How Inefficient Are Efficient Markets?

"Efficient Markets" Converge to Inefficient Competitive/Economic Conditions . . . This obvious statement[for many] seems to get far too little study amongst economists and industry analysts.

Research seems to assume that with a bit of anti-anticompetitive efforts, industries-economies generally will arrive at efficient supply-demand conditions.  However, most also seem to agree that the general level of concentration is rising:

- Within countries, the concentration of suppliers generally are increasing.

- In many cases, the concentration of customers has become extremely high.

- Cross-border expansion/imperialism and less vigilant markets have also allowed greater market power.

- Even technology such as e-commerce have offered tremendous advantages to scale (along with financial institutions, oil cos, agri-trading, content, etc.).

- And as previously discussed, the rise of command economies like China has had tremendous effect.

So Keynes, Sharpe/Markowitz/Miller, et. al. lived in a more efficient world.  Industry/economy efforts to develop goals and judge results -- must focus on analyzing how increasing concentration in various industries and countries are distorting the convergence toward "true" efficient industrial and economic structures.

There are plenty of other things to worry about -- but underestimating the inefficiencies of increasing global market concentration would seem to be an increasingly important issue.

BIG Headline - US now Net Exporter of Petroleum Products

When I read today that the US is now a net exporter of petroleum products (9Mo YTD exported 754m barrels of refined fuel and imported 690m barrels of crude), I am wondering why this is not a bigger headline.

As recently as 2005, US had a deficit of 900m barrels of petroleum products.  That must be over $100 billion per year change in 5 years!  The assumption was that US ran huge trade deficits that were offset by services surpluses (as well as usual net investment flows).  And we worried that: the dollar will dive, BRICs will take over, reliance on Middle East energy, poor state of US manufacturing, loss of leadership in the energy sector, etc.

But this "Petroleum Net Exporter" has wide ranging implications:

- There are many reasons for dollar strength, beyond flight to safety.

- The euro is way overvalued; yuan is probably less overvalued than believed if actual Chinese inflation is taken into account; and, the rise of IMF SDRs seems to be an idea of desperation (at least European).

- We seem headed to Euro-Dollar goes to parity, Yuan and HK dollar merge and fix, and Japan inflation kicks in and Yen reverses.

- Enhanced recovery and increased natural gas utilization has reversed declines in North American energy production [BTW -- It would seem that Canada is the new South Africa -- except a lot bigger.  The Canadian dollar is probably worth multiples of the US dollar.].

- And the US has shown that it is a pretty good "manufacturer" of refined petroleum products.  Building refineries in the Middle East, Nigeria, and SA would be great businesses.

- At the same time, US has surpassed Europe as the most lucrative market for wind and solar.  [It is too bad that nuclear just can't get a break.]  Also, China has effectively taken over the supply side of the alternative energy industry (though they still need some chemicals and production equipment).

- This Net Exporter status is actually not too big of an issue for the Middle East and Russia etc. -- as they can still sell crude.  I would guess that China, India, et. al. will soon reverse its foreign reserve accumulation -- as it imports energy and commodities.  Guess that is why they are building so many windmills and solar plants.  [So US becoming a net exporter -- really does not solve the "Middle East" issue.  The people of the Middle East seem to be doing a pretty good job on their own in many regions, of course.]

- I wonder what China's plan is to address: labor costs in major cities becoming uncompetitive, huge amount of imports of more "downstream" foods like meat, energy/resources required to address environmental issues (even for clean water), and the increasing difficult in understanding/managing their economy as they themselves distort the global market forces.

But I digress.  It would seem that we should: buy dollars (particularly TIPS) and farmland in the Dakotas (selling the mineral rights), short Euros/Gold, buy anything in Canada, focus on jobs not manufacturing in America, buy lot of solar modules and wind mills from China, and have our children study chemical and biochemical engineering (for energy, synthetic food, et. al.).

China Conquers Macroeconomic Theory

Readers (and, I assume, economists) wonder why macroeconomists are so wrong so often.

Perhaps an increasingly important factor is the increasing role of China in the global economy.

In our mad dash to participate in the economic renaissance in China, we seem to put on blinders to the fact that China is a communist country and the preeminent command economy that the World has ever been a party to.

The old rules of supply and demand and clearing prices, etc. -- particularly at the margin where macroeconomists largely play --  seem to no longer have even the semblance or an efficient market.

Many would agree with China's impact on absorbing global manufacturing -- and now its profound influence over commodities, energy, etc.  Its might in luxury good ascend -- and when they make pronouncements that they will buy Greek debt, China begins to implement their sway on the global financial and political landscape.

Certainly, many other economies (and multinational companies) have "command" characteristics.  However, none have near the scale that China has already attained.

I wonder if economists might consider adjusting their teachings and prognostications (including reducing the conviction behind macroeconomics' predictive possibilities).

