So Wolfowitz has left the World Bank, after a dodgy case of corruption where he appears to have engineered a pay rise for his girlfriend. In an organisation that must try hard to reduce corruption in the developing world this is obviously the right move; it is not acceptable to have corruption at the highest levels of such an organisation if it is to set a good example to those who need guidance in improving their economies. However there may be a downside.
A few years ago when he joined the World Bank Wolfowitz penned an excellent article in the Financial Times on the case for reduced farm subsidies in the EU / USA / Japan. I won't go over the arguments now, however they are summed up very well by the BBC here. Suffice to say it appears to be an issue that Wolfowitz would have given a great deal of attention to, and without him there is a concern that that focus could be lost. It is likely that George Bush will chose his replacement, and given that the US are not in favour of reducing farm subsidies, it appears possible that his successor will not give this issue the same level of attention. As a reduction in farm subsidies is such a key issue in reducing poverty in the developing world, lets hope that this is not the case, and that Bush makes a wise choice.
Monday, 28 May 2007
Cheap Labour is a Relative Term
There has been some controversy lately in the UK after supermarket Sainsburys launched a designer bag to carry your shopping home in, which being manufactured from cotton and rope would hopefully reduce the vast numbers of non degradable plastic bags thrown away each year. However, apparently these aims are not noble enough, and it has been seized upon as an opportunity for campaign groups to criticise Sainsburys for various reason. One aspect of this is complaints about the wages paid to workers in Chinese factories.
This is not a new cause of concern in some areas, particularly with trade deficits between developed and developing countries rising to all time highs. Manufacturers in the West are facing greater and greater pressure on their jobs due to the fact production costs are much lower in countries like China. It is not unusual to see incredibly low wages being quoted and raised as a cause for concern, the implication being that such low wages are unethical, and that companies should be much more reluctant to move production to developing countries. In the case of the Sainsburys bag mentioned above, there is a quote that "workers in the garment industry in China typically are paid 20p to 30p an hour" [1].
On the face of it, to someone in a developed country, this seems quite shocking, but we should investigate what this really means in terms of cost of living, and how this compares to wages for other workers in China, and in other countries. To make this comparison, I have decided to look at the salaries of teachers in China and the UK as a reference point, to try and decide what this sort of wage really amounts to in relative terms. I have chose teachers salaries here for no scientific reason, expect that in both countries, teachers salaries are managed by the government, and as such should be attuned to provide a decent, but probably not luxurious standard of living. You should treat this as an interesting benchmark, not a very precise comparison.
The first question is, what does 20 or 30p per hour equate to as a salary in Chinese Yuan (CNY). Using this website: Currency Conversion, and assuming an 8 hour working day, we can calculate that 25p (the mean wage estimate) per hour works out at 650 CNY per month. Next we need to know the monthly salary of a Chinese teacher. An approximate answer is 1000 CNY per month [2, 3]. This shows us that a Chinese manufacturing worker earns approximately 65% of the salary of a Chinese middle school teacher. This definitely doesn't sound so exploitative any more. Comparing now with English teacher salaries, which can be estimated at 23,000 GBP per year [4], we find that 65% of that is approximately 15,000 GBP per year, which while not a great salary, is certainly not exploitative or particularly unfair, bearing in mind that this is either unskilled or low skilled labour.
So in light of this, we should take it with a pinch of salt when we hear about Chinese manufacturing being unfairly cheap; in fact, considering cost of living adjustments and the relative position of the Chinese economy, the salary of an average manufacturing worker is actually quite reasonable, and not particularly out of line with what a similar unskilled worker might earn in the UK.
This is not a new cause of concern in some areas, particularly with trade deficits between developed and developing countries rising to all time highs. Manufacturers in the West are facing greater and greater pressure on their jobs due to the fact production costs are much lower in countries like China. It is not unusual to see incredibly low wages being quoted and raised as a cause for concern, the implication being that such low wages are unethical, and that companies should be much more reluctant to move production to developing countries. In the case of the Sainsburys bag mentioned above, there is a quote that "workers in the garment industry in China typically are paid 20p to 30p an hour" [1].
