Category: Economics

Categories
Economics

[2408] Market inefficiency and rating agencies

And so, S&P has decided to cut US debt rating, essentially stripping the T-Bills of its risk-free status from S&P’s perspective.[1] This is likely to trigger other agencies to follow suit. Theoretically, this has wide implication because risk-free asset is an important basis in asset pricing.

Although the cut is expected, I am maybe dissatisfied at the wide influence of rating agencies. Yields of the debt were relatively low before the cut despite everything that we know. What will make me positively dissatisfied is if yields increase after the cut. We will have to wait for Monday for that.

In that case, increase in yields after the announcement of the cut will feel artificial. It will feel inefficient in terms of information dispersion.

It will be dissatisfying because market players will mainly react to the cut rather than directly to the financial health of the issuers.

Perhaps through some kind of procedure or programming demanding risk-free status, the downgrade by S&P may trigger a rush out of the bonds (to where is a harder question to answer). If the S&P did not issue a downgrade, yields will probably be low still. So, the implementation of the rule that funds have to hold the highest rated debts rated by these agencies divorces its outcome from what an ideal free market outcome.

I would think a more efficient approach would see market players responding to the quality of the bonds even before S&P’s announcement. Yields should have gone up before the announcement. This has happened in some way as reported by the article at the New York Times, but not with the speed that I think is identifiable to efficient market in terms of information.

One could say that S&P is part of the market. One could say that S&P reacted to the health of the issuers and market participants only reacted accordingly by trusting S&P as the arbitrator of ratings, never mind the credibility of S&P and other rating agencies after the subprime crisis. S&P with its specialized skills helps distribute the relevant information as efficient as it can.

But the ideal outcome will not rely on just S&P, or any one rating agency. There are thousands if not millions of players out there. An efficient market would preempt any decision by these rating agencies: after all, the information these agencies rely on are very public information. Yields should have gone down earlier before the announcement.

If yields rise on Monday, that may suggest that rating agencies have too much power to decide on behalf of the market, a market which is more diverse than a couple of rating agencies. It will also suggest that the market is inefficient. To put it more clearly, an efficient market would have these agencies lag behind market sentiment, not the other way round.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

[1] — WASHINGTON — Standard & Poor’s removed the United States government from its list of risk-free borrowers for the first time on Friday night, a downgrade that is freighted with symbolic significance but carries few clear financial implications. [Binyamin Appelbaum. Eric Dash S.& P. Cuts U.S. Debt Rating for First Time. Wall Street Journal. August 5 2011]

Categories
Economics

[2406] Better food stamp and the wider context

The Malaysian government may introduce what seems to be a non-tradable food stamp program to combat high food prices. The goal behind it is noble. While that is so, it must be noted there are at least two ways to improve the outcome of the program. Moreover, the issue of high food prices should be assessed more holistically.

First, tradable food stamp will likely improve recipients’ welfare more than mere non-tradable arrangement can. Tradability will widen the recipients’ choice set and give them the opportunity to smooth their consumption. Furthermore, they may not always require subsidized food. Tradable stamps will allow the recipients to exchange the stamp for other items of need or even cash. Such exchange tradable stamps will widen the welfare-improving effect of the program by implicitly covering those who are not explicitly covered by the program. Whatever the price of sale of the stamp, it is will be lower than the face value of the stamp for otherwise, the stamp will be worthless. This essentially means the uncovered purchasers of the stamps will also be subsidized.

Second and perhaps the natural expansion of the first option is a direct cash transfer. From public finance perspective, this is likely to be the most efficient solution within the restrictive goal of enhancing the welfare of specific group of individuals.

Regardless of the costs and benefits of food stamp, high food prices in general is a wider issue. The wider context is important.

One context is the fuel versus food debate. Government policy on biofuel may have inflationary effect on food prices. As reported by Reuters in March 2010, the biofuel policy was supposed to start in June 2011.

The other more pressing context is monopoly of foodstuffs in Malaysia. Exclusive monopoly and quota granted to specific entities on various foodstuffs cause the very problem that the food stamp program aims address.

