The policies in the developing world are directly related to the housing market bubble in this country.

So what do we do? Well, the worst has already happened. A massive global recession is what intelligent policies may have been able to avoid. But what do we do going forward? If we are to sustain Asia's levels of production, demand there must be primed. It is unlikely that investment can go much higher (it is currently 40%, where investment in the US is 20% of GDP) so domestic consumption and government spending must make up the difference. If China had social safety nets and allowed its citizens to invest abroad, maybe as a nation it wouldn't save 59% of its GDP every year. In his book, Martin Wolf questions whether we need such a liberalized financial system in the first place. Everyone assumes that money should move around the world like free trade, but they're not the same and maybe shouldn't be treated as such.

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My Foray into Investing

While still in Las Vegas I decided to put my Economics degree to work and bought some stock. The economy was in a downward spiral and Lehman Brothers was collapsing, so I sensed an opportunity. I bought $500 worth of Freddie Mac, Tata Motors, MGM Mirage, and Bank of America between October 1st and 20th (total investment - $2,000). Then the market crashed further so I bought another $500 worth of Ford Motor Co. and U.S. Steel in November (bringing total money invested to $3,000). I plotted my portfolio's progress against the Dow Jones Industrial Average and included it below (I'm in blue and .DJI is in red). So what have I learned?


A lot actually. First, I bought in waaay too early. My short-term losses are massive. I'm still down 80% on my MGM purchase. The car companies were good buys. Tata is up more than 20% from where I bought in and I'm up 60% on Ford. My whole portfolio is down about 25% as of March 26th, but up from its lows of -53%.

I learned a lot about so-called investment professionals as well. Since moving to Boston I've become a loyal viewer of Mad Money starring the much maligned Jim Cramer. Cramer wrote a book in 2008 (right before the massive stock market losses) and in it he recommended 20 stocks for the next 18 month period. I created a value-weighted portfolio in Google Finance to track Jim Cramer's picks against my own. I gave him a break and decided not to track his picks from when he made them but from when I decided to buy in October. So what does a fully diversified portfolio chosen by a professional have over me? Nothing. I'm down 26.67% as of this morning and he's down 33.19%. I'm actually winning if you can call losing 26.67% of your money winning. Also -- on Jim Cramer's February 20th show, he recommended a 'recession portfolio' made up of a gold mine, Wal-Mart, Verizon and a few other things. I tracked this portfolio's progress against my own and since then, I'm up 41% and he's up only 1.5%. I think the purpose of that 'recession portfolio' was to prevent losses, not make money though, so maybe being up only 1.5% is what it's supposed to do.

Anyway, I'm confident my picks will pay off in the long-run, which is why I bought them when I did. If I had a job right now, I'd be plowing cash into the stock market as fast as I could. Unfortunately I am not employed, so I can't. Anyone in a better position than me will be rewarded for being brave. Just my opinion.

Technorati tags: Stock Market, Investing, Jim Cramer, BAC, FRE, Ford, Tata, MGM, US Steel

Rejection!

Anyone who has stumbled upon this blog while looking for porn knows that I applied to become a Foreign Service Officer. I registered to take the written exam in February of 2008 and I had my Oral Assessment -- the final step in the process -- this past weekend. I didn't get the job. My overall score was just under the 5.25 needed to pass.

For an awesome break down of the OA, see the March 5th entry on this guy's blog.

I am quite sure I know who passed the test and who did not. After all 12 of us had finished the group exercise, structured interview, and case management task, we assembled in a room for our test results. The first two names were called out in rapid succession and then the rest of us were called, one by one, afterward. It seems obvious that the first two guys got the job and the rest of us were told to scram. At the time, not everyone thought so. If I'm right, then two very qualified and smart guys got the job. A man in his 40s who and had spent the previous 8 years doing TB research in Africa got the nod, and so did a guy who flew in from Liberia for the interview. He did something there for the Carter center but now I forget what. I had a chance to speak with both of them during the day and was impressed.

Among those rejected: a woman in her 50s who worked at the Library of Congress, a girl getting her Masters from the Kennedy School, an annoying kid with acne who taught English in Japan, a woman who works for the US embassy in Kiev, and a very nice guy from Nigeria (now a US citizen). There were also 4 young women who were unexceptional and interchangeable as far as I could tell.

