The Big Mac Index

Concept of the day, courtesy of Investopedia: Big Mac Purchase Power Parity (PPP).

A survey done by The Economist that determines what a country's exchange rate would have to be for a Big Mac in that country to cost the same as it does in the United States. Purchase power parity (PPP) is the theory that currencies adjust according to changes in their purchasing power. With the Big Mac PPP, purchasing power is reflected by the price of a McDonald's Big Mac in a particular country. The measure gives an impression of how overvalued or undervalued a currency is.

The calculation of the Big Mac PPP-adjusted exchange rate looks at the price of a Big Mac in a given country and divides it by the price of a U.S. Big Mac. Let's say that we are looking at the Big Mac in China. If a Chinese Big Mac is 10.41 renminbi (RMB) and the U.S. price is $2.90, then - according to PPP - the exchange rate should be 3.59 RMB for US$1. However, if the RMB was actually trading in the currency market at 8.27 RMB for US$1, the Big Mac PPP would suggest that the rmb is undervalued.

Kevin Phillips: Why the economy is worse than we know

I haven't found much worth reading in Harper's these days, and let my subscription lapse last year.

But on impulse, I picked up a copy in the airport over the weekend. There's a terrific article by Kevin Phillips in the May 2008 issue (not available online unless you're a subscriber.) This will give you the flavor of it:

The truth, though it would not exactly set Americans free, would at least open a window to wider economic and political understanding. Readers should ask themselves how much angrier the electorate might be if the media, over the past five years, had been citing 8 percent unemployment (instead of 5 percent), 5 percent inflation (instead of 2 percent), and average annual growth in the 1 percent range (instead of the 3-4 percent range). We might ponder as well who profits from a low-growth US economy hidden under statistical camouflage. Might it be Washington politicos and affluent elites, anxious to mislead voters, coddle the financial markets, and tamp down expensive cost-of-living increases for wages and pensions?

Let me stipulate: the deception arose gradually, at no stage stemming from any concerted or cynical scheme. There was no grand conspiracy, just accumulating opportunisms. As we will see, the political blame for the slow, piecemeal distortion is bipartisan--both Democratic and Republican administrations had a hand in the abetting of political dishonesty, reckless debt, and a casino-like financial sector. To see how, we must revisit forty years of economic and statistical dissembling.

[...]

The real numbers, to most economically minded Americans, would be a face full of cold water. Based on the criteria in place a quarter-century ago, today's U.S. unemployment rate is somewhere between 9 percent and 12 percent; the inflation rate is as high as 7 or even 10 percent; economic growth since the recession of 2001 has been mediocre, despite a huge surge in the wealth and incomes of the superrich, and we are falling back into recession. If what we have been sold in recent years has been delusional "Pollyanna Creep," what we really need today is a picture of our economy ex-distortion. For what it would reveal is a nation in deep difficulty not just domestically but globally.

(excerpt from "Numbers Racket: Why the economy is worse than we know" by Kevin Phillips, from the May 2008 issue of Harper's Magazine)

Expert opinion

Sociologist and street-gang expert Sudhir Venkatesh watches the new season of The Wire with some retired thugs:

Ever since I began watching HBO’s The Wire, I felt that the show was fairly authentic in terms of its portrayal of modern urban life — not just the world of gangs and drugs, but the connections between gangland and City Hall, the police, the unions, and practically everything else. It certainly accorded with my own fieldwork in Chicago and New York. And it was much better than most academic and journalistic reportage in showing how the inner city weaves into the social fabric of a city.

Last year, I learned a lot by watching a few episodes of The Wire with gang leaders in Chicago. So, a few weeks ago, I called a few respected street figures in the New York metro region to watch the upcoming fifth season. I couldn’t think of a better way to ensure quality control.

"What do real thugs think of The Wire?" - Freaknomics Blog @ NY Times

Sudhir, who specializes in the underground economy, has a new book coming out called Gang Leader For A Day. His last effort, Off The Books, was one of the best nonfiction books I read last year.

And, of course, The Wire is the Best. TV. Show. Ever.

The $1.4 Trillion Question

Through the quarter-century in which China has been opening to world trade, Chinese leaders have deliberately held down living standards for their own people and propped them up in the United States. This is the real meaning of the vast trade surplus—$1.4 trillion and counting, going up by about $1 billion per day—that the Chinese government has mostly parked in U.S. Treasury notes. In effect, every person in the (rich) United States has over the past 10 years or so borrowed about $4,000 from someone in the (poor) People’s Republic of China. Like so many imbalances in economics, this one can’t go on indefinitely, and therefore won’t. But the way it ends—suddenly versus gradually, for predictable reasons versus during a panic—will make an enormous difference to the U.S. and Chinese economies over the next few years, to say nothing of bystanders in Europe and elsewhere.

