9/5/2012: Carat, Stick, Gold, Council Estate. Boom!

This week, Irish Times have ventured to cover gold in an article titled “The carat and stick approach to investment".  

Please see my disclaimer at the bottom of this post.

We can debate the semantics of the Irish Times headline, but the ‘stick’ suggests some sort of compulsion for investors to purchase gold. 

In reality, few dealers in Ireland actually offer direct access to properly stored gold at an affordable margin. I have not seen any ‘Buy Gold, or Else...’ marketing campaigns, comparable in the force of conviction or compulsion to the tsunami of sell-side promotions unleashed onto Irish investors in property and banks shares in the recent past. Irish Times does not have a dedicated portal 'MyGold.ie' or a special 'Buy Gold' supplement where gold dealers can advertise their coins, nuggets, bars, etc. When gold is covered on the pages of the Irish business press, it is almost invariably painted in apocalyptic terms.

In-line with this tradition, the article opens on a horror story of a young couple living on a council estate, all their savings in gold, stored on-site. One has to wonder if Irish Times writings on, say, pet ownership always relay bone-chilling tales of killer pooches attacking unsuspecting elderly owners. One has to wonder, because a gold bar has about as high probability of ending up under the mattress in a council dwelling as an average retiree faces the threat of being mauled by a man-eating Chihuahua.

I actually agree with the article implied thesis that no investor should be advised to put all their savings into gold or any one specific asset or asset class. Such an atrocity of mis-selling should never befall a retail investor.

However, prudent risk management does imply, in my view, that investors should hold a relatively fixed percent of their invested wealth allocation in gold. Not for speculative reasons, but for risk hedging reasons to cover over the long run wealth volatility induced by other assets and the adverse effects of inflation.

Hardly a ‘stick’ approach.

There’s a point about Gold being a rollercoaster-styled investment vehicle compared to stocks and bonds, raised in the article. Indeed, gold prices show high volatility. Less so on the semi-variance side (downside) than on the overall variance side (downside and upside). And less on geometric weighting (that concern wealth preservation) than on arithmetic (the one that is more suited for short-term returns comparatives), but this is too nuanced for a newspaper article.

The Irish Times seems to be unaware of the ‘survivorship bias’. Over the time horizon glimpsed across by the article, many investments in stocks and bonds have gone in value from ‘hero’ to ‘zero’, as companies went bust, sovereigns and local issuers of bonds defaulted or restructured, currencies disappeared and hyper-inflation bouts have demolished the value of assets, banks deposits have been lost, and so on. Pesky gold ‘relic’ is still here.

There is a priceless moment in Simpsons where Montgomery Burns checks his ticker tape to discover his Confederated Slave Holdings has gone bust. On a more serious note, Nassim Taleb wrote books and academic peer-reviewed articles on the stuff. And Taleb also brings up the value of gold as a hedge against such risks.

Irish Times frequently quizzes serious economics luminaries from stockbrokers and real estate agents. And with clear disdain, the article references the opposite sort – the ‘pop economists’. Let's take a look at some of those using historical valuations / references for highlighting gold’s functions in the real world:

• Nobel Prize winner Robert Mundell recognizes the value of gold as inflation hedge, stating that “Gold will be part of the structure of the international monetary system in the twenty-first century.” Yep, there’s even a website for this sort of pop populism: http://robertmundell.net/economic-policies/gold/, where he is quoted saying that “When the international monetary system was linked to gold, the latter … established an anchor for fixed exchange rates and stabilized inflation. When the gold standard broke down, these valuable functions were no longer performed and the world moved into a regime of permanent inflation.
• Another pop economist is Professor Roy W. Jastram, University of California, Berkeley. His The Golden Constant shows how gold maintained its purchasing power over very long periods of time.
• Professor Steve Hanke of the populism-swept Johns Hopkins University is another one who argues in favour of gold standard currencies precisely because he believes that gold is a long-term inflation hedge.
• John Nash, an unscrupulous peddler of gold with a Nobel Prize medal around his neck (made of gold, note), has called for a gold standard, presumably to sell more gold bars to London Council flats inhabitants.

Yes, there is much of a debate going on the virtues and pitfalls of gold as an investment vehicle or a monetary base. Yes, both sides of the argument have serious research behind them. But that is not what the Irish Times article portrays. Instead of presenting a debate, or actual evidence on the dangers of over-investing in an asset class, the article draws an extremely selective depiction of reality framed in derogatory terms.

