Category Archives: Random Hits

Random Hits: Chinese Economy as Winery, Understanding Europe, and “7:30am Nobodys” Ctd.

Consider the Chinese economy as a winery operation. The foot-stomped sludge of crush grapes represents investment, some combination of public, private and foreign capital. The tap that will eventually be shoved into the cask is the means of extracting the finished product, which for our purposes is analogous to sustainable economic growth. Like all metaphors, this is an over-simplification, but it does embody the time lag between investment and output as the fermenting period. (The biggest flaw clearly is the considerable output generated immediately by the investment – construction revenues and the spent wages of construction workers, etc, but stay with me for a second.)

No national economy operates frictionlessly at 100% efficiency. Any misallocation of capital, whether bad tax policy, inefficient social safety net spending, whatever, implies that some investment is wasted. There are, in other words, leaks in the wine barrel.

The issue for the China and industrial metal bulls at present is the state of integrity of the wine barrel. The bullish scenario for China is dependent on a resurgence of investment after a period of credit control designed to slow inflation. This period, however, also corresponds with further revelations regarding capital misallocation in the economy, most recently Shedlock’s piece today (“China’s Deserted Fake Disneyland”) outlining the severe declines in Chinese real estate prices. The world’s best blog, Financial Times Alphaville, has previously outlined the dependence of regional government finances on revenue from leasing land and while government finances remain extremely opaque, the large scale use of Special Purpose Vehicles to finance real estate transactions has been documented. Falling land prices are a major threat to the viability of these structures.

The Chinese government will undoubtedly end credit restrictions if growth falters and indeed, they are already doing so. The wisdom of investment in the China Story will depend on whether a renewed surge in credit, our crushed grapes flow, will merely leak out of the cask before it can be tapped.

Europe: The inner workings of the Eurocracy have been maddeningly unintelligible of late, most notably with its seeming ignorance of the market’s avowed belief that the ECB must provide massive liquidity before the crisis is over. The Washington Post’s Ezra Klein has, at least in my opinion, found the most believable framework for understanding political motivations. In Germany’s High Stakes Bet, Klein concludes that Germany is playing chicken with the EMU, using the crisis to bludgeon Southern Europe into conformance with the German model of fiscal prudence. When the Germans are satisfied, they will pave the way for “QE Europe” to repair government fiscal health and recapitalize the banks.   No other theory makes as much sense.

Clarification for “OWS and Why Anybody Not at Their desks at 7:30 is a Nobody”: I knew, writing that post, that it would generate some annoyance and was sorely tempted during the process to soften it up. But I didn’t and spent a good part of the day reading emails through my fingers in the same way I’d watch “Saw II”.  I am not one of those people who enjoys pissing people off or is likely to annoy readers for the sake of page hits.

In order to feel like there’s any point in blogging at all, it is important to choose topics that do not seem to be discussed elsewhere. Yesterday, unfortunately, this led me to a depiction of the worst kind of bigoted chest thumping behavior apparent in finance. But, given that I stand by the accuracy of the description, editorially I felt it was better and more interesting to tell the ugly truth than water things down into acceptable, less accurate platitudes to avoid offense.

This is not to say that if I re-wrote the piece I wouldn’t change anything.  The title was a bit, umm, blunt, but most of them are – it’s a big Internet and marketing is an ugly business. I certainly would have been clearer as to the targets of derision, because I have never heard it focused on professionals in most other fields. I should have specified that the feelings of superiority I described where more reserved for the professionally disaffected, the protestors who rotate from G20 meetings to any rally likely to be featured in the NY Times the next day.  I would also have mentioned the interesting fascination among financial professionals with people who “work with their hands”, a feeling consistently strong enough that it would surprise most outsiders. I attribute this to the lack of “tangibility” in finance that makes the thought of being a bricklayer, and building something visible and lasting, very attractive.  People who build their own businesses, regardless of scale, are also targets of admiration.

In the end however, the self-congratulatory arrogance of higher-end financial professionals is, in my experience, a general fact. It is also a fact that when the alarm goes off at 5:00am, motivating yourself to get up often involves in internal monologue featuring a myriad of half-truths about how important you are in the grand scheme of things, even if you know most of them are indefensible. A lot of the locker room-style humor on trading floors, really the primary source for the material from yesterday’s post, follows a similar pattern and it is not always clear the extent to which people actually believe it, or are just venting or trying to make someone else laugh. It is nonetheless there and at least you now know about it.

Random Hits: The debate, PSU and the danger of really good investment metaphors

I can’t seem to concentrate on anything specific this morning but given the market is alternating daily between “we’re doomed” and 3% rallies, I’m going to take this as an indication of my general sanity.  You may, however, disagree with this thesis after the following random list of thoughts that are competing for full attention.

