Derivatives: Lethal Financial Instruments of Mass Destruction

By Navin Doshi, June 19th, 2010

Warren E. Buffett has warned over the past decade that derivatives are the fiscal equivalent of a weapon of mass destruction (WMD). The consequences of an explosion of such a weapon could make the recent global economic crisis seem insignificant. But lobbyists, on behalf of big banks, plead for keeping the over-the-counter derivative market unchanged with no restrictions and no supervision.

Derivatives essentially are bets that come in different forms. Examples include a bet for or against the house in a casino, or against the weather in situations in which the weather is critical. Forwards, futures, options, and swaps are different forms of derivatives. Credit derivatives are based on loans, bonds or other forms of credit. Over-the-counter (OTC) derivatives are contracts that are traded and privately negotiated directly between two parties, outside of a regular exchange. Just as the velocity is a time-dependent derivative of distance, so are the financial derivatives time dependent. What happens between two parties, notably hedge funds, is like what happens between two individuals who bet on the final score of a football or baseball game. Congressional committees have been informed about “ticking time bombs” to no avail, demonstrating that both the U.S. government and the U.S. Congress are dysfunctional and out of sync.

On May 16, 2006, for example, Richard T. McCormack, Vice Chairman of Merrill Lynch and former undersecretary of state for economic and agricultural affairs, spoke at a Senate banking hearing on derivatives and hedge funds in 2006, when the derivatives industry was in the $300 trillion range. He is quoted as saying “the increasing internationalization of finance and investment suggests the need for an ever-more-global approach to monitoring and controlling potentially dangerous problems.” Derivatives played a key role in camouflaging the multibillion-dollar Enron scam in 2001. The Long-Term Capital Management (LTCM) hedge fund debacle of 1998 almost destroyed the global monetary system. Even though its trading losses were a mere $5 billion, it still threatened the soundness of the financial markets.

When the Russian ruble suddenly nose-dived without warning, LTCM found itself exposed with more than $1 trillion in foreign-exchange derivatives it couldn’t pay. The New York Federal Reserve Bank organized a consortium of companies to buy out LTCM and cover its debts. LTCM shareholders were wiped out, but none of the creditors took losses. LTCM was a hedge fund with just 200 employees, but without the New York Fed’s intervention, it would have caused a crash felt around the world. Mr. McCormack pleaded with congressional banking experts to correct any structural or technical problems that could increase the likelihood of systemic risk in the event of future shock to the financial system. There was no response from all the parties concerned, inside and outside the government. The 2007 U.S. subprime mortgage global disaster was also derivatives-driven, and provoked the biggest financial and economic disaster since the Great Depression.

Mr. McCormack, then a senior fellow at the Center for Strategic Studies, explained to the Banking Committee how Italy had secured entrance into the Euro by purchasing exotic derivatives that obscured the true financial condition of the country, until after they were admitted to the new European common currency. The same thing happened with Japan when some banks purchased derivative instruments, which disguised the actual catastrophic state of their balance sheets at the time. Today’s massive new derivative bubble is driving the domestic and global economies, far outstripping the subprime-credit meltdown. Currently very few, “too big to fail” banks, control the derivative markets and earn much more trading derivatives, employing their proprietary trading software, than from regular banking business. However as more banks and hedge funds learn the same trick, it could culminate into generating more unpredictable and catastrophic “Black Swan” events. This is reminiscent of the morphic field described by Rupert Sheldrake in his book The Presence of the Past. He hypothesizes that the rats in Europe learn the same trick, discovered by the rats in Asia, caused by this natural field analagous to an electromagnetic field. Please note that there is no interaction or communication in any form between these two groups of rats. Intuitively, we know that any trading system, no matter how advanced it may be, degrades in time as more players do the same.

While banks all over the world were imploding and some $50 trillion vanished in global stock markets, the derivatives market grew by an estimated 65 percent, according to the Bank for International Settlements (BIS). The BIS convenes the world’s 57 most powerful central bankers in Basel, Switzerland for periodic secret meetings. Occasionally, they issue a cry of alarm. In this particular instance, derivatives had soared from $415 trillion at the end of 2006 to $684 trillion in mid-2008. The derivative market is now estimated at $700 trillion (notional, or face, value, not market value). The world’s gross domestic product in 2009 is about $70 trillion and America’s is $14 trillion. The total market cap of all major global stock markets is a mere $30 trillion, and the total amount of dollar bills in circulation, most of them abroad, is estimated to be about $830 billion.

Cautious bankers around the world concede that, even after listening to experts, they still do not understand derivatives and therefore don’t trust them and won’t have anything to do with them. And when that weapon of mass destruction explodes, they explain, “Our bank’s customers, from all over the world, will be saved from the disaster.” George Soros thinks of the current state of the world economy to be in Act two of a three Act play. The melt down of 2008-2009 was Act one. He believes that entering into a double deep recession is Act two. Apparently the total collapse of the economy will be act three.

Congress is considering legislation to curb the use of derivatives and other methods that artificially boost returns. One measure proposed by Sen. Blanche Lincoln of Arkansas would bar banks from trading in derivatives. This, in turn, would push almost $300 trillion beyond the reach of regulators. Derivatives would become still more opaque. Some say abolish derivatives trading in the U.S. and push it offshore.

The Greek tragedy over its debt crisis is echoing around the world and certainly in the halls of Congress. Greece’s public debt is around 100 percent of its economy, about the same as for the United States. If you add unfunded U.S. liabilities for Social Security, Medicare, and Medicaid, the long-term shortfall is $62 trillion, or about the same as the total world GDP, or about $200,000 for each and every American. Fed’s current posture is to add liquidity (print money) when markets go down substantially (S/P 500 support at 1040), or stay on the side line if the mood of the market is positive. Please refer to articles like, Economics 101…, Butterfly Effect…, posted at http://www.nalandainternational.org, for detailed explanation.

When the Dow Jones went into a 1,000-point tailspin and back up in 16 minutes on May 6th of this year, economic and financial prognostication made astrology look respectable. Barron’s round table analyst Marc Faber, hedge-fund manager Jim Chanos and Harvard’s Kenneth Rogoff told Bloomberg that China’s economy will slow and possibly “crash” within a year or two as the nation’s property bubble is set to burst. Another Barron’s round table analyst Felix Zulauf anticipates the secular bear market bottom should occur at around the market book value. If it happens, then the S/P 500 would have to fall from the current level of about 1100 to the S/P book value of about 500. If I were to consider the forecast of UBS technician Peter Lee, it should happen sometime in 2012. However, in the mean time in coming months, S/P 500 could go over 1150 depending upon what the Fed does in matters of money supply. Market technicians in general believe the market is in a bullish territory if the index is over 200 days moving average and in bearish territory if it is below the same.

Needless to say that no one can predict the future accurately unless one happens to be Sahdeva of Mahabharata, or Cassandra of Greek mythology.

Mutually Assured Financial Destruction

By Navin Doshi, May 19th, 2010

Mutually assured destruction (MAD) is a doctrine of military strategy and national security policy in which a full-scale use of nuclear weapons by two opposing sides would effectively result in the destruction of both the attacker and the defender. The doctrine assumes that each side has enough nuclear weaponry to destroy the other side and that either side, if attacked for any reason by the other, would retaliate with equal or greater force. The expected result is an immediate escalation resulting in both combatants’ total and assured destruction. It is now generally hypothesized that the nuclear fallout or nuclear winter resulting from a large scale nuclear war would bring about worldwide devastation, though this was not a critical assumption to the theory of MAD. The primary application of this doctrine started during the Cold War (1940s to 1990s) in which MAD was seen as helping to prevent any direct full-scale conflicts between the United States and the Soviet Union while they engaged in smaller proxy wars around the world. It was also responsible for the arms race, as both nations struggled to keep nuclear parity, or at least retain second-strike capability. (From Wikipedia)

While we have overcome the Cold War, we are quickly descending into MAD in the financial markets among developed countries, with assured free market destruction as we know it, and with “Debt Bombs” countering with more printing paper money. However, there are differences in the two situations. First and foremost a nuclear holocaust did not happen, while today, in the views of many market analysts, we are on the path of eventual financial destruction. Unlike the bipolar world of MAD, our interactions are in a globalized world with multiple players making the situation much more complicated. First, the debt bomb went off in America in late 2008, causing tremors all over the world. So the Fed dropped the paper money bomb in a form of a trillion-dollar stimulus package, in essence creating the fiat money and degrading the value of the dollar. That was the beginning of state capitalism replacing the free market capitalism after its demise, taking over failed banks, automobile companies, and mortgage companies.