Meanwhile, the article description of various gold investment vehicles is incomplete, omitting, for example, the fact that some gold ETFs are synthetic, rather than physical gold-backed, and that some products available in the market allow to purchase gold on price-averaging basis, reducing exposure to price volatility.

A ‘rollercoaster’ investment vehicle that is gold is the only asset in existence that actually provides a risk hedge and a safe haven over long-term structural adjustments and short-term fluctuations across the majority of other asset classes, including stocks. If the Irish Times want proof of this, they can read research on the topic available on ssrn or repec or econlit. Professor Brian Lucey, researcher and lecturer Fergal O’Connor and myself are co-authoring on a database of studies on gold as an asset class, its properties, behavioural implications and empirical analysis, which is available at http://preciousmetalsresearch.wordpress.com/.

There is a priceless bit in the article on determination of an asset bubble. The author logic goes as follows: “In 2007, more than 80 per cent of the demand for gold was for jewellery and industrial use, while less than 20 per cent of demand was from investors. By 2009, this had changed dramatically. Investment demand had risen to 43 per cent of the total. The rise in demand from investors raises the question as to whether speculation is a key driver of the gold rally.”

This does a number of things:

•  It answers a question with a question.
•  It also suggests that investor demand is always speculative.
• It confuses speculation, investment and bubble formation. 90%-plus of equities (other than retained shares) and 100% of bonds are held by investors, and yet Irish Times does not call equities or bonds bubbles every day of the week.
•  It ignores the other side of the equation, what happens with the non-investment demand for gold.

Let me provide some more numbers:

Between 2002 and 2007, demand for physical use gold (jewellery, dentistry and technological) has declined on average at the rate of 1.5% pa, since 2008 through 2011 the rate of decline was -4.42%. At the same time, demand for gold bars and coins rose at 4.83% pa on average in 2002-2007 and at 41.93% pa on average in 2008-2011. Demand for ETFs-held gold, meanwhile, more directly instrumenting ‘speculative’ (or shorter-term) investments has 79.9% pa on average in pre-2007 period and at 5.14% pa on average in 2008-2011 (or crisis period).

Drama all around, unless you look slightly deeper into demand drivers.

Physical gold demand has been abating over the 2000s primarily due to diversification in jewellery demand away from gold (rise of prominence of platinum during the years of 2002-2007 and silver in the latter years, driven by tastes and price effects, plus recession-related income effects and tax and local currency considerations). A quick read through demand drivers analysis from the World Gold Council would help here.

In addition, it is wrong to classify sales of bars and coins as ‘speculative’. Behavioural studies suggest that sales of bars & coins are driven strongly by savers, rather than traditional speculative investors. These ‘savers’ are more often than not wealthier individuals (especially in the case of bars buyers) who tend to hold both instruments over longer horizon. Coins holdings are even less sensitive to price changes than demand for bars. For example, coins demand for US Mint Eagles has spiked around 1997-2000 with no reaction in the coins price. I doubt even the Irish Times would have spotted a bubble there. (chart).

These are not to be ignored, as roughly 20% of the investment gold demand is accounted for by coins and medals.

Lastly, one has to distinguish between speculative (capital gains-driven) investments and short-term risk management objectives (such as flight to safety or flight to quality considerations). These factors are hard to control for, but smoothing demand for investment gold in 2008 and 2011 – the two core years of the crisis, using historical trend suggests that the ‘hedging’ demand for gold to cover the spikes in markets volatility around the equities and sovereign crises peaks accounts for about 9-10% of total gold demand at the end of 2011.

A quick note below the post does some back-of-the-envelope illustration on price-demand links.

In brief, the issue of gold valuation is complex and very much open to the debate. I, personally, have no opinion on whether gold price today is a bubble or not. It might be, it might be at the beginning of the bubble formation or at the tail end of it. I have no idea. Nor do I have any idea where the gold price will be in 3 months time.

What I can say is what I keep repeating any time someone asks me about gold: gold is a wealth management tool suited for risk hedging and wealth preservation, not for chasing speculative gains.

Disclaimer:
1) I am a non-executive member of the GoldCore Investment Committee.
2) I am a Director and Head of Research with St.Columbanus AG, where we do not invest in any individual commodity.
3) I am long gold in fixed amount over at least the last 5 years with my allocation being extremely modest. I hold no assets linked to gold mining or processing companies.
4) I have done and am continuing doing academic work on gold as an asset class, but also on other asset classes. You can see my research on my ssrn page the link to which is provided on this blog's front page.

