Archive for June 21st, 2007

Difference between trade in goods and trade in finance

June 21, 2007

The best ideas on any topic in economics come when we have criticisms/critiques of an academic paper/ thought/article etc.

I just came across this piece written by Jagdish Bhagwati and critique by Maurice Obstfeld. And let me tell you it is super-stuff. This is what makes the field of economics so interesting.

I have often wondered what is the difference between trading in goods and trading in finance (assets)?  The latter has been distinguished from the former in wake of number of financial crisis. The initial idea was that trading in finance would also have similar benefits as trade in goods does (developing countries would need to fiannce their investments they would need additional finance apart from domestic savings) , hence it was advocated by a number of economists. Then came number of crisis in 1994 where finance (mainly short-term capital flows) was held largely responsible for the crisis. So now, we have 2 seperate topics and financial globalisation is a different topic altogether.

JB says in this famous and often cited piece that trade in widgets isn’t the same as trade in dollars. He says:

Each time a crisis related to capital inflows hits a country, it  typically goes through the wringer. The debt crisis of the 1980s cost South America a decade of growth. The Mexicans, who were vastly overexposed through short-term inflows, were devastated in 1994. The Asian economies of Thailand, Indonesia, and South Korea, all heavily burdened with short-term debt, went into a tailspin nearly a year ago, drastically lowering their growth rates.

The difficult part is the policies followed after the financial crisis. It basically leads to further opening of the capital markets which caused the crisis in the first place:

When a crisis hits, the downside of free capital mobility arises. To ensure that capital returns, the country must do everything it can to restore the confidence of those who have taken their money out. This typically means raising interest rates, as the IMF has required of Indonesia. Across Asia this has decimated firms with large amounts of debt. It also means having to sell domestic assets, which are greatly undervalued because of the credit crunch, in a fire sale to foreign buyers with better access to funds……. Thus, Thailand and South Korea have been forced to further open their capital markets, even though the short-term capital inflow played a principal role in their troubles in the first place.

He in the article then goes onto point out the Wall Street -Treasury Complex where both combine to always promote capital openness:

Wall Street’s financial firms have obvious selfinterest in a world of free capital mobility since it only enlarges the arena in which to make money. It is not surprising, therefore, that Wall Street has put its powerful oar into the turbulent waters of Washington political lobbying to steer in this direction……Wall Street has exceptional clout with Washington for the simple reason that there is, in the sense of a power elite a la C. Wright Mills, a definite networking of like-minded luminaries among the powerful institutions-Wall Street, the Treasury Department, the State Department, the IMF, and the World Bank most prominent among them……

So he provides a basic framework on which Obstfeld builds his thoughts. He says the difference between trade in goods and dollars is:

The basic differences relate to the intertemporal nature of financial trades and to the potential for asymmetric information to eliminate trade gains. Asset trade inherently involves commitment – the commitment to pay on a later date. Payment in reality is therefore always contingent, and the circumstances of contingency can depend on information known to only one party to the deal. Thus, financial transactions inherently must allow for the asymmetric-information distortions that we call moral hazard and adverse selection. These distortions reduce the gains from asset trade that would otherwise be available – even with an efficient and impartial judicial enforcement system.

As is well appreciated, government guarantees aimed at mitigating the redistributive effects of financial crises can, in fact, worsen moral hazard and raise the probaility of eventual crises.

Again, the difference compared to goods markets is a matter of degree. A consumer durable yields returns over time, it may be known to the seller to be a “lemon,” yet an unconditional service contract may leave the owner with insufficient incentives to operate the durable good appropriately. But there is no doubt that commitment and informational problems are by far most severe, and have the widest systemic ramifications, in the financial market setting.

Obstfeld then says domestic financial markets also pose problems as the above i.e. intertemporal nature and assymetric information are a problem in domestic markets as well. What makes international capital flows a bigger problem is addition of 3 more risks:

1.  Sovereignty: The potential involvement of two (or more) governments as implicit parties to international contracts.
2. Regulatory end-run:  International transactions can sometimes be used to evade domestic supervision.
3. Currency mismatch: The potential for unbalanced positions creates a significant additional systemic risk.

This is basic stuff and very well said. For a survey on whether financial globalization (or trade in finance) is helpful or not, I have put findings of the most exhaustive paper on the subject here and here. And in nut-shell the evidence so far has been mixed.

