14/5/18: Seeking Alpha on the U.S. Household Savings Pains

Great to see Seeking Alpha's Senior Editor covering my blog post on the pains of American household savings rates: https://seekingalpha.com/article/4167541-one-emergency-away-financial-disaster-financial-advisors-daily-digest.

The original post referenced is here: http://trueeconomics.blogspot.com/2018/04/28418-great-recovery-with-no-savings-us.html.

14/5/18: Irish Tax Avoidance Machine and the Balance of Payments

One blog post and one paper tackling one of the greater mysteries of the Irish National Accounts, the Balance of Payments, peeling the layers of tax avoidance onion:

• Tax Avoidance and the Irish Balance of Payments paper: https://www.cfr.org/blog/tax-avoidance-and-irish-balance-payments?utm_medium=social_share&utm_source=tw;
• The 2017 Balance of Payments post: http://economic-incentives.blogspot.com/2018/04/the-2017-balance-of-payments.html.

Both worth digesting.

12/5/18: Bubbles or Gartner Cycles? Tech is in it, again...

Nice visual on Gartner-maturity curve structure of sentiment driven fads in sectoral valuations:

12/5/18: Monetary Activism at ECB: A Chart of Failure

A simple chart, a great observation by Holger Zschaepitz @Schuldensuehner: "Chart of failure: #Eurozone core inflation has plunged to 0.7% despite #ECB balance sheet at record high. If ECB permanently fails to hit its #inflation target, it's time to rethink target. By the way, there is inflation in stocks, bonds, real estate not measured in official CPI."

The story of ECB racing away from the Fed and even BoJ in pursuit of the inflation Nirvana:

Which brings us to a bigger question: with ECB at play, what is there to brag about when it comes to Europe's latest growth "renaissance"? Read my article in the Business Post tomorrow... 

12/5/18: U.S. War in Afghanistan: when the patient yields to the compulsion to repeat

On and off, I have written occasionally about the complete lack of value-for-money accounting in the U.S. military spending and its imaginary successes. This is just another one of such occasions.

Here is a summary of the Special Report by the U.S. military watchdog, filed by the neoconservative in it is geopolitical positioning Foreign Policy magazine (the folks who support wars, like the one conducted in the Afghanistan): http://foreignpolicy.com/2018/05/01/the-afghan-war-isnt-being-won-says-new-pentagon-audit/.

I have summed the main findings in a series of tweets reproduced here:

Special Inspector General for Afghanistan reconstruction report of May 1: suicide attacks in Afghanistan up 50% in 2017, opium production +63%. Last GDP growth was recorded in 2012, since then, continued recession +

+ U.S. spent $126bn in relief & investment in Afghanistan over 17 years. The country now ranks 183 in the world to "do business.” < 1/3 of Afghans are connected to power grid. +

+ Number of bombs dropped by the West in Afghanistan in Jan-Feb 2018 was the highest it's been since 2013. Suicide attacks in Afghanistan are up 50% in 2017. Casualties from attacks are steadily rising. Sectarian attacks tripled in 2017. +

+ Only 65% of the Afghan population lives under government control, even though direct US expenditures to Afghan security forces of $78bn > than third largest military budget in the world. +

+ Number of serving Afghan military & police fell sharply in 2017, but U.S. forces presence is rising. "Insider attacks by Afghan soldiers are rising".

Note: the IMF data does not show decline in Afghanistan's GDP since 2013 in real terms (domestic currency), or in current US dollar terms, or in PPP-adjusted terms. The issue here is that the IMF data shows national accounts that include U.S. and Western Coalition spending and investment in the country and does not account for population growth. In fact: Afghanistan ranked 23rd lowest in the world in income per capita terms (using PPP-adjusted international dollars) in 2012. In 2017 it was ranked 19th lowest. This does mean that the economy got worse in Afghanistan in recent years. In line with this, Reuters reported earlier this year that Afghanistan's poverty rates have risen "sharply" over the last five years (https://www.reuters.com/article/us-afghanistan-economy/afghanistans-poverty-rate-rises-as-economy-suffers-idUSKBN1I818X) from 38% in 2011-2012, to 55% in 2016-2017. "Food insecurity has risen from 30.1 percent to 44.6 percent in five years, meaning many more people are forced to sell their land, take their children out of school to work or depend on food aid".

More details?  In September 2014, Foreign Policy wrote about another report by the same watchdog, headlining their story with a telling tag line: "Watchdog: United States Made Corruption in Afghanistan ‘Pervasive and Entrenched’". It is worth repeating that Foreign Policy is an intellectual bulwark of neoconservative doctrine that saw nothing wrong with any war the U.S. has started in the past.

The U.S. has already spent more on the war in Afghanistan (and related 'investments' there) than the entire country's GDP over the last decade. And it is tied into spending vastly more (https://www.forbes.com/sites/realspin/2016/11/21/war-and-debt-and-fiscal-ramifications-to-2053/#651c540b3d51 and http://trueeconomics.blogspot.com/2017/11/201117-tallying-costs-us-wars-in-iraq.html).

In January this year, to make the valiant efforts by the Western Coalition (read: Washington) in Afghanistan more transparent, Pentagon sought to withhold key information about the campaign from the public (https://www.reuters.com/article/us-afghanistan-usa-oversight/pentagon-blocks-release-of-key-data-on-afghan-war-watchdog-idUSKBN1FJ0GZ).

