Patience in Affliction

There are certain weaknesses in which I have difficultly showing patience. One of these is when people show a very low pain or physical distraction threshold. I had a colleague once walk in from outside to an important working session. He had been rained on. By his attitude you would think that either he was allergic to water (he was not) or it was raining acid (it was not). He excused himself for over 30 minutes because he had been rained on.

At another point, a very important deal preparation session with a large team as well as an external legal team. A mandated fire drill then occurred in the building. The law firm politely had their office excused because of the "essential nature of their business." (I do not buy that either, but we were the beneficiaries.) However, during this fire drill the building's air conditioning had been turned off. The temperature rose to just over 80 F (28 C). It's a slightly uncomfortable temperature, but one of my colleagues who was heading the deal brought up the temperature of the room about every 30 seconds for the next 20 minutes. Nearly nothing moved forward.

When I see this, I question the passion and interest of those who exhibit this behavior. When the situation is important and time is of the essence, I am not that concerned that your sweat glands turned on.

Important caveat: Now, because I did not have much of a choice, I've to put up with the elements, rain, snow, sun, heat, and cold, for many years of my life. Accordingly, I am probably not the most fair judge of this behavior. Glass houses and such.

Currency Swings in Brazil

In a recent conversation with a non-Brazilian colleague concerning strategy in Brazil she said, "Yeah, the Brazilian Real has weakened a lot, but that's just temporary. Exports will increase and it will stabilize." Because we had to move on to another topic, I did not have the opportunity to explain why I think that viewpoint is incorrect, especially for Brazil.

Take the macro equation: Trade Deficit = Capital Inflow. To balance out that equation, the exchange rate must adjust. For example, too much capital outflow coupled with a trade deficit or weak surplus causes a currency to weaken.

However, there is a big lesson to note in these situations: "Cash runs faster than boats." When people decide to pull their capital out of a country, it's a pretty quick process. The best example of this was Thailand and the 1997 financial crisis. Cash flees, but the advantage in exports takes months if not years to shake out. Also, the initial negative abrupt adjustments can delay the advantages in exports. With this backdrop, let's look at Brazil. Since the facts below are non-controversial, I'll be linking minimally.

First, the economy is doing poorly. Real GDP is about zero.
Second, 6-8% inflation has a direct weakening effect on the currency.
Third, Brazil is/was relatively expensive. Even basic commodities were comparable in cost to some of the most expensive cities / countries in the world.
Fourth, Brazil has pretty stringent capital controls for both inflow and outflow. If money decides to leave, it probably won't be coming back soon, as those involved probably had to bite a big bullet to get it out of the country.
Fifth, and this is the primary point of the rest of this post, even though cash is faster than boats, in Brazil cash is far far faster than boats.

I once had an extended and very interesting conversation with a banker who works in Brazil's import/export area. He explained that the ports were essentially all "effectively" operating at 100% capacity, and the amount of excessive demand would determine the number of day wait and/or peak pricing. For example, during the soy spike (and various other commidity spikes) in 2012, agriculture was trying to export everything possible. However, the net effect was a drastic increase in rail freight costs, shipping costs, and trucking costs. Essentially, little made it through, and what did make it through had it's economic rent extracted primarily by the distributors. Afterward, to avoid a "someone once told me," I poked around a bit more on Brazil's ports. The best article I could find in English also hit on the same points as the banker.

- Bureaucracy: "Every ship that arrives in the country waits at least 5.5 days to have the goods delivered by agencies such as IRS, the National Sanitary Surveillance Agency, the Ministry of Agriculture and the Docks. The world average is three days."
- Logistics: The physical ports in and of themselves are okay. However, the rail system is abysmal and access by road is limited. "The logistical problems of access are evident, the bottleneck of access from the cargo container terminals generate unproductive periods, which are highly detrimental to the foreign trade and financial activity of Brazil. It is a fact that the rail network and roads in the vicinity of the ports are insufficient."
- Union issues: not only are there occasional strikes, but many workers are only present during business hours on non-holidays. "In Brazil, the organs responsible for clearance of goods run only during business hours. It is the only country among the world's major economies which does not have these services available 24 hours."

Perhaps the Brazilian Real will rebound significantly, but it's difficult to foresee that happening over the medium-term.

Gates Foundation - Initiatives for the Future

A few last comments (for now) on the future.

The Gates Foundation annual letter is out and focuses on four developments that they both foresee and are pushing in the developing world.
1) Infant Mortality - Five simple steps to drastically improve infant mortality.
2) Africa Agricultural Productivity - Agricultural productivity by region of the world over the last 100 years is fascinating. Africa has lagged far far behind in these agricultural developments. This problem is more complex than infant mortality because best practices change according to both climate and infrastructure.
3) Mobile Banking - Discussed here previously.
4) Electronic Learning - Discussed here previously. The potential impact combined with mobile developments is interesting to note.

