[REVISED] Who Touched My RMB?

It’s always interesting to see how economic predictions and financial manipulations fail in China. The ridiculously high population/resource ratio turns China into a hungry giant that can easily overturn any rules: the Wall Street tycoons lost to Chinese housewives during the “gold battle”; Chinese government tried to stop the housing market’s craziness but ended up being one of the biggest obstacle to the success of taming the market. The list goes on and on.

And now it’s the RMB issue again. Bear with me if this topic is becoming increasingly boring for you. As the RMB’s behavior is totally going against the theory, it’s tempting to looking into the reasons behind all the weirdness.

Ever since the year of 2005, RMB has been appreciating internationally while depreciating domestically.

rmb_exchange_rate

Picture source: XE

rmb_inflation_rate

Picture source: Trading Economics

As explained clearly in this about.com thread, the value of a currency should be synchronized domestically and internationally. On one hand, when the exchange rate of RMB goes up, in theory, the demand of RMB will increase, leading to a decrease in the amount of liquidity, therefore the inflation will be alleviated, and eventually the value of RMB will go up. On the other hand, a higher value of RMB attracts investment from oversea, which will lead to a higher demand of RMB in the foreign exchange market and therefore drive up its exchange rate. However, historical data suggested differently: internationally up, domestically down. Why?

It’s a known fact that RMB was long undervalued in the foreign exchange market because of the government’s intervention. As Beijing gradually loose the leash, the exchange rate is bound to increase. So it must be the inflation, which comes from within the country, that’s causing the mismatch problem.

About the inflation, the government claims that “there exists measurement error that skews the statistical data”, and “the CPI data doesn’t fully reflect the reality”. Of course these official speech is too ambiguous to be believed, let alone the “CPI misreporting” can be interpreted both ways. As I see it, this inflation is due to the governments’ over-manipulation to the economy.

This manipulation is not the usual fiscal and monetary policy we’ve seen everyday. The level of governmental intervention in China is much higher than that. Since it’s difficult to explain this in theory, I’ll demonstrate it with China’s “land finance” example.

By constitution, all lands of China are owned by the central government. Therefore, Chinese government has control over the real estate pricing. To stimulate the local economy, local governments make huge spending every day, which almost always yields to budget deficits. To compensate the deficit, the most effective way is to sell the lands that are owned by the government. This is when things get crazy: since the government has control over the lands’ price, it can sell a certain piece of land at an extremely high price. And thanks to the heated housing market, there’s always a buyer. As a result, the price of houses almost doubles every year. House owners’ pockets are therefore inflated. The liquidity drastically increase in the market, and hence the inflation.

This kind of government intervention to the economy is not something foreseeable from the textbook, and the “land finance” is merely one piece of the puzzle. In a not-so-liberal economy, the government’s overexertion of its power to gain short-run benefit is clearly bringing problems to the economy. The mismatch of RMB value is one such example. What’s next? How to prevent these problems from happening in the future? Beijing needs to give better answers to these questions.

Still Working on Net Neutrality

Net Neutrality has been a topic I have written about at length, multiple times this semester. With the recent Netflix Deal in place the debate about the legality or consequences for the health of the internet as we know it. As I wrote about in my previous pieces on this issue, there seemed to be a general though that maybe the loss for the FCC against Verizon in the case on how Verizon needed to treat is broadband traffic regarding whether or not telecommunication antitrust rules applied to them, was not really a loss at all. In fact, the “loss” may have opened up the opportunity for the FCC to write all new legislation for ISP’s that would be much more strict and well defined than anything they could enforce via the old teleco rules.

Unfortunately today, the WSJ and NYTimes reported that the FCC was going to propose new Net Neutrality rules that to my eye, seem like a real cop out on the parts of legislators. With the new rules that the FCC will propose, ISP’s and certain companies would be allowed to create deals giving those companies preferential treatment in terms of bandwidth if the terms were “commercially reasonable”. The WSJ article claims that this is an attempt by the FCC to find a middle ground amongst the many different voices in their ear on how to legislate on this major issue. With companies like Apple and Amazon creating massive streaming operations the ISP’s will need to be more technologically sound than ever, but the question in the end is who should bear that cost and with what sorts of consequences.