State of WI Cricket and innovation at Wimbledon

June 21, 2007

First read this good story on Wimbledon….The Centre Court is being revamped, it would be without its roof this year. They would also be using hawk-eye technology at Wimbledon this year.

Now for some Cricket. Here is another great discussion on what ails WI cricket. Sanjay Manjrekar has done a great job as a moderator. He discusses it with Michael Holding (MH) and David Lloyd (DL).

MH nails the root cause at its head. When asked what the real problem is he says:

You don’t have that as many people playing the game in the Caribbean now, it’s as simple as that. Years ago you had a lot of people playing cricket. Football was also a very popular sport and is still a very popular sport as far as participation is concerned. But the amount of people who would play cricket 30-40 years ago is probably 3-4 times the number who play now.

It is important for the administrators to put in the infrastructure and the facilities so that the people who want to play the game can easily access all the required facilities. There are so many other games that are easily accessible plus we are in the modern age of computers – kids just do what is easiest for them. There are basketball courts with lights all over the Caribbean. So the kids don’t have to worry about playing just during the days – they can come home from school or work and start playing. They don’t have to worry about preparing surfaces, making pitches, wearing special uniforms or buying any expensive equipment – it’s all ready for them. What the cricket administrators need to do is make cricket just as readily available as the other sports and distractions.

He also raises questions about lack of domestic cricket etc but I think most important is the one that people do not play cricket at all.

Then DL says not all is lost and there is a lot of hope:

I think you have to be radical. Infrastructure is always important, you need top administrators, it needs to be an attractive game, it needs to be accessible and yes, you certainly need icons for the youngsters to emulate. I am miles away from what goes on in West Indies cricket but I do know of a man who is passionate about West Indies cricket called Mr. [Allen]Stanford – and he has the money. I think if the administrators and the ex-players could put forward a plan from the West Indies Cricket Board stating where they are looking to be in 5 or 10 years time and present that to Mr. Stanford and say, ‘please, help us out,’ he may just get involved; because from what I can see he is really passionate about West Indies cricket ….

Who is Alen Stanford? He is the chairman of a Financial Services Powerhouse called Stanford Group. He is immensely interested as MH also points out but has been goven a cold shoulder from WI cricket board.

So the basic issue is you need to develop more interest towards cricket amongst local population. Why doesn’t that happen? Two things, one other sports have better facilities and two higher incentives present at other sports.

Now, both are equally important. In India for instance, cricket is hugely popular but because of poor infrastructure that cannot identify right players becomes a problem. How do you reconcile the fact that Chiarman of Selection committee says there is not enough talent and on the other side there are young players who are committing suicides for not getting a chance?

For better facilities you need more finance (Finance is important) and this Mr. Stanford can provide and then the incentives have to be altered so that the public becomes interested and the game becomes popular. And in teh meantime other institutional changes like having a better board, more local cricket etc need to be brought about.

For Mr. Stanford WI cricket is like a distressed asset but has immense potential. So like a private equity player he would go about making changes in the entire structure and clean up the slate and eventually make a gain.

It is akin to a growth and development problem which economists face and have to tackle with most of the time.

Assorted Links

June 21, 2007

1.  TK Arun in ET says we should not worry about Rupee getting stronger. His summary is:

The short point is that a stronger rupee right now would help the economy consume and invest more and to enhance Indian ownership of assets in India and abroad.

I don’t really agree to his viewpoint. Firstly, we do not really know what is the right level of rupee. As India has current a/c deficit, the rupee should depreciate but because of capital flows the new effect is appreciation of the rupee. This means worsening of the deficit as imports become cheaper. And then we have RBI intervention which is done in an opaque manner and it is only of Friday we come to know how much RBI intrevened in the markets. More clarity is needed.

2. Super economics blog from WSJ. Thanks to Marginal Revolution for the pointer.

3. Mutual Funds business is a mess. SEBI Chairman says the growth is mostly in liquid funds and that too from corporates. It is hightime something is done about the Mutual Fund business- lot of schemes by one AMC with similar objectives, mostly used by corporates, high expenses, no idea about number of individual investors etc are some very important issues which have to be answered.

4. SEBI takes out a consultative paper for listing and trading securitised paper. Here is ET’s view . Here is the paper. I am a bit confused after reading ET’s view. SEBI should do something about its website.

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