Wednesday May 23, 2007

Throwing 'Resources' at Problems

I wrote about strategizing vs. economizing attitudes in my first ever entry on this blog. The problems associated with variations in these attitudes keep surfacing again and again.

In short, there are two modes of thinking when it comes to organized group or individual activity: the strategizing one and the economizing one. 

Throwing troops, tanks and dollars into fighting unwinnable battles for ill-conceived aims, throwing resources into implementing badly conceived business propositions, and other such activities --- all stem from strategizing thinking.

Creating an environment that improves complementarity of people's activities engaged in commerce, improving broad and varied commerce in goods and services at all economic scales, and reducing transaction costs (including security costs, transportation costs, etc.) --- all stem from the economizing attitude.

The strategizing calculations end with calling for more resources to gain leverage against one's opponents.

The economizing attitude focuses on a strategy of greater resourcefulness to accomplish global aims geared towards mutually rewarding commerce.

Monday May 21, 2007

London is Greener

Financial Times' Weekend columnist and author of Undercover Economist, Tim Harford, confirms my earlier claim that urban planning with good transportation systems can provide better energy security, where security can also come in the form of being greener.

I wrote my note lamenting the lack of energy security and urban planning with adequte public transportation in California, one of the largest economies in the world and one of the poorest places when it comes to good public transportation, and yet one of the places that has the greatest ambition to have cities as green as its environ. The only trouble is that you cannot be green with so many cars and so many roads and so few efficient (and nonexistent) public transportation networks.

This is what Harford writes (FT, May 18, 2007): 

The Office for National Statistics reports that Londoners produce much less household waste than anywhere else in the UK. From the same source I learn that London’s households are the most likely to have no cars, and the least likely to have two or more cars. Even before the congestion charge came into force few Londoners commuted by car.

London’s Mayor’s office informs me that London emits 40 per cent less carbon dioxide a person than the national average - which would be less than half the rate of ”carbon neutral” Ashton Hayes. All this from a city that is hugely dynamic, innovative and, frankly, disgustingly rich.

It is true that these figures do not include the environmental cost of producing products elsewhere and shipping them to London. That would be a more telling omission if the rest of the country was growing its food in the back garden, but the truth is that most UK citizens fill their houses with products produced elsewhere. They just have bigger houses to fill.

London, like other big, dense cities, is good for the planet. That fact seems to surprise people. After all, cities are polluted places.

...London’s environmental performance comes naturally. My in-laws live in the Lake District in a house that is twice as large as mine with half as many occupants; they drive into town to pick up the morning paper. We travel around by bicycle or walk pushing our kids in a baby buggy because a car is impractical. We are enormously greener than they, but not because we’re more virtuous nor because we’re poorer. We’d like a bigger house, but that costs too much in London. A fancy car would be a waste of money because we’d rarely use it. Economic necessity, rather than deeply held principles, compels us to be green. 

Addendum: Tony Raven of Herts, UK, recently wrote a letter to Financial Times' editors, noting that "As London has demonstrated in recent years, if you get more cyclists on the roads, other road users will both expect them and learn to interact safely with them. The number of cyclists in London has grown by 83 per cent since 2000, according to Mayor Ken Livingstone, while the number of serious or fatal cycle accidents has fallen by 28 per cent in the same period." London is also known for its diversity.

Tuesday May 15, 2007

Transaction Cost Economics and Open Source Software

It is good to see someone who has a relatively good understanding of Transaction Cost Economics write about the topic of open source software or software in general:

There was a time when a single determined individual could write the core of a single operating system for a primitive computer. But given the demands of computer applications and the capabilities of hardware technology at present, that is no longer conceivable. The task needs to be divided somehow. This immediately raises a ... core political economy question, about coordination of a division of labor within a centralized, hierarchical structure--that is, a firm. Within the firm an authority can make decisions about the division of labor and set up systems that transfer needed information back and forth between the individuals or teams that are working on particular chunks of the project. The boundaries of the firm are determined by make-or-buy decisions that follow from the logic of transaction cost economics. The system manages complexity through formal organization and explicit authority to make decisions within the firm as well as price coordination within markets between firms.