Yet, despite the U.S. larger-than-reported presence in the country, January report by SIGAR noted that  "43 percent of Afghanistan’s districts were either under Taliban control or being contested". This was after more than 16 years of war waged against the Taliban and other extremist groups by the largest, the mightiest and the best-equipped military force in the world. "Last year [2017], U.S. forces in Afghanistan restricted the amount of data it provided on the ANDSF, including casualties, personnel strength and attrition rates - data that has now been completely withheld." (See https://www.cbsnews.com/news/pentagon-fails-to-disclose-troop-numbers-in-syria-iraq-afghanistan/ for more details).

In 2011, ten years into the campaign that promised to bring democracy and human rights to Afghanistan, the U.S. State Department stopped listing human rights as an objective for the U.S. Afghanistan policies. Not because these rights have been fully restored (or rather instituted), but because it became too embarrassing to keep them in policy documents as a reminder of the U.S. failures.

Seventeenth year into what amounts to a small war for the enormous military machine of the Fourth Rome, and the 'most brilliant', 'highly decorated', grossly overpaid and deeply revered in the popular media culture U.S. generals and politicos are clueless as to why the exceptionalist U.S. of A. has failed to control a dispersed gang of resistance fighters that, unlike the Vietnamese of the 1970s and the North Koreans of the 1950s, do not even have a superpower standing directly behind them. The reason, of course, is in the very ethos of the American power, the notions of exceptionalism and self-appointed mandate, both of which imply zero capacity to think based on historical and rational premises. As one of the authors on the topic quipped, quoting from Freud's 1914 paper Recollecting, Repeating, and Working Through,  "...the patient yields to the compulsion to repeat, which now replaces the impulsion to remember... The greater the resistance, the more extensively will acting out repetition replace remembering."

The Freud's quote (part of it) appears in this article from 2017 on the depressing comprehensiveness of the American war failure. It is worth a read: https://www.thenation.com/article/what-the-us-military-still-doesnt-understand-about-afghanistan/ for it narrates in some detail the process of the repeated denial of reality by, at this stage, the third presidential administration in Washington engaged in an imperial dance of victory amidst the defeat.

The staggering cost of the Washington's adventurism in Afghanistan (and Iraq, and Libya, and next up - Syria, as well as in other parts of the world) has now cost the U.S. one of its historically closest proxies/allies, Pakistan (https://www.reuters.com/article/us-usa-trump-pakistan-idUSKCN1B3125).  This is a major, strategic defeat, given Pakistan's role in the region and the potential for the strengthening of the Pakistan-India-China-Iran cluster of power contests that will undoubtedly shape the entire region into the future. In simple terms, the U.S. has lost not just the war in Afghanistan, but it is losing dominance over the large swath of land that constitutes the largest cluster of world's population and has strategically central importance to the global economy and resources.

These failures are not surprising, once one takes a more rational look at the U.S. military machine and the religious devotion to it exhibited by Washington and American press. Quoting at length from Forbes (https://www.forbes.com/sites/realspin/2016/11/21/war-and-debt-and-fiscal-ramifications-to-2053/#370435f3d51a):

"As it happens, the Pentagon is unique among federal agencies in having never undergone a full audit, an oversight with serious national security consequences. ...The good news is Congress has finally mandated an audit be completed by September of 2017, a deadline reached after the Department of Defense managed to skirt a government-wide audit requirement for more than two decades. The bad news is likely the audit results themselves. After all, a recent audit of the Army General Fund found bookkeepers somehow screwed up their accounting by $6.5 trillion in 2015. That number is particularly remarkable given that it is 13 times the size of the entire Pentagon budget for that year. “How could the Army misplace, fudge, misappropriate or otherwise lose $6.5 trillion?” asked an incredulous Matthew Gault reporting on the Army audit for War Is Boring. “It’s simple. Years of no oversight, bad accounting practices and crappy computer systems created this problem. And remember, this is just the Army and just its general fund.” If that’s the sort of rot we find in a single branch of the military, imagine the fiscal horrors yet to be uncovered throughout."

Note: the Defense Department delayed the audit start until December 2017 and is now promising a report from the auditors by November 2018. Worse, the audit is conducted by internal teams, in other words, the lunatics who run the asylum are now counting plates and pills in the place too. To put some veneer on this exercise, the Inspector General has hired 'external audit firms' to help analyse data collected by Pentagon's teams. The same 'audit firms' are some of the largest military and security consulting contractors, of course.

Meanwhile, the idiotic parroting of the past and failed narratives remains the leitmotif of the Washington's policy. Best exemplified by the amnesia-ridden, Ivy League-trained army of status quo dependent 'experts' and the headlines in the U.S. media echoing them: https://www.usnews.com/news/politics/articles/2017-11-27/victory-or-failure-in-afghanistan-2018-will-be-the-deciding-year. "Armed with a new strategy and renewed support from old allies, the Trump administration now believes it has everything it needs to win the war in Afghanistan." This, pretty much, sums up the best that the American-trained 'intellectual class' of the West Point-graduated generals and Harvard-trained 'analysts' can produce in place of a strategy.

The logical denouement of the U.S. failure to learn from Afghanistan adventure is the loss of the U.S. position in the region to China, followed by Iran, Pakistan, India and Russia - in that exact order. Afghanistan is likely to be the next - much larger than Syria - theatre of confrontation between Iran and Saudi-U.S. coalition, with Israel at a play too, and the American liabilities in such a conflict will be well beyond anything experienced in Iraq and Afghanistan combined. A proxy war between Iran and the U.S. via Afghanistan can risk spilling into an outright war between the two countries, which the U.S. will lose more decisively than Afghanistan, although the toll on Iran will be huge as well.

