Not over yet

A new consensus is seeing the end of World Depression II sometime in 2010. As a matter of fact, the list of positive elements is not negligible:

• - The very existence and the conclusions of the G20 show the existence of a fast global public response to the events, certainly going in the right direction
• - The US stimulus plan has had an initial favorable impact, paving the way for the other plans
• - Europeans plans are not as small as they look, considering the fact that social protection mechanisms mechanically increase public spending each time unemployment levels rise
• - The banking system has now ceased to crumble down, and the main pieces are back in place
• - Protectionism is being discarded as a solution
• - Destocking is reaching its material limits
• - Most commodities are back to reasonable prices
• - Confidence is being restored
• - Key currencies are stable: the ‘Chinamerican’ system protects the dollar, while the Euro structure prevents members to freely print money for their own selfish benefit
• - A reinforced IMF can be of assistance gain in the most disastrous areas
• - Last but not least, the US administration, having ceased to be an arsonist force, is now a factor of global appeasement .

Now, on the other side of the balance sheet, still lies a list of liabilities of such importance that the 2010 target remains a product of wishful thinking:

• - The financial system is by no means limited to the banking system, and it will take a long time (years) to monitor, fix, regulate and control the non-banking part which had become the largest part. This requires a better understanding and monitoring of securitization, another revision of corporate accounting, multilateral as well as bilateral negotiations for the creation of appropriate regulation entities, and adjustment of tax laws
• - Stimulus plans, limited by a dominant ideology against public deficits, are being set at an order of magnitude below actual needs: the financial wealth recently destroyed (stock markets, real estate, commodities, leveraged securities, for a total of perhaps $ 200 trillion) had been fueling growth, and must be substituted by public injections (today in the range of $ 3 trillion). In the meantime, business will lack funding and growth will stall.
• - Toxic assets are not yet entirely eliminated (CDS, and weak real estate based securities) and not even entirely identified
• - The global real estate crisis has not by any means reached its climax, and in many places (such as Spain or Dubai) drops in prices are still expected to reach 80% from currently already discounted levels
• - The West should continue to keep for several decades the largest consumer markets, and is also the place where unemployment shall keep rising: the gradient in technology capabilities which had separated East and West for the last two hundred years, creating the global system of economic specialization which in turn did sustain the extraordinary economic growth rate observed along the same period of time, is now reduced to very little. Countries like South Korea can produce basically anything the West can produce (except in the fields of airspace, nuclear energy, and armament), and can produce what the West cannot efficiently produce (e.g. consumers electronics). When China –which is a subcontractor of the West in about every sector) inevitably reaches the same situation than Korea, then Western and Eastern salaries will have to adjust. If they don’t, unemployment in the West will reach unprecedented levels, triggering an attrition of Western consumers markets, in turn preventing the East to generate resources for their own new consumers markets. If they do, social unrest in the West will contribute to the depression. In any case, the substantial cause of the economic crisis (not the occasional cause which was the financial crisis) is still in place for a while
• - When such stubborn facts appear in public view, further stimulus plans shall come. This time, however, they will have to be funded by deficits that only inflation can cure. For a short while stock market’s rallies should multiply. One could even use the opportunity to invest in the most protected sectors (let’s talk about them some other day). Yet, better miss a rally that hit the next crash sooner or later.

This is how the world goes. Please stay tuned.

In Defense of P2P

While an emblematic trial against the activist group piratebay.org now starts in Stockholm, various parliaments – in an attempt to keep alive the obsolete business models of some ailing industries – are debating bills of law degrading further the intertwined principles of secrecy of correspondence and freedom of ideas.

As we all well know, ancient democracy, the system by which citizens directly govern themselves, is no more. Modern democracy, the system by which citizens actively protect themselves against their own representatives, is losing momentum. With a reduced constitutional protection of privacy and freedom, democracy vanishes altogether. It is the nature of governments to invade the content of private communications as much as they can, and to limit the scope of civil associations. Public officials are prone to always find new reasons for eroding the corpus of legal guaranties which is their sole hindrance. They usually base their will of control on the somewhat cynical claim that ‘good citizens’ should have nothing to hide and should never pursue any activities not in the immediate interest of the State. War, crime or even the mere consideration of health are the main chapters in the sad book of Attrition of Civil Liberties, which is now describing our political lives. The perpetual guerilla between ordinary citizens and their benevolent enemies mostly takes place on a series of seemingly benign grounds, carefully chosen as to minimize the probability of efficient counter-reactions. Peer to Peer electronic networks (P2P) are a recent example of such local battlefields where essential principles are nevertheless at stake.

P2P networks enable a correspondence between individuals in the same way postal and telephone services do. What makes them specific is that individuals subscribe  to information services providing the electronic address of other individuals willing to exchange pieces of data files. To compare it with older technologies, one could simply say that the system works as if lists of postal addresses were published, allowing readers to exchange letters, each containing parts of the texts they are mutually interested in and contain description of ideas, poems, drawings, musical scores, or any such intangible products of the mind. The main difference is that they P2P networks are much more efficient.

It is important to remember that ideas may not be appropriated, and that even the fiercest advocates of intellectual property do not go as far as pretending that they should. When Einstein discovered ‘E=MC2’, no patent, copyright, monopoly was provided to make him as rich as any successful music composer or movie director can become. What is supposed to be protected by intellectual property, as an exclusive right or monopoly, is only the material form under which the idea is expressed, in this case a scientific paper or a book containing the original expression of the celebrated formula, not the formula in itself. For a period of time, the paper  may not be copied by anyone unless previously authorized by the original publisher or the subsequent owners of the rights. Brief quotes, however, are permitted in order to avoid the obviously absurd consequence of preventing ideas from being not only copied but even mentioned.

The problem is that the distinction between an idea (or any product of the mind) and the form under which it is expressed is a misleading metaphysical concept. Suppose that the formula, instead of being short enough to be quoted in less than one line, would be so complex that it would take a whole scientific paper to express it. Then, quoting the idea would actually mean copying the entire text of the paper. As doing so is expressly prohibited by law, the very idea – not only its form -  then becomes the object of a monopoly and may  not be legally spread. This shows in a lear light how absurd the foundations of  the so-called ‘intellectual property’ can be.

This situation is not restricted to mathematics, physics or philosophy. When asked by a lady how he could possibly put his ideas into the marble with such ease, Rodin answered: ‘Madam, I think in marble…”. The same applies to all arts. There is no real difference between a product of the mind and its very expression. Therefore, preventing the copy of the expression of an idea (or any product of the mind) is equivalent to preventing the free communication of ideas, an unreasonable prohibition indeed. Legislators, being at least subconsciously aware of this implication, the more an idea or product of the mind is important for mankind, the least protection they actually grant it. Disney and rap dancers thus turn much better protected than Einstein.

Great artists are not put in any more danger by P2P than scientists or thinkers have always been. The main ones to be threatened by this development are the traditional music industry, and – to a certain extent – film industry, as their business model is based on the material monopoly they had kept in the distribution of music and films. It was not only illegal to multiply copies of songs and films, but it was mainly impractical. The progress of electronics now makes it extremely easy in the case of music, and rather easy in the case of films.

Adjusting the business models of these two industries to the technical change requires a degree of imagination their management is lacking. It would in any case hurt their short-term interests. So they found simpler to initiate a brutal crusade against P2P, mobilizing part of the vast financial resources and influence they had accumulated over the past. This is i nothing but a crusade against the tens (or possibly hundreds) of millions of consumers over the world now enjoying P2P protocols which have rapidly grown as the main usage of the Internet, way beyond browsing and email. What the crusaders are trying to obtain from gullible legislators is the protection of their old business model, an undertaking directly rooted in medieval corporatism. More modern is their lobbying practice: they take the precaution to pretend acting for the defense of artists and creators more than of their own. Who would indeed be cruel enough to deprive an aging industry from revenues artists and creators receive a (small) percentage of?

Of course, things are quite different. Musicians can always make money by giving concerts, and the more famous they become through free electronic access to their music, the larger the audience they attract. In other words, music production companies do no need to exist anymore for musicians to thrive. Younger talents can find a career after being chosen by the public rather than after being selected by the executives of music companies. Other industries would also be better off without them, such as radio and TV, not to mention night-clubs, bars and the many other businesses broadcasting music as waiting tones or in elevators.

The situation is slightly different with films, as the movie industry is better protected by the material nature of the product. Blockbusters are better viewed in large theater than at home, and can generate income in the traditional way. The more modest independent films are more difficult to find on P2P networks than on DVDs. The least well placed are the mid-size productions which are too expensive to amortize on the limited number of screens distributors are usually willing to grant them. Yet, even they can survive, cable channels having proven (immense) profits can be made by financing such films even in the absence of any other distribution. More importantly, all segments can thrive, provided the whole industry accepts to change business models from copyright-based to service fee-based distribution. Consumers, as a matter of fact, have shown (for instance with i-Tunes) that they are not unwilling to pay (large fees) for the service of providing good quality files from fast servers, as soon as or shortly after the content is available otherwise, in the same manner that they are willing to pay for theater seats. Artists and creators do not care which model is used or who pays them, as long as they are rewarded by salaries or otherwise.

The notion that replicating electronic files is a forgery is the miserable argument multimedia crusaders have found. By definition a forgery is the act of imitating documents or objects in order to deceive. When a file is exchanged on a P2P network no one is deceived, as nobody claims that the compressed electronic version of any given film is the film itself or has qualities equivalent to those of the original versions available from theaters or from high definition supports. The only exceptions are the fake files sometimes injected by the movie industry vainly hoping to make the selection of good files more cumbersome for P2P users. I see no reason why the authors of such injections, deliberately violating the contractual usage policy of P2P servers of trackers (the lists of addresses of interested users), should not be sued rather than the generally non-profit activists who maintain the servers.

From a broader standpoint, copying or replicating any document or product of the mind should never be restricted, unless the original remains unpublished, or unless the copy is a strictly defined forgery. It is not at all the same thing to distribute a copy claiming it is the original than distributing a copy advertized as such. Forgeries mislead consumers on the nature of their purchases. Overt copies don’t. The history of art and culture in general is made of a large number of overt copies and a smaller number of forgeries. Let the courts deal with the last. Let consumers determine the value of overt copies. At times, they give a higher value to copies, like the Romans did for marble statues imitating Greek bronze originals. At others, they are fetishistic enough to pay a fortune for one of Duchamp’s ‘original’ urinals and not a dime for the exact same object yet not approved by Duchamp himself. Legislators are not to interfere with such preferences.

Sadly, they do. Giving way to the outrageous claims of corporatist defenders of old business models, a galore of intrusions in the privacy of consumers is sanctified. Government agencies and private operators are allowed to set up a full scale surveillance of Internet users: who contacts whom, exchanges what files, using which trackers, ports or protocols. This information, kept in databases, will serve the purpose of fining users, shutting down servers, suspending Internet access, in other words, punishing in any possible way consumers who are simply hoping for the new business models to emerge and, who, by the way, often turn out to be the same people who also go to the theater and purchase DVDs (preselected after a P2P screening). Such information can also serve more perilous purposes, too easy to imagine and useless to describe here.

Even when reluctant to so restrict civil liberties, many governments seriously consider compensating the loss of income incurred from the obsolescence of the business models, by so-called ‘global’ licenses, which are taxes unfairly levied on Internet subscriptions, no matter the nature, number or even absence of downloaded data files.

Surprisingly, such blind and large concessions made to the lobbying of aging business actors, seem insufficient to appease the wrath and greed of some enraged multimedia crusaders. Recently, Luc Besson, a French filmmaker turned into owner of a film studio, published a most heinous article, asking all people even remotely related to P2P or streaming, from advertisers to Internet access providers, to be sent to prison as accomplices of a crime he compared to drug dealing. You would think this is the mere utterance of a deranged mind. Unfortunately, the current trial against the young activists of piratebay.org, shows that the danger is real, and that greedy madmen, when influential enough, may sometimes succeed in destroying the life work of good-will visionaries.

This is how the world goes. But let’s hope (and fight) for the best.

