2010 Economics Nobel Prize

The 2010 Nobel Prize for economics was recently awarded to Peter Diamond, Dale Mortensen and Christopher Pissarides for their analysis on “markets with search frictions”.

Complicated as this may sound, the core of this subject is fairly easy to understand and credits some economic hardships to the complexity of today’s trade systems. To understand, lets apply the prize recipients’ theory to the labor market. When an employer seeks a new employee, the search and hiring process requires time and resources. Even with the aid of intermediates such as consultants, the process will always take a toll. These factors mean that some demand will not be met while some supply not bought. And thus “frictions” are created in markets.

Such frictions can help explain the fact that many people may be unemployed at the same time that several job positions are available. In this manner, the Nobel winning Search Theory has been applied to monetary theory, the housing market and various other economic sectors.

Fast Money: The Potential of Speed (Part 1)

The New York Stock Exchange; it’s the iconic backdrop of all things financial and is a beacon of the complexity & supremacy of the US economy. But unknown to many, about 70% of stock trades occur off the NYSE trading floor and the majority of these occur through high frequency trading.

As the name suggests high frequency trading is fast as in extremely fast. Companies such as Goldman Sachs, Morgan Stanley, Merrill Lynch etc. that engage in this kind of transaction often buy or sell over a billion shares every day which to put in context, is over 11,500 stocks every single second. This outrageous volume is handled by computers governed by complex algorithms that take market factors into account to predict minute fluctuations. Despite the wealth of information processed, the end goal is simple; as always, buy low and sell high. Now high doesn’t have to be very high. In the example of the TradeWorks LLC, computers in charge of high frequency trading are instructed to make a profit as small as a penny or less 40 million times every day. It’s easy to see that the pennies really do add up as the relatively small corporation nets approximately $400,000 every day solely from this activity. Don’t forget that these numbers are based on 40 million stocks a day rather than the billion stocks daily of larger companies, mentioned above.

But in many cases, merely knowing the algorithms behind successful calculation is not close to enough. As TradeWorks LLC CEO puts it, eventual profit lies in the ability “to capture opportunities that last for only a fraction of a second” often less that the blink of an eye. This doesn’t require any “special” Wall Street knowledge as many falsely suspect but does entail knowing publicly available information long before it reaches the public. For this, companies adopted the most advanced computers and communication systems available. Yet as this sector becomes increasingly competitive, collocation has become popular in which traders offer tens of thousands of dollars every month to place their computers right next to exchange servers.

Fast Money: The Potential of Speed (Part 2)

Effectively, the only limitation to quicker computation has come down to the speed of the electrons. Thus, those who have attained everything necessary for a few centi or even milliseconds of extra speed, have secured the chance for increased millions or potentially billions annually.

Lucrative as this may seem, many remain skeptical considering the known shortcomings and foreseeable uncertainties. Fundamentally, this robotic system removes the human aspect of trading as the only consideration becomes quantifiable data. Additionally, this manipulation has been classified as parasitic for it fuels off small inflections rather than true variations in market activity. Perhaps most significantly, any accidents can be disastrous and occasionally, irreparable. In the case of the May 6^th, DOW Jones 600 point crash, a mutual fund emptied $4.1 billion in securities into the market. Computers instantaneously bought and immediately after sold these shares as programmed. Seeing this, real traders began selling as well causing prices to plummet; the end result was that an accident turned into a mild catastrophe.

Though counter arguments concerning liquidity are brought up the fact remains that this highly effective form of market exploitation must proceed with caution and under unyielding regulation.

Is Google Doing It Again?

First created three centuries ago by William Fleetwood, a price index offers average prices of categories of goods or services during a particular time period in a given region. As a result, it is an important value in trade, comparing prices over time and between regions all of which reflect inflation or deflation, standard of living and normal good values. Today the Consumer Price Index (CPI), Producer Price Index (PPI) and GDP deflator are the most commonly used price indices

Though still unfinished, Google has yet another implement of its infinite information access, up its sleeve. An inspired Hal Varian, Google’s chief economist, in the hope of conveying inflation statistics has compiled vast amounts of related web data to create a Google Price Index (as an alternative to classic statistical data).