5) I receive no compensation for research appearing on this blog. Everything your read here is my own personal opinion and not the opinion of any of my employers, current, past or future.

6) None of my research - including that on gold - should be considered as an investment advice or an advise to buy or invest in any asset or asset class.

Note: using annual data we can look at the relationship between demand for gold by various types and prices. Chart below illustrates.

Three things are relatively clear: 

1. Between 2002 and 2011 there is a rather strong positive relationship between gold price and demand for bars and coins;
2. Between 2002 and 2011 there is relatively strong negative relationship between gold price and demand for physical use gold;
3. Between 2002 and 2011 there is relatively weak relationship between gold price and demand for gold by investment funds

Now, here's a question, if bubble in gold is to be traced to 'speculative' demand spikes in response to the price movement, why on earth would there be less of a relationship between price and the most speculative type of gold investment - the ETFs and more of a relationship between less speculative physical demand for gold and price of gold?

7/5/2012: Analysis of April Irish PMIs (4): Profitability

This is the last post on April 2012 PMIs. In the first and the second posts, I covered headline index readings forManufacturing PMI and Services PMI for April 2012. In the third post, I looked at the Employment sub-indices for both sectors. This post will focus on profitability conditions, an index I derived from the PMI data.


April 2012 saw profit margins conditions deterioration slowing down in Services from -15.06 in march to -11.96 in April. 12mo MA is now at -15.9, shallower than the average deterioration in profit margins during the pre-crisis period (-17.8), but deeper than -14.7 average reading for the period since January 2008. Overall, -11.96 April 2012 reading is the slowest pace of profit margins deterioration recored since October 2010. 3mo MA is now at -13.8 and this marks a significant improvement on -19.8 deterioration for 3mo MA a year ago.

Manufacturing profitability index has moved from -24.84 in March 2012 to -22.86 in April 2012, marking the second sharpest decline since March 2011. 12mo MA is now at -17.1, while 3mo MA is at -23.3. This compares against pre-crisis average reading of -11.6 and January 2008-present average of -14.55.

So on the net, profitability conditions continue to deteriorate, but deterioration in Services is less pronounced and de-accelerating continuously compared to historic trends. Deterioration in Manufacturing profit margins continues unabated and is running well beyond historical averages.


The above suggests that while some positive momentum is possible for employment in Services sector, it is unlikely that profits conditions will support much of an employment uptick in Manufacturing.

7/5/2012: Analysis of April Irish PMIs (3): Employment

In the last two posts I covered headline index readings for Manufacturing PMI and Services PMI for April 2012. In this post, I am looking at the Employment sub-indices for both sectors.

Employment index rose to 52.9 in Manufacturing from 51.2 in March. The move is against 49.5 12mo MA and 50.0 average for Q1 2012, suggesting some expansion in Manufacturing employment. The change comes coincident with a decline in the rate of growth in overall sector PMI to 50.1 from 51.5 in March.

In Services, employment index declined to 50 from 51.9 in March 2012. The index 12mo MA is at 47.9 and Q1 average was 48.1. In contrast to Manufacturing, decline in Employment growth rate came against an improvement in PMI from 52.1 in March to 52.2 in April.

Short-term changes in the series, however, are pretty volatile. Chart below shows the counter-moves in the two sectors:

and the chart below plots relationship between Employment and Exports:

The good news is, March and April 2012 mark two consecutive months when exports expansions in both sectors led to above 50 readings in employment as well. Last time that happened on a monthly basis was in April 2011 and last time it happened in two consecutive months was in October 2007.

If sustained over the next 2-3 months, the trend might shift firmly to the upside.

7/5/2012: Analysis of April Irish PMIs (2): Core Services

Previous post dealt with the high level trends in Manufacturing PMI for Ireland. In this post we look at the core data for Services PMI.

Back in March, markit - the agency releasing Irish PMI data for NCB - headlined the changes in the Services index with a rather bombastic "Growth of Activity Sustained in March, and Optimism Hits a 22-month High". Of course, such was the booming time in Irish economy a month ago.

Fast forward one month to April and the headline remains bombastic: "Activity Growth Maintained in April as New Business Rises for Third Month Running"... Ok... so...