What Afghanistan has been exposing over the last 16 years, plus, is that the Pax Americana lacks not fire power, but vision, and that the lack of vision is what loses wars, and ends empires. Sail on, my thought-lacking friends from the Western Academia, military colleges, Washington's circles of Byzantine power-brokering expertise, and 'influential media'. Keep those aircraft carriers busy circling the globe. Keep awarding your military ranks free parking spaces at Walmarts and rent subsidies in the Paradise.

8/5/18: BRICS DECK: Part 2: PMIs, Investment and Inflation

In a recent post (http://trueeconomics.blogspot.com/2018/05/3518-brics-deck-2018-imf-updates.html) I have provided top level analysis of growth dynamics in the BRICS economies based on the IMF WEO April 2018 update. Here is the section of my BRICS deck with updated view on PMIs, Aggregate Investment and Inflation:

8/5/18: Law of Unintended Consequences and Complexity: Tax Cuts and Jobs Act 2017

The law of unintended consequences (or second order effects, as we call in economics) is ironclad: any policy reform has two sides to the coin, the side of forecasted and analyzed changes the reform engenders, and the side of consequences that appear after the reform has been enacted. The derivative proposition to this theorem is that the first side of the coin is what gets promoted by politicos in selling the reform, while the other side of the coin gets ignored until its consequences smack you in the face.

Behold the U.S. Tax Cuts and Jobs Act 2017, aka Trump's Tax Cuts, aka GOP's Gift for the Rich, aka... whatever you want to call it. Fitch Ratings recently released their analysis of the Act's unintended consequences, the impact the new law is likely to have on U.S. States' fiscal positions. And it is a tough read (see full note here: https://www.fitchratings.com/site/re/10025493).

"Recently enacted federal tax changes (H.R.1) are making budgeting and revenue forecasting more complex for many U.S. state governments," says Fitch. "...provisions including the cap on SALT deductions are a likely trigger behind a spike in state revenue collections for the current fiscal year. In Massachusetts for example, individual income tax collections through January 2018 were up nearly 12% from the prior year, this after the commonwealth recorded just 3% annual growth in January 2017. Many states are seeing robust year-over-year gains in revenue collections, though this will likely amount to little more than a one-time boost with income tax collections set to level off for the rest of the fiscal year."

State tax revenues can increase this year because, for example, of reduced Federal tax liabilities faced by households. As income tax at federal level falls, State tax deductions taken by households on their personal income for Federal tax liabilities will also fall, resulting in an increase in tax revenues to the States. Similarly, as Federal corporate income tax falls, and, assuming, corporate income rises, States will be able to collect increased revenues from the corporate activity domiciled in their jurisdictions. All of this implies higher tax revenues for the States. Offsetting these higher tax revenues, the Federal Government transfers to the individual states will likely decline as deficits balloon and as Pentagon demands an ever-greater share of Federal Budget.

In other words, the tax cuts are working, but do not expect these to continue working into the future. Or put differently, don't spend one-off revenue increases, folks. For high-spending States, like California, it is tempting to throw new money onto old bonfires, increasing allocations to public pensions and state hiring programs. But 2017 Tax Reform is a combination of permanent and temporary measures, with the latter more dominant than the former. Expiration of these measures, as well as complex interaction between various tax measures, suggest that the longer term effect of the Act on States' finances is not predictable and cannot be expected to remain in place indefinitely.

As Fitch noted: "Assessing the long-term implications of H.R. 1 will not be an easy task due to the complicated interrelationships of the law changes and because many of the provisions are scheduled to expire within the next decade. Yet-to-be finalized federal regulations around the tax bill and the possibility of additional federal legislation add more complexity and risk for states."

8/5/18: Germany's ifo: World Economic Climate Deteriorates

Here is the summary of the Germany's ifo Institute World Economic Climate outlook update (emphasis is mine):

"The ifo World Economic Climate has deteriorated. The indicator dropped from 26.0 points to 16.5 points in the second quarter, returning to more or less the same level as in the fourth quarter of 2017. Experts’ assessments of the current economic situation remained as favourable as last quarter, but their expectations are far less optimistic. The world economy is still experiencing an upturn, but it is losing impetus.

The economic climate deteriorated in nearly all regions. Both assessments of the current economic situation and expectations fell significantly in the USA. In the European Union, Latin America, the CIS countries, the Middle East and North Africa economic expectations also cooled down. Assessments of the current economic situation, by contrast, improved. Economic expectations also clouded over in the Asian emerging economies and developing countries. Assessments of the current economic situation, by contrast, remained more or less unchanged.

In line with rising inflation expectations, short and long-term interest rates will rise over the next six months. Experts also expect far weaker growth in world trade, partly because they are reckoning with higher trade barriers. Overall, experts expect world gross domestic product to increase by 3.9 percent this year."

This is in line with my recent warnings on the pressures building up in the global economy, as raised in a series of recent articles for the Sunday Business Post see http://trueeconomics.blogspot.com/2018/04/27418-global-growth-and-irelands.html and http://trueeconomics.blogspot.com/2018/02/27218-volatility-uncertainty-are-back.html, and for the Cayman Financial Review see: http://trueeconomics.blogspot.com/2018/04/27418-goldilocks-economy-of-state.html.