Capitalism takes many forms but all of them can be distinguished by their use of wealth to create more wealth, a broad enough definition to capture both free-market and state capitalism. In the free-market form of capitalism, the job of the state is to “enable” wealth generation by enforcing contracts and limiting the influence of moral bads such as greed—the latter can lead to market failures, which have occurred periodically since the Dutch tulip craze of 1637. Free-market governments attempt to ensure that the economic game is played fairly. In contrast to free-market capitalism, the economy in state-capitalist regimes, like in China and Russia, is dominated by the state agenda. If forced to choose between the protection of the rights of the individual, economic productivity, and the principle of consumer choice, on the one hand, and the achievement of political goals, on the other, state capitalists will choose the latter every time. Continuing the sports game analogy, state capitalists control the referees as well as the main players. (Refer to “The End of the Free Market” by Ian Bremmer)

A few weeks ago Jean-Claude Trichet, the head of the European Central Bank (ECB), was telling the world there was no way the ECB would go nuclear to resolve the Greek debt problem. Then, over the weekend, they went nuclear, creating a trillion dollars out of thin air. Rather than dropping an atomic bomb, however, Europe dropped a money bomb on the markets – a rescue package worth about a trillion dollars. The package included the authority for the ECB to wade into the markets and directly purchase debt. There is perhaps just one thing left to do: Destroy the euro. Jean-Claude Trichet, the head of the ECB, should swallow hard… admit his failure… and print like a madman, devaluing the currency in order to “monetize” the vulnerable eurozone countries’ debts. The euro was always a lousy idea – a hodge-podge of dissimilar cultures and economies, stitched together in a “Mad Doctor’s” dispensary. The same monetary policy for various and varied economies in the euro zone has created huge imbalances and stress. One medicine cannot cure all the ills.

While Germany has maintained discipline in its financial dealings since the inception of the European Monetary Union, Greece, Italy and Spain have partied. Enjoying the advantage of lower interest and inflation rates, Southern Europeans were caught up in a big credit-driven boom that has gone bust just as it had happened in the U.S.A. The big bailout, unprecedented in size for Europe, in truth is a bailout of the European banks which were on the hook as the main creditors. The ECB, by following the U.S.A. in matters of keeping a loose monetary policy, has demolished its own credibility. Apparently the outcome for the euro, dollar and the British pound should be an eventual self-destruction. In the words of Alan Abelson of Barron’s magazine, “all the central banks in Europe and U.S.A. are determinedly printing money like mad to save the world”. These actions of money printing are certainly bullish for gold and silver in long run. Please note that nothing goes up or down in straight line. Gold is over-bought and should correct itself downwards. There is a huge short position on the euro and could go up for a few months when the shorts are being covered.

The state capitalism is very much involved in market manipulation as we are experiencing in the U.S.A. Institutions, with the blessings of the government, use derivatives to artificially maintain a strong dollar so that the interest rate and therefore the cost of borrowing is maintained at a much lower level. In spite of this effort, the government seems to be losing control over the price of gold. During the September 2008 meltdown, the dollar and U.S. treasury went up over 10 % while the gold price was down by 20 %. However, gold has outperformed both the dollar and the S&P 500 in each and every time interval of 30 days, 3 months, 6 months, 12 months, 2 years, and 5 years. As a matter of fact, gold has gone up by about 170% while the S&P 500 is down by five % in the last five year time interval (As of May 19th, 2010).

Please note that 70 % of the trading volume comes from both foreign and domestic institutions employing their proprietary soft ware. The message here is that the foreign central banks are accumulating gold to strengthen their currencies because the confidence in western currencies is receding. The great games, played by world powers, are first played in the economic realm, before they consider going to war.

Looking at the state of the market, there were two melt downs in the last 25 days. One of them was an almost death experience. Only the dollar and the gold have been holding well. For graduating students, toughest test is getting a job. About 80 % of 2009 fresh graduates moved back home with their Parents, compared to 75 % in 2008, and 65 % in 2006. In the view of this writer, the most important responsibility of the executive branch of the government is to keep the job seekers, and certainly fresh graduates, employed.

(Mr. Doshi, a writer, trader, and a philanthropist, posts his articles at http://www.nalandainternational.org)

The Butterfly Effect – Seeds of the Meltdown

The Butterfly Effect – Seeds of the 2008-2009 Meltdown
By Navin Doshi, April 19th, 2010

In the last two decades, we have experienced the bursting of two bubbles- the first in technology in 2000 and the second in housing in 2008. When exactly were the seeds planted for the current American suffering with close to 20% combined unemployment and underemployment? Even those who are employed do not feel quite comfortable about their job security. Unemployment is much higher for those fresh graduates coming out of schools and universities. Senior citizens living on fixed income are suffering because the interest and dividend income on their savings and IRA funds have shrunk drastically. The purchasing power of the dollar has been steadily declining, causing increasing hardship to those who exist on meager income. The average household net worth has shrunk because of the depressed home prices.

The butterfly effect is a metaphor that encapsulates the concept of sensitive dependence on initial conditions in chaos theory; namely, that small changes in the initial condition of a dynamic system may produce large variations in the long-term behavior of the system. Chaos theory is a field of study in mathematics, physics, and philosophy concerning the behavior of dynamic systems that are highly sensitive to initial conditions. Here the dynamic system is the American economy, and we are trying to explore and determine what seeds were planted that caused the 2008-2009 chaotic meltdown and a deep recession. Simply stated, the fluttering of butterfly wings in Spain causes a hurricane in Florida.

Some would say that these seeds were planted in the 1980’s and ’90’s with financial deregulation. Some would say that it was due to the Fed’s easy monetary policy designed to stimulate economic growth by lowering short-term interest rates and making money less expensive to borrow. I would argue that the seeds were first planted in the 1970’s and later reinforced in the 1990’s when the market regulations were either removed or not implemented properly.

During the 1992 election, Ross Perot’s role as a third party candidate caused George H. Bush to lose to Bill Clinton. Bush lost the election for two reasons- high unemployment and high interest rates. Fed Chairman Alan Greenspan raised interest rates to tighten the money supply to bring some economic discipline whereby good businesses would survive and bad businesses would fail. In a free-enterprise capitalist system, economic cycles are natural. It allows the “dead wood”, that is, poorly run businesses, to die while the strong, more efficient businesses survive. The conservative vote got divided between Bush and Perot, giving the presidency to Clinton. There was some validity to Ross Perot’s argument in relation to NAFTA (North American Free Trade Agreement). Perot had argued that NAFTA would cause the loss of jobs without sufficient control, as cheap labor became more available from south of the border.

It was during the late 1990s when the CFTC (commodity futures and trading commission) chairperson, Brooksley Born, had proposed to regulate the exploding and out-of-control derivative market. However, she had hit the stone wall erected by then Fed chairman Greenspan and treasury secretary Robert Rubin, also supported by President Clinton. Under great pressure, she resigned the post. Ever since then, the derivative market of over $500 trillion, is the big elephant in the room. Warren Buffett has described it as a financial instrument of mass destruction. Just to put the size of the elephant in perspective, the yearly GDP of USA is about $14 trillion and the entire world GDP is about $65 trillion, while J.P. Morgan, one too-big-to-fail bank, holds derivatives of about $85 trillion. Derivatives do provide useful function of controlling the price movement of securities, similar to a closed loop feedback system to control the movement of a parameter like speed of a vehicle. However there has to have some safety mechanism to insure the system stability.

