The Stalwart

Forget the Fed Funds Rate

Interesting stuff from Dr. John Rutledge:

Monetary policy is a lot more than the Fed funds rate. What matters is whether the network of bank and non-bank lenders to businesses that make up the country's credit markets are functioning or not. As the chart below shows, business loans are growing like crazy.

That's important because credit markets don't work like the textbooks and macro models would have you believe. In the textbooks, investors compare the interest rate with projected returns on projects. Raising rates causes them to trim marginal projects, investment spending falls and output contracts.

The real world is not like that. In 30 years of investing and owning companies, I have never seen an investment project accepted or turned down because Fed funds rates were 1% higher or lower. But I have seen plenty of projects cancelled and businesses shrunk because the credit markets imploded. It is the availability of loans, not the posted interest rate, that matters.

Monetary policy has its principal impacts on the economy not by moving the economy from one equilibrium point to the next, like in the textbooks, but by causing sudden, discontinuous changes, or "blackouts", in credit availability.

The credit market is a communications network, no different from an electricity grid. Normally, credit markets function well. But, from time to time, a policy disturbance causes the network to "black out." During these times, the credit market is far away from equilibrium and recorded prices (interest rates) are not a good metric for incremental borrowing costs.

I have little to add to this, but it's worth reading the whole thing.

Update: For more unorthodox economic thinking about interest rates, check out this old Marginal Revolution post about economist Fischer Black, of Black Scholes fame:

Fischer Black is one of the great finance minds of the twentieth century.  (Here is my recent post on the new Fischer Black biography, which you must buy.) So why did both Milton Friedman and Bob Solow scorn him as a macroeconomist?  Well, Fischer pushed two (actually more) controversial claims.  First, the Fed cannot influence real or nominal variables, unless traders allow it to.  Second, business cycles are caused by mismatches of tastes and production plans. 

If both of these were correct, Black would be the greatest macroeconomist of the century.  Today we will consider the first claim...

Black's economic thought is centered around the view that all profit opportunities will be exploited.  So what happens if the central bank decides to add zeros to the accounts held at the Fed?

Here is the standard account. In Black's view banks were already holding all the dollars they wished to.  One reaction is for banks to borrow less money at the discount window, or perhaps borrow less from each other.  Money will leave the system as quickly as it entered.  Another reaction is simply for banks to sit on the new money.  Prices will not go up.  Alternatively, it could be argued that an indifference relation holds, and whatever people expect to happen will happen.  Multiple equilibria obtain. Prices might go up, fall, or stay constant.  Monetarism is then true only if people expect it to be true.

The Predictive Power of Markets

It's not often you can say this, but the stock market actually acted intelligently yesterday in the face of Hurricane Katrina.  By sometime around 10:00 am, yesterday, the S&P was shockingly positive (where it remained) even as New Orleans was getting slammed and oil was spiking above 70.  Well, surprise surprise, armageddon didn't occur.  Sure there was a lot of damage, estimates are around $25 Billion, but by yesterday evening, reporters were broadcasting live from Rue Bourbon, amazed that all the old bars and restaurants, and touristy Jazz cafes were intact.  The markets guessed that the media was likely to be mistaken in calling this storm "Biblical".

As for oil, Exxon Mobil (NYSE: XOM) announced that their refining operations had resumed by late monday.  Valero Energy (NYSE: VLO) says it'll take 1-2 weeks to resume operations.  That's not too bad.

Even the insurance companies, which spiked down hard monday morning were resilient, finishing up, or around flat on the day.  Whatever one-time losses they will deal with here may be cancelled out due to increased pricing power.  New found pricing strength for insurance would be a boon to the struggling insurance brokers, and it'll be interesting to watch them in the time ahead.

At it's best, the stock market is a strong leading indicator, which is how it behaved yesterday.  The oil market on the other hand, looks to be increasingly affected by speculators and in-and-out traders who have made oil look like another tech-stock.

Well that post was woefully premature.