Corporation, MD

The present economic scenery does not allow for narrowness in the search for diagnosis and remedies. It may very well be the case that our macroeconomic illness also plunges some of its roots into microeconomic malfunction.
Let’s therefore put aside for now both (i) the regular macroeconomic cycles, although one of them definitely just ended, and (ii) the long term decline in the technology gradient between East and West, although it threatens the foundations of the entire international trade model, as well as (iii) the leverage bombs which triggered the depression. Let’s focus instead on business management at corporate level.
Business administration theory is essentially teaching how to fight Schumpeter’s concept of inevitable corporate death. The mainstream idea is that, given enough goals setting, planning, focus, hard work, diligence, persistence and disciplined execution, corporations can follow a perpetual ‘S curve’ from fast growth to maturity, from start-ups to cash-cows. The transition to maturity is recognized as a critical phase, which calls for new managers and business consultants, in order to regenerate income, in spite of reduced growth. The task of the consultant is to recommend and the task of the tough (=good) new managers is to implement the recommendation of trimming the fat, i.e. eliminating any product line, market segment, supplier, channel, employee or investment, which either does not fit the historical success profile of the company or does not produce the best income. This method has proven itself, and it is a certain fact that the deliberate trimming of the business to the core, does indeed create a short- or mid-term improvement of income in the so-called ‘mature’ companies, i.e. companies large enough to be in the first tier of their own sector and now probing the limits of their core market.
On the other hand, it is a dangerous medicine the one that guaranties the death of the patient. If the trimming logics are pursued to their end, as a matter of fact, the company will find itself with only 1 product, 1 client, 1 employee and no investment, another name for sheer disappearance. There is no practical escape from this theoretical conclusion: large companies die. The more the mainstream management cure is applied and the better the managers are in implementing the recommendation, the more in fact the company is doomed.
With the temporary exception of oil companies, almost no corporation listed on the US stock market at the time of WWI is still in existence today; and the handful of survivors is mostly in bad shape. The biggest, strongest, and best managed corporations according to standards are dead or in agony. There is no space enough here for the endless obituary they would deserve. Just think of PanAm and most airlines, Polaroid, Kodak, Kmart, Dell, GM and most automakers, AT&T, ITT, DuPont, all banks, DEC, Bell-Lucent-Alcatel, Bethlehem and most steel titans, Tribune and most newspapers companies, AOL, Marlboro and most tobacco companies, etc, etc, etc.
The main reason behind the mass slaughter is that while companies tend to stick to what made their success and eliminate the fat around their core business, markets have a life of their own. Few assertions are more certain than the following: there will always be a market change capable of killing any company.
Based on these facts, one would think that the best management method is not the ‘trimming to the core’ but the preparing at all times for market change. The problem here is twofold. First, stock markets are not inclined to sacrificing sure short-term improvements by trimming for unsure long-term investments for survival.
Second, the risk, as usual, is to underestimate randomness. It takes many entrepreneurs to get a successful one. God and Evolution, with their 50 million spermatozoids per ejaculate, are in fact much more conservative than venture capitalists with their acceptance of a 90% average rate of failure. Moreover, the established business management theory is wrong in confining randomness at the level of start-ups. Randomness remains a reality after the initial stage. Even if an exceptional business genius was capable of anticipating most of the future market changes and designing the appropriate product solutions, he or she would still be confronted to randomness under the form of timing. Timing is determined by such a complex combination of factors, that it can almost never be forecasted and can only be guessed. Wrong timing is yet the worst of all outcomes, having consumed vital resources to no avail.
Under these conditions, is it possible to design the kind of meta-corporation it would take to continuously self-reorganize in order to face market change? A couple of entrepreneurs, like Jack Welsh (GE), Steve Jobs (Apple, Pixar) or to a lesser extent Richard Branson (Virgin) and Lou Gestner (IBM) have shown it can be done on an individual basis. But can this be done on a global basis?
In what is possibly one of most stimulating books ever written on Business Management (Create Marketplace Disruption: How to Stay Ahead of the Competition FT press, 2009), Adam Hartung gives a positive answer, and explores various ways for a corporation to manage its success formula to achieve adaptative success: such as stop the ‘Defend & Extend’ old habits through trimming, generate controlled disruptions of the corporate personality, and create an autonomous ‘White Space’ to continuously create revised success formulas.
Although I am not sure any business organization can overcome Schumpeter’s spell forever, Hartung’s suggestions may certainly increase their longevity. If he is right, the good old ‘best practice‘trimming will give way to a much healthier type of management. Successful corporations would probably not only survive longer, but they would also be likely to do a much better job than venture capitalists at attempting new success formulas , having more resources to do so and a portfolio of potentially synergetic technologies to leverage. Last but not least, consumers’ markets would be filled with a smaller number of laid-off employees…
This is how the world goes

Reflation – the basics

A major stock market crash reduces both the capacity (as a mechanical effect) and willingness (as a psychological effect) of consumers to spend, and the capacity and willingness of suppliers to produce. The crash, as a matter of fact, reduces the value of all assets (except cash). Therefore consumers have fewer saving to spend and suppliers get less financing to produce. Moreover, consumers, who depend on corporations for their income, also have less income to spend, and suppliers have fewer assets to use as collateral for their borrowings. The most logical cure is to restore first the capacity and willingness of consumers to spend, as this also creates not only revenues but also backlogs for suppliers who in turn can use such backlogs to obtain leverage.

Reducing interest rates is part of the treatment, but increasing the money supply in the hands of consumers is the main one. Some consider it wiser to increase public spending under the main form of new infrastructures. If these infrastructures are not productive, however, they cannot be as efficient as private spending which brings stronger social and psychological benefits. Increasing consumer spending can be achieved in many ways, such as tax reductions or subsidizing pensions.

The well-known risk of this type of cure is of course inflation when demand eventually overreaches supply. There is yet a long way to go in the present situation. The mistake would be to consider only the monetary mass and its strictly defined aggregates, which vary must less throughout a depression than the value of the assets that can be used as collaterals. An injection of additional monetary mass, as a matter of fact, can and should compensate the loss of asset value.

The global loss of asset value is reaching gigantic proportions: perhaps up to $ 200 trillion (¼ for the stock market and ½ for commodities as of today, and ¼ for real estate within the next 12 months). All were assets that could be used as collaterals and can no more. On the other hand substituting this entire loss would be madness, as prices vary much faster than demand. For instance a 10% increase in the demand for commodities can raise the price of commodities by over 50%, just in the same way than 10% of more cars in the streets create major traffic jams and vice versa. A tripling of the current plans (about $3 trillion were announced worldwide), however, would seem a strict minimum.

There is unfortunately no way I am aware of to adjust the money supply to the loss of asset value with precision. The effects (particularly the psychological ones) are certainly not linear. This means that when governments realize they need to change gear, and they now do need to, or when they realize afterwards, they should start reducing the supply again, inflation will be triggered at some point. I would thus personally consider inflation-protected securities as a wise choice for a while.

Once the depression is more or less over (this is not happening overnight), only technological innovation can sustain new growth. Technological ‘reserves’ in the pipes are not many: green techs will have to wait until the price of dirty energy is on the rise again; biotech will have to wait even longer for budget deficits to stabilize; and hopefully military spending (until now the main source of innovation) will be kept under control if we really want the planet to survive. This implies to concentrate already the new public infrastructure spending on civilian research, the most productive of all methods, while leaving a place to subsidizing pensions and other social benefits on the short term.

Dissenting voices can be heard. The ones consider the monetary mass as the Holy Grail and will simply not back reflation or not back it enough. Others believe in sheer magics, and expect the end of the recession for next year, based on a combination of Obamania and a blind belief in some anonymous ability to rebuild as fast as mankind can destroy. Beware: such voices can become very loud and could make the depression even longer.

This is how the world goes.

Maalox for Madoff

You are inevitably aware of the nature and magnitude of the fraud: $50b lost in a Ponzi scheme, according to Madoff’s own confession, the exact amount remaining to be determined. The scam is different from any of those which were recently revealed, as it is based on an absence of due diligence rather than an absence of regulations. The most interesting aspect is that a man, for over 20 years, was able to convince most members of an entire profession he could fulfill their dreams, and maintain their unwilling complicity, by offering high and constant returns insensitive to market conditions and generating high fees.

Asset managers – a motto in this blog – are totally unable to produce – as advertised – long term returns for their clients at higher rates than economic growth corrected by inflation, while grossing for themselves between 2 to 4% of the mass under management. They know they cannot achieve this by themselves individually or as a profession globally. They are ready, however, to believe in exceptions in others, and prefer to leverage such exceptions for their own profit rather than question their reliability. Although betting on exceptions made into an average phenomenon is certainly not the soundest of ideas, it seems a good way for average people to reach impossible goals.The most reckless and/or naive  among money managers started doing this in the 80s. The 90s turned it into an industry trend.

It is true, after all, that at any given moment, a handful of asset managers have beaten the market for a long time and made an impressive fortune. The best known are Warren Buffet and George Soros, others are Louis Bacon, Paul Tudor Jones, Julian Robertson and …Bernard Madoff. Obviously, not all are crooks like the later. Most are simply lucky. Some are even lucky and shrewd. Luck is a very important element in what is essentially a random distribution of outcomes. It is a well known fact that the ‘Monkey’ investment (i.e. random stock picking with positions held over a long period of time) produces results that are strictly superior to those of average professional asset managers. One of the reasons for this is that the Monkey is not concerned with generating fees by a fast turnover of portfolios, and carries fewer costs. Shrewdness cannot hurt: Warren Buffet has shown that Grand Pa’s type defiance against anything sophisticated, together with a witty wording of principles, can be good for business. Shrewdness may also reach some rationality when arbitrating between market discrepancies over identical assets. This last method – the best one – is unfortunately limited in scope and self-cannibalizing, as the more discrepancies are used the less remain to be exploited.

In any case, as these exceptions do exist, the advertized concept became: our bank (or financial entity of some sort), is formed of professionals capable not of outstanding results (something as a matter of fact difficult to believe) but of identifying outstanding independent asset managers. Asset managers picking soon replaced ‘stock picking’. The hunt was supposed to be so difficult and tricky that funds of funds had to be created and a whole new profession of distributors of funds invented. These new distributors of funds did not need any specific training, except in hunting, golfing and/or gourmet dining. Most came either from banking mid-management or impoverished aristocratic families. All they had to do was to be lavish enough in their invitations and jolly enough in their conversations to become your friend (if you are a ‘high net-worth individual’) and your banker’s friend (if you are not). In this way they could foster trust, a necessary item when dealing with expensive opacity.

From this moment on, bankers enjoyed a wonderful streak. Salaries paid to well trained asset managers for managing your money according to your own actual needs could now be eliminated. Younger, better looking and less paid account managers were in charge of convincing you to accept the new products: house funds mimicking successful funds, funds of funds, and ‘alternative’ funds that few could understand and less could explain. Not only these products came to the bankers at no cost, but they also started receiving kickbacks (more politely called ‘retrocessions’ from brokerage fees), on top of the fees you were officially paying (entrance fees, redemption fees, management fees, performance fees, custody fees). Your banker friend being your friend he could be nice with you and lift one of these many fees generated by your own money.

All such funds were supposed to have long track records showing steady returns and outperforming markets. When the emphasis is on performance, the track record is usually limited to an ad hoc selection of the best performing among a series of sister funds. When the emphasis is on the duration of the track record, a scarce item, a promise is made to provide funds by the most successful managers. This is where Madoff played his best cards. In order to create the proper hype, he made people believe that his funds were ‘closed’ and would not accept any new investors. In other words the most open of funds (what can be more open than a Ponzi scheme?) were sold as closed. Letting you in was a favor made to friends.

In a way, you can consider it good marketing: against all expectations, the ‘Dom Perignon’ is the best sold champagne in the world (it really is). Yet, this has had far reaching consequences. One cannot be too picky with favors. Illiquidity (redemption notice on the last day of each month, 35 days to redeem, then 30 days to obtain payment) was overseen. Complete opacity of the underlying assets was accepted as an effect of a necessary confidentiality (after all funds of funds have even more opacity as they refuse not only to disclose the nature of the assets – your assets- but even sometimes the name of the asset managers). Absence of understanding of the techniques being used was partly an effect of opacity. Absence of real guaranties, by the formal waiving of most rights, seemed a natural condition for products reserved to ‘sophisticated investors’. Absence of alignment with the client‘s interests was hidden, as most banks would prefer to cash-in their fees rather than include such products in their own portfolio, or simply denied (‘the managers have their own money in the fund’). Market risks involved were covered by distortions in the terminology: sheer speculation was called ‘arbitrage’, build-up of leveraged open positions were called ‘hedging’.

Facing such hype and making money at every step, the financial industry forgot all diligence: money managers trusted their bank, banks trusted distributors, distributors trusted custodians, and custodians trusted auditors. All trusted their own fees to come, and no one checked. This confederation of dunces became so powerful that regulators and authorities had to look somewhere else.

This is how an average man who certainly started his career with reasonably good performances, based on a right combination of luck and insider’s information, could then become a crook when his investments started going array. He is probably not alone in the present state of the financial industry. But we shall know quite soon, as no scam can resist for long the current storm. Attorneys are likely to be the only winners when one of the largest class-action ever starts, including the SEC among the many defendants. Last but not least, beneficiaries of a Ponzi scheme are liable to give their returns back to indemnify the last comers and victims. Considering the exceptional duration and magnitude of the scam,  it is going to be very messy.

There is little doubt that the money management industry is going to change dramatically after such events.  After a period of attempted resistance, bankers who had cautiously stored their profits in Treasury bonds while their own (now infuriated) clients are the first victims of their policies, will have to take some commercial (or legal) losses. Insurance companies, custodians, auditors and governments will contribute. Most hedge funds boutiques will have to shut down. Funds of funds will slowly vanish . Regulations will be drastically reinforced. Opacity will be banned and kickbacks will disappear. Bankers’ and managers’ responsibilities will be increased. Asset management will cease to be the cure-all for banks who had opted-out from lending. Risks awareness will be somewhat restored. Bankers will start playing serious golf or  kill less game.  Perhaps, the day will come when the best offer on the market will be a guarantied loss of 1% per year in real terms: a serious improvement indeed.

This is how the world goes.

 

Back to the Future

In 1992, a very famous book announced the End of History. For the better or for the worse, current events may be pulling us back to the future, i.e. to change under incertitude, the old feature of human condition. One of the foremost economic crises in modern times is not only blurring the vision of a triumphant capitalist market, but is also reopening the possibility of a political eschatology somewhat different from the everlasting parliamentary State.

