One, two, three, forex

Basics of foreign exchange


During the United States occupation of Iraq, at the American coffeehouse Starbucks, Bill Burbank made money by selling the same. From Middle Eastern suppliers, he bought 950 units of the Iraqi currency, the dinar, for a dollar – and sold them to Americans at the café to the tune of 500 dinar for a buck.  That was nearly double the original price.

Even amid the bloody occupation, speculators bought the dinar because they anticipated that Iraq would someday regain its feet and export oil, expanding its economy. As spending on Iraqi goods rose, demand for the dinar would increase, propelling its international price and blessing those who had bought it cheap.

That cunning typifies the market for foreign exchange (forex): Most currency trades are not to buy foreign goods but to take profits. In Kazakhstan’s stock exchange, dollar-and-tenge trades account for 99% of the forex market, averaging $4.8 billion (710 billion tenge) per month. Trading has been volatile but rising throughout 2012, according to data from the National Bank of Kazakhstan.

Most forex consists of bank deposits that traders swap – for example, a dollar account for a euro account.  Swaps are easy in such a gargantuan market. By 1998, daily trading in traditional forex products alone, such as spot trades, was already $1.5 trillion. Future market growth will depend on whether expansion of world trade will offset the tendency to simplify transactions by adopting a major currency. The euro reduced forex trading between European countries, but entry of post-Soviet nations into world markets increased it, noted the New York branch of the U.S. central bank, the Federal Reserve.

Getting a head in the forex market

Half of all trades occur in the United Kingdom or the United States. Traders prefer London for its time zone; its morning corresponds to the late hours of Asian and Middle East markets, and its afternoon overlaps the morning hours of North American markets. By trading through London, a seller can find as many buyers as is possible, and vice versa, said the New York Fed.

Almost 90 percent of all trades involve the dollar, partly because it offers thick markets. Suppose that you would like to sell Kazakhstani tenge for Philippine pesos. Probably you will trade the tenge for dollars, then the dollars for pesos. The market for either currency in dollars is thicker than is the market of tenge for pesos, so the exchange rates for the dollar reflect better information. The dollar is a vehicle currency.

Between the two world wars, the dollar and the British pound sterling – so called because it was originally a pound of silver – were vehicle currencies. But as America's economy waxed and Britain's waned, the dollar supplanted the pound. Momentum for the dollar reinforced itself. As fewer people used the pound, it became harder to find someone who would sell it at the price you sought, so you would buy the dollar instead, explained the former Fed chairman Alan Greenspan. Someday (but certainly not today), the euro may challenge the dollar as the vehicle of choice, suggested Mark Wynne.

The dollar also plays a riskier role. In 2004 – and, for that matter, in 2012 -- speculators took advantage of low interest rates in the U.S. to borrow dollars in order to buy currencies that paid a higher rate of return. The dollar is a funding currency.

Since it is widely accepted, the dollar is convenient in black-market transactions such as drug deals. Here the euro may supplant the dollar. The largest U. S. denomination is the $100 bill, which is mostly held overseas, reported Michael Lambert and Kristin Stanton. The Europeans offer a 500-euro bill, worth about $650, which would enable black marketers to carry their ill-gotten gains inconspicuously.

International transactions both demand and supply foreign exchange. The Kazakhstani importer of a Japanese car must pay for it with yen. To obtain them, he pays tenge to his bank, which then cuts a check denominated in yen for the Japanese bank. The Kazakhstani bank’s yen come from Japanese importers of our oil, who pay their home currency to obtain tenge.

A generation or so ago, most forex trades paid for imports and exports. Today, financial transactions dominate the market. Mutual funds trade forex to improve their rates of return. So, speculators may plague any nation that tries to steady its exchange rate. When they assailed the franc in 1992, the finance minister recalled -- with a twinge of nostalgia --  that they had been decapitated during the French Revolution. Moral for risk lovers: Don’t lose your head. –Leon Taylor, tayloralmaty@gmail.com

Good reading

Federal Reserve Bank of New York. The foreign exchange market in the United States. Online. A worthy primer.

Robert L. Hetzel. German monetary history in the second half of the twentieth century: From the deutsche mark to the euro. Federal Reserve Bank of Richmond, Economic Quarterly. Spring 2002. Online.  The source of the story about the French Revolution.

Craig Karmin, Bullish on Iraq: Average Joes place bets on the dinar. Wall Street Journal. April 23, 2004.  Page A1. The source of the Starbucks story.

Mark Wynne. European Economic and Monetary Union (EMU). Federal Reserve Bank of Dallas, Expand Your Insight. February 1, 1999. Online.


References

Alan Greenspan. The euro as an international currency. Federal Reserve Board. November 30, 2001. Online.

Steve Johnson, Dollar drifting dangerously on overseas capital flows. Financial Times. March 19, 2004.

Michael J. Lambert and Kristin D. Stanton. Opportunities and challenges of the U.S. dollar as an increasingly global currency. Federal Reserve Board, Federal Reserve Bulletin. January 8, 2003. Online.

Pulling the trigger

When does stability destabilize?


Since February 2009, when the national economy was in the throes of a slowdown, the central bank has held the value of the currency to about 150 tenge to the United States dollar. This stability has surely made Kazakhstan more attractive to foreigners intent on building factories. But it also comes at a cost.

By defending the tenge’s foreign value, the National Bank deprives itself of the power to defend the currency's domestic value. Inflation may result. For example, suppose that world demand rises for the tenge, strengthening its foreign value to 120 tenge to the dollar. To bring the exchange rate back to 150 tenge, the National Bank may have to create more currency in order to satisfy the new demand. We thus have more tenge chasing the usual amount of products. Domestic prices will rise. In fact, Kazakhstan had an inflationary spike in April 2008, when consumer prices momentarily rose by more than 10% over the previous April. Although inflation is usually lower in Kazakhstan than in Russia, the former’s economy remains vulnerable to it.

What should sharpen our sense of danger is that a small open economy like ours faces a relatively large global demand for its currency. Changes in that demand can rock the tenge. When world oil prices escalate, demand will rise for Kazakhstani oil – and the tenge will rise, too. This is not an immediate problem, especially since one of our largest oil customers, China, has seen its economy cool off this year. But oil prices are volatile, and their sudden surge may force the National Bank to act so quickly as to create uncertainty about domestic prices. This may lead consumers to cut back spending – creating for themselves a nest egg – until they are surer of where the economy is headed. Due to less spending, Kazakhstan’s economy may stagnate.

In this light, we may be troubled that the rate of spending a tenge – called “velocity” -- has fallen steadily since 2000 (see the Notes). Velocity equals total spending on Kazakhstan products divided by the number of tenge. Evidently, the supply of tenge (cash and checking deposits) has long risen more rapidly than total spending has. The possibility of steep inflation someday is hard to dismiss. If, in some episode, the National Bank suddenly prints tenge in order to hold down the exchange rate, then it may trigger the inflation that has long remained latent. –Leon Taylor, tayloralmaty@gmail.com


Notes

1. For the M1 money supply, annual velocity has fallen from 4.0 in 2000 to 1.9 in 2011. The raw data for this calculation is from the National Bank of Kazakhstan.

Are we living in the fast lane?

Is the Age of Scarcity upon us?

If we could forecast the scarcity of such natural resources as oil, then we could remove much of the uncertainty in Central Asian economies that frightens investors. But analysts disagree over the extent of scarcity, largely because they differ over how to measure it.

Perhaps the most famous study of scarcity, by Harold Barnett and Chandler Morse, examined the cost of extracting resources in the United States from 1870 (the end of the Civil War era) to 1957. They treated rising extraction costs as signals of growing scarcity. In most extractive industries, unit costs fell, particularly after 1890. In fact, they fell even faster than those for non-extractive industries. The exception was the forestry.

Follow-up work found that extraction costs fell even more steeply from 1957 to 1970 – and that they kept falling in the 1970s for ferro alloys and nonferrous metals, noted a resource economist, Jeffrey Krautkraemer. However, extraction costs for coal and oil rose in the United States throughout the Seventies. Whether this was due to scarcity or to OPEC is a matter of conjecture.

Barnett and Morse explained that when extractors exhausted high-grade resources in most industries, they would discover low-grade resources in even greater abundance. Also, the rise in the price of a resource that has become scarce for a while would induce searches for new deposits and cheaper substitutes. Innovation has sharply cut extraction cost “even as the quality of exploited deposits has declined,” observed Krautkraemer.


Keep these data under your hat

Writing in 1963, Barnett and Morse didn’t consider the cost of energy in extraction. In 1991, Cutler Cleveland found that the costs of labor and manmade inputs (capital) in extraction had fallen because extractors were replacing these with fossil fuels. Were fuels becoming more scarce, then extraction costs in general should rise (which is exactly what some statistical studies of the Seventies didn’t find). Data on extraction cost are hard to collect, because producers regard them as confidential. And as a measure of scarcity, extraction cost is flawed because it looks backward; it does not directly reflect expectations of scarcity.

A measure that does reflect expectations is the cost of exploring for another unit of resources. An expected increase in profits down the road will fuel exploration and thus push up its cost at the margin.

Unless we find cheap new ways to extract resources, or to substitute for expensive ones, resource prices will eventually rise because of scarcity. The prices may follow a U-shaped curve over time, falling and then rising. In 1982, Margaret Slade reported evidence of this curve in the prices of 11 of 12 metals and fuels studied over the period from 1870 to 1978. Other studies confirm that the prices of exhaustible resources don’t always rise or fall. However, not all of such prices kept rising after the 1970s, which is what a U-curve price path might suggest.


It’s about time

Most statistical analyses of resource scarcity use data that change over time, called “time series.” An example is the annual price of oil from, say, 1970 to 2010. The methods used to examine time series have changed dramatically over the past 30 years. Old methods assumed that the basic traits of a time series did not change over time. For example, the price of oil would have the same basic average in any year, although random events – such as Mideast wars -- may cause the observed price to differ from this fundamental average in a particular year. Today, we know that most economic time series do change in basic ways over time. For example, the value of production in the United States – gross domestic product – has usually risen for two centuries. It would be difficult to argue that GDP has the same fundamental average now as it had in 1812. GDP is “nonstationary.” For such a time series, the usual statistical model is not accurate, because it assumes that given factors, such as the number of workers, will affect GDP in the same way over time when in fact the response of output to labor is changing. Unfortunately, this was the approach taken by many statistical studies of resource prices in the early Eighties.