That's from Steven Weber's The Success of Open Source.

Saturday May 12, 2007

Security Consequences of Urban Planning


Modern urban planning in the U.S., as it has been conceived and implemented in the urban sprawl since WWII, poses serious security concerns that arise from its economic vulnerabilities. The vulnerabilities are both explicit, in terms of direct transaction costs such as transportation to work, and more implicit, in terms of aggregate and individual worker productivity. Thus, did The Economist ("In a Jam," May 5, 2007, p. 38) describe the situation in the area where I live:

[The] Bay Area is not set up like a European metropolis. Most suburbanites have quite a drive just to get to an underground station, and must then win a vicious struggle for parking to make it onto a train.

The description fits well with my family's experience here.

In major American cities, workers have to drive long distances (of the order of 80 - 200 km / day) from home to work and back, and a significant increase in gas prices, without a similar increase in better communications technologies (that allow people to reduce trips to work to compensate for other losses) or a similar increase in energy efficiency of automobiles (at the same unit price) can cause perturbations towards lower growth rates.

Lack of adequate and efficient public transportation is not limited to major cities. One in eight who live in the U.S. live in California, just as I do. The state by itself has consistently accounted for one of the top 10 largest GDPs in the world for multiple decades, and it drives the U.S. economy with its vast consumption, tax base, farming and real estate, not to mention high technology. And yet, there are no super fast trains connecting any of its major metropolitan areas together: Los Angeles, Orange County, San Francisco Bay Area, Sacramento Valley, etc.

The economic inflexibility of urban sprawl leads not only to higher overall transaction costs throughout the economy but also to instabilities in various sectors. For example, The Wall Street Journal recently reported that 51 leading retail store chains have reported a collective 2.3% decline in same-store sales. Michael Niemira, chief economist of the New York-based International Council of Shopping Centers says this is the weakest showing since he began tracking the closely watched industry measure of performance in 1970. People have blamed this on a soft housing market, bad wheather in March, a fast Easter or fuel prices. Fuel prices and a soft housing market seem to be the most likely explanations for why this drop has been as large as it has been. While the real estate industry benefits from generally cheap gas prices (which lead to better possibilities for greater urban sprawl) and may be willing to go to war for it (observe how the representatives of American economic power offered almost universal support, in 2002-2003, for aggression against and occupation of Iraq), the spending for war might come back to bite the real-estate and other industries in the form of rampant deficits and inflation, higher interest rates, higher fuel prices and general asset attrition. One would expect that the economic elites and political leaders of a super power to comprehend that peace, justice, stability and truly open commerce (of course, not in commerce of aggressive war machinary) remain the solid base and the best guarantors of mutual understanding and development, economic vitality and growth. However, "stability" is often confused with the extension of imperial rule. In the meantime, a rampant political jargon and an infected moral language equates mass aggression with liberation, injustice with natural rights, murder with "collatoral damange," etc. Such infection of moral language, publicly spread, will always fog people's minds and provide a kind of self-belief among the elites to perpetuate the rule of what becomes a militaristic economy unashamedly pursuing its ends until it exhausts all resources at its disposal (and reaches its own end) at a huge toll in human life and well-being.

Saturday Apr 07, 2007

More on Trust

[Earlier, I have written about the concept of "trust," including trust in the cyberspace. I have also shared a paper and pointed to Oliver Williamson's analysis of the concept of trust and to his papers on credible commitments, comparing it to the analysis Thomas Schelling offers in his work on conflict and strategy.]

Michelle Dennedy, Sun Microsystems' Chief Privacy Officer, has written a note about "trust" in which she gives the formula: "GOOD MANNERS x STANDARDS x TRANSPARENCY x TIME = T R U S T...maybe."

