Sunday, January 23, 2011

Fukuyama discovers Deleuze

Francis Fukuyama can be a thoughtful guy (The End of History screwed the pooch in spectacular fashion, but Trust was really interesting).  Here he reflects on the differences between governance in China and the US.

Nonetheless, the quality of Chinese government is higher than in Russia, Iran, or the other authoritarian regimes with which it is often lumped – precisely because Chinese rulers feel some degree of accountability towards their population. That accountability is not, of course, procedural; the authority of the Chinese Communist party is limited neither by a rule of law nor by democratic elections. But while its leaders limit public criticism, they do try to stay on top of popular discontents, and shift policy in response. They are most attentive to the urban middle class and powerful business interests that generate employment, but they respond to outrage over egregious cases of corruption or incompetence among lower-level party cadres too.

However, if the democratic, market-oriented model is to prevail, Americans need to own up to their own mistakes and misconceptions. Washington's foreign policy during the past decade was too militarised and unilateral, succeeding only in generating a self-defeating anti-Americanism. In economic policy, Reaganism long outlived its initial successes, producing only budget deficits, thoughtless tax-cutting and inadequate financial regulation.

These problems are to some extent being acknowledged and addressed. But there is a deeper problem with the American model that is nowhere close to being solved. China adapts quickly, making difficult decisions and implementing them effectively. Americans pride themselves of constitutional checks and balances, based on a political culture that distrusts centralised government. This system has ensured individual liberty and a vibrant private sector, but it has now become polarised and ideologically rigid. At present it shows little appetite for dealing with the long-term fiscal challenges the US faces. Democracy in America may have an inherent legitimacy that the Chinese system lacks, but it will not be much of a model to anyone if the government is divided against itself and cannot govern. During the 1989 Tiananmen protests, student demonstrators erected a model of the Statue of Liberty to symbolise their aspirations. Whether anyone in China would do the same at some future date will depend on how Americans address their problems in the present.

The praise of China's ability to turn on a dime is nothing new, even though this does not make it any less praiseworthy -- their ability to make things happen simply because they make good economic sense is sometimes awe inspiring to me; it represents a level of cohesion that seems laughably distant in the US.  

What's more interesting here is how the arch-theorist (/apologist) of liberal democracy has started to add in a practical element to his analysis.  Maybe the details matter and history isn't over. However the think tanks label it, the reality on the ground marches on.  Maybe, just maybe, Hegel is bunk.  Maybe it's the mechanism that moves the spirit, and not just spirit sovereign and absolute playing charades with the world.

Should we call this (implicit) new idea the Forest Gump theory of legitimacy: Democracy is as democracy does?  Should we finally admit the what we're really interested in is not some grand theory but in analyzing the precise mechanism by which power is constructed and continually reconstructed every time it is obeyed?  If there is more effective feedback to this mechanism in "authoritarian" China than in the "democratic" United States, should we ship the statue of liberty to Shenzen instead?  

The question is facetious of course, but the idea of evaluating the government on the basis of its ability to process and respond to information -- or better yet, ultimately on its ability to facilitate information processing systematically and generate a coherent, consistent, outcome -- is a good direction to move this debate in.  Thankfully, wikileaks has already opened up new terrain in the theory of computational governance.

Switching Sides

One of the things I most enjoy about the current US relationship to China (and here I mean more our cultural and intellectual relationship, not simply our State department's diplomatic relationship) is the knack it has for dredging up ideological issues that confuse the fixed-in-stone left-right sides which constitute our country's stale parody of political debate.  

For example, in an irony Jeremy Grantham noted a while back, China is widely if warily admired in the business community, as if it were just another very large and successful business.  How did all these rabid free market types end up envying an economy run on the communist party's five year central planning?  

Today's twist is brought to you by Hu Jintao's recent visit:

As the two leaders stood side by side at a nationally televised news conference, he called on China to live up to human rights values that he said were enshrined in the Chinese Constitution, adding that Americans "have some core views as Americans about the universality of certain rights: freedom of speech, freedom of religion, freedom of assembly."

Mr. Hu, for his part, seemed to hearten White House officials by acknowledging that China had a ways to go on human rights issues. "China still faces many challenges in economic and social development," he said. "And a lot still needs to be done in China in terms of human rights."

Looking at a few other articles, you can already see it dawning on people that China treats a basic level of economic freedom, freedom from poverty at least, as a human right -- in fact, as perhaps the most basic human right.  So, "a lot needing to be done," here means doing a lot more to raise everyone's standard of living so that they don't remain forever locked to the land or the factory floor.  The mainstream left, in its clamor for "human rights in China", does not tend to sympathize with this much more radical point of view on human rights, which I associate with Chomsky's notion of anarchy (succinctly introduced in this video, by the way).  