Oil Map of Katrina

For those keeping score at home, here's a map of the oil assets that were in the path of Katrina and and how much production they are responsible for:
(found via calculated risk)

Apple, A Scent of Mystery

last week, we discussed how Google (NASD: GOOG) took advantage of being mysterious.  Any tech related project you can think of, someone's speculating that Google's got a category-killer under warps.  Well, this should have been part of the same entry, but the same can certainly be said for Apple (NASD: AAPL).  In fact, it seems that there's a whole industry based on speculating what Jobs & Co. are gonna announce next.  Jobs' regular keynotes, at which he always announces something new help fan these rumor flames. 

The new date is September 7th where Jobs will either announce, finally,  iTunes phone, produced by Motorola, or announce a new music video related service.  So for the next 9 or 10 days, the guessing game is on.

Opposite Problems

Most Japanese Reluctant to Borrow:

"I pay for everything in cash," says Shu Nagaye, a 23-year-old student, as he meticulously scrubs both his paper money and coins -- 11,720 yen, worth roughly $105 -- all placed carefully in a woven basket.

"When I don't have money, I control myself and don't buy anything."

Like most Japanese, Nagaye despises being in debt. And unlike most Americans, he assiduously avoids it at all costs.

And on the opposite side of the world...

Plastic Surgery Financing:

Plastic  Surgery Financing offers loans for all cosmetic, plastic, dental, laser, gastric bypass and infertility surgery. You may use any doctor of your choice. You are under no obligation or  incur any cost by applying for surgery financing. Please email us with any financing questions or comments you may have about  our site.

Perhaps, just perhaps Japanese banks, could look overseas to find lending opportunities.

Mobile Banking in Africa

Experts in international development like to talk about technological leapfrogging, the phenomenon of developing countries to skip over certain technologies (like land-line phones) and go straight to mobile.  Last week talked about the fact that Africa is the fastest growing mobile market in the world, and whether it was investible.  Well, Africa may be on the verge of leapfrogging another outmoded technology--physical currency.  The Christian Science Monitor reports that Africa's cellphone boom is creating a base for e-banking.  Awesome:

JOHANNESBURG, SOUTH AFRICA – With the new technology, a grandmother in rural area can receive money from her son, working hundreds of miles away, with the beep of her cellphone. A teenager can buy groceries with a few punches of keys. Not a coin need change hands.

Cellphones are already used for music downloads, text messaging, and video games. But here in South Africa, they are beginning to perform another function: personal piggy bank.

 

It's a high-tech solution designed to help poor people here who never have had access to banks, cash machines, or credit cards. And it's another example of using digital technology to fast forward development in remote areas.

Earlier this month, one of South Africa's main cellphone networks and one if its largest banks launched a new cellphone banking system that they hope will bring millions of poor South Africans into the official economy for the first time. The venture hopes to build on the rapid spread of pre-paid cellphones to create a whole new banking system, one designed for low-income users that have long been under-served or ignored by traditional banks.

"There's a large number of individuals who are unable to access banking services because conventional banking is expensive, relative to their income. And physically we don't have banking facilities in remote areas," says Herman Singh, director of technology engineering at Standard Bank, which has partnered with cellphone company MTN Group on the project. The goal, he says, was to create a form of banking "that would be very easy to register for, and that we could run at a low cost."

Asking a question like "Now when will we be able to do that here?" seems almost silly.

Droppin' Rhymes, Droppin' Products

Back in May we brought you the story South Korean pop-Idol Lee Hyo Lee who was paid by Samsung to cleverly sing lyrics that helped promote new products. We were quite amused and speculated that dropping product names could become a real skill.  Well, good news, it's coming here:

Corporations want consumers to assume that rappers name-dropping hamburgers, cell phones or cars wrote the brands into their lyrics because they love them not because they were paid, said William Chipps, senior editor with IEG Sponsorship Report.

"It has to be organic," Chipps said. "It can't be blatant."

"Organic" is subjective. Robert "T-Mo" Barnett, a member of the once widely popular Atlanta rap group Goodie Mob, is working with Maven on a deal to promote a brand. Maven gave him the name of the product, and he wrote it into the lyrics of the single he is planning to release this year. T-Mo's contract with the company has not yet been signed, and Maven would not identify the brand. How much the company pays him for mentioning the brand depends on the radio popularity of the single.

T-Mo was in the studio recently and laid down the song, which he is calling "What's Happening."

"I was vibing," the rapper said. "It just came natural. I heard a good beat, and I just flowed with it. It was nothing I had to really force.