Companies: The Best Banks to Foster SME Employment

Companies routinely borrow and lend from other companies (called Accounts Receivable and Accounts Payable).  If we rejigger this financing arena, we can significantly improve financing to SMEs and accordingly employment.

The Situation:

- Banks cannot find enough credit-worthy borrowers to stimulate the economy -- limiting the effectiveness of monetary policy (which has so far only helped banks and large corporations).

- In difficult times, companies try to increase cash-on-hand by reducing AR (with more aggressive collections and lower inventories) and increasing AP (slowing payments to their suppliers).

- This means big companies accumulate cash by taking away from medium-sized suppliers, and the medium-sized take cash from smaller suppliers.  Then the [less capital-intensive] small suppliers do not have the financing to maintain operations (nor the credit to borrow) and must layoff employees.

The Short-Term Carrot:

- Banks must extend themselves to provide greater financing rates for SMEs borrowing against receivables and inventory.  For example, rather than lending 70% of receivables and 50% of inventory -- a move to 80%/60% would make a significant difference.

- More importantly, companies have to be provided "AP Financing".  The Fed/SBA et. al. needs to figure a way (via Banks or directly) to provide funds to corporations to REDUCE their AP days outstanding.  If companies paid their suppliers in 15 days rather than 45 days, there would be little need for other bank financing at many companies.

- The key here is that we can get around the credit-worthiness issue -- by providing financing to bigger companies so that they can provide "financing" to smaller companies (by paying of AP faster).  In many ways, companies are best able to manage credit as customers to suppliers, particularly as they can influence the credit of smaller suppliers by managing orders from them.

The Short-Term Stick:

- Large companies must be discouraged from taking advantage of smaller suppliers as they head into recession.  I am certainly for less government interference, but this really is a "public good" arena -- providing funding to SMEs, particularly going into recessions, would be great for all participants in the economy.

- There are many ways to do this.  Perhaps linking payroll tax credits to AP days outstanding would be an easy one to pursue.

Longer-term Management:

- It has surprised me that companies do not do a better job of tracking and recording who their AR and AP are associated with.  The SEC/IRS could easily mandate that public companies must categorize AR/AP relative to:  investment grade credits, non-investment grade credits, unrated credits.

- This would allow policy makers to track and put in place measures to insure that big companies are not squeezing smaller companies going into difficult economic times.

Remembering to Preserve Jobs Going into Recessions

Getting back to some semblance of full employment continues to be an issue with everyone focusing on job creation.

At this point job creation should be emphasized, of course, but a prior focus on job preservation going into recessions would have been a big help. Despite retraining programs, etc. -- it is the transition cost that hurts the economy (job loss, loss of confidence, loss of productivity, ramp up time at new position, lingering reduced spending with uncertainty).

The countries that figured out ways to keep its people employed -- even if it meant reduced compensation and job sharing -- are the ones that best recovered.

CEO's are not rewarded by the capital markets for "milking the company" going into recessions in order to maintain profits with broad layoffs. The answer seems to lie in CEO compensation schemes -- where profit/ROE targets are emphasized in the short-term and where "one time" charges works to the CEOs advantage in the longer term.

Regulations, laws, subsidies, thought leaders, boards, and managers would need to try to keep people employed going into recessions (perhaps with reduced compensation) in order to be able to quickly bounce back. This may seem anti-capitalist in the short-term, but in the longer-term it would achieve the prime directive for the economy (full employment).

It would seem that we easily forget that full employment is what the economy is all about.  The economy, the national/global production has its foundations on fully employing people (and allowing them to make and spend [money]).  Capital employed and productivity measures are really secondary if full employment is not regularly maintained.

Tyranny of the Intellect

Today's Bloomberg opinion piece on GOOG points out the increasing power (and earnings potential of the intellect).  Whether with biotech, Internet, financial engineering, patent trolls -- we are able to leverage intellect for much greater purpose and advantage than in the past.

But the financial crisis -- I would argue largely created by smart people that convinced others that they could control/manage mortgage and other derivatives [when they could not, and some of them knew it] -- is the big one.  But there are many examples -- MSFT, GOOG, Facebook, Apple market dominance.  GS [too much] leadership.  The riches and recent abuses of hedge funds -- which seem to foster risk taking.  Expert networks, even leadership at McKinsey.

There were times when the intellectual class were a contrast to the warlord class (who would gain great advantage with the use of force, and modest moral imperative).  But now it would seem that the intellects are conquering with little moral consideration.

Most families and countries have placed the intellect on a pedestal.  It would seem that we have forgotten that the intellectuals are also supposed to contribute a level of philosophical and moral suasion -- necessary to provide the checks and balance, and properly channel the General Will.

I would conjecture that many warlords have become business and other leaders -- but they are increasingly losing control to the intellects.

We seem to be out of balance.

Commodity Standard -- Not Gold

While many might support the concept of currency that is backed by something of value -- the traditional concept of Gold as a standard for the dollar or other currencies, seems rather archaic.


Gold has modest intrinsic value -- i.e., we could probably live without it!