On the face of it, to someone in a developed country, this seems quite shocking, but we should investigate what this really means in terms of cost of living, and how this compares to wages for other workers in China, and in other countries. To make this comparison, I have decided to look at the salaries of teachers in China and the UK as a reference point, to try and decide what this sort of wage really amounts to in relative terms. I have chose teachers salaries here for no scientific reason, expect that in both countries, teachers salaries are managed by the government, and as such should be attuned to provide a decent, but probably not luxurious standard of living. You should treat this as an interesting benchmark, not a very precise comparison.
The first question is, what does 20 or 30p per hour equate to as a salary in Chinese Yuan (CNY). Using this website: Currency Conversion, and assuming an 8 hour working day, we can calculate that 25p (the mean wage estimate) per hour works out at 650 CNY per month. Next we need to know the monthly salary of a Chinese teacher. An approximate answer is 1000 CNY per month [2, 3]. This shows us that a Chinese manufacturing worker earns approximately 65% of the salary of a Chinese middle school teacher. This definitely doesn't sound so exploitative any more. Comparing now with English teacher salaries, which can be estimated at 23,000 GBP per year [4], we find that 65% of that is approximately 15,000 GBP per year, which while not a great salary, is certainly not exploitative or particularly unfair, bearing in mind that this is either unskilled or low skilled labour.
So in light of this, we should take it with a pinch of salt when we hear about Chinese manufacturing being unfairly cheap; in fact, considering cost of living adjustments and the relative position of the Chinese economy, the salary of an average manufacturing worker is actually quite reasonable, and not particularly out of line with what a similar unskilled worker might earn in the UK.
Saturday, 26 May 2007
Fruit, Vegetables and Tea?
There was an interesting advert on the London tube in the last few months extolling the virtues of drinking lots of tea, which appeared to be claiming some very significant health benefits from so doing. The most eye catching of these adverts was titled "5 portions of fruit & veg plus 4 cups of tea, it all adds up to a healthy diet".
I think it is important to be careful with what you believe when you see adverts claiming certain benefits, and particularly I think you have to think very carefully about the wording used to see what is actually being claimed, versus what is being implied, verses what the advertiser is hoping will be inferred. In this case the small print is quite long winded and I think very cleverly worded (unfortunately too small to read in the version above, but this was printed on a 6 feet tall poster on the tube):
I think it is important to be careful with what you believe when you see adverts claiming certain benefits, and particularly I think you have to think very carefully about the wording used to see what is actually being claimed, versus what is being implied, verses what the advertiser is hoping will be inferred. In this case the small print is quite long winded and I think very cleverly worded (unfortunately too small to read in the version above, but this was printed on a 6 feet tall poster on the tube):
"Fruit and Vegetables are a good source of antioxidants and the Government recommends that we should eat 5 portions or more a day. But did you know that tea is too? We recommend 4 cups a day to contribute to a diet rich in antioxidants which could help to protect your body against the damaging effects of free radicals".There are a number of reasons to be sceptical about this.
- It doesn't actually say why the government recommends eating 5 portions of fruit a day, just that fruit and veg contain antioxidants and the government recommends eating it - there is no link between the two.
- It is stated that tea and fruit and veg have something in common - that is antioxidants, but it is not claimed that this is the property that makes fruit and veg so healthy.
- The supposed benefits of antioxidants are actually not proven - only that it "could" protect you from the damaging effects of free radicals.