While governments minimize by a full order of magnitude the quantities of financial medicine they should inject into the arteries of a chocking world trade, entire populations get closer everyday from feeling personally the pains of new poverty. The higher the recent growth their respective countries had reached, the harsher the depression will be for them. The most dependent zones on foreign trade are likely to undergo a severe social turmoil. For once, Western Europe is not the weakest link. Equipped with the strongest social infrastructures and relatively good reserves, the area is also protected by its dominant inner trade, as well as a long habit of bad news and of lagging in economic growth. “Chinamerica” should be the seismic zone, together with Eastern Europe. The United States cannot solve all issues by simply playing with an overwhelming currency, as in the good old days, and the Chinese armed forces are not strong enough to fight a violent resentment against so great lost expectations.

What’s really new is that domination of the State is not as much at stake as the State itself. We are not confronted with the prospect of opposition parties taking over, but with the one of a pervasive distrust for States in general. Tax boycotts could very well appear in America, and riots in many places. Young people raised in false hopes will show their anger. Nihilistic sabotage, rejection of intellectual property may also join the symptoms. Such disorders, not being driven by a structured vision of society, are among the most difficult to fight by anything else than extreme ideologies. Even Islam may prove unable to capture a negative energy essentially indifferent to geopolitics.

You may smile at this kind of doom saying and you may be right in only one case: if we can rebuild the system nearly as fast as we destroyed it, if the economy can take a fresh start on the basis of a fraction only of the assets which were annihilated. If you do not believe this is a real possibility, then better get ready to meet History again.

Bertolt Brecht had a say for the optimist and one for the pessimist. You can now make your choice: ‘The worst is never certain’ and ‘The belly is still fertile from which the foul beast sprang’. Personally, I would pick both.

This is how the world goes.

GDII?

The Great Depression II (or Great Recession for the optimist) has taken most of us by surprise. Its most astonishing feature certainly is the speed with which the financial crash has been hitting trade, way beyond the global credit crunch generated by the interbank crisis. The credit crunch should have been more moderate after the recapitalization of major lenders and the injection of liquidities which took place almost immediately and on a massive scale. Even if we take into consideration the additional force of the end-of-cycle recession which was due in any case, both the magnitude and velocity of the impact on trade could not have been expected at this level. This means that most economic actors (even those who were not yet directly affected in their current production capacity and did not observe a sharp decline in demand on their own segments) overreacted in their anticipation of a market crunch, creating a self-fulfilling prophecy. In other words, negative expectations went much faster than the negative mechanical effects which are unfortunately still to come as a direct consequence of the ongoing stock market crash, e.g. reduced offer from undercapitalized corporations and declining consumers’ demand from both unemployed and retirees.

In front of such a disaster, even the nationalizing of major financial institutions and industrial leaders, together with a continuation of the lowering of interest rates (possibly even briefly to negative levels, which can become an option if governments and central banks start being considered as the only reliable borrowers), is unlikely to be enough for the job. Large public deficits now look inevitable, in order to both reflate the system and amortize the social turmoil to start anytime soon. Governments shall be tempted by the ‘wise’ approach of new infrastructural investments. They are yet bound to take care of consumers if they want to avoid the collapse of the two pillars of the entire modern growth: automobile and real estate (the growth of services being ultimately associated to the one of final products). New technologies are unfortunately not well placed to be chosen as the core of reflation: bio techs represent for the time being an insufficiently productive additional burden for governments, while green techs are temporarily competing again against low cost traditional energies. As to renewed military spending, no one in his own mind can consider it seriously, at least until the main mistakes of the Bush administration are repaired.

In theory, stimulating demand by large public deficits can be done without uncontrolled inflation as long as the previous level of liquidity is not substantially restored. It has been done in the past, but not on the scale to consider now. We are thus entering unknown and probably stormy waters. Let’s hope for the best as

This is how the world goes.

The Crash for Dummies

Although brokers are doing most of the crashing for us, a crash course in crashonomics seems more urgent today than any ‘Ms Office for Dummies’ or ‘Family website creation for Dummies’. As passive crashing represents the largest part of a crash, it should be interesting for almost anyone to understand the mechanics of crashes and learn how to talk to bankers rather than listening to what they are paid to say.

- Can one make profits during a crash?

Basically no (see exceptions below), for a crash is precisely a massive loss with no or little counterpart. In regular situations and according to the laws of physics, whenever people lose money, others simultaneously make money. In a crash, on the opposite, wealth is annihilated, not captured by anyone or stored anywhere.

- What are the exceptions?

Obviously some people get luckier than others by losing less than most others. These are the ones who, for some reason, held a larger percentage of liquidities at the beginning of the crash (unless, of course, the crash is a monetary crash, in which case people holding the wrong currency get busted). There are many random reasons for this to happen: some may not have had time to make the specific investments they were preparing for, others may suffer from a maniacal fear of investing, and some others may have had a bad feeling about the health of the markets, thus divesting before the crash. All of these in fact increase their own net worth, even if they take losses on the invested part of their portfolios, for their cash assets would now allow them to purchase more of the discounted assets on the market. A much smaller group may even have increased their cash holdings, having used special financial instruments to sell the market instead of buying it, and getting paid as the market declines. Please note however that selling the market being a very dangerous exercise, past gains can quickly turn into major losses during oscillations of the market, which always occur, no matter the trend. In any case, winners in a crash are a minority by definition.

- Are these exceptions a sign of genius?

Nope. Nobody can forecast accurately and with certitude the behaviour of unbiased markets. A theorem exists to prove it, but it should be enough to realize intuitively that if anyone could, he or she would accumulate the entire wealth present on the markets. People may have good or bad reasons to anticipate the behaviour of a market the way they do, but they cannot overcome incertitude. Astrologists as a matter of fact obtain on the long run equivalent results to Nobel Prizes’. Globally, winners and losers are distributed at random. It is mathematically inevitable that some investors make more accurate (although no less random) anticipations than others, even over very long periods of time. The illusion than such people have a secret and profound understanding of the markets is also inevitable. As they tend to be treated as pundits or even oracles, masses of average investors imitate their investment decisions, giving them a small edge, and reinforcing – up to a certain point- the influence these gurus can have on the markets. Asset managers, whose are supposed to make more enlightened investments recommendations than astrologists, always find an unlimited number of arguments to explain why they made you lose money, their main excuse remaining, however, that on the average they did not make any worse than the other average asset managers. In the best case scenario, one can become a savvy investor, cautious when others get frantic and capable of spotting opportunities (when they can be double checked).

- Does this mean that markets are irrational?

Not at all. Markets accomplish rationally what they can accomplish. However, markets do not have any knowledge of anything; they simply match offers and demands from actors who have various levels of knowledge and yet all share in the overall incertitude. For instance, in March 2000 most investors started underestimating the positive implications of the Internet, not realizing it was the most important industrial development in the last part of the XX century. A sudden panic seized them and the notion of a ‘dot.com bubble’ emerged, wiping out many technology companies. In October 2002 $ 5 trillion had been destroyed. It took about 5 years for the average actors (summed up as ’the market’) to understand they had been wrong, and for market indexes to reach unprecedented highs. If the savvy anti-internet oracle nicknamed ‘Bluffette’ had been as insightful as he suggests he is, he would have purchased technology shares over the crash and become not the second but –by far – the richest investor on earth.

- Do crashes destroy ‘nominal’ or ‘real’ wealth

No matter how we call it, wealth it is (or was). At any given time, there is no difference between nominal and actual wealth. The underlying substance of wealth – buildings, companies, commodities, pieces of art, etc – is not economic wealth in itself: these things are wealth only as much as they have a price tag. When their price goes down sharply, destruction effectively occurs.

Against certain appearances, stock markets are not primarily gambling houses. They are tools for corporations to obtain financing (a vital necessity) and for individuals to maintain some of their savings. After a crash, the average corporation cannot produce as much as before and the average consumer cannot consume as much. Therefore economic crashes entail or reinforce recessions.

- Is it good or bad to destroy nominal wealth based on wind?

Yes and no. Phony assets, like many of the securities which just exploded in flight, must be eliminated, no doubt about it. On the other hand they were very useful as currencies. Without them the world would never have reached its recent level of growth and globalization would have taken much more time. Now that this phony and yet useful currency is getting eliminated, it must be replaced.

Here is an example. Let’s say that I purchase your shoes for $ 100 million dollar, while you purchase my watch for an equivalent amount. This is something we can do as I can pay you in paper from my company, and you can do the same. Each one of us now has $100 million in our books, and together we have created about $ 200 million. Let’s assume now that for some reason our banker accept these values (for instance we have convinced him that the watch is capable of predicting bad crops and that the shoes are made from an extra-terrestrial material with amazing properties which will become obvious in 10 years from now). He will lend us cash against shares of our companies as collateral. As the banker is otherwise very conservative, he ‘only’ lends us 2/3^rd of our nominal assets, i.e. about $ 133 million. Now, we can use this cash to build a solar energy platform in China and a hotel in Spain. Our suppliers are getting more work; they hire people who in turn spend their income. We have contributed to the worldwide growth. When suddenly it is revealed that we were nothing but crooks, the banker refuses to renew his loans and we go bankrupt. Yet, we are not the only ones in trouble: the banker himself has probably lost a part of the loans and must restrict his credit policy for a while; our suppliers must lay off workers who in turn will spend less than before; the price of hotels in Spain shall decline, and China will lose some resources, among many other repercussions. If we want the global economy to recover, someone has to inject brand new money to turn around our failed ventures. This is called ‘reflating’ the economy. After a crash, it is always a good idea to reflate the economy in order to attenuate the coming recession.

- Is it easy for governments to reflate the economy after a crash?

First of all, it must be done; otherwise the risk is to transform a recession (i.e. a short term decrease of production) into a ‘depression’ (i.e. a long term decrease of production). This is not a problem as long as governments and central banks use the money they have to invest or lower taxes, and lend (or guaranty loans) based on assets they have. The thing is this may be insufficient to fill the gap, in which case the only solution is to ‘print’ money at the risk of triggering inflation. For instance, as of today, the gap between the worldwide hole (certainly more than $ 100 trillion) and the current available public resources (certainly less than $ 10 trillion) is gigantic. ..

- How long can the downturn last?

What matters in not so much the length of the crash, measured as the time it takes for the markets to reach their bottom, than the duration of the subsequent recession which lasts as long as the pre-crash amount of wealth is not recovered. No economy can regenerate wealth in a ‘natural’ manner anywhere as fast as a crash can destroy it. The 1929 crisis, not so long ago, lasted almost 2 decades.

- As the pace of economic changes is now much faster, should not a recovery come earlier?

Apart from the global amount of money available , economic velocity depends mainly on the rate of innovation and the size of consumers’ markets. We are currently in a phase of relatively slower innovation (see the many previous posts on this). Energy would be the core of innovation today. Unfortunately, the recession entails a decline in prices of energy, in turn hindering new developments. The positive element is globalization.

- How deep can markets crash?

Nobody knows exactly, but possibly very deep. The final magnitude of crash cannot be extrapolated from observed trends, as any number of thresholds can be crossed before things eventually settle. Market oscillations are normal, and rallies certainly do not seal the end of the turmoil. Temporary rallies mostly mean that investors like to ‘average’ their losses by purchasing the same assets that declined at a lower price.

The best approach is to compare the main causes of the crash with the simultaneous capacity to reflate. The 1987 crash had been triggered by what investors had perceived as an excess of so-called junk bonds (which were basically corporate obligations). The total amount of such bonds which had been issued in 1986 was $ 200 billion only. No wonder the recovery was fast. We are dealing today with an unheard of level of uncontrolled leverage forming a completely different order of magnitude of bad assets. Rescuers are on the job but with very limited means compared to the phenomena they are dealing with. Next to so many uncertainties, we are left with at least one certitude: the crash was not irrational and will carry long lasting consequences.

This is how the world goes.

Elements of Speleology

How deep? That is the question. Stock markets have now lost 25 to 30% globally in less than a month, which represents a destruction of nominal wealth of approximately $25 trillion.

Announced bailout packages amount globally to about $3 trillion. The largest portion of such packages is made of temporary loans from central banks and guaranties, as opposed to long term transfers of liquid assets from national treasuries. A significant part has already been used to cover the losses from subprime loans, as well as the immediate consequences of Lehman’s failure under the double form of defaulting receivables and defaulting Credit default swaps. Assuming the packages can be doubled in size (which is probably the upper limit before entering into stormy monetary waters), they cannot cover the reasonably expected defaults within remaining CDS net positions ($ 37 billion). If we add to theses amounts the destruction of nominal wealth in real estate to be expected over the next 6 months (perhaps 30 % globally) and in other real assets such as mineral reserves, it is hard to imagine how governments could reflate the system at the appropriate level fast enough to avoid a depression.

If stock markets are rational they should drop further. More likely, some cash-holders will start believing they are soon reaching the levels of new opportunities for a reentry into the market, triggering volatile rallies, yet unable to steadily reverse the trend at least for a while.

Obviously the world economy will be craving for a recovery and there is little limit to what can be invented in terms of money creation to soothe social injuries and calm down unrest. Risky times, by all means.

