The Big Picture

Abenomics – Mission Impossible?
Who Gets the Biggest Tax Breaks?
The Future of the Web is Video
Why Do You Want To Be A Hedge Fund Investor?
10 Weekend Reads
Seth MacFarlane’s Harvard Class Day Speech 2006
At Least One Reason Why People Shouldn’t Hate QE

Posted: 02 Jun 2013 02:00 AM PDT

June 1st, 2013

ABENOMICS – MISSION IMPOSSIBLE?

It's very simple. They (the Bank of Japan) can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy.

-Milton Friedman, advice first given to the Bank of Japan in 2000

No recovery without structural reform

-Former Japanese Prime Minister Junichiro Koizumi

Japan's unfolding recovery is real because firms have finally stopped paying down debt, and have begun to borrow again for the first time in more than a decade.

-Richard C. Koo, The Holy Grail of Macroeconomics: Lessons from Japan's Great Recession, 2011

Abenomics Equals Monetary Confusion

You can't destroy your currency, prop up your stock market, set an inflation target more than 2 percent above the negative level where it is now and expect your bond market to remain stable all at the same time. Especially when your gross general government debt/GDP is on the order of 240 percent of GDP. But that's what the new economic policy of Japanese Prime Minister Shinzo Abe with its aggressive quantitative easing and fiscal stimulus is trying to do. The markets are rendering their thumbs down verdict as I write. Or perhaps the verdict is simply "confused."

The trashing of the yen via quantitative easing and an expansive fiscal policy is quite correctly viewed by Asian competitors like South Korea as a "beggar thy neighbor" policy. Of course, the US isn't going to complain since the US is following its own quantitative easing approach. The Japanese stock market at first reacted positively. As legendary GM boss Charlie Wilson might have said, what's good for Toyota must be good for the nation. But now the stock market is having second thoughts. In my view cheapening the exchange rate to give exporters an edge is the wrong kind of structural "reform."

Japanese Government Bonds (JGBs) have taken it on the chin since the introduction of Abenomics . JGB yields, though still low by world standards, have doubled since the Abe program was announced. Given the government's debt burden, the introduction of a massive quantitative easing program and the promotion of currency weakness constitute "playing with fire" by the Abe government. Remember that Japan, as aging society with a declining population, faces a tsunami of old age payments in the coming years.

Quantitative easing, with Milton Friedman one of its enthusiasts, has been tried in Japan particularly over 2005-6. The general conclusion had been, at least until Shinzo Abe resurfaced as prime minister, that QE didn't do much. So why now?

The Japanese Balance Sheet Recession – Is It Finally Over?

Economic historians will in my opinion classify the work of Richard Koo, Chief Economist at Nomura Research, as one of the more perceptive analyses of the Japanese economic funk starting in 1990. Koo's work, which by the way is consistent with conclusions reached by Gary Shilling and Kenneth Rogoff and Carmen Reinhart, concludes that Japan has suffered from a "balance sheet recession." Japanese stock and real estate prices were products of an enormous bubble that peaked in 1990. The resultant horrendous asset deflation, totaling three years' worth of GDP according to Koo, rendered Japanese corporations and individuals deeply insolvent. Since 1990 Japanese corporations have not been maximizing profit but rather minimizing what were high debt loads. Japanese corporations and consumers have been net savers in this circumstance and quantitative easing was a completely useless exercise. In a separate point which economists might debate, Koo believes the high level of government borrowing substituted for the greatly weakened consumer and corporate demand and prevented Japan from entering a catastrophic depression.

But nothing lasts forever including balance sheet recessions. In his 2011 book Koo refers to Japan's "unfolding recovery" and seems to suggest that the Japanese debt minimization process and the balance sheet recession may have been near its end. It's now 2013 and 23 years since 1990 and two more years since Koo wrote this. If the economy is coming back on its own, why the need for more stimulus now?

Japan – the Land of (Recent) Bad Luck

The Japanese economy in recent years has been subjected to a number of exogenous shocks, that with one exception are not the fault of its government and cannot be offset by monetary and fiscal easing. These events should not be intellectually conflated with the balance sheet recession. Remember Japan is an export economy very much dependent on events in the rest of the world. If the rest of the world is in recession or something close to it, this is a negative for Japan not under its control. Here's a list of recent exogenous shocks to the Japanese economy:

The US led Great Global Recession of 2008 and the so-so US recovery.
The recession of the Eurozone.
The earthquake and tsunami of 2011 with its wake of destruction.
The post tsunami shutdown of Japan's nuclear industry.
The diplomatic tiff with its number one customer China over some tiny islands.
The slowdown in the Chinese economy.

