Wealth of nations

Looking at how the EU continues to struggle has made me wonder at the future of nations.  What will nations look like in a century?

Looking backwards -- nations increased their wealth by territorial expansion in the Middle Ages.  That continued with centuries of imperial domination of smaller nations.

By the 16th-17th century, a nation's wealth was measured by the size of its gold holdings. The mercantilist era favored gold over the more illiquid holding of land.

During the industrial era, a nation's value changed to be defined by its manufacturing. How much coal it mined, or how much steel it made, became more important than how much gold it had stored in its vaults.

For the last century, national wealth was directly linked to how its currency was

traded across the world's markets.

The USA gained enormous status when the dollar was accepted as the de facto currency after WW1 hurt the Pound, Franc, Mark. etc. And the devastation of Europe in WW2 gave the USA and the dollar enormous strength.

Now after decades of Keynesian banking, massive national debts have piled up for every nation.  What's next?

For the EU, the next step might be negative interest rates.  This was tried in a small way last year and the EU is currently limited by a "zero-bound" in pushing more gov stimulus via QE-style tricks.

Mario Draghi seemed to say this week that the ECB would take the next step to try to inflate the euro.  Like the US's Fed, the ECB has been printing lots of money but the huge influx of money hasn't sparked a recovery. The monetary pumping has failed.  Only central bankers complain about "too low" interest rates.

I think that if the ECB goes to a policy of negative interest rates, then lots of money now in EU banks will move out to other nations, most likely the USA and China. And the EU's euro will decline in power as an international currency.

3 Rules of Life

[Yep, the topic is ambitious and a bit pretentious, but what the heck.]

Rule 1: Life is uncertain
Multiple outcomes are possible everyday for everybody.  Some are good; some are bad.

This sounds obvious and trite.  Some people minimize the feelings caused of not knowing what will happen next by ignoring the uncertainties, by focusing on only one possible outcome, or by rejecting the uncertainties through a lifestyle without changes.

Rule 2: Uncertainty is probabilistic
Not al outcomes are equally likely.   Some are nearly 100% likely to happen. Will the sun rise tomorrow? Some are nearly 0%. Will you be hit by a falling piano? The hard cases are the ones in the middle. Will you get sick? Will you receive a telephone call?

All of the possible outcomes can be ranked by likelihood. However the ranking is difficult because people are poor at assigning probabilities. We have biases and our thinking is often faulty.  We confuse risks with probabilities.  Low-probability events with huge results are often viewed as more likely than high-probability events with small results.  People worry more about an earth-shattering asteroid (very low probability, but with fatal results) than stubbing your toe (higher probability, but a recoverable injury).

Uncertainty is often not independent.  Events might be chained.  A Bayesian logic might apply. One thing does lead to another.  Increasing one uncertainty, such as speeding in a car, can lead to other uncertainties.

Rule 3: The rules change
Even recognizing the inherent uncertainty of life and understanding the varying likelihoods of them, the last rule is that reality throws curveballs.  Or as in the quote of Donald Rumsfeld, there are "unknown unknowns".

Fourth branch of government?

Two federal courts ruled today on Obamacare.

First, the US District Court of Appeals ruled that the federal exchange subsidies are illegal. Later in the day, the Fourth Circuit Court of Appeals ruled that the IRS could issue subsidies in the federal exchange.

The Fourth Circuit said the Act's language was “ambiguous” but deferred to the IRS to implement the law according to how the agency decides.


As a result of the conflicting rulings, the cases look to be heard by the Supreme Court. This may open the door to a wide challenge to several laws.

Several recent laws (Obamacare, Dodd/Frank, Sarbanes-Oxley, etc) pushed a large amount of the law's formulation into the hands of bureaucrats.  Congress only passed a vague outline. Is that constitutional?  Perhaps the Supreme Court will reject all laws that were not fully specified by Congress. 

Aereo

The Supreme Court did not issue a ruling Monday on Aereo's case.
Their schedule lists the next likely days for a ruling as Wednesday, Thursday, and possibly next Monday.

Aereo’s technology is complex, but the Supreme Court case is fairly simple -- does Aereo take broadcasters’ programming without paying for it, or does Aereo just let consumers legally receive TV signals?

The case depends heavily on the 1976 Copyright Act. That 1976 law predates the huge rise in cable TV, satellite TV, VCRs, and internet TV. Three decades after that law a Federal judge said remote VCR/DVRs are legal (AKA "Cablevision ruling").

Aereo won two previous federal court cases: New York circuit and appeal.

The more I think of it, Aereo's argument looks unbelievable that they are a remote personalized antenna system.