Going back to 1969, the Nixon administration expanded the war in Vietnam, which led to much greater death and destruction in Indo-China. Due to the excessive spending for the Vietnam War and providing arms and ammunitions to Pakistan, the value of the dollar began receding. Countries holding dollars demanded gold for dollars since the dollar was convertible to gold at a rate of $35 per ounce. Half of the gold reserves stored in Fort Knox, about 9,000 tons, were delivered to the holders of dollars. With 9,000 tons of gold remaining, Nixon officially removed the gold standard. That action created tremendous inflationary pressure, resulting in gold peaking at over $800 per ounce in 1980. The price of all commodities, most importantly oil, rose to the stratosphere, thus creating the terrible inflation of the 1970’s. The Yom Kippur war of 1973 had created an oil cartel that had put additional pressure on inflation. A gradual degradation of auto and steel industries due to the cheaper imports from abroad, accelerating manufacturing job loss, added more misery to the people. (Refer to articles including, Dysfunctional Detroit, and Sweat, Think and Philosophize, at http://www.nalandainternational.org).

The second misfortune for America was the Watergate scandal that caused the country to go through the long-drawn process of impeachment. Watergate was a political scandal in which a break-in into the Democratic National Committee headquarters resulted in the eventual resignation of Richard Nixon. Recorded conversations in President Nixon’s offices revealed his involvement with the break-in along with members of his staff. Before Watergate, the United States government was basically considered “God” in the eyes and minds of most Americans. I recall a few of our American friends considered it sinful to evade paying taxes to the American Treasury. This blatant show of corruption changed the attitude of many Americans and created a pattern of cynicism that still exists today.

Thirdly, Nixon is responsible for opening the floodgate of cheap labor from China. He had a very high admiration for Mao Zedong, the leader of Communist China. Nixon was incredibly anxious to meet him and asked his National Security Advisor Henry Kissinger, to arrange a meeting. Pakistan, being friend of both America and China, helped to arrange the meeting. We do know that India and Pakistan have an existing conflict over Kashmir ever since they became independent in 1947. These conflicts escalated as the people of East Pakistan, now Bangladesh, began en-masse to migrate to India from East Pakistan due to the atrocities committed by the Pakistani Army.

West Pakistani elites could not accept Bangladeshi leader Sheikh Mujibur Rahman, who had won the election, as the prime minister of the whole country. Nixon had provided more arms to Pakistan for its defense. Additional arms helped Pakistan perform great atrocities through “Operation Searchlight” against the Bangladeshi people, killing as many as 3 million and creating 5 million refugees. These events led to the India-Pakistan war of 1971 and later, to the creation of Bangladesh. Nixon’s dislike of India’s Prime Minister Indira Gandhi is well-known. He went as far as sending the U.S. Navy’s mighty 7th fleet to the Bay of Bengal to pressure India and help the Pakistani army to save them from defeat. He even encouraged China to invade India to avoid dismembering Pakistan with no success. During the meeting with Mao Zedong, Nixon spoke, “This was the week that changed the world. We will do in the years ahead to build a bridge across 16,000 miles and 22 years of hostilities that have divided us. And what we have said today is that we shall build that bridge.” This “friendship” of sorts literally opened up the floodgate of cheap labor as American corporations went overseas to increase their profit. This has been the main cause of the transfer of manufacturing jobs for the last 35 years. Nixon resigned in 1974 before he was impeached by the congress.

So how does the future look on Wall Street? A UBS technician, Peter Lee, sees a correction of about 10 to 15 percent in the coming summer months, then a rise of about 40 percent going into 2012. Then he believes the market should test the March 2009 low of DJI of 7000 before 2012 ends. There are two views on interest rates that may influence the stock market. Goldman Sachs projects the interest rate of a 10-year treasury to remain around 3.75 % going into 2011, while Morgan Stanley projects the interest rate of the same to be around 5.5 %. None of the outcomes seem to be very bullish in the view of the writer. Now that Goldman Sachs has been indicted by SEC, the knowledge of market manipulation has entered into the mainstream, which may foreshadow dark times ahead. Europe is already experiencing dark days and may be even dark times, thanks to the volcanic irruption and Greek debt problem.

(Mr. Doshi, a writer, trader, and a philanthropist, posts his articles at http://www.nalandainternational.org)

Transcendence, Saving Us From Ourselves, a Review by Sujay Desai

Transcendence, Saving Us From Ourselves, a Review
By Sujay Desai

In Saving Us From Ourselves, Navin Doshi presents the sterling truths of ancient Indian philosophy as a coherent solution to the complex issues that humanity faces in the modern age. Although we have achieved tremendous technological and material progress as a human race, the basic problems of war, greed and the whole gamut of human maladies continue to plague and perplex us. In response to these dilemmas, Mr. Doshi illuminates the profound wisdom of the Indian sages regarding human nature and society. When we cultivate a greater awareness of ourselves within and our outer world, we can move towards higher states of being and transcend the dysfunction which permeates much of the world today.
Mr. Doshi thoroughly explores the domains of the body and the mind along with the interrelationships between the two realms. He deftly explains that while the two are autonomous and independent, they are causally interconnected in the development of the total human self. If we focus on one at the expense of the other, then we will suffer from imbalance. The overall goal is to gravitate towards greater discipline and a movement from a self-centered (aham) view to a selfless (aum) existence.
Furthermore, we learn that nature is an often misunderstood or largely ignored aspect of our modern existence. For most of us who live in urban or suburban America, our contact with nature is quite infrequent and inconsequential. We tend to think about nature very rarely. However, we depend on nature in very important ways. The looming water crisis in the Western U.S. is an immediate example. On the whole, Western civilization has sought to subdue the natural world and greedily extract from it all possible resources. This exploitative view of nature can have disastrous consequences for our sustainability as a human race. If we look at the devastation that we have inflicted on the planet, we will notice that our desire to dominate nature could ultimately spell the end of mankind. In Transcendence, Saving Us From Ourselves, Mr. Doshi emphasizes the importance of a symbiotic relationship between humankind and nature.
Mr. Doshi poses some fascinating parallels between his theory of the human self and society as a whole. In Chapter 5, we see that the traits of the human being manifest themselves in the realms of economics, government, mathematics and other fields. Mr. Doshi puts on full display the holistic view of the world that is a trademark of Indian philosophy. We learn that the idea of separateness is a Western illusion, and that all the facets of human existence and society originate from the universal consciousness, or Brahman.
For the reader, Transcendence, Saving Us from Ourselves is a prayer that exhorts all of humanity to strive for greater peace and harmony in all areas of existence. If we can harness some of the wisdom beautifully captured in this book, then we may witness increased clarity and happiness in our own lives. Ultimately we can only hope that humanity can embrace Mr. Doshi’s vision of unity amidst all of life’s diversity.

All the Emperors with No Clothes by Navin Doshi

All the Emperors with No Clothes
(By Navin Doshi, March 5, 2010)

Looking carefully at the economic indicators, the current state of the Western (G7) economy appears quite dismal. Led by the Europeans, a competitive devaluation of currencies is wreaking havoc on the economic recovery prospects for the Western nations. The devalued Euro will not help the U.S.A. and Canada, a tired country with little or no gold reserves to back the Canadian loonies. People delude themselves into thinking that Greece, Spain, U.K., Canada, California, New York, and the entire U.S.A. will solve their problems through a tightening of the fiscal belt. Economists believe that governments should start cutting their spending and increase taxes, but such measures could result in astronomical unemployment as seen in Africa. The G7 apparently is a form of a grand Ponzi scheme, with little or no productive backing, like defunct Enron. Emperors of the West, just about a century later, are essentially broke by spending their fortune on an unsustainable life style.

As I have opined in earlier articles, governments need to focus on production, not consumption, to create wealth. Paper money becomes money only when it is convertible to an asset class that is acceptable and respected the world over. Unfortunately, governments are not showing any signs that they will be heading in the right direction.