- The damage caused by free radicals is again not defined
- While it is the government that recommends fruit and veg, it is only "We" that recommends 4 cups of tea. In this case you should know that "We" is actually the United Kingdom Tea Council -
"We represent the world's major tea producing and exporting countries and the UK tea packing, and distribution companies".The inference drawn by most people from this advert is that tea is good for you. However, the actual wording is such that it avoids making this claim, presumably because there is no evidence that supports such a statement. We can make this presumption on the basis that if tea really was great for your health, that fact would be the subject of this advert. As it is however, we are presented with a very cleverly worded attempt at linking tea with the benefits of eating fruit and veg, which when read more closely, in fact says very little, except that tea manufacturers would like us to drink more tea.
Clearly, an organisation that has a vested interest in encouraging people to drink more tea.
Fear of Derivatives - Followup
I found the article below on the web recently and wanted to respond to it, however the author does not allow comments on his blog:
Fear and Loathing - WMD or "What are Derivatives?"
The article is an edited extract from the book: Traders Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives by Satyajit Das. It is precisely the sort of article that I had in mind when I wrote my earlier article on derivatives. It attempts to instill fear in the mind of the reader without actually addressing the real issue of derivatives.
He talks in a Rumsfeldian (not a compliment) manner about "known unknowns" and "unknown unknowns" in the area of derivatives, and makes the case that unknown unknowns are a cause of obvious concern. He then name drops a complicated sounding financial product "double knockout currency option with rebate" and presents it as a known unknown.
Obviously, yes, most lay readers of his book don't know what such an instrument is, however to portray it as an unknown in the context of financial markets is ridiculous. Anyone involved with such instruments knows what they are and why they are used (I may discuss it in another post), and they are certainly not an unknown of any sort.
His article therefore appears to be attempting to instill in the reader a sense of fear in derivatives, based on their own lack of knowledge. He also goes on to state that the only driving forces behind the use of derivatives are fear and greed. I don't intend to discuss the actual uses for derivatives in this article but suffice to say, you wouldn't see a 400+ trillion USD market for them if their use was only motivated by such irrational emotions.
As for the motivation of the author for writing such an article, I can only assume that at least one of those emotions was his driving force - and he seeks to sell more copies of the book based on the back of it.
Fear and Loathing - WMD or "What are Derivatives?"
The article is an edited extract from the book: Traders Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives by Satyajit Das. It is precisely the sort of article that I had in mind when I wrote my earlier article on derivatives. It attempts to instill fear in the mind of the reader without actually addressing the real issue of derivatives.
He talks in a Rumsfeldian (not a compliment) manner about "known unknowns" and "unknown unknowns" in the area of derivatives, and makes the case that unknown unknowns are a cause of obvious concern. He then name drops a complicated sounding financial product "double knockout currency option with rebate" and presents it as a known unknown.
Obviously, yes, most lay readers of his book don't know what such an instrument is, however to portray it as an unknown in the context of financial markets is ridiculous. Anyone involved with such instruments knows what they are and why they are used (I may discuss it in another post), and they are certainly not an unknown of any sort.
His article therefore appears to be attempting to instill in the reader a sense of fear in derivatives, based on their own lack of knowledge. He also goes on to state that the only driving forces behind the use of derivatives are fear and greed. I don't intend to discuss the actual uses for derivatives in this article but suffice to say, you wouldn't see a 400+ trillion USD market for them if their use was only motivated by such irrational emotions.
As for the motivation of the author for writing such an article, I can only assume that at least one of those emotions was his driving force - and he seeks to sell more copies of the book based on the back of it.
Thursday, 24 May 2007
Should We Be Scared of Derivatives
I've seen a number of articles on the net over the last few months or so where the authors appear to have a fear of the derivatives markets for a few ill considered reasons. I want to take a bit of time to allay those fears and discuss the markets in a bit more detail.