This is how the world goes

No explosion, Turkish-style strangulation

Quite a lot was learnt yesterday from the settlement of Lehman’s credit default swaps. First of all, we were all relieved to see the process complete with no major incident. Simultaneously, the reasons to continue worrying were made clear: (i) the main losses had already been taken and gradually paid for over the last weeks, under the form of both margin calls or “stop loss” returned positions; (ii) payments were made using the recent giant bailout packages as well as the central banks’ new credit facilities; (iii) and such packages and facilities had precisely been precipitated in order to allow the settlement. We also learnt the exact amount of CDS contracts now registered in the Depositary Trust and Clearing Corporation’s clearing warehouse, totaling approximately $34.8 trillion at this time (as opposed to the previously estimated $ 60 trillion, which was based on surveys, and down from an actual $44 trillion in April).

The residual funds transfers that took place yesterday were only the last ones to complete an actual monster loss of about $400 billion. There was basically no difference between nominal and actual losses: margin calls are not a free ride, nor is returning one’s position (unless this can been done way before the event and in a none-volatile environment). Instead of one-day explosion, death took therefore the smoother form of a slower Turkish-like strangulation.

One has to remember that Lehman’s CDS were nothing but a first test of the process, representing a minute portion only of the total outstanding Credit Default Swaps. It is true that the percentage of loss was extremely high in this specific case due to an underlying bankruptcy. It is yet fair to say that very few net positions on all other CDS are winning, in a global situation when almost if not all credit ratings are crumbling down fast.

Regulators are of course scrambling to take some control over CDS. All they can do, however, is limit the creation of new ones and give them more transparency. They cannot reduce by 1 cent the present amounts of further losses to settle which should reflect in the quarterly reports to come, at least for listed companies.

This is not good news for the stock markets and yet

this is how the world goes.

Bloodbath aftermath

A quieter week was wrongly expected after the interbank pacemaker was put into place and before October 21^st, the day when the general public discovers the meaning of the three letters C.D.S.

Leveraged investors are now forced to sell and the professional wishful thinkers (e.g. your account managers) are losing drive, leading markets to nervously slide down to the levels reached 6 years ago (2002). This is much steeper than the 87 crash, the oldest memory of most traders, and the main obstacle to their comprehension of current events. As they were raised to believe that stock markets downturns are short-lived, they took immediate comfort in a ready-made solution: just wait for recovery while only the panicking fools are selling. These ideas led them to ignore 2 important facts: thresholds can be reached beyond which situations do not repeat themselves; and this crash has causes (uncontrolled financial leverage on a giant scale) that the 87 crash did not have. Even the optimist is now aware of the recession to come (it has hardly started yet), under the impact of the inevitable crunch of consumers’ markets which shall follow mechanically a universal loss of net worth, leverage and employment The only debate is how deep? How long?

This depends on various factors, such as the intensity with which leveraged real estate shall blowup, the magnitude if the CDS blast and the capacity of governments, which are already drained of blood, to ‘reflate’ the economy. Concerning real estate, prices have not yet declined in percentages anywhere close to those of the early 80s. Thus the risk is high in many places, including Europe and emerging countries, where a 50% decline is not unrealistic at all. For the CDS, better not talk about them until October 21, where we shall know the proportion of net exposure in the due $410 billion for Lehman only (i.e. 0.6% of the total), who are the main victims and if they can survive. As to what’s left of the capability of governments to compensate all the losses, no one has the slightest idea at this time.

Let’s fasten our seat belts (before tightening our own belts)

This is how the world goes

Multiple organ dysfunction syndrome

Considering that the lead physician in the intensive care room was, by far, the most incompetent of all, we are very lucky a proper treatment was eventually applied. Following the bold plan designed in UK, Europe has mobilized enough resources to reestablish interbank confidence, and driven a clumsy US administration into following (more or less) the same path. Theoretically things should improve for some time: guarantying interbank credit is like inserting a pacemaker to make a failing heart continue to beat. Recapitalizing major institutions is also a good remedy: it is not only a better way of injecting liquidity than adding to the total amount of debts, but also leaves some hope of getting part of the taxpayers money back once the markets are completely cured.

No doubt governments will use the opportunity to treat the very origin of the disease, i.e. uncontrolled leverage. Most financial institutions should be submitted from now on to banking rules, and especially the Cook ratio. Exposure will become more explicit and subject to surveillance. New equivalents of the good old Glass-Steagall Act, which had protected generations of depositors against the hidden risk of seeing their own money burn under the form of mindboggling securities, should be put into place. There is no need of a world government to achieve this; any local regulator of a market large enough to be indispensable to global investors, can impose it worldwide.

Everything would then be fine if the banking system was the only failing organ. Unfortunately the volume of wealth destruction which has occurred goes far beyond the $ 3 (or perhaps 5) 000 billion governments can possibly gather to reflate the economy at a proper level, and goes far beyond banks. The sepsis has reached industrial corporations, both as stockholders and as suppliers of markets. It has reached pension funds, as well as consumers directly. Even if the real risk represented by CDS (see previous posts) did not turn out as disastrous as it could be (we’ll know for sure before the end of year), a consumers’ market crunch is inevitable, which cannot be adequately compensated by sufficiently massive injections of additional cash. Even if some confidence was to be restored for a while, a deep recession would still be inevitable.

This recession will be dangerous for fragile stock markets and for depleted public treasuries. It should also bear large-scale social consequences. The average person is still stunned and silent. Scared for his (or her) family‘s future, he cannot believe what he is witnessing, and hardly realizes he will be the main payer of other peoples faults, the same people who just kicked him out of his home and his job or threaten to do so anytime soon. It will not be long before he awakens to the fact he has been playing an unfair game for the profit of an unreliable, reckless and somewhat criminal elite. Then what is likely to happen?

This is how the world goes.

Good Sunday

Today is Sunday; most stock markets are closed except in the Gulf area; it’s time for a pause. My recent posts have be depressing friends and giving nightmares to my son. So, let’s sit down for a minute and look and at the bright side of things. Yes, there is a good side.

Free markets, as opposed to planned economy, are as important and useful an invention as writing. They allow people to exchange any services (the so-called ‘goods’ are in fact services) they are capable and willing to exchange, and thus to benefit from the existence of other economic agents also capable and willing to exchange. As such, free markets are definitely a good thing and should be preserved.

Free markets, however, must always be regulated. Aristotle, who was the first theorist of markets, explained it very well: without a public control of weights and measures, people could not possibly know what they are actually exchanging, and would end up being cheated most of the times. Indeed, a large majority of goods cannot be checked at the time of purchase: how would we know what molecule is in the pills, if the pilot of the flight we are about to take has been properly trained, if the securities we intend to buy correspond to real assets? Two millennia later, Adam Smith, who was not a communist, insisted on the importance of public infrastructures, including courts, to make the system work.

An essential aspect of globalization is that a significant part of the financial markets was able to evade public regulations and controls. This is the main cause of the major problems we are currently confronted with. Things could have gone otherwise: it would have been relatively easy for the regulators of either or both the two most important economies, the USA and Europe, to impose global regulations. Exactly in the same way that the USA were able to efficiently pressure Switzerland (and other countries with ‘offshore’ banking) into submitting themselves to certain US rules (the deadly threat being to ban their banks from US markets), it would have been possible to prevent the global trading of uncontrolled securities, such as subprime loans and CDS. Ideology was the sole obstacle: 20 booming years of reagonomics and thatcherism had convinced many – against the constant opinion of free markets thinkers- that markets could self-regulate. We now realize that this was nothing but magical thinking. The good news is that, after we are finished paying the tremendous price, we know the cause and we know the remedy. No doubt it won’t happen again for a very long while.

Toxic securities are not the only issue the current crisis can help solving. The price of assets had reached ridiculous levels. Some companies were selling for 100 years of profits, when we now know (see Adam Hartung’s excellent blog on the blogroll) that no company has ever been able to anticipate the necessary market disruptions for any such length of time. The same applies to real estate which had been reaching price levels which would have made sense only if the earth was overcrowded, whereas millions of square miles can still be build (most of London is underused), and whereas most office space in the world is empty at least half of the time. It will take a long while before a closet should reasonably be worth $50.000, a price recently reached in several cities, including Mumbai…A world with cheaper enterprises, real estate and commodities can only be a better world.

Last but not least, the economic comeback will be centered on high-tech sectors, including green techs. This is also very good news. Feeling better now?

Have a nice Sunday. Worries on Monday. Perhaps also a quieter weather for a few days… until October 21, date of the first test for the CDS blast.

This is how the world goes

How will the world look like when the shock wave hits?

It has been fashionable for some time now to distinguish between ‘finance’ and the ‘real economy’. This is not very sound as finance is nothing but the cardiovascular system of the economy (made of goods and other services). The heart is now in surgery room, surrounded by physicians with limited knowledge and – above all – limited means. All they know is not to repeat the same mistake that was made in 1929, which consisted in adding a liquidity crisis to a stock market crash, and putting the overall activity close to a standstill. Governments and central banks are now pouring all the cash they have and soon all the cash they don’t into the failing arteries, in order to keep liquidity at a par with the massive destruction of wealth which is now occurring on stock markets. They definitely try their very best to save the banking system from complete crumble, by guarantying and nationalizing one after the other major financial institutions. Even after their current reserves are gone, they should be able to continue doing this by using their status of ‘least bad’ borrowers: sovereign obligations (close to having null interests’ rates) shall allow them to pursue this exercise for a while.

There is however a quantitative limit to the number and scope of entities they can bail out. Financial institutions are one important thing, and yet not the only components of the financial system. Corporations, pension funds, high net worth individuals are also facing almost unprecedented financial losses. Even massive tax cuts cannot compensate such losses (tax cuts are more or less automatically granted as losses are not supposed to be taxed in any case). For the economy to work, corporations and high net worth individuals must invest and pay salaries, while pension funds must pay pensions to consumers. Globally, they will not be able to do it at previous levels for a long while. And this is precisely how the shock waves hit the rest of the economy.

At this point, even if both causes and treatments are different from what they were in the 1930s, the phenomenology of the crisis shall look pretty much the same: massive plunge in the price of assets, massive unemployment, and massive physical poverty. As during the 30s, there will be some winners too: these are basically the owners of cash, now able to purchase the massively discounted assets as they come, provided however their cash is in safe currencies placed in a safety deposit boxes or nationalized banks. Opportunities, as a matter of fact, should multiply for them when the stock market goes down to 25-30% of its peak values, and real estate (or contemporary art) 50 to 20%. The problem is obviously that most people and corporations not only have little cash but are carrying heavy debts. Leveraged assets (many exist in the private equity sector) should go bust, and consumers’ markets will violently contract, fueling the vicious circle of recession. This should happen even if the CDS shock wave does not hit (see previous posts). If it does, you’ll see your attorney offer to work for food, and fascism come back.

Many people do not realize this. As few of them were directly exposed to the stock market, they are happy to see the ‘traders’ and the rich in general pay the price of their own mistakes, and believe they won’t have to pick the tab also, while governments are finding a solution. How wrong. They should start discovering the ugly truth sometime in 2009, and feel the consequences for a while (5 or 20 years?) afterwards.

How will the final relief come? As usual instant experts will promote gigantic schemes involving new ‘Bretton Woods’ (to achieve what as this is not a monetary crisis?) and ‘Marshall Plans’ (how can this be done in the absence of the equivalent of the 1945 USA?). As usual also, the military will attempt to be the new trusted economists, pointing at strategic hotpots (Iran, Taiwan) and lurking at weaker countries were money is left.

Let’s hope Obama can resist and someone comes up with better ideas.

This is how the world goes (sorry about that)

Don’t bother to be pessimistic: things are much worse than you may think

Remember my last post on the Credit Default Swaps? Dubai just obtained a 15 billion $ bailout from Abu Dhabi to face a default of their own Credit Default swaps. Dubai…

Let’s look again at the issue. The outstanding amount of subprime debt is about of 1,300 billion $. The outstanding amount of CDS is about 50 times larger. The good news is that a large part of this amount is made of offset positions by players reducing their exposure or netting their own contracts. As it is currently impossible to know the net total amount of outstanding CDS, let’s make the most unrealistically optimistic assumption, and consider 90% of the positions as offsets. The bad news is we are still left with at least 5 times the total amount of subprime debt.

Another element to be taken into consideration is that subprime debt is somehow based on real assets: even if they are worth a fraction only of their nominal value, buildings and apartments are still worth something. This is not at all the case with credit default swaps which are based on nothing else than gambling, a very special case of gambling, indeed. Casino gambling is regulated, CDS are not. Casinos have money to pay their own losses; this is not the case with CDS issuers. Casino’s risks are stable; CDS’s risks are not. Quite the opposite in fact: Credit Default Swaps are bets on the credit quality of third parties, at a time when the credit quality of all institutions in the world (including governments) is crumbling down under the effect of the financial crisis. Therefore most (net) CDS are doomed.

Just as the explosion of an H-bomb is initiated by the explosion of an A-bomb, the subprime crisis is getting ready to trigger the CDS crisis.

How many crises are we dealing with? Let’s count. 1 is the end of cycle which started last year and was accelerated by the surge in the price of commodities. 1 was strong enough to entail a recession that the general public would have started feeling in any case by the end of 2008. 2 is the subprime loans crisis, which already turned out to be big enough to shake the world banking system. 3 is the CDS crisis which has not started yet but looks inevitable, considering the combination of 1 and 2. 3 is definitely capable of destroying a large part of the global financial system. 4 is the subsequent mega recession which should logically follow, with major expected unemployment levels and market crunches.