Here is my analysis of this formula which I think is a bit different from Dennedy's. 

The time element has to do with repeated transactions and/or long-term relationships.  Through repeated transactions with a particular party we gradually become familiar. An element of "reputation" is introduced. In long-term relationships (of business or other kind), parties to the transaction often make relationship-specific investment, through which they come to "trust" each other more because they have mutual stakes that will be lost if the relationship is broken.

The transparency element has to do with an openness which again produces mutual stakes. Each party knows valuable information about the other party to the transaction. This alleviates some of the information asymmetries which often lead to a lack of "trust."

With standards, we can define or at least bound the rules of the game. Laws contain standards and permitted mechanisms for their application. Knowing the rules of the game to be the same for both parties leads the transacting parties to understand how the other party will react under certain circumstances. Standards, like transparency, also help with reducing information asymmetries.

We can think of good manners as an adequate implementation of standards. If one does not exercise good manners, one will most probably have broken the standards, one may then find no choice out the quagmire but to become less transparent, which often will lead one to be less worthy of long-term relationships through time. Thus, one becomes less trust-worthy.


By way of extracting a few paragraphs from one of my comments on this entry, I'd like to share another formula.

First, note that good manners, consistency of behavior and standards all can be categorized under the same element, perhaps "consistency" ...

On the other hand, transparency has a lot to do with information exchange and asymmetries. Such mutual "hostages" (a la Thomas Schelling and Oliver Williamson) in the form of valuable information on one's transacting partner can actually cement "trust" by creating mutuality of vulnerabilities.

Transparency and information sharing is only one way to cement "trust" relationships through mutual vulnerabilities. Here are some other examples: Employees working for a firm often learn firm-specific skills. They are also often protected by the firm against market ups and downs and receive special benefits for remaining with the firm. Many other examples have to do with mutual investments that could lost in case a "trust" relationship is broken. (Relationships are broken when "trust" is lost.) The "trust" relationships between the U.S. and Europe and between the U.S. and Japan are as much based on tremendous and large mutual investments as on anything else. (See also Hubert Dreyfus' discussion of "trust" in his On the Internet. He describes and gives some real-life examples of how mutual vulnerabilities lead to trust.)

Finally "time" has often more to do with reputation than with "trust." In fact, one may argue that "time" only plays into trust when it leads to greater mutual vulnerabilities in the relationships because of some relationships-specific investment by both parties.

So, an alternate, simpler formula could then be


Some have also argued "consistency" out of the formula because they believe that consistency in relationships grow out of "mutual vulnerabilities" that demand consistent behavior. In this sense, "consistency" multiplier applies to both sides of the equation and can be eliminated from both sides.

Tuesday Apr 03, 2007

Political Economy of Open Source Communities

Lots of people have said lots of things about open source communities.

Among the books I have seen on shelves and articles in books and online, I've been wanting to read Steven Weber's 2004 book The Success of Open Source but time has never allowed.

Finally, I've been able to start and finish the first 15 pages of Weber's book, and I can tell you that it has all the right elements and sources for its analysis of the political economy of open source communities. Mancur Olson's work, transaction cost economists', Chester Barnard's and others' are weaved together beautifully in those pages.

I look forward to reading more of it as time allows, and I'll be quoting from Weber, here.

Thursday Mar 29, 2007

Inducement and Growth

Douglass North, a Nobel Prize winning economist, writes: 

A stationary state will result when there is no inducement for individuals in a society to undertake those activities that lead to economic growth. Granted that individuals in the society may choose to ignore such positive incentives, and that in all societies some are content with their present situation; yet casual empiricism suggests that most people prefer more goods to fewer goods and act accordingly. Economic growth requires only that some part of the populace be acquisitive.

It seems to me that acquisitiveness does not embody the only sufficient condition for economic growth. Other models of growth involve social growth for social purposes which create a more living environment, leading to greater productivity and growth through the modified activities of members of a society. Here, no acquisition may have happened. Only changes in the environment of activity has transformed the quality and quantity of it.