Antibiotics and Desalinization

In a previous series I pointed out two potential critical turning points in our potential future. The first was antibiotics (downside risk), and the second was low-cost desalinization (upside potential). In the past few months there have been breakthroughs in each of these areas. Although the breakthroughs could be considered "small," these smaller breakthroughs are necessary steps to reach the eureka breakthrough moment.

Antibiotic breakthrough: Multiple target binding bacteria as well as a novel method to efficiently test many many more antibiotics. My long run bet on humanity just might be shorter than I anticipated.

Desalinization continues to push forward. Graphene had already been established in prior studies and experiments, primarily from Lockheed. However, one primary challenge has been to develop a method to efficiently clean the filters. This appears to be a change in concepts for filter cleaning which can be further improved upon.

I want to reiterate the importance of desalinization in a slightly different way. There are a lot of young marginally employed males living in areas facing water scarcity because these regions are arid and have poor water management. As water shortage becomes an ever more serious issue to those living in these areas, these young men could become a local destabilizing force, and consequently become these regions can export this instability throughout the world.

Imagine an environment with a severe water shortage and no job prospects. Your short-sighted government and their cronies wasted it all and, for some reason you don't understand, the government is not able to get more of it. The gut reaction for many (most?) is to throw these pernicious and evil officials out by any means possible, especially once the photos leak of lavish parties and swimming pools behind those 50 foot walls of theirs.

Hubris and Statistics

I recently finished a fascinating Econtalk podcast with Joshua Angrist dealing with different methods in Econometrics and how slowly we have gained knowledge in the field over time. The podcast had me reflecting on four of my statistics-related experiences. All are examples of hubris or folly (primarily mine) in the use of statistics.
Disclaimer: My work is not this disgraceful all the time. I label these "learning experiences" for a reason.

1) Econometrics Competition - This might surprise most of the people who know me, but I once won an econometrics competition. Each candidate needed to submit a model together with the theoretical reasoning to justify along with their data. The product we were dealing with was somewhat of a signalling/luxury good, so my model included an exponential component as well as an attempt at instrumental variables. I somehow won. However, when actually applying the model later in the real world, it was simply mediocre and no better than many of the other submissions. Getting the good job sticker sadly did not enhance my ability to predict the future.

2) Predicting tax revenue - In college I worked on a predictive tax revenue model for a nearby municipality. The municipality needed to decide a budget in August of the preceding year, but it was still unaware of what tax revenue, primarily sales revenue, would be for the next year. My team and I were able to create a very strong predictive model. There was just one problem. Our largest errors from prediction were quarters in the two final years, 2001 and 2002. There was this invention called the internet, and online sales started to heavily impact municipal sales tax revenue. The model still performed decently, but the world is not a statistical distribution with 11 fixed primary variables that were true for the last 15 years and will be true for the next 15 years. The world is a complex place, and what makes it complex is not just the randomness and noise, but also the unprecedented. This same lesson applied to the airball in AAA rated mortgage-backed securities five years later.

3) Inverted demand curves - Another project I once worked on dealt with perishable goods that actively changed prices. I was assigned to come up with a type of elasticity and competitive response framework, but I was only provided the company's pricing data. After about 20 hours of fiddling, I discovered that the demand curve was inverted. The more the price was raised, the more quantity sold increased. I discovered the ever elusive Giffen good! I wasn't quite that naïve, but I didn't take the time to structure my thoughts and the request before diving in. Then the realization came, "Of course. We raise prices in anticipation of higher volume." This isn't randomized data that they created for this test. They just want after-the-fact justifications. Also, without competitive data and other critical pieces of information that drive sales, even a randomized experiment would likely lead to incorrect results, as the pricing effects would likely be overwhelmed by the noise of holidays, competitive price changes, weather, advertising, etc. I wasted time with a comically obvious error because I was "thinking fast" before I was "thinking slow." Just because one's task is thinking doesn't mean one is being thoughtful.

4) Willful Ignorance - I was performing a project for a company that was to be acquired. During this work I discovered that the revenue from the existing customer base was on a downward trajectory and the rate of new customer acquisition was obviously slowing (very negative second derivative) in every existing market in which the company participated. The company was making up for this revenue by incrementally adding a few medium-sized markets periodically to the mix, but with every round these new markets were less and less favorable for the company. I took this analysis with some statistical tools and presented it to some senior management members. I was immediately shut down with explanations like, "well, there's no seasonality control here" and other explanations that did not hold any water whatsoever. Shortly thereafter I was reassigned and then pushed out. It wasn't until after that I had realized the obvious, "They were selling the company, you nincompoop. Of course they don't want to provide ammunition to their buyers."

