April 2-8, Finance and Economics: A Treat for Aussie readers, the "lottery-liquidity tradeoff", the Germans get the ECB to raise rates, why you should buy land in Spain, Operation Twist : QE Episode I, - and more!

Well, it was bound to happen sooner or later, and evidently, it has happened sooner: the fates have intervened and hidden my March 26 issue, so we've had to skip ahead to the current issue, April 2-8. I know what you're thinking - it will be like skipping a chapter in a book - last week's episode was such a cliff hanger, we may never know what happened! I have no idea what went down in Portugal, and I may never know. Kind of sad. On the bright side, we won't have to feel that nagging feeling like we're behind all of the time. So here we go. This week's issue is kind of a hard one - lots of unfamiliar themes, a number of inferences made on a solid comprehension of macroeconomic principles and relationships (well beyond my own current understanding) and some kind of dry writing if we're being candid. In this week's economist:

• An examination of Australia's economy - with an exciting promise for more articles of the same kind as part of a series on "economies that exemplify global trends". I'm shaking with anticipation.
• Butonwood reviews a book on investment strategies, but really writes a very confusing article about volatility and liquidity in investor behavior.
• The editors chastise the European Central Bank for what will probably be a raise in the policy rate on April 7.
• A follow up on Spain's banks, but really an article about the huge tracts of land in Spain backing 320 billion Euros in loans. (A little Monty Python reference there for you.)
• A pretty interesting story about  how JFK attempted a variation on quantitative easing in 1961 through debt term restructuring, the effects of which are still being debated.
• A real snoozer about a settlement with holders of Lehman "mini-bonds" in Hong Kong
• A short one - my favorite - about the departure from Berkshire Hathaway of David Sokol, long rumored to be the heir-apparent to Warren Buffet.

But first, in honor of the start of baseball season and the statistics it will bring with it:


This Week's Fun Economic Facts:

• According to the Reserve Bank of Australia, five years ago, a shipload of iron ore bought the equivalent of 2200 flat screen TV's in Australia in terms of relative import/export costs - now it buys 22,000!
• Australia's jobless rate is only 5% and falling - and Australians save 9.7% of their disposable income
• The German economy out-performed the rest of the Euro area, with a GDP rise of 3.6% compared with everybody else's 1.7%. (Had to get a good German fact in there, right?)
• Spanish banks are currently exposed via loans to 100 billion Euros worth of empty plots of land.
• $589 billion: amount the U.S. Treasury has issued in long term bonds (debt)
• $514 billion: amount the U.S. Federal Reserve has bought in Treasury-issued bonds.
• 87%:  514 billion as a proportion of 589 billion - for those keeping score at home.

All of this, and extra innings, after the jump.


Everybody Needs Good Neighbors: I can hardly contain my excitement - this article about Australia is the first of a promised series on economies that exemplify global trends. This piece is sort of like a prospectus on Australia - and if you're Australian, things are looking pretty good. Seems like the only things to complain about are the constraints on growth imposed by an incredibly high employment rate, a hyper-competitive currency, and the possibility of a budget surplus that nobody knows what to do with.  We start with favorable trends along Australia's export competitiveness which has delivered Australia from a much less promising stage in 2004. As noted above in the description of Flat-Screen TVs and Iron Ore, in the past seven years or so, the price of Australia's exports have improved in comparison with the price of imports by 42%. Driving the demand for Australia's iron ore and its soda ash crystals (seriously) is the rapid growth of chief trade partners China and India. The Australian Reserve Bank is keen to note that once the central banks in those countries raise interest rates to curb inflation, as is likely, imports will become more expensive and the relative advantage will deteriorate some - but it looks like there is lots of room for balancing. On the other side of the economics curve is Australia's production of goods and services. The article uses one of my favorite terms, Dutch Disease to describe the possibility of a situation in which Australia's shift to production of high-in-demand commodities like coal will boost domestic prices and further strengthen the Australian dollar and hurt manufacturing export competitiveness. In fact, the Australian dollar already is too strong for its own good - an Australian dollar currently buys $1.033. However, the strength of the currency, along with current moves to raise the interest rate notes the article, is good for curbing inflation in a hot economy despite the immediate impact on manufacturing and construction. Next, on to the labor situation - which is good news for the  most part if you're Australian - you probably have a job. Australia's jobless rate is only 5% and supposed to fall further. But along with new immigration regulations, which curbed immigration by 36% in 2010, there are limits to how much Australian firms will be able to grow just based on a lack of skilled labor - (so that to me means I should start looking for a job in Australia - they can compete for me and I'll take the highest bidder.) Next is commentary on the possible impact of saving on exports - the argument is that if Australia finds ways to spend rather than spend the fruits of its growth, it can further reduce inflation and create more competitive exchange rate. Evidently the Australians are already not doing too shabby here - households save 9.7% of their disposable income, and the government will be running a surplus in the fiscal year from 2012-2013 (from the current  4.4 percent deficit). Some speculate that Australia should put its money in a sovereign wealth fund. Another alternative to create a more favorable exchange rate of course is tariffs and trade barriers like subsidies, but Australia, like the good free-market citizen it is, seems reluctant to do so - and probably would prefer to avoid a trade war with China.  Instead, firms are encouraged to become more innovative and efficient. There's a novel concept.


