EconIssues - Patrick A McNutt

Drifting into a debt-recession trap

Patrick McNutt — Thu, 14 Feb 2013 16:36:01 +0000

The despondency that has attached itself to the financial crisis is ‘taking shadows from the reality of things’. Dante would not approve. Europe is drifting into a prolonged recession as policy-makers worry about inflationary expectations and competitive devaluations. Households hope to be delivered from this agonizing crisis. Are there solutions? The following is a grand narrative of policy options, contingent on a managed exchange rate regime, an idea first aired in the Letters to Editor page of the Financial Times in 2009. G20 has not acted. They meet in Mexico – maybe recent Yen, RMB, Euro, Sterling, Swiss Franc and US Dollar movements may persuade them to look at the role of exchange rate fluctuations ‘midst this financial crisis as Europe drifts into a debt-recession trap.

Drifting into a recession

There is a palpable sense of despair and hopelessness, a lack of demand yet inflationary expectations have become embedded in the policy-maker’s crystal ball. The real economy of households and companies is shrinking in a vacuous cycle of intermittent growth as rising bond prices and lower yields improve the real economy of the investor. Banks, the exogenous factor in the policy-makers’ macro-economic models, still fail to understand that job creation, time-to-build technologies and innovations require a flow of credit. Personal balance sheets are moving into safe harbours, given the wealth destruction that has occurred in the property and equity markets and will continue for the foreseeable future. Anybody who can is saving, more are spending less. Welcome to the debt-recession trap.

Household balance sheets

Recovery must be centred on the household balance sheet; however, household budget patterns are unpredictable. Current decisions depend on expectations of what future policies will be. This is a conditioned response for households in a debt-recession trap. The mismatch between policy-maker and reality creates a short period – a phenomenon that households imagine if they change demand and spend more the other households will neither keep demand unchanged (so all increase demand and prices go up) nor continue to keep their behaviour unchanged (so bargains become available to the first mover) if they alter their behaviour. How each household responds depends on how each believes the other will respond. The result is demand is less, output is less and the recession is prolonged.

In the interim, households have adjustment costs – no interest income from government bonds, no dividend income from company-issued equities and minimal after-tax spend so unlike in the macro-economic models of our Central Banks, households are not seeking to maximise the concave single-period utility function subject to a budget constraint wherein the present value of consumption equals the present value of disposable income. Savings, for example, in a debt-recession trap signal to policy-makers that rational householders are experiencing low levels of expenditure in the present period due to the short-period phenomenon thus reducing the marginal utility of expenditure in future periods. So there should be a greater willingness to spend when the personal balance sheet are restructured.

Policy prescription: reduce income taxation to increase after-tax spend

QE and the US Dollar

During the Great Depression banks restructured their balance sheets; reduced loans in absolute and relative terms and invested (mainly) in government bonds. Isn’t this happening today? The ECB/Bundesbank believes that purchasing government bonds is tantamount to monetising government debt, thus leading to high inflation or a loss to the ECB on a government default. Paradoxically pre-crisis banks were turning government bonds from across the Euro zone into cash at the ECB, as governments borrowed and the banks relied on short-term funding. So really, all Central Banks – the Fed, BoE, BoJ and even ‘the outright monetary transactions’ policy at the ECB/Bundesbank facilitate the buying of government bonds – so why the mystery?

The Fed signals less worry about inflation through QE and the printing of money. Lowering interest rates may be devaluing the dollar but it is facilitating increased US export competitiveness. Central Banks that want to support their currencies are willing to increase interest rates. The Fed does not. The US dollar has been captured by Fed announcements. It is widely accepted that QE has contributed to a weak US dollar.

Exchange rates

When Timothy Geithner described China as ‘a currency manipulator’ in 2009 the exchange rate became politicised. More recently, Jens Weidmann, President of the Bundesbank, expressed concern about Central Banks’ efforts to revive exports by facilitating competitive devaluations. Did he have the Fed in mind? Music to the ears of Brazilian Finance Minister Guido Mantega, who first signalled the ‘currency wars’ in 2010 as Brazil worried about an overvalued real. Its current account deficit is now contributing to a reduction in its economic growth. And the new PM of Japan, Mr Abe has had an impact on the Yen’s exchange rate pushing it from 78 per US dollar to 89 as he asked the Bank of Japan to double its inflation target to 2% – and to buy government bonds until that target is met.