One way to handle nonstationarity is to put the time series into a form with essential characteristics that do not change over time. Such a form is “stationary.” Although GDP may be nonstationary, the annual change in it may well be stationary. Another approach is to estimate a GDP model that explicitly controls for a time trend. In either case, once the time series is rendered stationary, we can apply the usual statistical techniques to it, since we no longer need to worry that the estimated parameters, which are assumed constant over time, may mislead us. We can then reverse-engineer the model in order to get forecasts of the original variable – say, in the level of GDP rather than its annual change. (The Notes offer an example.)

In 1996, Peter Berck and Mike Roberts took this approach in estimating the price paths of natural resources like oil. From an extension of Slade’s dataset, they used the annual price changes for their stationary time series. They found “only a weak supposition that natural resource prices will rise….We would predict rising prices but be much less surprised about being wrong than were the previous authors.” Price increases were most likely for zinc and copper. The Age of Scarcity remains a strong possibility, but it is not entirely clear that it already engulfs us. – Leon Taylor, tayloralmaty@gmail.com



Notes

Suppose that we estimate the following model for the price of oil in year t: P(t) = 2 P(t-1). According to this model, whenever the price of oil rises by one dollar in the previous year (t-1), it will rise by two dollars in the current year (t). This model may work fine for the time period over which it was estimated – say, from 1970 to 1990. But if the time series for oil prices is nonstationary, then the model may not fit other time periods. Using it to forecast the 2013 price of oil would be futile.

Suppose, then, that we estimate a model for the annual change in oil prices. Denote this change as D(t) = P(t) – P(t-1). Suppose that our new model is D(t) = .5 D(t-1). Also suppose that D(t) is stationary. Then the new model would fit time periods in general, and we could use it to forecast the 2013 price of oil. To do this, note that we can write the new model as P(t) – P(t-1) = .5 D(t-1). Rearrange this: P(t) = P(t-1) + .5 D(t-1). Specifying the values of these variables will give us the forecast: P(2013) = P(2012) + .5 D(2012). For example, if P(2012) is $100 and D(2012) is $10, then the forecast for 2013 is $105.



Good reading

J. A. Krautkraemer. Nonrenewable resource scarcity. Journal of Economic Literature 36(4). 1998. Pages 2065-2017.



References

Harold Barnett and Chandler Morse. Scarcity and growth: The economics of natural resource availability. Baltimore: Resources for the Future. 1963.

Peter Berck and Michael Roberts. Natural resource prices: Will they ever turn up? Journal of Environmental Economics and Management 31. 1996. Pages 65-78. Online as Working Paper 699, California Agricultural Experiment Station, Giannini Foundation of Agricultural Economics.

Cutler J. Cleveland. Natural resource scarcity and economic growth revisited: Economic and biophysical perspectives. In Robert Costanza, editor, Ecological economics: The science and management of sustainability. New York: Columbia University Press. 1991.

Margaret E. Slade. Trends in natural resource commodity prices: An analysis of the time domain. Journal of Environmental Economics and Management 9. 1982. Pages 122-137.

Is the world still running out of oil?

Can Kazakhstan count on the blessing of rising oil prices?


When people forecast continued growth of the Central Asian economy, they usually assume that the prices of natural resources – such as oil, natural gas, and gold – will keep growing, too. How likely is this?

Those who foresee price hikes point out that as population and income keep growing, so will the demand for natural resources. Some resources, like oil, are finite; others, like whales, grow slowly. When demand for a resource grows faster than supply, its price will increase.

How can we tell when we may reach the point of scarcity for resources in general?

This is an old problem. In 1980, the late economist Julian Simon challenged biologist Paul Ehrlich (author of The population bomb) to a $1,000 bet over whether resources were becoming more scarce. Ehrlich invested $200 in each of five metals on the commodities market: Copper, chrome, nickel, tin and tungsten. In 1990, the bettors would assess the new prices of the metals.

Exploration may mitigate oncoming scarcity. The oil firm will spend more money to discover deposits until the additional bit of revenue from another discovery equals the additional cost. Up to that point, exploration tends to be profitable because the firm begins with its best prospects – fields that promise to yield a lot of oil at a relatively low cost.

New technology also delays exhaustion. For example, pelletization lowered the cost of producing steel, noted economist Tom Tietenberg. The producer extracts iron ore from taconite ore of a low grade and processes it at the mine. This cuts labor and energy costs.

Finally, when one resource becomes too costly to extract, we can often substitute a cheaper resource for it. To produce electricity, Kazakhstan has plans to substitute nuclear energy for coal-burning that incurs such environmental costs as air pollution that aggravates lung disease and carbon gases that strengthen global warming. Looking at the big picture, H. Goeller and Alvin Weinberg foresaw that, over the centuries, an “age of substitutability” would dawn in which virtually inexhaustible elements would replace the fossil fuels. “To reach this state without immense social disruption will, however, require unprecedented foresight and planning.”


The good ol’ days of copper


Indeed, the price increase of the exhaustible resource may induce firms to develop its substitute, in order to earn profits. Copper telephone wires today are valuable only to nostalgia buffs.

How can we gauge imminent scarcity? The most popular measure is the ratio of reserves to current consumption. If oil reserves are 40 times annual consumption, then we supposedly would run out of oil in 40 years.

Since the reserve-to-use ratio is a physical measure, it would make sense to count as reserves the entire endowment of the resource. In 1976, Goeller and Weinberg did just that, defining the endowment as the atmosphere, the oceans, and a one-mile-deep layer of earth. They computed reserve-to-use ratios for every element in the periodic table and for some compounds. The common element that would run out first, phosphorous, would last 1,300 years. For most elements, supply was practically unlimited. Exceptions included trace elements used in farming (cobalt, copper and zinc) -- and the fossil fuels (oil, coal and natural gas), “by far the most important scarce natural resource[s].” Some assumptions underlying the study may have been strong: Lower grades contained more of the resource; the economic and environmental costs of extraction were not prohibitive.

The reserve-to-use ratio is easy to interpret -- but inaccurate, because it treats scarcity as a physical concept. In truth, the market determines scarcity if we define it as unsatisfied demand at the given price. Such scarcity raises the price, which discourages consumption and encourages production, obviating the scarcity, be it physical or economic. In this cornucopian perspective, Goeller and Weinberg overstate the need for planning. A drop in the reserve-to-use ratio may predict impending abundance about as well as it does an impending shortage. In 1960, use-to-reserve ratios for gold, lead, mercury, silver, tin and zinc were less than 30 years. But we still have all of these resources.

So why not use movements in the market price to gauge whether scarcity in the near term is rising or falling? Well, markets are not well defined for all resources. The unregulated market for coal takes no account of the illnesses and storms that arise from coal burning, since a particular illness cannot be traced back to a particular power plant. The market price for coal is too low. The “market” for the fishery is a misleading concept, since no fisher owns a migratory school of fish. Since no fisher gains from conserving the school that he happens to be harvesting today, he will overfish. The result is that the price of fish is too low, because it does not represent the loss of fish to future consumers that occurs through overfishing.


Simon says…


Another possibility is to look at the profit rate for extracting, say, oil. The oil producer can choose between drilling and selling the oil today or doing so next year. If oil is becoming more scarce over time, then next year’s price ordinarily would be higher than this year’s, even though we adjust for inflation. To prevent a loss of profits, the oil producer would raise his price this year. The greater the expected scarcity, the greater the boost in the current price. This boost, called “scarcity rent,” thus measures expected scarcity. An example is the stumpage fee that timbermen pay for the right to cut.

Being a price increase, the scarcity rent is subject to the same weaknesses as a measure of scarcity as is the market price. In an unregulated market, an increase in pollution costs over time will not show up in the scarcity rent. And even when the rent accurately measures expected scarcity, it will not indicate whether this arises from an expected increase in demand or an expected decrease in supply.

Despite their flaws, economic measures of scarcity, such as the market price and the scarcity rent, at least account for a dimension that physical measures, like the reserve-to-use index, ignore – human behavior. Which brings us back to Simon’s bet.

In 1990, the market prices for all five metals in the bet had fallen, reported John Tierney. Ehrlich paid Simon $576. Simon then challenged Ehrlich to a $10,000 bet, based on any resources that Ehrlich wished to choose. Ehrlich took a pass. – Leon Taylor, tayloralmaty@gmail.com


Good reading

Harold Barnett and Chandler Morse. Scarcity and growth: The economics of natural resource availability. Baltimore: Resources for the Future. 1963.

H. E. Goeller and Alvin M. Weinberg. The age of substitutability. American Economic Review 68. December 1978. Pages 1-11. Reprinted from Science, February 20, 1976.

J. A. Krautkramer. Nonrenewable resource scarcity. Journal of Economic Literature 36(4). 1998. Pages 2065-2017.

Bjorn Lomborg. Environmental alarmism, then and now. Foreign Affairs. July/August 2012.

John Tierney. Betting on the planet. The New York Times Magazine. December 2, 1990.

Tom Tietenberg. Environmental and natural resource economics. Boston: Addison Wesley. Seventh edition. 2006. Chapter 14 discusses generalized resource scarcity.

Where’s the silver lining?

Are the banks of Kazakhstan long on cash and short on chutzpah?


A stark lesson of the 2008-9 financial crash is that reckless lending in real estate can create a price bubble that perpetuates itself…for a while. The complement may also hold: A lack of lending inhibits future loans. The hesitation of banks to lend conveys a pessimism about the economy that eventually infects potential investors.

Real estate and construction loans still comprise a large share of the loan portfolios of some banks, including 45% of Kazkommertsbank’s and nearly three-fourths of BTA’s, reported the business weekly Delovaya Nedelya. This concentration contributed to Standard & Poor’s downgrade three weeks ago of Kazkommertsbank, from “stable” to “negative.” Real estate prices have fallen by half since the bubble burst in mid-2008, reducing the collateral backing the loans, which themselves are often delinquent, noted Standard & Poor’s.