Buttonwood: Liquidity and lottery tickets:  Here's another article I had to read a few times to understand and that I think you can skip. Antti Ilmanen, a hedge-fund manager, has written a book called "Expected Returns: An Investors Guide to Harvesting Market Rewards" (which I will not be buying) which outlines some of the reasons that markets don't always work the way they should according to the models, e.g. when investors invest in more volatile instruments such as 30 year T-bills which offer lower term returns or overpaying for shares in growing companies. These behaviors are explained by a kind of lottery ticket model, in which the investor looks to get a larger return on their investment even though it's not a likely scenario. But investors also like liquidity - the ability to sell assets easily, and that's why the perfect tradeoff is the longer term treasury bond, but only up to  2 years term maturities, after which the rate of return evens out. The liquidity and lottery preference can be seen, according to Buttonwood in what is called "carry trade", in which investors borrow money in a low-yield currency, such as Yen, and invest in higher yielding currency, such as the Australian dollar. Evidently, despite its deceptively simple scheme - so simple it shouldn't work - carry trade as given investors constant returns. There are risks and rewards. The risks include a case in which the borrowed currency goes belly up, like happened in Iceland, or that the funding currency rises sharply as a result of a financial crisis or panic. I really don't understand this article or why it is supposed to be enlightening, and we'll leave it at that.

Trigger Happy: Despite the fact that Euro-zone inflation has just about stayed close to the target rate "just below 2%", especially if only measuring by core inflation (without energy and food prices), it looks like the European Central Bank is going to get out in front and raise the policy rate to 1.25% (from 1%). Other than just being out of sync with the low core inflation rate, the Economist argues that the move is premature and probably not a great idea for other reasons as well, essentially challenging one by one the ECB's justification for doing so. Once again, the editors note that the "knock-off effects" of inflation (i.e. a spike in wages, etc) is a lower risk during times of higher unemployment, not to mention that  wages have only risen 1.4% over the year in the Euro area- i.e. below inflation. Furthermore, the rapid and promising growth in business in the first few months of 2011 follows a second half of 2010 in which GDP only rose by .3% per quarter. Monetary policy reasons offer little reason for the rate rise either, with M2 (money supply, remember?) rising only 2% in the year up to February. The article suggests that perhaps the ECB is trying to stay disciplined and retain its hard-ass credentials after buying up lots of messy Greek, Irish, and Portuguese debt. And of course politics are at play too - Jean-Claude Trichet, the head of the ECB, is due to stand down in October, and the successor, likely to be the Italian Mario Draghi, will need to hew closely to the German perspective on things because of the influence of Angela Merkel on the choice of Trichet's successor. The problem of course, is that the rate rise will not likely affect Germany too terribly - but the Spanish, Greeks, and Irish will get hit in their soft underbelly on mortgage rates and household borrowers. The Economist uses a great Greek myth reference, likening the addition of higher rates to the austerity programs in the troubled countries as piling Pelion on Ossa.  Robert Graves would be happy.