Policy prescription: looser monetary policy and higher inflation targets

China and the Yuan/RMB

Elsewhere www.patrickmcnutt.com/wp-content/uploads/ChinaRMB.doc we had argued that Yuan appreciation will not and cannot solve the Sino-US trade imbalance. China in time, will, we had argued then, move to a more flexible exchange rate regime but at its own pace. It could occur during the 12^th Five-Year-Plan 2011-2015 as economic growth in China becomes less reliant on export-led growth. By 2015 China trade and FDI flows will have moved away from US and Europe and more towards what we had described as the ASLEEP economies www.patrickmcnutt.com/video/cnbc-financial-crisis-interview/. We agree with Professor Subramanian at the Peterson Institute for International Economics that the RMB could displace the US dollar as the leading reserve currency in the next decade. Trading nations and TNCs are already diversifying into RMB – being able to trade in RMB reduces transaction costs and mitigates currency risks for exporters. Liquidity from China could relieve any inflationary pressures in trading economies.

Solution Template

Many trading nations are considering a looser monetary policy combined with a higher inflation target – it presents an optimal policy and an escape hatch in a debt-recession trap. An inflationary bias in the conduct of monetary policy might be optimal if inflation shocks can lead to (welfare enhancing) increases in output. Albeit, any comparative statics exercise emanating from policy-makers’ models should be interpreted with great caution. A looser monetary policy could drive their respective currencies lower but any hope of sustained growth will be frustrated by a beggar-my-neighbour policy of competitive devaluations in the race to win the greater share of increased exports.

As previously outlined, http://www.ft.com/intl/cms/s/0/bb726952-6b57-11de-861d-00144feabdc0.html#axzz2KtE2NBLz a period of managed exchange rates may be required under the auspices of G7, and ultimately G20. Europe, specifically, and the G20 trading nations more generally, need to manage their monetary and fiscal policies within a managed exchange rate regime in order to escape the debt-recession trap.

Policy prescription: managed exchange rate regime to align world currency fluctuations.

Rational households and companies may have ‘parked’ demand and production, delayed in the anticipation of an inflationary period with looser monetary policy and competitive devaluations. If their expectations were managed within a managed exchange rate regime then there could be some hope that the real economy may improve as the worlds’ trading nations together plan an exit from the financial crisis. ENDS/PatrickMcNutt

Masterclass

Administrator — Sat, 24 Nov 2012 20:14:20 +0000

MasterclassUSA.docx
DecisionTree2012.pdf

Fiscal cliff and Kantian equilibrium

Patrick McNutt — Fri, 16 Nov 2012 16:40:31 +0000

The fiscal cliff is the Nash Equilibrium [NE]..it is the best the Democrats can do given the reaction of the Republicans; they will debate big ticket items on spending asnd taxes but both know that neitherparty wants to go there - but it will happen if there is no compromise, according to game theory. The NE is often best understood as a ‘trap’ to avoid, but you can only avoid it, if there is compromise, and we can only compromise if I trust you and you trust me! The ethical dimension to this can be found in the answer to ‘who will compromise first’, that is, fulfil duty and take responsibility to find a Kantian equilibrium; the Kantian sequence could be observed….Move A: I move first, then you follow: Move B: you move next and then I follow..Move C: we both observe each other as ‘taking responsibility’…How either party moves in the sequence and thus ‘fulfils duty’ depends on what each party believes the other will do…you might just be about to read these signals in the US.

Spin-0 for Apple in a French defence: from iPod to iNext or acquire a telco?

Patrick McNutt — Fri, 16 Nov 2012 13:33:38 +0000

In our previous Blog entries, on the smartphone and tablet market, we referred to the market as a game, G. In G a new phenomenon has occurred, created by a convergence of technology coupled with rational consumers asking: is the iPhone5 = a mini iPad or is the new iPad mini = iPhone6? This line of questioning, we believe, translates the Apple products into a scalar (spin-0) with no strategic direction. A scalar product, if you recall from physics, only needs a numerical value, and is not attached to a direction. Where is Apple going? Earlier this year, IDC Research reported that Apple’s share of the global market for tablets fell sharply in 2012 from 65% to 50%.

Strategists therefore need to ask the entropy question: do gains necessarily accrue to Samsung, Amazon and Asus or are rational consumers simply waiting or delaying buying Apple devices? To find an answer, we posit that Apple products and non-Apple products may share common features and functionalities but they do not overlap, thus creating lines of adjacent vertices in an evolving market share game. Furthermore, Apple may have the greatest App store in the game but as it continues to rotate through iPod, iPhone and iPad to iNext, spherical competitors from anywhere at any time to will enter the game and win. Rational consumers delaying a purchase and the convergence in rival technologies facilitate competition, and by Q4 2011 Google powered devices began to close in on Apple’s dominance. More recently, Microsoft’s Surface, the Google-Samsung Nexus 10 running on the latest Jelly Bean software, the Amazon Kindle Fire HD and the Asus-Google Nexus 7 have emerged as formidable competitors in the game.