In general, construction's share of all industrial bank loans in Kazakhstan fell steadily after March 2011, when it was 19.1%, and most sharply after October 2011, falling to 14.9% by January 2012, or 3.2 percentage points lower than in January 2011, according to the National Bank of Kazakhstan.

Is this cooling-off auspicious? The answer is unclear. A rising share of construction in the economy (measured as gross domestic product, or GDP) is not always troubling. In an economy expected to grow rapidly, firms may add buildings in order to house future inputs. At present, investors do not seem to anticipate the 10%-plus rates of annual economic growth that Kazakhstan enjoyed before the financial crisis. Adjusted for inflation, the value of new physical capital in Kazakhstan has grown slowly or stagnated for several years. This hardly signals great expectations for the economy. The IMF projects a rate of economic growth of 6% or so through 2017.

Perhaps the country is still digesting the effects of the construction bubble. Adjusting for inflation, investment in fixed capital (durable and immobile inputs) in Kazakhstan was the same in 2011 as in 2010. New floor area in Kazakhstan more than tripled from 2003 to 2008, from 2.1 million square meters to 6.8 million, before leveling off at 6.4 million square meters in 2009 and 2010, according to the national statistical agency.

The cities dominate new construction. Almaty and Astana account for 38% of all new floor area in the country. This statistic leveled off in Almaty in 2010, at 1.1 million square meters; but it kept rising in Astana, to 1.4 million square meters. Although construction loans endangered the banks in 2008, new floor area kept increasing in the cities and is growing slightly faster in the oblast surrounding Almaty than in the city itself.

Bank credit in Kazakhstan grew 15% over 2011 after stagnating for three years, noted the International Monetary Fund (IMF). The banks still have lots of money that they could lend but don’t. Instead, they park much of it at the central bank (basically, the banks’ bank). The National Bank of Kazakhstan held as much as 5.5% of their assets in 2009, when their dread of risk was understandable, and 3.1% as late as March 2012, according to the IMF.


Pay it again, Sam


Not all of this mattress-stuffing is due to timidity. Some banks can’t lend their excess funds to those short on money, because the interbank market is sketchy. Other banks can’t find good borrowers. Real estate and construction firms propose fewer projects than before the crash.

Finally, the banks are saddled with bad debt. As a share of all loans, “nonperforming” ones (no interest paid in 90 days) quadrupled in 2009 to 21.2%...and kept rising, to 31.9% by March 2012. For BTA, which the government took over, it’s 80%. Moreover, overdue interest has increased from 2% to 7% of all bank assets. For banks like BTA that are trying to recover from bankruptcy – the polite term is that they have “restructured” – the figure rose from 3% to 17%. This suggests that the bad-loan ratio is higher than reported, said the IMF. However, the bad-loan ratio varies considerably from bank to bank. For Halyk, it is 8.3%, said Standard & Poor’s.

In general, the banks’ lack of lending renders them unprofitable. Their rate of return on assets was zero or negative from 2008 through 2010 and was only 1% in 2011, reported the IMF. In addition, a measure of the banks’ inability to cover bad loans – the assets-to-capital ratio – has been rising for more than two years.

“In the end, restoring the banking systems’ health requires recapitalizing viable banks and restructuring or closing unviable ones,” writes the IMF (wisely neglecting to define “viability”). “Capital shortfalls [roughly, the lack of money on hand to cover bad loans] represent public contingent liabilities, given the need to protect depositors and the fact that [Samruk-Kazyna, a government holding company] is the biggest shareholder in several large banks.” The capital shortfall for BTA alone is 2.5% of GDP. The government’s “Too Big to Fail” policy may be leading to another: “Too Big to Do Anything But Fail.” – Leon Taylor, tayloralmaty@gmail.com


Good reading

International Monetary Fund. Republic of Kazakhstan 2012 Article IV consultation. 2012. www.imf.org


References

National Bank of Kazakhstan. Statistical bulletin. Various issues. www.nationalbank.kz

Reuters. TEXT-S&P revises Kazkommertsbank's outlook to negative. July 31, 2012. Online.

Semen Skarga. Kazkommertsbank prodolzhaet “zarivat’sa” v nedvyzhymost’. (Kazkommertsbank continues to “bury itself” in real estate). Delovaya Hedelya.  August 10, 2012. Page 1.

Genuine coin of the realm

The contents of the envelope were thousand-dollar bills, smooth and stiff and new. Spade took them out and counted them. There were ten of them. Spade looked up smiling. He said mildly: “We were talking about more money than this.”

“Yes, sir, we were,” Gutman agreed, “but we were talking then. This is actual money, genuine coin of the realm, sir. With a dollar of this you can buy more than with ten dollars of talk.”


I think of that passage from Dashiell Hammett’s classic detective novel, The Maltese falcon, whenever I hear happy talk about Kazakhstan’s allegedly resurgent economy. The usual story is this: Because foreign investors, in such surveys as Ernst & Young’s, say they believe in Kazakhstan, the nation will surely attract investment dollars that will pump up its economy. That’s not even five dollars of talk. Let’s look at what investors actually do.

Since the financial crisis of 2008-9, investment – which is the addition to manmade inputs of production -- has stagnated in Kazakhstan. Adjusted for inflation, the value of annual investment in fixed (i.e., durable) capital here was 1.8% lower in 2011 than in 2008. An index for the amount of physical investment in Kazakhstan fell steadily, and by nearly a fourth, from 2005 through 2011. Unfortunately, the national statistical agency, which publishes the index, is habitually careless and nowhere explains how it constructed the index or even defines it. But the index conveys a general sense of stagnation. Over the seven-year period, it fell in every oblast and in Almaty.

The exception was Astana, where the index rose by 15% over the period. This may partly reflect the stability of spending by the national government, which could attract lobbyists. As a share of gross domestic product (GDP), government spending in Kazakhstan peaked at 26.9% in the crisis year of 2008 and since has held steady at about 24%, according to the International Monetary Fund. By global standards, Kazakhstan’s government is small, as measured by its share of GDP; but its concentration in Astana makes the city a convenient target for investment. From 2003 through 2011, the real value of annual investment in fixed capital in Astana rose 240%.

Compared to that in Astana, investment in Almaty is struggling. From 2003 through 2011, the real value of investment in fixed capital rose only 75.7%, the second-slowest pace of the 16 areas in Kazakhstan. This annual investment had been about a fourth higher in Almaty than in Astana – until the financial collapse of 2008-09. Astana rebounded; Almaty didn’t. In 2011, investment was 38% higher in Astana than in its older sister city.


Great expectations?

Investment is based on market expectations; for example, a firm will expand its factory only if it believes that more buyers each year will demand its products in the future. Because expectations are ever-changing, investment anywhere is volatile. But it may introduce instability especially into rural oblasts, where the economic base is small. Of the 16 areas of Kazakhstan, from 2005 through 2011, the index of physical investment fell most sharply in the oblasts of Atyrau (38.7%), in the oil-producing region of the Caspian Sea; Kyzylorda (37.4%), east of the decimated Aral Sea; and of Zhambyl (40.9%), a low-income farming area north of Shymkent. Over the period 2003-11, the volatility of the investment index in Zhambyl oblast – where the Asian Development Bank and others are financing a road project worth several hundreds of millions of dollars -- was more than twice as high as in any other region; it also had the highest annual average of the investment index in that period.

In the oblast of South Kazakhstan, the value of investment in fixed capital increased eight-fold. In volume, however, physical investment there fell somewhat more sharply than was average for the nation – by 28% from 2005 through 2011. Perhaps the value of a new unit of fixed capital is rising sharply in the oblast.

In terms of investment, the most quiescent oblast is a rural one -- West Kazakhstan. Only in this area did real investment in fixed capital decline from 2003 through 2011, by 37.9%. It also had the lowest annual average of an index of physical investment from 2005 through 2011.

Judging from what they do – not what they say – real investors are only cautiously optimistic about Kazakhstan and are most enthusiastic about the prospects for political spending. – Leon Taylor tayloralmaty@gmail.com





Notes

All statistics used here are from the national statistical agency unless attributed otherwise.

I used the Consumer Price Index to adjust for inflation, since the CPI measures the opportunity cost of investment in terms of consumption bundles foregone.


Good reading

Dashiell Hammett. The Maltese falcon. 1930.


References

Aleksandr Bogatik. Kazakhstan’s Zhambyl Oblast faces stagnant economy. centralasiaonline.com . July 27, 2010.

Asian Development Bank. CAREC Transport Corridor 1 (Zhambyl Oblast Section) [Western Europe-Western People`s Republic of China International Transit Corridor] Investment Program - Tranche 4 : Kazakhstan. Online.

Economywatch.com . A compendium of economic statistics.

The year of the doddering dragon

Will the slowdown in China’s economy endanger Kazakhstan’s?


China buys one-eighth of the oil and gas exported from Kazakhstan (11 million tons per year; Kazakhstan produced roughly 80 million tons per year in 2010 and 2011), according to Robin Paxton of Reuters. Since oil and gas exports account for roughly a fourth of Kazakhstan’s GDP, a slowdown of the world’s second largest economy could affect us substantially.

The Chinese economy is growing less rapidly. GDP in the second quarter of 2012 grew by the annual rate of 7.6%; the corresponding rate in the second quarter of 2011 was 9.5%. Similarly, GDP in the first quarter of 2012 grew at an annual rate of 8.1%, sharply below the rate of that quarter in 2011. In the world financial crisis of 2008-2009, the growth rate of Chinese GDP fell as far as to 6.6% (which is still twice the current rate of global economic growth). Apparently, GDP in Q1 of 2012 was less than 2% higher than in Q4 of 2011, but much of that change might have been seasonal. Finally, China’s economy may be reacting to the globe’s: The International Monetary Fund (IMF) estimates that recession in Europe may reduce Chinese GDP by as much as 4%, reports Rob Minto of The Financial Times.