I allegedly signed a non-disclosure agreement, so I can't talk about the specifics of the interview. However, I can tell you about two bonehead things that I said. When asked how I would handle being offered a local dish that would almost certainly give me parasites, I said "grin and bear it." I later qualified that statement, but I think the damage had already been done. I also said that I butt into my coworkers' business too much when asked to give a weakness. That's not a good answer but what makes it hilarious is that it's the opposite of who I am. I am much more likely to not notice what you're doing than to get too involved. Why did I say that?

In the end, I'm fine with the State Department's decision. Being rejected always sucks, but I wasn't looking forward to asking Daniela to live with me in some god forsaken place. Right now I think graduate school is the better option anyway.

Technorati tags: Foreign Service, OA, Oral Assessment, Washington DC

Bullish on MGM

From a high of $96 bucks a share, MGM Mirage is now trading at $2 and change. If I had the cash to spare, I'd buy a few hundred more shares. Now, I'm not an expert (far from it since I paid $15 for my shares when I could have had them now at $2) but I'm very bullish on MGM. I guess the problems that MGM is having right now stem from the $1.2 billion it still needs to complete its CityCenter project -- the largest "privately"-financed project ever -- along with a lack of debt financing for this year and next. MGM and Dubai World (Dubai World is a sovereign wealth fund and 50% stakeholder in CityCenter) were in talks with Deutsche Bank to get the rest of their CityCenter cash but walked away from the table yesterday. I think this is a good sign. Deutsche Bank wanted crap terms (to merge the CityCenter property with one it owns next door, the Cosmopolitan -- I'm not quite sure why this was so objectionable) and apparently MGM and Dubai World aren't desperate enough yet to agree to that. MGM has said that if the situation in Vegas doesn't improve this year, they're going to default on their debt, which unless I'm missing something, means bankruptcy. That makes the situation seem pretty dire, but if it is, how can they afford to walk away from a deal with Deutsche Bank? MGM can always shop some of its properties to raise cash (it sold TI last year so I guess there's still buyers out there) and I guess that's the next step. Although Bloomberg is reporting that MGM is in talks with other banks. I think it looks bad for MGM right now, but I have confidence they'll pull through it. And if I'm right, shares at $2 is a steal.

Genius Business Models

It's no secret that Daniela and I like pizzas from Domino's. We've ordered it about twice a month since I got back from Japan. It's always been cheap, it's delivered right to your door, and it's basically junk food. What's not to like? They had cheeseburger pizza for a while, they currently have a white garlic sauce option, and for $.50 extra, they send you a little tub of ranch dressing for your crust. Dipping your crust into Ranch dressing is big on the West Coast and Daniela put me onto it. It's awesome. I'm not here to sell you on Domino's pizza though, I want to cast some light on their genius business model. I'll call it the 'drug dealer' model.

Until recently, we've been able to find coupons online that knock off like $10 per order. The coupons vary by location and time of the year, but we liked a coupon in Vegas for two two-topping medium pizzas for $14.99. By trolling retailmenot.com, I can see that there was once a coupon for a large one-topping pizza, 1 bread side, and a 2 liter bottle of Coke for $12.99. Regardless of the time of the year, we were always able to find a coupon online that would just reduce what we were paying without changing what we wanted to order.Since relocating to Boston we've noticed all the awesome coupons are gone. Now the best thing online is a deal where you can get a one-topping medium pizza for $5.55 but you have to buy three of them. That's fine, but there's a huge difference between a one and a two-topping pizza, and what the hell do we need a third pizza for? To recreate our old orders of two two-topping medium pizzas, cheesy bread and a bottle of coke, we'd have to spend $29.18. That's not a lot of money, but as a percentage of the cost, it's a huge jump compared to what we were paying just a little while ago.

So here's the model: create a product made entirely out of cheese, grease, and meat because those things are as addictive as crack but not illegal. Then price it out at $20 a pop but give everyone a coupon that makes it only half that. After everyone gets addicted to your product, lose the coupons and jack the price back up. What makes that especially genius is that you're not even jacking the price up because the pizzas were always $20. They're just not heavily discounted now. If I can trust movies, then I know this is how crack is sold. Genius.