I believe that the passing on of these costs to consumers will be a huge limiting factor for companies who need the larger bandwidth constraints but cannot pay for it as well as a barrier to entry for those potential companies that cannot afford to strike deals with the major ISP’s. Cable prices have skyrocketed over the past 20 years as I am sure the majority of us can attest to as we pay the Comcast bill every month, and in my opinion if these companies are allowed to charge for preferential treatment the costs will be passed onto the consumer and then some, all the while stifling any competition left in the market. The road will not be easy for the FCC with multiple lobbying efforts going on and with a new technological reality than they have ever faced sitting in front of them, but hopefully they stay strong on net neutrality rules for the sake of the internet.

(Revised) China’s Stimulus Package for Growth

In the past few months, the market focus has been on the Federal Reserve’s exit strategy and the slowdown of China’s economic growth. Regarding the latter one, the world-second largest economy grew at 7.4% in the first quarter, a level significantly below the double-digit growth many years ago and the 7.7% growth last year.

Since the country has set a target of 7.5% economic expansion for 2014, the below-expectation performance triggered further concern about its growth momentum. In response to that, China’s State Council, the government’s executive body, unveiled a stimulus package in early April to boost growth, including additional spending on railways, upgraded housing for low-income households, and tax relief for small businesses.

Although the package is considered as a mini one compared to the four trillion yuan ($650 billion) program rolled out in late 2008 amid the global financial crisis, it would still impact its overall economy in many ways.

Stimulus 1: Additional Spending on Railways

The government would further develop infrastructure through accelerated railway construction, particularly in the nation’s central and western regions, and more aggressive financing. Some operations in the public interest would be subsidized and 150 billion yuan ($24.6 billion) in bonds would be offered by the government to finance construction for the railways. Relatively, the stock prices of companies in the railway sector rallied, as shares of China Railway Group surged 5.1% and China Railway Construction Corporation’s shares jumped 7.2%.

Personally, I think the spending will have a double-sided effect. Positively, tremendous infrastructure construction will boost growth effectively, and the emphasis on development in the central and western region will lead to more balanced economic landscape across the country. Negatively, as China is undergoing a significant transition from being overly dependent on investments and exports to relying more on domestic consumption, the massive government-led investment project might impede structural reform, and the increasing credit along with financing might pose additional risk in the credit market.

Stimulus 2: Upgraded Housing for Low-Income Households

The government would also spend more on slum clearance and upgrade of poorer urban areas. It added that the China Development Bank, a lender for key government policy projects, would set up a special arm to issue bonds to support new homes.

In my view, this measure could be a complement to the railway construction because of its focus on ordinary people’s well-being. It is a tradition that Chinese people care a lot about their housing and treat it as one of the most important measures of their living standard. If the housing upgrade can be implemented effectively, it could ease social instability and stimulate domestic consumption in the mid- to long-run.

Stimulus 3: Tax Relief for Small Businesses

The government would extend existing tax breaks to small businesses until the end of 2016 and raise the threshold for taxing smaller businesses, which have been struggling as economic growth slows.

I do believe that small businesses will benefit from decreasing tax burden, but this measure might not address their problem radically, which is largely due to the lack of financing. State-owned banks mainly offer loans to large, state-owned enterprises, putting small and medium businesses in a significant disadvantage in market competition. So in addition to regulating state-owned banks, the incorporation of private capital for lending and in-depth financial reform is also indispensable.

In conclusion, as the market force is set to play a fundamental role in the overall economy, it is the quality rather than the quantity of growth that should be strengthened. Therefore, the new leadership should be committed to structural reform with emphasis on wealth increases of ordinary people so as to unleash domestic consumption and underpin growth stability.

The Essence of Wealth Management

Wealth management is a lifelong task. Either you are an individual investor or a professional asset manager, the central goal is to steadily increase your wealth through proper management of capital. Personally, I think there are two keys to successful wealth management: diversification and customization.

Diversification for Capital Growth

Every single investor has to face a certain level of risk when investing in the capital markets, ranging from bonds and equities to derivatives. Diversification can be effective in optimizing the risk-return payoff through well-structured asset allocation. Simply speaking, investing in asset classes with alike market performance could lead to huge reward, or huge loss as well. Comparatively, the exposure to diverse assets with different or even opposite performance is therefore a great hedging strategy, leading to stable investment return in the mid- to long-run.