There are plenty more examples demonstrating contradictory and convoluted government policy.

Perhaps the problem of high food prices is better addressed by undoing unproductive government interventions in the food market. These interventions benefit only specific parties instead of the wider public. Without these interventions and with a little bit of luck, the rationale for food stamps might disappear. More importantly, public welfare can be improved without spending too much public money.

Categories
Economics

[2405] The end of the world? Not today, Galvatron

Now that we are staring at the possible end of the world — or rather, the possibility of the US defaulting on its payment — I am an optimist (hey, the yield rates are still low. That gotta mean something). In any case, a default would likely be temporary. Never mind that the US can still prioritize its payments to prevent default by suspending some relatively non-essential government operations.

Even if it would be more serious like the one in Greece, I have made my position known: the market can live without government bonds. The short run would be ugly. But in the long run, we will be fine.

Categories
Economics

[2403] The world has gone crazy

“…Treasuries have become a form of insurance against their own downgrade.” [Chris Reese. Bonds climb with safety buying as stocks dip. Reuters. July 26 2011]

Categories
Conflict & disaster Economics Liberty

[2402] The cost to the Beijing development model

The rapid and successful economic development of China so far has been presented as the superiority of central planning over the approach taken, for example, by India. It is the Beijing development model as some would say. Authoritarian top-down approach gets things done, unlike the messy democratic means from the bottom up. All those criticisms weigh things down needlessly.

The recent high-speed train disaster that killed nearly 40 persons[1] should give advocates of the authoritarian approach a considerable pause the next time they try to sell the Beijing model over democratic ones. Reports are coming out that these infrastructure projects were rushed for the 90th anniversary of the Communist Party.[2] Results do not look good for the Chinese government.

The Beijing way of doing things has become controversial, especially after the accident.

How much of infrastructure projects all around China suffer from abuse of power or corruption in general? Was the accident a symptom of a rotten system?

Between authoritarian and democratic states, the former lacks real mechanism to make the state accountable. It will be hard to answer the questions even in democratic states, much less in ones like China’s.

Typical of authoritarian governments, the Chinese government is trying to muzzle investigations into the incident.[3] This is amid angry allegations of corruption with respect to these projects and specifically, the high-speed train system. That is an example how there is little accountability in China. Any reprimand is for public show only. Such reprimands have proven to be inconsequential. In Malaysian parlance, small fish.

Even before the train disaster, the system was already suffering from service interruptions, barely weeks after its official opening. Something must be wrong when so many glitches happened so frequently so soon.

Something is rotten in the state of China. That rottenness is the cost of the authoritarian model. There is a cost to absence of check and balance, of accountability, of freedom. It is a shame somebody has to die to learn that.

While India suffered from embarrassing criticisms before and during the last Commonwealth Games due to perhaps their incompetence in meeting deadlines, at least we knew the problems before it was too late. Remedies were taken. For China, there is a guessing game: which one is the facade and which one is real. As the train disaster showed, we found out about the rotten apples way too late.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

[1] — BEIJING—The first high-speed train passed through the tracks where a deadly train collision occurred in eastern China, as authorities sought to soothe public concern over safety and the handling of the accident as well as jitters about the future of its prized high-speed rail system. [Norihiko Shirouzu. Beijing Seeks to Soothe Train Jitters. Wall Street Journal. July 26 2011]

[2] — China’s high-speed rail line between Beijing and Shanghai has been beset by glitches in the two weeks since it opened to great fanfare on the eve of the Chinese Communist Party’s 90th anniversary celebration. [David Pierson. China’s high-speed rail glitches: Racing to make errors?. Los Angeles Times. July 16 2011]

[3] — BEIJING — China has banned local journalists from investigating the cause of a deadly high-speed train crash that has triggered public outrage and raised questions over safety, reports said Tuesday. [Allison Jackson. China seeks to muzzle reporting on train crash. AFP. July 26 2011]