Statistics is a tool. Outside of a laboratory, and even sometimes within a laboratory, it's a very imperfect tool, and sometimes an irrelevant tool. The future is complex and filled with new challenges and people with their own agendas. If you don't stop and look around once in a while, you could miss it.

Government Defaults - Why is Japan Not Bankrupt?

In the previous post the fundamentals of government defaults were examined. Given the fundamentals, how is Japan not bankrupt? The debt level is over 2x GDP and there is no end of deficits in sight. Why isn't there a run on the Yen today?* One approach is look at the Japanese situation under the national accounting formula (see twin deficit theory), propensity to pay, and ability to monetize.
1) According to the national accounting formula, Budget deficit = Savings + Trade Deficit - Investment. Japanese savings rates are high, have not shown to decrease significantly despite an aging demographic, and the residents tend to keep their cash within the country. Japanese households not only save, but they save in Yen. There have been signs that high savings have recently begun to slacken.
2) Because of deflationary trends over the last twenty years, the Japanese government has been able to monetize its current debt through the central bank. The central bank has expanded its balance sheet significantly.
3) The Japanese government has been able to monetize its current debt from investors through negative real rates. Simply put, over the last eighteen months Japanese bonds have paid less than the inflation rate. This is similar to having someone pay you for the opportunity to lend you money.
4) The Japanese governments have shown political will to pay. There aren't rumors flying about minority parties saying that they will simply default.

That keeps things limping along. However, according to the fundamentals, Japan has no good options left. Escaping the present problem is not because of a fault of courage or competence, and it is not driven by government corruption. It is not like the movie "Dave," where if those in charge can just put their heads together and put special interests aside they can find the solution and come up with the money. Defining "survival" as "not defaulting, technically or otherwise," the historical survival rate for countries in similar situations is zero. The Japanese miracle would be navigating the next ten years without default. What are some potential options?
- Productivity improvements, which necessitates upending many aspects of the social and labor structure. This was supposed to be the "third arrow" of Abenomics (reforms named after the Prime Minister) but it is politically difficult and has yet to make its appearance. Mark as doubtful.
- Population growth, which necessitates either having more children or importing immigrants preferably at least a medium skilled or high potential. Incentivizing people to have more children is very difficult, and concerning immigration, those that are more familiar with the political conditions in Japan tell me this is a complete non-starter. Mark as doubtful.
- Narrow or zero out the current deficits, then thread the needle between nominal interest rates, inflation, and GDP growth. This is theoretically possible, especially because of the prefecture system. It is similar to the United States in that the federal government runs deficits and transfers money to smaller government sub-entities. The Japanese national government can dramatically lower the transfers to prefectures and run at least primary surpluses (revenue minus spending excluding interesting payments). Mark as possible.
- Monetize - Central bank threads the needle between hyperinflation and hitting the print key and gobbling up the debt. This is already occurring, as the central bank's balance sheet has nearly doubled over the last two years, but it will prove ever more difficult to implement.
- Asset/liability balancing - The Japanese government has a huge relative amount of assets on its balance sheet compared to other countries. If these assets are only tapped at critical junctures to navigate this process, it might be just enough lifeline to pull through.

It is a very difficult situation, and I would put even odds on a technical default in some form in the next ten years.

*For the sake of both simplicity and the fact that there are others leagues more knowledgeable than I, I won't delve into the complex banking/government financing structure and its corresponding risks

Government Defaults - Why is Venezuela Bankrupt?

Japan's debt to GDP is over 200%, while Venezuela's is around 50%. Why is it that Venezuela is in the middle of a cash crisis but Japan is not yet? A few facts on the Venezuelan economy:

- Accuracy: Exact numbers on debt, GDP, and inflation do not have high confidence. Negative impact.

- Debt to GDP: Estimates of debt to GDP put it around 50%-65%. This can be positive (low) or negative (high) depending on the other factors.

- Propensity: The government has defaulted five times in the last twenty-five years. Negative impact.

- Collateral: Overseas seizable assets. Positive impact.

- Budget deficit: Venezuela's budget deficit zeroes out only when oil is above $117.

- National Account Theory: Budget Deficit = Savings + Trade Deficit - Investment. Savings are low in a high inflation environment. Investments have been historically low as well. In order to run a trade deficit, a capital inflow is needed.

- Oil: Oil has accounted for 96% of its export revenue, and the price of oil has dropped by nearly half over the last year. Negative impact.

- Cutting spending: There are a few options, many of which have historically led to coups and unrest. Negative impact.

On net, this is why Venezuela's government is in dire straits. There are some holding out, believing that the upside is there, but the consensus is heavily in the default camp barring a dramatic increase in oil prices in the near-term.