"I am helping them brand their company and at the same time they are helping me," he said. "I got a brand new baby boy, and I'm trying to feed him right now. I want to be smart about every move I make so I can maximize my earnings."

This seems to us a good move for both the entertainment industry and for the artists.  After all, rappers have been mentioning name brands in their music for a long time...this is essentially free advertising.  It's time they got back some of that money they were brining in for these companies.

Apple Looking Vulnerable

Apple Computer (NASD: AAPL) sits a couple of points away from an all time high.  They're growing fast, and they've got a lot of cash in the bank.  The company is over-loved by consumers and the media.  It all works out to good times for Apple Shareholders

But sentiment may be getting ready to turn.  The company recently lost an admittedly small case related to iPod battery replacement that'll cost them a few mil.  Financially it's no big deal, but why did they let themselves get into a lawsuit with their customers?

More importantly, serious tensions are emerging between the company and the record lables over their iTunes music store:

Two and a half years after the music business lined up behind the chief executive of  Apple, Steven P. Jobs, and hailed him and his iTunes music service for breathing life into music sales, the industry's allegiance to Mr. Jobs has eroded sharply.

Mr. Jobs is now girding for a showdown with at least two of the four major record companies over the price of songs on the iTunes service.

If he loses, the one-price model that iTunes has adopted - 99 cents to download any song - could be replaced with a more complex structure that prices songs by popularity. A hot new single, for example, could sell for $1.49, while a golden oldie could go for substantially less than 99 cents.

Music executives who support Mr. Jobs say the higher prices could backfire, sending iTunes' customers in search of songs on free, unauthorized file-swapping networks.

It's not even the price so much (I suspect) that keeps people using iTunes, but the safety and simplicity.  A commplex pricing structure would be terrible for the user experience, and could definitely push consumers back into the dark world of p2p.

Also disturbing is a growing chorus of consumers irritated with Apple products  (includng yours truly, but mainly since I can't run any of Google's neat software on them, and my Mozilla software freezes a lot).  Yesterday Om Malik announced he was switching back to the Panther Operating system from the newer-released Tiger.  A good friend has been in a battle with the company over a faulty iPod that has really soured her on the company.

So how does this disparate series of anecdotes affect AAPL?  Because at these valuations, so much of it depends on sentiment.  Any sign that that is being chipped away it, could cause investors to scurry.

Storm Fallacy Watch!

As New Orleans rebuilds from the aftermath of Hurricane Katrina, you're bound to see headlines about how the storm could be an economic boon to the region as construction induces hiring and spending.  I hope that Stalwart readers would be sophisticated enough not to buy into such faulty reasoning, but if you need a refresher on the so called "broken-window fallacy" you can read up, here.

The Economy, Two Years From Now

If you look in our different categories, you'll find that the Oil, Asia, and Real Estate categories have gotten well more than their fair share of posts.  Our Apparel and Europe categories have gotten far less attention, which perhaps reflects the failings of this blog.  We're not contrarian enough that we can't stop talking about the same stuff that everyone else is talking about.  At least we've been skeptical of the unabated rise in these two asset classes.  In both cases we've been flat wrong early; and in the area of Real Estate, our stance was the exact same held by such esteemed financial publications as Time & Newsweek (it hurts to be both wrong and in the mainstream). To be fair, this digital fishwrap is only around 5 months old, and it's free, so it's not like we owe anyone too much. 

But what will be the big categories 2 years from now, or six months?  If we're still posting about Oil shattering records then our economy will almost certainly have ground to a halt.  If homes are still reaching new highs, that means everyone will be a millionaire from Manhattan to the Quad Cities. 

But somehow that doesn't seem likely.  That's not to say it's impossible, but not many stories persist that long.  Everybody can't become a millionaire, and economies don't generally grind to the ground.

Perhaps, the busiest categories from now haven't even been created yet.  (I'm trying to think of an example right now, but I'm drawing a blank, it's hard to predict the future).  Maybe it'll be Radio, Aviation, printing, or Organized Labor.  But there are new stories all the time, and the dominant themes of the economy do change.  At any moment, there are those who declare that we've entered a "new period" and that we'll never go back to the way things were.  That may be true, but more importantly, nothing ever stays the way things are, at least not for too long.