Oh my, enough for today (to be continued though if you can still face it)

This is how the world goes.

From Financial A-bomb to Financial H-bomb

On the A-bomb (i.e. subprime securities meltdown), please see the March 11, 2008 and March 20, 2008 posts.

As if things were not bad enough, a financial H-bomb is about to explode in Wall Street. The name is CDS for Credit Default Swaps. Please get ready for the blast.

Subprime securities and Credit default securities have a lot in common: i) they were designed for the sole purpose of generating fees, ii) they are submitted to no control, regulation or authority whatsoever, iii) they appear as assets from the outside, iv) they are in fact instruments of credit deprived of guaranties or collaterals, v) they are worth a small fraction only of their book value, v) they contaminate any other assets they are combined with, vi) they are the product of a collective crime (by financial institutions and absentee- regulators), vii) they have generated unheard of amounts of fees for the culprits, as well as vast quantities of ideological exhilaration for the self-restrained regulators, viii) their necessary elimination may represent the strongest blow ever on the world economy.

The technical difference between them is minor. Subprime securities consist in postponing as long as possible the built-in default of borrowers, by lending (third party’s) money to people who cannot pay it back, and differing installments for a while. CDS consist in being paid to guaranty the credit quality of any entity, with no obligation of offering a collateral. You do not have to be an insurance company to do this, not even a bank, but simply licensed to sell securities. You do not have to tell the market how much risk you are taking, as these securities do not appear on your balance sheet, except as generated fees. Of course you do not need to have the money to fulfill your commitments. Best of all, you can get rid of the risk by selling the securities (confusingly mixed with other derivatives or assets) to your victims. I know, it sounds like a joke or a mistake. If you do not believe me (how could I blame you?), just search the web for “Credit Default Swaps” and see by yourselves.

Now the main difference between them is not technical. It is their magnitude. Subprime securities are in thousands of billions of dollars. That is certainly a lot of money, and enough to create a recession when taxpayers have to pick the tab. But it can still be handled somehow.

So, what about CDS? Their total outstanding value this morning was close to (hold your breath) 60.000 billion dollars, i.e. slightly more than the total of all bank deposits on earth or 10,000$ per living human being (including infants in Ethiopia) . If any significant fraction of them go bust, then we’d better have kept a few rolls of cash in our drawers.

What can I say?

This is how the world goes.

A solution to the oil crisis?

The most serious dangers come unannounced and generals are not the only ones to prepare for the last war. We became aware of the depletion of oil& gas resources and now start panicking at the very time an exit solution is at hand.

No matter what the primary source of energy is (hydrocarbons, biomass, nuclear, solar, geothermal, aeolian or hydraulic), electricity is a universal carrier, as any primary source of energy can be transformed into electric current. Electromechanical heat engines or kinetic energy directly activate turbines which in turn produce electricity ready for distribution.

The only limit to existing centralized or semi-centralized electric distribution grids is a lack of portability, excluding most mobile engines, with the notable exception of railways. Until very recently the weight and inefficiency of batteries was such that the additional energy needed to simply transport them, made electricity impractical for most vehicles.

The situation has changed. A combination of major improvements in the technology of batteries and a bright and simple idea are placing us on the eve of a major energy revolution. By 2011 the automotive industry will put on the market not prototypes but mass series of electric cars with an average autonomy of about 150 miles, a threshold for convenient urban use. A larger autonomy is of course required for a full substitution of thermal engines, considering in particular the time it takes to recharge a battery. This is where the bright and simple idea comes into the picture. Just as Formula1 cars can be refueled in a matter of seconds, car batteries can be instantly replaced at will. Using the existing network of gas stations, extended to other kinds of outlets, car batteries will be recharged from the power grid, allowing subscribing drivers to exchange their empty battery against a charged one for a fee, with no waiting time. The system is being experimented by Total in Israel as we speak. No doubt it will be a tremendous success, leaving only aircrafts and boats (partially) to the old hydrocarbons system… until the next generation of batteries comes up.

Technically, substituting most of the existing installed base of mobile thermal engines can be done in a decade, and this is the kind of good news both the world economy and the environment were badly waiting for. Extending the substitution to coal-supplied plants is nothing but a matter of political opportunity, as it is both easy and tempting for certain countries to tax ‘dirty’ imports, made from polluting energies together with other negative factors (e.g. slave work). Heating is likely to be the last element to be aligned with the new system, and the price of fossil energies mostly will decide of the pace for this sector.

While these events are taking place, the skyrocketing price of oil & gas is generating a new cycle in exploration. This means that as the use of petroleum products decreases the amount of reserves will increase in possibly unprecedented proportions. For instance, it has been know since the 70’s (before the first oil crisis) that the Western Mediterranean basin, having been depleted 150.000 years ago, is covered with a thick layer of salt, which is not unlikely to hide among the largest fields of fossil energy on earth. Exploration (now possible at such depth) should soon start in Marseille and Cyprus. If successful, the oil & gas markets are doomed even sooner than the above mentioned revolution would have entailed by itself.

A zero oil economy, therefore, with local exceptions in the poorest countries (then unwillingly limited to using ‘cheap’ oil!), far from belonging to science fiction or utopia, is a good prospect for the middle of this century. Obviously, the question of the primary energies remains open. Most large resources have a limit or a downside. Nuclear energy is dangerous, coal and biomass extremely polluting; and other energies still insufficiently efficient. Nuclear energy, however, is the only one which can sustain the new energy system on a massive scale, until technological innovation allows its potential elimination. Reserves are not a problem at this stage. The proven reserves of uranium can cover 60 years of the current needs. The limited proportion of mineral costs in nuclear energy (about 5% of total costs) makes exploration (today almost at a stop) financially easy. Above all, a new generation of so-called ‘rapid neutrons reactors’ exploiting the plutonium produced by the very transformation process occurring in reactors, should soon increase by a factor 50 to 100 the efficiency of Uranium 238 (which represents 99.3% of the reserves). Nuclear energy can therefore offer a constant fallback position, as long as it takes to make non-polluting renewable energies, e.g. solar and tidal, efficient enough to become the main sources of primary energy for the electric power grid.

The laughable paradox in all this is that crumbling petroleum markets could become be the main factor of slowdown in the change, postponing somewhat the major economic benefits of the energy revolution to come (new technologies, new products, new markets, new investments, reduced financial and environmental costs). The other factor is more simply political. How long will it take for Europe, Japan and other countries to force the US (where 49% of electricity generation comes from burning coal) as well as China to drastically reduce their consumption of highly polluting coal, through new treaties against global warming and import taxes? Some time indeed.

This is how the world goes.

Food or drug administration?

Genetic Modification technologies are neither good nor bad, they are tools. Anyone can agree with this, including activists and Monsanto.

Can GMOs be bad? They certainly can, for simple logical reasons. When a genetic modification is introduced, the resulting organism is different by definition. The differences may be small or large, visible at first sight or after microscopic investigation only, immediate or delayed; they may relate to the shape, chemical composition or biological properties (such as resistance of reproduction) of the resulting organism. A GMO may therefore carry or produce toxins, hormones, proteins which were absent from the natural organism. Their presence may induce, on the short or longer term, allergies, epidemics, all of which may also be extended and multiplied by genetic alterations all over the food chain, as well as by contamination of other cultures.

It is therefore a logical property of Genetic Modification technologies to induce a high level of risks. Theoretically, risks of the same kind are also present in the random natural modifications described by the theory of evolution. They exist, however, at a much higher order of magnitude in GMOs, as modifications occur and spread at a completely different pace and on a totally different scale. Traditional graft hybrids were unable to affect most aspects of the DNA and definitely did not cross the animal/vegetal-barrier, generating moderate biological risks. It should also be noted that graft hybrids increased biodiversity, when GMOs now tend to reduce it, because of the existence of specific ‘kill-all non GMOs’ pesticides (namely the ‘RoundUp’), as well as for economic reasons.

Now that we have the certitude that Genetic Modification technologies can induce dangerous biological consequences on a very large scale, the only question becomes: how should we handle them?

Industrial GMOs appeared in the 90’s, during the peak of the Great Deregulation move. Instead of being submitted to at least the same control than pharmaceutical products, or even the same than mere food additives, they benefited from an extraordinary political decision in the U.S. It was legally decided (not scientifically established, which would have been impossible) that a ‘substantial equivalence’ existed between them and natural organisms. The meaning of this decision, which is still in force, is that no evidence of their innocuousness has to be established by their producer, under the control of independent public agencies like the FDA, before they are put on the market. Moreover GMOs should not be tagged as different for the consumer who thus becomes the unwilling guinea-pig of a free and large scale experiment from which no one can opt out.

In practice, free trade agreements do not allow any country to decide in favor of more reasonable precautions. The maximum limit to GMOs is the possibility to tag them locally or suspend their distribution when and only when positive evidence of their actual dangers can be legally set forth. As even complete bans could not protect entirely other crops from contamination (which already happened in the case of the Mexican maize), any shorter measure represents a superior level of risk.

The advantages of GMOs would deserve a specific discussion. Let’s say briefly that they are unclear. They probably can increase the productivity of certain crops, prolong the delay of conservation of fresh products, improve the visual quality or even the taste of insipid industrial food, and they certainly can increase the profits of Monsanto. This is well enough to build up strong lobbies in their favor. On the other hand, they cannot eliminate or even reduce the need for pesticides. They increase the cost of seeds now submitted to a growing monopoly. They tend to eliminate agricultural independence of other countries. It is also interesting to note that the generalization of GMOs preceded a spectacular surge in the price of agricultural commodities, particularly those, like soy, in which their market share is the largest. Once these macroeconomic downsides and the biological risks described above are put together, the cost/advantage balance seems to go clearly at this stage against the GMOs.

One would like to review more scientific literature on such a major topic. It unfortunately turns out that most of the relevant research is directly or indirectly funded by Monsanto, and should be considered as unreliable at best, a situation which in turn increases the level of incertitude and risk.

The problem is that no matter how powerful lobby is, it cannot resolve the issues it so actively keeps hiding. No matter how blind a government is, when pushing across all borders a potentially very dangerous type of product for a short-term trade-balance advantage, it cannot prevent disasters to occur. Innovation does not imply letting irreversible problems take place before we learn how to take them under control.

GMOs may have a brilliant future once we know how to handle them. This is not the case yet. Even though genetically induced pandemias have been avoided during their very recent industrial devolopement, biological and economic incidents have already taken place, from mass suicides of Indian peasants, to accidental contamination of crops and allergies to associated pesticides. Time has come for independent research, limited experiment, premarket control, not yet to wild and world-scale industrial applications. The exact opposite is happening.

This is how the world goes.

How working hard has led to ignorance and could lead to poverty

From Ancient Greece to WWII social elites belonged to the leisure class. In other words they did not work or did not work hard, using their vast free time not only for love and hunting (as a training for war), but also for reading, writing, travelling, learning all sorts of things. As others were working for them, from childhood to their death, the happy few had culture for environment and did take a decisive part in it. When they entered politics, they carried with them a strong base of information, having read law, history, philosophy and geography, seen at least a couple of continents and usually given some previous thought to what should be done.
Things have changed dramatically. The so-called working classes are working less and often not at all. Children go to school, teens also go to school or join the gangs and adults retire in their 50’s or at the latest in their 60’s, while work hours have been reduced by half (in some countries by 2/3) in less than a century. Unemployment adds to the phenomenon. At the same time the elites have become workaholics. Their unlimited pursuit of wealth does not allow for much rest. Business breakfasts are being prepared under the shower, meetings follow meetings, dead times are entirely filled by the operation of PDAs. At night, time has come for emailing more than for love. Deals are discussed even on the golf course, and hunting parties produce more business cards than dead game. Vacations, limited to 2 weeks, 4 in Europe, are used for  business encounters as much as or visiting family. Patronizing the arts is mostly a housewife activity, and collecting a speculative endeavor. Information is obtained from business news, press excerpts or Internet briefs. Almost no one reads books, but a best seller here and then.
Books stores, when they still exist, keep a small space somewhere in the back for the lunatics interested in ‘Non-fiction’, and Plato can only be found inside a bizarre mixture of ‘Religion & Spirituality, Self-help, Philosophy, Gay& Lesbian studies, Foreign Language Non-Fiction’. Books are produced only according to market segments, and are not supposed to be read by anyone not pre-approving their content. The word ‘Culture’ applies to about everything from folk dance to comic strips, and exclude literature and thought almost entirely.
As a consequence, thinking is an activity one pays other people to do, advisers, consultants and journalists mainly. These are however too busy themselves to read much or think deep. One can become head of state without having crossed more than one border, or knowing the names of most capitals and prime ministers. An entire region can be conquered without the least clue of its anthropology or sociology. Vast operations are conducted, with no one having worked on a plan B.
Even business gives no price to ideas (under the pretext that only implementation has any value), and cares only for proven recipes. Dissenting positions get the young ambitious employee fired more surely than laziness. The only wise new investment of the past 20 years, the Internet, was eventually called the ‘dot.com bubble’. Venture capitalists actually venture very little, having no new ideas on their own, investing only into what the next big guy has already invested in. Things have reached the point where lack of innovation is becoming the main economic issue for the near future.
While the lower classes are informed by propaganda and TV, ignorance grows everywhere among the elites. Universities have become temples of specialized knowledge. Academics pursue their careers completely sheltered from criticism from anyone else that a handful of experts, and are forbidden to publish outside their limited field of immediate expertise or even acquire a global vision. When called for assistance in real life, they can hardly be of any help, other than on minute topics strictly belonging to their own specialty.
The only consolation is to imagine the face of Karl Marx discovering today what the contradictions of class struggle have been leading to.
This is how the world goes

Capitalodespotism in Chinamerica and other places

Capitalism likes Free Market up to a certain point, i.e. as long as it means not to be hindered from selling and buying any quantity of merchandise. Capitalism, however, starts disliking Free Market when it allows foreign products to do better than your own and manpower to increase its costs, or when it prevents the governments under your influence to grant you subsidies and de facto monopolies, or to negotiate for you some privilege abroad.