What if the XBox music internet service has the potential to impact on iTunes? Investors are not clueless about the technology convergence nor are they aloof to the need for an optimal strategic response from Apple. With a cash balance that is equivalent to a quarter of its CAPM, investors will want more investment. They may ask: why not acquire a telco? The iPhone5 can indeed promise 4G technology, albeit not everyone, who has an iPhone 5, nor anyone anywhere in the world, who is thinking about buying an iPhone 5, will be able to avail of 4G. There is no point really in offering rational consumers a new fountain pen without the ink! As rival competitors continue to enter the game G, the family of competitors grows and new features and functionalities create entropy and adjacent vertices that will limit Apple’s progress unless they join the family. For example, today in November 2012, Apple is not a key player in social media, digital mobile advertising, OLED Smart-TV, nor is it dominant in cloud computing, NFC and mobile e-wallet payments. They could be in time, many investors hope that they will – sometimes this is not how it works.

Apple can fail: who remembers the Newton in the 1990s? Or the more recent befuddled roll-out its mapping service? The more we observe G the more convinced we are than it mirrors a game of chess. But is it a game of French defence where it will be challenging for Apple (White) to hold on to the centre as opponent’s attack its Queen (iOS) quickly and swiftly, faster than any counterattack from Apple. Maybe Apple should stop defending its pawn line of iPod-iPhone-iPad? Acquire a telco. In chess language, Black is out to attack the pawn line. What is Apple’s optimal sequence of moves? Is the ecosystem a sub-game of Alekhine defence by Google (Black) or Android alliance (Black), allowing its King’s Knight (Android) to be positioned across the board so as to weaken White’s centre pawns? We will take up these issues in next Blog entry – our continued recommendation for Apple is to play not to lose rather than play to win.

i-Lag or Byte of the Apple

Patrick McNutt — Thu, 27 Sep 2012 16:55:47 +0000

The smartphone has evolved from new gadget to just another gadget – it has become commoditized. The Razr i will indeed allow you to switch quickly between the web, play games, send texts and take photos. Will iOS 6 disappoint as consumers realize that it begins to slow down your iPad2 and is backward incompatible with the new generation iPod touch? A case of i-lag will emerge as random consumers begin to ask: why upgrade to iPhone5? Why queue? Why buy Apple product? The convergence of technology will trump the key players as spherical competitors from anywhere at any time enter the game. Google’s Motorola has now unveiled its first smartphone with Razr i, a social media and mobile advertising market game began without Apple, SmartTV technology resides with LG and Samsung, and the new spherical competitors in smartphones are likely to be the Chinese players, Huawei and ZTE. Forget the device; the game has evolved from a game of competing ecosystems, OS v Android and 4G technologies to one of consumer expectations. Rational consumers have no idea what they want, but whatever it is, they want it now. So expectations are dangerously high, matching them with low prices may be an optimal response. Judicious pricing policies will facilitate a winning strategy. We have argued before in this Blog for a nano-iPhone – a strategy to compete on price against the impending challenge from Huawei in the US. Launching a nano is a dominant strategy for Apple Inc because its payoff in the smartphone game will be (i) always at least as much as that of iPhone5 [whatever Samsung or Huawei do] and, (ii) at least some of the time actually better in the evolving game of commoditized smartphones.

Refer back to Blog entry: Simon en-cycling to SMIN!

Refer back to early Blog entries: The Brontosaurus paradox

Economic Damage & Spoiled Markets

Patrick McNutt — Sun, 16 Sep 2012 11:53:27 +0000

Markets are spoiled when policymakers place greater worth on the value of a penny saved than on a pound spent on doing something. Consumers prefer to save instead of spend, as each fears to spoil the chance of getting a better price later. With a declining demand at a time of positive technology expectations, economic damage embeds itself into the spoiled markets, as the experience of buying and selling in bad times influence future behaviour and the damage will occur and recur in a pattern of lifecycle debt and deflation. G20 policymakers could endorse global policies that borrow more of the future and spend in the present. The economic damage today is in government cutbacks, indebtedness, redundancies, job losses and credit restrictions. Although technology and innovation cycles are visible across many products and services, although we are in an information business cycle, any expectant boost to world growth has been muted by the debt of economic damage. Banks had had converted a simple banking exchange of deposits and lending into a complex debt instrument exchange system – complex betting on the probability that a no income, no job or assets (NINJA) loan recipient would repay. They have spoiled banking, they have lost credibility as their profits continue to be privatised, and their debts socialised. The recent initiatives from ECB and the Fed represent a pan-QE3 frontal attack on a stubborn world economy that is stumbling into an era of deflation and economic damage. The QE3 is a positive signal, it has a chance of success, but more has to be done now.

