The Inquisitive Economist

Renewable Energy

2012-01-18T16:06:00.000-07:00

I just came across this video on the state of renewable energy in Germany.
http://www.youtube.com/watch?v=tR8gEMpzos4&feature=player_embedded#!

The Germans have been pushing the sustainability frontier for decades and are actually attempting to put into place a system that relies solely on renewable energy production. As the video alludes to, much of the problem with renewable energy is in regards to the storage and transmission of the electricity; many of the areas that are great for solar and wind generation are located long distances from metropolitan areas which lack adequate transmission lines. In addition, storage of the produced energy, especially solar, is difficult as the sun only shines during the day and there are power requirements during the night. Part of the German's solution is the part about pumping the water up the hill when there is excess and releasing it when there is a need. While there is some efficiency loss, it appears to be significantly more economical than the production of batteries (not to mention better on the environment).

There is considerable innovative thinking occuring in the renewable energies sector all around the world. The Germans, however, are implementing these highly innovative technologies. This is an approach I believe would be in the United States best interests as we as a country have always prided ourselves on being at the technological forefront and clean energy has time and again delivered numerous jobs for both high and low skilled workers.

Federal Reserve Forecasts

2012-01-05T12:29:00.002-07:00

This morning, the Federal Reserve released forecasts of interest rates for several years out. This has raised considerable debate on the subject of these forecasts. The Fed has moved in this direction to and claimed that it will increase transparency in the Fed's actions and calm markets. This action is supposed to reduce the uncertainty over how the Fed will set interest rates. The Fed has repeatedly said that they plan on keeping interest rates low for an extended period, but traders continually speculate as to what they will actually do. Where uncertainty as to statements made by any central bank relates to how strong commitment device is; a central banker can make any statement they want and then whenever they feel like it can do the opposite. Without an adequate commitment device, traders in the market discount the actions of the central bank, thereby lessening their effectiveness. While these projections are not as effective a commitment device as pledging to "fall on your sword," they do help as diverging from forecasts leads to credibility issues.

As to John Mason's comment:

"to produce projections of interest rates three years into the future? Come on…"

No, you come on; these projections aren't coming from some investment banker who has to use the market rate, but from the people who actually SET THE RATE. While the actual interest rates are set according to market conditions, they are able to make projections into the future and come up relatively close to those figures; they have also pledged to update these figures as things change. Another of Mason's comments is completely erroneous:

"…uncertainty should surround its goals because this allowed markets to move incrementally due to the fact that market participants had to search for where the Fed was moving."

The only reason a central bank would want uncertainty is to "fool" market participants. This policy of "fooling" only works a couple times and then renders the remaining policies ineffective. The idea that markets incrementally because of uncertainty has no basis in reality. Uncertainty in any market leads to jumps in prices as speculators push prices one way or another. A perfect example is in futures markets (which historically have had the highest levels of swings due to speculation) during World War II where food prices were fixed; the Merc and Chicago Board almost folded because they had nothing to trade. Knowledge of where any commodity, stock, or bond yield is going to be will decrease levels of trading and reduce spreads as volatility WILL decrease. These forecasts lead us closer to "perfect information"," less uncertainty in markets, and more confidence in the central bank's actions.

The arguments against these interest rate projections are a red herring; it appears that the main criticism to these policies is the fact that short and medium term rates are significantly too low and appear to remain there. These are not criticisms on increased transparency, but rather where the rates are actually set. In my "expert" opinion, this is a beneficial movement towards more stable markets and decreasing the amount of speculation and volatility in the market.

World GDP Growth

2012-01-04T16:18:00.000-07:00

The recent financial crisis and world recession has brought to the forefront research that looks into how deep the recession is relative to how developed the financial markets are. As a simple exposition, Figure 1 displays growth rates of aggregated income quintiles from high to low income. The precipitous drop in late 2006 in GDP growth rates largely displays how much of a drop the world's markets took. The anomaly of these drops is that the poorer the countries are, the less GDP growth dropped with the wealthiest countries actually having negative growth for a period of time. Why might this be? My explanation for this is simply that this world recession was derived from a financial crisis and poor countries do not have highly developed financial markets.

Figure 1: World GDP Growth. Source: World Bank and Chase DeHan

There is significant research on the "finance-growth nexus" where higher levels of financial development are directly correlated to a higher GDP per capita. However, this research is somewhat misleading as a country may get rich before developing their financial markets, rather than developing financial markets for increased growth (for a detailed survey of the literature see Ang 2008). What can be seen from the recent financial crisis is that growth rates were in the same range for rich and poor countries until they began to diverge in the early 2000s, but when large financial crises emerge, those without large amounts of exposure to those markets will fare the storm better. Well-functioning financial markets can be beneficial to growth, but there exists a point where financial markets exceed their societal benefits. While this is a simplistic examination of the subject, it is interesting to note that countries with less developed financial markets did not suffer as deep of a recession.