Indirect indicators of GDP are also murky. On one hand, industrial production is rising at a healthy annual pace, well over 9%. On the other hand, production of electricity, steel and concrete (an indicator of China’s construction market, the world’s largest) is slowing or falling, noted Keith Bradsher of The New York Times. Fixed-asset investment is down sharply this year, and urban housing prices have been falling since late 2009. These trends suggest that the government recognizes that the economy already has excess capacity. In that event, the GDP slowdown may be temporary.


Easy does it


The Chinese slowdown does not seem likely to affect global oil prices as much as the Eurozone crisis will. The Chinese handled well the global crash of 2008 as well as the Asian currency crisis of 1998, and they have improved their management of inflation over the past 20 years.

A soft landing of their economy seems likely. After resisting interest-rate cuts for three years, the central bank -- The People’s Bank of China -- has cut them twice in a month, amid cooling inflation, reported The Financial Times. This year the Bank also reduced the share of deposits that banks are not permitted to lend out.

Half of the GDP growth of 2012 was in capital spending, which Beijing can stimulate by permitting local governments to invest, according to Nick Edwards and Kevin Yao of The New York Times. Private consumption is only just over a third of GDP, so fiscal policy can be relatively powerful. China’s small debt could enable a fiscal stimulus that packs a wallop: The national government’s debt share of GDP is 25%, as compared to 102% in the United States, wrote Bob Davis and Tom Orlik of The Wall Street Journal. (In China, the GDP share of local government debt is another 22%.)

On the other hand, the fiscal stimulus of 2009-10, which focused on infrastructure, increased the debts of local governments and stimulated inflation. The IMF recommends a stimulus to private spending – tax cuts and subsidies for consumption of durable goods, reported Minto. The private sector’s share of the economy may already be growing: 2011 wages were up by 18%, a bit faster than GDP (with no adjustment for inflation), noted Orlik. Disturbingly, an increase in private or public consumption would likely increase the credit-to-GDP ratio, which was 171% in 2010, up from 122% in 2008, said The Economist.


The IMF forecasts that China’s economy will grow by 8% per year for the next five years, noted Ian Johnson of The New York Times. That had been Beijing’s target rate since 2005 until it lowered it to 7.5% this March. Before the financial crisis of 2008-09, Chinese growth rates averaged over 10% per year.

Financial investors may overstate the Chinese slowdown, to judge from circumstantial evidence. Although emerging market economies are growing more rapidly than developed economies, a stock market index for the former performs worse than is average, reported The Financial Times. The MSCI stock market index for emerging market economies has lost 21.7% of its value in the past year. The global version of that index lost 10.7%. Conceivably, stock markets in emerging economies perform poorly because investors over-estimate the Chinese slowdown and its subsequent impact.


Dragon on a cigarette break


To some degree, the Chinese slowdown may be intentional. The overall saving rate in China is 51%, and Michael Pettis, a finance professor at Peking University, argues that China must increase consumption’s share of its economy in order to provide balanced growth. To do this, China must “get household income to rise from its unprecedentedly low share of GDP,” he wrote in The Financial Times. “This requires China to increase wages, revalue the renminbi and, most importantly, reduce the enormous tax that households implicitly pay to borrowers in the form of artificially low interest rates.” If The People’s Bank does not cut market interest rates as rapidly as the expected rate of inflation has fallen, then real interest rates will rise. China could also boost consumption by providing comprehensive health care, for which households today must save, remarked The Economist.

Chinese demand for crude oil remains at a peak despite the fall in the rate of GDP growth, said UniCredit. If Chinese growth slows to 8% per year, then this could directly reduce Kazakhstan’s GDP by .06 of one percent. Conceivably, the indirect impact on Kazakhstan may be more severe: Each change in Chinese GDP of 1% relates to a change in global oil prices of 10% to 30%, claims Ruchir Sharma of Morgan Stanley. Obviously the estimate could hold only for small changes in the size of the Chinese economy; a fall of just over three percentage points in GDP is not going to cut oil prices to zero.  The dragon is not that powerful. – Leon Taylor tayloralmaty@gmail.com



Notes

Chinese purchases of oil and gas directly generate about 3% of Kazakhstan’s GDP ((1/4)*(1/8) = 1/32). A Chinese slowdown of 2% could decrease our GDP by roughly (1/50)*(1/32) = 1/1600.


References

Jamil Anderlini. China cuts rates amid growth fears. Financial Times. July 5, 2012.

Keith Bradsher. Affirming slowdown, China reports second month of scant economic growth. New York Times. June 9, 2012.

Keith Bradsher. After barreling ahead in recession, China finally slows. New York Times. May 24, 2012.

Bob Davis and Tom Orlik. Beijing's growth tools are limited. Wall Street Journal. May 13, 2012.

Economist. How strong is China’s economy? May 26, 2012.

Economist. Not with a bang. July 28, 2012.

Nick Edwards and Kevin Yao. Hand forced, Beijing opts for old fix. Reuters. Published in New York Times. July 16, 2012.

Leslie Hook and Peter Marsh. Sany job cuts signal Chinese slowdown. Financial Times. July 4, 2012.

Ian Johnson. China’s growth rate slowed in the 2nd quarter. New York Times. July 12, 2012.

Rob Minto. IMF: Europe could hit China, hard. Financial Times. February 6, 2012.

Tom Orlik. Numbers show China’s still working. Wall Street Journal. May 29, 2012.

Robin Paxton. Update 3 -- Kazakhstan sees 50 pct oil export growth by 2020. Reuters. October 4, 2011.

Michael Pettis. A slowdown is good for China and the world. Financial Times. July 23, 2012.

Ruchir Sharma. China slows down, and grows up. New York Times. April 25, 2012.

Jochen Hitzfeld and Kathrin Goretzki. Weekly commodity outlook. UniCredit. July 3, 2012.

Wall Street Journal. Economists React: China GDP Growth Hits Three-Year Low. July 13, 2012.

Bettina Wassener. Slow first quarter in China, but recent signs of growth. New York Times. April 12, 2012.

Robin Wigglesworth. China slowdown fears overstated, says Mobius. Financial Times. July 27, 2012.

Beware of chimps bearing darts

Is KASE as chaotic as it seems?


Kazakhstan’s stock market is as changeable as Almaty’s weather. In May, a sudden drop of two-thirds in the price of Kazakhtelecom stock precipitated a swoon in the KASE index of 12%, reported Bloomberg News. The problem may be general. In the first half of this year, the volume of KASE trading had fallen nearly 13% since early 2011, reported the business weekly Kursiv’.

One can interpret such mercurial price movements in one of two ways. First: The stock market here is not efficient. Trades are few and far between, so the price adjustments that would occur daily, and on a small scale, in a more active market tend to pile up in ours. Second: The market here is efficient, in the sense that it responds right away to new information. The price changes are large not because the market tarries in digesting news but because we know so little about Kazakhstan’s emerging economy that recent events can change radically our perception of it.

KASE is not the only stock market to defy characterization. Three or four decades ago, financial economists thought that markets for stocks and bonds absorbed information quickly (the “efficient markets hypothesis”). If, in 2009, you heard that General Motors was about to go bankrupt – and who didn’t – then you need not have bothered to sell its stock short; other investors had already acted on the information, selling the stock and forcing down its price right away. Only unanticipated events – “news” – can affect current stock prices. Since news, by definition, occurs at random, so do changes in current stock prices. These changes will be independent of previous prices.

In that case, technical analysis, which seeks visual patterns in past stock prices, can’t predict the price. One financial economist, Burton Malkiel, called technical analysis “alchemy.” In a 2000 study, Andrew Lo, Harry Mamaysky and Jiang Wang conceded that “the presence of geometric shapes in historical price charts is often in the eyes of the beholder.” To detect patterns more objectively, they permitted random price movements in either direction to cancel out. Working with a 31-year sample, they concluded that “several technical indicators do provide incremental information and may have some practical value,” especially for a U.S. stock exchange favored by computer firms, Nasdaq.


The chimp paradigm


In lieu of technical analysis, one could comb financial information in search of stocks that are under- or over-valued, given the firm’s apparent strength. But such “fundamental analysis” won’t work if stock prices already reflect enduring information about the firm. You might as well buy shares in a good index fund as to speculate. Malkiel writes: “A blindfolded chimpanzee throwing darts at the Wall Street Journal could select a portfolio that would do as well as the experts.”

Malkiel concludes that stock investors cannot earn unusually high returns without accepting unusually high risks. One thinks of the student who espies a $100 bill on the ground and is about to pick it up. “Don’t bother,” says his economics professor. “If it were really a $100 bill, it wouldn’t be there.” Malkiel argues that there are no $100 bills on the trading floor. Market bubbles may sometimes occur; but in the long run, “true value will win out.”

Recently other economists have questioned the efficient markets hypothesis. Robert Shiller, who popularized the phrase “irrational exuberance,” may be the best-known of these critics. They maintain that patterns in past stock prices can enable investors to earn unusually high rates of return, even when adjusted for risk.

Early work on the efficient markets hypothesis looked for correlation across time in stock prices. Such a connection can enable us to predict tomorrow’s price. Many studies of the 1960s and 1970s failed to find correlation.

But some new studies do. They argue that stock prices move in the same direction often enough not to qualify as “random walks,” in which a price is as likely to rise as to fall. In Irrational exuberance, Shiller offered an explanation: “Investors under-react to new information.” If the full impact of news unfolds only over time, then we may observe positive correlation in stock prices: The higher prices of yesterday link to the higher ones of today.


Fiascos, fads and finance


Malkiel doubts these arguments. The correlations observed in stock prices are too small to yield an unusually good return to the investor. Lo and coauthors say that technical analysis provides “incremental information.” As for the behavioral economists, while fads may pop up from time to time, little evidence suggests that they occur systematically. Malkiel cites a 1998 survey of studies, in which Eugene Fama concluded that investors under-reacted to news about as often as they over-reacted. Also, the returns observed depended on how the model was specified: A study that equally weighted the returns of various stocks after some announcement led to different results than did a study that weighted the returns by value.

In his 2003 article, Malkiel asserts that stock-price correlations appearing in the late 1990s had disappeared by 2000. Some patterns may disappear shortly after publications disclose them because investors take advantage of the information. For example, the “January effect,” in which stock prices rose in early January, no longer seemed to exist.

