Friday, October 30, 2020

The etiology of Chinese yuan

Chinese is a tonal language, and the pronunciation sounds more like yoo-en than yoo-aan. The only people who say R-M-B (renminbi) are bankers who can’t wrap their mouth around a foreign word and refuse to try.  

The pronunciation sounds pretty similar to the Japanese currency, yen, because it is.  The Japanese aristocracy originally borrowed written Chinese and many of its words, including  (yuan, yen).  Both still use the same character for pricing. 

In Chinese, yuan holds the closest translation with the word dollar. If you are talking colloquially you would use the word kuai (, pronounced kwai and translated as fragment, shard or piece). This would be similar to using buck or quid in American or British English respectively. 

RMB is the romanized abbreviation of the word renminbi (人民币) which translates as “the People’s Currency” which has that distinct socialist flavor. The last part of the word, bi, is an older word meaning currency, for instance like the old Chinese coins with the square hole in the middle. Despite the perception of China as an overbearing communist country, in many ways its domestic economy functions with far less regulation and interference than you find in the West.  

The American dollar in full is called meiyuan (美元, which translates literally as beautiful dollar). This not a reverent description, but rather the United States in Chinese is called meiguo (beautiful country) which works as a loose transliteration of the name. The “beautiful” is transferred as a national descriptor for the currency, however feel free to assume the literal, poetic meaning. 

HT:  Jake K.

Tuesday, October 27, 2020

CDC data on TN Covid hospitalization and death rates (17 day lag)


Red line is over age 65 years of age
Dark blue is 50-64 years
Light blue is 18-49 years


Why are house prices climbing?

Two obvious answers:  cheaper borrowing is increasing demand; or consumers want a better place to work-at-home.  The bigger price increases in lower density (lower virus risk) areas suggest that it is the latter:

Phoenix, Seattle and San Diego reported the highest year-over-year gains among the 19 cities (Detroit excluded from report due to virus-related reporting constraints). Chicago and New York reported the weakest YoY gains.

Thursday, October 15, 2020

Airlines are Sunk Costs

Demand for air travel fell during the pandemic, like a lot. It fell to about 5% of the previous year in early March and is still at 30%. And it won't get back to 100% for at least a year, maybe two or three. Assets are going to have to leave this industry.

The physical assets are very industry specific. There is little else you can do with an airplane but fly it. This is a risk one takes when one invests in airlines. Subsidizing these does not help since these assets are sunk costs.

Human capital is also very industry specific. There is little use for most pilot, flight attendant, and airplane mechanic skills for a years. For many, this human capital is now worthless. Fortunately, humans are more fungible than airplanes. They can acquire new human capital. Perhaps we want to help them out until then. How much?

The bailout in March was $25 Billion and the industry employed ~634,000 full-time workers. This comes to ~$40,000 per worker for six months. Unfortunately, a stipulation was to prevent layoffs - that is, keep people from acquiring new human capital. They say they need another $25 Billion to keep these workers employed over the next six months. Perhaps, instead, we allow the airlines to shed these workers but give these laid-off workers retraining subsidies.

HT: Tim Wunder

Monday, October 12, 2020

Are workers being compensated for living in Minnesota?


It appears that the higher real wages (adjusted for the cost of living) reflect the cold, unpleasant climate.  

Sunday, October 11, 2020

Reducing leverage hurts options buyers

Financial options on funds are bets that, e.g., a fund's price will increase up to a specified strike price.  Leverage tends to make a fund more risky, and more likely that the fund price will hit the strike price at which the option pays off.  

So far so good.  But for every person who buys an option (long) hoping that the price will increase to the strike price, there is a seller on the other side (short), who hopes that it doesn't.  

Colleague Bob Whaley has pointed out that changes in leverage of the fund can reduce its volatility which would make it less likely to pay off (link).  Using data from 2018, Whaley gives an example:

...ProShares had reduced its leverage ratios in Ultra VIX Short-Term Futures fund (UVXY) and its Short VIX Short-Term Futures ETF (SVXY). The combined market value of options on the two names fell more than $116 million, ... 