Monday Mar 26, 2007

Open Source and Property Rights

Open Source development—whether it is OpenOffice, Apache, Open Solaris, Linux (Debian), Sun Studio, Open JDK, Apache Derby (Java DB), PostgreSQL, Glassfish or Netbeans—engages communities in production of value governed by a revolutionary model for property rights, emphasizing open distribution of software rather than the traditional "exclusive-rights" notion of property.

The new property model finds its grounding in the use of the Internet as the backbone for parallel development of relatively complex systems of value generated by (non-idyllic) communities of developers—large quantities of value being generated for little, direct financial compensation. 

In the exclusive-rights model of property ownership, the state uses force (or the threat of force) to prevent "unlawful" use, in order to "secure" those rights and encourage their development. 

In the open-source model of property ownership, the width of distribution and availability represents the only "security" that needs to be provided.

The state's role must be vastly different, and it must be focused on rights of distribution and use, and of mixing. Being a vastly different model of ownership, open source has often confronted a state which wants to apply its traditional understanding of property and its "security." We have witnessed this with property "rights" over content because general content in the digital-distribution world possesses many characteristics similar to software.

Saturday Mar 24, 2007

Risky Loans Story Surfaces more Fully

Several weeks earlier, in mid February 2007, The Wall Street Journal first reported on the risky subprime loans' defaults and subsequent mortgage-backed securities losses. The news gradually broke into the more popular press. A couple of weeks ago, BusinessWeek, carried a cover story about the subsequent volatility in the stock market, and now, The Economist carries a "briefing" on the subprime defaults. (Subscription may be required for viewing.) According to The Economist, of the $40 tillion debt market (including the $10 trillion mortage market), only $650 billion relates to the adjustable-rate subprime loans. This has some optimists believing that the economy will avoid a credit crunch. Others, like Stephen Roach of Morgan Stanley, have "called subprime mortgages the new dot coms," according to The Economist.

Of the $10 trillion mortgage loans, some 75% are repackaged as mortgage-backed securities (or bonds). Some two thirds of borrowers have good credit and fixed interest rates. However, a growing number have weak credit and adjustable rates, and "little, or no, cushion of home equity."

When the housing market began to slow, lenders pepped up the pace of sales by dramatically loosening credit standards, lending more against each property and cutting the need for documentation. Wall Street cheered them on. Investors were hungry for high-yielding assets and banks and brokers could earn fat fees by pooling and slicing the risks in these loans.

Standards fell furthest at the bottom of the credit ladder: subprime mortgages and those one rung higher, known as Alt-As. A recent report by analysts at Credit Suisse estimates that 80% of subprime loans made in 2006 included low “teaser” rates; almost eight out of ten Alt-A loans were “liar loans”, based on little or no documentation; loan-to-value ratios were often over 90% with a second piggy-bank loan routinely thrown in. America's weakest borrowers, in short, were often able to buy a house without handing over a penny.

... A new study by Christopher Cagan, an economist at First American CoreLogic, based on his firm's database of most American mortgages, calculates that 60% of all adjustable-rate loans made since 2004 will be reset to payments that will be 25% higher or more. A fifth will see monthly payments soar by 50% or more.

... Mr Cagan marries the statistics and concludes that—going by today's prices—some 1.1m mortgages (or 13% of all adjustable-rate mortgages originated between 2004 and 2006), worth $326 billion, are heading for repossession in the next few years. The suffering will be concentrated: only 7% of mainstream adjustable mortgages will be affected, whereas one in three of the recent “teaser” loans will end in default. The harshest year will be 2008, when many mortgages will be reset and few borrowers will have much equity.

Mr Cagan's study considers only the effect of higher payments (ignoring defaults from job loss, divorce, and so on).... Mr Cagan's work suggests that every percentage point drop in house prices would bring 70,000 extra repossessions.

