On the bus

I think we have another winner here:

Two collegiate-looking dudes are arguing intensely in German: The translation stream in his glasses tells him they're arguing over whether the Turing Test is a Jim Crow law that violates European corpus juris standards on human rights.

BINGO!

Peter Orszag, formerly of the Office of Mangement and Budget, and now of Citigroup, has come up with a brand new system for encouraging savings in America: a savings lottery. 

In the quest to raise saving rates, this allure of lotteries may be quite helpful. To be sure, most of any increase in national savings will come from a reduction in budget deficits. But a secondary priority is higher household savings, especially among lower- and middle-income groups.

 

This is where prizes can help. A recent paper for the National Bureau of Economic Research laid out the case for a savings vehicle coupled to the opportunity of winning a large prize. One way to think of these "prize-linked" accounts is that they can offer an expected market return, but in an innovative way. They pay a guaranteed return below market interest rates, but also provide a lottery ticket whose value makes up the difference.

 

To be specific, a lottery-lined savings account could offer a lower rate of interest, but also say a one-in-a-million chance of winning $1m for each $100 deposited. Mathematically, the expected return is the same, but the chance to win $1m makes the account much more attractive.

What he fails to mention is exactly who is supposed to be running the lottery.  He does acknowledge that lots of states have lotteries now, and that the expected return is well below one (on average you "win" 50 cents by buying a one dollar lottery ticket).  And he mentions that if the state is running the lottery, this amounts to a form of regressive taxation because more poor people play, and lose, than do rich folks.  But then he sort of slips a gear and proposes his altruistic scheme where the expected return is equal to exactly one -- 1 million people put up $100 each, you take the resulting $100m and invest it a 2% return, and at the end of the year, you give everyone $101 back except for one lucky soul who receives $1m.  Very tidy.

But who is running this show I wonder.  The same state that already fleeces the guy in the food stamp line every week with the current lottery?  Or some more altruistic state that runs the whole thing like a small town raffle and skims nothing off the top? 

Assume NC starts a program like this and is giving you back, on average, $100 plus 2% interest, for every $100 you save.  It proves wildly popular and NY decides to copy it.  Only they realize that they might attract more people if the prize is $2m.  Naturally, in this case, after the prize, there's no money left over to pay everyone else their interest, but they still get back the $100 they saved.  Would people be more interested in this lottery?  The expected return is lower, but the prize is bigger.  How about NJ, who decides to offer $10m in prize money, and reasons that even with this princely sum, they will still be giving $92  back to the losers for every dollar.  That's not the end of the world, is it?  And the expected return is still exactly one.  And if these lotteries prove popular why wouldn't NM perk up to a chance to change things ever so slightly and give everyone $90 back, give away $10m, and just keep $2m for the guvna?  Wouldn't people play this lottery too?  They already play ones that are much less rewarding.  

So then what prevents a state from skimming a little?  And then the next from skimming a little more?  Until we reach the point where the odds are so bad that the it limits itself, which would represent something like the market price for the gambling instinct.  I mean, if the odds were worse, fewer people would play so they would raise less revenue but pay out less, and if the odds were better more people would play but they'd have to pay out more.  Don't states already set the odds on their lotteries to raise maximum revenue?  

I was joking, but now I'm kinda curious.

Anyhow, my point was just that we already have a household savings system linked to a lottery ticket, and we call it the stock market. The odds are most definitely rigged, but people still LOVE to play.  And the house, just like the state lottery, keeps a big chunk of the kitty.  Perhaps this accounts for Mr. Orszag proposing this scheme now that he has moved over to Citigroup.  It makes me feel terribly modern to know that the government could outsource corruption.

Mr. President, we must not allow a wine shaft gap!

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.  

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.

See and download the full gallery on posterous

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:

P+i+I+G+S

$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.