It should be kept in mind that Japan's unemployment rate is only 4.1 percent. Its rate of GDP/capita growth, after allowing for deflation and the decline in population, in recent years might even be superior to that of the US. Anyone visiting Japan does not see a country mired in poverty or civil unrest.

Had Japan experienced a more favorable external environment and assuming the balance sheet recession is largely behind it, would not real GDP/capita growth of the last two years have been stronger? So why the panic stimulus program?

Come to think of it. Is Japanese deflation a natural product of declining population and ever increasing global technological productivity?

Structural Reform Is What is Now Needed

Japan can be characterized as an advanced but stagnant society with a huge demographic problem. It would be easy to simply dismiss the Japanese government debt situation as hopeless and simply assume that its legion of retirees and its bondholders (ultimately the same people) will eventually get defaulted on in one way or the other by the Japanese government. In some ways Sony is a symbol of this stagnant Japan. Once the Apple of its day, the electronics part of Sony at least seems to have lost its way in the rigidities of Japanese labor practices and lack of originality.

But hopeless may be too strong. What could save Japan is growth. Koo argues that massive government borrowing is what saved Japan from economic catastrophe. Fine. But the borrowing cannot go on forever. Faster growth will be needed. Japan's population is hard working and highly educated. Technology is accelerating globally. But it is those corporations and entities which are fully subjected to the discipline of global competition and openness which benefit most from technology's acceleration. Can the protectionist, rigid, government directed Japanese economy – sometimes classified as an example of the East Asian Economic Model –be reformed?

The so called "third arrow" of Mr. Abe's economic policy is structural reform. But can he pull it off? Or, does he mean it? We've heard this before with Japanese prime ministers. With the exception of Junichiro Koizumi, no post-war Japanese prime minister has been able or willing to carry out any serious reforms which would untie the knots that have crippled the Japanese economy in recent times. Of course there are those who will argue that structural reforms that increase productivity are deflationary. But this is "good" deflation. Common sense dictates that anything that improves productivity and enhances output must be good. Japan should embrace productivity improvements and good deflation.

Economists who can think outside the demand management box have been writing about needed Japanese structural reforms for years. A recent Wall Street Journal article (5/17/2013) summarizes some of these nicely. Here is a list of some needed structural reforms:

Eliminate protectionism – The Japanese economy is sheltered by a host of tariff and non-tariff barriers, among the most extensive in the world. Mr. Abe says he wants Japan to participate in the Trans-Pacific Partnership free trade negotiations. Good start. But will anything really come of this? The major Japanese corporations are world class. But they are harmed by the fencing off of their domestic market. The failure of Japanese manufacturers to participate in the global 3G telecommunications markets is an example. The Japanese corporations sat back with their non-compatible domestic standard captive market. The Japanese corporations don't need a beggar thy neighbor boost from a trashed exchange rate. They need to have to fight for their home market.
Eliminate coddling of the rural sector – According to the WSJ, in 2010 Japanese farmers "added 4.6 trillion yen ($45 billion) in value and consumed 4.6 trillion yen in subsidies, meaning the industry netted out to zero." The average Japanese farmer is 66 years old and tills 1.9 hectares of land. Tariffs of Himalayan proportions protect the Japanese rural sector from foreign imports. You don't have to read Adam Smith and David Ricardo to come to the common sense conclusion that this situation is an economic disaster. Unfortunately the rural sector is overrepresented in the Diet and a bulwark of the ruling Liberal Democratic Party. You have to wonder if agricultural reform will have to wait until the last geriatric farmer buys the farm. (US slang, definition "to die")
Make major changes in labor practices – Labor rigidities, including Japan's legendary lifetime employment, are major productivity inhibitors. The markets love Sony's profitable American entertainment division. Its hidebound Japanese electronics division is another matter.
Reform land use taxes and practices – High capital gains taxes and a morass of zoning and other regulations in the opinion of many observers have created artificial land scarcities and a dysfunctional real estate market.
Liberalize the retail market—By regulation and tradition Japan's retail economy is a collection of inefficient mom and pop retail stores.
Reform the educational system – Openness, critical thinking, technological literacy, dominance of English – these are what a modern knowledge society needs.
Turn the nuclear power plants back on – Before the tsunami and Fukishima, nuclear energy provided some 30% of Japanese needs. The bulk of Japan's energy needs must be imported. A persistent current account deficit would be fatal for Japan with all its debt. Fukishima was a traumatic accident and I don't mean to underplay this. But so far there have been no direct deaths due to radiation. One might guess that Fukishima itself has brought about significant improvements in Japanese nuclear safety. Let the Germans waste their money on green alternatives and energy imports.

