As far as the global picture is concerned, I suppose one question is whether the crisis that started in Asia represents a failure of the free-market system, as some have contended. I do not believe so and I would argue that the move to more open markets simply exposed the fault lines created in economies where market forces were being suppressed or distorted by government intervention, crony capitalism and a lack of financial transpar ency. One could further argue that the growth of information technology will force governments to be more open to the benefit of long-run economic prospects. Perhaps there is no room for the middle ground. Governments will have to decide to either fully embrace a free-market model or impose a closed siege economy, with all that entails. The latter will be increasingly hard to do, however, in an information age of e-cash, the internet etc.
Perhaps it is not so much a new global financial architecture that is needed as a more open endorsement of free-trade principles. Of course, there will always be lots of volatility in capital flows and often these can be destabilizing to individual economies. I would have thought that such problems could be dealt with by micro-policies aimed at controlling certain types of short-term capital flows.
I continue to be struck by the growing divergence between the US and overseas economies. It has long struck me that Europeans have always misunderstood and underestimated the strength of America. They find the US political system chaotic compared with a parliamentary system, but fail to take account of the checks and balances. They mistakenly think that many of the new jobs are hamburger flippers, they are obsessed with the US crime rate and income inequalities. Yet look at the record: who has fast growth, low unemployment, a budget surplus, a lead in high-tech innovation, etc., etc.? Certainly not Europe!
Yes, the United States cannot remain an island of prosperity in a global sea of depression, but the benefits of having a flexible and dynamic economic structure will become increasingly important in the new global economy and the United States has a big advantage on that score. Could the United States remain in a long-wave upturn while the rest of the world flounders? It would not seem possible yet we cannot rule it out. Most likely, I suppose that building global deflationary forces would eventually crush the US stock market and that could unleash a very bearish cycle of negative feedback loops.
Tuesday, May 31, 2011
Counterpoint to Martin Barnes' Theory ''
Money makes the world go round," went the song from The Threepenny Opera and it does. But the theory of money is often misunderstood. Many of us think of money as a thing, as a constant, as capital, as something that can be preserved. We forget that money is not a thing. It is a promise a promise amid a chain of other promises. And if any part of that chain breaks and cannot be replaced by some stronger action or force, or replaced within the chain itself, then all the promises are broken. Money is now shrinking on a global basis, and shrinking very drastically because we are doubtful that the promises can be kept.
Old ideas are abandoned only when they have proven faulty, and surely many of the premises of the international monetary system have given a resounding signal that they are no good. Despite the work and the money spent in studying global economics, we know very little. Largely, we are studying old, outmoded precepts. We can do no harm by accepting the challenge to use complexity to find new ones. When we incorporate the principles of complexity, we have a chance, just a chance, to understand this adaptive world better.
For example, the conventional IMF view of development says that sound policies tight money, balanced budgets, flexible labor markets will attract capital, boost exports and help promote non-inflationary economic growth. Indeed, much of the work of the IMF is offering macroeconomic policy advice that politicians can sell as their own, and promoting microeconomic reforms that might otherwise be politically unacceptable. A complexity view, in contrast, suggests that economies are not necessarily homogeneous and that growth can come in many forms: through internal demand as in China as well as through exports as in the Asian tigers prior to the crisis.
There is an idea on the part of developing countries that prescribed behavior democracy, human rights, environmental concerns will lead to cheap, long-term money. It is quite possible that the advice of the post-war period for development of war-ravaged areas was good for the early days of developing markets, coupled with large amounts of money when none other was available. But it may be that growth, at whatever cost, is more necessary. And post-war Japan under General MacArthur and Chile under Pinochet were hardly paragons of democratic virtue. The advice prescription from complexity is to adapt to the times.