In the long run, high stock returns fall, and low returns rise. Why? In a widely-cited 1985 study, Werner DeBondt and Richard Thaler looked at whether stock investors over-reacted to “unexpected and dramatic news events,” as people seemed to do in experiments by psychologists. The two authors concluded that investors may over-react to recent events. Stock prices rise or fall, then return to the average. “Portfolios of prior ‘losers’ are found to outperform prior ‘winners’.” Maybe you should buy dogs and avoid beach beauties.

In a study of stocks from 1957 to 1971, Sanjoy Basu found that those with low price-earnings ratios generally earned higher returns (adjusted for risk) than did stocks with high P/E ratios. “Contrary to the growing belief that publicly available information is instantaneously impounded in security prices,” Basu wrote in 1977, “there seem to be lags and frictions in the adjustment process.” In 1983, Basu added: “While neither E/P nor [firm] size can be considered to cause expected returns, the evidence lends credence to the view that, most likely, both variables are just proxies for more fundamental determinants of expected returns for common stocks.”

In principle, the price that one would pay for a stock depends on the size of its expected dividends. (Yes, you may sell your stock before collecting dividends, but the price that you receive will depend on the dividends that the new owner expects.  Even if you do not sell the stock, an increase in its price reflects the market's expectation of higher dividends.) Via market competition, the P/E ratio should tend to be the same for all stocks bearing the same risk. A stock with a low P/E ratio is presumably under-valued, so it should attract buyers. They will push up its price. The initial under-valuation may be an over-reaction to temporarily bad news. And likewise for over-valuation: Behavioral economists think that the stock market is subject to fads. For example, initial public offerings of dot.coms skyrocketed in the U.S. stock markets of the technophilic late Nineties.

Malkiel believed that the strongest evidence for a negative correlation in stock prices over time came from the Great Depression, which might not be a typical period. The negative correlations may result from fluctuations in the interest rate, which also reverts to the mean. When the interest rate rises, you would expect stock prices to fall, since investors may sell their stocks in favor of bonds that deliver a relatively higher return than before. When the interest rate falls back to the mean, demand will shift back to stocks and push up their price. – Leon Taylor, tayloralmaty@yahoo.com




Good reading

Burton G. Malkiel. A random walk down Wall Street: The time-tested strategy for successful investing. W. W. Norton. 2003.

Burton G. Malkiel. The efficient market hypothesis and its critics. Journal of Economic Perspectives 17. Winter 2003.

Robert J. Shiller. From Efficient Markets Theory to behavioral finance. Journal of Economic Perspectives 17. Winter 2003.

Robert J. Shiller. Irrational exuberance. Crown Business. 2006.



References


Sanjoy Basu. Investment performance of common stocks in relation to their price-earnings ratios: A test of the Efficient Market Hypothesis. Journal of Finance 32. June 1977.

Sanjoy Basu. The relationship between earnings’ yield, market value and return for NYSE market stocks: Further evidence. Journal of Financial Economics 12. June 1983.

Werner F. M. de Bondt and Richard Thaler. Does the stock market overreact?  Journal of Finance 40.  July 1985.

Eugene Fama. Market efficiency, long-term returns, and behavioral finance.  Journal of Financial Economics 49. September 1998.

Nariman Gizitdinov and Ksenia Galouchko. Kazakhtelecom retreats most ever as dividend date passes. Bloomberg News. May 16, 2012. www.businessweek.com

Andrew W. Lo, Harry Mamaysky and Jiang Wang, Foundations of technical analysis: Computational algorithms, statistical inference, and empirical implementation. Journal of Finance 55. August 2000.

Yurii Valykov. “Punkt naznacheniya” KASE. Kursiv’. July 19, 2012.

Market clout

Does privatization always improve economic performance?



The government’s planned sale of large enterprises, “The People’s IPO,” allegedly would make Kazakhstan’s economy leaner, meaner and competitive. In reality, competitiveness depends not on whether individuals own a firm but on the firm’s clout in the market. Privatizing Kazakhtelecom (the government still owns 51%) wouldn’t make the market for telecommunications competitive in the sense that no seller or buyer would be large enough to affect the market price. Given its track record, Kazakhtelecom will dominate the market regardless of whether it has one owner or many. It has 90% of the fixed-line subscriptions, and it is the only holder in Kazakhstan of a license to Long Term Evolution, an advanced wireless standard, according to OpenNet Initiative and Halyk Finance, respectively.

The government can take one of two courses: Recognize that Kazakhtelecom is a virtual monopoly and regulate it accordingly; or break it up into many firms, each too small to set the market price. The justification for the latter course is that small firms must fight to survive by pleasing consumers, whereas a firm that dominates the market need not cater to anyone.

This course is ill-advised. A national infrastructure for telecommunications, such as fiber-optics links between the cities, costs much to build. Net fixed assets for Kazakhtelecom were 227 billion tenge (about $1.5 billion) in fiscal 2011, 54% of total assets, according to Bloomberg News. There is no point in throwing bad money after good by inducing a new firm to build a duplicate infrastructure, particularly when fiber optics networks tend toward excess capacity.

Perhaps the government could retain control of the infrastructure and carve up Kazakhtelecom into small firms that would lease this network in order to sell services. (Roughly 100 Internet providers have been leasing in recent years, according to OpenNet.) Competition among them would hold down prices.

The first course – regulation – is deceptively simple. As a private firm, Kazakhtelecom would control the infrastructure; but the government would limit its price to consumers, subsidizing it if necessary so that it would earn a normal rate of return. Over time, however, the government may rely increasingly on Kazakhtelecom for market information vital to estimating the size of the subsidy, since its own data – obtained when the firm was a public enterprise -- may become obsolete. Kazakhtelecom may be tempted to fudge the numbers.

Going, going, begone


Here’s a hybrid approach: The government could auction off a lease of the infrastructure to the private firm that bids the lowest price at which it would sell to consumers, for a given subsidy; or the government could specify the consumer price and then grant the lease to the firm that bids for the smallest subsidy. The beauty of the auction is that it induces the firm to provide accurate information about its costs, in the form of a bid. However, the experience of United States governments with auctions in a similar market -- cable television -- has not been ecstatic. A firm might enter an artificially low bid and then, after winning the auction, force government officials to provide a larger subsidy than it had originally requested. In Milwaukee, the winning bid promised to provide 108 channels for a monthly fee of $4.95. What Milwaukee actually got was 54 channels for $11.95, according to regulatory economists Kip Viscusi, Joseph Harrington and John Vernon.

An American drama may shed light on problems that Kazakhstani regulators might face in loosening constraints on the telecommunications market. For decades, American Telephone & Telegraph (AT&T) enjoyed a protected position as a regulated monopoly. It was known as the safest financial investment in the country. But by the 1960s, demand increases as well as cost-cutting innovations were expanding the telecommunications market beyond the point where one firm could serve it efficiently. Gradually the federal government deregulated the submarkets such as the one for a firm providing internal phone services. By the early 1980s, AT&T’s monopoly was confined to the market providing phone services between cities – and it was coming under attack there, too.

The question was whether to let AT&T compete in submarkets that had already been deregulated. On one hand, the company might be able to cut costs for the deregulated good because of synergies with production of the regulated good. For example, experience with local phone service might reduce the cost of long-distance service. On the other hand, AT&T might cunningly use guaranteed profits in the regulated market to pay for price-cutting in the deregulated one; after driving rivals out of the latter market, it could charge the highest price that buyers could bear.

In 1982, a pact with regulators, supervised by the courts, shut out AT&T from deregulated markets. It slipped into a coma. In 2005, it was acquired by one of its own spinoffs, Southwestern Bell.

One problem may be that regulators balk at experimenting, note Viscusi, Harrington and Vernon. Change is politically risky since it may raise prices or cripple an industry. Also, deregulation curtails the agency’s duties, reducing “power, prestige, and income for the regulators.” So we may get too much change too late. – Leon Taylor, tayloralmaty@gmail.com



Good reading

W. Kip Viscusi, Joseph E. Harrington, Jr., and John M. Vernon. Economics of regulation and antitrust. Fourth edition. Cambridge, Mass.: The MIT Press. Chapter 15 discusses the AT&T case.



References

Bloomberg News. Kazakhtelecom JSC. 2012. bloomberg.com

Kazakhtelecom. General information. April 12, 2012. telecom.kz

Timur Omoev. Key takeaways from meeting with managers. May 15, 2012. halykfinance.kz

OpenNet Initiative. Kazakhstan. 2010. opennet.net .

Tele-miscommunications

Does Kazakhtelecom have a future as a private firm?


Kazakhstan’s latest drive to privatize – “The People’s IPO” – is understandably half-hearted. The government would be pleased to be rid of notorious money-losers such as BTA Bank, which it took over in 2009 rather than watch it go down in flames. But the crown jewels are another matter. The oil and natural gas enterprise, KazMunaiGaz, is one of the government’s main sources of revenue. Also profitable is the telecommunications company Kazakhtelecom, of which the government owns 51%. Excluding its KCell sale, its 2012 profit may come to 22 billion tenge (about $147 million), reported Bloomberg News. The firm has said it would pay 210 billion tenge (about $1.4 billion) in dividends, according to Standard & Poor's.

The loss of a cash cow is not the only reason that the government may balk at selling Kazakhtelecom. Another is that the enterprise dominates its market and, left to its own devices, might take advantage of its position by selling too few services to the public at too high of a price. In the telecommunications industry, setup costs – such as building facilities to receive and process satellite signals – are high. A potential entrant would think twice about incurring them. Kazakhtelecom has already paid them (at least, until a new technology creates setup costs of its own) and has only the low costs of hooking up new subscribers to worry about. Free of competitors, Kazakhtelecom could charge whatever price the market would bear.

That price would pique consumers. In principle, a firm should set a price that barely covers the cost of serving one more customer. We want to serve her as long as she values the service by more than it would cost the seller. As a virtual monopoly, Kazakhtelecom would surely bolster its profits by setting the price well above the cost of adding a customer. This stiff price would discourage some households from subscribing even though they value the service at more than its cost.