Headline PMI in Services (Business Activity index) improved from 52.1 in March to 52.2 in April, which is good news nominally, but statistically still indistinguishable from 50. Good thing is, the moving averages are a bit stronger along the just-above-50 trendline. 3mo MA is at 52.5, 12mo MA at 51.3, and 3mo MAs for 2011 and 2010 are all below the current running at 52.1 and 49.8 respectively. So business activity is indeed somewhat on the rise, albeit a very shallow rise.

Overall, headline Services Activity has been running on average above 50 since June 2009. Anyone noticed the boom, yet?

New Business Activity firmed up to 52.7 in April, from 52.1 in March, marking the third consecutive month of above 50 readings. 12mo MA is at 50.0 and 3mo MA is at 52.8, ahead of same period 3mo average in 2010 and 2011 (49.1 and 51.9, respectively). All, however, remain statistically indistinguishable from 50.

Again, trend pattern in New Business sub-index is identical to the pattern in overall Business Activity index - flat just above 50 since, roughly Q2 2011. The snapshot of more recent data illustrates, next.

Input-output prices are both moderating in trend, but input prices continue to expand, while output prices continue to post significant deflation. Profit margins, therefore, are shrinking more and more - the pattern that is running solidly since August 2009. More on this in future posts, however.

On core components of PMI: New Export Business growth moderated, but remained above waterline at 54.3 in April, down from 55.5 in March 2012. Both monthly readings were statistically significantly above 50, the same as in February. 12mo MA is now at 52.7 - barely statistically significantly above 50, while 3mo MA is at 55.0 - strong reading, ahead of 54.6 in 3mo through April 2011 and 52.8 reading for the same period of 2010.

As mentioned earlier, Profitability remained in the contraction territory, posting a reading of 47.5 in April, worse than 47.9 in March. Last time Profitability sub-index posted a reading above 50 was in December 2007.

Employment sub-index declined to 50.0 in April 2012, down from 51.9 in March 2012. 12mo MA is at 47.9 and 3mo average through April 2012 is at 49.9. This is virtually identical to 3mo MA through April 2011 which came in at 49.8 and is better than a rapid contraction-signaling 43.7 for the sub-index 3mo MA through April 2010.

Confidence slipped to 64.1in April 2012  from 70.4 in March. The series reading is now at 3mo low, but ahead of 12mo MA of 62.5. 3mo MA through April is very strong 67.1, while 3mo average through April 2011 was 66.5 and for 2010 period it was at 64.2. Overall, business confidence is relatively inflated indicator, as shown in the chart below. The indicator has relatively strong coincidental connection - in historical data - to the same period Business Activity index.

Overall, Services PMIs are showing stronger performance in the sector than in Manufacturing, but the numbers are more volatile and trending along the flatline. Business expectations continue to out-perform actual activity and exports orders, although this is hardly a new trend. With profitability severely constrained and actually deteriorating, I wonder if the 50+ readings in the last two months in Employment sub-index are credible.

7/5/2012: Analysis of April Irish PMIs (1): Core Manufacturing

With both Services and Manufacturing PMI data out last week, time to update some charts. This post will deal with core trends in manufacturing PMIs, following by posts covering core data in Services PMIs, employment trends and profitability trends.

Core PMI in manufacturing slid to 50.1 in April 2012 - level consistent with zero growth - from 51.5 in March. Although nominally, the PMI remained for the second month above 50, both March and April readings were not statistically significantly different from 50. Longer term averages also disappointed: 12mo MA slipped to 49.5 - below 50, nominally, 3mo MA is at 50.4. This compares to same-period 3mo average of 56.1 in 2011 and 51.7 in 2010. So overall PMI activity is at the slowest in 3 years. 6mo MA is down at 49.45 and 9mo MA at 49.3.

New Orders sub-index came in at 51.4 in April, a decline from 52.7 in March. March reading was barely statistically significantly different from 50, with April level of activity sliding below the statistical bound. 12mo MA for sub-indicator is now at 49.3 and 3mo MA through April 2012 at 51.4 compares poorly compared to same period average of 58.1 in 2011 and 53.2 in 2010. 6mo MA is at 49.45 and 9mo MA at 49.07.

New Export Orders sub-index is at 53.1, still above the expansion line of 50 and statistically significantly so, but down from 55.1 in March 2012. 12mo MA is at 52.0 and 3mo MA at 52.6, compared to same period 3mo MA of 59.9 in 2011 and 58.7 in 2010.