The ne plus ultra is a combination of Free Market and Despotism, a good model of which is now in place in Chinamerica, a chimera which should stay alive as long as the two economies can complement each other. In order to do so, the West must keep the most advanced technologies, while the East keeps sheltering the cheapest mass production system. The West must continue to shift its intermediary productions to the East, while retaining most of the profit margins as a payment for its own technologies. In exchange, the East benefits from massive investments, becomes a dominant exporter, and grows at a rapid pace.

Despotism plays here a double role. Totalitarianism – a direct legacy of the Communist system – is used to control the cost of manpower and reduce sovereign risks in the East, while covert public subsidies and militarization allow the West to maintain its vital technological edge.

Unfortunately for its beneficiaries, such a synergy cannot last forever: a) Western governments are unable to justify their hidden support to totalitarianism, a system absolutely opposed to their own public opinion’s ideology. The Olympic flame crisis is nothing but an example of this difficulty. b) Transfers of production entail transfers of technology; while at the same time a constant increase of wealth in the East allows a gradual build up of an autonomous technological capacity. At some point the two poles are therefore bound to compete on the same technologies, losing their complementarities. c) Shifting production in the East also implies growing unemployment in the West, reducing in relative terms the size of Western markets and increasing social costs and pressures in the West. This reduction cannot be fully compensated in the East by the growth of its inner market, exports representing too large a share of the national income.

For the battle to come, the West is at first sight better placed than China, as India represents an excellent substitute for cheap mast production with less ideological downsides. A political liberalization of China is a very difficult exercise, never attempted to this day. Economic growth being a strong factor leading to it, the immediate outcome is likely to be a new surge of despotism and repression, making it very difficult for the West to keep a harmonious relationship with China, and fostering the shift to India.

On the longer run, however, the West is likely to lose the economic war, for lack of innovation. Mechanical engineering and electronics are already behind. Its advance in both computing, telecommunications, energy technologies is soon to be reduced to nothing. Its financial techniques are currently undergoing a fatal blow. Biotechs and materials are lagging. The absence of both large-scale military opponents and financial reserves of governments limits the prospects of military funding of R&D. The cost of manpower in developed countries has seriously weakened their agriculture. Remain the consumers’ brands. How long will it take before there are taken over by the actual producers?

If and when this happens, a new poverty in the West will call for a new despotism.

This is how the world goes.

Tibet and Game theory

During its long history China never was an expansionist power and yet never abandoned lightly any inch of gained territory.  The notion of Yellow Peril originates in the Mongols, the most expansionist people in the history of mankind, not in the Chinese. The common absorption of China and Tibet by the Gengiskhanids, in the 14^th century, put an end to their old rivalry. Since that time, Tibet has always been considered somehow as a Chinese protectorate. Even though most Tibetans would certainly prefer to regain their independence, the protectorate is at least de facto accepted by both the Dalaï Lama and the international community. A Tibetan war of Independence would mean nothing else than a war between India and China, a most unrealistic prospect. The only thing at stake for Tibet is therefore a possible return to home rule within Chinese borders. Can this happen?

Humiliating China over the Olympic Games can achieve little. Chinese nationalism would be exacerbated to no avail. On the other hand, the international community is not prevented from stating that the Chinese presence in Tibet is acceptable if and only if the cultural and legal internal autonomy of Tibet is achieved. Should this stance be adopted simultaneously by the United States, Japan, India and the three main European countries, not precluding discrete and yet firm prospects of commercial sanctions, this strategy would have a limited but real chance of success. Its current trade balance makes China ultra sensitive to such pressures.

However, would the International community be willing to keep a united front that China should try to break by using Game theory and extending here and there commercial favors? Odds are high that any single player having a greater advantage in betraying the group than in obtaining a collective advantage, will indeed betray the group.

This is how the world goes.

Cassandra’s Principle (part 4)

This time Cassandra’s dark predictions are showing some of their truth in real time. One after the other, major players/abusers of the financial system join the defaulting league, saved by central bankers. The nature of the rescuers is not indifferent. It is not exactly the same thing to be bailed out by a government or a central bank. Governments can spend taxpayers’ money, something central bankers cannot do. They are limited to lending, a short term exercise nor adapted to structural failures, or creating money which -except to accompany growth- means adding a disease to a previous one. Governments, particularly when their respective deficits are already high, as it is the case today, can at best slow down a recession or speed up a recovery, not change the phase of the cycle. They certainly cannot at the same time also save the largest financial institutions from the inevitable consequences of their past mistakes.

Markets are indulging in wishful thinking for now, mixing up the willingness of central banks and governments to do their best with their actual capacity to do so. They also are blind to the nature of the recession, not understanding that what’s at stake is nothing but the real value of securities. How many Enrons are still undercover? How many torpedo stocks will appear when the lack of technological innovation shows its magnitude? How many bonds are waiting to be written off?  Nobody knows and markets don’t want to know for the simple reason money has nowhere else to go. While lunatics build their fragile rafts in gold, silver and Swiss francs, assets will continue rallying until eyes open on the naked king.

This is how the world goes

Who is leading trade? – The facts

(source WTO, 2007)

Share of world merchandise exports

o   1948: United States 21.7% Europe: 35.1% China 0.9%

o   2006: United States 14.2% Europe: 42.1% China 8.2%

Share of world merchandise imports

o   1948: United States 18.5% Europe: 45.3% China 0.6%

o   2006: United States 21.0% Europe: 43.1% China 6.5%

Intra-regional trade flows (2006)

o   North America: 905 b$

o   Europe: 3651 $b

o   Asia: 1638 $b

Inter-regional trade flows (2006)

o   North America-Asia: 1022 b$

o   North America-Europe: 709 $b

o   Europe-Asia: 970 $b

Cassandra’s Principle (part 3)

In the mind as well as writings of its historical fathers, free market economy was never supposed to mean wild and unregulated economy. Left to itself, any free market inevitably generates distortions, e.g. monopolies behaving like tumours which may very well kill it if left unchecked. It is therefore the duty of market authorities to constantly protect markets from self-generated diseases.

A well-known condition for a healthy open economy is for instance the speed and quality of the information circulating within markets. This principle is today often understood as meaning that prices will automatically incorporate all available information about underlying assets. This interpretation is wrong. Market information does not come as a fixed quantity and its quality is a goal to be proactively achieved, not a given or spontaneous feature. Sources of distortions are varied and many: for instance, some agents are too weak to leverage the good information they possess, while others draw their strength from distorting information.

It is indeed difficult to overstate the importance of protecting economic agents in complex markets against bad information. This is particularly true in an age of extended securitization. Series of complex operations can transform any financial product bearing on real assets into an unrecognizable object composed of intricate layers of derivatives. When the distance between the final buyer of a security and the underlying assets is very large, there is simply no way for the final buyer to verify the nature of assets actually purchased. At each step of the transformation process, waivers are signed making it impractical or impossible to exercise guarantees from operators who may have corrupted the product or its components.

The subprime mortgage tragedy is nothing but the most massive example ever seen of this problem. Market authorities and regulators were unwilling to prevent manufacturers and brokers of such trash securities to create and sell on the largest scale nominal obligations having the highest probability of default. A chain of intermediaries was able to multiply their poisonous effect by mixing them up with otherwise healthy securities, spreading both the disease and its opacity into what was precisely supposed to be the safest and most liquid part of portfolios.

The magnitude of the crisis can only be guessed based on unheard of injections of liquidity made by central banks visibly attempting to avoid a market meltdown, without any further consideration for what used to be their primary concern, i.e. inflation. The best informed institutions all simultaneously trying to get rid of their plagued assets, are calling all possible margins, also creating the conditions for a domino effect and credit crunch.

 At this stage the probable willingness of governments to bail out irresponsible lenders is the least of many systemic problems induced by a major lack of market regulation and surveillance. Good wealth (made from real contributions to the global economy, e.g. long term investments in emerging countries) is likely to be destroyed together with artificially made wealth (from junk assets), when stock markets eventually adjust to the situation. Stagflation, the cancer of economy, will then show its hideous figure.

Cassandra’s principle (II)

If certain pessimism seems appropriate when considering geopolitical affairs, one would hope for some relief from the economy.  Cassandra, unfortunately, is not in a better mood in this regard, for economic globalization is not as tranquil a road that theoretical thinking would have leaded us to believe. The current squeeze in natural resources is but a consequence of another scarcity. The most important by far of all economic resources, i.e. technological innovation, has entered a phase of slow down.

We are so used to technological change that we take it for granted, and we should not.  Any technological system is centered on a source of energy. Ours is still the same than in 1875, based on hydrocarbons. Nuclear energy is limiting the problem, yet only to a certain extent. Its dangerous side effects, both environmental and political are well known. With the exception of railroads, it cannot fulfill the growing needs of transportation. Alternative energies are either inefficient (solar) or direct sources of greenhouse effects (biofuel). Moreover, no energy revolution is in the pipes for the visible future.

Biomedical research is increasing the scope of treatable diseases at an increasing cost, when reducing the cost of global public health would be more urgent and useful. Nano-technologies have little to offer for the present, while discovery of new materials is stalling.

The last major technological revolution was the Internet and cellular telecommunications. There is of course still some way to go until it is fully deployed, and its last major elements (eg Wimax or equivalent) are in place. It is however unlikely that it can by itself sustain a durable growth of the world economy for several decades.

As I said in a previous post, growth is dependent on the persistence of waves of technology. Innovating countries increase their own efficiency and fulfill new needs, while transferring to other countries their previous technologies. Developing countries, producing at a lower cost, can export to developed countries which in turn finance their imports with the products of their newer technologies. There may be hiccups, bottle necks, or cycles, but the overall picture remains positive as long as the transfer of mature technologies goes on a par with the constant influx of new ones.

In the event innovation slows down in such a way that all countries en up sharing more or less the same level of technology, their complementarities are turned into a competition for production prices, and all markets retract. Richer countries are bound to adjust their own labor costs, reducing both their own consumption and imports. Their markets start closing themselves to developing countries which in turn start facing the prospects of a recession.

This danger is not the only one we are confronted to.

 

(to be continued)

 

 

Please make me pay!

The more we use the Internet, the least we seem to have to pay for anything. I couldn’t list the almost unlimited number of things that are offered for free. Free search, free delivery, free trial, free software, free email account, free download, just name it (even THIS blog is free). Everything is free, gratis, no strings attached. What a wonderful world.

Of course you know the secret: the so-called ‘ad-funded’ model. You don’t pay for anything, as the nice, the sweet, the generous advertisers do it for you. The ad-funded model is what allowed Google, one of the smallest companies in the world to become almost overnight one of the largest ones. Every day the add-funded model gains more ground. Forecasts are clear: the future is there. Web 2.0 or Web 99.0 simply means more and more advertising all over the web. In the event you are an entrepreneur, don’t even think of raising a dime for anything else than a project under an ad-funded model.

Yes, I know there is no free lunch and you sometimes wonder if the whole thing is really that healthy. Let’s not be paranoid. Why bother when such a galore of free stuff lies beyond the keyboard? Do I really care if my mailbox is limited in size or if the software I downloaded will only work for 2 weeks? Or if I lose my account when I change my ADSL subscription? Is it more meaningful that search results showing advertised links at the top, quickly followed by garbage at the bottom, or scientific information drawn from an unedited encyclopedia? Is it of any importance to me that my email address and all information gathered about me are being resold all over the planet, generating spam and opening the fascinating possibility of identity theft? Why should I worry about discreet cookies allowing gentle advertisers to better target me? A minor inconvenience compared to all the money I save. Because I save, don’t I? It is after all the well-known purpose of advertising to make people spend less and save money. On top of it, all the messages advertisers send me are for my own good. Thanks to them I am more intelligent and better informed. I had no clue, for instance, that my next car was a transformer and that it would make me a better father. Now, I know.

What would be really great is a fully ad-funded universe. What if I id not even have to pay for my car? Well, in fact, I don’t have to. They will give me such extended credit that buying it is definitely a no brainer. Can you imagine calling long-distance for free, and simply having a reliable soda company interrupt the boring conversation every 2 minutes for always more instructive news?

I am dreaming. Things are not that perfect yet. For some bizarre reason, some of the things I need most still carry a price-tag, including my high-speed Internet connection. Can’t I change that, for a marvelously free and sluggish connection, full of funny pop-up screens? Yes, you can.

This is how the world goes.

Re-educating educators

The education system in France, which used to be among the best in the world, undergoes a deep crisis, for reasons of wider interest than the local problems encountered by this specific nation.