Reviewing the history of currency, the barter system came first and continued for a millennia, but that initial arrangement was replaced by a more efficient and sophisticated system of world currency in the form of precious metals. Europe became rich because of the Industrial Revolution together with colonization that provided raw materials. The riches and wealth of Europe essentially disappeared by the middle of the 20th century as a result of the two world wars and government socialistic tendencies. Following World War II, America came of age and amassed more than half of the world’s gold and built Fort Knox to store it. In the post-WWII era, if you owned the dollar you also owned gold since the dollar was convertible into gold. America, as a victor of WWII, with the support of the Allies, was able to establish the dollar as the world reserve currency. But human nature rarely fails; power corrupts men sooner or later, if not in the first generation then in the second or third. America, though born out of idealism, is an unexpected example of how corruption and decadence seeps in and spreads.

The U.S. soon used its world dominance to print money to finance a military-industrial complex, multiple wars (Korea, Vietnam, Iraq, etc), to dole out foreign aid, and to exert its political influence all over the world. Some of us would have to confess that we took advantage of the situation since we came to America for higher education, but we took employment in the same military-industrial complex instead of going back to our homeland.

This spending extravaganza eroded the integrity of the U.S. dollar. America maintained the facade for a while by exchanging foreign dollars for gold, with France leading the charge to demand gold for dollars. When half of the gold, about 9000 metric tons, evaporated from Fort Knox in a short span between the late 1960s and the early 1970s, President Nixon disconnected the dollar from gold. That decision marked the end of the true international trading standard. If we compare currencies to the blood of a living organism, the removal of gold as an anchor, or as a “quality controller”, caused the decline in the “nutritional” value of currencies. As a result, for the last 40 years, the U.S. and the rest of the world have embarked on a nonstop printing spree. Trillions have been spent on wars, trillions to save the banks, trillions on health care, and trillions for the good life of the chosen few, and the spending spree continues on and on just like the Energizer Bunny in the battery advertisement.

Please note that after the peak was established in the ’50’s and ’60’s, the U.S. growth rates of GDP, employment, and income have been declining. For example, the average GDP growth rate peaked in the 1940’s at 5.5 %, and it has been declining steadily with the lowest in the first decade of the 21st century at 1.9 %. (Economist magazine, Feb 27th, p. 36).

Ironically this situation has been brought upon us with the blessings of all the great minds of our era including John Maynard Keynes, many Nobel Laureate economists, and rocket scientists who have applied the laws of natural science to economics with very little regard for human psychology. The great minds of the Western world that include psychologist Sigmund Freud, political theorist and sociologist Karl Marx, physicist Rene Descartes and economist John Maynard Keynes have all failed in varying degrees.

I submit that two significantly important causes for the decline are the Western belief that nature must serve humanity’s interests and the “Holier than Thou” mindset. On the other hand, the Eastern belief states that humanity must have reverence for nature since she is the mother, and second, the truth is never absolute. Recall the truth described by the parable, “Elephant and the Blind Men”. Ultimately humanity and nature must exist in a symbiotic way. The growth does not have to be at the expense of the environment. The growth can be extended seamlessly from without to within.

With the institutional manipulation in full bloom, the economy and markets give an impression that we have overcome all the excessive indulgence of the past. Oblivious to reality, stock prices are driven up, down, or sideways by proprietary computer programs with devilish cunning to suck money from idealistic dreamers who believe that markets are free and unbiased. When the stock price drops in a split second, the little guy probably feels like Charlie Brown when Lucy tempts him to kick the football, but falls on his behind every season. Faster than the shark attack or a blink of an eye, high frequency trading machines, employed by the great parasitical vampire squid, a.k.a. Goldman Sachs, alertly look for their prey. The name, “vampire squid”, coined by Matt Taibbi of Rolling Stone magazine, seems most appropriate metaphor for the predatory mentality of the bank. These machines, employed by a few giant banks, can read your order in a microsecond, and squeeze the little guys to their tolerance level for a nickel or a dime, billions of times during every trading day and make millions for their owners. Is it legal? Probably yes, but it is certainly not ethical. Nevertheless, the banks do it to everyone, including to their own clients. The Secretaries of Treasury for the last two decades, Robert Rubin, Henry Paulson, and Timothy Geithner, all came from Goldman Sachs. Wall Street in essence has been able to highjack Washington. Democracy seems to have been replaced by plutocracy. There is a recent news story that Europe, under the leadership of German Chancellor Angela Markel and the French President Nicolas Sarkozy, has declared a war on Wall Street by limiting the sales of some of their derivative products, thanks to Goldman Sachs involvement in helping Greece to hide its debt.

At this stage of economic history, our only solution will be to bring back the discipline that removes the tendency of governments and “Too Big to Fail” corporations to take advantage of others. It is apparent that only the markets, with little but appropriate supervision by policymakers, will determine the next policy system. In some ways, precious metals will be one of the participants if not the only one. In the meantime, we will see uncertainty, volatility and defaults. Keeping substantial cash, investing in precious metals and their mining stocks, and little in growth stocks is a good idea as long as the money supply M3 is stable in an environment of rising mortgage defaults and unemployment. Trading agility is extremely important in this market environment because a black swan could appear at any moment with devastating results. There are a few observers who claim that M3 in reality is manipulated and rising. The real inflation rate given on http://www.shadowstat.com is significantly higher. Highly respecter market analyst, Marc Faber, advises people to keep buying precious metals at equal time intervals for the rest of their lives, since the money printing press is being operated at a much higher speed than the mining of precious metals. Well, Indians have been doing it for thousands of years because they have learnt that rulers almost always cheat their subjects by devaluing their currency.

(Mr. Doshi, a writer, trader, and a philanthropist, posts his articles at http://www.nalandainternational.org)

Economics 101 and the State of the World Economy By Navin Doshi

Economics 101 and the State of the World Economy
By Navin Doshi, February 23, 2010

A good image for the state of the world economy is a giant bathtub whose water tap is controlled by the central banks of countries around the world. The water level in the bathtub represents the overall strength of the economy. The banks are keeping the taps open at this time by printing money to stimulate slumping economies. This giant bathtub also has several large unplugged holes through which the water is gushing out uncontrollably. Each hole is created by a mini-explosion due to an economic event like a jump in the mortgage default rate or a rise in the number of unemployed. The world’s fundamental economic problems created by banks will not disappear simply by keeping the printing presses running nonstop. One “hole” was created by Greece, which deviated from the Euro-imposed discipline of keeping the government deficit below 3% of GDP, and another was created due to the implosion of the Dubai economy caused by excessive debt. In the U.S.A. the increasing deficit, now over 9 % of GDP, due to bail out and stimulus packages, decreasing tax revenue and sagging demand seems to be a perennial hole. When they plug one hole, another is created. Please note that we have not addressed in this image the long term leaks such as transfer of wealth due to consumption much greater than production.

Central bankers insist on quantitative easing by increasing the money supply or printing money as a short-term solution, which is analogous to pouring water into the bathtub, but at the same time the water is gushing out due to the holes at the bottom. Deflationary pressure, due to the oversupply of goods and services and decreasing employment, also causes the water level in the bathtub to fall. When asset prices keep declining due to the oversupply of goods and services and insufficient demand, the water level falls, thanks to Adam Smith’s supreme law of demand and supply. Falling bank lending at the fastest rate in history is another deflationary hole that can be plugged only when the rise in economic growth accelerates. Total bank lending has dropped by about three quarter of a trillion dollars in the last 12 months. The broadest money supply measure, M3, a leading indicator of the state of the economy, has been contracting at a rate of 5.6 % over the last three months. The risk of a double-dip recession or even worse is growing by the day.

Economists’ perception of the current state of the world economy is divided. Those who look at the top of the bathtub see this as an inflationary situation as they focus on the abundance of paper money in the form of stimulus packages to jumpstart the economic engine. Those who dare to look at the bottom of the bathtub recognize the fundamental problems and see uncontrolled deflation in our future. Currently no one knows for sure what will happen in the future due to the uniqueness of the current state of the economy. In March 2009, the market crashed, and the inflationary pressure since then has been marginal. The water level seems to rise when the taps are opened, and on the surface the markets seem to stabilize. However, when a new crisis arises due to fundamental economic issues, new holes emerge and the water level starts falling once again. European countries like Portugal, Italy, England, and Spain, or even troubled states in the U.S. including California, New York and Illinois, also have the same problem: the deficit as a % of GDP is far greater than the acceptable level of 3%. Until the underlying inadequacies are addressed, this systematic pattern will continue to plague the world economies.