This “GPI” would offer a real time depiction of pricing in contrast to delayed, manually processed past indices such as the CPI. Though the tool may lack the depth of analysis that has garnered the CPI its enduring support and respect, the GPI is based primarily in goods sold online and therefore will be of much greater use to the masses.

Current observations have confirmed such potential, as the GPI has accurately offered values within less time as the CPI of similar products. Nonetheless, the GPI is merely in its infancy and will be meant as a supplement rather than competitor to existing records… for now.

RIC? No It's BRIC (Part One)

A few posts ago I discussed the potential BRIC powers of the 21^st century who are forecasted to overtake current economic superpowers and dominate the G6 by the year 2050. Yet a mere 20 years ago, such prospects for Brazil would have seemed hopelessly optimistic and almost laughable; so how did Brazil progress so far?

                Starting in the 1950s plans to build a dazzling new capital for Brazil called Brasilia were in full swing. To finance the enormous costs, the state began printing vast sums; though this lasted only a short while it had a lasting and almost irreparable effect. Yet this kind of economic disaster was fundamentally different from the sort of problems that fiscally plague countries around the world in that this inflation stemmed from the instantaneous addition of a lot of money into public circulation and not from economic fallout. This fact would prove key in the eventual re-stabilization of Brazil.

By the 1980s Brazil suffered from a skyrocketing inflation rate that reached 80% every month. To put this figure in context let’s refer to an example on NPRs Planet Money; at 80% monthly iinflation, eggs priced at $1.00 one day would cost $1.02 by the very next day. Now that doesn’t seem too bad, right. Even by the end of a month, the eggs would cost $1.80 which though double the cost, was still affordable to many. Now let’s fast-forward to the end of the year; by the end of just 365 days, your wonderful, Sunday morning eggs would have gone from a dollar to almost $1,200 and by the end of the second year, oh just a meager $1.34 million. This meant that stores had to hire a person whose sole job was literally to walk the aisles updating the prices of items constantly. As detailed in one account, people used to race the “sticker-man” to grab what they needed before a new price got tacked on. Humorous as it seems to us, this was the startling and sad truth in late 20th century Brazil.

Through these decades, numerous leaders tried their hand at fixing the problem from freezing prices, to bank accounts to commodity production itself and yet, nothing seemed to work. Then in 1992, reform in the finance ministry ushered in a group of four advisors from the Catholic University of Rio de Janeiro including Edmar Bacha (studied inflation through grad school).

RIC? No It's BRIC (Part Two)

After brief meetings with the president and other representatives of state, the group of four embarked on their mission. Their plan was simple enough; print less money for obvious reasons and rebuild the public’s faith in the common currency (which is absolutely key as reflected in last week’s money posts). The former seems difficult as it is, I mean it’s not exactly easy to convince someone to stop turning paper into money when they have the power to do so. Yet hard as it may be, the latter was much bigger a problem as it meant somehow convincing the populace that money had value and should be trusted (would you trust the dollar if the egg example above were a reality?!). Yet recognizing this issue as foremost in the struggle to revitalize Brazil’s economy was the very genius behind the plan.

To do this, they set about creating a brand new virtual currency, the unit of Rio value or URV, without the expected coins or notes nor meant to replace the cruzeiro (the failing entity at the time). The URV was then used to denote all values merely as a label that translated to a varying number of cruzeiros. In the case of our pack of eggs, the eggs may become equated to 1 URV, so now whenever you went to the grocery store and found your eggs, they would always be 1 URV. It was only after you went to checkout that the cashier would then inform you of how many cruzeiros that 1 URV meant. This was applied to anything that had to do with money so wages, prices and even taxes were listed in URVs. At this point it occurred to me and you yourself might be saying that this solved nothing. All we’ve done is add a medium of exchange for a medium of exchange and all of this at the expense of the poor old “sticker-man’s” job. Yet the key to the URVs success was its stability in that thought its value fluctuated on a daily basis, it represented the same thing to people because now one URV always was and always would be your wonderful, Sunday morning eggs. Thus people began to think in URVs, and started to believe in this constant and unchanging value.