Aereo shows off a teensy tiny antenna (roughly coin-sized) that they say is dedicated to a specific user.  Huh? That wouldn't get past the giggle stage of an electrical engineer.

Instead of providing 1000s of individual antennas, Aereo's system is really one big antenna built from 1000s of those little elements.  Sort of like the military phased-array antennas.  Looking at the placement of the amplifier and signal processing components, they are NOT dedicated to a user.

Instead of 1000s of remote antennas, it looks like Aereo's system is a variation of the ordinary "community antenna" system.

And for copyright law, a community antenna DOES trigger the "retransmission" and the “public performance” rules. On that technology perspective, Aereo loses.

But after reading (okay ... "skimming") the appellate ruling, which said the antenna is individual not shared, if the Supreme Court goes along with that finding, then it looks like Aereo will win.

High-tech R&D labs?

A rumor going around today that Oracle will another big acquisition. Oracle might buy Micros (MCRS).  Rumored price is $5B.

Yawn....

Oracle has been doing at least one big acquisition roughly every year.  

Some succeed, some fail.

What is interesting is the question if this should be the model for other big high-tech companies.

Decades ago, the model was for every company to run its own internal R&D labs.  This was a copy-cat of AT&T's Bell Lab (or IBM's or RCA's or Xerox's or ...)

Now the model is either:

Oracle, Microsoft, Yahoo -- big and small acquisitions

Apple, Google, Facebook  -- (mainly) small acquisitions

IBM might be the only company that is still highly dependent on its internal labs. Why is that? Is it a fall-out of "disruptive" development?

BTW, over the past decade Oracle spent:
 ~10% on internal R&D

 ~20% on buying companies

 ~70% on everything else

World elections

In May, 2014, worldwide elections show the change in voters' views.  Will the results be attributed to a "throw the bums out" sentiment or does it reflect a deeper change?

India has turned away from the socialist Congress Party that had been supported by generations under the leadership of the families of Nehru and Gandhi.  Now a pro-growth politician will be prime minister and the Indian markets are rising.

In Europe the movement away from the leftist political parties is clear.  How that will affect its markets is unclear.

High-frequency trading

HFT has been a hot topic for the last week after Michael Lewis promoted his book on "60 Minutes" and claimed that the markets are rigged.

There's a lot of opinions written on it but the details are often not given.
My knowledge of the market internals are probably out of date, but I'll give a shot at describing what happens for a trade.

A market order from a retail brokerage might be matched internally by the brokerage (ie, your buy order matches somebody's sell order).  If not, the brokerage tries matching your order with consolidators or with dark pools.  If still no match, the brokerage sends the order to a market.
All this happens quickly, typically under a second.

In all the attempts at matching, who sets the price? This is were HFT comes in.

Decades ago, there were human "market makers" who who set the price based on supply/demand of stock trading. Really long ago, prices would be posted on

blackboards by aides every hour or so.

Now prices are set by software and updated in a fraction of a second.  Every trade might change the price. HFT firms compete by have the fastest speed at price detection.

There are 3 government rules that limit price setting:
1) NBBO (National Best Bid/Offer)
2) decimalization
3) regulation NMS

NBBO says all of the national markets have to be shared so that brokerages can
pick which brokerage will get an order. HFT firms try to be faster than the NBBO network so they can find imbalances.

The decimalization law says that stocks must be priced in cents, but dark pools allow trading in fractions of pennies. HFT firms try to find pricing differences
between markets and dark pools.

Finally, regulation NMS uses the NBBO to require that current price settings are

not sent to anybody before it is sent to everyone (via a security information processor). HFT firms discovered they could find a price quicker if they actively probed for prices than wait for the slow SIP network.

(Reg NMS: Warning 500+ pages of mind-numbing)

http://www.sec.gov/rules/final/34-51808.pdf

Reg NMS started in 2007.  That’s when high-frequency trading really started.

So the markets are "rigged" because the laws don't make sense in an era of fast

computers and networks.  It's like applying laws for horse&buggies to automobiles.

HFT firms were really profitable 5 years ago. Now the competition between HFT firms has dropped profits by ~80% as they fight for smaller and smaller sub-penny profit/trade.

I'm not concerned about HFT.  For the average person, the difference is less than

a penny per share and there are other things that have a much bigger effect.

If you are worried, then use limit orders so you can specify the price you want.

Cliometrics and Cliodynamics

This blog has mused about historical and social trends. In particular, how can those trends be understood or predicted

Two academic fields have emerged -- cliometrics and cliodynamics.

Both fields start with economic history but now look to widen their study.

Milk prices

Milk prices are rising in the US.  Prices have climbed to nearly the 2011 highs.

Why the price increase?

Some of the higher prices stem from higher feed prices and smaller herds.