The financial markets should be able to whether these losses, The Economist observes. Mr. Cagan's estimate of losses, $112 billion, compare with the $600 billion "wiped out on the stockmarkets as share prices fell on February 27th." However, loss of confidence will affect the collateralized debt orbligations (CDOs) markets and may lead to demand for higher spreads and a classic credit crunch.

Finally, a historical dictum: A loose monetary policy instituted to save the economy from the disasters of one bubble can only lead to another bubble, perhaps of a larger impact.

The bursting of the stock-market bubble in 2000 led to a plunge in investment at American firms. To stave off recession, the Federal Reserve loosened monetary policy. Short-term interest rates fell to historic lows, propping up consumer spending, but also fuelling the housing bubble and sowing the seeds of today's upheaval.

Only disciplined frugality, savings and attention to real assets, and not more legislated regulatory burdens, can help rein in break-neck speculative swings.

In the meantime ...

Nancy Trejos of The Washington Post reports the most recent housing statistics released by U.S. Department of Commerce on March 26. The statistics speaks of a sharp drop in new home sales in February and it has pulled down all three major indexes on the Wall Street on its release. There is quite a bit of regional variation, Trejos reports:

The supply of new homes for sale increased by 1.5 percent in February to 546,000. At the current sales pace, it would take 8.1 months to get through that supply, up from 7.3 months in January and 6.4 months a year ago.

By region, the Northeast had a 26.8 percent drop in home sales, the steepest decline in the country. The Midwest had a 20 percent drop. The South, which includes the Washington region, was down 7 percent.

The West was the only part of the country to have an increase in sales, up 24.6 percent from January.


Friday Mar 02, 2007

Protracted Wars and Asset Attrition

Much earlier, I've written about the use of war spending as a quick-and-dirty means to apply a consumptive forcing function in an economic cycle. (On the issue of economic time scales and the dynamics involved, I have also written an earlier note.)

When aggressive wars are waged with the purpose of acquiring resources (geopolitical bases, currency values, people, mines, energy resources, transportation resources, land, etc.), besides the moral bankruptcy of such a behaviour, the utilitarian calculation that takes the aggressor into war also stems from the "positive" consumptive impact on its economy. The "positive" nature of the impact shows up in the hope of the application and execution of war in a short time scale in order to solve a specific problem in a specific economic cycle. The impact of war spending on the cycle will always prove more dramatic than any long-term investment, whose impact will be faced and felt in a term longer than of interest to the executioners of "national interest."

However, matters of war and peace, and life and death, have always proved to be more complex than what simple utilitarian calculations tend to reveal.

Despites rosy predictions and enthusiastic promises pundits of the war party give, the aggressive war itself drags on when it faces resistance, which it often does. Note that historians have found it odd and unusual when an aggressive war has encountered no resistance. While the planners of aggression always do what they can to dismantle resistance, the aggressor should always bet on encountering resistance to its aggression. (Even little Melos resisted the Athenian armada.) Occasionally, the aggressor perpetrates extreme violence in order to prove resistance futile. As a consequence, those who resist fold temporarily but only as a means to survive for a better day.

So, as a historical experience, all aggressive wars in history have bred resistance in various forms, scales and stages. Often the aggressor is quite well-versed in history and knows this fact of history full well. So, the aggressor takes care only to attack those who cannot be expected to defend themselves or only targets which have been "softened" through years of brutal but calculated preparation. Of course, not always do such preparations and campaigns succeed. History is littered with their failures more than with their successes. However, the successes occur with enough frequency to salivate the aggressor's appetite.