In the long term, central bankers tend to err on the inflationary side as they had during the 2002-2007 period after the recession of 2000 and the 9/11 event. Economic history has always been on the side of inflation. In fact, 3% inflation rate is the current acceptable level central bankers shoot for. Olivier Blanchard, IMF’s chief economist, now recommends that central bankers should raise their target to 4% inflation rate (Economist, February 20th, 2010 issue). Even staunch ultra free-market economist F.A. Hayek, whose views come from the Austrian school of economics, and are the opposite of those of John Maynard Keynes, a strong proponent of government intervention, agree that when the economy falls off the cliff, the intervention of central bankers in creating more credit and money is essential to avoid catastrophic depression.

Now more than ever before, all the markets in the world are interconnected. It is indeed a reversal of fortune that the Western countries now prefer that the emerging economies of China, India and Brazil increase their GDP growth rate. The Western countries would like to see stronger emerging market economies that will generate a demand for the export of goods and services from Western countries. Sooner or later, the holes of the bathtub will get plugged and the water level will rise and even overflow, bringing the economy to an inflationary domain. I do hope they get plugged sooner than later.

So how does one invest when the treasury yields are near zero with high stock market volatility? I would prefer a mixed asset allocation that includes short-term (five years and shorter) investment grade bonds, precious metals, substantial cash, and a bit invested in very stable growth stocks. Those who are willing to take some risk can consider shorting U.S. treasury bonds. The logic of short-selling U.S. treasury bonds is very simple. America is drowning in a sea of debt at a near-zero interest rate. Essentially, there is no upside other than the belief in the strength of the dollar. Undoubtedly, there will be inflation at some point in the future. Currently the decreasing money supply M3 shows deflationary pressure. Only when most of the holes of the bathtub are plugged, meaning M3 and employment starts rising and the real estate markets are stabilized, will the equity markets perform better. However, if the rate of inflation goes out of control and keeps rising, the long bonds will get slaughtered while precious metals will probably out-perform almost all other asset classes. I do emphasize that one needs to be nimble and agile in this highly volatile market.

(Mr. Doshi is a writer, trader, and a philanthropist and his articles are posted at http://www.nalandainternational.org)

BOOK REVIEW: What the Dog Saw (Malcolm Gladwell) by Sujay Desai

BOOK REVIEW: What the Dog Saw, by Malcolm Gladwell
By Sujay Desai

Over the last decade, Malcolm Gladwell has developed a singular reputation for delivering a fresh perspective and unique insights into a diverse and fascinating array of topics. His insatiable curiosity is put on full display in his new book What the Dog Saw, a collection of Gladwell’s most interesting intellectual adventures taken from his days at The New Yorker. Gladwell tackles such subjects the problem of homelessness, Enron, criminal profiling, and job interviews. Perhaps it is not the subjects themselves but Gladwell’s signature approach that sets him apart. His goal is first and foremost to tell a story with vivid characters and fascinating details. Through the story, Gladwell educates the reader and leaves him/her feeling more informed and intelligent about the world than before. More than anything, he helps us understand ourselves better as human beings.

Gladwell’s exploration of homelessness is a shining example of his unique approach to a seemingly mundane topic. The chapter is titled “Million Dollar Murray”, and Gladwell uses the story of the most expensive homeless man in Nevada, Murray Barr, as a starting point to exploring the issue as a whole. Murray is a colorful character, and through his chronic alcoholism, he has cost the state of Nevada over one million dollars in medical bills. Even if we are not particularly interested in homelessness per se, we become interested in it because we are curious about this man named Murray and how he cost the Nevada taxpayers such an outrageous amount of money.

In the chapter on Enron, Gladwell chooses a subject with which we are all very familiar and provides a very different perspective on it. He challenges our deeply held assumptions about the causes of the Enron debacle. People have felt and still believe that a lack of information led to this scandal. In essence, our perspective is that Enron concealed information and misled Wall Street. Gladwell is not convinced, and finds through his research that all the Enron financial information was freely available, but everyone chose to ignore it. Human nature, he concludes, is to transfer blame rather than to accept responsibility.

Gladwell devotes several chapters to the challenges of recruiting, interviewing and hiring. The talent hunt, we learn, is not quite as straightforward as it seems. In one segment, he explores the question of what interviews really tell us. Does an interview really predict a person’s job performance, or is it just a test to see how well they perform in an interview situation? In another chapter, Gladwell follows the tale of an NFL scout looking for the next star quarterback. Does success in college translate into success in the pros? To our surprise, often times it does not.

The beauty of What the Dog Saw is that it works on several different levels. On the one hand, it is a collection of stories and essays that entertain and amuse the reader. In addition, the book will appeal to intellectuals who want to explore interesting issues. If you are looking for a book that educates while it entertains, you will undoubtedly enjoy this one.