The financial collapse in Russia has further lessons. The IMF has come to be viewed as global lender of last resort during a liquidity crunch, though this role was not spelled out at Bretton Woods. And the crisis has shown the institution to be no longer effective on the global scene. It is out of money, with the US Congress, among others, refusing to give it more, and it is unable to stop the flow of crisis from Asia to Japan to Russia, potentially back to China, Eastern Europe, and maybe even back to the United States. The system is broken and it seems unlikely that we can fix it at the same time as we are putting out fires. Building a new "international financial architecture" is a global issue and it will take a global
Old ideas are abandoned only when they have proven faulty, and surely many of the premises of the international monetary system have given a resounding signal that they are no good. Despite the work and the money spent in studying global economics, we know very little. Largely, we are studying old, outmoded precepts. We can do no harm by accepting the challenge to use complexity to find new ones. When we incorporate the principles of complexity, we have a chance, just a chance, to understand this adaptive world better.
For example, the conventional IMF view of development says that sound policies tight money, balanced budgets, flexible labor markets will attract capital, boost exports and help promote non-inflationary economic growth. Indeed, much of the work of the IMF is offering macroeconomic policy advice that politicians can sell as their own, and promoting microeconomic reforms that might otherwise be politically unacceptable. A complexity view, in contrast, suggests that economies are not necessarily homogeneous and that growth can come in many forms: through internal demand as in China as well as through exports as in the Asian tigers prior to the crisis.
There is an idea on the part of developing countries that prescribed behavior democracy, human rights, environmental concerns will lead to cheap, long-term money. It is quite possible that the advice of the post-war period for development of war-ravaged areas was good for the early days of developing markets, coupled with large amounts of money when none other was available. But it may be that growth, at whatever cost, is more necessary. And post-war Japan under General MacArthur and Chile under Pinochet were hardly paragons of democratic virtue. The advice prescription from complexity is to adapt to the times.
The financial collapse in Russia has further lessons. The IMF has come to be viewed as global lender of last resort during a liquidity crunch, though this role was not spelled out at Bretton Woods. And the crisis has shown the institution to be no longer effective on the global scene. It is out of money, with the US Congress, among others, refusing to give it more, and it is unable to stop the flow of crisis from Asia to Japan to Russia, potentially back to China, Eastern Europe, and maybe even back to the United States. The system is broken and it seems unlikely that we can fix it at the same time as we are putting out fires. Building a new "international financial architecture" is a global issue and it will take a global
Thursday, March 31, 2011
Martin Barnes, the International Money Expert
Martin Barnes has a tough job. He took over the editorship of the Bank Credit Analyst, the leading newsletter of international monetary commentary, from Tony Boeckh, who put the publication on the map. Following Boeckh, who in turn had succeeded the newsletter's founder, Hamilton Bolton, was no simple task. Barnes had to be balanced but appeal to the generally conservative, absolute return clientele that he served. And he did it in a masterly way so that now the BCA, as the monthly publication is informally called, carries his stamp. Barnes is the serious Scot of literature. But talking about finance and global figures brings forth a twinkle. He finds global finance a world of amazement and wonder. And his charge is to survey it all, to sort and make something of the pieces he likes. He brings a classicist's range of intellect to the task. And numbers are the language of his choice. Give him a set of data, and he is likely to produce a chart, perhaps going back fifty years, illustrating a parallel to the conditions he sees today.
Barnes is a real long-termer in a market where the long term typically means a week or a little longer over holidays. Thus he has trouble with the market demands of hour-by-hour trading insights. His tools are not that fine but rather suited to cycles: one of his favorites, for example, is long-wave dynamics, which have a periodicity of about 60 years. But Barnes balances the demand for nowism with perspective. And he, Boeckh and their colleagues have broadened the geographic coverage of the BCA and its stablemate publications in the BCA group to cover with equal intensity every developed market, most major developing ones and all instruments. If you had to choose between a daily chart book or the BCA, you would be better off taking Barnes' work. It not only tells you where you are on the investment map but, more importantly, which map you have.
Barnes' research and writing cover a broad spectrum of subjects of relevance to investors. In the past few years, he has written extensively about new technologies and long-wave cycles, the financial market implications of low inflation and trends in corporate profitability.
What is International Money ?