With the stretching of the war beyond expected scope, larger chunks of hard-to-renew resources continue to be wasted on it. Even as such wasteful spending may be advocated to drive further consumption, in reality, it generates no added value to supplement existing asset values. Hence, a general asset attrition sets in, and by extension, inflation takes hold, and soft and hard landings beset various asset-based sectors of the economy. Note that all sectors of the economy ultimately prove to be asset-based if we are daring enough to include, also, non-physical assets in our utilitarian calculations. We can think of various types of assets -- for example, national currency value (determining the value of various forms of savings and investments), stock values, real-estate values, expertise, know-how, skills and knowledge -- these are all assets, the latter few examples of which, by themselves, are non-physical assets even if they may have physical representations. Note that the most important assets are the human beings. This makes a mockery of aggressive war as one waged "for the hearts and minds" of the targets of aggression.

As war drags on, a grinding attrition grips all national assets. Resources that should have been invested to improve such assets are wasted, and the negative long-term economic impact draws itself near. (I refer the reader to a note elsewhere which extracts one of Nobel Prize economist Joseph Stiglitz' relevant observations on the cost of war.)

In conclusion, we should note that asset attrition has a multiplicative effect at a macroeconomic level. The value of assets deployed in a value network depend on the value of other asssets. So, as a particular group of assets lose value due to a lack of proper and long-term investment, they depress value of other, related assets.

Thursday Feb 22, 2007

Commerce and Development

In his commentary, "Competitive Cooperation" written to honor the 50th anniversary of the Treaty of Rome, the 2004 Economics Nobelist Edward C. Prescott reminds the readers of the importance of commerce in mutual economic development and growth.  

Let's review some historical facts. With the signing of the Treaty of Rome in 1957, France, Italy, Belgium, West Germany, Luxembourg and the Netherlands formed what would eventually become the European Union. For six decades prior to the treaty, those countries were about 55% as productive as the U.S. But over the following 25 years, those countries essentially caught up to the U.S. in terms of productivity.

When that historic economic treaty was signed, three countries were roughly on par with those original six -- Denmark, Ireland and the United Kingdom. However, a funny thing happened in subsequent years -- those three countries started falling behind their former peers. So in 1973 they joined the original group and their economic fortunes improved. It took time, but the U.K. now is as productive as Germany.

...And what of Latin America? Unfortunately, the region provides a case study in the perils of protectionism. Recent research by my Minneapolis Fed colleagues, Lee Ohanian and Jim Schmitz, and two co-authors, shows that from 1950 to 2001, per capita GDP for Europe increased 68% relative to the U.S.; Asia increased by 244%, while Latin America decreased by 21%. This is all the more striking when we realize that Latin America's per capita GDP actually exceeded Asia's by 75% in 1950.

Perhaps, it is time for a Latin American Union.

Some nations use trade policies to punish others. Whether politically motivated or otherwise, policies that raise barriers to potentially beneficial trade or create trade zones or alliances that exclude others are ultimately doomed to lead both groups worse off. Of course, the exclusionists, when powerful, come to believe they represent the house with infinite resources in the trade gamble.

Note: In his Getting it Right: Markets and Choices in a Free Society, Robert J. Barro advances points similar to Dr. Prescott's.

Sunday Feb 18, 2007

CDOs and Default Risk

Elsewhere, I follow the recent instabilities in the collateralized debt obligations market, and in particular, the segment involving mortgage-backed securities.

Friday Feb 16, 2007

Driving To Work

Consider the table below, originally published by The Wall Street Journal.

It shows the growth in traffic costs (fuel and lost personal time) in various urban areas in the U.S. from 1983 to 2003.  The actual and aggregate "cost" of a transportation system that relies, primarily, on individuals driving themselves to places goes well beyond that of fuel and lost personal time. One must also include other costs such as health care, insurance, repairs, etc., which arise when people have no reliable public transportation choice and have to drive themselves to work and other places over long distances.

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Table from the WSJ.

When active producers in an economy spend large parts of their time and resources driving back and forth to work, they are contributing to the aggregate transaction costs of that economy, making it less "competitive" than economies that make better use of time and resources ("Bush Plays Traffic Cup in Budget Request," WSJ, Feb. 5, 2007). Witness, as examples, public transportation systems in Tokyo and Berlin.