3/5/18: BRICS Deck 2018: IMF Updates

The first part of my slidedeck on BRICS economies, covering headline growth and macro performance dynamics and forecasts from the IMF WEO database:

3/5/18: Irish Exchequer Returns: April 2018

My article on Irish Exchequer returns for April 2018 is now available on Sunday Business Post site: https://www.businesspost.ie/business/no-fiscal-panic-yet-figures-highlight-tax-uncertainty-spending-weaknesses-415535.

28/4/18: Unintended Consequence of Tax Audits

The law of unintended consequences applies to all policies and all state systems design, including tax policies, tax laws and tax enforcement. This is a statement of truism. And it  works both ways. A well-designed policy to promote income supports and aligned incentives to work, for example, can have an unintended impact of increasing fraud. Conversely, a measure to enforce the policy to prevent fraud can result in undoing some of the positive impacts of the policy which it was designed to deliver. These statements are also a form of truism.

However, rarely do we see research into the unintended consequences of core tax policies delivering a negative view of the perceived wisdom of regulators and enforcers. Instead, we tend to think of tax laws enforcement as an unquestionable good. Fraud and tax evasion prevention are seen as intrinsically important to the society, and the severity of penalties and punishments imposed on non-compliance (whether by error or design) is seen as being not only just, but pivotal to the sustainability of the entire tax system. Put differently, there is an inherent asymmetry in the relationship between tax payers and tax enforcers: the former face potentially devastating penalties for even minor infringements, while the latter face zero cost for wrongfully accusing the former of such infringements. Tax audits are free of consequences to enforcers, and tax audits are of grave consequences to those being audited.

In this environment, tax audits can lead to severe distortions in the balance of intended and unintended consequences of the tax law. Yet, rarely such distortions are considered in the academic literature. The prevalent wisdom that the tax authorities are always right to audit and severely punish lax practices is, well, prevalent.

One recent exception to this rule is a very interesting paper, titled “Tax Enforcement and Tax Policy: Evidence on Taxpayer Responses to EITC Correspondence Audits” by John Guyton, Kara Leibel, Dayanand S. Manoli, Ankur Patel, Mark Payne, and Brenda Schafer (NBER Working Paper No. 24465, March 2018).  Five of the six authors work for Uncle Sam in either IRS or Treasury.

The paper starts by explaining how EITC audits work. "Each year, the United States Internal Revenue Service (IRS) sends notices to selected taxpayers who claim Earned Income Tax credit (EITC) benefits to request additional documentation to verify those claims." Worth noting here, that IRS' EITC audits are the lowest cost audits from the point of view of the taxpayers who face them: they are based on email exchanges between IRS and the audited taxpayer and request pretty limited information. In this, the EITC audits should create lower unintended consequences in the form of altering taxpayers' behavior than, say, traditional audits that require costly engagement of specialist accountants and lawyers by the taxpayers being audited.

So, keep in mind, fact 1: EITC audits are lower cost audits from taxpayer's perspective.

The study then proceeds to examine "the impacts of these correspondence audits on taxpayer behavior." The study specifically focuses on the labor market changes in response to audits. Now, in spirit, EITC was created in the first place to incentivise greater labor force participation and work effort for lower income individuals. The authors describe the EITC as "the United States’ largest wage subsidy antipoverty program."

Thus, keep in mind, fact 2: EITC was created to improve labor supply choices by lower income individuals.

As noted by the authors, "because these correspondence audits often lead to the disallowance of EITC benefits for many individuals, we are able to examine how the disallowance of EITC benefits affects individuals’ labor supply decisions." The authors use audits data for 2010-2012 and have accompanying administrative data for 2001-2016, so the "data allow for analysis of short-term changes in behaviors one year after the audit, as well as persistent or longer-term changes in behaviors up to six years after the audit".

The study "results indicate significant changes in taxpayer behavior following an EITC correspondence audit. In the year after being audited, we estimate a decline in the likelihood of claiming EITC of roughly 0.30, or 30 percentage points. The decrease in the likelihood of claiming EITC benefits persists for multiple years after the EITC correspondence audits, although the size of the effect is reduced over time." In year four, the likelihood of audited EITC filers still filing EITC claims is 1/4 of that for non-audited higher risk EITC filers.

Now, logical question is: was the decrease down to audits weeding out fraudulent claims? The answer is, not exactly. "Much of the decline in claiming EITC benefits following an EITC correspondence audit appears driven by decreases in the likelihood of filing a tax return." Authors suggest that 2/3rds of the decline in EITC filings post-audit is down to taxpayers stopping filing any tax returns post-audit. Which means that even some of the taxpayers who continue to file returns post-EITC audit are dropping out of EITC system.

Audits seem to trigger reductions in tax liabilities post-audit for self-employed taxpayers (ca $300 in a year following the audit) and no changes in tax liabilities post-audit for wage earners. This suggests that post-audit reported incomes either fall (for the self-employed) or remain static for those in employment. This, in turn, suggests that EIDC audits do not lead to improvements in income status for those audited by the IRS. In other words, audits do not reinforce or improve the stated objectives of EITC (see fact 2 above).

"For the Self-Employed, we estimate an increase in labor force participation (where labor force participation is defined in terms of having positive W-2 wage earnings), possibly indicating some reallocation of labor supply from self-employment to wage employment. In contrast, for Wage Earners, we estimate a decrease in labor force participation following the EITC correspondence audits."

