Pettis, Michael – The Great Rebalancing

Princeton University Press, 2013 [Economics] Grade 4

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World trade doesn’t work as most pundits think it does. At least the author argues that the effects on national current account balances, savings ratios, investments etc. are too often poorly understood. The author Michael Pettis - formerly a banker at Bear Stearns and a trader at today’s JP Morgan - is a professor of finance at the Peking University and a well-read, prolific blogger, discussing topics like global trade and the Chinese economy. In this book Pettis tries to set the record straight and explain why trade policies, in a broad sense, was one of the major factors behind the 2009 financial crisis and what this says about the future for the Chinese economic growth model etc.

Apart from an introductory chapter and a concluding one (including some predictions about the future) the book is structured to try to explain three “confusions” in the trade debate. The first confusion has to do with the causes of trade imbalances and how these generally are the result of distorted economic policies in one or more countries (chapters 2 to 4), the second is related to the relationship between trade, the savings rate and international capital flows (chapters 5 to 7) and the final confusion is that the role of the USD as the global reserve currency is an advantage for the US (chapter 8). As I read the 2014 printing of the book it also contains an appendix with an explanation to why the imbalances discussed in the book emerged to start with. If your copy of the book contains this appendix I would advice you to start your reading with this as it provides background and further details the macro economic accounting identities that are frequently used in the book. Although several countries and regions are discussed, the symbiotic relationship between the US and China is really the key topic of the book.

You get the feel that The Great Rebalancing is written out of frustration that so few understand global trade economics. The big advantage of the book is that it looks at the economic causes and effects of trade as an interconnected international system where every country is affected by every other one through the capital and current accounts. Hence, where many economics textbooks look at theoretical examples containing only two countries Pettis discusses the real-world, complex web of relationships. Still, the book also very much feels like sitting in on a slightly repetitive academic economics course in trade theory, but instead of equations and arrows that point to chains of events everything is described in text only. It would have been more enlightening if the author had added some occasional pictures with the described equations. Hence, the best advice for getting the full benefit of this book and making reading it a valuable learning experience is to write down the equations that Pettis uses on a piece of paper and have it handy while reading the book.

Pettis views imbalances between production and consumption – or rather “underconsumption” as once discussed by Karl Marx – to be the primary source of economic instabilities and from this argues that the economic growth model of China has actually been tried several times before and as it is imbalanced it will have to reverse. In the case of Japan it reversed through a crisis while in Brazil it did so by a lost growth decade. It is this later fate the author sees for China in the end. The growth model builds on financial repression (in China’s case through low regulated interest rates), currency manipulation and a wage growth that is slower than the productivity growth. The author claims that there are only three ways that China realistically can rebalance and this is through higher unemployment, increasing debt or through wealth transfers. The best way would be to shift the economic model in a way that shifts means from the state and the corporate sector to consumers. Although this would be relatively painless the GDP-growth will have to slow substantially and it is also a policy that threatens many vested economic interests.

I’m not a good enough economist to know if Pettis is right but despite the somewhat dry writing this is an important book to have read.

Mats Larsson, December 26, 2018

Kindleberger, Charles P. - Manias, Panics and Crashes

Palgrave Macmillan, 2015 (7th ed), [Economics] Grade 4

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There are countless opinions about whether it's preferable to have a top-down or a bottom-up approach to investing. Typical value investors embrace the bottom-up approach where they mainly look at company fundamentals while others have a more open approach of considering factors as the business cycle and various macro factors. The top-down investor risks falling into the trap of predicting the unpredictable and the bottom-up approach got criticism after the financial crisis which hurt many value investors badly. Many have recovered well since then though. It is in my view useful for all investors to study financial history in order to learn from events of the past as it often repeats itself. In the words of George Santayana "Those who don't remember the past are condemned to repeat it".

Charles P. Kindleberger's Manias, Panics and Crashes is an oft-cited book in the realm of financial history and used in MBA programs across the world. Kindleberger was an economic historian and author of over thirty books and he originally published Manias, Panics and Crashes in 1978. During his career, he held senior roles within the US Treasury, the Federal Reserve and Bank for International Settlements. He finished his career as Professor of International Economics at MIT where he worked for more than thirty years. Robert Z. Aliber, who has updated the last three editions of the book, is a professor emeritus of International Economics and Finance at the University of Chicago.

The first couple of chapters presents a background of historical financial manias and typical patterns of how a mania evolves and how it turns to a panic and eventually a crash. Fraudulent behavior that is a typical theme towards the end of a mania is described with the examples of Charles Ponzi and Bernie Madoff as well as with instances of corporate frauds including Enron. The author summarizes some of the worst financial panics from the tulip mania in the 17th century, through the Great Depression in 1929 to the latest financial crisis in 2008 among others. The last couple of chapters of the book are primarily written for policy makers, advising on how to understand financial calamities in order to decide on the right policy from a fiscal and monetary perspective.