Energy Use to GDP

2012-01-03T12:15:00.002-07:00

It is widely acknowledged in the economics literature that in order for developing countries to "catch up" to the West that they must develop industry and manufacturing of some sort. In order to do this there must be sufficient energy available at an affordable cost. However, the fact that there is less innovation in the developing world makes it more difficult to innovate within the energy sector to produce cheaper energy.

Figure 1: GDP per unit of energy use.
Source: World Bank and Chase DeHan

Figure 1 depicts the GDP to energy cost ratio ($PPP) on the vertical axis, with year on the horizontal axis for each income quintile. What is immediately obvious is that the wealthier a country is, the more income (GDP) they are able to generate for each dollar of energy. It is also interesting to note that the income groups in the middle (lower-middle, middle, and upper-middle) are roughly close to each other while high income countries are significantly higher, while low income countries are significantly lower; all income groups are showing increased efficiencies as shown by the increasing trend over time. My interpretation of this is that the wealthy countries have been able to invest in the newer, more energy efficient technologies, those below are still using yesterday's technologies, while the poorest are relying on severely outdated, inefficient energy sources. This "trickling" of innovations is typical of many other industries where the highest level innovations are occurring in the high income countries while everyone else has to wait for the technology to be proven.

The part that is personally troubling to me is that the poorest countries have the highest cost of energy use, which is what they need in order to develop. It is unfortunate that we, as Americans, are unable to assist the developing countries to get, in the word of Jeffrey Sachs, "their foot on the first rung of the development ladder" to allow for successful development. These countries need cheap energy in order to become competitive on the world market; without it, there is no way to take advantage of the low-cost labor as there are plenty of other countries with cheap energy and cheap labor. This energy issue is one of the most important in bringing the least developed countries (LDC) out of extreme poverty where there is a struggle for daily subsistence. Bringing cheap energy to the LDCs may not bring prosperity, but should alleviate pain.

Casinos in NY

2012-01-03T10:10:00.000-07:00

Governor Cuomo of New York, along with legislators Dean Skelos and Sheldon Silver, have decided that bringing casinos to New York would be beneficial to the state. This appears to be a back room deal with the casino lobby as casinos have been time and again shown to not contribute to economic growth. As with any lobbying group, their public front is that whatever they are lobbying for will contribute to growth and create jobs. However, that is often not the case with some legislators able to see through the murk.

With specific regard to casinos, the net gain to society is minimal. Casinos do not contribute anything economically to areas; sure they create jobs, but the income generated comes at the expense of other activities. Nothing of value is created with casino activities as there is merely a transfer of wealth from one person to another, with the casino acting as a middleman skimming off the top. The only way that casinos generate any impact on the local economy is through the multiplier. The way the multiplier works is that a building is constructed, giving a construction worker a job, who then goes out and buys a new car, the dealer buys a steak dinner, etc. If money is put into working peoples hands, higher demand is created as they have the funds to spend as those multiply through the economy.

While it is said that there is a minimal societal benefit to a casino, they can be beneficial to local areas such as: Las Vegas and Atlantic City. Where these differ from the above scenario is that there is a large influx of people from outside the local area who spend their money in the area. When there are sufficient visitors from out of the area, the benefit is large at the expense of wherever the people are coming from. So, the net benefit is still zero, but there is transfer from everywhere else to Vegas. If creating a casino will bring tourists to the area and not be a drain on locals, it may be a beneficial policy. But, cities be warned, most areas that have allowed casinos have seen transfers from local businesses to the casinos as it is nearly impossible to take business from Vegas and AC.

This is the article that tipped me off; appears to be a case of crony capitalism.
http://www.timesunion.com/opinion/article/More-casinos-Think-again-2437628.php

Clusters

2011-12-29T13:49:00.002-07:00

Every area of the country wishes to decrease the unemployment rate and increase wages. Companies are always looking to cut costs and do this partially through tax incentives from governmental agencies. However, as often happens when cities and states compete with each other is a race to the bottom in order to attract these new jobs. If communities would work in conjunction rather than competing with each other, all areas would be better off (in a sort of prisoner’s dilemma). Perhaps the best way to attract jobs to an area is to make them want to come to the area without tax incentives; this would be by creating a cluster industry.