Two solutions are evident. In one, Kazakhtelecom would charge these additional buyers a price below the one paid by customers of long standing. That would be a PR man’s nightmare.


The price ain’t right


In the other solution, the government would force Kazakhtelecom to charge a low price and to serve all customers willing to pay it. Kazakhtelecom would still be a private firm, albeit a regulated one. But the price may be too low to permit Kazakhtelecom to recover its setup costs. To keep the firm from going broke, the government could subsidize it. Ideally, the grant would enable the firm to earn an average rate of return and no higher. Determining this exact amount, however, may require the government to know more than it does.

This problem may be temporary, since Kazakhtelecom may gradually lose its lockhold on the market. Its market power stems from high setup costs that discourage potential. competitors. But historically, innovations have reduced setup costs (for given capacity) in telecommunications – fiber optics rather than copper wires, for example. Someday, Kazakhtelecom may find that it is no longer a monopoly. Regulating its price then may handicap it permanently. – Leon Taylor tayloralmaty@gmail.com




Good reading

W. Kip Viscusi, Joseph E. Harrington Jr., and John M. Vernon. Economics of regulation and antitrust. Fourth edition. Cambridge, Mass.: The MIT Press. Discusses the regulated monopoly.


References

Nariman Gizitdinov and Ksenia Galouchko. Kazakhtelecom retreats most ever as dividend date passes. Bloomberg News. Online. May 16, 2012

Reuters. Text – S&P summary: Kazakhtelecom (JSC). Online.

Going private

Is privatization the ticket to improving production?



In The People’s IPO, the government of Kazakhstan plans to sell off part of the ownership of such state enterprises as the airline Air Astana and the railway Temir Zholy. How could this affect their performance?

Radically. The incentives facing the private firm differ dramatically from those for the public enterprise.

The manager controls what the private firm does, although stockholders are the owners, since they cannot monitor him continuously – and lack reason to do so, given the small stake of the typical shareholder in a large corporation. The manager works less – and provides more nonmonetary benefits – than owners would wish. Consider that nine-hole golf course on the corporate grounds, which the manager is prone to investigate each weekday at 2pm.

The manager’s incentives for boosting profits might include a bonus as well as a growing reputation that attracts tempting job offers. Those are the carrots. The stick is in the New York Stock Exchange: If the manager does poorly, then the firm’s stock will lose value. A raider might buy up the shares, boot the manager, hire a new team to improve profits, and then sell the firm at a healthy price.

Those incentives don’t apply to public enterprises, as Cotton Lindsay pointed out in 1976. Private and public enterprises behave differently, because they are controlled by different groups.


Gargantuan groves of academe


Consider a private university. Ultimately, it is controlled by the customers – students and their parents. To satisfy them, the school will offer them the desired courses, taught in the desired style.

But a public university is controlled by legislators. They don’t take classes, so they judge the school instead by variables that they do observe: The number of courses, students and professors. Rather than improve the quality of education, the school will increase those observable factors. Prediction: The public university will be larger, and more diverse in offerings, than the private college.

To test his theory, Lindsay compared public hospitals in the United States, run by the Veterans Administration (VA), to private hospitals. The latter will improve care through such attributes as the doctor’s bedside manner, since this attracts patients. But in a VA hospital, bureaucrats and legislators do not observe patient care, so the hospital will increase instead observable characteristics such as the rate of survival. Since this requires only a minimal amount of care, the staff-to-patient ratio should be lower for a VA hospital than for a private hospital where additional staff improves unobservable care. Lindsay did find lower staff-to-patient ratios for VA hospitals.

Similarly, in Kazakhstan, Air Astana might accrete political support by offering sumptuous meals (at least in theory), albeit at a high cost and price.


The price isn’t right


Other economists regard the price itself as an observable factor of the public enterprise. In the early 1970s, Sam Peltzman proposed a model in which the enterprise sets the price below the profit-maximizing one, because voters dislike subsidies. It would not prefer a price that was higher than the profit-maximizing one, since it would lose both profits and votes. Privatizing the airline and railway in Kazakhstan might lead to higher ticket prices.

Also, because it wants political support, the public enterprise is less likely to price discriminate – to charge different prices to different groups of consumers -- than the private firm is. If privatized, Temir Zholy would become more likely to offer cheap tickets to youths – and expensive ones to businessmen.

Why won’t public enterprises discriminate? Suppose that as the government keeps raising the price of, say, airline services, the resulting loss of additional votes among passengers enlarges. The government might mitigate this loss by spreading the cost of services over non-passengers as well.

In general, the government will consider both taxes and demand for a good before providing it. Consider the demand for operas, which is largest among the rich. Since they pay the same tax rate on personal income as do the poor – roughly 10% -- a sharp reduction in the cost of an opera ticket could be politically costly. The rich will respond to the discount by demanding many more operas, increasing the total subsidy. But since the income tax rate is flat, the rich will pay only a proportional share of the tax revenues that finance the operas, although they receive a disproportional share of the benefits. The politically savvy government will cut the price of an opera ticket only slightly.

Peltzman’s main point: Since the public enterprise is political, financial markets cannot discipline it as easily as they can a private firm. When the firm is inefficient, its stock prices will fall, inviting a raid. But for a public enterprise, the “owners” are the voters, who are unlikely to leave the jurisdiction just because they dislike one state-owned enterprise.

In Lindsay’s model, the public enterprise may charge a higher price than private firms do, so that it can afford to offer observable quality. In Peltzman’s model, the public enterprise charges a lower price, in order to attract political support.

What are the facts? A 1970 study in the U.S. by Thomas Moore found that regulated electric utilities charged a price that was 5% or less below that of an unregulated monopoly. But electric utilities that were public enterprises charged prices 10% to 22% below the monopoly price.

In 1971, Peltzman found that among electric utilities, the number of rate schedules for public enterprises – a form of price discrimination -- was much smaller than the one for private firms. The difference exceeded six standard errors, which is a measure of dispersion. A difference of just two standard errors would have been quite unlikely to have occurred by chance; a difference of six almost certainly means that the public utilities differed inherently from private ones. These results raise the possibility that in Kazakhstan privatization may increase both profits and practices, like price discrimination, that many citizens regard as unfair. – Leon Taylor, tayloralmaty@gmail.com



Good reading

Cotton Lindsay. A theory of government enterprise. Journal of Political Economy. October 1976.

Thomas Gale Moore. The effectiveness of regulation of electric utility prices. Southern Economic Journal. April 1970.

Sam Peltzman, Pricing in public and private enterprises: Electric utilities in the United States. Journal of Law and Economics. April 1971.

W. Kip Viscusi, Joseph E. Harrington, Jr., and John M. Vernon. Economics of regulation and antitrust. Fourth edition. Cambridge, Mass.: The MIT Press.2005. Chapter 14 surveys work on private and public enterprises.

The KASE of the missing trades

Is the Kazakhstan Stock Exchange getting any better?

Though it bills itself as the second-largest in the Commonwealth of Independent States, the Kazakhstan Stock Exchange (KASE) suffers from thin trading. While the volume of trade doubled in the stock market over 2011, other KASE markets were less fortunate. The trade in the two largest – for foreign exchange and overnight loans (“repos”) – barely grew. The market for government securities shrank by a fourth. Overall, trade at KASE grew by less than 3% in the first nine months of 2011, less than half the rate of growth of the national economy.

The stock market at KASE illustrates its main problem. Stock purchases are large, few and far between. Consequently, prices are volatile. On August 19 alone, the KASE Index fell by nearly 5%. In a press statement, the Exchange blamed turbulence in global markets. The share price of copper mining alone fell more than 10% that day.

Such tailspins scare off risk-averse investors: Thin trading gets thinner. The volatility may also hinder the national economy. A sudden fall in stock prices reduces wealth and thus national spending. A steep rise may mislead stockholders into thinking that they are rich. Conceivably, they may try to buy more goods than producers can provide. Prices will rise throughout the economy. Hello, inflation.

KASE may seem too small to damage the macroeconomy. In terms of capitalization (the value of stock shares offered), the New York Stock Exchange is 325 times larger. But the volume of trade at KASE in 2011 exceeded the value of Kazakhstani production that year (gross domestic product). While fewer than 10,000 Kazakhstanis may trade at KASE, they include rich citizens who hold a disproportionate share of national private wealth.

Although its listings have been declining since 2009, KASE is in better shape now than in the late 1990s, when it had to suspend trading for a year or longer in government securities and currency futures (essentially bets upon the value of currency on a given date). One of its new rules, however, may handicap it. A firm that wants to list on KASE must offer at least a fifth of its shares there before going to foreign exchanges. This restriction cuts the rate of return to offering stocks. It may lead firms to prefer debt to equity more strongly than before, or perhaps to sell all shares on foreign exchanges rather than mess around with KASE. The Exchange’s trading may diminish again.



Brisk risk



Another reform may have ambivalent effects on KASE. Originally, KASE granted one vote for each share owned by the Exchange’s shareholders. When KASE went commercial in 2007, its general meeting decided to give each shareholder one vote regardless of his number of shares. Indeed, no shareholder can hold more than a fifth of KASE shares, reported Wikipedia. Had these rules not taken effect, a few large shareholders – like the pension funds – could have dominated KASE policy. Now a diverse group may influence what the Exchange does, but most of the decision-makers have too little at stake in KASE to want to gather much information about it. In effect, the new rules empower the management.

More auspicious for KASE is the People’s IPO (initial public offering), in which the government is selling off portions – ranging from 5% to 15% -- of its enterprises. Air Astana and KazTransOil may go public this year. The government estimates that Kazakhstani citizens may demand $100 million to $200 million of state-held shares. Kazakhstani pension funds, already major players in KASE, may snap up $200 million to $300 million of shares.