The most-cited causes are lack of public funding and rigidity of the unions. Lack of public funding is a relative notion, especially when the entire proceeds of the national income tax are devoted to education (€77 billion in 2007, equivalent to 28% of government spending, almost 6% of GDP, compared to about 5.5%. in the U.S.). Private funding is missing much more, as the total expenditure for all levels of education reaches 7.5% of GDP in the US against 6.4% in France, a spread that could not possibly be reduced by a further increase in public spending.

Improper diagnosis and subsequent mistreatment only add to the intricacies of any serious illness. What motivates teachers’ unions to oppose almost any reform is a combination of constant decline in relative income together with a severe degradation of their working conditions. Masses of students are now unfit to classical forms of education for which they show little or no respect at all. It should be said in their defence that the system was not designed for their current needs, leaving them with high levels of unemployment.

The key to these issues is that a small-scale production system was turned into a mass-production with no structural change. This would be true in almost any country. Shameless demagogy only made things worse in France. Politicians, who had received an ultra-elitist education, promised the baccalaureate to everyone (a target of 80% of each generation was proudly announced in 1985).Putting aside the pure and simple impossibility to do this by other means than devaluating diplomas, professional training at primary school level was abandoned, secondary education being put on the same track in the name of equality, while overcrowded universities were discreetly postponing the necessary selection until it was too late.

Before WWII, a university such as Sorbonne had a faculty of hardly a few dozens people and a few thousands students. Secondary school teachers were recruited among the best students, paid like superior army officers, and treated as notables. Most jobs were obtained after primary school. Faculties are now measured in thousands, upper education in millions, teachers are underpaid, students spend years unwillingly sitting in classes where they remain unprepared to the real world. Those of them who do not dream of becoming drug-dealers or civil servants struggle to obtain internships from corporations terrified by what they see as hordes of unreliable barbarians.

Well-off families spend fortunes in private lessons to help their children keep up with the most exclusive private or public schools which, in any case, eliminate all students not on a par with their statistics, leaving others with the prospects of always more assistance from their parents or of a shaky future.

Few students are good or bad in maths by themselves. Some are lucky to have had a good math teacher, while others were not. The same applies to most fields of knowledge. No country can produce tens of thousands of good maths teachers. It is even more difficult to train at once new teachers for new branches of education better corresponding to the actual marketplace: accounting, law, electronics, general problem solving, design, etc.

The goal therefore is not to have more teachers leading more students to upper education, but teachers better paid, preparing all students to citizenship and employment.

One way to do this is to include professional training at every level, instead of turning it into mockery and a dead-end for the least gifted. One doesn’t need to be a follower of Mao to understand the advantage of having been trained in several skills during one’s youth. Some notions of say carpentry learnt at primary school and of software development learnt at secondary school would not make a worse lawyer after he got his PhD. Conversely, the basics of citizenship (introduction to the legal system, tax returns, world history, etc) should be considered a must for everyone.

The other way is to switch from the archaic system of one teacher in his class, to fully interactive digital learning. Richard Feynman, a leading physicist of the 20^th century, was also a great pedagogue. He could have planted the seeds of science in to the mind of lemmings. Minds of such quality are scarce, and yet can be found in every generation. We can however leverage their talents by massive investments in the production of multimedia courses by people of this kind. Regular teachers should be retrained as coaches for the controlled and efficient use of digital lessons and related tests. A smaller number of more efficient teachers would select these courses as they used to do with manuals, customizing their usage for their various types of students. A large part of school time would be spent at multimedia libraries and workshops, requiring less physical supervision. Work could be seamlessly continued from home. Programs could easily evolve according to the economical or technological developments.

The goal is clear, the money is there. Will it happen soon enough?

You know how the world goes.

Intellectual Improperty (Part 3 – end)

In the same manner that new technology and market forces are undermining the role of copyrights in performing arts and related industries (see previous post), plastic arts (sculpture, painting, photography, etc.) are being forced to change directions and return to more traditional solutions.

Marcel Duchamp and Andy Warhol are landmarks of contemporary art which cannot be fully understood without their contributions. Although both were gifted artists under classical standards, showing great talent at creating individual and carefully crafted masterpieces, their fame came from their opposite stand that major art may come from minor displacements in our relationship to highly reproducible objects. Duchamp introduced ‘ready-mades’ and his famous ‘Fountain’ (a mere urinal) as a proof that industrial objects of minimal value can acquire an entirely new meaning when the very exhibition of art is used as an artistic tool. Warhol continued the demonstration with reproducible images of commodities, such as Campbell cans, Brillo boxes or icons of movie stars.

The irony was that while both artists were denouncing the fetishism traditionally associated with art, their own works became subjects of more veneration and more fetishism than anything before. Collectors started purchasing at prices never heard of and storing inside vaults objects which could have been obtained for a dime, and that a better understanding of the artists’ explicit intentions should have led to acquire preferably from supermarkets. The comedy was to reach a climax when Duchamp’s Fountain was hammered by a fan at the Beaubourg museum. During his trial the iconoclast explained that he agreed to pay for the repair, within the limits of what a decent plumber could ask for, as opposed to the half million requested by the museum as the actual cost of the restoration by experts trained in works from the Renaissance. He also claimed to be recognized as a co-contributor to the piece and a co-beneficiary to all related copyrights. Hilarious indeed and a good example of the paradoxes of copyright…

For a while photography was threatening sculpture and painting to become the major form of contemporary art. Serial art was reaching the same prices than unique pieces. Things have been recently calming down, and the specific quality of each singular copy is again considered as an essential factor of its economic value.

Absurdity, however, has not completely left the field of photography, as owners of rights to the objects that are being photographed are also granted rights to the picture itself. I am not talking of the legitimate right to privacy and control over one’s own image, but the strange idea that the mere image of material objects should be appropriated by someone. The city of Paris has a claim, for instance, on any picture taken of the Eiffel Tower. One could understand that smaller museums with limited funding would ask for a modest fee for using a camera within their premises. There is no justification, however, to limiting the passive reproduction of images of things already offered to public view, unless we adopt the metaphysical and rather primitive creed that the essence of things resides in their image.

In the distribution of digital copies of images of any kind, a part of the value comes from the service of distributing them, sometimes more than from the image itself. An image bank can draw revenues from gathering pictures, classifying them and making them available for downloading. The bank still has to pay for procurement, particularly when images are associated to trademarks, as trademarks imply contractual arrangements with their respective owners. A photographer’s trademark may or may not be important, only the market can decide. What is certain is that no one can contract on behalf of Leonardo when dealing with a picture of the Mona Lisa!

Protecting artists against unauthorized commercial use of their work does not mean preventing unlimited duplication for private use, nor the free secondary reproduction of images taken of any primary work.

Analogue is the situation of writers. In the case of journalism or screenplays, the work being created at someone else’s request for immediate release, a simple contractual arrangement is sufficient to generate payment. Such contract may very well include an override on future revenues. If the signature of the author has any residual value, then it can be treated as a trademark and protected as such for a while against infringements during secondary distribution. If on the contrary the market does not acknowledge any value to the trademark, i.e. if the text is completely dissociated from the author’s name when reproduced or used, such text has become a commodity, and I frankly would see no reason to grant it any privilege, compared to ideas or concepts. I feel sorry while writing this for one of my closest friends who specializes in remakes of foreign films. I simply hope he will see the advantage the recommended change could mean for the creation of films in general.

It is considered ignorance or bad taste to refer to a concept without mentioning the name of its first author, unless the reference is implicit or obvious. Nevertheless, it would not cross anybody’s mind to initiate lawsuits for payment of fees to Freud’s or Lenin’s heirs for use of their respective notions of the unconscious or the proletariat. Why then should we be fined for having bought a cheap copy of a Gucci © handbag, at least when the trademark is not used? Infringement of the trademark should be repressed (through sellers not buyers), as it can induce the consumer in error about the genuine quality of the object. In the absence of a trademark, however, the transaction bears on the idea of a Gucci © handbag, which is a totally different reality.

A world with no patent and copyright (and yet with trademarks) would be a better world, more logical and efficient. Creators would still create, and their creations would be used more. Trade would continue, based on services rendered and contractual arrangements. Lawyers and monopolies only would have something to lose. Who do you think will win, at least on the short term?

This is how the world goes ©.

Intellectual Improperty (Part 2)

Copyright is the minefield of intellectual property. Its main beneficiaries seldom are intellectuals, and yet find among the intellectuals their best allies, copyrights applying to books, newspapers, plays, films, software, websites, painting, sculpture, photography, architecture, etc.

As post-Guttenberg kings were trying their best to make sure no publication would escape their control, free minds were left with no other choice then than finding publishers in foreign republics, drawing small income from their works, if any at all. At the end of the 18^th century, an awkward alliance took place between the censorship of governments and the greed of authors. Beaumarchais, the author of the ‘Marriage of Figaro’, also an arms dealer and a tirelessly litigious character, succeeded in combining things at his best advantage: from now on the legal control of printing would be used not only for censorship but also for remunerating authors. This was the beginning of copyright.

Not a philosopher nor a mathematician, Beaumarchais did not bother to protect ideas or concepts, no matter how valuable they were. As a matter of fact copyrights do not protect any such things, or for that matter, anything immaterial. They only protect the material form of the specific types of immaterial creations people like Beaumarchais could produce. No wonder paradoxes and contradictions would flourish on such grounds.

The current problems are quite different depending on the area of we consider: e.g. performing arts, writing and plastic arts. Performing arts have found themselves in the eye of the cyclone since the introduction of digital technologies. Verdi never sold music; he contracted with owners of theatres to sell seats, and became rich. One would purchase a ticket to listen to his performances, and the Italian wall painters whistling his best airs next morning on their scale were not asked for a fee. A contemporary Verdi can do exactly the same, leaving Sony Music desperate. Record companies had a short moment of glory. Among the mass of would-be musicians, they used to pick talents on a commercial basis. In the digital world, the audience is in charge of discovering new artists, for free, mostly though websites and (still illegal) copies. No one can impose purely commercial choices anymore, and talents can emerge as they did in older times, by the force buzz. Successful artists give concerts and can make fortunes. Copyright in music is useless and should therefore disappear. It will unless an irrational protection is given to an obsolete industry.

The next victim, obviously, will be the film industry. The disaster is soon to occur. There is simply no way to prevent a digital copy of a film to spread over the Internet in a matter of hours. The good news for the industry is that most people would probably be ready to pay for the service of a guarantied quality of the files, and of large bandwidth for faster downloads. The bad news is they would only pay a modest fee, unlikely to be sufficient to amortize the cost of Hollywood productions. The only reasonable solution I can see, other than fighting lost legal battles against millions of consumers, is to change the very nature of future films, dividing them into two completely different types. The first group would be productions so spectacular that it would make little sense to watch them on a TV or computer monitor. Such films would be placed in a situation very similar to live concerts. After all, who would bother downloading a digital copy of an Imax movie? The second group would be inexpensive and smaller films, typically shot with video cams, and perhaps pre-financed by subscriptions. The film industry is likely to resist as much as possible this evolution which will however open new paths to creation. Yet, inertia guarded by lawyers is a losing strategy.

(to be continued)

Intellectual Improperty (Part 1)

The choice of words is a powerful weapon. For years Marxists were the great masters in this art, naming single-party dictatorships ‘Popular Democracies’, a cynical antiphrasis among many others. After enough harsh lessons, Conservatives have achieved equivalent mastery.

‘Intellectual property’ is one of these magical expressions which can trigger instant approval as soon as pronounced. Who can oppose ‘intellectual property’ but an idiot, an anarchist or a thief? Property is a universal right. The epithet ‘intellectual’ gives it full sanctity. Intellectual property, as it would seem, is the reward of genius and a key to human progress.

One might nevertheless wonder why it took so long for mankind to discover such obvious a concept, and why it does not apply to the most valuable products of the human mind. I am not referring only to Homer, Plato, Mozart or the inventor of the wheel, none of whom where protected by any kind of intellectual property; but also to Einstein whose ‘E=MC2’ was immediately appropriated by the world. Why is it that reproducing the last video clip of a rapper can lead you to jail, while one can freely use any major theorem even if discovered last month? What makes Mickey Mouse so important and so special that his very name and image still belongs to a single corporation after so many years, while no philosopher can retain the least control upon his own ideas?

From a legal standpoint, the confusing notion of ‘intellectual property’ (which remarkably belongs to no one) includes 3 main and somewhat unrelated components: trademarks, patents and copyrights. Trademarks are certainly a good invention. They play a role similar to measures. Measures have been controlled and guarantied by governments since markets started being in existence. As buyers can seldom verify by themselves the nature of what they intend to purchase, a public control of weights and measures remains an essential service. Verified trademarks carry important information on the quality of crafts. It is critical for instance to make sure that such or such pill contains the right molecule, something patients could never check by themselves. The manufacturer’s reputation being a strong indication in this respect, the presence of an appropriate trademark should not be overlooked. Even people involved in “piracy” over the web, insist on the value of their own informal trademark as a guaranty that their DVD ripping is state of the art.

Patents are a completely different animal. They inconsitently apply to certain sectors of the economy, not to others, with no better justification that old habits and vested interests. Manufacturing is much better protected by patents than any other area. Different countries choose to include extremely different types of inventions in the bizarre list of what may or may not be patented. Isn’t it quite irrational to allow the patenting of human genes (oh my!) on a continent and not on another? It makes little sense to protect a chemical process, not a financial invention.