Industry clusters are derived from David Ricardo’s theory of comparative advantage in 1817, and developed formally into business clusters by Michael Porter in 1990. The basis of these theories is that specialization in a narrower aspect of the economy leads to economies of scale and higher levels of efficiency. Silicon Valley, Wall Street, and Detroit were symbols of efficiency in their respective fields and were able to develop their products at more efficiency than other areas that did not have the geographic relationships. However, as is the case with Detroit, stagnation and lack of innovation can reduce the efficiencies gained by the cluster and send portions to other areas.

Clusters can be based around many different aspects by attracting a workforce to the area to engage in the type of production, research, or supplier. The separation and specialization of the area further attracts more firms to the area and raises the chicken or egg question in regards to Silicon Valley – did the technology boom occur there because the people were there or the firms were there? The likely answer is that there were feedback effects that brought more workers to the area which brought more firms, which brought more workers, etc. Technology firms did not need tax incentives to locate to Silicon Valley, but rather were pulled by the amenities (workers, infrastructure, etc.) available.

A wise strategy for a community looking to increase the number of jobs would be to determine which industries or activities have the greatest competitive advantage and leverage them. In the early stages, there may be a necessity for tax incentives, but if properly implemented, the cluster should provide more jobs and higher wages for every community.

America's Best Banks

2011-12-29T09:21:00.000-07:00

Last week Forbes released their "Best and Worst Banks of 2011." The entire rankings can be found here:

http://www.forbes.com/sites/kurtbadenhausen/2011/12/13/full-list-americas-best-and-worst-banks/

This report gauged the financial health of the top 100 banks. Financial health of banks is something that is typically not viewed a whole lot during boom times in the economy, but following a financial crisis of the depth we have seen, it becomes a big issue. Each of the banks were evaluated on the amount of non-performing loans (NPL) on their books, leverage ratio, and reserves to non-performers. The healthiest banks are those who did not take huge risks during the bubble phase of the housing crisis, and therefore did not see the large returns on investment in 2004/05, but were not exposed to catastrophic mortgage failures.

Rank	Company	Total assets ($bil)	Return on avg equity	NPLs/total loans	Reserves/ NPLs*	Tier 1 ratio	Leverage ratio
1	Prosperity Bancshares	$10	9.30%	0.10%	1030%	15.50%	7.70%
2	Bank of Hawaii	13	15.7	0.8	317	17.6	7
3	First Republic Bank	27	15.2	0.1	191	13.8	9
4	Community Bank System	7	10.7	0.5	246	13.8	8.2
5	Signature Bank	14	13.5	1	124	17.3	9.8
6	East West Bancorp	22	10.5	1.4	111	14.6	9.3
7	Commerce Bancshares	21	12.3	1	203	14.6	9.7
8	SVB Financial Group	19	11.2	0.6	210	13.4	8
9	First Citizens BancShares	21	11	1.7	104	15.5	9.8
10	Cullen/Frost Bankers	20	10.1	1.5	94	14.6	8.8

Source: Forbes

What should be immediately evident when looking at the rankings on Forbes list is that the top performers did not have the highest returns to equity with the least healthy banks actually having the highest returns to equity. However, there is a dark side to higher returns, increased risk. The best banks are those that focus on the long run and manage risk as best they can. All too often, however, a manager will get caught up in chasing the highest returns and subject their firm to unacceptable risk. The top bank on the list - Prosperity Bancshares - apparently was not caught in the chase, did their due diligence, and are not carrying bad loans. This can be seen by the highest reserve to NPL ratio on the list of 1030%. Their return to equity and leverage ratio are also some of the lowest of the top 100 banks.

Banking in the long run is always won by the tortoise who steadily accumulates. However, the structure of our current financial system seemingly encourages hare-like activity to achieve the highest gains as quickly as possible (see: AIG, MF Global, Long Term Capital, Savings and Loans, Indy Mac, etc.)

Disclaimer: The founder of Prosperity Bank is a family friend.

Green Affordable Housing

2011-12-20T13:22:00.001-07:00

The combination of affordable housing an energy efficiency are essential in the development of city’s housing plans. This story discusses Washington DC placing PV panels on rooftops of affordable housing buildings. This is a great integrated project as poorer households tend to spend a larger portion of their income on utilities than richer families. Cities have the ability finance the higher initial investment in solar power that will pay off in the long run with lower utility bills. This effectively lowers the cost of living for households in search of affordable housing.