Now all we need is a People’s Exchange. KASE is caught in an infernal loop: Its lack of investors leads to price volatility, which in turn discourages potential investors. To attract them, KASE needs some relatively safe products, despite their small payoffs. The economic justification for this is the widely-accepted idea that an additional dollar of spending adds less satisfaction than did the dollar before it. A dollar means more to a pauper than to a millionaire because he needs it to survive. Given this assumption, an investor will turn down a “fair bet” – say, a financial investment with a 50% chance of gaining $1,000 and a 50% chance of losing $1,000 – because he likes the gain less than he dislikes the equivalent loss. A major stock that drops 10% in a day does not exactly commend itself to the risk-averse investor. – Leon Taylor, tayloralmaty@gmail.com





Good reading

Michael Quinn. Is the Kazakhstan Stock Exchange efficient? MBA thesis, KIMEP University, 2012.



References

Interfax-Kazakhstan. JSC Kazakhstan Stock Exchange President Kadyrzhan Damitov: New defaults possible. July 2011. Online. Yet another cheerleader interview with KASE’s president, retold in mangled English.

Wikipedia. Kazakhstan Stock Exchange. Online.

World Finance Review. Kazakhstan Stock Exchange: Better years ahead. December 2011. Online. Full of softball questions and grammatical gaffes.

Danger – insurance ahead

Does deposit insurance really insure against trouble?


Even before 2008, banking crises were common around the globe. One study reports 160 calamities in more than 150 countries over two decades. The currency crash of 1997 cost Thailand and South Korea nearly a third of their GDP – and Indonesia, almost half -- thanks to tottering banks.

Small wonder, then, that depositors demand insurance. In 1974, only 12 countries offered deposit insurance; by 1999, 71 did, according to Asli Demirgüc-Kunt and Edward Kane. Kazakhstan has offered deposit insurance since 1999, through the Kazakhstan Deposit Insurance Fund. It’s owned by the National Bank of Kazakhstan, which initially kicked in a billion tenge for the till. The Fund said it had enough to pay for the failures of two mid-sized banks, or 7 billion tenge. That was before 2008-9, when two of the nation’s largest banks collapsed. A deposit had been insured for up to 400,000 tenge ($2,700 at today’s exchange rate). In 2008, the Fund increased coverage to 5 million tenge ($33,800).

Yet insurance may increase the chances of a bank collapse. After all, a fully-insured depositor no longer has reason to monitor the care that the bank takes in lending. The insurance may also make the banks careless about their loans, because they know that most of their depositors can get their money back, regardless of whether the borrower pays back. In the United States, most banks paid no premiums for their deposit insurance, even though the risk of failure was not zero, reported Fred Furlong and Simon Kwan in 2002.

By making the banks careless, the insurance creates a “moral hazard” – that is, a change in behavior, arising from a contract, that hurts one of the signers. For example, in the Eighties, savings and loan associations in the U.S. – which offered home mortgages -- often had little net worth, so they literally bet the bank on risky loans. They figured that if the loans paid off, then they would profit handsomely, because they could charge a high interest rate for risk. And if the loans went bad? No problem: The federal government would pay off the depositors, and the thrifts weren’t worth much, anyway. In 1989 alone, 327 thrifts failed, according to Antoine Martin. The banks were also more likely to take risks in the Eighties when their charter value fell. Less efficient banks took on more risk, more loans per dollar of assets, concluded Thomas Siems in 2002.

In this light, Kazakhstan’s exemption of bank executives and top shareholders from insurance in bank failures seemed to address a special moral hazard. (The Kazakhstan Deposit Insurance Fund didn’t insure deposits of top executives and of shareholders who owned more than 5 percent of the bank’s voting shares. Neither did it insure the so-called VIP deposits – time deposits that exceeded 7 million tenge.) If the bank executive didn’t even have his own money at stake, then why should he object to risky lending that may indirectly push up his salary?

Ironically, the U.S. government offered deposit insurance to try to save the banks, during the Great Depression of the 1930s. If depositors knew that the government would reimburse them, then they might not have reason to run on the bank, all of them demanding their money at once. During the Depression, deposit insurance seemed to work: The number of bank failures fell from 4,000 in 1933 to just over 50 banks a year from 1934 to 1941, wrote Martin.


Branching for safety


Today, as developing countries with undercapitalized banks adopt deposit insurance, the moral hazards are more evident. Statistical studies suggest that banking crises are more likely in countries with extensive deposit insurance, particularly if its institutions are weak – for example, if the government is prone to corruption. You would think that the government of a developing country could stave off a banking crisis by guaranteeing to repay the depositors. But if the government is poor, then its promise is not credible.

We need not insure deposits in order to protect them. The bank could instead diversify its risk by offering branches. For example, YourBank may have a branch in Almaty and another in Astana. When education turns down, due to a booming national economy that attracts potential students into jobs, then the Almaty branch may do relatively poorly; but the Astana branch will be swimming in cash, and this will protect depositors in Almaty. During the 1920s in the United States, banks with branches were less likely to fail than banks without branches, according to economic historians Jeremy Atack and Peter Passell. Even before 2008, the number of bank branches in Kazakhstan was declining, according to First Initiative.

If the depositors will monitor the bank, then it will lend with care. One way to ensure that the depositors keep an eye on their institution is to make them co-pay for deposit losses, suggested Demirgüç-Kunt and Kane.

Otherwise, the government could motivate the bank to exercise caution by charging rates for deposit insurance that rise with risk; that rise, in particular, with the percentage of loans that are bad, since it is hard for the regulator to know exactly which loans are risky. Maybe the bank will promise to extend only safe loans, in order to procure the low premiums, but then lend to risky enterprises, in order to earn high rates of return, suggested Edward Simpson Prescott.

The government can also make clear that the healthy banks must repay the deposits at failed banks. This will give the healthy banks an incentive to monitor its ailing brethren. Finally, the government can close weak banks before they go under. Under a 1991 law in the U.S., the feds could close any bank with a capital-to-asset ratio below 2 percent. That is, if the bank’s net worth is less than 2 percent of its assets, which are mainly loans, then the government can shut it down. This, at the least, avoids the expense of reimbursing the depositors in the event of a bank failure, noted Martin. Canada has a provision like this. As a consequence, when Canada introduced deposit insurance, the banks did not take many more risks. – Leon Taylor, tayloralmaty@gmail.com





Good reading


Charles Calomiris. Is deposit insurance necessary: A historical perspective. Journal of Economic History 50. Pp. 283-296. 1990.

Fred Furlong and Simon Kwan. Deposit insurance reform – when half a loaf is better. Federal Reserve Bank of San Francisco Economic Letter. May 10, 2002. Online.

Asli Demirgüc-Kunt and Edward J. Kane. Deposit insurance around the globe: Where does it work? Journal of Economic Perspectives 16:2, summer 2002, pp. 175-195. Online.

Antoine Martin. A guide to deposit insurance reform. Federal Reserve Bank of Kansas City Economic Review. First quarter 2003. Online.

Thomas F. Siems. Survival and the hump in the CAMELS. Federal Reserve Bank of Dallas Expand Your Insight. October 2, 2002. Online.

Edward Simpson Prescott. Can risk-based deposit insurance premiums control moral hazard? Federal Reserve Bank of Richmond Economic Quarterly. Pp. 87-100. Spring 2002. Online.

Jeremy Atack and Peter Passell. A new economic view of American history. New York: W.W. Norton. Second edition. 1994.

Eugene Nelson White. State-sponsored insurance of bank deposit in the United States, 1907-1929. Journal of Economic History 41. Pp. 537-58. 1987.



References


First Initiative. www.firstinitiative.org

International Association of Deposit Insurers. Member profile: Kazakhstan Deposit Insurance Fund. www.iadi.org

Kazakhstan Deposit Insurance Fund. Otveti na chasto zadavaemie voprosi (FAQ). The Fund does not offer a FAQ for depositors in English. www.kdif.kz

A plight to remember

Has London anything to teach Almaty?



Amid economic growth, prices have remained volatile in Central Asia since the turn of the century. A measure of dispersion, the standard deviation, was twice as volatile for prices in the region as for those in the United States from 2000 through 2009. Even Kazakhstan, which has the strongest economy in Central Asia, has suffered more inflation over the period than has the U.S., according to World Bank data.

Fluctuating rates of inflation induce buyers and sellers to err, because they cannot be sure whether the price changes they observe for some product are due to changes in its supply and demand or to inflation that has yet to affect other products. Such errors retard economic growth. Since long-run inflation usually occurs because of excess money in the economy, is it time for the National Bank of Kazakhstan to stabilize money supply rather than the exchange rate?

A similar debate in England almost two centuries ago may shed light on the National Bank’s predicament. In the early 1800s, the price of a typical bundle of goods in England -- the “price level” -- fell about as sharply as it rose, resembling a roller-coaster. The most influential critics of the Bank of England, called the “Currency School”, demanded that the central bank stabilize the money supply, which at that time comprised gold and silver as well as paper money. Led by Lord Overstone, the critics argued that the Bank’s fine-tuning of money had undermined its credibility. In a recession, speculators could anticipate that the bank would issue more paper money, effectively to try to stimulate spending. But because the new money was not backed by a commensurate increase in gold, a pound sterling would lose value. Speculators knew this, so they would try to profit in advance by selling pounds to banks in exchange for gold. The loss of gold reserves left the banks vulnerable to panicked withdrawals of yet more gold. Sooner or later, the banks would collapse. Rather than risk this scenario, the Bank of England should commit to a given level of money supply -- no matter what the commercial banks demanded -- in order to preserve confidence in banking. A few commercial banks would fail, because the Bank would not lend to them in emergencies; but this was better than losing the system of banks.

The friends of the Bank, called the "Banking School", thought the Currency medicine too harsh to swallow. The Bank should simply lend to anyone who was creditworthy, they argued. Because such people borrowed money only to increase output, the resulting economic growth would justify expansion of the money supply. (To buy more goods, we need more money.) The best way to stabilize the economy was to ensure that people could always get gold from banks in exchange for paper money (or near-money, like bills of exchange). Secure in that knowledge, they would not run on banks.


Taking chances


In 1844, Parliament bought the Currency argument. It compelled the Bank to back its paper money 100% with reserves of precious metals. To issue additional notes, the Bank would need additional gold. The Bank also had to separate its two main functions – managing the money supply and supporting commercial banks.

