Housing Starts

...the driving force to which the housing market responds is not relevant…

The Wall Street Journal published an article on December 14, 2006 entitled “Housing, Auto Slumps May Defy Usual Role as Recession Harbingers”. Usually, the housing industry slows construction and new home starts in response to rising interest rates. The rise in interest rates makes homes less affordable reducing demand. In this case, the article proposed that the housing industry has slowed construction and new home starts in order to sell off inventory, so it may not be a predictor of broader forces that would cause a recession. But the driving force to which the housing market responds is not relevant to the predictive ability of the housing market
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The construction industry as a whole and the suppliers of construction materials together represent the largest employer of semi-skilled labor in the US economy. Construction labor is also the largest employee pool which can never be outsourced overseas. An employer can’t generally hire a team of Chinese laborers to build a house and ship it to Seattle. Of course, there are exceptions, but not significant ones.

Fewer starts don’t immediately affect the labor pool…

The reason that housing is a predictor of the economy is that housing starts don’t slow directly due to a slowing in the economy, rising interest rates, or a decrease in affordability. They respond to a buildup in housing inventory and contractors who are unable or unwilling to capitalize additional construction. As contractors reduce construction efforts, it causes that slowing economy, hence the predictive component. When housing starts slow, eventually construction laborers lose their jobs. Fewer starts don’t immediately affect the labor pool because of the projects which are already under way, but as these laborers lose their income a few months later, they will begin to spend less. Again, there is a delay since people take time to reduce their spending. As money gets tighter from prolonged unemployment, spending reduces even further.

The largest relevant moderator to the potential slow down is…

The fact that retail sales rose 1% in November from October is not surprising or, for that matter, particularly relevant to the argument. I don’t believe that the delay from reduced housing starts has had time to work its way through the economy. The largest relevant moderator to the potential slow down is the change in the strength of the dollar. As exports increase and imports decrease in response to a weakening dollar, this will help to moderate the slow down from housing.

Rogue trader

In an article for the New York Times Business section…

Finally there is an article that speaks to the other side of the risk of trading. When so much press revolves around people like Warren Buffet, and movies like “Pursuit of Happiness” touting the chances of getting rich quick, the uninformed may begin to think that anyone with half a brain should be able to make money. In an article for the New York Times Business section entitled “Ex-Trader Tells Story as a Warning”, Nicholas W. Leeson is put forth as an example that not every informed individual fares well.

Trading is not a zero sum game as some people believe. For every winner there is not necessarily a loser. On the other hand, with millions of people trading, there are bound to be some statistical anomalies; very big winners and very big losers even if all the choices are purely random. No one hears much about the very big losers, and there is normally a smaller limit to how much any one person can lose, but no limit to how much can be won.

By hiding his trading losses…

Mr. Leeson’s story is an interesting study of what can happen when the downside stops are essentially removed. Mr. Leeson traded for Barings Bank in Singapore. By hiding his trading losses (which led to his criminal conviction and prison sentence), Mr. Leeson had access to virtually all of the resources of Barings Bank allowing him to rack up losses of over a billion dollars, bankrupting Barings Bank. Individual traders usually bottom out long before losses of this size, making their demise less than newsworthy leaving the rest of us to read only big success stories. If an individual investor loses everything he has it rarely makes the news.

The unfortunate side effect of the lopsided press is that it brings uninformed individual traders to the table, many of which are trading with their life savings thinking they will be rich, too. The Efficient Market Theory tells us that the only way that these risk taking souls can consistently win is if they have information not available to the rest of the market. If they do, and they use it, they are most likely to be in danger of retribution by a federal judge for insider trading.

…the average individual will fare slightly worse

The market in general has an average positive return. Conventional loans and the use of derivatives can increase leverage, risk, and return, pushing these risk takers to the end of the statistical bell curve. If we assume that most of the professional and institutional traders fare slightly better than the market, then the average individual will fare slightly worse, though still perhaps achieve positive returns. Again the “house” has the advantage, and trading has transaction costs giving the “house” a further edge.

The reference to gambling in the New York Times article is appropriate. Many investors don’t realize what risks they are taking, or the fact that they have only a slightly better chance of making half again as much money as they’ve invested than they do of losing half of their money. The Efficient Market Theory gives some comfort as well, though, because it should be just as difficult to pick a particularly bad deal as it is to pick a particularly good one. Market psychology causes the losses to generally be much faster than the gains, however.

I agree with him on one point

It’s not that I like seeing Mr. Leeson make a fortune on his bad risk taking, but it is nice to see some press showing that trading is not a get rich quick scheme. So that everyone might be more aware of the risks, let him speak. I agree with him on one point. He predicted that the dollar had further to fall against the pound and the euro in mid-November 2006 and I believe that is still the case in early 2007. Strong economies in both geographies and a flagging economy in the US struggling with inflation will continue to push the dollar weaker. I think the more dramatic changes will be against the Chinese Yuan, however (see Chinese Currency)

Chinese Currency

“U.S. Treasury Says Chinese Currency Isn’t Manipulated”

A Wall Street Journal article published December 20 titled “U.S. Treasury Says Chinese Currency Isn’t Manipulated” brought into question whether or not the title statement was politically motivated. Judging by the comments quoted from Senators Schumer (D., N.Y.) and Graham (R., S.C) no one could really argue this point. What is not addressed is that China has very little choice in whether or not it manipulates its currency, but when will its needs finally outstrip its abilities to manipulate and what should its economy expect when China can no longer keep it up?