By STEVEN PINKER
Published: November 7, 2009
Have you ever wondered why there are so many kinds of mustard but only one kind of ketchup? Or what Cézanne did before painting his first significant works in his 50s? Have you hungered for the story behind the Veg-O-Matic, star of the frenetic late-night TV ads? Or wanted to know where Led Zeppelin got the riff in “Whole Lotta Love”?
Neither had I, until I began this collection by the indefatigably curious journalist Malcolm Gladwell. The familiar jacket design, with its tiny graphic on a spare background, reminds us that Gladwell has become a brand. He is the author of the mega-best sellers “The Tipping Point,” “Blink” and “Out¬liers”; a popular speaker on the Dilbert circuit; and a prolific contributor to The New Yorker, where the 19 articles in “What the Dog Saw” were originally published. This volume includes prequels to those books and other examples of Gladwell’s stock in trade: counterintuitive findings from little-known experts.
A third of the essays are portraits of “minor geniuses” — impassioned oddballs loosely connected to cultural trends. We meet the feuding clan of speed-talking pitchmen who gave us the Pocket Fisherman, Hair in a Can, and other it-slices!-it-dices! contraptions. There is the woman who came up with the slogan “Does she or doesn’t she?” and made hair coloring (and, Gladwell suggests, self-invention) respectable to millions of American women. The investor Nassim Taleb explains how markets can be blindsided by improbable but consequential events. A gourmet ketchup entrepreneur provides Gladwell the opportunity to explain the psychology of taste and to recount the history of condiments.
Another third are on the hazards of statistical prediction, especially when it comes to spectacular failures like Enron, 9/11, the fatal flight of John F. Kennedy Jr., the explosion of the space shuttle Challenger, the persistence of homelessness and the unsuccessful targeting of Scud missile launchers during the Persian Gulf war of 1991. For each debacle, Gladwell tries to single out a fallacy of reasoning behind it, such as that more information is always better, that pictures offer certainty, that events are distributed in a bell curve around typical cases, that clues available in hindsight should have been obvious before the fact and that the risk of failure in a complex system can be reduced to zero.
The final third are also about augury, this time about individuals rather than events. Why, he asks, is it so hard to prognosticate the performance of artists, teachers, quarterbacks, executives, serial killers and breeds of dogs?
The themes of the collection are a good way to characterize Gladwell himself: a minor genius who unwittingly demonstrates the hazards of statistical reasoning and who occasionally blunders into spectacular failures.
Gladwell is a writer of many gifts. His nose for the untold back story will have readers repeatedly muttering, “Gee, that’s interesting!” He avoids shopworn topics, easy moralization and conventional wisdom, encouraging his readers to think again and think different. His prose is transparent, with lucid explanations and a sense that we are chatting with the experts ourselves. Some chapters are master¬pieces in the art of the essay. I particularly liked “Something Borrowed,” a moving examination of the elusive line between artistic influence and plagiarism, and “Dangerous Minds,” a suspenseful tale of criminal profiling that shows how self-anointed experts can delude their clients and themselves with elastic predictions.
An eclectic essayist is necessarily a dilettante, which is not in itself a bad thing. But Gladwell frequently holds forth about statistics and psychology, and his lack of technical grounding in these subjects can be jarring. He provides misleading definitions of “homology,” “sagittal plane” and “power law” and quotes an expert speaking about an “igon value” (that’s eigenvalue, a basic concept in linear algebra). In the spirit of Gladwell, who likes to give portentous names to his aperçus, I will call this the Igon Value Problem: when a writer’s education on a topic consists in interviewing an expert, he is apt to offer generalizations that are banal, obtuse or flat wrong.
The banalities come from a gimmick that can be called the Straw We. First Gladwell disarmingly includes himself and the reader in a dubious consensus — for example, that “we” believe that jailing an executive will end corporate malfeasance, or that geniuses are invariably self-made prodigies or that eliminating a risk can make a system 100 percent safe. He then knocks it down with an ambiguous observation, such as that “risks are not easily manageable, accidents are not easily preventable.” As a generic statement, this is true but trite: of course many things can go wrong in a complex system, and of course people sometimes trade off safety for cost and convenience (we don’t drive to work wearing crash helmets in Mack trucks at 10 miles per hour). But as a more substantive claim that accident investigations are meaningless “rituals of reassurance” with no effect on safety, or that people have a “fundamental tendency to compensate for lower risks in one area by taking greater risks in another,” it is demonstrably false.
The problem with Gladwell’s generalizations about prediction is that he never zeroes in on the essence of a statistical problem and instead overinterprets some of its trappings. For example, in many cases of uncertainty, a decision maker has to act on an observation that may be either a signal from a target or noise from a distractor (a blip on a screen may be a missile or static; a blob on an X-ray may be a tumor or a harmless thickening). Improving the ability of your detection technology to discriminate signals from noise is always a good thing, because it lowers the chance you’ll mistake a target for a distractor or vice versa. But given the technology you have, there is an optimal threshold for a decision, which depends on the relative costs of missing a target and issuing a false alarm. By failing to identify this trade-off, Gladwell bamboozles his readers with pseudoparadoxes about the limitations of pictures and the downside of precise information.
Another example of an inherent trade-off in decision-making is the one that pits the accuracy of predictive information against the cost and complexity of acquiring it. Gladwell notes that I.Q. scores, teaching certificates and performance in college athletics are imperfect predictors of professional success. This sets up a “we” who is “used to dealing with prediction problems by going back and looking for better predictors.” Instead, Gladwell argues, “teaching should be open to anyone with a pulse and a college degree — and teachers should be judged after they have started their jobs, not before.”
But this “solution” misses the whole point of assessment, which is not clairvoyance but cost-effectiveness. To hire teachers indiscriminately and judge them on the job is an example of “going back and looking for better predictors”: the first year of a career is being used to predict the remainder. It’s simply the predictor that’s most expensive (in dollars and poorly taught students) along the accuracy-¬cost trade-off. Nor does the absurdity of this solution for professional athletics (should every college quarterback play in the N.F.L.?) give Gladwell doubts about his misleading analogy between hiring teachers (where the goal is to weed out the bottom 15 percent) and drafting quarterbacks (where the goal is to discover the sliver of a percentage point at the top).
The common thread in Gladwell’s writing is a kind of populism, which seeks to undermine the ideals of talent, intelligence and analytical prowess in favor of luck, opportunity, experience and intuition. For an apolitical writer like Gladwell, this has the advantage of appealing both to the Horatio Alger right and to the egalitarian left. Unfortunately he wildly overstates his empirical case. It is simply not true that a quarter-back’s rank in the draft is uncorrelated with his success in the pros, that cognitive skills don’t predict a teacher’s effectiveness, that intelligence scores are poorly related to job performance or (the major claim in “Outliers”) that above a minimum I.Q. of 120, higher intelligence does not bring greater intellectual achievements.
The reasoning in “Outliers,” which consists of cherry-picked anecdotes, post-hoc sophistry and false dichotomies, had me gnawing on my Kindle. Fortunately for “What the Dog Saw,” the essay format is a better showcase for Gladwell’s talents, because the constraints of length and editors yield a higher ratio of fact to fancy. Readers have much to learn from Gladwell the journalist and essayist. But when it comes to Gladwell the social scientist, they should watch out for those igon values.

o Ian Sample
o The Guardian, Saturday 17 October 2009
o Article history

In 1984, a history graduate at the University of Toronto upped sticks and moved to Indiana. His grades weren’t good enough to stay on for postgraduate work, he’d been rejected by more than a dozen advertising agencies, and his application for a fellowship “somewhere exotic” went nowhere. The only thing left was writing – but it turned out that Malcolm Gladwell knows how to write.
Gladwell’s journalistic trajectory from junior writer on the Indiana-based American Spectator to the doors of the New Yorker makes for a story in itself, but only after arriving at the magazine did he become established as one of the most imaginative non-fiction writers of his generation. As of last year, he had three bestsellers under his belt and was named one of Time magazine’s 100 most influential people.
Gladwell owes his success to the trademark brand of social psychology he honed over a decade at the magazine. His confident, optimistic pieces on the essence of genius, the flaws of multinational corporations and the quirks of human behaviour have been devoured by businessmen in search of a new guru. His skill lies in turning dry academic hunches into compelling tales of everyday life: why we buy this or that; why we place trust in flakey ideas; why we are hopeless at joining the dots between cause and effect. He is the master of pointing out the truths under our noses (even if they aren’t always the whole truth).
Gladwell’s latest book, What the Dog Saw, bundles together his favourite articles from the New Yorker since he joined as a staff writer in 1996. It makes for a handy crash course in the world according to Gladwell: this is the bedrock on which his rise to popularity is built. A warning, though: it’s hard to read the book without the sneaking suspicion that you’re unwittingly taking part in a social experiment he’s masterminded to provide grist for his next book. Times are hard, good ideas are scarce: it may just be true. But more about that later.
Gladwell has divided his book into three sections. The first deals with what he calls obsessives and minor geniuses; the second with flawed ways of thinking. The third focuses on how we make predictions about people: will they make a good employee, are they capable of great works of art, or are they the local serial killer? Brought together, the pieces form a dazzling record of Gladwell’s art. There is depth to his research and clarity in his arguments, but it is the breadth of subjects he applies himself to that is truly impressive. He bounds along from the inventors of automatic vegetable choppers and hair dye to Cesar Millan, the American “Dog Whisperer” behind the title piece, and Nassim Taleb, the US banker who turned his nose up at the investment strategies of George Soros and Warren Buffet and made himself a pile of money.
Gladwell is more than just a people person, though. His forensic dissection of the collapse of Enron and his survey of the causes of the Challenger space shuttle disaster manage to be fresh and compelling when you could be forgiven for thinking there was nothing left to say about the events. “The Art of Failure” is a fascinating examination of how experience plays a part in how you’ll fail when you do fail.
The common theme that runs through all Gladwell’s pieces is his desire to show us the world through the eyes of others – even if the other happens to be a dog. Inevitably this becomes the world as Gladwell sees it through the eyes of others, but his cast of characters (except perhaps in the case of the dog) is strong enough to withstand the filter.
The story of Murray Barr, which first appeared in 2006, is a classic. Barr is a hopeless alcoholic who lives on the streets of Reno, Nevada, and spends more weekends than not in hospital or drying out in a police cell. He is a burden on the system, but that is the fault of the system, Gladwell argues. Barr’s routine involves getting drunk, falling over and being taken to hospital. When he is released, he starts all over again.
The first to raise doubts about society’s way of dealing with people such as Barr are local police officers. Over 10 years Barr’s hospital bills mount up. “It cost us $1m not to do something about Murray,” says one of the officers Gladwell quotes. Barr’s personal story becomes the springboard for Gladwell’s argument that society finds it more palatable to manage homelessness than to end it. Surely it would be cheaper – not to say more helpful – to give people like Barr a flat of their own, he suggests, to keep a watchful eye over them rather than leave them on the streets to rack up medical bills. He plays the idea out by examining pilot programmes that have attempted to do just this, and then muses on why society hasn’t embraced the strategy. We don’t do it because it doesn’t seem fair. Why should someone who contributes so little to society be tossed the keys to a new home? Morality prefers equity, and rewards for doing nothing are inequitable.
This is what Gladwell does best: he takes an idea, recasts it as a human story, and works it through to its conclusion, taking a strip off conventional wisdoms as he goes. Even when the patterns he identifies are spurious or the conclusions flawed, the arguments he raises are clear, provocative and important. It’s as if he is saying, read this, then go and think for yourself. His pieces, he says, are meant to be “adventures”.
Gladwell’s most recent book, Outliers, was knocked by some critics for stating the obvious: that successful people put in a lot of hours, but crucially are often in the right place at the right time and seize the opportunities life throws their way. Before that, Blink drew flak for urging readers to go with their gut feelings, except when their gut feelings were wrong.
Both books were spun out of articles Gladwell published in the New Yorker, and it is easy to see why they met with a mixed reaction. When Gladwell’s theories are drawn across a broader canvas, the cracks are harder to ignore. One virtue of What the Dog Saw is that the pieces are perfectly crafted: they achieve their purpose more effectively when they aren’t stretched out.
In his introduction, Gladwell tries to head off the familiar criticisms by re-stating what his writing is and isn’t trying to achieve. “Good writing does not succeed or fail on the strength of its ability to persuade. Not the kind you’ll find in this book, anyway. It succeeds or fails on the strength of its ability to engage you, to make you think.” On that basis, Gladwell surely succeeds.
Back to that warning. There is nothing new in this new book, but that is clear from the start. What is less clear is that all the pieces are available free of charge from Gladwell’s own website. If you like, you can go there and read the original New Yorker articles, complete with beautiful layouts and cartoons. You can even print them out and staple them together using an industrial stapler from the stationery cupboard at work. A trial run suggests that this could occupy an idle lunchtime.
Gladwell’s publisher no doubt paid a lot of money to repackage his free stories and sell them on for a tidy profit. It is a scenario that has the makings of a Gladwellian dilemma. Why buy the book if the content is free? And what does that say about me? Is the feeling of being mugged by the publisher trumped by the virtue of convenience? The book is beautiful and brings together the writing that made Gladwell the extraordinary figure he is today. That alone is worth paying something for, but if you want to avoid mental anguish it might be safer to buy it for someone else.