Thus, we have fact 4: self-employed are likely to switch their income from self-employment to wages post-audit, while wage earners tend to drop their labor force participation post-audit.

The former part of fact 4 suggests can be reflective of fraudulent behavior by some self-employed who might over-state their self-employment income prior to audit in order to draw EIDC tax credits. The latter effect, however, clearly contravenes the stated objective of the EIDC system. On the first point, quick clarification via the authors of the study:"Intuitively, some lower-income individuals may increase reported self-employment (non-third-party verified) income, possibly by choosing to disclose more income, invent income, or not disclose expenses, to claim the EITC, but if they are detected by audit, they may become averse to inventing self-employment income for purposes of claiming EITC and without this income they may not file a tax return. These taxpayers may perceive the payoff from not filing as better than the payoff from filing and correctly reporting income."

Now, one can think of the effect on self-employment to be a relatively positive one. "Following the disallowance of EITC benefits due to an EITC correspondence audit, taxpayers with self-employment income on their audited returns appear more likely to have wage earnings in the next year, perhaps to offset the loss of EITC as a financial resource." But that is only true if we consider self-employment as a substitute for employment. In contrast, if self-employment is viewed as potentially entrepreneurial activity, such substitution harms the likelihood of entrepreneurship amongst lower earners. The study does not cover this aspect of the enforcement outcomes.

In measured terms, if EITC audits were successful in reinforcing EITC intended objectives, post-audits, we should see increases in wages and earnings for EITC audited individuals. Thus, we should see migration of lower earners EITC recipients to higher earners. Put differently, the share of higher earners within EITC eligible population should rise, while the share of lower earners should fall.

This is not what appears to be happening. Instead, we see increase in density (share) of lower earnings and slight decreases in densities of higher earnings:

Unambiguously, however, the study shows the damaging effects of audits: they tend to reduce labor force participation, offsetting the intended positive effects of the EITC program, and they tend to increase income tax non-filing, effectively pushing taxpayers into a much graver offence of income tax non-compliance.

Yet, still, we continue to insist that punitive, aggressive audit practices designed to impose maximal damage on tax codes violating taxpayers is a good thing. There has to be a more effective way to enforce the tax codes than throwing pain of audits around at random.

28/4/18: The Great Recovery with No Savings: U.S. Households' Meet 'Exceptionalism'

Via @bySamRo, a chart from Deutsche Bank research:

Which, of course, illustrates the marvels of the current 'recovery' cycle - a steady rise in the proportion of U.S. households with no wealth. More than 30 percent of all U.S. households have zero or negative non-housing wealth.

To pair this with other data, here is the U.S. household saving rate:

And here are the median saving account levels by age:

Not scared yet? Ok, here's another fact: according to Bankrate's financial security index survey, released in January 2018, only 39 percent of Americans said they would be able to finance a $1,000 emergency spending using their savings. In 2016, a survey found that 69 percent of Americans had less than USD1,000 in savings, while 34 percent had zero savings.

A dental emergency, even with a dental insurance coverage, can knock a good half of 69 percent of the U.S. households into zero savings territory. Credit cards and personal loans are de facto shoring up the Great American Dream for the vast swathes of the middle classes. Some 'exceptionalism', folks...

27/4/18: The Goldilocks Economy of State Policies

My column for the current issue of the Cayman Financial Review is out: http://www.caymanfinancialreview.com/2018/04/19/the-goldilocks-economy-of-state-policies/.

27/4/18: Global growth and Ireland's prospects: 2018-2019

My article for last weekend's edition of Sunday Business Post on the implications of peak cycle in global growth for Ireland: https://www.businesspost.ie/business/risks-global-growth-cloud-irelands-future-414819.

25/4/18: 90 years of Volatility: VIX & S&P

A great chart from Goldman Sachs via @Schuldensuehner showing extreme events in markets volatility using overlay of VIX and realised volatility from 1928 on through March 2018:

For all risk / implied risk metrics wonks, this is cool.

25/4/18: Draining of the Washington Swamp Reveals Mulvaney

Quote of the month, if not of the year, belongs to yet another Trump Administration 'draing the swamp hero, Mick Mulvaney, currently the White House budget director and, according to some rumours, a prime candidate to be the next Chief of Staff. Speaking at the American Bankers Association, Muvaney, who previously served as a Congressman declared: "We had a hierarchy in my office in Congress. If you're a lobbyist who never gave us money, I didn't talk to you. If you're a lobbyist who gave us money, I might talk to you."

So here we have it, folks: top Trump official claiming on the record to have engaged in a cash-for-influence peddling, the very same offence that Trump campaign routinely accused the Clinton Foundation of.

That is some draining of the Washington swamp that President Trump accomplished. Right there, in swamp's prime dweller's own words.

Link to the quote: http://www.businessinsider.com/mick-mulvaney-tells-bankers-donate-to-congress-for-influence-2018-4.

As an aside, Pew Research data shows that the American people, by a large majority, are aware of the deep corruption in Washington. "Americans think that those who donate a lot of money to elected officials have more political influence than others. An overwhelming majority (77%) supports limits on the amount of money individuals and organizations can spend on political campaigns and issues. And nearly two-thirds of Americans (65%) say new laws could be effective in reducing the role of money in politics." (see http://assets.pewresearch.org/wp-content/uploads/sites/5/2018/04/26140617/4-26-2018-Democracy-release.pdf).