Thus, out of all 3 core indices, only one - New Export Orders - is consistent with growth. On the positive side, however, all three indices have deteriorated on March, but remained above 50 in nominal terms.

Chart below plots shorter-range highlight for the above series, plus Output sub-index. Output sub-index slipped to 48.6 in April from 52.8 in March - a sizable swing of 83% of the crisis-period STDEV. A nasty surprise pushed 12mo MA to 50.2 - within a whisker of 50, with 3mo MA at 50.6, compared to 2011 same period 3mo average of 59.1 and 2010 of 55.0.

The trend of flat - on average virtually zero growth - in all four series continues since June 2011.

All other core sub-indices are underperforming as well:

The gap between input and output prices is staying wide, implying continued pressures on profit margins (to be covered in a separate post), while employment outlook improved from 51.2 in March to 52.9 in April.

All core series show flat trend at below 50 since, roughly June 2011.

6/5/2012: Live Register for April 2012 - Sub-trends Part 2

Last post of three on the Live Register. The first post looked at the core trend in the Live Register, the second dealt with sub-trends by nationality, duration and casual/part-time employment.

In this post, I am dealing with occupational distribution of Live Register.

CSO covers occupational data as follows:

"Craft and related (24.1%) remained the largest occupational group on the Live Register in April, despite the fact that the number in the group fell over the year by 8,580 (-7.6%) to 103,626. The second largest annual percentage decrease was in the Clerical and secretarial group (-5.4%). Slight increases were seen in the Sales group (+1.8%) and the Personal and protective service group (+0.6%) over the year".

Here are some additional details:

Comparing y/y changes by category:

So several interesting things jump out of the data.

As expected, Associated Professional & Technical occupational category performed better than overall Live Register, posting stronger declines. This is consistent with the idea that exporting firms are maintaining their employment levels of mid- to lower-end staffing with some specialist knowledge. Alas, this outperformance is hardly spectacular.

Managers and administrators did relatively well until March 2012, since when their Live Register reductions have been underperforming overall Live Register - a worrying movement, but too short-lived to establish a trend. Clerical and Secretarial is posting some significant improvement relative to overall trend, but this comes on foot of average performance since November 2011 through February 2012.

Craft and related (the category including construction workers) is performing surprisingly well, suggesting that much of 'improvements' in the Live Register overall have been driven by people dropping out of LR coverage, not by jobs creation (recall, construction activity continues to tank).

An interesting feature of underperforming sub-categories is that they include manufacturing-linked Plant and Machine Operatives category (a sign that overall exports-led growth is jobless) and Sales category (showing the level of jobs destruction in domestic services, such as retail).

Changes in 2010-2012 April figures in absolute levels, shown in the first chart above show that Professional and Associate Professional & Technical categories have managed to reduce their overall Live Register counts by a combined 1,415 in two years! This is hardly consistent, overall, with a boom in profits expatriation by the MNCs and exports that we have experienced. Welcome as these numbers might appear, I wonder, how many of these LR reductions were due to emigration of skilled workers?

To summarise, I suspect that the core (practically the only) drivers of LR reductions have been drop-outs from the LR due to benefits expiration (especially for the categories with largest recorded declines), plus transition into state sponsored training schemes, plus emigration. I see basically no evidence consistent with the story that exports-led (or rather MNCs transfer pricing-led) growth has been strongly net additive when it comes to jobs in any of the occupational categories. In fact, this economy might be becoming top- and administration-heavier, rather than more skills-intensive.

6/5/2012: Live Register for April 2012 - Sub-trends Part 1

In the previous post I looked at the headline Live Register stats for April. Here, let's take a look at the sub-trends.

The number of long term claimants on the Live Register in April 2012 was 184,053, up 14,633 y/y and down 412 m/m. This is not seasonally adjusted. Per CSO: "The number of male long term claimants increased by 7,744 (+6.2%) in the year to April 2012, while the comparable increase for females was 6,889 (+15.4%) giving an overall annual increase of 14,633 (+8.6%) in the number of long term claimants.

Numbers of those in casual and part-time employment declined 274 to 88,442 in April 2012. Year on year the number is up 2,848 (+3.33%), compared to y/y change to March 2012 of +2,561 (+2.97%) - marking a slight deterioration of the trend. Overall, as chart below shows, things are running with a slightly upward trend. Again, you can opt to interpret part-time and casual employment as a good thing, or as a bad thing - glass half-full or half-empty, but generally, in my view, absent robust new jobs creation, this speaks more of a hidden unemployment, rather than of nascent entrepreneurship or a pick-up in some hiring activity.