There seem to be a number of areas for concern, and I want to discuss each in turn. The first problem seems to be with the sheer volume of derivatives trading that takes place. People see the headline figures and think the numbers are so crazy as to be unsustainable or unmanageable. One example is that the total size of outstanding contracts in oil derivatives can be larger than the total amount of oil in the ground. Actually this is not such a surprise due to the concept of "Notional Value" in derivatives contracts. This means that when someone uses a derivative to gamble on the future price of oil, they can "up their stake" by increasing the hypothetical amount of oil that they want to gamble with. If things don't go their way, they pay the counter party the cash amount that was lost in the bet, rather than supplying some oil at a favourable cash value - no physical delivery means there is no dependence on the black stuff in the ground. This leads us to the idea that contracts are "Cash Settled"; that means physical delivery is in the vast majority of cases not performed, so therefore the amount of oil in the ground is not relevant. What actually happens is hypothetical amounts of oil are used as the basis for betting on future prices - either as a means of speculation or to hedge risk (this risk hedging is common in the airline industry for example).
A second worry seems to be with managing risk, with such large numbers going around, its easy to think that if someone defaulted somewhere in the system, the knock on effects could be disastrous. However this problem can be controlled in a number of ways - first of all is
"Margining", which means a trader has to front money (the "margin") to an exchange before being allowed to trade. If a position starts to go badly, the exchange will pocket money from
the margin account until it falls to a certain, minimal level. At this point the exchange makes a "margin call", whereby the trader has to refund his margin account or the position gets closed. In this way, an exchange will never be out of pocket, because they have the right to close positions that do not have sufficient margin to cover the hypothetical losses for a few bad days trading.
Another point is the lengths that banks have to go to when covering the money they have at risk. The regulatory authorities (FSA in the UK and SEC in the US) enforce certain rules about how much money banks have to keep readily available to pay off potential future losses. This is often done based on an analysis of their current investment portfolios and a statistical likelihood of the future value. From this it is possible to say, "We're 95% sure that we won't lose more than 100M USD in the next 10 days". The regulators will take that value, multiply it by maybe 3 or 4 depending on the model used to calculate it, and then ensure that that value (300 or 400M USD) is kept in reserve for unexpected heavy losses. The calculations are performed on a daily basis and monitored by the regulators very closely - so the dangers of catastrophic loss are virtually eliminated.
There seem to be a number of areas for concern, and I want to discuss each in turn. The first problem seems to be with the sheer volume of derivatives trading that takes place. People see the headline figures and think the numbers are so crazy as to be unsustainable or unmanageable. One example is that the total size of outstanding contracts in oil derivatives can be larger than the total amount of oil in the ground. Actually this is not such a surprise due to the concept of "Notional Value" in derivatives contracts. This means that when someone uses a derivative to gamble on the future price of oil, they can "up their stake" by increasing the hypothetical amount of oil that they want to gamble with. If things don't go their way, they pay the counter party the cash amount that was lost in the bet, rather than supplying some oil at a favourable cash value - no physical delivery means there is no dependence on the black stuff in the ground. This leads us to the idea that contracts are "Cash Settled"; that means physical delivery is in the vast majority of cases not performed, so therefore the amount of oil in the ground is not relevant. What actually happens is hypothetical amounts of oil are used as the basis for betting on future prices - either as a means of speculation or to hedge risk (this risk hedging is common in the airline industry for example).
A second worry seems to be with managing risk, with such large numbers going around, its easy to think that if someone defaulted somewhere in the system, the knock on effects could be disastrous. However this problem can be controlled in a number of ways - first of all is
"Margining", which means a trader has to front money (the "margin") to an exchange before being allowed to trade. If a position starts to go badly, the exchange will pocket money from
the margin account until it falls to a certain, minimal level. At this point the exchange makes a "margin call", whereby the trader has to refund his margin account or the position gets closed. In this way, an exchange will never be out of pocket, because they have the right to close positions that do not have sufficient margin to cover the hypothetical losses for a few bad days trading.