To sum up the main thesis of the book there are some typical factors that usually leads to a forthcoming mania and crash. The two most important factors have been increases of cross-border investment inflows as well as credit. The increases have typically led to rising stock- and real estate prices which have led to further increases in cross-border investment inflows and credit and in turn further increases in asset prices in a positive feedback cycle supported by behavioral phenomena. To cite from the book: "Asset bubbles - most asset bubbles - are a monetary phenomenon and result from the rapid growth of the supply of credit". The party has typically stopped when the creditors have got worried that debtors won't be able to pay back the loans and have in turn stopped issuing new loans. The debtors have relied on new loans to cover the interest payments and when the flow stops bankruptcies erupt.

As there are regularities in the financial crises the reading gets a bit monotonous at times. Also, I felt it was difficult to get a flow in the reading but that can probably be explained by it being a book written by academics for academics. It is not a must to read this book from cover to cover. The book is still a great source for investors who want to learn history in order to be able to be on alert for future occurrences. It's also a great start for those who want to dig into a specific event.

This is a book that is beneficial for both bottom-up and top-down investors. Just as individual companies, the stock market and currencies follow the investment market’s pendulum swings of euphoria to depression and overpricing to underpricing to use some of the terms often used by the legendary value investor Howard Marks.

Niklas Sävås, April 11, 2018

Wray, L. Randall - Why Minsky Matters

Princeton University Press, 2016, [Economics] Grade 4

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After the financial crisis a lot fewer need to be convinced that Minsky does matter. This is a short overview of the academic working life of the late Neo-Keynesian economist Hyman Minsky written by his apprentice, the University of Missouri professor in economics, Randall Wray. After the carnage of the GFC there was a search for improved explanatory models and many found one in Minsky’s Financial Instability Hypothesis. It even became fashionable to make use of the expression “Minsky moment” among financial market actors. In this book we get a broader understanding of the theories of an unconventional economist.

Minsky’s writings centered on financial instability, on employment, inequality and poverty and finally on how to reform capitalism since it is instable in its present form. I will focus more on the financial parts. Underlying his work was the view that economists - Keynesian and neoclassical alike - has it wrong; market processes are not stabilizing around an equilibrium to which they according to conventional thought are supposed to return after being exposed to external shocks.

Minsky’s claim that all his academic colleagues were wrong combined with an impermeable writing style full of self-invented Wall Street-like expressions made him an outsider during a career that spanned from the 1950s to the 1990s. Minsky’s background was indeed eclectic as he was a devoted Keynesian who also had had the great Joseph Schumpeter as his dissertation advisor. Minsky, as his starting point for economic models, focused on the investment of the entrepreneur and the financing of that investment – similarly to the Austrian business cycle or J. M. Keynes himself, but not the Keynesians or neoclassicists. In addition to his radical political views he sat on the board of a bank and befriended people like Salomon Brothers’ investment strategist Henry Kaufman and famed investor Leon Levy.

An important contribution of Minsky is that he adds the functionality of financial markets to the core of macroeconomic models – something that mainstream economics still fail to do. With regards to the financial system Minsky’s key idea is that “stability is destabilizing”, i.e. periods of calm change the psychology of the market, making participants take on more risk, which in the end leads to a crisis that ends the calm. There can be no stable equilibrium as the stability of such a state changes behaviors, policies, and business practices in a way that in the end prevents it.

A key part of this pendulum motion between stability and disturbance is the use of leverage and the pro-cyclical behavior of both lenders and borrowers. Minsky developed a classification for financial fragility where “hedge finance” described a situation where the income of a borrower is sufficient to pay both interest and principal, in a “speculative position” only the interest payments are covered and in a “Ponzi position” the obligor will even have to borrow additional funds to finance his interest payments and he can only continue his operations as long as the lender allows the loan balance to grow. Loan growth chases asset values in an upwards spiral until it doesn’t. Profit maximizing banks provide liquidity and leverage through financial innovation until they don’t. The Minsky moment, a concept that was minted by Paul McCulley at PIMCO after Minsky’s death, is the tipping point in time where the spiral goes from positive to negative.

The above cycles and the rejection of equilibrium resonate with most people active on financial markets. However, even though the diagnosis is well executed, I’m not sure all in the financial markets would appreciate the recipe that Minsky prescribed. He was a Keynesian with a belief that the enlightened governing of the big state and the wise handling of central banks could right the inherent wrongs of capitalism as diagnosed.

Wray guides us through the opaque writings of his master. At times it is slightly hard to distinguish the views of the author from those of Minsky but overall this is an important job well done.

Mats Larsson, Feb 3, 2017

Schiff, Peter D. & Schiff, Andrew J. - How an Economy Grows and Why It Crashes

John Wiley & Sons, 2010, [Economics] Grade 4

This is an unusual book - it’s part comic book, part short novel. How an Economy Grows and Why it Crashes is something as rare as a basic primer on Austrian economics in fictional form. Irwin Schiff was an Austrian economist during the heydays of Keynesianism and later a tax protester... Further reading... Link to Amazon...

Buchanan, Mark - Forecast

Bloomsbury, 2013, [Economics] Grade 3

The raison d’être for this book as the author describes it, is to fill a void. After the financial crisis there has been an immense amount of books describing psychological and institutional reasons for the crash. Yet the discussion around the soundness of the economic theories used to make... Further reading... Link to Amazon...