One the results: "Overall, nearly six-in-ten Americans (58%) say democracy in the United States is working very or somewhat well, though just 18% say it is working very well. Four-in-ten say it is working not too well or not at all well."

Any surprise, when the likes of Mulvaney are running public offices?

25/4/18: Dombret on the Future of Europe

An interesting speech by y Dr Andreas Dombret, Member of the Executive Board of the Deutsche Bundesbank, on the future of Europe, with direct referencing to the issues of systemic financial risks (although some of these should qualify as uncertainties) and resilience of the regulatory/governance systems (I wish he focused more on these, however).

https://www.bis.org/review/r180226b.pdf (Links to an external site.)

25/4/18: Tesla: Lessons in Severe and Paired Risks and Uncertainties

Tesla, the darling of environmentally-sensible professors around the academia and financially ignorant herd-following investors around the U.S. urban-suburban enclaves of Tech Roundabouts, Silicon Valleys and Alleys, and Social Media Cul-de-Sacs, has been a master of cash raisings, cash burnings, and target settings. To see this, read this cold-blooded analysis of Tesla's financials: https://www.forbes.com/sites/jimcollins/2018/04/25/a-brief-history-of-tesla-19-billion-raised-and-9-billion-of-negative-cash-flow/2/#3364211daf3d.

Tesla, however, isn't that great at building quality cars in sustainable and risk-resilient ways. To see that, consider this:

1. Tesla can't procure new parts that would be consistent with quality controls norms used in traditional automotive industry: https://www.thecarconnection.com/news/1116291_tesla-turns-to-local-machine-shops-to-fix-parts-before-theyre-installed-on-new-cars.
2. Tesla's SCM systems are so bad, it is storing faulty components at its factory. As if lean SCM strategies have some how bypassed the 21st century Silicon Valley: http://www.thedrive.com/news/20114/defective-tesla-parts-are-stacked-outside-of-california-machine-shop-report-shows.
3. It's luxury vehicles line is littered with recalls relating to major faults: https://www.wired.com/story/tesla-model-s-steering-bolt-recall/. Which makes one pause and think: if Tesla can't secure quality design and execution at premium price points, what will you get for $45,000 Model 3?
4. Tesla burns through billions of cash year on year, and yet it cannot deliver on volume & quality mix for its 'make-or-break' Model 3: http://www.thetruthaboutcars.com/2018/04/hitting-ramp-tesla-built-nearly-21-percent-first-quarter-model-3s-last-week/.
5. Tesla's push toward automation is an experiment within an experiment, and, as such, it is a nesting of one tail risk uncertainty within another tail risk uncertainty. We don't have many examples of such, but here is one: https://arstechnica.com/cars/2018/04/experts-say-tesla-has-repeated-car-industry-mistakes-from-the-1980s/ and it did not end too well. The reason why? Because uncertainty is hard to deal with on its own. When two sources of uncertainty correlate positively in terms of their adverse impact, likelihood, velocity of evolution and proximity, you have a powerful conventional explosive wrapped around a tightly packed enriched uranium core. The end result can be fugly.
6. Build quality is poor: https://cleantechnica.com/2018/02/03/munro-compares-tesla-model-3-build-quality-kia-90s/.  So poor, Tesla is running "reworking" and "remanufacturing" poor quality cars facilities, including a set-aside factory next to its main production facilities, which takes in faulty vehicles rolled off the main production lines: https://www.bloomberg.com/view/articles/2018-03-22/elon-musk-is-a-modern-henry-ford-that-s-bad.
7. Meanwhile, and this is really a black eye for Tesla-promoting arm-chair tenured environmentalists, there is a pesky issue with Tesla's predatory workforce practices, ranging from allegations of discrimination https://www.sfgate.com/business/article/Tesla-Racial-Bias-Suit-Tests-the-Rights-of-12827883.php, to problems with unfair pay practices https://www.technologyreview.com/the-download/610186/tesla-says-it-has-a-plan-to-improve-working-conditions/, and unions busting: http://inthesetimes.com/working/entry/21065/tesla-workers-elon-musk-factory-fremont-united-auto-workers.  To be ahead of the curve here, consider Tesla an Uber-light governance minefield. The State of California, for one, is looking into some of that already: https://gizmodo.com/california-is-investigating-tesla-following-a-damning-r-1825368102.
8. Adding insult to the injury outlined in (7) above, Tesla seems to be institutionally unable to cope with change. In 2017, Musk attempted to address working conditions issues by providing new targets for fixing these: https://techcrunch.com/2017/02/24/elon-musk-addresses-working-condition-claims-in-tesla-staff-wide-email/. The attempt was largely an exercise in ignoring the problems, stating they don't exist, and then promising to fix them. A year later, problems are still there and no fixes have been delivered: https://www.buzzfeed.com/carolineodonovan/tesla-fremont-factory-injuries?utm_term=.qa8EzdgEw#.dto7Dnp7A. Then again, if Tesla can't deliver on core production targets, why would anyone expect it to act differently on non-core governance issues?

Here's the problem, summed up in a tight quote:

Now, personally, I admire Musk's entrepreneurial spirit and ability. But I do not own Tesla stock and do not intend to buy its cars. Because when on strips out all the hype surrounding this company, it's 'disruption' model borrows heavily from governance paradigms set up by another Silicon Valley 'disruption darling' - Uber, its financial model borrows heavily from the dot.com era pioneers, and its management model is more proximate to the 20th century Detroit than to the 21st century Germany.