Travel congestion is "increasingly troubling," Transportation Secretary Mary Peters said in an interview. "It's a cost to business and probably affects our ability to be competitive on the global market. But it's also something that just drives people crazy."

It would be misleading to think that work-from-home in the Internet age will solve the problem. A quick analysis of the social life of information would make it clear that work from home has its own significant transaction costs for corporations. So, while by working from home we reduce some aggregate transaction costs, we add others.

Maturity and Interest Rate Risks

China seems prepared to deal with some interest rate and maturity risks.

Mortgages and Repurchase Safeguards

The image “” cannot be displayed, because it contains errors.

Not only subprime lenders but also most other lending institutions package and sell their mortgage loans to investment banks who often slice and dice these loan pools to issue mortgage-backed securities of varying risk levels. Occasionally, as HSBC seems to have done with some loans, the bank may keep these loans on its own books.  This is a very risky proposition. However as was also the case with subprime loans purchased by HSBC, most investment banks purchasing these loans include repurchase clauses in the mortgage pool contracts. After adding $1.76b to bad debt costs, HSBC has sued some subprime banks who have failed to abide with repurchase clauses. (See "Mortgage Hot Potatoes: Banks Try to Return High-Risk Loans To the Originators," The Wall Street Journal, Thursday, February 15, 2007. page A4.)

In economics, such repurchase clauses are called transaction "safeguards," which if set correctly, will lead to a better hybrid transaction model. They discourage subprime lenders to take unreasonable risks and put them in a risky position if they do take extreme risks. The investment bank purchasing the loan pool may at any time (coinciding with a trigger, perhaps) want to exercise the repurchase option.

Sunday Feb 11, 2007

More on Vacancy

I have explained, elsewhere, why I wrote about vacancy rates earlier.

Friday Feb 09, 2007

Optimal vs. Natural Vacancy and Unemployment

There is a similarity (as one thinks of self-silimarity and self-similar transformations in non-linear differential equations) between "vacancy rates" as seen in the world of real-estate economics and "unemployment rates" as seen in the world of macroeconomics.

This should become clear when we look at optimal vs. natural vacancy and unemployment rates. 

Optimality can be defined once we know what it is we are optimizing.

Naturality (to coin a word) can be defined when we know what vacancy rates or unemployment rates a particular market's transactions dynamics will create given its parameters of routine operations.

In a non-monopolistic real-estate market, optimal vacancy rate is 0. All landlords would like to have all of their units rented throughout the year. If tenant X moves out on January 31, the landlord would like tenant Y to start paying rent on February 1. In a monopolistic or oligopolistic market, say in the market for prime office space in San Francisco, optimal vacancy rate might be non-zero. For the monopolist, what matters is an optimal level of profit, not demand satisfaction. Similarly, optimal levels of unemployment are said to occur when Gross Domestic Product (GDP) of an economy is maximized. Of course, the solution to this optimization exercise depends on how we measure GDP. (The general concept also holds at the level of families as socio-economic units. One family may measure their gross domestic product to include things like childcare and nurturning and another may not. Their "optimal" money-driven employment rates will be different.)

For a given real-estate market, natural vacancy rate occurs in order to support the routine movement and migration of tenants from one site to another. For example, if finding a new property proves slow in a particular real-estate market, that market will have a higher "natural" vacancy rate. Similarly, the natural unemployment rate occurs in order to support the routine movement and migration of workers from one job to the next.

We can also talk about natural vacancy rate of positions within an organization or a company. There are always some number of unfilled positions due to the natural rate at which they are vacated and filled and the time lag involved in filling a position.

I should end this entry by noting that in a real economy, there's usually a relationship between all the various kinds of "vacancy" rates (employment, rental-property, etc.) but that relationship has not been the focus of what I've written here.


Thursday Feb 08, 2007

chiemgauer, urstromtaler, landmark, kirschblüte and kann

We know about Open-Source Software but can we also talk about Open-Source Currencies. A report by International Herald Tribune's Carter Dougherty reminds us that we can.