Last 3 months average is now running at 1.89% increase on previous 3 months, and 3.33% rise y/y.

Now, for Live Register breakdown by nationality:

In April 2012, 77,015 non-Irish nationals were on the Live Register, down 1,065 from march 2012 (-1.36%) and down 508 (-0.66%) y/y. In March 2012, y/y decline was 514 (-0.65%). Since series is not adjusted for seasonal variation, it is worth looking at 3mo averages. 3mo average through April 2012 was up 1.72% on 3mo average through January 2012, but down 0.61% on same period 2011. The trend for non-nationals is therefore practically flat.

There were 352,986 nationals on the Live Register in April 2012, representing a decline of 2,988 on March (-0.84%) and a drop of 9,062 y/y (-2.50%). This compares to a y/y decline of 6,625 (-1.83%) in March 2012. 3mo through April 2012 average was down 0.41% compared to 3mo through January 2012 and declined 1.85% y/y. So the series are showing stronger downward momentum, but still a flat, albeit volatile trend. Chart above clearly shows the seasonality pattern and the flat trend.

April 2012 non-Irish nationals accounted for 17.91% of the total number of persons on the Live Register - an increase from 17.64% a year ago, but down from 17.99% in March 2012.

Stay tuned for occupational analysis of the LR in a subsequent post.

5/5/2012: Live Register in April - trending flat at 'glass half-full'

It's been a while since I updated the Live Register figures, and given that some fresh data was released this week, I think it's time to revisit the trends.

First off, the LR-implied unemployment (or standardized unemployment rate) remained at 14.3% in April 2012, unchanged from March 2012 ad below 14.6% reading for the actual unemployment rate for Q4 2011 (based on QNHS).

So far, crisis-period average LR-implied unemployment rate is 13.8% - still below that for April 2012, although with STDEV of 1.3 we are getting closer and closer to the statistically average rate. Crisis-period average monthly movement in the LR-implied unemployment is 0.14 percentage points, so with zero movement in April 2012, things are better than average. April 2012 marks 6th consecutive month during which the implied unemployment did not rise, of which exactly 3 months have seen zero change in unemployment and 3 months say declines of 0.1 percentage point. So as can be seen pretty clearly, January-April 2012 trend is not exactly encouraging, but on the 'glass half-full' side, it is also not exactly severely disappointing either.

In terms of absolute numbers, seasonally adjusted LR rose by 100 entrants in April 2012 to the seasonally-adjusted 436,000, so year on year LR dropped 6,400 in April 2012 (-1.45%) against a y/y decline of 8,000 (-1.80%) in March 2012. 3-mo average for the period through April 2012 is 1.35% below same period in 2011. This marks a moderate, but positive trend for the series and is a good news.

Alas, as the above figure illustrates, the good news on LR are clearly offset / accounted for by aggressive reclassification of assistance recipients into training programmes. Before you start biting off my head, let me clarify - training and re-training is good, but until the person exits the programme and gains a job, in my opinion, it is dishonest to claim that this person is not unemployed. So, per chart above, if we add March 2012 (latest) data for state training programmes participation numbers, we get 517,440 persons on the live register and in state run training programmes in April (against 517,340 in March). That is a rise of 12,694 y/y (+2.51%).

Chart below shows the LR struggle to break out of the flat trend since Q4 2010 that continues to-date.

The following post will look into some sub-trends in the LR composition.

5/5/2012: Marx v Austrians: 0:1... still

A superb and a must-read paper on virtues, failures & quantifiability of 'alternative' ideological structures: Capitalism, Socialism and Calculations, by Brent Butgereit and Art Carden.

The paper is now published in the Economic Affairs, Vol. 31, Issue 3, pp. 41-45, 2011  but you can get a working paper version of it free here.

Per authors: "The merits and demerits of what we call ―capitalism have been sources of much attention since Adam Smith...  We consider the criticisms of the Smithian capitalist system as stated most prominently by Karl Marx, and we evaluate Marx‘s proposed solution to the evils of capitalism—specifically, socialism. We also explore the contributions of Ludwig von Mises and Friedrich Hayek to the debate about whether Marx‘s proposed alternative was really an alternative.