Another point is the lengths that banks have to go to when covering the money they have at risk. The regulatory authorities (FSA in the UK and SEC in the US) enforce certain rules about how much money banks have to keep readily available to pay off potential future losses. This is often done based on an analysis of their current investment portfolios and a statistical likelihood of the future value. From this it is possible to say, "We're 95% sure that we won't lose more than 100M USD in the next 10 days". The regulators will take that value, multiply it by maybe 3 or 4 depending on the model used to calculate it, and then ensure that that value (300 or 400M USD) is kept in reserve for unexpected heavy losses. The calculations are performed on a daily basis and monitored by the regulators very closely - so the dangers of catastrophic loss are virtually eliminated.
Wednesday, 23 May 2007
The Value of the Yuan - Redux
Someone pointed me at this article on a report by the Chinese government stating that a 5-10% increase of the value of the Yuan would cost their economy 3.5 Million export jobs hurt 10 Million farmers:
Costs of Revaluation
Numbers like this should always be taken with a grain of salt, but supposing even that they are double the actual impact, it is clear that the Chinese have a lot to lose by acquiescing to US demands. When analysing the expected movement of the Yuan / Dollar exchange rate therefore we should bear in mind facts such as this and accept that if the Yuan does move, it will be as slowly as Beijing can manage.
Thanks to immobilienblasen for bringing this to my attention.
Costs of Revaluation
Numbers like this should always be taken with a grain of salt, but supposing even that they are double the actual impact, it is clear that the Chinese have a lot to lose by acquiescing to US demands. When analysing the expected movement of the Yuan / Dollar exchange rate therefore we should bear in mind facts such as this and accept that if the Yuan does move, it will be as slowly as Beijing can manage.
Thanks to immobilienblasen for bringing this to my attention.
Monday, 21 May 2007
Why the Chinese Will Not Revalue the Yuan
In China, much like in many Asian countries, the local currency, the Yuan, has had a fixed exchange rate to the dollar for many years. Historically, the value of this exchange rate was entirely under the control of the government, a fact which gave them great control over the way in which money flowed in and, more importantly, goods flowed out of the People's Republic. There has been growing pressure for more than a few years for the Chinese government to release their control of this exchange rate and to allow it to move, in the natural course of market trading, to a more freely determined level. The Chinese government, one must assume reluctantly, in 2005 allowed this to begin to take place, by fixing the rate of the Yuan to a secretive "Basket" of currencies that would be designed to allow the overall exchange rate of the Yuan to move more freely. However in the almost 2 years since this took place, relatively little movement has been seen in the value of the Yuan, and the Chinese are facing calls to devalue their currency further. The interesting question here is what do we expect the future to hold for the Yuan? To understand this we need to understand why the Yuan is valued the way it is at the moment, what the impact of a revaluation might be on Chinese economics, and what are the consequences of doing nothing.
For many years the growth of the Chinese economy has been one of the most impressive stories of global economics, averaging 9% GDP growth per year for the decade to 2004. This growth shows no sign of stopping, and is a major driving force behind the urbanisation and modernisation of Chinese life. It is a testament to how far the Chinese economy has progressed in the recent past, that a country which suffered food shortages and starvation in the previous generation is now in the unprecedented position of being talked about as overtaking America as a global economic superpower in the next generation. The smartest and hardest working Chinese students can afford jet half way around the world to study at the best universities, paid for by their now wealthy parents - the same ones that may have suffered hunger themselves not so long ago - and who know very well that China's new found wealth should be held on to and respected for the better life it can bring their children.
