Wednesday, February 18, 2009

Is Starbucks really a charity? Or a measure of our laziness?

Here's something I wondered about after visiting a few Starbucks in New York City: when you drop in for a cup of coffee, you are paying 2-3$ for something that only has about 10 cents worth of materials in it, and something that you could create yourself in less time than it actually takes you to go to the store. Most people seem not to use Starbucks stores for socializing, and indeed most stores don't even have enough space provided. So you are getting something that is intrinsically worth 10 cents, not saving any time, and not paying for space to socialize.

It seems to me then that you can view Starbucks Coffee from one of two angles:
  1. Starbucks is really a glorified charity where people go to deposit their 3$ every day so that someone out there could have a medical insurance and a minimal wage. Cup of coffee in this context is like a t-shirt you get at local fund-raising event for donating. Or...
  2. The actual value people get out of Starbucks is the excuse to get away from work for 10 minutes. Then the average cost of the cup of coffee is the price people are willing to pay for a break.

Saturday, February 14, 2009

Happy Valentine's Day!

Sign of the times, from New York Times:
[...] on Yahoo, searches for “cheap engagement rings” are “off the charts” compared with a year ago, according to Vera Chan, a trend analyst for the company.Other searches that are up over last year include “cheap lingerie,” “free Valentine’s Day cards” and “homemade Valentine’s Day gifts.”
Cheap engagement rings sounds almost like an oxymoron. But I liked that part:
Personal jewelry is being replaced by personal poems.
Maybe that's good news. So on that happy note, happy Valentine's Day to everyone!

Friday, February 13, 2009

How big is a trillion USD, part II.

Now that times are getting leaner, and bailouts are getting bigger, I decided I needed a sequel to my earlier post about how much a trillion dollars can buy you. That post was about weaponry, but how about food?

So I looked at the world's total agricultural output (1.87$ trillion) and discovered that for a "measly" trillion dollars you could feed entire world for half a year.

This provides a tasty yardstick for the amount of money Congress spent on stimulating the financials (700$ billion plus 800$ billion to be added soon), or the total amount of guarantees that Fed has given to the banks (over 12$ trillion).

Wednesday, February 11, 2009

Projecting the severity of the recession from credit market spreads.

When I was reading about the Great Depression in US I was struck by the following observation: the GDP decline of 28% peak to trough, which took somewhere between 2 and 3 years, correlates very well to the total number of failed companies (30%) and the peak unemployment (25%). After thinking about this for a while, I believe this is not a mere coincidence. In a severe, quick economic contraction, it would make sense that the number of working people directly relates to the GDP, since productivity does not have time to change much. It is also reasonable that the percentage of failed mid-size companies reduces GDP by the same amount, although this requires that the additional contraction among the surviving companies is offset by increased government activity and small businesses started by newly unemployed.

So while the number of failed companies is not a precise predictor of the depth of a depression, it should give the right ballpark number. Since we can deduce company failure rates by their bond spreads, one can therefore estimate market-implied severity of a recession.

From Financial Times:
US investment-grade corporate bond prices, for example, imply a cumulative default rate of 36 per cent over five years, assuming a typical recovery of 40 cents in the dollar, according to analysts at Morgan Stanley. This is more than 7.5 times higher than the worst default rate in any previous five-year period.
5 year default rate is not horribly useful, since a lot can change in 5 years. So let's convert it to a more relevant metric of roughly 8-9% of defaults per year. I think we can safely assume that the rate at which new mid-size companies are created goes down to roughly 1% from the typical 2-4% in 'normal' years. This means that within the next 2 years (typical time-frame for the worst part of recession) we are looking at the number of investment grade companies in US to shrink by roughly 15%.

So the market is pretty pessimistic and investors seem to project a recession with GDP decline in the ballpark of 10-20%, which puts it squarely in the depression camp.

TARP against H1B.

It has been reported that Congress is working on an amendment to the stimulus bill that would prevent TARP recipients from filing H1B petitions (or make it much harder, in the current form). H1B term extensions may be affected as well.

Considering how many companies received TARP money already, and how many more are likely to receive government aid in the future, this may significantly cut into the number of H1B workers.

Hopefully this amendment won't get included. It would severely impact competitiveness of American companies at the time when they desperately need to improve it. It surely isn't going to result in higher employment among American workers, and it will delay any economic recovery.

Monday, February 9, 2009

From bad science department: environmental impact of walking.

I often lament the lack of common sense in many scientists. Today's exhibit is going to be about a crazy piece of research which was even enthusiastically discussed by Freakonomics blog in Be Green: Drive followed up by More Analysis of the Environmental Impact of Walking vs. Driving. The researchers tried to calculate the carbon footprint of walking 1.5 miles versus driving 1.5 miles. Depending on how bad your diet is, walking could generate more carbon. One author then even went as far as recommend driving instead as more environment friendly.

Let me make a few observation which firmly put all of that research into mad science department.
  • Worrying about the carbon footprint of human metabolism is silly for two reasons. First, unless you want to consider killing humans, we cannot do much about metabolism itself. It continues even while we sleep. Second, this carbon footprint comes mostly from food production, so we should work on making food production cleaner, not stop walking around, as the paper seems to suggest.
  • Among those who try to achieve a greener lifestyle, walking is not considered an alternative to driving. Environmentally friendly alternatives to driving are living closer to work, taking commuter trains and using bicycles (which are 3-5 times more efficient than walking).
  • People need exercise to stay healthy. That's why people should take a walk instead of driving (that, and fresh air).
  • Even if all of us walk all day long, we will only increase the pollution levels by a minuscule amount.