Any economist will say that Americans have been living better than they should—which is by definition the case when a nation’s total consumption is greater than its total production, as America’s now is. Economists will also point out that, despite the glitter of China’s big cities and the rise of its billionaire class, China’s people have been living far worse than they could. That’s what it means when a nation consumes only half of what it produces, as China does.

Neither government likes to draw attention to this arrangement, because it has been so convenient on both sides. For China, it has helped the regime guide development in the way it would like—and keep the domestic economy’s growth rate from crossing the thin line that separates “unbelievably fast” from “uncontrollably inflationary.” For America, it has meant cheaper iPods, lower interest rates, reduced mortgage payments, a lighter tax burden. But because of political tensions in both countries, and because of the huge and growing size of the imbalance, the arrangement now shows signs of cracking apart.

The $1.4 Trillion Question (James Fallows, The Atlantic)

Stagflation on the way?

I've been one of those on the stagflation bandwagon, deeply concerned about the weakness of the dollar, the likelihood of the Fed continuing to reduce rates in the face of locked-up credit markets, rising food and energy prices and persistent and rising deficits. This is a toxic macroeconomic cocktail I've written about and which has been the source of much worry. And to add insult to injury, a rash of economic statistics were released last week that generated articles this weekend that only served to reinforce my Droopy Dog attitude towards the US economic landscape. So I'm here to share the pain.

Information Arbitrage: My Gloomy Thesis Is Playing Out (18 Dec 2007)

Party like it's 1999

mr bubble
Originally uploaded by Carol Esther.

Silicon Valley’s math is getting fuzzy again.

Internet companies with funny names, little revenue and few customers are commanding high prices. And investors, having seemingly forgotten the pain of the first dot-com bust, are displaying symptoms of the disorder known as irrational exuberance.

Consider Facebook, the popular but financially unproven social network, which is reportedly being valued by investors at up to $15 billion. That is nearly half the value of Yahoo, a company with 38 times the number of employees and, based on estimates of Facebook’s income, 32 times the revenue.

Google, which recently surged past $600 a share, is now worth more than I.B.M., a company with eight times the revenue.

More broadly, Internet start-ups are drawing investment based on their ability to build an audience, not bring in revenue — the very alchemy that many say led to the inflation and bursting of the dot-com bubble.

There's a lovely symmetry in the choice of Yahoo as the benchmark for 2007 dotcom value vs. Facebook.

Silicon Valley Start-Ups Awash in Dollars, Again (The New York Times)

Talking sense on global warming

Bjorn Lomborg, writing in the Washington Post:

We must accept that climate change is real and that we've helped cause it. There is no hoax. But neither is there a looming apocalypse.

To some people, cutting carbon emissions has become the answer, regardless of the question. Cutting emissions is said to be our "generational mission." But don't we want to implement the most efficient policies first?

Combating the real climate challenges facing the planet -- malaria, more heat deaths, declining polar bear populations -- often requires simpler, less glamorous policies than carbon cuts. We also need to remember that the 21st century will hold many other challenges, for which we need low-cost, durable solutions.

Information Arbitrage: Keep it simple

Discipline, especially when it goes against one's native instincts, is hard. When your friend brags about a particular stock or strategy on the golf course, you are jealous, right? And when you hear stories of people making tons in _____ (choose your era - tech stocks, commodities, currencies, gold, etc.), regardless of a lack of documentation (self-reporting is notoriously poor as people tend to remember wins and forget losses), you want in, right? It is very hard to be the tortoise when you are seemingly surrounded by hares. But you know what, you can try your hand a bit if you adhere to a few simple guidelines:

1. Set an asset allocation mix that makes sense for your age, stage, family circumstance, etc. If you can't do this with confidence get some help;
2. Establish the majority of your allocation using low-cost, liquid instruments like index funds and ETFs;
3. Figure out if you want to try and dicker with investing at all, and if the answer is yes;
4. Limit your "play money" to 5-10% of your total portfolio.

By all means have some fun. Do some research. Collaborate with others. Try and generate some real alpha. But don't, DON'T have this be the core of your investment strategy. Please. Don't. Do. It.