The engine of China's economic growth has been manufacturing, and, more specifically, the revenue generated by exporting those manufactured goods to wealthier countries. First of all, it is interesting to note that around 20% of exports from China to go the US, and are predominantly in manufactured goods; items such as electronics, office equipment as well as clothing and textiles make up just over half of all Chinese exports. Clearly there is a large vested interest in manufacturing and exports; the manufacturing side is driven by a large availability of cheap labour (China is the worlds most populous country, and around half those people work in agriculture), and exports create revenue by virtue of their affordability to a large number of people around the world. It is this affordability which the Chinese government are looking to control when they manage the exchange rate of the Yuan; and if managed correctly, their exports and associated revenues will continue to grow, and be a boon to the lives and well being of the Chinese people, leading them to the greater prosperity and comfort which all people strive for. Clearly therefore it is in the interests of policy makers in Beijing to attune the exchange rate of the Yuan to suit the needs of the Chinese people - although they may not be democratically elected, the government must keep the needs and wishes of the Chinese people foremost in mind when making strategic decisions - and this will always therefore lead them to keep the Yuan low enough to stimulate growth, particularly in the form of those exports to richer countries that bring in valuable foreign money, which is the main reason for the growing prosperity of modern China.
Therefore, we can expect that the future will not bring any major revaluations of the Yuan - the Chinese government has been under pressure for some time now to devalue the currency, but has not done so in any significant fashion, and we should expect this trend to continue as long as no extraordinary external pressures force it to do otherwise. That the Chinese have allowed the Yuan to float freely at all has been in response to strong criticism, particularly from the US, that the currency is too weak. The fact that the Yuan has only moved around 5% in the last year, when some in America are calling for a 40% revaluation, shows how reluctant the Chinese are to concede to these demands - it is from this that we can infer that the decision was taken reluctantly, and that the Chinese will resist as much as possible any further requests to devalue the Yuan further.
For many years the growth of the Chinese economy has been one of the most impressive stories of global economics, averaging 9% GDP growth per year for the decade to 2004. This growth shows no sign of stopping, and is a major driving force behind the urbanisation and modernisation of Chinese life. It is a testament to how far the Chinese economy has progressed in the recent past, that a country which suffered food shortages and starvation in the previous generation is now in the unprecedented position of being talked about as overtaking America as a global economic superpower in the next generation. The smartest and hardest working Chinese students can afford jet half way around the world to study at the best universities, paid for by their now wealthy parents - the same ones that may have suffered hunger themselves not so long ago - and who know very well that China's new found wealth should be held on to and respected for the better life it can bring their children.
The engine of China's economic growth has been manufacturing, and, more specifically, the revenue generated by exporting those manufactured goods to wealthier countries. First of all, it is interesting to note that around 20% of exports from China to go the US, and are predominantly in manufactured goods; items such as electronics, office equipment as well as clothing and textiles make up just over half of all Chinese exports. Clearly there is a large vested interest in manufacturing and exports; the manufacturing side is driven by a large availability of cheap labour (China is the worlds most populous country, and around half those people work in agriculture), and exports create revenue by virtue of their affordability to a large number of people around the world. It is this affordability which the Chinese government are looking to control when they manage the exchange rate of the Yuan; and if managed correctly, their exports and associated revenues will continue to grow, and be a boon to the lives and well being of the Chinese people, leading them to the greater prosperity and comfort which all people strive for. Clearly therefore it is in the interests of policy makers in Beijing to attune the exchange rate of the Yuan to suit the needs of the Chinese people - although they may not be democratically elected, the government must keep the needs and wishes of the Chinese people foremost in mind when making strategic decisions - and this will always therefore lead them to keep the Yuan low enough to stimulate growth, particularly in the form of those exports to richer countries that bring in valuable foreign money, which is the main reason for the growing prosperity of modern China.
Therefore, we can expect that the future will not bring any major revaluations of the Yuan - the Chinese government has been under pressure for some time now to devalue the currency, but has not done so in any significant fashion, and we should expect this trend to continue as long as no extraordinary external pressures force it to do otherwise. That the Chinese have allowed the Yuan to float freely at all has been in response to strong criticism, particularly from the US, that the currency is too weak. The fact that the Yuan has only moved around 5% in the last year, when some in America are calling for a 40% revaluation, shows how reluctant the Chinese are to concede to these demands - it is from this that we can infer that the decision was taken reluctantly, and that the Chinese will resist as much as possible any further requests to devalue the Yuan further.
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