Customization for the Best Allocation

After knowing the importance of diversification, we still have to face a quantitative issue of “what is the percentage of each asset class in a diversified portfolio?”, which has to do with customization.

As said in the book “A Random Walk Down Wall Street”, the risks you can afford to take depend on your total financial situation, including the types and sources of your income exclusive of investment income. Your earning ability outside your investments, and thus your capacity for risk, is usually related to your age.

Therefore, there is not a “best” portfolio for everyone. A responsible asset manager has to develop the investment decision for a particular client based on the well-rounded mastery of his/her financial situation and beyond.

Personally, I interned at AIA Hong Kong office as a financial planner last summer. One of the tasks I accomplished was “financial health check interview”. The goal of the interview was to understand the financial status of clients and ensure their benefits from total protection. In the fact-finding stage of the interview, I collected financial facts, including income level, family expenses, aggregate debt, and investment style, as well as non-financial facts, including age, family status, diagnosed illnesses, smoking & drinking habits. The integration of all these facts would offer a strong fundamental for the execution of a tailor-made financial solution spanning insurance, savings, and investment.

In conclusion, a truly diversified portfolio is not the result of a random selection from various asset classes in the market. Instead, it is derived from in-depth analysis of their features and correlations, as well as the client’s earning power and risk appetite.

Need for a Minimum Standard

In an earlier post I argued that sweatshop, a shop or factory in which employees work for long hours at low wages and under unhealthy conditions, is a better choice for folks in least develop and developing countries than no place to work at all. This is why, in general, workers there do not request high standard of working condition as their counterparts in developed world do. They adapt to some poor condition even though at the same time they are not well paid.

This situation attracts many major retailers in U.S. and other developed nations to massively relocate their productions abroad, such as to China, Vietnam, Bangladesh, Indonesia, and other countries with low labor cost. A figure said that more 97 percent of apparel and 98 percent of cloth sold in U.S. are imported while in 1960an, that figure is only 5 percent.

Developing world, home for the factories, benefits from this shift. Since in general the new industries are labor intensive, they have been creating a huge number of jobs.  In 1980s, the number of garment factories in Bangladesh is only hundreds while recently, that number reaches nearly 6000 factories.

However, the world was shocked by witnessing 1134 people dead and hundreds injured when the Rana Plaza building in Savar, Bangladesh collapsed last year.  This is just a problem among many other issues involving multinational companies searching for low cost labor.

While I argue that sweatshop is one solution for the poor in least developed and developing countries, but dangerous working condition is another issue. What I mean by dangerous is a situation where it may threaten life safety of the workers.  a minimum standard has to be set up to avoid such tragedy or other accident in a smaller case. Then, the question is who should be in charge of such rules. The industry itself is not a good choice for this responsibility since a player could not be a referee.

Leaving the task to the government to regulate is also not a guarantee since low labor cost is one of its comparative advantages. Imposing too many restrictions might cause its industry less competitive and it means that investors could easily move their productions to other countries with less strict regulations. Thus, a collective action should be taken to overcome this issue. In my opinion International Labour Organization (ILO) and World Trade Organization (WTO) are good candidates to take this responsibility given their credibility among parties involved.

First State to Enact GMO Food-Labeling Law

In the U.S., genetically modified food-labeling is optional. The Food and Drug Administration only makes sure that the food consumers consume is safe and wholesome, it does not consider the fact that the sources of GM foods are genetically engineered. Considering the FDA is responsible for protecting and promoting public health, you would think that the labeling of GMO foods would be a requirement by now. Altering crops’ genes can not only be harmful to the environment by causing a greater use of pesticides, but it can also potentially be harmful to human health. With this in mind, it is no surprise that more and more states are proposing bills to require GMO labeling. As of Wednesday, Vermont could likely be the first state in the country to require labels on genetically modified foods.