Finally the day came that all of a sudden, the cruzeiro vanished and the URV, almost symbolically renamed the real (pronounced ray-al), took its place. And on July 1^st, 1994, the Brazilian Central Bank distributed the new currency and the BRL became Brazil’s official currency. The result can only be described as miraculous as poverty decreased, the economy boomed and faith was restored.

This is the story of the B in BRIC and with genius as was displayed in the URV, we would be hard-pressed to say Goldman-Sachs prediction will not at least in part come true.

Economic Warfare!

The current economic crisis appears to be coming to an end but the mood is still grim as was reflected at the fall meetings of the International Monetary Fund and World Bank in Washington DC. As the economy begins crawling in the right direction, countries have started vying for any way to increase their portion of the coming economic recovery and potential success. But how do countries go about this? Trade treaties, tariffs or similar examples may initially come to mind but how can the value of currency used as a weapon?

The fact is, lowering the value of a nation’s currency can directly translate to increased demand for the countries goods. At first this might catch you off guard; but to understand you can’t think of this as inflation. Instead if a country can lower the value of its currency to the outside world but domestically reduce prices as well, then the populace is no worse off but goods the country produces are cheaper.

For example, if the of Indian rupee were sold on the foreign exchange markets or similarly manipulated to decrease in value while the Chinese Yuan increased then the exact same car made in India would cost less than one made in China. If India were self-sufficient so that the price of goods did not increase, then the Indian people would have the same cost of living while the goods they produce would increase significantly in demand and generate greater revenue.

Today, several countries primarily including China, Korea, Taiwan, Japan, and Switzerland have used such means to depreciate or otherwise alter the value of their currency. The shortcomings of such practices are obvious for they defy the principles of currency, run contrary to capitalist beliefs (government intervention), give some nations an unjustifiable advantage, promote disunity in a time when it is needed more than ever and has the potential to cause trade or real warfare.

GDP: The Story Behind the Numbers (Part One)

The GDP; you’ve undoubtedly heard of it before and if you haven’t you really should watch the news every once in a while. But what exactly is the gross domestic product?

                Gross domestic product is the market value of all final goods and services produced within an economy in a given period of time; in other words, the GDP puts a single dollar value to the total output of goods and services with an economy over a set period of time. Though this may seem similar to the fiscal measures mentioned in earlier posts (such as C, M1, M2, M2 and M3), they differ in that GDP depicts flow while the latter show stock. To better understand the difference, think of a bathtub; flow values represent changing values from a set unit of time similar to the flow of water from the faucet while stock values are unchanged and measured at one point in time similar to the water sitting in the tub. Thus, the GDP illustrates the exchange of currency and consequently, is often used as a measure of economic activity.

                The GDP can be measured in two main ways both of which reflect the same eventual value: as the sum of income and labor or as the sum of goods and expenditures. So calculating GDP as the total exchange of money for a certain time frame seems easy enough but how do we compute this value for a whole country for as long as an year. There are five main rules that allow us to figure out such a tremendous value. The first rule almost goes without saying; the price of individual goods affects their value in the GDP. This just means that 5 flash drives each worth $10 and 5 HD LCD flat-screens each worth $1000 translate to $5,050 GDP increase rather than a 10 electronic item increase. Next, the exchange of used goods cannot play a part in the GDP. This is because the GDP is meant to reflect production and economic activity. So when grandpa decides to sell his old used car to a desperate teenager, the trade doesn’t involve any form of manufacture or fiscal productivity and therefore is not input.