Seeing a certain level of economic development as itself a form of freedom takes the left's question of human rights in a more radical but also more pragmatic direction.  The same thing happens to the debate about the wonders of the free market when you see representatives of the right acknowledging the productive role state involvement can play in practice.  I'm hardly saying that either side has found a solution to these problems, but I hopefully imagine that the rise of a (relatively) pacific new superpower could alter the terms enough to make progress.

Makes me wonder what happens to the political debate in China when they have to talk about the US.  

Tuesday, January 18, 2011

A Financial Allegory

Debt is a zero sum game where the debtor's liability is equal to the lender's asset.  

This makes debt akin to a game of musical chairs.  

Musical chairs can be a fun and exciting game to play if the number of chairs keeps increasing over time -- yes, there may still be those crazy moments where everyone scrambles for a chair, and in the fear and uncertainty some may even irrationally grab two or three at once, just to be on the safe side.  But in general, with more chairs, things will work themselves out pretty quickly even if the music stops.  Capitalism can be fun for the whole family!

Musical chairs is a lot less fun to play when people keep removing the chairs.

The following charts are taken from a recent Bank for International Settlements report on the interaction between balance sheet recession and demographic trends.  Looks like Chuck Prince is going to need to dance a lot faster in the future.

Tuesday, January 11, 2011

Circular Reasoning

Yesterday I read a report about the European Sovereign Somethingorother Fund (EFSF), one of many acronyms Ma Merkel assures us is set to ride to the rescue should the campaign to recolonize -- sorry, I mean rescue -- the PiIGS (Portugal, ireland, Italy, Greece and Spain) gets really hairy.  In includes the first chart, which details the respective contributions various European countries have made to this particular Deus Ex Machina, which represent $440b in total firepower.

This sounds like the big guns at first, but it turns out to be remarkably expensive to bail out even rinky-dink little countries like Greece and Ireland (and Portugal pretty soon).  For example, later in the report they give a breakdown of Ireland's recent $85b bailout.  About a quarter comes from raiding the country's pensions (65 year old Irish have just doubled down on Guinness), about a quarter comes from the EFSF, and the rest from the IMF and related alphabet soups.  The point being that Ireland is set to receive $22b out of this $440b, despite the fact that it contributed only $7b.  Of course, if they only got out what they put in, it wouldn't be a bailout.

But take a glance at the other chart, from this morning's WSJ, which has the CDS spreads on these countries' debt.  Credit Default Swaps are insurance the lenders can buy in case the guy they're loaning to skips town -- so this chart shows how everyone is confident that the Germans will pay their debt back, but increasingly less so for the rest of the dominoes.  Looking at this got me thinking about what the appropriate CDS spread for the EFSF itself would be.  After all, this is essentially a distressed bond fund like any other.  Each country agrees to put up the capital shown, and on the basis of this collateral, the fund will go out and borrow in the markets.  True to form, S&P and Moody's have blessed this structure with their kiss of death -- a perfect AAA rating -- so it's practically guaranteed to blow up.  Because the ratings agencies are walking on eggshells at this point, they did manage to extract a pound of flesh, and the fund will only be able to issue $367b worth of debt, so that the total sovereign guarantees backing it are 120% of the amount of bonds it can issue and subsequently use to make rescue loans.  That sounds safe, ¿right?

Look at what happens, though, when you try to bail out one of the big PiIGS.  Ireland gets $22b from the fund, Greece got $110b in total, and let's say that includes $28b from the fund, just to use the same breakdown between rescuers.  This means that Greece got between 2 and 3 times what they put in.  They haven't announced Portugal's package yet because they are still busy denying that it will need a bailout, but we can guess that if Portugal is about the same size as Greece (as measured by their contributions to the fund, which I'm assuming were calculated off of something like their respective contributions to eurozone GDP) it will get about the same amount of bailout.  So the little countries -- the P, the lower case i, and the G -- are eating up around $75b of capacity.  If the ratio of fund bailout to fund contribution hold at, say, 2.5 times, bailing out Spain would require $156b and Italy would cost $236b.

Let's see then:

$28 + $22 + $236 + $28 + $156 = $470 billion > $440 billion >> $367 billion

Hmmmm ...