Hard Landing: Think the American housing crisis was bad? Wait til you get a load of Spain's land problem. Evidently, land was the big ticket commodity during the last decade in the run up to the Spanish crisis. As a result of liberally-issued zoning licenses and building permits, a full quarter of the 320 billion euros in loans to Spain's developers is backed by land assets according to Goldman Sachs. Of the 70 billion in assets owned by Spanish banks, about half is made up of land, and the writers speculate that Spanish banks, all in all, are exposed to about $100 billion in empty land plots. Complicating things is that there are also about 1.5 million unsold homes in Spain, which of course need to be absorbed if the land acreage is going to be profitably developed, and estimates suggest that the total capacity on the land is about 2.7 million homes. The lesson: get a job in Australia, and a house in Spain.

Twisted Thinking: We've been talking (and writing) much about Quantitative Easing lately, but evidently, a variation on this theme was played out during the Kennedy administration, and given the moniker "operation Twist" named after the Chubby Checkers hit. (Let's hope this isn't the last time we get to use Chubby Checkers in this blog!) Instead of the modern version, in which the Treasury issues debt, and the Fed buys it, Kennedy figured that the Treasury could collude with the Fed, and the Treasury sold short term bonds (rather than the modern sale of long term bonds) and then bought long term bonds, the idea being to "twist" the yield curve and restructure the debt. Evidently, many if not most economists have dubbed Twist a big fat failure, noting that yields weren't really impacted, but an upstart economist, Eric Swanson, suggests that most studies of the policy didn't correctly isolate the impact of Twist from other countervailing variables. His own study suggests that the impact was a lowering of  15 basis points of the yield, which would have been a very good thing for the debt. The idea, contends the article - and this seems like a leap to me - is that the Treasury could actually conduct Quantitative Easing in a different way than issuing lots of long term debt, simply by issuing fewer rather than more bonds and thereby driving up the price. But at risk of course is that short-term interest rates could spike which the Fed is trying to avoid (right?)


The good inside the bad: A recent settlement in Hong Kong for investors in "mini-bonds" bilked out of their investments by the collapse of Lehman, seems to imply that like little Cadbury's eggs, the securities actually had some value hidden inside. These mini-bonds are complicated in structure - basically collateralized debt obligations issued outside of Lehman. So, when regulators went after assets to pay out the investors in a settlement on the offer of about 60% of the investment, they found out that the assets weren't as worthless as once thought, and now it looks like the investors might recover as much as 96.5% of their investment.

Unexpected Loss: This one made me think of the movie Wall Street for some reason. One of the primary contenders to take over Berkshire Hathaway, now valued at 211 billion (with a B) in market capital, David Sokol, abruptly resigned amidst the possibility that his trading in millions of dollars of stocks of Lubrizol prior to Berkshire's acquisition of the chemical firm was perhaps improper. Although he didn't have the call on whether or not Berkshire bought the company, he did make the recommendation to the current octogenarian head of Berkshire, the estimable Warren Buffet. Something tells me he'll have a pretty soft landing.

Random Musings: Well, that was somewhat painful, and I'm still wistful for missing a review of the last week's issue. I'm getting this out tonight late because I was actually playing tennis and working on other projects today. On the former, despite an emotional and close win in two long sets (7-6, 7-5), I have realized I am no longer the spring chicken I once was on the court, and my back is killing me. But my serve is unhittable when it goes in, which is unfortunately rare. It's also opening week for baseball, and I sat with frozen feet drinking cold beer at Nats Stadium on Thursday. Up until today's terrible collapse by the bullpen and the weirdest balk I have ever seen, I would have said I was optimistic for the season - at least there's 159 games to go. Finally, I caught the Arena Stage production of "Who's Afraid of Virginia Woolf" on Friday night, which was spectacular and highly recommended. I raise it because I have been getting a lot of flack for going by myself, which I don't quite understand - it's half as expensive and I don't have to talk to anybody about the play afterward (a grossly overrated activity, along with the same thing vis-à-vis movies.) So, enjoy the week and the coming of spring.