This is what they mean by "foreign exchange risk."

Swatch was hurt by the Swiss franc appreciation, but strangely, so were others:

Swatch:  Citigroup estimates that about 85 per cent of its cost of goods sold is in Swiss francs. A much lower proportion of sales are at home. The broker thinks that a rise of 12 per cent to 13 per cent in the Swiss franc against the euro could wipe 8-10 per cent off its earnings. Its shares fell 16 per cent on Thursday.

Novartis, Roche, and Nestlé : a combined $750bn or so in market value — each fell by a tenth immediately after the SNB shock. It is tempting to call this excessive. These companies are based in Switzerland but their revenues and costs are overwhelmingly located elsewhere. For Nestlé and Roche, which report in Swiss francs, there will be a translation effect on the accounts: reported sales will fall by the amount the currency rises, and reported earnings by a bit more than that. But there will be no economic effect on non-Swiss operations. For Novartis, which reports in dollars, there is not even the translation effect.

Swiss franc appreciates agains the Euro

The Swiss Central Bank had been "pegging" the price of the Swiss franc to the euro, to make sure that Swiss exports were not priced out of the European market.  To do this, they had to print swiss francs and buy foreign assets, or hold foreign currency.  This increased demand for foreign currency, which increased the "price" of a euro in the market for foreign exchange.  This benefited European consumers, and Swiss exporters.  

Apologies to the Venezuelan Bishops

In past posts, we have blogged about how ignorant our clergy is about wealth, poverty, and policy.  But after the Venezuelan Bishops came out with a strong and simple brushback of the Pope, I owe them an apology

In a refreshingly powerful and direct statement, Venezuela’s bishops Monday blamed “Marxist socialism” and “communism” by name for the horrors and chaos gripping their country, according to a story in El Universal. 

The bishops said the long lines of people trying to buy food and other basic necessities and the constant rise in prices are the result of the government’s decision to “impose a political-economic system of socialist, Marxist or communist,” which is “totalitarian and centralist” and “undermines the freedom and rights of individuals and associations.” 

The Venezuelan bishops specifically stated that the private sector was critical for the well being of the country. The document, read by Monsignor Diego Padron in Spanish, said the country needs “a new entrepreneurial spirit with audacity and creativity." 

So not only did these bishops diagnose the cause of the misery correctly; they also warned that communism harms the poor most of all.

I think the Pope could use a copy of the new edition (fourth) of Managerial Economics, like the one I sent to the Venezuelan President.

Effects of disability payments

An interesting story is developing around a West Point professor and disabled vet on the perverse incentives created by our efforts to help wounded vets:

As he paced back and forth in front of the soldiers, some of them leaning on crutches, Colonel Gade said that too many veterans become financially dependent on those monthly checks, choose not to find jobs and lose the sense of identity and self-worth that can come from work.

“People who stay home because they are getting paid enough to get by on disability are worse off,” he said. “They are more likely to abuse drugs and alcohol. They are more likely to live alone. You’ve seen these guys. And the system is driving you to become one of them, if you are not careful.”

Obviously, the messenger is important for a message like this.

What makes us happy?

Vanderbilt's Ted Fisher has the answer:

Using information to price discriminate more profitably

WSJ spills the beans on retailers strategies:  they try to figure out what motivates each shopper and then give it to them.

A fifth of online shoppers are considered true “discount junkies,” people who make purchases only when plied with discounts, according to new data from AgilOne Inc., which works with 150 retailers to analyze customers’ purchases and predict their behavior. About 15% of shoppers generally pay full price for items and don’t bother searching for sales.
“Smart retailers understand discounting only moves the needle for a portion of their customers,” said Omer Artun, chief executive of AgilOne and a former marketing executive at Best Buy Co.
“You don’t want to offer discounts to full-price shoppers, because over time your profit margins will erode,” he said.
Shoe brand Donald J Pliner, which is sold online, in department stores and through an eponymous six-store chain, divides its customers into three types based on their previous shopping behavior: Discount shoppers who buy clearance items and last season’s styles once they are priced at more than 25% off; full-price shoppers who rarely buy clearance items; and customers who fall somewhere in between.

HT:  Erin

Putin's bubble bursts

Earlier we blogged about the effects of the drop in oil prices on the fall of the ruble.  Paul Krugman has penned a good column on why the rouble has fallen much farther than the oil.  The key to understanding it is the large scale borrowing, with debts denominated in a foreign currency, from abroad.

When the nation’s currency falls, the balance sheets of local businesses — which have assets in rubles (or pesos or rupiah) but debts in dollars or euros — implode. This, in turn, inflicts severe damage on the domestic economy, undermining confidence and depressing the currency even more. 

So what does this have to do with Putin?  The answer is crony capitalism.  Russia has been running trade surpluses (which should make the ruble appreciate), but this current account surplus has been offset with huge foreign borrowing by the private sector.

