"Des waerelds doen en doolen, is maar een mallemoolen,"

"Des waerelds doen en doolen, is maar een mallemoolen," engraving from Het Groote Tafereel der Dwaasheid, 1720.

"The actions and designs of the world go round as if in a mill." South Sea bubble financial crisis.

Wednesday, November 9, 2011

Time of markets and time of politics

Krugman's Eurovenn, or notes reading Martin Wollf

Barclay's math says italy's down. Tyler Cowen posted a summary of Barclays Capital Inst sales:
1) At this point, it seems Italy is now mathematically beyond point of no return
2) While reforms are necessary, in and of itself not be enough to prevent crisis
3) Reason? Simple math--growth and austerity not enough to offset cost of debt
4) On our ests, yields above 5.5% is inflection point where game is over
5) The danger:high rates reinforce stability concerns, leading to higher rates
6) and deeper conviction of a self sustaining credit event and eventual default
7) We think decisions at eurozone summit is step forward but EFSF not adequate
8) Time has run out--policy reforms not sufficient to break neg mkt dynamics
9) Investors do not have the patience to wait for austerity, growth to work
10) And rate of change in negatives not enuff to offset slow drip of positives
11) Conclusion: We think ECB needs to step up to the plate, print and buy bonds
12) At the moment ECB remains unwilling to be lender last resort on scale needed
13) But frankly will have hand forced by market given massive systemic risk

Hint:Not Good.Sell EUR, Buy Gold
Bullet point number 8 points at the difference markets' and politics' time. Markets dynamics are on a different time level than politics. It takes longer to reach politically acceptable solutions, and even more longer to build institutions. This crisis speaks about a mismatch between financial systems and institutions and so the intersection between the later and what would be needed to solve the crisis is zero. 

Tuesday, November 8, 2011

It is NOT about inequality

The mechanisms that make economies create value are not based on equality, but cooperation. These are nicely explained in E.D. Beinhocker's book. Cooperation is crucial to the functioning of institutions (N. Fergusson's killer apps). Yet researchs point that fairness is a necessary element of cooperation. If some players feel the game is rigged, they simply want to end the game. S.F. Brosnan and F.B.M. de Wall showed that capuchin monkeys react the same way too:
Monkeys refused to participate if they witnessed a conspecific obtain a more attractive reward for equal effort, an effect amplified if the partner received such a reward without any effort at all. These reactions support an early evolutionary origin of inequity aversion. [...] People judge fairness based both on the distribution of gains and on the possible alternatives to a given outcome. Capuchin monkeys, too, seem to measure reward in relative terms, comparing their own rewards with those available, and their own efforts with those of others. They respond negatively to previously acceptable rewards if a partner gets a better deal. Although our data cannot elucidate the precise motivations underlying these responses, one possibility is that monkeys, similarly to humans, are guided by social emotions. These emotions, known as ‘passions’ by econom- ists, guide human reactions to the efforts, gains, losses and attitudes of others. Clearly if these reactions evolved to promote long- term human cooperation, they may exist in other animals as well.

Monday, November 7, 2011

Islamic finance watch

A good explanation of what a sukuk is provided by the Economist

A sukuk is structured to avoid the Islamic prohibition on interest payments. It manages this by paying bondholders with the cashflows generated by specific assets, which are put into a special-purpose vehicle (SPV) as part of the deal. Many seem to have thought that the bonds were “asset-backed”, giving them a claim on the assets in the event of a default. Most sukuk, however, are “asset-based”, handing investors ownership of the cashflows but not of the assets themselves. “Many sukuk holders have a perception that they hold a security that is collateralised,” says Anouar Hassoune of Moody’s, a rating agency. “In 90% of cases, that is incorrect.”

If the lionization of firms is unhelpful, how about gazelisation ?

The Mighty Middle by GOOD infographics

There has been a wave of skepticism against small firms. Charles Kenny exposes why support for SMEs in developed economies is not beneficial to the economy as a whole (but beneficial to politicians). Felix Salmon argues that lionizing small business is unhelpful. James Surowiecki compares the growth rate of different developed economies with more of less percentage of small firms:
The developed countries with the highest percentage of workers employed by small businesses include Greece, Portugal, Spain, and Italy—that is, the four countries whose economic woes are wreaking such havoc on financial markets. Meanwhile, the countries with the lowest percentage of workers employed by small businesses are Germany, Sweden, Denmark, and the U.S.—some of the strongest economies in the world.
These articles deserve a few comment. First, the debate over firm's size and growth started with D. Birch claiming that small firms generated a large share of net job creation. The literature on SMEs (here's an excellent review of it by Henrekson) and job generation separates now between "elephants" (large companies), "mices" (small one that tend to stay small) and "gazelles"(not nessarily small but fast growing). So it is not simply Big versus Small.  Second, the lacking component of this debate is the link with entrepreneurship. The praise of SMEs is attached to the notion developed economies have of it. Whereas a classification of firm's size is fixed in time, entrepreneurship as a concept captures a process. The benefits or disadvantages of small firms don't come exclusive from it size, but how the size relates to entrepreneurship and innovation, and the of "population" of firms. Perspectives from evolutionary economics would enrich the debate. Big is not necessarily better in evolutionary economics and you adaptive efficiency has to be taken into account. By te same token, as this study from Badudenko shows, reaching an optimal scale of production can be more important than technical efficiency.