If you hold Tesla stock, you need to decide whether all of the 8 points above can be addressed successfully, alongside the problems of production targets ramp up, new models launches and other core manufacturing bottlenecks, within an uncertain time frame that avoids triggering severe financial distress? If your answer is 'yes' I would love to hear from you how that can be possible for a company that never in its history delivered on a major target set on time. If your answer is 'no', you should consider timing your exit.

19/4/18: Geopolitical Risk: Who Cares?..

Geo-political risks, geo-shmalitical risks... who cares... not the markets...

None of the geopolitical risks registered on S&P 500 companies reporting radar according to Factset in 1Q 2018 https://insight.factset.com/more-than-half-of-sp-500-companies-citing-positive-impact-from-fx-on-q1-earnings-calls.  This is not very surprising as majority of earnings for 1Q accumulated before any spikes in these, and as "Tariffs" category probably absorbed the 'China' effect. Notably, however, earnings were impacted adversely by trade conflict and cyber risks (total of 3/25 companies impacted).

15/4/18: US Trade Wars and the Global Economy

My interview for Icelandic TV on the threat of trade wars led by the U.S. :http://www.visir.is/section/MEDIA99&fileid=VTV094E2C7D-0F20-48CA-ADB4-8F8515C4B1E7

15/4/18: EuromoneyCountryRisk 1Q 2018 report

Euromoney Country Risk 1Q 2018 report (gated link) is out, quoting, amongst others, myself on geopolitical and macroeconomic headwinds to global economic growth:

Two interesting tables/charts:

My quote:

11/4/18: Social Mobility in the U.S.: Another Chunk of the Facade Goes Down

Via @QZ - share of young Americans living with parents and grandparents is now back to the WW2 levels:

Source: https://qz.com/1248081/the-share-of-americans-age-25-29-living-with-parents-is-the-highest-in-75-years/

No kidding. 33 trillion dollars of economic rescues/stimuli/QE etc and the Great Recovery, the Bull Economy, the Zero Unemployment Goldilocks Era, the MAGA thingy all are a straight line up to rising rates of inter-family subsidies.

11/4/18: Sand Castles of Local Government Regulations in U.S. Property Markets

A new paper, "Sand Castles Before the Tide? Affordable Housing in Expensive Cities" by Gabriel Metcalf in the Journal of Economic Perspectives (Volume 32, Number 1—Winter 2018—Pages 59–80, https://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.32.1.59) looks at evolution of house prices in the major urban areas of the U.S. where "the demand for housing is growing at a much faster rate than the supply. These so-called “superstars” include New York City, Boston, Washington, DC, San Francisco, Los Angeles, Seattle, and Denver (Gyourko, Mayer, and Sinai 2013)."

These cities have "a seemingly permanent crisis of affordable housing," despite the fact that "...policymakers expend great amounts of energy trying to bring down housing costs with subsidies for affordable housing and sometimes with rent control. But these efforts are undermined by planning decisions that make housing for most people vastly more expensive than it has to be by restricting the supply of new units even in the face of growing demand."

The author provides an interesting data summary for these cities. Table 2 in the paper reports the proportion of housing units that are price-controlled or subsidised:

Of all cities areas covered, only one - Dallas - has unregulated rental market share of >50% of the total supply. Put differently, in all but one cities, subsidised and/or rent-controlled housing accounts for more than 50% of the total rental market. Only four out of 11 cities have owner-occupied housing share of the overall property market in excess of 50%.

The rest of the paper proceeds to tell us all the possible reasons as to why this capture of the property markets by price fixing and state ownership is just not enough.  Some of these reasons and arguments are not bad. Some are simply the dogmatic rehashing of the traditional Government-will-solve-everything mantra. That said, the section on the effects of poor regulation (not in quantity, but quality) of the housing markets is spot on and worth reading.

The author first tackles the issue of zoning regulations, arguing (correctly, imo) that zoning regulations both restrict supply and distort types of supply away from what is needed in addressing affordable housing shortages. The section is very brief.

The same applies to the housing approval process, that, according to the author, can result in "more uncertainty and greater risk" which result "a higher cost of capital. Longer approval processes translate into higher carrying costs for the land... Perhaps the greatest negative impact of an uncertain and hyperpoliticized entitlement process is that it functions as a barrier to entry for developers and investors into a market. The net effect is to reduce competition among developers."

"The fourth type of local regulation on housing development is financial: fees and exactions... if the rules are inherently unpredictable and changeable, it is nearly impossible to bid rationally on land, which inevitably drives up the cost of capital, and results in inefficient outcomes. ...the market price for housing has to remain high enough to cover the cost of the fees and exactions, so these function as a price floor that keeps housing more expensive than it otherwise would be."

In summary, and I find myself in agreement with author on this, "For the country as a whole, the restrictive housing policies of the cities in expensive metro areas leads to the segregation of the wealthy into zoned enclave communities; a reduced ability of lower-income people to move to areas of higher opportunity; a diversion of enormous wealth into rent-seeking behavior by landowners; and a decrease in economic productivity for the country as a whole, because labor is not able to be allocated to the most productive economic clusters".

The article provides a good summary and some good insights into potential solutions to the problems summarised above and to the phenomenon of the failure in collective action that occurs between city-level Government policies and those of the wider (commutable) metropolitan areas.