These types of corporate events, not accounted for properly, result in “windfall transfers of wealth from outstanding long to outstanding short option holders,” Whaley concluded. 

BOTTOM LINE:  Beware of buying options on funds that can change their own volatility.  (I wonder if anyone sold options on the stock who had had control of the fund's leverage.  If so, it is a textbook example of Moral Hazard!)

Wednesday, October 7, 2020

Thursday, October 1, 2020

Nobel for figuring out how best to tie pay to performance

One of the enduring themes of out textbook is that to give employees enough information to make good decisions--and the incentive to do so--what we call "goal alignment," you have to tie pay to performance.  The not only attracts the most productive workers (adverse selection) but also motivates them to work hard once they arrive (moral hazard).  The tradeoff is that you expose the employees to risk, for which they have to be compensated.

The Nobel in Economics was just awarded to two economists who have figured out how best to do this.  Our friends at Marginal Revolution wrote a nice essay summarizing their contributions:

  • Use all signals of productivity to better measure performance ("informativeness principle").
  • Put greater weights on the best measures (least noisy).
  • Use a higher base salary when employees are risk averse (to compensate them for bearing risk).
  • Use relative performance metrics ("tournaments") when employees have similar abilities.
  • Use absolute performance metrics when employees do not (otherwise, employees with the most ability will easily win the tournament--without working hard).

We can use this analusis to critique executive pay:
...executive pay often violates the informativeness principle. In rewarding the CEO of Ford for example, an obvious piece of information that should used in addition to the price of Ford stock is the price of GM, Toyota and Chrysler stock. If the stock of most of the automaker’s is up then you should reward the CEO of Ford less because most of the gain in Ford is probably due to the economy wide factor rather than to the efforts Ford’s CEO. For the same reasons, if GM, Toyota, and Chrysler are down but Ford is down less then you might give the Ford CEO a large bonus even though Ford’s stock price is down. Oddly, however, performance pay for executives rarely works like a tournament. As a result, CEOs are often paid based on noise.

Management matters

in exactly the way that economists would predict, both across countries:

Income differences between rich and poor countries remain staggering, and these inequalities are in good part due to unexplained productivity gaps , ..., US productivity is more than 30 times larger than some sub-Saharan African countries. In practical terms, this means it would take a Liberian worker a month to produce what an American worker makes in a day, even if they had access to the same capital equipment and materials.

and across firms within a country:

This huge productivity spread between countries is mirrored by large productivity differences within countries. Output per worker is four times as great, and TFP twice as large, for the top 10% of US establishments compared to the bottom 10%, even within a narrowly defined industry like cement or cardboard box production (Syverson 2011). And such cross-firm differences appear even greater for developing countries (Hsieh and Klenow 2009).

A new survey relates these differences to management practices:
we rated companies on their use of 18 practices, ranging from poor to non-existent at the low end (for example, “performance measures tracked do not indicate directly if overall business objectives are being met”) to very sophisticated at the high end (“performance is continuously tracked and communicated, both formally and informally, to all staff using a range of visual management tools”)...
The large, persistent gaps in basic managerial practices that we document are associated with large, persistent differences in firm performance. Better-managed firms are more productive, grow at a faster pace, and are less likely to die. 


What is the best warfighting strategy?

It is interesting to compare the allied strategy in Libya:
But the first shots fired didn’t appear to produce an immediate collapse in the rule of Qadhafi, who has surprised his enemies with his resilience. Qadhafi’s tenacity, both in his present circumstance and as evidenced over decades of survival in a very tough neighborhood, begs the question of what happens if this self-consciously limited allied response does not succeed in chasing him from power.