In a few years, the Bank was back in a jam. When English harvests failed, grain imports and prices rose. So did the demands for liquidity from commercial banks.  Before 1844, banks might have been able to make good on the withdrawals by drawing upon the reserves that they kept at the Bank of England. But the Bank’s Issue and Banking departments had been separated; the Issue department had plenty of gold in reserve, but the Banking department didn’t. So it balked at issuing notes.  In the liquidity crisis that followed, the government suspended the 1844 law and authorized the Bank to lend freely at an unusually high rate of interest (8%), noted an economic historian, John Wood.


Unfortunately, such largesse may bring on the crises that it was meant to prevent. Suppose that speculators anticipate that a crop failure will lead the Bank eventually to lend notes freely. They realize that this increase in money supply may lower the value of a note (in terms of the products that it can purchase). So, as soon as the crops fail, they will exchange their notes for gold while these are still worth something. Gold reserves at the banks will fall, stirring doubts about the value of the notes and paving the way to a panic.

The National Bank of Kazakhstan faces a similar conundrum today. Countries today are no longer on a gold standard, but the U.S. dollar plays a similar role, since it exchanges easily for most currencies. Should the National Bank maintain large reserves of dollars, in order to avoid lapses of public confidence in Kazakhstan’s currency? Or should it use the dollars to bail out troubled banks? Should it announce that it will permit the money supply to increase at only the rate of economic growth, no matter what the immediate demands for money may happen to be? Suddenly, London is no longer so distant from Almaty. – Leon Taylor, tayloralmaty@gmail.com


Good reading

Walter Bagehot. Lombard Street. Various publishers. 1873. A classic tract of monetary economics by the editor of The Economist.

Anna J. Schwartz. Banking School, Currency School, Free Banking School. In John Eatwell, Murray Milgate and Peter Newman, editors, New Palgrave Dictionary of Economics: Money. Norton. 1987.

John H. Wood. A history of central banking in Great Britain and the United States. Cambridge University Press. 2005. Lively and informative.


References

World Bank.  World Development Indicators.  http://www.worldbank.org/

A grain of truth

Are grain farmers in Kazakhstan acting on bad information?


The grain market in Kazakhstan may be headed for the economic version of a train wreck. According to the business weekly Kursiv’, experts expect an increase in Chinese demand for Kazakhstani grain this year, accompanied by a shortage of grain carriers and granaries in the country as well as by a reduction in the harvest since last year’s record yield.

All of these factors presage an increase in grain prices here. But what is most striking about the market is its volatility. The grain yield in 2011 was more than twice that of 2010, which in turn was 40% below the yield in 2009, according to Kursiv’.

Cobweb, anyone?

The term refers to a market in which output and prices fluctuate because producers act upon mistaken expectations. Suppose that wheat prices are unusually low in Year 1. Farmers planning for next season’s market may assume that prices will remain anemic; and so they will sow little. As a result, the harvest will be small. This scarcity of wheat will send its prices soaring in Year 2. Now farmers, anticipating a bonanza, will sow a bumper crop…which will pull prices back down in Year 3. Economists call this predicament a “cobweb” because of the ever-growing oscillations of price and quantity when plotted on a market graph. Its vital feature is that the farmer always presumes that this year’s price will also be next year’s.

The grain market in Kazakhstan may be particularly vulnerable to cobwebs because nearly 90% of the country’s yield goes into the domestic market -- partly because of the lack of export facilities, although the country is a leading exporter of wheat and flour. In the domestic market, sharp changes in output may lead to sharp changes in prices.  On the other hand, wheat farmers in northern Kazakhstan may sow regardless of the expected price because they have few other uses for the land, suggest researchers at the United States Department of Agriculture


Cobwebs in the brain


A cobweb market has two causes. First, producers assume that current conditions will hold in the coming season. The government can address this misunderstanding by publicizing more sophisticated forecasts – or by developing the futures market, which rewards accurate forecasting.

Second, the farmer when planning his sowing assumes that his harvest will be too small to affect the national output and price. That’s rational, but if every farmer makes that assumption as well as the one of cobweb prices, then the national market may indeed gyrate.

One solution to this problem – organizing the farmers into a cartel that will make sowing decisions for all – is the sort of cure that kills the patient. Unfortunately, with its penchant for industrial planning, the government may choose essentially this treatment. A less intrusive policy would have the government – perhaps via KazAgro -- buy surplus grain in bumper years and release it in years when the harvest comes a cropper.

The cobweb model fails to explain why farmers repeat their errors when there is money on the table. Perhaps the market oscillations arise from rational expectations – which use all available information, not just past prices -- about shocks to the system. For example, a cattleman must decide whether to slaughter and sell his animal now or to breed it. A rise in beef demand that seems temporary may lead to more slaughters for a while. This affects the age distribution of the cattle, the birth and death rates, and ultimately the size of the stock. The cattle cycles generated may resemble cobwebs, but they stem from well-informed decisions.

At the University of Chicago, economists Sherwin Rosen, Kevin Murphy and José Scheinkman found that a rational-expectations model snugly fit the cattle cycles observed over 115 years when adjusted for trends in beef demand. They write: “Shocks to demand and supply have persistent long-term effects on future shocks by changing farmers’ incentives to carry breeding stock and altering the age composition and reproductive capacity of herds.”

Some studies have tried to observe cobweb expectations directly, by running a laboratory experiment. Participants in a simulated market are asked to predict the price in the next period. At the University of Arizona, Charissa Wellford found “little or no indication that cobweb or rational expectations are employed by the sellers.” (A pox on both houses.) Adaptive expectations, in which one forecasts the price partly by extrapolating past prices, “perform somewhat better.” This is not the first time that a cherished notion from economics has failed to find support in the lab. -- Leon Taylor tayloralmaty@gmail.com





Good reading

Mordecai Ezekiel. The cobweb theorem. Quarterly Journal of Economics 52: 255-80. February 1938.

United States Department of Agriculture, Production Estimates and Crop Assessment Division, Foreign Agricultural Service.  Kazakhstan Wheat Production: An Overview.  Online.


References

Sherwin Rosen, Kevin M. Murphy, and José A. Scheinkman. Cattle cycles. Journal of Political Economy 102: 468-92. June 1994.

Bakitzhan Toksharayev. Nazlo recordam. Kursiv’. March 20, 2012.  Page 1.

Charissa P. Wellford. A laboratory analysis of price dynamics and expectations in the cobweb model. University of Arizona Discussion Paper 89-15. 1989. Online.

The saving grace

Does Kazakhstan save enough to ensure future growth?

A student radical once asked the philosopher Sidney Morgenbesser if he agreed with Mao Zedong’s pronouncement that a statement could be both true and false. Morgenbesser replied, “I do and I don’t.”

In the same way, Kazakhstan is poor and it isn’t. Adjusted for prices and exchange rates, its income per person is less than a sixth of that of an American, according to World Bank data. But the nation saves a much larger share of income than does the U.S. (Any income that is not spent or paid in taxes is “savings.”) National savings – deducting the amount needed to replace worn-out capital – have increased steadily in Kazakhstan, from 4% of gross national income in 2000 to 20% and higher after 2006. Mr. Micawber, in Charles Dickens’s David Copperfield, would have approved. “Annual income twenty pounds, annual expenditure nineteen, nineteen six, result happiness,” the clerk intoned. “Annual income twenty pounds, annual expenditure twenty ought and six, result misery.”

Savings pay for expansion of stores and plants, for education, and for other ways to increase the amount that we can produce in the future. Such additions to our means of production are what economists mean by “real investment.” Thus, Apple invests when it builds a factory. When you buy a stock share of Apple for $80, you don’t invest; you save. When Apple spends the $80 on its plant, then it becomes investment.

The way that household savings pay for investment is simple: Kazakhstanis stash their savings into accounts at the bank, which lends them out to businesses (or, for that matter, to college students who borrow in order to pay tuition – yet another form of investment).

Since the slowdown of the global economy in 2008-9, however, real investment has stagnated in Kazakhstan. In Almaty, investment in fixed capital – immobile assets such as office towers -- in the first half of 2011 was 2% below that of early 2010. One problem is that household income in Kazakhstan remains too modest to provide huge savings.

Treasure chests of tenge

Another way to pay for investment is through businesses themselves. Firms save by hanging on to profits rather than paying them out as dividends to shareholders. In the U.S. before the Great Recession, these retained earnings came to a trillion dollars a year and were the country’s largest source of funds for investment. In Kazakhstan, retained earnings are anemic, partly because our market economy is only two decades old – not enough time for firms to build up their coffers of profit.

A sort of hybrid of the household and the firm is the venture capitalist. She lends savings to the entrepreneur directly, as a general partner who owns part of the funded project. Once the project sells its shares to the public, he sells his own shares for a profit. Only one project of every ten ever gets that far, but they include Microsoft, Apple Computer, Intel and Federal Express, note two American researchers, Edgar Parker and Phillip Todd Parker. Venture capital is less visible in Kazakhstan than in the U.S.

Aside from households and firms, who else can provide savings to finance investment in Kazakhstan? The remaining possibilities are the government and foreigners. We can quickly rule out the latter. To accumulate savings, foreigners must sell more products to Kazakhstan than they purchase from it. But the reality is the opposite. Kazakhstan has long had a trade surplus; its exports exceed its imports. (On the other hand, foreigners do invest in Kazakhstan. As a share of Kazakhstan’s economy -- measured by the market value of Kazakhstan’s annual production, called “gross domestic product” -- the net inflow of foreign direct investment increased 24-fold after 1992 to 12% in 2008, according to World Bank data.)

That leaves the government. Its National Fund of oil export taxes holds $45 billion, the rough equivalent of a third of Kazakhstan’s income. It is the obvious potential source for financing investment in health and education. – Leon Taylor, tayloralmaty@gmail.com


Good reading


Jagdish Bhagwati. Don’t cry for Cancún. Foreign Affairs. January/February 2004. The source of the story about Mao Zedong. Online.

Edgar Parker and Phillip Todd Parker. Venture capital investment: Emerging force in the Southeast.  Economic Review. Federal Reserve Bank of Atlanta.  Fourth quarter 1998.  Pp. 36-47. Online.


References

World Bank. World Development Indicators. Online.