Inspired by a long-dead German theoretician, Silvio Gesell, the currencies mine a hoary conflict in economics — usually pitting the mainstream against subversive outsiders — about whether paper money is a neutral medium of exchange whose purchasing power should be scrupulously guarded, or an instrument that could be manipulated to fulfill capitalism's untapped potential.

Dougherty notes that the value design for these currencies encourage people to use them more quickly. For example, "[in] the case of the chiemgauer, the notes lose 2 percent of their value each quarter if people do not spend them in time." (This policy increases the "velocity" of money.)

Some 21 such currencies exist in Germany. Some 31 more are in preparation and "Gerhard Rösl, an economist with the University of Applied Sciences in Regensburg, has also located similar experiments in Denmark, Italy, Scotland, Spain and Italy."

The main effect of these local currencies is an increase in the "velocity of money" in the local economy where they are used. The automatic devaluation rate of the chiemgauer, apparently increases its circulation by a factor of 3 compared to central bank issues used in the same market. The factor will obviously depend on a number of macroeconomic variables.


By "Open-Source Currencies," I mean currencies that are not sourced from central banks. These are often sourced, openly, from private non-bank or non-profit institutions.

You may wonder about the words in the title of this blog entry. They all refer to currencies issued by non-bank institutions.

Monday Jan 29, 2007

Derivatives at Davos

Back in December of 2004, in a weblog entry entitled The Basel Accord and the Value at Risk (VaR), I wrote the following:

While the advance in synthetic financial derivatives have allowed hedging of bets across the board and through the wide range of financial institutions, since these derivatives have also led to greater interlocking and entanglement of all aggregate financial bets across institutions, they may leave the whole system under a larger meta-level risk. The only breathing space left as an influence factor seems to be how the system is connected and interacts with its "edges" such as the emerging economies. In other words, while entanglement of bets has led to greater distribution of risks into a lower overall risk aggregate, the boundaries still determine how stability may "leak."

Now, at the Davos 2007 World Economic Forum, Jean-Claude Trichet, the president of the European Central Bank seems to be moaning the opacity of fancy derivatives and hedge funds who use them.  Trichet spoke as part of a session dedicated to whether central banks could manage global financial risks. As reported by Financial Times from Davos:

Conditions in global financial markets look potentially “unstable”, suggesting investors need to prepare for a “repricing” of some assets, Jean-Claude Trichet, president of the European Central Bank, said over the weekend in Davos ......

“There is now such creativity of new and very sophisticated financial instruments ... that we don’t know fully where the risks are located.” He added: “We are trying to understand what is going on but it is a big, big challenge.”

Mr Trichet’s comments reflect a debate in policymaking circles about the implications of the growth in derivatives.

Many investment bankers and some regulators and economists argued at last week’s World Economic Forum in Davos that the growth of the $450,000bn (€350,000bn, £230,000bn) derivatives sector had helped reduce market volatility and made the system more resilient to shocks by spreading credit risk. But other officials fear these instruments may be raising leverage and risk-taking to dangerous levels and keeping the cost of borrowing artificially low, potentially increasing the chance of financial crises.

I have to say that at least in my 2004 blog entry, I had some conjectures regarding the form of the risks and how they may leak out of the system so tightly bound together in hedges, bets and counter-bets.

Monday Jan 08, 2007

Shifting Transaction Costs

Regulatory measures can impose, shift or reduce transaction costs for business operations.

For example, the Committee on Foreign Investment in the U.S. (Cfius) has recently moved to impose security requirements on the proposed Nokia Siemens venture.

It is not clear whether Cfius is going beyond its mandate by imposing such requirements. "The process has become a tool for Cfius to impose security requirements on foreign companies, while government lacks the legal authority to impose them on U.S. companies," a U.S. business lawyer David Marchick told Financial Times. (Reuters cites the FT report in its own story on the same subject.) 




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