But another important trend is that China is now the world's largest dairy importer and its buying is affecting US milk prices.  Dairy prices could continue to rise in 2014 as Chinese imports more.

Who benefits? Dairy farmers in California are the biggest immediate beneficiaries.  They have been squeezed by high cattle feed prices due to drought conditions over the past year.

Investmet buying of foreclosed housing

Since the bottom of the subprime crisis, some big institutional investors have been buying foreclosed houses to convert them into rentals. Institutional investors have 100s of thousand homes in the past five years.

But, is the big wave of buying over?

The biggest buyers -- Blackstone Group, American Homes 4 Rent, and Colony American Homes -- appear to have slowed their buying.  Instead of buying across the country, they are still buying but mainly in selected regions in lat 2013.

Perhaps the slow-down is due to higher prices.  But some states are completing foreclosure proceedings with the start of a new year as shown in monthly statistics from January 2014.

CBO says minimum wage hike = job losses

The CBO just came out with a document on the effects of a minimum wage increase. The CBO's conclusions is that 16.5 million would get a higher wage but 1/2 million would lose their job.

I'm surprised that news reports are surprised. The evidence is clear that minimum wage increases cause job losses.

The best overview is this book where its authors conclude that minimum wages hurt the poor.

A more recent study in 2010 (and follow-up column) shows the effect of the last increase in 2009 resulted in 100s of thousands of lost part-time jobs:

A 2012 research paper looks at claims of no job losses from higher minimum
wages and found that those claims used poor techniques:

A minimum wage is a clear example of a government distortion that causes
unintended and negative side effects.  For example, unemployment didn't
get really bad until several years after 1929 stock market crash. The "trickle

down" phrase originally meant that high union wages helped other workers.

Google's sale of Motorola -- profit or loss?

There's a flurry of articles about Google's sale of Motorola. For example:

this report gives the broad details on the deal with Lenovo.

Most articles are negative, concluding with a "buy high, sell low" message.

In contrast, I think the deal was good for Google. My calculations:

•  purchase = $12.5B
•  Motorola cash+investments = $5B
•  sale of Motorola set-top division = $2.4B
•  sale of Motorola handset division = $2.9B

That equates to: 12.5 - (5+2.4+2.9) = $2.2B total cost

This columnist came to a similar conclusion but estimates a total cost of $3.2B.

There were probably other tax-loss benefits and some R&D credits to help Google.  They might be offset by about $1B in losses for running the money-losing company for about two years.  Motorola lost $100-200M/quarter on the handset business.

If the patent portfolio is worth over $2-3 billion, then Google comes out ahead on the whole deal.

Google may even show a profit if tax losses from Motorola are realized.
These might be worth $6.5B spread over the next half-decade.

resident vs citizen

Will a two-tier citizen system emerge?
<p>
With the current Congressional debate over aliens living in the US, will the notion of citizenship change?
For example, could a person legally live in the US without being a citizen?  Today that is allowed with "green cards", student visas, guest worker permits, and other exemptions.
<p>
But there are many people -- maybe as many as 10 million -- that reside in the US illegally without having a legal permit.  What should be done with them?
<p>
Maybe Congress will move to a two level system.  Citizens have all rights and protections. Residents have the protections of living in the country but do not have all privileges.
<p>
If such a 2-class system is established, what happens to citizens that lose privileges or rights?  For example, convicted criminals lose the right to own firearms, vote,  the right to live in certain locations, or the right to hold certain jobs. Are these people still citizens?

Abenomics after 1 year

<p>
It's the end of the first year of Abenomics.  Prime Minister Shinzo Abe won election in December, 2012.
<p>
Abe introduced several measures to help Japan's poor economy and battle deflation.  Under Abe, the Bank of Japan in January set its inflation target to 2%.
<p>
So far the results are mixed.  While the risk of deflation looks lower, the main effect has been in the value of its currency.  The yen has weakened against the dollar by about 20% in 2013 and is likely to continue weakening in 2014.  Japan may be fixing its deflation internally by exporting deflation.
<p>
There are many unanswered questions about Japan:

• what effect will its shrinking population have on the economy?
• how coupled is Japan's economy with China's?
• will Japan's economy grow?
• how will Japan's huge debt level (over 200% of GDP) be resolved?

Tesla too high?

Tesla has had an amazing year, going from about $25 to $150. But, several worries: 1) it doesn't have legal rights to its name in China even though it's trying to sell there 2) gasoline prices are trending down 3) the company loses money on selling cars but makes money on emission credits

The potential of the credits is what drove the stock this year. Tesla makes $millions from selling the credits. http://www.arb.ca.gov/msprog/zevprog/zevcredits/2012zevcredits.htm

A big problem is that Tesla may have gamed the California law to qualify for more credits.