Book Review: Poorly Made in China by Sujay Desai

Book Review: Poorly Made in China

(Sujay Desai, Jan 18^th 2010)

When most Americans see the words “Made in China” on a consumer item, they immediately think of low prices.  Fueled largely by Wal-Mart and other national discount superstores, we tend to focus more on the price tag of the item and less on the item itself.  Our love affair with low prices has become one of the trademarks of our culture.  After all, when it comes to basic consumer items such as soap, shampoo, or toy cars, the price is all that counts.  Or is it?  In his book Poorly Made in China, Paul Midler provides a fascinating and disturbing look inside China’s consumer products manufacturing machine.  Using a storytelling format, Midler’s book is an autobiographical tale from the front lines.  Midler relates his experiences working in China as an intermediary between Chinese manufacturers and American importers.

By making price the primary focus, Americans have allowed the Chinese to manipulate the production game to their own advantage.  Midler very successfully explores the importance of understanding culture, psychology and law when doing business in a foreign country.  For example, we Americans, who are accustomed to a strong legal system that enforces contracts, are quite bewildered by China’s complete absence of a legal system.  And as Midler explains, the Chinese are masters at exploiting this lack of law and order to their advantage every step of the way.  In addition, despite the impressive advances in Chinese infrastructure, Midler illustrates that China is far from a first world country when it comes to the backward nature of its business dealings.  While we Americans are interested in reducing everything to a number, namely price, we see firsthand how this tunnel vision is dangerous, both economically and ethically, when it comes to China.  Ultimately, the beauty of this book is that it entertains while it educates.  It is a thoroughly enjoyable and educational account of gamesmanship at its finest.

Poorly Made in China is as much a revealing glimpse into Chinese culture as it is a mirror on the American psyche.  Many American entrepreneurs have flocked to China in search of lower prices and a quick buck.  However, every cloud has a silver lining.  When we look at the recent financial crisis, the American hunger for short-term gain proved to be devastating for many.  In the same way, Midler shows how the Chinese have exposed and exploited the weaknesses in the American psyche.  The consequences are dire not only for the American importer, but also the consumer.

(Sujay Desai is an aspiring writer and film enthusiast.)

Book Review: Poorly Made in China

Chinese Companies Masters of Obfuscation

By Phil Randell

VERY RISKY: Unlike the legal protections in Western countries for people in business, doing business in China poses mind-boggling risks in a country in which norms have been turned upside down from traditional culture, according to business consultant Paul Midler. (wiley.com)

I just returned from an amazing, eye-opening journey to China. However, I never left the United States.

While reading Poorly Made in China, An Insider’s Account of the Tactics Behind China’s Production Game, by Paul Midler, it was as if I was there with the author as he detailed the misadventures of Western importers being out-maneuvered by mainland China manufacturers at almost every turn.Through a vivid narrative of his own experiences, Midler, a Mandarin-speaking consultant for Westerners trying to do business in Asia, exposes the mind-boggling risks of conducting business in a country in which norms have been turned upside down from traditional culture. Yet, the author’s style is humorous at times and often light.

In the West, businesses often court each other with caution at first, and then slowly develop trust as the business relationship evolves. Through the descriptions of about eight business pairings, the reader is shown how Westerners are at first lavishly treated. However, once they make their initial investments, their situations become progressively more difficult. Midler uses pseudonyms for the people and companies he describes.

One pairing between an importer and manufacturers was the story of Bernie, the savvy owner of Carter Johnson, a body-care products company, and the Chinese company King Chemical. Through his story, we learn of “quality fade,” a deliberate, incremental, and surreptitious process in which manufacturers reduce the quality of ingredients to widen profit margins. One of the products Carter Johnson hired King Chemical to produce was shampoo. When the factory owners were caught using smaller, inappropriate labels, they continued to do so until the supply ran out, despite protests from Midler and the importer.

The thickness of the plastic shampoo bottles was slowly reduced until they broke under pressure while being warehoused, causing a mess and a considerable financial loss. The factory owners passed the cost onto the importer. Bernie had provided King Chemical with the formulation for the shampoo, but when quality problems arose and he asked to see a list of the ingredients, he was told it was proprietary information.

Through all the accounts in this book, it becomes clear how Western countries have become plagued by defective products, such as exploding tires, poisonous toys made with lead paint, and as reported in The Epoch Times, drywall that emits poisonous fumes.

What also becomes obvious is what a weak bargaining position the Westerners are in. They are in a country in which they do not understand the language or business tactics. Businessmen know that in negotiations, information is power. The Chinese manufacturers written about in the book were masters of obfuscation, obtaining much information, while disclosing little, and creating illusion after illusion. Most importantly, the mindset and negotiation strategies many Westerners used seem to be anchored in the legal protections that they had in their own countries, but that do not exist in China.

Midler, who has an MBA from Wharton, was even-handed; he also showed how some importers were trapped by their own greed. Other Western business people were more sympathetic subjects. Without clarity of their situations, they were trying to help their companies in an ever-changing world economy. In addition, the author shows great sympathy for many of Chinese citizens he meets who are trapped within a system they did not create.

Midler said in an interview, “There are a lot of people who remain in denial about the China opportunity.” Commenting about the factory owners, he said they “forever keep foreign partners at a break-even point,” shifting all of the profits to themselves. Through the author’s eyes and ears, the reader is transported into a business environment where appearance triumphs over substance and quality, workers rights are almost non-existent, and safety standards are completely arbitrary.

In addition, one is given an inside view into an industrial environment almost devoid of designers, but filled with experts in copying, retrofitting, and counterfeiting. As I closed the book, I thought of the made-in-China umbrella that I had recently used only twice, which sprang apart into many parts as I opened it. I was grateful it was not a device that I depended on for safety.