Investment decisions must increasingly be made with an eye on what is happening throughout the world economy. As barriers to trade and financial flows between countries have come down, the global movement of goods, services and capital has made national economies more and more interdependent. Daily currency flows approximate four months of world trade. A single country's long-term financial plans can be swamped in a few days by ravenous traders sensing weakness. And watertight doors of credit agreements and domestic central banks collapse under the weight of collective monetary movements. In these circumstances, it is no longer possible for governments and central banks to conduct monetary policy at the national level: policy cooperation through international bodies like the IMF and the G-7 has become essential. And it seems certain that a crisis in one part of the world will ultimately affect everyone else. One senses that the private view of government officials and bankers is that something has to be done. But what? Disagreements that were previously guarded now flare in public. Yet all that can be agreed is to form a new committee or meeting group.
The forces of globalization and liberalization have led to major changes in the way central banks go about their principal tasks. Markets have become much more powerful: they discipline unsustainable policies; and they give participants ways to get round administrative restrictions on their freedom of action. This means that central banks have to work with rather than against market forces. Maintaining low inflation requires the credibility to harness market expectations in its support. And effective prudential supervision involves incentive-compatible regulation.
In monetary policy, attempts to exploit a supposed trade-off between inflation and unemployment have given way to a focus on achieving price stability as the best environment in which to pursue
sustainable growth. The intermediate goals of monetary policy have also changed. Monetary targets and exchange-rate pegs have proved difficult to use in practice, and an increasing number of countries have adopted inflation targets, backed up by transparency in the policy-making process and independence of action for central banks.
The objective of financial stability has acquired much more prominence in recent years, following various high-profile mishaps at individual institutions and severe problems in some financial systems. It has become harder to segment different types of financial activity or to apply restrictions to the activities of individual institutions. Systemic stability requires ensuring that financial institutions properly understand and manage the risks they acquire, and hold an appropriate level of capital against them.
The international monetary system has been through a major transformation in the past 25 years. The Bretton Woods system developed at the end of World War II was government-led: official bodies decided on exchange rates and the provision of liquidity, and oversaw the international adjustment process. Now, the system is market-led: major exchange rates are floating; liquidity is determined by the market; and the adjustment mechanism operates through market forces. The job of central banks is to see that market forces work efficiently and that any instability is counteracted. This seems to mean stable and sustainable macroeconomic policies, and, where possible, action to ensure that inevitable changes in the direction and intensity of capital flows do not destabilize financial systems.
Changes in interest rates, inflation rates and exchange rates across the international monetary system are likely to have a significant impact on investments of all kinds. But of overriding importance at this turn of the century is what has become known as the global crisis. What started in the summer of 1997 as a regional economic and financial crisis in Asia had developed into global financial turmoil by the summer of 1998. The troubles spread to Russia with its debt default and currency devaluation; and they have since threatened Latin America. Meanwhile, Japan, the number two
economy in the world, has sunk into a depression from which it seems powerless to recover.
Despite the respite seemingly provided by coordinated interest rate cuts led by the US Federal Reserve, the global crisis is still with us. It seems unlikely that the United States can continue for long to be "an island of prosperity in a sea of depression." In a new and increasingly unstable system, the benefits gained by quickly grasping the dynamics are huge. A scholarly and instinctive approach is needed.
The Future of IPO
Research shows that IPOs are far more likely when valuations are high than when they are average or low. They seem to be fixtures of a bull market an offensive strategy, often cynical though some would say that IPOs follow up markets more than they forecast down markets. But why, for example, did Goldman Sachs decide to cancel its planned IPO as the market turned down in the late summer of 1998? Because the market no longer supported a valuation above what the insiders considered the investment bank to be worth. But as with any IPO, that implies that they were previously planning to sell it for more than they thought it was really worth and that potential buyers were getting carried away on a wave of overconfidence and overselling.
So IPOs should be treated as suspect. A simple trading rule is that if they start selling below the offer price on the first day of settlement, you should stop buying them. And if you are unable to acquire them at the offer price, the deck is stacked against you.