Saturday, January 31, 2009

Better way to stimulate the economy.

Leaving aside my doubts about the fairness of the currently proposed stimulus packages, government could still justify executing them if they were effective in helping the economy. Here I will try to rationalize why they won't be, and propose a much more effective and ethical way to spend taxpayer money on economic improvement.

First let's recognize that recessions have both desired and undesired effects on the economy. Recessions happen when the rate at which non-viable businesses die temporarily exceeds the rate at which new business is created. The increase in the destruction rate can be set off by many different reasons, but remember that that rate is never zero even in the best of times, and this destruction is both necessary and healthy. The unhealthy (undesirable) effects are the self-reinforcing negative feedback loops that usually accompany recessions - and these effects are mostly psychological.

Consider this example. Let's suppose people think the country is in a recession. Naturally, they expect job cuts and start worrying about their own security. In a country like USA loss of a job is a pretty severe blow to most families - you lose medical insurance, and unemployment assistance is only available for a short time. Therefore, anyone worried about their job naturally restricts their spending and tries to save as much as possible to protect themselves. If half of the families in US try to cut their spending by just 5%, a lot of the industries that rely on discretionary and semi-discretionary income could see huge drops in revenues, up to 50%. This may happen even if the actual unemployment rate does not increase at all, purely due to the fear. Of course, as revenues fall, this fear of job loss becomes a self-fulfilling prophecy as businesses contract and lay off workers. From here on, this becomes a self-reinforcing feedback loop. And that is the part of a recession that is not justified by the economic fundamentals and is entirely undesirable. Businesses that are viable in normal times suddenly find themselves bankrupt, and so on.

The idea behind stimulus based on creating arbitrary government projects is to pick up the slack in spending that workers who are unemployed (or insecure) have caused, and thus help healthy businesses live through the downturn. This is where things get tricky, however. This spending-for-the-sake-of-spending stimulus idea was not bad in the 1930s, or even 1950s, when most of the income was spent on necessities like food, and not a whole lot of spending could be called fully discretionary. A lot of decrease came from the people who actually become unemployed, and therefore the negative feedback was weaker (since the purely psychological component was much smaller).

Today, the economy looks much different. With 70% of it being in the service sector, the discretionary spending is a very big fraction of total, and it is much easier for people to cut their expenses. This means that the psychological negative feedback is much stronger than that driven by pure financial fundamentals. The stimulus now is supposed to pick up the tab not only for those who are out of funds, but also for those who have money but decided to willingly withdraw from the excessive consumption. Trying to counter that consumer withdrawal with government spending is like pissing against the wind, or shoveling against an avalanche. You achieve little, and risk getting yourself in trouble.

Instead, government should try to directly attack the purely psychological component of the negative feedback loop. How do you do that? By reducing the incentive to save for the rainy day.

People are worried that without the jobs, there would be no medical insurance and no food or housing for their families. Government could just give a blanket guarantee on these things and eliminate most of these worries entirely. It would have a lot more effect on the economy than direct government spending on random projects, like in Obama's plan. It would also cost a lot less.

To understand the scale of the numbers involved, remember that Obama's universal healthcare plan is supposed to cost additional 100$ billion a year. So if we took just the original TARP money we could eliminate all healthcare worries in the country for 4 years. Remember that Fed and the government already given guarantees worth over 10$ trillion dollars to the banking sector. Imagine how much less money would we need if we simply guaranteed food stamps and housing stamps for anyone who gets laid off? I bet that would do a lot more good than just doing something for the sake of spending money.

That would also be a more ethical way to use taxpayer funds, since no money would go to the private sector, and even government itself would get a very small windfall, since most of these social guarantees could be provided by existing agencies like Medicare without major increases in funding.

Friday, January 30, 2009

Why TARP #2 will still look like theft.

As Fed has become powerless (and all but irrelevant) in the recent months, the powers that be have been trying fiscal measures. The original TARP has now been recognized by most as a failure, mostly because the money pretty much went to line up the pockets of the bankers at virtually no upside for the taxpayer. See for example how Merrill Pay Was Down Only Slightly in 2008 From 2007 Levels. At the same time, most people don't realize how close the whole financial system was to a complete breakdown (as in, no ATMs, no credit cards working) in the October of 2008. It is quite likely that TARP has prevented that event. So even though the plan resembled theft much more than a rescue mission it did do some good.

Now we have Obama's proposed 825$ billion stimulus that is being debated in Congress; and on paper it looks better, since money seems to be intended to go to various 'productive' projects like education, infrastructure maintenance, etc.

I already wrote in the previous post about my distrust for any centrally planned initiatives, and about the dangers of fiscal recklessness, but for the moment I want to leave these aside and present you with a little piece from Bloomberg about how government projects actually work in practice: Hidden Bonuses Enrich U.S. Government Contractors. Here comes the choice cut:

...the government spent $368.4 billion on all contracts in 2008, and Republican Oklahoma Senator Tom Coburn estimates that about $100 billion of that was wasted.

US government actually managed to dwarf the numbers that caused recent outrage about Wall Street bonuses: 16$ billion in bonuses, compared to unknown trillions of taxpayer money spent on maintaining the financial system alive.

That is why I don't believe Obama's TARP will be more ethical than Paulson's. Money is still going to line up the pockets of the bureaucrats, just slightly different ones.

There is a way to effectively spend money for economy stabilization, but it is not what the corrupt politicians in Washington are doing. We could have much more bang for the buck spending this money where it really helps, but I probably should write a separate post about it.