Maybe we should be generous and assume that Italy won't need a bailout.  In that case, the fund would disburse $234b, or 64% of its total capacity to the 4 remaining borrowers.  However, given that it doesn't make much sense for Spain to try pulling itself up by its own bootstraps  (the last entity that crafted a successful program of loaning to itself was called Enron), there is a clause in the fund whereby a country being rescued is no longer liable for their contribution.  If Spain pulls out of its $52b commitment, the fund's available capacity would be reduced by 120% of this amount, leaving it with $388b nominally and around $305b of effective firepower, $234b of which (77%) would have been loaned to PiGS.  And that's not even adjusting for the guys who are exempt because they're already being bailed out (though they are smaller) Of course, theoretically Germany and France could just pony up more, but try telling the Germans and French that.

So now look at this bond fund from the perspective of an investor.  You loan these guys $440b, of which only $388b has a contingent guarantee that does not contain a political bomb, and they're going to go invest 60% of it in dodgy Southern European countries that have had huge property bubbles, face years of austerity budgets and wage deflation, and already have other sovereign debts about the same size as the GDP (not to mention private and financial sector debt, which we have seen migrates to the sovereign as a last resort).  I admit, you have some wiggle room.  You could probably get your money back if the losses to these guys were under 20%.  But what sort of credit spread would you demand for investing in this?  Where should the price of its own CDS fall in the continuum of that chart?

On second thought, I'm probably being just pessimistic.  I'm sure somebody will bail out the bailout.  So what could go wrong?

See and download the full gallery on posterous

UPDATE: Apparently, the Capitalist Axiomatic is not big in Japan.  Go figure.
Japan has pledged to buy more than 20 per cent of the eurozone’s first ever bond issue, raising expectations that other international investors will support the pioneering fund-raising move and help ease the region’s debt crisis.
The European financial stability facility, the €440bn ($570bn) eurozone bail-out fund, is marketing its first bond issue of up to €5bn among investors in Europe, the US and Asia. Bankers close to the deal are confident of attracting support from sovereign wealth funds in China, Norway and the Middle East.

Saturday, January 8, 2011

Japan Inc.

The other day, the FT ran a comment that put a very different spin on the last 20 years in Japan:

Is Japan the most successful society in the world? Even the question is likely (all right, designed) to provoke ridicule and have you spluttering over your breakfast. The very notion flies in the face of everything we have heard about Japan's economic stagnation, indebtedness and corporate decline.

Ask a Korean, Hong Kong or US businessman what they think of Japan, and nine out of 10 will shake their head in sorrow, offering the sort of mournful look normally reserved for Bangladeshi flood victims. "It's so sad what has happened to that country," one prominent Singaporean diplomat told me recently. "They have just lost their way."

It is easy to make the case for Japan's decline. Nominal gross domestic product is roughly where it was in 1991, a sobering fact that appears to confirm the existence of not one, but two, lost decades. In 1994, Japan's share of global GDP was 17.9 per cent, according to JPMorgan. Last year it had halved to 8.76 per cent. Over roughly the same period, Japan's share of global trade fell even more steeply to 4 per cent. The stock market continues to thrash around at one-quarter of its 1990 level, deflation saps animal spirits – a common observation is that Japan has lost its "mojo" – and private equity investors have given up on their fantasy that Japanese businesses will one day put shareholders first.

Certainly, these facts tell a story. But it is only partial. Underlying much of the head-shaking about Japan are two assumptions. The first is that a successful economy is one in which foreign businesses find it easy to make money. By that yardstick Japan is a failure and post-war Iraq a glittering triumph. The second is that the purpose of a national economy is to outperform its peers. 
If one starts from a different proposition, that the business of a state is to serve its own people, the picture looks rather different, even in the narrowest economic sense. Japan's real performance has been masked by deflation and a stagnant population. But look at real per capita income – what people in the country actually care about – and things are far less bleak. 

In a thought-provoking article in The New York Times last year, Norihiro Kato, a professor of literature, suggested that Japan had entered a "post-growth era" in which the illusion of limitless expansion had given way to something more profound. Japan's non-consuming youth was at the "vanguard of the downsizing movement", he said. He sounded a little like Walter Berglund, the heroic crank of Jonathan Franzen's Freedom, who argues that growth in a mature economy, like that in a mature organism, is not healthy but cancerous. "Japan doesn't need to be No 2 in the world, nor No 5 or 15," Prof Kato wrote. "It's time to look to more important things.

Devoted regular readers (allow me to briefly flatter myself) will realize that this idea that the state is not primarily about economic growth is an idea close to my heart.  I'm sure an interesting intellectual history could be written about the transition from Adam Smith's classic liberal critique of the state, to our current situation, where the rhetoric of endless growth has gotten deeply baked into all politics, regardless of where it locates itself on the left-to-right spectrum.    However, I won't bore you now with another rant about how growth is an outcome of functioning government, not a goal of it.  Come back tomorrow.

