This is what I found interesting from the current issue of the “The Economist” (July 24^th - July 30^th 2010).

Preface:

Concept change. To change is to evolve. This issue has an article on change – ‘Agent of change’ – clearly, bandage policy responses to the global economic crises is not evolutionary. For instance, to tinker with Fannie Mae and Freddie Mac is non – attempt to change the basics. On page 61 of the issue, some new concepts are discussed - “dynamic stochastic general equilibrium” (DSGE) and “agent-based models” – seismologists may not be very precise on movement of tectonic plates. But they do map the stress patterns. “Why not do the same with economy?” More important than the models discussed is going to the base - Dis-equilibrium of real resources (provided by earth). To sustain the growth and well-being of a billion inhabitants, real resources is the only capital available to mankind.

1. “Unnecessary evils”

2. “The two firms, which own or guarantee more than half of the country’s $10.7 trillion of mortgages, are awash in red ink.”

3. “More than nine in every ten new mortgages written in America during the first quarter of 2010 were government-backed.”

Page 11 – “Unnecessary evils”

4. “They were “making money on the back of the unhappiness of the people”, lamented Michel Barnier, the European commissioner for the single market. The crisis was blamed on wolf-pack markets (Anders Borg, Sweden’s finance minister), cynical hedge funds, cocky credit-ratings agencies, neoconservative capitalism.”

5. “Fully 29% of Spaniards and Italians, and 43% of the French, told a global poll last October that free-market capitalism was “fatally flawed”. Only 13% of Americans shared that view.”

Page 44 – “Europe’s dark secret”

6. “Banks’ bad debts are shrinking but so too are revenues.”

7. “The good news is that loan losses are easing. At JPMorgan Chase second-quarter charge-offs (of loans viewed as beyond repair) fell by 28% compared with the previous quarter, for instance. That allowed the banks to release some of the reserves set aside to cover dud loans. However, this will provide only a temporary pop to earnings.”

8. “Big banks, both over the previous quarter and year on year. One factor was subdued capital-markets activity, caused by Europe’s debt crisis and the stockmarket “flash crash” in May. At all firms, trading revenues were down sharply from the strong prior quarter. Goldman Sachs’s fell by 36%. Its recent $550m settlement with the Securities and Exchange Commission also dragged down its results.”

9. “Slack lending, thanks to both lack of demand and tighter underwriting, could prove a more persistent problem. Consumer credit has been falling since mid-2008 as households try to cut their debts.”

10. “Bank of America put the possible hit to its profits from new rules on current-account, debit-card and credit-card fees at $4 billion (it also took a one-off accounting charge of up to $10 billion). Lenders also face a possible tax on liabilities.”

Page 58 -59 – “When the chips are down”

11. “Nowadays the price of gold is set by the market rather than by official diktat. When explaining shifts in the bullion market people tend to think in terms of supply and demand. Perhaps, however, they should view gold-price movements in terms of investors’ confidence in the dollar, and in paper money in general.”

12. “After gold was set loose in 1973 its price rose at a rapid rate for the rest of the decade, peaking at $850 an ounce in 1980. In other words the dollar had lost around 90% of its value since the demise of Bretton Woods. The 1970s was a period when economic policy in the developed world seemed to be in disarray, with inflation and unemployment high, and confidence in central bankers low.”

13. “From 1982 onwards developed economies seemed to enter the “great moderation”: inflation was low or falling, and recessions were rare and mild. The authorities developed the knack of delivering stability with paper money, thanks to independent central banks committed to a low inflation target. Gold fell from $850 to $253 by 1999. With confidence in economic policy restored, the dollar was revalued by 236% over almost two decades.”

14. “Maestro”, Bob Woodward’s portrait of Alan Greenspan, came out in 2000. The dotcom and housing bubbles led to a reappraisal of Mr Greenspan’s career. Many commentators now feel he paid too little attention to credit growth and asset prices. As Charles Dumas of Lombard Street Research tartly remarks, Mr Greenspan displayed “asymmetric ignorance”. He claimed not to know when asset prices were in a bubble but he did always claim to know when falling asset prices were likely to cause havoc. Investors were given a one-way bet.”

15. “When push comes to shove the latter duty seems to outweigh the former, and the bankers turn on the monetary taps. The result has been a loss of confidence in the dollar. Gold’s rise since 1999 in effect means a near-80% devaluation of the dollar over the past decade.”

16. “One reason why countries tried so hard to maintain the gold standard and the Bretton Woods system was to reassure creditors that they would be repaid in sound money. Since 1971 most countries have had the right to repay creditors in money they could print at will. The likes of America and Britain are now perceived as “lucky” because they, unlike Greece, can devalue their currencies and default in real terms.”

17. “America and Britain are paying only 3-3.5% to borrow for ten years. That may be because deflation seems the more immediate threat. It may be because bond markets are now dominated by other central banks, which are more interested in managing exchange rates than in raising returns. But it is not stable to combine low yields, high deficits and governments that are happy to see their currencies depreciate. Something has to give.”

Page 59 – “Losing confidence”

18. “What really sets Metro Bank apart is its state-of-the-art IT system. New customers will be able to get their account, chequebook, debit and credit cards within 15 minutes, and all the data for each customer will be kept in one place.”

19. “That puts Metro Bank in an enviable position. IT at many other Western banks is often a hotch-potch of homemade systems.

20. “That is good news for start-ups such as Metro Bank, which wants to open more than 200 branches in Britain by 2020. With such grand designs, isn’t Vernon Hill, one of the bank’s founders, tempted to build an IT system of his own? “I hate programmers,” replies this dyed-in-the-wool entrepreneur. “They only cause trouble.”

Page 60 – “Computer says no”

21. “A hearing of the House of Representatives Committee of Science and Technology on July 20th targeted the “dynamic stochastic general equilibrium” (DSGE) models used by the Federal Reserve and other central banks. The hearing aimed to “question the wisdom of relying for national economic policy on a single, specific model when alternatives are available.” The Institute for New Economic Thinking in New York, which had its inaugural conference in April, has attacked many of the assumptions, including efficient financial markets and rational expectations, on which these models are predicated. These assumptions were clearly too simplistic. But there is less agreement on what should replace the old ways.”

22. “Agent-based modelling does not assume that the economy can achieve a settled equilibrium. No order or design is imposed on the economy from the top down.”

23. “Although DSGE models are also based on microeconomic foundations, they accept the traditional view that there exists some ideal equilibrium towards which all prices are drawn.”

24. “ABMs, in contrast, make no assumptions about the existence of efficient markets or general equilibrium. The markets that they generate are more like a turbulent river or the weather system, subject to constant storms and seizures of all sizes.”

25. “At the workshop Andrew Lo of the Massachusetts Institute of Technology presented a model of the American housing market, inspired by ABM approaches, which showed how a fateful conjunction of rising house prices, falling interest rates and easy access to refinancing created an awesome burden of debt. John Geanakoplos of Yale University explained how the debt cycle in remortgaging—high amounts of leverage during booms, low amounts during recessions—can act like an out-of-control pendulum to create instability.”

26. “Seismologists may not be able to forecast earthquakes precisely but it would be deplorable if they were to resign themselves to modelling just the regular, gradual movements of tectonic plates. Instead they have developed ways of mapping the evolution of stress patterns, identifying areas at risk and refining heuristics for hazard assessment. Why not do the same for the economy?”

Page 61 – “Agents of change”