“The vast majority of corn and soybeans grown in the U.S. are GMOs, and food companies estimate that about 80% of U.S. packaged-food products contain GMO ingredients in some form.” With many people being aware that the use of genetically modified plants and animals has already become commonplace in today’s society, the lack of consumer consent in the choice to eat these foods creates an ethical dilemma. With nearly 80% of all prepackaged food in a normal grocery store containing GMOs, it is a bit concerning of whether or not these foods are safe. Similar to the way that drugs have to be tested to be put on the market and need to have the ingredients and side effects clearly labeled on the package, it should be the same case for food. Consumers should have the right to know what exactly they are eating. With very little testing having been done on genetically modified foods and long-term results being unclear, many other countries have already put much stricter regulations on GMOs. In the European Union, for example, the introduction of labeling requirements led to the virtual extinction of GMOs in food. Gov. Peter Shumlin of Vermont says, “I am proud of Vermont for being the first state in the nation to ensure that Vermonters will know what is in their food.”

However, the labeling of foods containing genetically modified ingredients will come with a cost to Vermont. Farmers, food manufacturers, distributors, and grocers will have to spend more on record keeping and compliance. Could this result in products being assigned a higher price than what a consumer would see them priced at in another part of the country? Considering the bill’s two-year timetable, it should give farmers and companies plenty of time to adjust. “There is no reason this would put a real burden on farmers, food makers or consumers,” according to the Wall Street Journal.

Ukraine Crisis Hits Soccer

Amid the political tensions between Ukraine and Russia, which have also involved most Western countries on Ukraine’s side, there are many economic and social repercussions to consider. As has been discussed on this blog, the economic implications of the crisis are vast, especially when looking within Ukraine. However, this period has been very tense business-wise between Russian companies and Western countries. A very unexpected implication of the crisis, at least for me, is that with the popular German soccer team Schalke. According to an article from the Wall Street Journal, Russian state-owned gas giant OAO Gazprom pays around $20 million a year to sponsor Germany’s Schalke soccer club. The problem here is not that Gazprom will halt its sponsorship, it is in fact very content with the market results of the sponsorship. However, out of this Russian-German connection, Russian President Vladimir Putin extended an invitation for the team to visit the Kremlin.

The article notes that “new complications for German business leaders who have been trying to maintain normal ties to Russia amid the mounting crisis in Ukraine. German companies trying to take a business-as-usual stance with Russia increasingly find themselves under political pressure at home to avoid appearing to be part of Moscow’s propaganda efforts.” Earlier this week, the team seemed inclined to accept the invitation. But today the backed down and declined it. Apparently, Schalke’s chairman, Clemens Tönnies, has serious business ties with Russia; besides the sponsorship of the team, him and his partners are investing over $800 million in pork factories in Russia. His initial response in an interview was that “the team would love to see the Kremlin and is interested in Moscow…and the Russian president is interested in Schalke and invited us.” But after political outrage on the behalf of German Chancellor Angela Merkel’s allies, today Mr. Tönnies took back his comment: “there was never and there is no commitment to such a visit…this would not be appropriate in light of the current political situation.”

It’s interesting to see the repercussions of the political tensions in Ukraine. And it is unexpected to see it manifested in areas like soccer. Luckily for German soccer lovers, the team says its fans are widely unaffected by the situation. With respect to the sponsor, they say most people just see the sponsor as a source of capital, and not a national flag. Personally, I think this is the right approach to the situation. Though it is more complicated when considering the Putin himself invited the team to Russia, it is important to remember that the Russian government’s actions do not represent every Russian’s views and wishes. In general, it is unfair and economically-illogical to punish Russian businesses for the actions of its government.

Reflections on Economics at Michigan

For my 40th blog post (about an hour before the last post is due) I wanted to reflect on a few details of my economics major at Michigan. I hope that some of the other seniors in the class will agree with some of the points that I make here.

First off, I would like to echo professor Kimball’s words. To paraphrase; while we obviously learn a lot in each class, that dwarfs what we can learn from a lifetime of following the news and reading articles related to Economics. This is true not just of this course, but the economics program as a whole. I am sure that maybe someone going on to a PHD or Masters in Economics may disagree, but since I am stopping my formal studies of economics at the undergraduate level, I am hoping that I can continue learning a substantial amount using my economics studies at Michigan as a lens with which I can view the rest of the information that I consume throughout my career.