Measuring unemployment in China has always been difficult. In an article for the China Economic Review entitled “What is China’s True Unemployment Rate?” it estimates urban unemployment at 14% in 2002 and continues for many pages trying to frame the answer in appropriate context of assumptions. Current estimates seem to be around nine to ten percent.

As China continues to be sluggish in allowing its currency to float freely, internal pressures will eventually make the point moot. If the exchange rate is kept artificially low, and China continues to control capital movement into and out of the country, forces of inflation will eventually dominate, slowly eroding the price advantages that China’s labor markets enjoy.

Several factors will continue to keep Chinese unemployment high

Several factors will continue to keep Chinese unemployment high. Productivity of Chinese workers is increasing as more and more technology is available to Chinese workers. As the Chinese Yuan increases in value relative to the dollar, Chinese exports become more expensive to residents of other countries reducing demand for those products, as seen by struggling Chinese importers to the U.S. like Walmart (Wall Street Journal article “Hefty Discounting of Flat-Panel TVs Pinches Retailer”, December 20, 2006).

Most of the unemployment figures are stated for urban areas

The biggest unknown factor in unemployment is the influx of rural residents that will eventually move to the cities. In the U.S., this effect happened in the early 1900s, but is just beginning to happen in China. Most of the unemployment figures are stated for urban areas. As the quality of life improves in Chinese cities, more agricultural labor will be attracted to the urban areas, just as the improving economy and quality of life appeal to scientists who are repatriating (see entry “The New Brain Drain”), increasing the labor pool and potential unemployment.

… if it slows too quickly, the unemployment in China will skyrocket

The increase in both productivity and labor pool size has allowed amazing growth in China’s GDP. If China releases control of its currency too quickly, the momentum built up by new entrants into the labor market and other unemployment factors could easily swamp the economy. The question is, does China have enough staying power to control the money long enough to prevent a hard landing? Inflationary pressures could be a reasonable measure to see how effectively China is managing the situation. Inflation helps to slow the economy much as a rising currency valuation does, but if it slows too quickly, the unemployment in China will skyrocket.

The New Brain Drain

“Indian Scientists Return Home as Economy Moves a Step Up”

On December 14, the Wall Street Journal published an article entitled “Indian Scientists Return Home as Economy Moves a Step Up” in which it discusses the increase in highly skilled labor trained in the U.S. and Europe returning to take their next career steps in India.

This was inevitable. For years, Indian scientists have been training in the US while general labor costs in India have remained well below labor costs in the US. As US and European companies moved semi-skilled occupations to India, the Indian government has continued to spend a far higher percentage of its GDP on infrastructure and education.

As the outsourcing progressed, management of these up and coming companies such as call centers became an issue in India. As any economy grows at 8% the way India’s has over the last three years, it attracts those trained in business and management. Once managers and business owners are in place, larger projects can be sustained attracting the scientists who previously saw opportunity for large projects only in the US and Europe where large private capital investments were more common.

Although the article concentrates on the pharma industry, it mentions a chip completed by Wipro for a US gaming company. For many years, US silicon design centers have kept teams of designers in India, especially for backend layout work and sections of design that could be isolated requiring minimal Indian management. Because of difficulties in obtaining adequate management, most US companies kept the larger designs in house.

As the quality of management improves, larger projects are sustainable

As the quality of management improves, larger projects are sustainable. As larger projects begin to develop, the projects become more attractive to Indian scientists. Within the next few years, we should see a marked increase in companies in India that design and produce their own projects rather than simply outsource their talents to US and European firms. Couple this increase in project size with the continued life style advantages to highly trained Indians who choose to return to India and the process should accelerate.

As the Wall Street Journal points out, western life style companies (like specialty coffee houses) have begun to appear to serve these repatriated scientists. I believe that opportunities for these types of lifestyle support companies will continue for several years. The cultural impact to India is increased due to the service oriented nature of India’s exports. Call centers, design outsource companies, and other service businesses often train their employees in American and European culture even if they have never been outside of India. The increased interface that these employees have with American and European customers increases the rate of adoption of western culture.

China is already experiencing the same type of repatriation

China is already experiencing the same type of repatriation, but the effects, especially cultural effects, will be delayed and less pronounced. There are several reasons for this. Two primary reasons are that the number of foreign trained skilled employees is a smaller proportion of the total population than in India, and governmental control over both the economy and the culture is more pronounced. Add to this the fact that China’s export economy is based more on manufacturing than service and it all serves to help isolate the cultural influence of the returning scientists.