Will the structural reforms be enacted? Near term I am doubtful. Japan is a very conservative country and historically great changes have not happened often. The protectionist, government directed East Asian Economic Model is embedded in Japanese cultural DNA. But Japan has made major changes in the past. The ending of the Tokugawa Shogunate in 1868 with the turn to modernization and relative openness internationally is one example of where Japan was able to sense major threats and to change voluntarily. The defeat of WWII and the American occupation and imposed constitution also brought about great change. But unfortunately it took a disaster to produce that change.

The problem is Japan is not really in crisis today. Suboptimal economic performance isn't a great crisis. Affluent stagnation does not produce change. 4.1% unemployment rates do not produce revolutions. If Apple and Samsung and not Sony own the smartphone and tablet market, that's life.

Will Abenomics bring about the collapse of the Japanese bond market and will that be the catalyst that overthrows Japan's East Asian Economic Model Shogunate? Possibly. Then the country may owe Abe a debt of sorts. But he won't get a statue erected in his honor for that. Because there had to be a better way.

Peter T. Treadway______________________________________________________

Dr. Peter T Treadway is principal of Historical Analytics LLC. Historical Analytics is a consulting/investment management firm dedicated to global portfolio management. Its investment approach is based on Dr. Treadway's combined top-down and bottom-up Wall Street experience as economist, strategist and securities analyst.

Dr. Treadway also serves as Chief Economist, CTRISKS Rating, LTD, Hong Kong.

Who Gets the Biggest Tax Breaks?

Posted: 01 Jun 2013 04:30 PM PDT

Click to enlarge

Source: Washington Post

The Future of the Web is Video

Posted: 01 Jun 2013 12:00 PM PDT

Video is not only the future of the web—it’s the future of digital communication, and a disruptive force across platforms. This presentation follows video’s journey on the web, then focuses on where it lives today, where it’s going tomorrow, and how different players are to leverage its potential.

Emerging technologies are part of this transition, but there’s a human story at the core—how we process information and how we tell stories.

This presentation was part of a keynote I gave at the Portland Webvisions Conference on May 23, 2013.

The Future of the Web is Video from Leslie Bradshaw

by Leslie Bradshaw on May 28, 2013

Why Do You Want To Be A Hedge Fund Investor?

Posted: 01 Jun 2013 06:30 AM PDT

A hedge fund for you and me? The best move is to take a pass
Barry Ritholtz
Washington Post May 24 2013

Earlier this year, Goldman Sachs Asset Management announced that it would launch a new mutual fund that — apparently — will bring the joy of hedge fund investing to the masses. For as little as $1,000, the Multi-Manager Alternatives Fund (GMAMX) allows mom-and-pop investors to put their life savings into some of Wall Street's riskiest and most expensive products. This "fund of funds" will, according to its prospectus, let investors gain exposure to the trading strategies of hedge funds.

The obvious question is: "Why would investors want that?"

Despite all the media coverage, glitz and glam of hedge funds, they have not done well for their investors. They have high — some say excessively high — fees; their short- and long-term performance has been poor.

Before delving into the details, let's define exactly what we are discussing: Hedge funds are private investment partnerships. The general partner is typically the fund manager (on occasion it includes his financial backers). The investors in the fund are the limited partners, normally institutions and accredited investors. This partnership structure typically has a max of 99 limited partners. Unlike mutual funds or brokerages, hedge funds are mostly unregulated.

The global hedge fund industry manages $2.13 trillion, or about 1.1 percent of all assets held by financial institutions, according to the Coalition of Private Investment Companies. Given what a relatively small asset class this is, hedge funds certainly receive an excess of media attention. Many hedge fund managers have become billionaires; perhaps this — plus their reputations as the smartest guys in the room — is why they have captured the investing public's imagination.

Most hedge funds are "go anywhere" funds — they can own derivatives, mortgage-backed securities, credit-default swaps, structured products and illiquid assets. They also can use nearly unlimited leverage.

Gee, that sounds kinda hazardous. Why would anyone want to assume all of that risk? Originally, hedge funds earned their outsize compensation by, well, hedging their investments. This is a risk-mitigation strategy that can reduce the gains investors reap when markets are up but avoids much of the losses when markets are down.

That no longer seems to be the case with modern hedge funds. They have morphed into "absolute return" funds — more aggressive, greater leverage, more speculative, all in an attempt to generate returns that outperform their benchmarks. Not surprisingly, they have become riskier than the overall market.