I would also like to mention one of the courses that I took at Michigan that has had a substantial impact on me. The first elective that I took in the economics department was Econ 395, the Economics of Education with Adam Stevenson. The course looked at economics models of why people choose a given amount of education and examined different ways to improve education in the United States, among other things. Not only did this class do an excellent job of preparing me for Econ 401 and other upper level courses, it gave me an interest in education policy in the United States that has stuck with me for the past three years. With the amount of resources spent per pupil, it is amazing that our elementary and high school students are not performing better on international comparisons. While this is all unrelated to the job I will be starting in a few months, education policy is something that I follow on news sites such as politico (not to mention, it gave me a better understanding of the education reform bill that was discussed throughout the first several episodes of House of Cards).

I could write a similar paragraph about most of the economics courses that I took here. My point is that as many of us get ready to move on to the next chapter of our lives, we shouldn’t forget the impact that each class has had on us and how truly valuable our economics degrees will be to us.

(Revised) Can QE* Be an Effective Long Term Policy? Yes, and Here’s How.

The Fed’s decision to implement quantitative easing and other unconventional monetary policy in December 2008 sparked a blaze of heated discussion amongst economists that has been burning to this day. The questions of if and how these new measures affect economic growth have become the focus of countless blog posts and editorials, and have become an integral part of many university Econ courses. The beginning of QE tapering in December 2013 added even more fuel to the fire, but it also gave many traditional economists a sense of relief. It finally looked like there was an end in sight to these unfamiliar and controversial policies. To the dismay of these traditionalists, however, recent research by the Brookings Institution (paper #1 and paper #2) suggests that there are significant benefits of pursuing unconventional monetary policy in the long term. A recent Economist article, “Staying Unconventional,” emphasizes some of the most important results of this research and raises a provocative question: Can QE and forward guidance, or some alternate forms of these policies, be combined to create an effective long term policy?

Based on my reading of the research papers that the article cites, I am inclined to say yes. It may not be the QE policy currently being rolled back, but I can see an alternate form of such a policy (hence the * in the title) being effective in the long term. Not only does unconventional monetary policy not cause riskier financial behavior, but it also provides a substantial boost to economic growth. In this blog post, my goal is to defend the bolded argument by highlighting some of the key findings of the research papers I mentioned earlier.

1.    Unconventional Monetary Policy Does NOT Cause Financial Instability

The argument commonly used to refute long-term implementation of QE is that it encourages individuals and financial institutions to pursue riskier investments, thereby reducing financial stability. The prediction is that long periods of low interest rates incentivize investors to ‘reach for yield’ and take on more credit risk, duration risk, and/or leverage. The research by Gabriel Chodorow-Reich of Harvard University confirms this prediction but emphasizes that the story is not so cut and dry. Although the Fed’s low interest rate policy has caused financial institutions to take on some riskier investments, it has also boosted the value of these institutions’ portfolios, making them less risky and strengthening the stability of the U.S. economy. Most importantly, Chodorow-Reich’s analysis shows that the stabilizing effect of QE has been stronger than the destabilizing effect caused by ‘reaching for yield.’

Chodrow-Reich determined the magnitude of each effect by evaluating the effect of the Fed’s policies on four categories of financial institutions: life insurers, commercial banks, money market funds, and defined benefit pension funds. Together, these institutions manage $24 trillion in assets. The effects are nicely summarized in the graphic provided in the abstract of the paper:

unconventional MP_1

As Chodrow-Reich states, “In the present environment, there does not seem to be a trade-off between expansionary [monetary] policy and the health or stability of the financial institutions studied.”

If the biggest argument against long-term use of QE (investors reaching for yield) is nullified, perhaps the Fed should think twice about continuing to taper. There is, however, the problem of surprising the market with such a change in policy. A possible solution to this is to continue the taper, but then start buying a constant level of bonds again after the taper is complete. If the Fed warns the public of such a long term policy change in advance, it could dampen the volatility the move would create in the markets.

2. Unconventional Monetary Policy Boosts Immediate Economic Growth and May Have Substantial Long-Term Growth Benefits As Well

The research conducted by Joshua K. Hausman (University of Michigan) and Johannes F. Wieland (University of California, San Diego) examines the success Abenomics has had in boosting Japanese GDP and gives insight into how such unconventional monetary policy can sustain amplified GDP growth in the long term.

Named after Japanese Prime Minister Shinzo Abe, ‘Abenomics’ is the name used to refer to Japan’s current three-pronged economic stimulus policy, which consists of a combination of monetary policy expansion, fiscal stimulus, and structural reform. It is the only real and current example of long-term unconventional monetary policy, and is thus viewed by economists as an important test of its validity.