Retail Investors + Complex Investments = Failure (Information Arbitrage, 16 Aug 07)

(Speaking of investing, the White Trash and Minor Vices Portfolio is taking a beating but, with its emphasis on consumer staples, doing one hell of a lot better than the markets as a whole. The White Trash Portfolio is only up 0.3% since inception, but that's compared to a 0.4% loss for the S&P 500 over the same time period and a 1.1% loss for the US stock market as a whole, as measured by the VTI ETF.)

Jim Webb on "Class Struggle"

The most important--and unfortunately the least debated--issue in politics today is our society's steady drift toward a class-based system, the likes of which we have not seen since the 19th century. America's top tier has grown infinitely richer and more removed over the past 25 years. It is not unfair to say that they are literally living in a different country. Few among them send their children to public schools; fewer still send their loved ones to fight our wars. They own most of our stocks, making the stock market an unreliable indicator of the economic health of working people. The top 1% now takes in an astounding 16% of national income, up from 8% in 1980. The tax codes protect them, just as they protect corporate America, through a vast system of loopholes.

Incestuous corporate boards regularly approve compensation packages for chief executives and others that are out of logic's range. As this newspaper [The Wall Street Journal - bc] has reported, the average CEO of a sizeable corporation makes more than $10 million a year, while the minimum wage for workers amounts to about $10,000 a year, and has not been raised in nearly a decade. When I graduated from college in the 1960s, the average CEO made 20 times what the average worker made. Today, that CEO makes 400 times as much.

In the age of globalization and outsourcing, and with a vast underground labor pool from illegal immigration, the average American worker is seeing a different life and a troubling future. Trickle-down economics didn't happen. Despite the vaunted all-time highs of the stock market, wages and salaries are at all-time lows as a percentage of the national wealth. At the same time, medical costs have risen 73% in the last six years alone. Half of that increase comes from wage-earners' pockets rather than from insurance, and 47 million Americans have no medical insurance at all.

Manufacturing jobs are disappearing. Many earned pension programs have collapsed in the wake of corporate "reorganization." And workers' ability to negotiate their futures has been eviscerated by the twin threats of modern corporate America: If they complain too loudly, their jobs might either be outsourced overseas or given to illegal immigrants.

"Class Struggle"; Senator-Elect Jim Webb (D-VA), writing in The Wall Street Journal, November 15, 2006

The Commitment Device

Steven Levitt, one of the authors of Freakonomics, is a recreational poker player who occasionally plays in tournaments. Last weekend, he found himself sitting at a table with a middling pile of chips, with the required departure time for McCarran Airport drawing ever closer... and so he adopted a strategy of going "all in" on every single hand from there on out, so as to either win or lose quickly enough to make his plane.

Excerpt:

I was in Las Vegas yesterday celebrating my 10 year anniversary with my wife Jeannette, who loves me but not nearly as much as she loves poker. So even though this blog is about my anniversary and about commitment, it is not about the sort of commitment you might suspect.

Rather it is about what economists call a “commitment device,” which is when someone locks himself/herself into a course he/she wouldn’t otherwise want to have to follow, but as a result the person benefits.

The idea of a commitment device is counter-intuitive. How can it make you better off to lock yourself in so that you have fewer options to choose from? Aren’t more choices always better than fewer? If there is no strategic interaction, more is always better, but when you are competing against someone else, limiting your options can be helpful. A classic example is an attacking army burning the bridges behind them so that they have no easy way to retreat. It commits the army to fight harder and might lead the opponent to retreat, avoiding a battle altogether...

Read on for a fascinating tale of how this worked out.

As for Levitt's meditations on his anniversary, yesterday was my eighth wedding anniversary, actually...

Our commitment device is working just fine, thanks.

Love you, Carrie.

The Insecure American

Pressured by foreign competition and impatient domestic investors... employers broke the post-war "work contract" with employees under which they had shared the gains and risks of the post-war economy. As a result, more of the risks were shifted onto employees. Under the old contract... "workers received job security, guaranteed benefits, and good pay,” while "employers got loyal, productive workers who invested in skills specific to their jobs and didn't jump ship when times were tough." Under the new contract, set unilaterally by employers in a labor market in which private-sector unions are about as weak as they were in 1906, workers have no job security, they pay more for their health insurance, and they face lean retirements on 401(k)s. A 1980s memo from the CEO of General Electric stated the new contract's terms: "The only job security is a successful business. If loyalty means that this company will ignore poor performance, then loyalty is off the table." Peter Drucker expressed the underlying dynamic in a chilling image: "Companies built to last like pyramids are now more like tents."

The Insecure American (The Atlantic Unbound, September 21 2006)

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