GDP: The Story Behind the Numbers (Part Two)

The third rule concerns inventories or extra goods whose production was paid for but do not end up being sold. Either one of two things happens in a scenario such as this one. If the goods are perishable and become spoiled or for any other reason must be disposed of, they do not factor into GDP. On the other hand, if the stock is inventoried for later sale, it is assumed that the vendor has bought its own goods and the sale value is input. Remember though, that when consumers do eventually buy these goods, they must be considered similarly to used goods for they have already been bought once. Next we must consider intermediate goods which though present in the final product, are added at distinct stages. Thus, the fourth rule states that a products value on the GDP is the market value of the item or the total value added by firms in the concerned economy. To explain, let’s look at a Panchero’s burrito. The total cost of the raw goods may have cost the restaurant about $3. These are then put together to create the delicious burrito we dish out $11 for. So what affect did my meal have on the United States GDP? The answer is $11 and not $14 because the original $3 is a part of the final retail value. We can also arrive at this by summing up the value added at each stage which is $3 at the farming/raw goods level and then $8 at the restaurant.

Finally and perhaps the most unsuspecting value comprises housing services and similar imputations. Imputed value is the estimated price of goods and services not sold in the market. For example, just as a tenant pays a monthly rent, a homeowner gives up a certain “rent” through the act of living in his/her residence (this is directly seen in the lower value at resale). Other such amounts include government services such as the police, fire department etc. and oddly enough, things like cooking, lawn mowing etc. Despite these efforts, imputing value is very difficult and uncertain; as a result, with the some exceptions (like the ones listed), this practice is avoided.

These are the broad concepts behind the calculation of a single yet comprehensive and telling figure. In the United States alone, the 2009 gross domestic product amounted to a mind-numbing $14.59. To put this in context, that’s the wealth of about 300 Bill Gates or to further simplify (sort of) about six billion of the leather couches from my previous blog entry. Needless to say, it’s a bit too much to comprehend, but through the gross domestic product we can arrive at a general picture of the staggering economic activity we are a part of.

Are BRICs the Foundation of Tomorrow?

The BRIC was a concept coined by the global investment banking and securities firm, Goldman Sachs back in the October of 2001 as published in Dreaming With BRICs: The Path to 2050. The paper through extensive research, affirms that by the mid-21^st century, the economies of Brazil, Russia, India and China could become the dominant world powers replacing many of today’s wealthiest states.

If the findings of the publication, which have been investigated and asserted numerous times over the years, prove to be correct, the BRICs which currently comprise only about 15% of the G6, will surpass their wealth by about 2040, making Japan and the United States the only enduring members. Furthermore, China will overtake the US shortly after, the BRICs will become the world’s dominant consumers, and the dynamics of fiscal dominance will change for the largest economies may not be the richest per capita (overpopulation in China, India etc.).

These changes, as dramatic as they seem, are very possible especially considering the changing face of the planet over just the past 50 to 100 years as Britain fell from centuries of supremacy, replaced by a short-lived USSR and continuing United States. Yet these specific outcomes pivot around several uncertain patterns and choices on the part of the BRIC nations. Furthermore, about a century ago, economists predicted their own version of today’s BRICs with Argentina, Russia, Austria-Hungary and the US becoming the world’s largest economies. Investment in these nations rose just as it is today and initial years forecasted success. Yet as the new millennium approached, the United States was the only one left standing as Argentina fell to dormancy, and Russia and Austria-Hungary ceased to exist (as they previously did).

Nonetheless, with the exception of World War III or a similar global meltdown, the BRICs remain on track with Goldman Sachs’ predictions and have grown astonishingly. Foreign investment in these nations has been at its highest with 34 Brazilian, six Russian, eight Indian and sixteen Chinese companies listed on the NYSE (this doesn’t even include technology companies listed on the Nasdaq). Though, we cannot decisively say what the future holds, Brazil, Russia, India and China will undoubtedly play a vital role as world leaders if not superpowers.