Given these increased risks (and higher fees), how have hedge funds performed?

By most measures, not well. They have failed to keep up with major averages when markets were up — and they got mangled (like nearly everyone else) during the 2008-09 downturn. It turns out, most hedge funds are not very hedged.

The latest performance data (via the HFRX Global Hedge Fund Index) reveal that hedge funds haven't fared well at all: They returned a mere 3.5 percent in 2012, while the S&P 500-stock index gained 16 percent. Over the past five years, and the hedge fund index lost 13.6 percent, while the indices added 8.6 percent. That's as of the end of 2012; it has only gotten worse in 2013. Most hedge funds have fallen even further behind their benchmarks this year, gaining 5.4 percent vs. the market's rally of 15.4 percent. As a source of comparison, the average mutual fund is up 14.8 percent.

Which brings us to fees. Most hedge funds charge an industry standard "2 and 20." This is a 2 percent annual management fee against the original investment, plus 20 percent of the investment profits. Compare this with annual mutual fund fees, which average about 1.44 percent. Fees for an index ETF are typically under 0.25 percent.

Those outsize hedge fund fees are an enormous drag on performance. But they do create wealth — for the managers. "Two and twenty" as the industry calls it, is why even middling hedge fund managers can become billionaires. According to Simon Lack, author of "The Hedge Fund Mirage," this fee arrangement is effectively a wealth transference mechanism, moving dollars from investors to managers. As he puts it: "While the hedge fund industry has generated fabulous wealth and created many fortunes, it has largely done so for itself."

Lack is no ordinary critic — he spent his career at JPMorgan Chase, where he allocated more than $1 billion to emerging hedge fund managers. Some of the statistics he amassed in the process are nothing short of astonishing:

●From 1998 to 2010, hedge fund managers earned $379 billion in fees. The investors of their funds earned only $70 billion in investing gains.

●Managers kept 84 percent of investment profits, while investors netted only 16 percent.

●As many as one-third of hedge funds are funded through feeder funds and/or fund of funds, which tack on yet another layer of fees. This brings the industry fee total to $440 billion — that's 98 percent of all the investing gains, leaving the people whose capital is at risk with only 2 percent, or $9 billion.

What other concerns should investors have? Hedge funds are not especially liquid. Many are "gated" — meaning there are only small windows when you can withdraw your money. They typically have a high minimum investment and often require investors keep their money in the fund for at least one year.

Why would anyone in their right mind invest in these funds?

So many kids dream of becoming LeBron James, but most will never play in the NBA (to say nothing of amassing championship rings). So it also goes with hedge fund investors. Most of the more than 10,000 hedge funds out in the wild are not big moneymakers for their investors. Investors tend to discover "hot" mutual fund managers just after a successful run and just before the inescapable force of mean reversion is about to kick in. Similarly, hedge fund darlings are born at exactly the same moment in their trajectory.

John Paulson is a classic example. The bet against subprime mortgages that he and Paolo Pellegrini created in 2005-06 put them on the map and turned Paulson into a billionaire. He became widely known, and the money flowed in. Within a few years, Paulson was managing a slew of hedge funds, and his assets under management had swelled to $36 billion. Soon after, he hit the skids, with losses of 52 percent in one fund and 35 percent in another.

But the lure of the superstar manager — the guy who can make you fabulously wealthy – continues to attract capital. In 1997, $118 billion was managed by hedgies; as of the first quarter of 2012, that had grown to $2.04 trillion.

Investors have also embraced other non-financial remunerations: Client-only market commentary, access to star managers, attendance at exclusive conferences. These perks generate cocktail party bragging rights, despite the poor performance.

But what about the top-performing funds, such as Jim Simon's Renaissance Technologies or Ray Dalio's Bridgewater? Sure, give them a call.

The Lebron James of hedge fund managers are few and far between. This is the crux of the issue with hedge funds. A small percentage have significantly outperformed the markets; an even smaller percentage have done so after fees are taken into account. While we all know which ones have outperformed over the past few decades, no one has even the slightest clue which ones will outperform over the next one. It is akin to picking out from the ranks of high school sophomores who will be the next NBA superstar. Best of luck with that.