...walking around Mayfair in London, or (to a lesser extent) Manhattan’s Upper East Side, especially in the evening, and observing the long rows of luxury residences with no lights on — residences owned, as the line goes, by Chinese princelings, Middle Eastern sheikhs, and Russian oligarchs. Basically, Russia’s elite has been accumulating assets outside the country — luxury real estate is only the most visible example — and the flip side of that accumulation has been rising debt at home.

How do oil investors (principals) align the incentives of operators (agents) with their profitability goals?

With the so-called "1/3 for 1/4" contracts:  if an investor pays for 1/3 of the cost of the well, she receives 1/4 of the net revenue from the well (after the landowner receives a royalty payment, e.g., 15%).  If the operator sells three shares, then the costs of drilling are covered, and the operator gets a 1/4 share of the well.

Since the operator gets 1/4 of the upside but the investors bear most of the downside, the operator has a bigger incentive to drill a marginal hole than do the investors.  To mitigate the costs of adverse selection and moral hazard, the operator releases information to the investors:

As soon as the well is spudded, the investor will be entitled to receive daily drilling reports to keep him abreast of the well’s progress. Ordinarily, all sophisticated industry working interest partners are responsible for their proportionate part of the drilling costs, regardless of what the operator’s initial cost estimate was or how much money they have prepaid. If the well goes over budget, those partners may be called upon to contribute additional funds to keep the drilling rig going. A partner who fails to respond in a timely manner may forfeit all or part of his interest in the well.

In general, here are rules to screen out bad investments:

• Beware of overly simple deals in which you are approached by a broker or landman brandishing a small lease map with nothing more than a yellow outline on it. A legitimate prospect will almost always be presented by one or more industry professionals who have taken the time to prepare a comprehensive (and comprehensible) brochure that contains maps, several pages of text describing the geology of the immediate area, nearby (and presumably analogous) production data, cross sections, etc. 

• A slick brochure is no guarantee that the prospect has any geological merit. Your best bet is to hire a consulting geologist for half a day to take a look at the information the operator has furnished you and render an opinion. 

• Beware of “hot” deals that have a short fuse. If you have to put your money up by the end of the week in order to get in on a “can’t miss” prospect that is about to spud any day now, forget it. This is one of the oldest come-ons in the book.

• Don’t be in too big a hurry to spend your oil and gas investment money. Industry insiders ordinarily expect to participate in only about one out of every 10 to 20 unsolicited prospects that are submitted to them. You should be discriminating with your funds as well.

• Don’t put all your eggs in one basket. Take a small piece of several deals in several different areas. 

1. • Most sophisticated investors within the industry would have to be very impressed with the geological features of the prospect before they would agree to a anything less than 1/4 for 1/3.
2. 
   

Can the Russian Central Bank stop the rouble's fall?

Apparently not, i.e., the promise of 10.5% rates is not enough to increase demand for roubles:

Russia’s central bank raised interest rates on Thursday, but the move failed to stop the drop of the rouble as the slide in oil prices continues to put pressure on the currency.

Here is the bigger problem:

Economists said the Bank of Russia faced a conundrum: only decisive rate increases had a chance of reining in inflation and stopping the currency devaluation, but further steep rises risk weighing on an already stagnating economy. In a reflection of this dilemma, analysts’ forecasts ahead of Thursday’s rate decision had ranged from no further increase to a three percentage points rise.

Why do US public pension funds carry so much risk?

Under-funded pension funds can "catch up" by either (1) saving more or cutting benefits; or (2) going into more risky investments that have higher expected return, which makes the current liabilities look smaller (because future liabilities are discounted at the higher rate).  They often choose the latter because it is less painful, at least in the short run, than the former.

In November the Society of Actuaries noted that “public sector plans in the U.S. are unique in that they have taken additional risk as the plans have become more mature, compared to private sector plans in the U.S. and private and public sector plans in Canada, UK and the Netherlands, which have taken less risk as plans have matured.” The reason: GASB accounting rules let U.S. public plans credit themselves with the higher returns on risky assets before those returns are earned, creating an artificial incentive to take risk. U.S. corporate pensions and public plans overseas may credit themselves only after investment risks pay off, and thus better balance risk and return.

To see how much they are over-investing, they compare the actual asset allocation (75% in risky investments for California) vs. a conservative "rule of thumb" for individuals:

Many individuals follow a rough “100 minus your age” rule to determine how much risk to take with their retirement savings. A 25-year-old might put 75% of his savings in stocks or other risky assets, the remaining 25% in bonds and other safer investments. A 45-year-old would hold 55% in stocks, and a 65-year-old 35%. Individuals take this risk knowing that the end balance of their IRA or 401(k) account will vary with market returns.