This document describes the law: http://www.arb.ca.gov/msprog/zevprog/zevregs/1962.1_Clean.pdf

A zero-emission vehicle gets 3 credits if it can go over 100 miles and 4 credits for 200 miles without any emissions.

The top vehicle class gets 7 credits if can go 300 miles and refuel in less than 15 minutes. Unfortunately for battery cars, even the fastest recharging takes about an hour. The top class was expected to be hydrogen cars or equivalent.

This is where the story gets tricky...

Tesla had a splashy media demo in summer where they showed a battery swap in a few minutes. Is a "swap" the same as "refueling"? Who knows. Tesla appeared to qualify for ~twice the credits.

Everyone believed the demo and the stock moved higher on anticipation of the extra credits.

I'm doubtful that an automated system could safely could replace a critical piece of the car in an Indy-car-like pit-stop.

Months later -- the Tesla SuperCharger network still isn't ready and the company has not built the battery swap facilities.

This is raising a big red flag for the stock. The company appears golden if you believe the media but the numbers are looking questionable.

End of era of aircraft carriers?

Are aircraft carriers becoming obsolete?

The new Jerry Ford carrier just launched. Aircraft carriers supplanted destroyers a generation ago because carriers had airplanes that could fly farther than the big guns on destroyers could lob a shell. Destroyers could hit targets up to a few miles away. Aircraft carriers could reach 50X farther with better accuracy and cause more damage.

My guess is that the next generation will be missile carriers. Instead of one ship with dozens of planes, the new missile carriers will have 100s of missiles that launch faster and covers more territory than planes launched from an aircraft carrier.

My expectation is that the current Ford class carriers will be the end of the line. The will still be used for decades but the ships that replace aircraft carriers will be quite different. Instead of a floating city of 1,000s of sailors, the next navy will have aircraft carriers for reconnaissance drones and electronics planes, not loaded with fighter planes. A strike force will be several missile carriers and several aircraft carriers as a coordinated group instead of one huge aircraft carrier (and dozens of support ships).

Economic generations

Economics change its central beliefs about every 30-50 years. I guess that is the length of a generation of economists who start with the standard thinking and then are replaced by the next generation who have a new standard.

Two generations ago (~1900-1930s): Economists used Victorian thinking and followed classical theories about human behavior. Rigid, predictable models. Sociological and historical theories formed the basis of economic thinking. People were driven by "animal spirits".

One generation ago (~1950-1970s): Lots of math and physics influenced the models. Some results seemed bizarre from everyday assumptions. Statistical models of crowds drove economic thinking. "Aggregate demand" was measured and predicted.

Now (~1990-?) Models of randomness and risk are now getting more attention. Instead of Guassian probabilities, the new theories refer to Levy processes and Doob's martindale. This is like quantum physics instead of Newtonian. Models look at game theory and probabilistic outcomes.

Next generation? Who knows. Maybe machine learning combined with behavioral economics will drive new theories where people are not 100% rational agents that decide based on marginal utility.

2014 pivot to Asia?

Will the emphasis be on Asia in 2014? I expect the Obama admin will soon talk up a "pivot" in foreign policy that focuses on Asia.

The recent Iran agreement was, on its face, a horrible deal for the US. The Afghan deal was another bad deal for the US. Why? Is this incompetence or a strategy change?

The only positive conclusion I reach is that the US is washing its hands of everything in the Middle East in preparation for looking elsewhere. Probably towards Asian countries.

Maybe the success of fracking means that Middle East oil isn't as crucial as it was even a few years ago. Maybe they now realize that the problems are intractable. Maybe domestic politics has changed (the pro-Israel bloc was frustrated by Clinton so they became the neo-cons)

If this view of a foreign policy shift is true, then Israel's position is weakened if the US views the region as non-primary.

Lots of investing ramifications...

Deflation?

After trillions of dollars/yen/euros over the past decades, is the next risk from deflation?

In Europe, inflation has been below expectation. Latest measurement is 0.7% that's below last year's 1.1%.

In Japan, the result of Abe-nomics is still unclear but Japan has had weak GDP growth for two decades while experiencing slight deflation.

In the US, the Fed has been targeting 2% inflation and inflation has been about that level. However, the latest number was below the target. The November 2013 Consumer Price Index for Urban Consumers (CPI-U) showed an annual inflation rate of under 1%. Something to fear?

The enormous progression of computing power has been endlessly reported. But how does it affect cloud computing? An amazing statistic was given in an article about IBM's Watson project.

“It’s now $90 an hour to rent 10,000 computers.”