Otherwise, flip to your heart's and wallet's content. But buying new issues should be no different from investing in existing quoted companies, with decisions made on the basis of as much knowledge as you can accumulate on company and price. Supply is always likely to outweigh demand, so you can be highly selective.
Will IPOs be launched over the internet in future, and might that make them more accessible at a reasonable price to the private investor? Certainly, electronic trading is growing many times faster than conventional trading. But the potential for electronic IPOs will be greater when electronic brokers can overcome the traditional resistance of blending conventional selling groups with electronic commerce specialists. At the moment, there are regulatory impediments in the United States that presume new issues will be offered state by state to meet blue sky regulations rather than globally; and paper prospectuses have to be issued, which contain outmoded information compared to what a machine could do in real time.
Electronic IPOs today look more like regular issues with machines rather than telephones. They present only a modest adaptation of the old-fashioned system and maintain the normal agency price structure. However, when there is a combination of market pressure for lower costs, a regulatory framework designed for the advantages of computers and high quality issuers who demand the best technology for their issues, we shall see global electronic IPOs with an open market book, fully disclosed interests and real-time corporate information at issue costs at tiny fractions of money raised.
Monday, February 28, 2011
Counterpoint to IPO
In The Intelligent Investor, Benjamin Graham describes new issues as having a special kind of salesmanship behind them, which calls for a special degree of sales resistance. Brokers are typically rewarded with double and triple commissions for pushing new issues, and their firms earn handsome fees for advice, structure, pricing and support of the aftermarket.
Brokerage firms almost always push their own IPOs, and usually rather aggressively. In the aftermarket support function, advice to customers who have bought the stock is often one-sided. There is little evidence that issuing houses will make sale recommendations to customers who have bought the new issue even if such recommendations are warranted. And if an analyst forgets and does recommend an action counter to the distribution, that analyst will have new opportunities to explore the job market.
Studies have shown that expense control can be an important determinant of long-term investment return. But expenses tend to be ignored during exuberant markets, despite their importance, only attracting attention when markets are declining. And expenses are especially high for IPOs. By the time all underwriting and service expenses are accumulated, charges of 510% of an offering price are the norm. High sales charges are one of the incentives for sales people to push new issues and there are all the legal, accounting and corporate expenses that must be covered.
While privatizations around the world might seem attractive following investors' positive experiences with the UK, there are numerous complications with overseas IPOs on top of the regular difficulties of global investing. These include international differences in accounting practices and settlement arrangements; the identity and reputation of the sponsor; the language in which the prospectus is written; whether some issues are not available to non-residents; and the procedures for scaling down an application in the event of oversubscription. For example, if a German stock is oversubscribed, a non-euroland investor may suffer considerable exchange losses converting in and out of euros. In a great many countries, investors will have difficulty in getting the information needed, and a good broker heavily involved in this kind of business will often be hard to find.
New issues and privatizations in developing markets can cause additional conflicts. Brokering and banking may be combined so that an investment banking manager may have to offer interim financing to win the IPO business. Sometimes this link can bring down a top-notch firm like Peregrine in Hong Kong, which failed because it tied a $250 million loan guarantee to an Indonesian taxi company to tide it over until a share offer could be arranged. In between the loan guarantee and the planned share offer, Indonesia had a currency crisis and Peregrine had a balance sheet crisis.
It is conceivable that similar problems may arise as US banks get back into the new issues market. After the Depression, banking and securities were separated, but now they have come back together to meet international competition. It is possible that Goldman Sachs was close to going bankrupt in the British Telecom IPO because of a guarantee similar to that provided by Peregrine in Indonesia.
Brokerage firms almost always push their own IPOs, and usually rather aggressively. In the aftermarket support function, advice to customers who have bought the stock is often one-sided. There is little evidence that issuing houses will make sale recommendations to customers who have bought the new issue even if such recommendations are warranted. And if an analyst forgets and does recommend an action counter to the distribution, that analyst will have new opportunities to explore the job market.