Today, I'm more interested in the way Japan is leading the rest of us.  This is the first big, developed economy to actually start facing up to a population that is past the steepest part of the S curve, and in fact even declining at this point.  And given that something about Japan's culture causes it to act as a closed system, which of course the earth ultimately is (excepting sunlight and the occasional meteor), I think it pays to look at their experience as a precursor.  As Kato puts it in that linked op-ed:

Freshly overtaken by China, Japan now seems to stand at the vanguard of a new downsizing movement, leading the way for countries bound sooner or later to follow in its wake. In a world whose limits are increasingly apparent, Japan and its youths, old beyond their years, may well reveal what it is like to outgrow growth.

When you put things this way, you can actually start to see Japan as a success story, which turns out to be one of Richard Koo's points. He argued that the ability to manage a bust of the scale of the bubble economy in 1990 without ending up in a depression should be counted as a major victory.  While his point was strictly macroeconomic, I think you can extend it a bit and see it as a political and social victory as well.  It's hardly a daring hypothesis to see their bust as, at least partially, a lagged effect of the dramatic step change in birth rate that happened in 1974, which would mean that what they really had to handle, at bottom, is the transition from an economy predicated on continual growth to one where a main driver of economic growth has flattened out.  In my mind, it's obvious that increasing debt makes perfect sense in the first system, but will only have a very limited role in the second.  But this deleveraging is just the macroeconomic indicator that gives a number to a much more profound transition.

If you keep going with this thought, you start to wonder whether the other obvious ways in which Japan is leading the rest of the world are related.  For example, is it all but inevitable that technology increasingly reigns supreme in a flat-population world?  The Japanese have long been leaders here, especially with the mobile stuff, and their fascination with robots fits into the same theme.  I don't want to engage in too much armchair sociology, and of course there are cultural differences that clearly play a role (ex hypothesi if we're trying to get at what happens in general to a closed system).  Still, we might consider it hopeful that those who have preceded us have, for all the difficulties encountered, been managing reasonably well if you look at the big picture and consider the scale of the problem.

Wednesday, January 5, 2011

Public and Private

With more time, one could write a lot about this question, but I just wanted to pass along a quick bit of commentary from John Battelle on the big financial news of the week: Facebook's decision to stay private.

Facebook is the greatest repository of data about people's intentions, relationships, and utterances that ever has been created. Period. And a company that owns that much private data should be accountable to the public. The public should be able to review its practices, its financials, and question its intentions in a manner backed by our collective and legally codified will. That's the point of a public company - accountability, transparency, and thorough reporting.
If Facebook wants to stay private and not be part of the social mores which we've built that govern major corporations (flawed though they may be), well I think that would be a major strategic blunder, one that would ultimately doom the company. It's fine for all sorts of companies to stay private, for all sorts of reasons. But a company like Facebook, with its unprecedented grasp of our social data, should be accountable to the public. If it isn't, we'll migrate our "social graphs" to a company that is.
If Zuckerberg doesn't want to be a public CEO and deal with the realities of that, as this Reuters piece argues, well, he should find a CEO who is willing to do the job.

I think this is absolutely a valid point.  Privately owned businesses are still part of a larger democratic system, and they shouldn't be able to hide from scrutiny if they become an important part of that system just because they are able to pull off some fancy financial shenanigans.  The reasons for having publicly regulated markets go beyond their usefulness to the companies that list on them. They serve to improve transparency in the overall economy, which improves price discovery, policy making, and strategic planning for everyone.  I don't know what size is too big to be private, because I haven't thought carefully about how to quantify the social benefits involved, but I'm
positive that Facebook is bigger than that.  

If your gut reaction is to disagree, I recommend you follow through, and only invest in countries where most of the big companies are sprawling family run conglomerates.  

Tuesday, January 4, 2011

This system of property rights works great!

From the 2009 10-K of Borders Group, a notorious not-quite-for profit making headlines for other reasons today.

In October 2009, U.S. Ethernet Innovations, LLC offered us an unsolicited license to 35 U.S. and foreign patents relating to Ethernet technology for a one-time fee of $3.0m, and implied that it would commence litigation if we do not accept the offer. We are evaluating the offer, as well as the amount of our potential exposure, which could be greater or less than $3.0m, if we do not accept the offer. We intend to seek indemnification from the relevant equipment vendors. We have not included any liability in our consolidated financial statements in connection with this matter and have expensed as incurred all legal costs to date. We cannot reasonably estimate the amount or range of possible loss, if any, at this time.