Allied leaders so far haven’t provided defining answers; in fact, quite the contrary. In a series of comments and communiques over the weekend, American, British, and French officials stressed that they aren’t attacking Qadhafi’s forces to achieve “regime change” – while at the same time maintaining, as British Prime Minister David Cameron insisted, that Qadhafi “needs to go.” the US Marine warfighting manual. One of my colleagues uses this to teach MBA's how to formulate succesful business strategy.  Starting out with lack of a clearly defined goal leads to what the manual calls "frictions."
The very essence of war as a clash between opposed wills creates friction. It is critical to keep in mind that the enemy is not an inanimate object but an independent and animate force. The enemy seeks to resist our will and impose his own will on us. It is the dynamic interplay between his will and ours that makes war difficult and complex. In this environment, friction abounds.

Friction may be mental, as in indecision over a course of action. Or it may be physical, as in effective enemy fire or a terrain obstacle that must be overcome. Friction may be external, imposed by enemy action, the terrain, weather, or mere chance. Or friction may be self-induced, caused by such factors as lack of a clearly defined goal, lack of coordination, unclear or complicated plans, complex task organizations or command relationships, or complicated communication systems. Whatever form it takes, because war is a human enterprise, friction will always have a psychological as well as a physical impact.

While we should attempt to minimize self-induced friction, the greater requirement is to fight effectively within the medium of friction. The means to overcome friction is the will; we prevail over friction through persistent strength of mind and spirit. While striving to overcome the effects of friction ourselves, we must attempt at the same time to raise our enemy's friction to a level that destroys his ability to fight. 

Which organizational forms can best adapt to change?

One of the themes in this blog is that it is not necessarily the strongest firms that survive, but the most adaptable.  Kodak once dominated the film industry but now it is bankrupt.  How did this happen?

Part of the fault lies with Kodak's centralized structure which was slow to react to the expiration of its patents, and the advent of digital photography.  Colby Chandler, former CEO of Kodak, admitted as much at the 1984 annual meeting:
Like many companies, we are not used to working in an environment where there is rapid technological transfer from laboratory to the marketplace. But we know that will be important in our future.
In 1984, in the hopes of encouraging innovation, Kodak decentralized decision making to 17 different business units with profit and loss responsibility.  However, the decentralized decision making was not accompanied by incentive pay.  Instead, small bonuses were doled out by officious bureaucrats, according to office politics. 

As a result, Kodak continued its slow decline, and in 1993 the board of directors fired its CEO for not holding its managers accountable for failure.  This year, Kodak entered bankruptcy.

The moral of the story seems clear to me:   decentralized decision making is better for adapting to technological change, but only if accompanied by strong incentive pay.  This may be the reason that much of certain types of innovation is done by small firms:  owner/operators have the strongest incentives to perform. 

The costs of fighting inequality

Following up on an earlier post, Why are there so few unicorns in Europe?Bloomberg suggests an answer straight out of Chapter 1:  the EU limits on incentive pay, particularly on stock options, make it difficult for innovators to align the incentives of employees with the profitability goals of the company:

"...when you’re not highly profitable, you have to incentivize employees on the promise of the upside.”  

Onerous rules and taxation make this difficult to do.  Examples of EU limits on incentive pay:
  • The Dutch capped bonuses for bankers, money managers, and other financial professionals at 20% of base salaries. 
  •  Entrepreneurs must navigate onerous tax rates and restrictions that often make equity sharing and options more trouble than they’re worth. 
  • When employees in Germany exercise options, they have to pay income tax on the difference between the fair market value and the strike price, that runs from 14% to 47.5%. They also pay a 25% capital-gains tax on additional profits when they sell their shares.
In contrast, American employees typically pay a 0% to 20% rate on capital gains when options are redeemed, ...

Chatterbug's COO, sums it up: “I wish we had the same system as the U.S.,” she says. “But they don’t want us to get rich in Germany.”

HT:  Gus B.

ADDENDUM:  when I ask my EU colleagues about the disparity, they point to other factors as well, like bankruptcy codes that discourage risk-taking.