One thing that is, however, clear that housing affordability in major cities has not been meaningfully supported by the already extensive regulatory, price control and subsidy-providing systems. The idea that rent controls can offset bad regulatory and permissioning, as well as financial charging policies is simply not supported by the evidence provided for the largest and growing cities in the U.S.

9/4/18: Some evidence on Chinese tech & IP practices

Not being a fan of the current U.S. Presidential Administration (easy enough to confess to that, being a libertarian), and not being a fan of trade wars (even easier to confess to that, being a libertarian), I must note that the U.S. does indeed have a serious and legitimate problem with Chinese long-term industrial and economic development strategies.

And the U.S. is not alone in that, for Europe - a major engine of innovation, and to a lesser extent, Japan and South Korea, as well as pretty much every other nation injecting new technologies into the modern global economy - also have the same China problem. That problem is: Chinese State policy-linked practices of predatory technology transfers from the Western companies to Chinese markets and industries.

How do we know? Well, besides the Chinese own strategic approach to demanding technology transfers by global multinationals and other innovating firms alike as a ticket to accessing the Chinese markets, we also have empirical studies that attempt to capture data on the West-to-China technology leakages.

Here is one. "International Joint Ventures and Internal vs. External Technology Transfer: Evidence from China" authored by Kun Jiang, Wolfgang Keller, Larry D. Qiu, and William Ridley and released as the  NBER Working Paper No. 24455 (March 2018: http://www.nber.org/papers/w24455) used "administrative data on all international joint ventures in China from 1998 to 2007—roughly a quarter of all international joint ventures in the world".

The authors found that:

1) "... Chinese firms chosen to be partners of foreign investors tend to be larger, more productive, and more likely subsidized than other Chinese firms". In other words, your technology partner in China is more likely to be a State-connected firm.

2) "... there is substantial technology transfer both to the joint venture and to the Chinese joint venture partner". In other words, technology transfers leak within joint ventures - your partner in China is your first channel for losing intellectual property control.

3) "... with technology spillovers typically outweighing negative competition effects, joint ventures generate on net positive externalities to other Chinese firms in the same industry. Joint venture externalities are large, perhaps twice the size of wholly-owned FDI spillovers, and it is R&D-intensive firms, including the joint ventures themselves, that benefit most from these externalities". In other words, your technology feeds Chinese partners, although it benefits your joint venture too.

4) "... external effects from joint ventures are highest in R&D-intensive industries, and the largest externalities tend to arise in industries with a large concentration of joint ventures with a U.S. partner". In other words, if you are bringing into an joint venture an R&D intensive technology, your impact on diffusing your own intellectual property to broader Chinese markets will be greater.

To sum all of this up: over the period 1998-2007, China-based international joint ventures involving R&D intensive, technology-rich foreign partners acted as effective channels for diffusion of new, predominantly Western, but also Japanese and Korean, technologies into the Chinese markets. Which would be fine, if it were not driven by the direct dictate from Beijing.

8/4/18: U.S. economy: entrepreneurship is not 'the new thing' outside Academia

These days, every business school on every university campus is sporting a burgeoning post-graduate program in Entrepreneurship. And this trend is driven by the perceived - and often hyped up by the media and by business futurists - rise in entrepreneurship in the modern society. Apparently, allegedly, an increasing proportion of today's business students want to start their own businesses (despite the fact the vast majority have never worked in a start-up and have no expertise to run one). The new dynamism of the economy, the college-to-start up model of business education, the 'can do' attitude (or aspirations) are all part and parcel of the mythological creature that is the New Economy.

In reality, of course, brutally put, there is no evidence of rising demand for entrepreneurship. And, worse, in fact, there has been a dramatic decline in entrepreneurial rates in the U.S. economy:

Source: http://rooseveltinstitute.org/wp-content/uploads/2018/03/Powerless.pdf.

Now, consider the two data series above, together: firm entry (new firms creation) and firm exist rates. As the blue line trended down, rapidly, without a pause, the green line remained relatively flat. Which means that the ratio of entries to exits has fallen over the time, pretty dramatically. In the 1970s and 1980s, firms entries had, on average been more frequent and less likely to be associated with higher firm exits. In the 1990s,  both relationship deteriorated. In the 2000s, both literally went down the drain.

So as the rate of new businesses additions went down, the rate of old businesses exiting did not change that much. So much for dynamism and for 'entrepreneurial spirits' of the young. The start ups mythology is strong. But the reality of the U.S. economy is that of concentration, market power, monopolization and decline of entrepreneurship. Funny thing, how Silicon Valley propaganda works, right?

How do we know the bit about monopolization? Why, look at profit share of output:

Still want to build up that 'entrepreneurship program' in the University? Because students want to learn about starting their own businesses? Should you really think twice?

8/4/18: Tail Risk and Liquidity Risk: What about that Alpha?

An interesting data set that illustrates two key concepts relating to financial returns, covered extensively in my courses:

1. Liquidity risk factor - inducing added risk premium on lower liquidity assets; and
2. The importance of large scale corrections in long term data series (geometric vs arithmetic averaging for returns)

Indirectly, the above also indicates the ambiguous nature of returns alpha (also a subject of my class presentations, especially in the Applied Investment & Trading course in MSc Finance, TCD): micro- small- and to a lesser extent mid-cap stocks selections are often used to justify alpha-linked fees by investment advisers. Of course, in all, ranking in liquidity risks helps explain much of geometric returns rankings, while across all, geometric averaging discount over arithmetic averaging returns helps highlight the differentials in tail risks.

Sounds pretty much on the money.