Greek crisis is a sub-game

Patrick McNutt — Thu, 17 May 2012 10:58:27 +0000

Europe is in the long game of a United States of Europe and the Greek crisis is one sub-game in the time continuum, but the sub-game to watch in order to define a Nash Equilibrium is a Euro currency crisis…such a crisis has not happended although the Euro at May 2012 is devaluing against Sterling and US dollar. I had made a similar point in an interview on Bloomberg London last May 2012 [available on my webpage]. A Euro currency crisis will dictate the elements of a final solution [whether Greece departs from the Eurozone]…a devaluing Euro now plays to Germany’s strengthens as an exporter……so we need to look at the Euro as a currency, its stability, its continued credibility as an international currency; if it continues to devalue and risks the United States of Europe then we could observe IMF and G20 exchange intervention [check the Yen crisis in 2011] so it is the Euro currency signals to observe as a critical pattern in order to find an equilibrium and thus comment on the present…For the moment the Euro currency is stable in a devaluing mode, the Greek crisis is a sub-game, of secondary importance to the primacy of the Euro and United States of Europe.

Simon en-cycling to SMIN!

Patrick McNutt — Wed, 25 Apr 2012 12:31:13 +0000

In less than 10 years the smartphone game has eclipsed its humble beginnings of combining a PDA with a phone. The App-ing Generation T who communicate and share across technologies can have an ice cream sandwich in their operating system or a mountain lion or faster graphics performance with ivy. Poorer consumers across the developing world simply want a phone to curve with messaging and FM radio and a 2 mega pixel camera. But do you remember where you were in 1992 when we witnessed the planting of the seed of the smartphone tree with the inaugural launch of the IBM Simon? Do you care? How many remember the first smartphone, the Ericsson GS88 with the open OS Symbian? That was 1997. By the time it had re-launched in 2000 as R380, the Palm Kyocera 6035 enabled you to phone a friend from your PDA contact list. So cool! How many remember the Palm Kyocera 6035? That was 2001. In 2012 Generation T eagerly await the global launch of Apple iPhone5 and the Samsung Galaxy S3. Analysts are reporting that Apple and Samsung could account for 30% of volume and 52% of sales in the global smartphone game. The game is less about the device or product – it is more about the ecosystem, the operating system in the game of smartphones. We are observing a battle of OS standards through the lens of a convergence in technology that will end the game because time available to the key players, young and old, from Apple to Samsung, from MS to Nokia, from HTC to Sony Ericsson to RIM, to make a decision is diminishing in time itself. In others words the game is en-cycling to an end point as spherical competitors from anywhere at any time are entering the game: the Nokia-MS alliance with Lumia platforms powered by Win8 and supported by Intel and AT&T, MS-Facebook alliance to challenge Google in social media and in search with a new search engine, a possible MS-Nokia-RIM-Dell alliance, emergence of Huawei and ZTE, of China Mobile and Data Wind. Who? The game started with Simon in 1992 and will end with the must-have small and thin, SMIN, the outcome that Generation T, the customer, wants rather than the device that produces it. Think on to 2022 and the Blog reader asks: who was Apple? But who is SMIN? Ref back to early Blog entries: The Brontosaurus paradox

Presentation at Google London HQ

Administrator — Thu, 19 Apr 2012 20:05:44 +0000

Comment:
My presentation at Google London HQ April 18 2012, introducing patterns and
observational learning, looking at soccer pattern, rational behaviour,
Google, Nokia, Sony, MS and discussing future of search, smartphones and a
convergence of technology.

predict the future by observing the past says game theorist

nano iPhone now or lose the game!

Patrick McNutt — Fri, 06 Apr 2012 11:36:56 +0000

It could be time in the smartphone game for a nano iPhone from Apple Inc as spherical competitors, ie from anywhere at anytime enter the game,…with Huawei and Qualcomm new chip spec in low cost low price with multi-functionality and the emergent DataWind in India with the $35 phone and promised $100 tablet……already we see the convergence of technology at Samsung Galaxy with the telephony function in the tablet….whither?….the iPad converges to the iPhone or the iPhone converges to the iPad….the SMIN [introduced in Game Embedded Strategy] is launched like a pheonix rising from the ashes and it may not be with Apple Inc!..game on..so launch the nano iPhione now or risk losing the smartphone market-as-a-game….patrick