As commodities ETF's become more popular (and strategic commodities stockpiles are accumulated) -- the financial and intellectual underpinnings for using a basket of commodities as the standard for existing or a NEW global reserve currency would seem self evident.


In order to best combat inflation, "downstream" commodities could make more sense.  This could include gasoline rather than crude oil, processed food rather than wheat, steel rather than iron ore, etc.  Individual countries could skew the basket to the commodities that it produces/consumes.


And as Mr. Paulson has developed a gold-denominated fund -- commodity (basket)-denominated funds would make sense.  This would particularly apply to foreign exchange reserves (rather than investments in Treasuries, etc.).  Unfortunately, this might be adverse to gold and Treasury prices.

Asset Sales to Balance the Budget

Republicans say no to tax increases.  Democrats wants to save programs like medicare and education.  Everyone agrees we need to cut the deficit by $4-6 trillion over the next decade.  And people finally seem interested in potential inflation.


The answer for the U.S. as well as Greece, Portugal and many others?  Asset Sales.


Everything from natural resources (even islands) to roads and government buildings could be sold, sold and leased back, etc.  This would also reduce inflation pressures on everything from real property to all other goods and services that are sensitive to excess liquidity.


So another perspective -- would the Republicans consider raising taxes for the rich and reducing loopholes to avoid paying tolls on the Long Island Expressway on the way to the Hamptons?

Basics for Automobile Fuel Mileage - Tire Pressure, Radiator Cover

As we are all shocked by the Japan earthquake and the nuclear power crisis (that may shift future power generation to fossil fuels), I am reminded of some basic ideas on conserving gasoline (the leading culprit for imported oil).


I have [briefly] advised on a number of new technologies designed to improve fuel mileage -- including additives, electromagnetic treatments, NG mixes, powertrain modifications, etc.  Usually, the industry response is negative as the technologies tend to be "5% solutions" rather than hoped-for 10+% improvement answers.  Beyond the cost-benefit analysis, it is not clear what the real source of resistance is to new technologies.


What amazes me is that automobile companies do not implement well-known solutions.


Tire pressure
- We all know this can make a significant impact on fuel mileage (in addition to tire wear and handling -- and how well your tire rim withstands potholes).
- Rather than merely indicating when the tire pressure is critically low -- the car really needs to tell us (on a temperature adjusted basis) whether our tires needs even 2-3 lbs. of pressure.
- Even better, cars should generally have systems that automatically adjusts tire pressure (on the run). In addition to fuel mileage, this would certainly help adjust to driving conditions (snow, rain, surface) and handling needs.


Dynamic Radiator Cover
- Many of us know that the fuel mileage declines during the winter -- seemingly due to lower engine operating temperatures (lower fuel and engine temperatures).
- Many in-the-know people will place a simple cover in front of their cars during the winter -- so the cold outside air does less engine cooling (and the converse should happen in summer).
- All cars could simply come with dynamic radiator covers (that adjusts air flow into the radiator and engine compartment) so as to regulate the engine operating temperature.  Seems a cheap solution -- compared to the lengths they go in putting holes in the side of car, and fans/turbos to improve the air mixture.


Also on my wishlist:
- Flying Cars - At the Boeing museum, there is a model of a flying car from many decades ago.  It would seem that we have the technology to do this cost-effectively (along with the guidance system so that we do not run into each other).
- 2-Wheel Cars -- Rather than the modestly useful 2-wheel person carrier -- I thought they were developing a larger one that could actually be more like a car.  In addition to fuel mileage, these would help the environment with far less mechanical parts, be far more agile (including parallel parking), and safer (braking, agility, etc.).
- Steam-Engine Cars - Train engines run on diesel engines generating electricity (as does many hybrids) -- but it seems that the old steam engine model could be made to work (with greater fuel efficiency, no internal-combustion engines, and none of those batteries that will be hard to recycle).

Who Should Hold Treasuries? EU, Japan, China

Now that we are finally admitting that inflation may be a factor -- at least on a "non-core" basis, we may actually begin to think about when the Fed will raise interest rates.

People do not seem to be talking about what would happen to the U.S. deficit if we must pay more to borrow.

So if the economy does better, inflation increases, interest rates rise, treasury prices decline, the Treasury borrows more to fund higher interest payments, then treasury prices decline further, U.S. dollar will be weaker (at least against those with less problems than the U.S.) + usual snowball effect of sellers further depressing prices.

I suppose the Fed can implement QE3 -- buying more treasuries (and other securities that are crowded out by increased Treasury borrowing) while nominal interest rates increase.  Perhaps the U.S. government will takeon some austerity measures.

In the end -- the E.U. and Japan can hold treasuries because their currencies will likely decline more than the dollar.  The Chinese have to hold treasuries -- though they seem to be diversifying out into energy, commodities and even equities.

Everyone else?  Everyone should buy and hold a lot of treasuries when the return gets above 9%.