Ferguson, Niall - The Great Degeneration

Penguin Books, 2013, [Economics] Grade 4

Authoritarian state capitalism à la China is on the rise while the democratic, economically liberal societies seam to be in a dead end. In this book Niall Ferguson, a Scottish born Harvard professor of history, examines the underlying reasons for the stagnation of the Western World. The... Further reading...  Link to Amazon...

Frydman, Roman and Goldberg, Michael D. – Beyond Mechanical Markets

Princeton University Press, 2011, [Economics] Grade 5

Beyond Mechanical Markets is among the best and most rewarding books I have read for a long time. Two renowned professors at NYU and UNH, present an economic theory—Contingent Market Hypothesis—that explains how the financial markets really work. I believe most... Further Reading...  Link to Amazon...

Geithner, Timothy F. – Stress Test: Reflections on Financial Crisis

Crown Publishers, 2014, [Economics] Grade 4

Geithner’s Stress Test must be a perfect summer reading for financial markets addicts. It is engaging, informative and gives an alarming awakening for anyone who has forgotten the Global Financial Crisis’s initial drama. I even got the same thrill from it as from “Too Big Too Fail”...  Further reading...  Link to Amazon...

Kaletsky, Anatole - Capitalism 4.0

Bloomsbury, 2010, [Economics] Grade 4

Are you worried that capitalism will be dismantled following its alleged failure during the recent financial crisis? You shouldn’t worry too much because, as Anatole Kaletsky puts it, “capitalism doesn’t break because it bends”. Democratic capitalism has self-improvement in its DNA. In fact...  Further reading...  Link to Amazon...

Akerlof, George A. & Shiller, Robert – Animal Spirits

Princeton University Press, 2009, [Economics] Grade 5

Animal Spirits is a book about macroeconomics with an interesting twist.  Rest assured this is not another mundane behavioral economics handbook. The book was written in response to the financial crisis and the authors are economics rockstars. Robert Shiller and George Akerlof are...  Further reading...  Link to Amazon...

Robinson, Lee (ed) & Young, Patrick (ed). – The Gathering Storm

DV Books, 2010, [Economics] Grade 3

Economies are more fragile and volatile, and recessions will be more frequent after a credit crisis than during more “normal” supply-demand cycles (a.k.a. inventory-led). That much is near certain. To add insult the aftermaths of the credit crisis of our time will take place during the “Nervous...  Further reading...  Link to Amazon...

Friedman, Milton – Capitalism and Freedom

The University of Chicago Press, 1962, [Economics] Grade 5

In the post-Lehman world Milton Friedman has regained his 1970’s role as someone to scare children with. In reality the writing of a Friedman, or for that matter a Keynes, is much more nuanced and diverse than their adversaries would probably want it to be. The monetarist...  Further reading...  Link to Amazon...

Silber, William – Volcker: The Triumph of Persistence

Bloomsbury Press, 2012, [Economics] Grade 4

After a lot of research and 42 lengthy interviews with the subject of this book Mr William L. Silber, a professor at New York University’s Stern School of Business, has a better understanding than most of two major economic events; the introduction of fiat currencies (The Nixon chock 1971) and the...  Further reading...  Link to Amazon...

Cassidy, John – How Markets Fail: The Logic of Economic Calamities

Picador, 2009, [Economics] Grade 4

This is one of the books I have enjoyed the most during the last few years. And I believe it is an important book, too. It is an intellectual journey of the history of economic theory. One can’t avoid being amazed by all the tricks economists have played in order to try to transform economics into...  Further reading...  Link to Amazon...

Koo, Richard C.- The Holy Grail of Macroeconomics

John Wiley & Sons, 2009, [Economics] Grade 4

In the end, an economic theory is just as good as its basic assumptions. One of the core assumptions for almost all Economists is the belief that all corporations always try to maximize profits. Is that assumption always valid? No, argues Richard C. Koo, Nomura’s Chief Economist. A few times during a...  Further reading...  Link to Amazon...

Reinhart, Carmen & Rogoff, Kenneth - This Time Is Different

Princeton University Press, 2009, [Economics] Grade 5

It’s very rare for a book to become an instant classic, but this book made it. The reason was the subject, a great work effort and the perfect timing of the book. In 2009, when the financial crisis reached its nadir, this book seemed to give some answers on what had happened and what will...  Further reading...  Link to Amazon...

Lewis, Michael - Boomerang

Penguin Books, 2011, [Economics] Grade 3

Michael Lewis latest success, The Big Short, is about the financial meltdown in the United States. Boomerang is a follow up, focusing on the international crisis of sovereign debt. As always, Michael Lewis is truly entertaining. This book is witty and worthwhile to read, but...  Further reading...  Link to Amazon...

Hazlitt, Henry - Economics In One Lesson

Three Rivers Press, 1979, [Economics] Grade 5

Economics has always had the nickname, “the dismal science”. This has probably never been truer today. People who can explain how economics work in a simple way are rare. Henry Hazlitt is one of few. This book was first written in 1946, a time when his views were...  Further reading...  Link to Amazon...