Mises and Hayek provide powerful critiques of Marx‘s socialist vision by addressing the problem of economic calculation and the inability of central authorities to acquire knowledge diffused and distributed across an entire society.  We question whether Marx offered a solution and then consider more recent attacks on capitalism and its alleged destruction of cultural capital.

The theoretical contributions of Mises and Hayek are supported by recent empirical contributions suggesting that liberal political economy is robust."

Worth a read!

5/5/2012: Can austerity work as default probability evaluation aid?

Usual argument in favor of a fiscal contraction in response to an adverse fiscal shock goes along the lines of the Expansionary Fiscal Contraction - or structural - argument. There are many who agree/disagree with this proposition, but there's plenty of literature covering it.

A new argument in favour of 'austerity' response to a fiscal shock is presented in the recent paper from the Bank of Italy.

Optimal Fiscal Policy When Agents Fear Government Default, by Francesco Caprioli, Pietro Rizza and Pietro Tommasino (March 2012), link here, argues that under optimal fiscal policy, when a government is facing with investors who fear a sovereign default, and assuming investors learn over time so as to gradually correct from the initially over-pessimistic view of the default probability, "a frontloaded fiscal consolidation after an adverse fiscal shock is optimal". In other words, 'austerity' can work when it facilitates learning process to support investors' discovery of the 'true' lower probability of default.

In a summary, the findings are:

• When agents fear government default, a fiscal consolidation after an adverse fiscal shock becomes optimal. The intuition is that the interest rate on government debt is too high due to distorted expectations about government default; therefore the marginal cost of higher distortionary taxes today is more than compensated by the expected future marginal benefits of lower distortionary taxes tomorrow. 
• The incentive to reduce debt is stronger: a) the more pessimistic agents are about government solvency and b) for a given degree of pessimism, the higher the post-crisis debt level. 
• The state of agents initial beliefs has an effect on the long-run mean value of the tax rate and debt. In particular, the more pessimistic agents initial beliefs, the lower the long-run mean value of debt. The intuition is that the more pessimistic the agents are, the stronger the incentive to change their expectations.

5/5/2012: Incentivising Altruism?

Yesterday, I was honored to help launch a new - and a very promising and interesting, including from economics research point of view - initiative in Clonakilty, the Clonakilty Favour Exchange.

There has been some coverage of the Exchange launch here, here and here. And there's more forthcoming.

At the launch, myself and Bill Liao (a fantastically engaging speaker with a hell of a great message to share on the role of altruism and passion in our lives - social and individual alike) had a very interesting, albeit brief discussion as to the balance between the economic values of human capital and the social values, as well as individual well-being. Bill, absolutely correctly, in my opinion, raised the issue of how rewarding altruism and care for others in the community must be an integral part of the economic exchange.

Here is an interesting piece of recent research showing that traditional economic incentives, such as pay for altruistic endeavors, can empower greater engagement

Written by Nicola Lacetra, Mario Macis and Robert Slonim, the study "Rewarding Altruism? A Natural Field Experiment" was published as Milton Friedman Institute Working Paper No. 2011-010 (link here) and looks at the evidence "from a natural field experiment involving nearly 100,000 individuals on the effects of offering economic incentives for blood donations". Key findings are:

• "Subjects who were offered economic rewards to donate blood were more likely to donate, and more so the higher the value of the rewards."
• Subjects "were also more likely to attract others to donate, spatially alter the location of their donations towards the drives offering rewards, and modify their temporal donation schedule leading to a short-term reduction in donations immediately after the reward offer was removed." 
• Although offering economic incentives... positively and significantly increased donations, ignoring individuals who took additional actions beyond donating to get others to donate would have led to an under-estimate of the total effect, whereas ignoring the spatial effect would have led to an over-estimate of the total effect." 
• The authors also found "that individuals who received a reward by surprise were less likely to donate after the intervention than subjects who received no reward, suggesting that for some individuals a surprise reward adversely affected their intrinsic motivations."

In fact, as I recall, Bill explicitly raised a point that in some cases, rewarding for altruistic behavior can lead to apprehension on behalf of the person carrying out altruistic activity.

I am certainly looking forward to having a deeper discussion on the topic with Bill.

And in the mean time - massive thanks to the wonderful people of Clonakilty and to all engaged in the Clonakilty Favour Exchange for their hospitality and for their enthusiasm! Contagious stuff.