Every fund in the world warns that past performance is no guarantee of future results. It is too bad that investors refuse to believe it.

~~~

Ritholtz is CEO of FusionIQ, a quantitative research firm. He is the author of "Bailout Nation" and runs a finance blog, the Big Picture.

10 Weekend Reads

Posted: 01 Jun 2013 04:00 AM PDT

My longer form journalism for your less hassled weekend reading pleasure:

• How much value does the finance industry create? (Noahpinion)
• Billy Joel on Not Working and Not Giving Up Drinking (NYT)
• The Money Shot: Behind the sale of Instagram to Facebook for a cool billion (Vanity Fair)
• Fascinating: I was a liberal mole at Fox News: From Bill O'Reilly to Ailes, all the inside dope (Salon)
• The Real Space Age: Head into space for just $200,000 (NY Magazine)
• Some of My Best Friends Are Germs (NYT)
• The Suicide Epidemic (Daily Beast)
• The Trip That Doesn't End (New Yorker)
• The Price of a Human Kidney (priceonomics)
• The Completely Awesome San Antonio Spurs (WSJ)

Whats up for the weekend?

Dow Moves Up Despite Bad Week in Japan

Source: WSJ

Seth MacFarlane’s Harvard Class Day Speech 2006

Posted: 01 Jun 2013 03:00 AM PDT

Seth MacFarlane's Harvard Class Day Speech 2006

Part 1:

Part 2 (Peter):

Part 3 (Stewie):

Part 4 (Quagmire):

At Least One Reason Why People Shouldn’t Hate QE

Posted: 01 Jun 2013 02:00 AM PDT

At Least One Reason Why People Shouldn’t Hate QE
Dave Altig
Atlanta Fed May 30, 2013

You might not expect me to endorse an article titled “The 7 Reasons Why People Hate QE.” I won’t disappoint that expectation, but I will say that I do endorse, and appreciate, the civil spirit in which the author of the piece, Eric Parnell, offers his criticism. We here at macroblog, like our colleagues in the Federal Reserve System more generally, pride ourselves on striving for unfailing civility, and it is a pleasure to engage skeptics who share (and exhibit) the same disposition. What the world needs now is…well, maybe I’m getting carried away.

Let me instead appropriate some of Mr. Parnell’s language. It is worthwhile to explore some of the reasons that people do not like QE from someone who does not share this opposing sentiment. In particular, let me focus on the first of seven reasons offered in the Parnell post:

First, a primary objection I have with QE is that it results in a government policy making and regulatory institution in the U.S. Federal Reserve directly determining how private sector capital is being allocated… in recent years, the Fed has dramatically expanded its policy scope into areas that are normally the territory of fiscal policy. This has included specifically targeting selected areas of the economy such as the U.S. housing market including the aggressive purchase of mortgage backed securities (MBS) since the outbreak of the financial crisis.

This statement seems to presume that monetary policy does not normally have differential impacts across distinct sectors of the economy. I think this presumption is erroneous.

The Federal Open Market Committee’s (FOMC) asset purchase programs have long been seen as operating through traditional portfolio-balance channels. As explained by Fed Chairman Ben Bernanke in an August 2010 speech that set up the “QE2″ program:

The channels through which the Fed’s purchases affect longer-term interest rates and financial conditions more generally have been subject to debate. I see the evidence as most favorable to the view that such purchases work primarily through the so-called portfolio balance channel, which holds that once short-term interest rates have reached zero, the Federal Reserve’s purchases of longer-term securities affect financial conditions by changing the quantity and mix of financial assets held by the public. Specifically, the Fed’s strategy relies on the presumption that different financial assets are not perfect substitutes in investors’ portfolios, so that changes in the net supply of an asset available to investors affect its yield and those of broadly similar assets. Thus, our purchases of Treasury, agency debt, and agency MBS likely both reduced the yields on those securities and also pushed investors into holding other assets with similar characteristics, such as credit risk and duration. For example, some investors who sold MBS to the Fed may have replaced them in their portfolios with longer-term, high-quality corporate bonds, depressing the yields on those assets as well.

I think this is a pretty standard way of thinking about the way monetary policy works. But you need not buy the portfolio-balance story in full to conclude that even traditional monetary policy operates on “selected areas of the economy such as the U.S. housing market.” All you need to concede is that policy works by altering the path of real interest rates and that not all sectors share the same sensitivity to changes in interest rates.

Parnell goes on to discuss other problems with QE: stress put on individuals living on fixed incomes, the promotion of (presumably excessive) risk-taking, and the general distortion of market forces. All topics worthy of discussion, and if you read the minutes of almost any recent FOMC meeting you will note that they are indeed key considerations in ongoing deliberations.

These issues, however, are not about QE per se, but about monetary stimulus generally and the FOMC’s interest rate policies specifically. As the conversation turns to if, when, and how Fed policymakers will adjust the current asset purchase program, it will be important to clarify the distinction between QE and the broader stance of policy.

Photo of Dave Altig By Dave Altig, executive vice president and research director of the Atlanta Fed