So far, Abenomics has stood up to the challenge. The Japanese stock market has risen, the exchange rate has depreciated, and Japan’s GDP has jumped by up to 1.7%. Hausman and Weiland claim that one percent of this GDP growth has been directly caused by the monetary policy shift. Furthermore, Abenomics’ effect on the Japanese money supply has been much more effective than that of previous QE policies. The below graphic from the Economist article provides a nice summary of the effects of Abenomics:

unconventional MP_2

Hausman and Weiland attribute the superior effectiveness of Abenomics to the change in inflation expectations it has caused. Japan has set a new 2 percent inflation target and because Abenomics was announced to the public as a permanent change in policy rather than a temporary measure to boost GDP, inflation expectations increased for both the short and long terms. Both short and long-term borrowing appeared cheaper as a result. This, in turn, caused borrowing to increase across the board, stimulating increased consumer spending.

One should not go all-in on Abenomics quite yet, though. Both the article and research paper emphasize that Abenomics is still in its initial stages and has yet to prove itself as an effective catalyst for long term growth. When discussing the long-run outlook of Abenomics, Haussman and Weiland assert:

The research shows that the Bank of Japan is achieving its intermediate objective of higher expected inflation, but that the inflation target itself ‘remains imperfectly credible,’ with long-run inflation expectations below 1.5 percent.  Thus the modest estimates of Abenomics’ effects reflect in part that the Bank of Japan has not yet fully convinced the public that inflation will be two percent.

If the Bank of Japan could somehow more strongly convince the public of a future two percent inflation rate (perhaps through a public announcement reinforcing its intention to pursue the policies of Abenomics), the effects could be substantial. Hausman and Weiland estimate that “the output effects of Abenomics could as much double if inflation expectations rose to the 2 percent level.

In summary, based on the results presented by Gabriel Chodorow-Reich about the positive effects of QE on financial stability, and Hausman and Weiland’s estimates of past and future Japanese output growth as a result of Abenomics, I am convinced that unconventional monetary policy can be used effectively in the long term. If the Fed can convince the public that inflation will be steady at two percent and interest rates will remain low, whilst continuing to purchase assets and pursuing fiscal stimulus, it can achieve both strong economic growth and increased financial stability.

Tech Companies’ Customer Retention

As my Apple Iphone 4 is approaching three years old and is starting to have some problems, I have been researching some new mobile phones and seeing what is out there. While I haven’t made a purchase yet, the two I was deciding between are the Samsung Galaxy S5 and the Apple Iphone 5s. With Apple’s most recent software update for their Mac computers (OSX Mountain Lion), you are able to use iMessage on your laptop. When it dawned on me that if I switched to the Galaxy S5 I wouldn’t be able to use this feature, my mind was made up, I would be sticking with an iPhone.

It is worth noting that usually Apple’s major operating system updates would cost twenty or thirty dollars. The most recent one was free. While I am sure that there were other reasons, I am also sure that this idea of getting Macbook users to stick with the iPhone by adding a whole new level of seamless interaction between the devices was part of the justification for giving this software update away.

Screen Shot 2014-04-24 at 8.53.25 PM

 

While the above infographic shows that this problem of customer loyalty isn’t really an issue for apple, it is for many other major tech companies. This got me thinking of ways that tech companies can do a better job with customer retention. As the example above demonstrates, Apple’s messaging feature being linked to their laptops got me to stick around as an iPhone customer. Many have noticed this trend of high customer retention with Apple. South Park even made an episode that made drew parallels between Apple and a cult or religion.

Clearly Samsung, LG and the others could take some lessons from Apple. With Blackberry’s terrible decline from the dominance they once held over the smartphone market, these companies have a lot of incentive to learn a thing or two about customer retention. As this driving sales article points out, and in line with the example I gave in my introduction, Apple’s products work flawlessly together. This is one benefit to the fact that you can’t buy Apple’s software unless it comes preinstalled on one of their machines. This is much different from Microsoft’s Windows or Android’s mobile operating system, that can be used on many different brands’ devices. While Apple’s policy on this has drawn some criticism, from the standpoint of brand loyalty, it has surely been a winning strategy.