This being said, the most important aspect of patents is the way they work: a patent does not allow someone to use an invention, it only excludes others from doing it. In other words, by their very structure, patents do not spread new knowledge but help slowing down its expansion. The main argument in their favour is that they are supposed to stimulate research and discovery by rewarding inventors. Inventors however are not the ones who are protected by patents but those who invest in their creations. Elizabeth Maggie was the inventor of the ‘Landlord’s game’ soon to be made famous, after minor modifications, under the name of Monopoly ©. Parker had bought her out for $500 and no royalty. Albert Fert, Nobel Prize in physics (2007) is responsible for an invention which changed the order of magnitude of data storage. He could easily have claimed a patent and become one of the richest men. His deliberate choice was not to delay the advantage for mankind of a discovery all of us are using today, rather than accumulating a wealth almost impossible to efficiently spend in charities.

Even if we consider investment in research, as opposed to inventors, as a valid object of protection, it remains to be seen whether or not patents are good at stimulating research, and whether or not the larger number of economic sectors in which patents play a minor role, have been less inventive or prosperous than the others. Finance and banking have been doing rather well (or at least did until ‘subprimes’ were invented!). They continuously bring to market highly sophisticated products, and the people who come up with these concepts for them are generally well paid. When traveler’s checks were introduced by American Express in 1891, the absence of patents did not impede success, this company having kept a leadership for over a century. Patented electronic traveler’s checks are hardly used by anyone. Pharmaceutical industries are patent-freaks, a feature which turns out to be counterproductive not for their revenues but for their discoveries: when was last time new antibiotics (a major need) appeared on the market? Not a convincing change from old times when universities and hospitals did the primary work in medical research, and when discoveries were almost immediately published and rarely patented. The cliché that patents are made necessary by the sky-rocketing costs of biomedical research rests on shaky grounds. Patenting is a partial cause of the increase, together with lobbying (and corruption in various countries). The associated secrecy is another one, making evaluation and clinical trials such an inefficient process that in the U.S. only public funding (through the National Institutes of Health, not to mention other public sources) has had to be raised to almost $30 billion a year.

I personally would be inclined to get rid of all patents altogether; not for the sake of an ideology but for a better release innovation in the economy, and a faster cross-seeding of ideas. The most inventive corporations would still retain a decisive advantage under the form of acquired market-shares, experience and know-how.

(to be continued)

 

 

On Beautiful Taxes

As much as we usually dislike taxes (at least those applicable to us), we avoid to even think too deeply about them. This is unfortunate, as they would make a great topic for philosophers, as important perhaps as justice or death.

Although I have more practical knowledge of the matter than proper theoretical training, I feel that the field should start with asserting of a couple of eternal truths, such as: “at the end of the day, there are only taxes on the money you have or make and on the things you use or buy”. After all, even a poll tax bears on your main asset (your own person), and even taxes on production or sales are paid by consumers.

This being said, taxes can be beautiful or ugly. Suggested definitions: “Is ugly a tax which tends to always increase the need for more of the same tax. Is beautiful a tax which contributes to eliminate its own purpose”. This is admittedly the kind of beauty one can encounter in mathematics more than in nature, but one may reckon that the term of “beauty” still applies.

Taxes on labour, a French specialty, are particularly ugly, as the more labour is taxed, the more expensive labour becomes, the less labour remains available for taxing, and the more tax rates must be raised to sustain tax revenues and cover the artificially created need for compensating the unemployed.

Replacing a tax on labour by a tax on sales makes things much less ugly. According to the eternal truth stated above, a tax on labour is paid by the consumer just like a sales tax, for the cost of any labour tax is incorporated into the sales price. Provided applicable rates are adjusted in accordance to the respective sectors of the economy, the final price level remains the same, as you have simply substituted a new cost (the sales tax) to a former one (the labour tax). The main difference is that by doing so you also eliminated a distortion against labour, labour being after all the very thing you were willing to promote! Automation and shifting production overseas can still occur. They have however ceased to be the main priority of good management. Beautiful also is the fact that by reducing unemployment in this manner you also reduced related costs, and the very need for your tax. Last and not least, you do not impose anymore artificial costs to your exports as you were doing before, which is excellent news for your economy, while also eliminating a former bias in favour of slave work in certain countries, as your imports from them will from now on carry the same tax. Free trade is maintained as it is your local consumer and your local consumer only who will pay the price of purchased goods and finance your public needs.

A similar concept applies to pollution. An environment tax can be very ugly if you apply it directly to production, for its outcome might be to delocalise production from countries were pollution is taxed to countries where it is not, increasing the global level of the very pollution you were hoping to reduce! If on the other hand, if you start applying it to products instead, basing the tax on the quantities of pollution incorporated into them, you have introduced a strong incentive for reducing pollution in your own country without favouring countries indifferent to their pollution levels anymore. Additionally, the tax being paid by your own local consumer, and applied to products of any origin, the principles of free trade are maintained. The chimera of an easy consensus for a worldwide treaty on climate becomes much less necessary (and in fact much more realistic).

There have been many talks about such beautiful taxes and very limited action. I shall easily concede that some technicalities must be taken into consideration, starting with the different situation of the various economic sectors with respect to labour intensiveness for instance. Resolving this kind of issues though is not rocket science, once the logics are clearly understood. The main objections that have been raised hardly make any sense at all: for instance, the notion that taxing the (poor) consumer would be unfair, justice demanding that only the (rich) producer should be taxed. This is quite ironical really, as if producers paid production costs (which include production taxes) from their own pocket without incorporating them into their prices!

Smaller minds seem to prefer ugly taxes.

This is how the world goes.

The mortal trap of innovation

For over 20 years European countries have done everything they could possibly think of in order to “modernize”. Even socialist governments have privatized their formerly enormous public sectors and deregulated. Continental economies have adopted a single currency. Corporations went for the whole shebang: concentrating, shifting production overseas, and downsizing personnel. Apparently to no avail, as it would take sheer blindness not to see Europe’s economy and therefore rank in the world sliding down in relative terms.

The reasons for this decline are many and well known. The main one, in my opinion, is that economic dominance is always based on innovation, a dimension under which Europe is now lagging. As long as you are on the edge of technological discovery, you are doing fine. Except in the case of natural resources, which are distributed at random, the industrious introduction of more efficient products or services remains the best way to obtain domination in a sector. Of course, cheaper manpower elsewhere, together with the natural diffusion of knowledge, will slowly generate competition abroad. Don’t worry, you may still benefit from this competition in several ways. Your accumulated investment capacity allows you to control in variable proportions your main “competitors”. Their countries become markets for your new products. Lower procurement costs increase either your standards of living or your own competitively or both. In other words, while surfing on renewed waves of technology, you constantly dominate new sectors, transfer older industries to other countries under your control, and improve your costs while your markets grow. I should add that profits made by foreign countries tend to be recycled in your own economy, as successful innovation is generally a better investment than cheap manpower, and as more developed governments are also normally more stable. Last bit not least, brain drain plays at your advantage.

This looks like magic, except for 2 problems. The first one is that countries which are competitive in older sectors will try their best to enter directly the new ones. After all, you can easily fight this by imposing them “free trade” (use your armies when need be), preventing them from raising temporary barriers to your own products, in such a way they can never build up any strength in any new sector. The second problem is you have to make really sure you stay on the edge of innovation, but cannot take your superiority as granted.

Unless I am mistaken, there is no better path to critical innovation than intense research: even serendipity occurs in the right environment. This is where the trap is to be found. The best research is long term research, as it is the only one which favours thinking out of the box. Corporations by themselves are not very good at this, for the simple reason that their value is measured on short term scales. Only governments can afford thinking on longer terms. There are basically two ways to do this: one, the “European” way, is directly through public universities, public research agencies, and public sector research labs; the other, more “American” is to subsidize private research by military contracts. When subsidized corporations don’t find anything, things are still ok, as they are in any case reinforced by the subsidies they receive. When they do find something, it’s even better, as they can now invade markets with the subsequent innovations. Another advantage of military contracts is to appear not as subsidies, but as mere contracts that may be reserved to nationals. When this is done, in the name of free trade you can now prevent other countries (with more limited military budgets and/or using civilian channels) to subsidize their own companies.

The more European countries “modernized”, the more they reduced their public sectors and military spending, the less research they had. Inevitably they started losing market share to US companies directly or indirectly benefiting from growing military contracts, as well as to emerging countries where they had been moving their production.

Europeans are still wondering what went wrong.

This is how the world goes.

Can museums make money?

I am not sure art gained much from deserting the service of the gods for the service of money. Once the harm has been done, however, better be consistent. New puritans of art, replacing older puritans of religion, frown at the opening of a branch of the Louvre in Abu Dhabi (next to the Guggenheim’s).

This is strange, really. None of us has had time to see all the works belonging to the Louvre, or, for that matter, all works exposed in the regional museums participating in the project. So, the “Oh no, we won’t see these 300 works for 30 years!” sounds hypocritical to say the least. Why not start by having a better look at the tens of thousands of remaining works we keep neglecting every day?

As to the so-called “alienation of national treasures”, one should remember that many of these works were stolen by French armies or bought at a time when France had more cash than Abu Dhabi, and that they will be back anyway.

More importantly, even if museums are now quite uncertain of their missions, education certainly remains one of them. Educating other people to European art sounds like a decent idea. Doing it for a price makes perfect sense when you lack money and such people hardly know what to do with theirs.

The problem is that we are not very clear either about what education is. Understanding a work of art implies some knowledge of its iconography (another word for its “meaning”) and historical context. In order to acquire this kind of knowledge, digital copies can be used until a minimal level of familiarity is reached. They can easily be multiplied all over the world, while original works are used to show the real thing to people in grade of appreciating them. We are not exporting this to Abu Dhabi for a good reason: we don’t have it even at the Louvre. All we seem to offer to the masses of tourists invading the premises every morning are “Da Vinci Code trails”. Lucky Abu Dhabians who will be deprived of such achievements!

This is how the world goes

Das Kapital 2008: the exploitation of fools by fools

You probably heard by now of Jerome Kerviel, world champion of trading scams, who was capable of generating by himself a loss of no less than €5 billion (yes) to his employer, the giant Societe Generale.

Being a reasonable person, your guess is of course that the young man is a genius and/or a criminal, one of these overpaid traders seized by some hubris. He is not. He was actually one of the least paid traders in the Western world: € 35.000 (before tax and social insurances, equivalent to € 20.000 net) + a gross bonus (still before tax etc.) of € 60.000.

Understandably the young man wanted to increase his bonus. The employer’s response was: “Are you kidding us? First increase your profits for the bank and we shall see to raising your bonus”. All right, thought the young man, and as there is no way I can increase my profits by regular means (after all, all traders have more or less the same training, information and skill), I shall increase them by taking more risks. Well, not really more risks, because there is a well know trick: if you go wrong one day, simply double the stake the next day, until you are back to profits. Renew the operation as long as necessary. This takes a deep pocket, but Societe Generale does (did) definitely have a deep pocket.

As a matter of fact it did work! On December 31, 2007 Kerviel had made € 1.4 billion in undisclosed profits. Why undisclosed? Because there was simply no way to announce such a gigantic amount without revealing at the same time the unauthorized risks that had made it possible. Stupid isn’t it?

A criminal mind would have cashed in the € 1.4 billion by putting it onto some offshore account, then resigned from the bank and gone for a long cruise with at least a couple of Russian models. Kerviel however was honest! As a new kind of proletarian banker, he simply was looking for a better salary. As a fool, he was using a method that cannot be disclosed, and cannot therefore trigger a bonus. There was only one way out left: going on like this for ever, until you reach irreparable losses (with stakes superior to the very capital of the bank). And so he did.

Now, if we consider the employer, underpaying traders may look rational at first sight (after all, as I said, they are all about the same, with simply more or less individual luck). But if you do, better enforce your procedures! Even if you have never been a banker, you know that limits must be documented and checked by third parties. It was not the case. And if you have been a banker you also know that the most basic rule applicable to anyone in a bank, including a mere cashier, is to have people take their vacations! When they go on vacation they have to release their books and positions to someone else. Thus, should there be a scam, it gets discovered. Kerviel did not take any vacation and the bank was happy to have an underpaid trader doing overwork.

Hence, the title of this paper: New capitalism is turning into the exploitation of fools by fools. As to Societé Generale, due to be taken over after such a loss: requiescat in pace!

This is how the world goes.

How to turn a good idea into a bad one

During a recent press conference, President Sarkozy (one new idea a day) announced he would prohibit advertising on public TV networks in order to free them from market constraints and let them pursue quality. Excellent goal indeed: why would we need public networks if their programs are more or less identical to commercial TV’s? He suggested that from now on public networks would be financed by some new tax on TV advertising. Brilliant idea: advertising masses remain unchanged and public TV is freed from advertisers.

A few days later, when asked about this project, staff members start saying that, after all, the new tax could be based on TV sets or cell phones, or God knows what else. Now an absurd imbalance in created in favour of commercial TV (benefiting from a huge and unjustified increase in their advertising income), allowing them to crush Public TV. A couple of other sectors, starting with electronic appliances, suddenly become victims of a distortion.

This is how the world goes.