Creating solar panels is still not enough, however, to create sustainable affordable housing. Solar is considered "active" heating where machinery brings hot or cold air to change the temperature, where much of the new green building incorporates "passive" heating, which sets the home up to use less energy by using heavy insulation and positioning windows to take advantage of heat from the sun. Affordable housing complexes, like Sheridan Station in DC, that take advantage of passive heating and solar energy create not only a lower burden on lower income families, but is also good for our environment.

image via Sheridan Station

Poverty Figures Questioned

2011-12-19T11:11:00.000-07:00

Last week I wrote about the 1 of 2 households in poverty figure. This post from Slate questions the figures, cites census analysts saying that the low-income households actually are closer to 1/3, which is what the census shows. As the Slate article reports:

"It's not exactly clear where the mistake came from -- or, for that matter if the original reports got their math wrong -- but the Census officials speculated to the NBC station that it was a case of reporters misunderstanding the data."

But what interests me is that the news story spread to over 300 different news outlets. It appears as though one outlet got the information wrong and then others took the report as fact.

1 in 2 households in poverty?

2011-12-15T16:49:00.001-07:00

There have been numerous reports today over the fact that nearly 50% of the country is classified as being in poverty or low-income.
http://news.yahoo.com/census-shows-1-2-people-poor-low-income-054325860.html

That number seemed surprisingly high and after a fact finding mission found that the number appears to be grossly overstated. Low-Income people are classified by those whose incomes are less than 200% of the poverty line. The 2010 American Community Survey (ACS) 5-year estimates run by the Census Bureau report the total of all living under the poverty line being 40,917,513, which is 13.8% of the United States population, while those under 200% of poverty at 94,693,417, which is 31.9%. This figure of low-income is significantly lower than the 50% figure from the Associated Press.

It is unknown where these figures are derived from, but the hundreds of news reports show the same figures. Is this one of those circumstances where journalists write an article without fact checking? To be sure 94 million people is still a sizable chunk of the population and something that does need to be addressed. Imagine being one of the nearly eighteen million people living on less than $5,000 per year.

All Individuals below:
50 percent of poverty level	17,762,160
100 percent of poverty level	40,917,513
125 percent of poverty level	54,155,678
150 percent of poverty level	67,790,487
185 percent of poverty level	86,708,847
200 percent of poverty level	94,693,417
Total Population	296,141,149

Source: U.S. Census and Wikstrom Economics

MF Global

2011-12-15T10:10:00.004-07:00

MF Global has been in the news recently for their bankruptcy and the misallocation of customer funds. The majority of media outlets report that the failure was the result of failed bets on Euro Zone debt. However, that does not appear to be the case as many of those bets were profitable. Well then, how exactly did MF Global go bankrupt if most of their bets were profitable? The simple answer is that they were overleveraged with regards to their trades.

The way the majority of broker-dealers leverage their trading is not only through margin accounts, but is through a process called re-hypothecation. Re-hypothecation occurs when a broker-dealer receives collateral on a loan and then uses that collateral as collateral for a loan of their own. In the absence of a “haircut” (http://en.wikipedia.org/wiki/Haircut_(finance)) this initial collateral can multiply almost infinitely. If this concept is confusing, that’s because it is; essentially this works in the same way as banks would with a reserve requirement of zero and no FDIC insurance. The United States does place a limit on the amount of times an asset can be re-hypothecated, but MF Global found a loop-hole in the UK financial system where they were able to re-hypothecate assets with no limit, thereby leveraging to the hilt.

There are positives and negatives to leverage; it is possible to greatly increase returns on investment, but can also multiply losses. MF Global was so leveraged that their Euro Zone bets were profitable, but the slightest hiccup caused a run on their assets. The high levels of leverage MF Global was exposed to did not leave much capital to be able to face margin calls. As with any financial firm who encounters trouble, contagion spreads and all their creditors demand more collateral so they are not left holding the bag. This was the end result of the MF Global debacle: they may have had some profitable trades on Euro Zone debt, but were sufficiently overleveraged and illiquid that they were not able to meet their repayment requirements.

Now keep in mind, this says nothing about the missing customer funds, which appeared to be used in their speculative bets.

2012: The Year of Cooperatives

2011-12-14T12:44:00.000-07:00

The International Labor Office (ILO) created this video in response the United Nations General Assembly proclaiming 2012 to be the year of cooperatives.

http://www.youtube.com/watch?v=KALLFDpuHUE

Cooperatives are a great way of promoting and enhancing the standards of living of millions of people around the world. Cooperatives are owned by the customers and employees and secure the livelihoods of nearly a quarter of the world's population. The great thing about them is that it allows control of the company to not be lodged purely with a CEO or board of directors, but rather with the backbone of the company (the workers) and the customers. The active involvement of the community creates an environment conducive to creating jobs, empowering people, and alleviating poverty, especially during times of crisis.

More information on the ILO and cooperatives can be found at:
http://www.ilo.org/global/topics/employment-promotion/cooperatives/lang--en/index.htm