Studies have shown that expense control can be an important determinant of long-term investment return. But expenses tend to be ignored during exuberant markets, despite their importance, only attracting attention when markets are declining. And expenses are especially high for IPOs. By the time all underwriting and service expenses are accumulated, charges of 510% of an offering price are the norm. High sales charges are one of the incentives for sales people to push new issues and there are all the legal, accounting and corporate expenses that must be covered.
While privatizations around the world might seem attractive following investors' positive experiences with the UK, there are numerous complications with overseas IPOs on top of the regular difficulties of global investing. These include international differences in accounting practices and settlement arrangements; the identity and reputation of the sponsor; the language in which the prospectus is written; whether some issues are not available to non-residents; and the procedures for scaling down an application in the event of oversubscription. For example, if a German stock is oversubscribed, a non-euroland investor may suffer considerable exchange losses converting in and out of euros. In a great many countries, investors will have difficulty in getting the information needed, and a good broker heavily involved in this kind of business will often be hard to find.
New issues and privatizations in developing markets can cause additional conflicts. Brokering and banking may be combined so that an investment banking manager may have to offer interim financing to win the IPO business. Sometimes this link can bring down a top-notch firm like Peregrine in Hong Kong, which failed because it tied a $250 million loan guarantee to an Indonesian taxi company to tide it over until a share offer could be arranged. In between the loan guarantee and the planned share offer, Indonesia had a currency crisis and Peregrine had a balance sheet crisis.
It is conceivable that similar problems may arise as US banks get back into the new issues market. After the Depression, banking and securities were separated, but now they have come back together to meet international competition. It is possible that Goldman Sachs was close to going bankrupt in the British Telecom IPO because of a guarantee similar to that provided by Peregrine in Indonesia.
IPO analysis Guru: Ivo Welch
Finance professor Ivo Welch has an excellent ''resource page" of IPO data, literature and links on his website. One feature is an assessment of the twin phenomena of short-run underpricing and long-run underperformance of new issues. On the first point, Welch notes that the typical IPO underpricing the return from the offer price to the price when the market starts trading is about 10%, an astonishing figure for an average daily return. He asks why issuers "leave so much money on the table" and suggests a number of reasons: When applying for shares in an IPO, you will typically get all the shares you requested if it is overpriced you are a victim of the winner's curse. But when an IPO is underpriced, you will only get shares on rare occasions, especially if you are not a favored client of the underwriters. As a result, you come out down on average and are unlikely to apply for shares in a fair-priced offering. So to get you to participate at all, issuers set a lower price, and while it appears that the average IPO leaves money on the table, the typical investor cannot profit from it.
Issuers like to donate some money to investors since they may want to return later for further funds. Investors will remember how good a deal they got with the IPO.
Underpricing solicits information from investors about their potential interest. Why would investors tell underwriters they like an offering unless they know that by doing so, the underwriter will give them more shares for a better price?
If one important investor defects, maybe all investors will follow. Hence, to ensure the first investor does not defect, it is better to play it safe and underprice.
There is an agency problem for the issuer: because underwriters naturally prefer easier to harder work (especially when the price is high, which makes selling difficult), it is best to make selling a little easier for them and underprice.
While IPOs can be very profitable for institutions with relatively short investment horizons and which have access to them at their offer price, this is rather like a quick payback for early support. For in the longer term, new issues are not attractive investments. A significant body of evidence indicates that on aggregate, they have underperformed the market, typically 3050% below comparable companies over three- to five-year periods. A study by Tim Loughran and Jay Ritter discusses some of that research and presents their own findings, which confirm IPOs' poor performance.
How can this long-run underperformance be explained? Welch explores the two most prominent explanations, the first of which is that corporate managers are smarter than the market and thus good at timing, taking advantage of overpriced stock. The second is that managers manipulate earnings, past and forecast, dressing IPOs up for sale. While analysts advising investors should spot these exaggerated figures, they are paid by firms in the business of selling IPOs.
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