The Debate: Rarely in human history has the collective gullibility of a populace been as sorely tested than by Herman Cain’s statement that “America wants leadership”.  I’m not even talking about the harassment allegations. This definition of leadership, apparently, involves a careful avoidance of rudimentary economic knowledge and ignorance of the established law stating that a sitting Fed Chairman can not be fired.  Poor Romney’s primary focus is dumbing down his answers so he doesn’t offend anybody by actually knowing anything, a process which strikes me as less than Lincoln-esque. The audience wants to be appeased, not led anywhere, and the same is true on the other side of the aisle. The odds of anyone becoming president by suggesting a path different, or further, than it already wants to go has to be at an all-time low.

Penn State: Not to beat a dead horse here, but the same psychological traits I discussed HERE as the basis for scapegoating by investors are evident, at least to me, in the all-around disgusting horror show in “Happy” Valley. If the allegations against former coach Jerry Sandusky are proven even mostly true, my initial emotional response will be the same as anyone else – I’d like to see him pulled apart by horses at the 50-yard line. The allegations (I am thinking specifically of some of the allegations being investigated by NESN, reported today) imply an absolute monster, so far beyond the boundaries of acceptable behavior, so inexplicable, that it can’t fit within our framework of what a human being could possibly be.  Too random, in other words. The average person’s reaction is so justifiably strong that the dismissal and/or imprisonment of any number of anonymous school bureaucrats are entirely insufficient to sate our outrage. Taking down a legendary coach (who I do not suggest for a second is blameless) is as close as we’re going to come. And no, I am not equating the importance of market volatility and child abuse, just suggesting that the reactions, which should be of different magnitudes, are probably coming from the same psychological place.

A brilliant article and the danger of metaphors.  Patrick Chovanec’s “Deja Vu All Over Again” post yesterday was brilliant, providing new support for the validity of comparisons between late 1980s Japan and the current Chinese economy.  The part that got me, in light of the fact that China’s fixed investment is at unprecedented levels relative to consumption, were these statements by a former official of Japan’s Ministry of Finance:

 

Another economic indicator that [we] should have studied more carefully was private fixed investment.  In 1988 it suddenly increased by 14.8 percent.  The following year saw a big increase of 16.6 percent.  In 1990, it recorded an 11.4 percent rise … The indicator’s continuous increase at such rapid rates for three consecutive years should have been more critically examined.  Though economists were quick to judge that these investments would not lead to overcapacity because the majority of the investments was directed to nonproductive facilities for employees, they were slow to notice that a part of the robust investment was merely a by-product of too much liquidity [in] the firms concerned.

 

Chovanec’s post as a whole reminded me of a terrific China-related metaphor concocted by the mega-bears at SocGen. While granting that the Chinese government did enjoy far more control over the economy because of the country’s autocratic structure, they suggested that it wouldn’t help them overmuch. SocGen (either Edwards or Grice, I honestly couldn’t find it) compared the situation to an airline passenger forced to try and fly the plane after both pilots were incapacitated by heart attacks. Sure, all the necessary controls were right there in front of them, but a positive outcome was really unlikely.

As a mid-term China skeptic, I loved the analogy because it perfectly and succinctly summarized my concerns. The tricky part, though, is that perfect communication skills can have very little bearing on the logical validity of a thesis. The fact that the metaphor clearly articulated the argument doesn’t make the argument more true, despite the fact we intuitively assume it does.  I can perfectly picture a panicked passenger trying to fly a plane, but this doesn’t mean, in itself, that the Chinese are incapable of engineering a soft economic landing. I can note the similarities of Japan’s historic and China’ current economy, but this does not mean that the outcome will be the same. This is the danger of really good metaphors.

Coming Soon: The next big post will be titled something lie “In Case of Investment Emergency: Break Glass” which, at Reformed Broker’s suggestion, will attempt to provide some perspective on investing in really uncertain markets. Academically, the primary issue is that uncertainty (in this case the possibility of an EMU break-up) can constitute an opaque “time wall” in the near future that makes it impossible to predict future earnings and cash flow beyond that point.  This in turn makes it extremely difficult to effectively estimate a value for investments by conventional DCF methodologies. For those who like homework, I am going to suggest attempting to assess what the market environment will look like in 36 months, rather than January, to try and “hop the wall” and get past this.

Final Note: The Interloper blog started only three weeks ago, at which time I fully expected having to beg friends to reach 30 page hits per day. Things have worked out much better than expected in this regard and to those who are primarily responsible for this, please be aware that I internally note appreciation for your support every day.  I remain greatly thankful to everyone who stops by to read, whether they agree or not.  So, officially, I send out a huge thank you to you, the person reading this right now.

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