Midler did not start out intending to write a book. During the course of his experiences, he took notes, thinking perhaps he would create a brief for his clients. He eventually realized that the understanding he had gained could benefit many. The 236-page text is a fast, enjoyable read. There are a few times when the pace does slow, but the author is explaining simple situations in great depth to give the reader more understanding of business and interpersonal dynamics.

Poorly Made in China is an invaluable book for anyone considering doing business in China or teaching a course in international trade. This is also a book for all consumers in countries that import products from China.

Poorly Made in China, An Insider’s Account of the Tactics Behind China’s Production Game, by Paul Midler (2009), is published by Wiley and is available at Amazon.com.

Book Review: Poorly Made in China

Midler, Paul. Poorly made in China : an insider’s account of the tactics behind China’s production game. Wiley, 2009.

Paul Midler could be said to be biting the hand that feeds him. After all, he has built a lucrative career as a China-based manufacturing consultant, using his expert knowledge and insight into Chinese history, language, and culture. And yet, he has penned a work that, while frank in its admiration for many Chinese cultural idiosyncrasies, is also sharply critical of both the questionable ethical basis on which the Chinese have built their gargantuan export economy, and the impatience and greed of American businesses in rushing to embrace the perceived advantages of having their product lines manufactured in China.

In the 240 smoothly written and eminently readable pages of Poorly Made In China, Mr. Midler recounts his daily experiences in creating and managing relationships between Chinese factory owners and American importers, giving us example after example of why the Chinese, in his opinion, win at every hand dealt at the negotiating table of price and quality. Thus the importer and the U.S. consumer often have a good chance of ending up with a product that either degrades in quality over time or increases in cost without benefit to the consumer, or both.

For example, a manufacturer will agree to initial product specifications at a price the importer jumps at. The manufacturer then figures out how to unilaterally change some specifications for his own increased profit, while appearing to offer the same product. A shampoo bottle might be made of progressively thinner plastic in order to save the manufacturer on material costs. When the importer discovers a shipping container full of collapsed bottles and unsaleable product, the manufacturer says there is a production problem.

The importer demands that it be corrected. The manufacturer agrees that it should be fixed, but it is not possible at the originally agreed price point, so the price on the product goes up in order to restore the original quality. If this sounds like negotiating in bad faith, read Mr. Midler’s book to find out why, on the shores of mainland China, foreign importers have no choice but to play by Chinese rules or take their business elsewhere, and why many importers have realized that this is no choice at all.

Epilogue: Midler also points out that the Western stigma attached to the production of “counterfeit” goods does not exist on the same scale in China due to their cultural reverence for the skill of the artist / producer — even if the goods are not original creations. Midler’s point is driven home by a recent Wall Street Journal article (via ProQuest | via WSJ.com ) that describes the status of Hong Lei, creator of China’s popular “Tomato Garden” pirate edition of Windows XP.

“People regard Hong Lei as a talent, a national hero,” said Liu Fengming, vice president for Microsoft in Greater China. “This is part of the problem.”

Guest reviewer Marlys Ray is a librarian at the Institute on Aging at the University of North Carolina at Chapel Hill.

Gazing Into the Crystal Ball for 2010 by Navin Doshi

GAZING INTO THE CRYSTALL BALL FOR 2010
by Navin Doshi

Gerald Celente, who predicted the crash of 2008 and 2009, publishes a trend research report for his clients. Here are his predictions and probable future trends: The stock market will crash again in the later part of 2010. Printing trillions of dollars that don’t have real value in the end won’t be helpful. Central banks of Western countries have been loaning commercial banks money at an interest rate of zero in exchange for their worthless mortgage-backed securities. Banks in turn buy secured government bonds instead of lending to cash-starved small businesses. 2010 will see the exhaustion of stimulus money, causing the market to crash and sending reverberations all over the world. The Federal Deposit Insurance Company (FDIC) is broke. They’re relying on three year’s worth of insurance premiums from banks just to stay alive. As central banks keep printing more money, currencies will get clobbered; the winner will be precious metals.

Neosurvivalism: Today’s Darwinian survivors are average people making intelligent decisions to prepare for the worst. We must be self-sustaining, doing our best to make it on our own. A commitment to neighbors and community will be the only way for everyone to survive, as we need to help each other get through this crisis. The human population was about one billion a century ago. Our population has increased by about 5 billion people. Naturally, there aren’t enough jobs to go around, and as supplies deplete, the welcoming attitude for immigrants that had existed before will deplete as well. More and more countries are going to focus on kicking out illegal immigrants in the struggle for resources.

TB (Too Big) or not TB: Right now, 34% of the adults in the U.S. are considered obese, and in a mere eight years it is expected to reach 40%. Jobless people of the 2010 depression have much bigger waistlines than those of the 1930s depression. The business of shaping people up will grow with America’s waistlines, and even the government will get involved. A trend toward elegance will emerge as people strive to compete for jobs. Everyone is trying to look their best and do their best. Quality counts. Art, architecture, and elegance will get more prominence to lift up the depressed spirit. Bigger is not better in fashion, food, and entertainment. If two candidates for a job are on the same level but one is obese, no matter how unjust one might find it to be, the employer has enough to worry about without considering the higher health insurance cost and taxes due to obesity. I would add that TB has become a health care issue when they discover that the smaller people of Kerala, India, are healthier than the big people of Washington D.C.

Innovation: Celente claims that we can expect our own people’s minds to go into high gear in the rough times. He predicts that technology will reach out to the lower socio-economic strata. Making the best with the least is becoming the new goal. I would suggest if we look east, we see cheaper creations of the highest technology inspired by India’s $2200 Nano car and $70 refrigerator. Contrary to popular belief, this is not merely a green movement, but a smart one, and the U.S. could be at the forefront of it.

Not Made In China: As was previously stated, people are going to have to realize how important it is to support one’s community and neighbors to live a higher standard of life. Even now we can see the influx of farmer’s markets and the resurgence in popularity of the “mom and pop shop.” Celente says “China will become a great pariah as they undercut even the poorest of nations with their products. And so, barriers of trade protectionism will shoot up, which many may think will hurt the economy, but it’s a fallacy. Expect to see more “Made in YOUR COUNTRY” products as long as small manufacturers can market their products well.”

New Communication Technologies Over Old News: What with the investigative journalism scandals and lack of real news (as opposed to celebrity gossip), people have begun to look elsewhere for the truth. Celente says that “as long as we have net neutrality,” NBC, CBS, and other similar networks will either go under or “go web-only.” People are beginning to see that they need to take care of themselves and know the truth so as to survive.

Is It Written In The Stars? – Arch Crawford bases most of his projections through the use of astrology. Crawford sees not just another crash this year but dramatic societal changes to go with it. In his words, “We will do everything but guarantee you that stocks will crash worldwide within three months of August 1st (that is between May 1 and November 1). It is expected that technical market analysis of data generated by current market action will assist in pinpointing most danger/opportunity as critical moments approach. The fate of the world is in the balance!” While we don’t know Crawford’s track record, we, too are concerned about societal strains produced by the strident populist posturing in Washington and elsewhere. We also think this could be a year of food shortages which will strain the lower strata of society. There could be an unusual second quarter that needs to be watched carefully. Institutions, with the backing of the government, have been able to manage markets so far after the March 2009 crash. They can do so indefinitely as long as they have a control over the reserve currency, the dollar.

Yes, with their power of printing money they can prevent a crash and manage the market movement within an acceptable band. There is nothing I see out there that would make me change my view about the precious metals market. Banks and governments only have one choice: “Inflate or die!” Or even “Inflate and die” if they lose control walking on the razor’s edge. Any move to withdraw liquidity from the market by increasing interest rates would kill the equity marks stone cold dead in a heartbeat. This is a lose-lose situation for the banks and the government of their own making. On one side of the fence is death by hyper -inflation… and on the other hand is death by deflation. Banks and governments have always preferred the inflationary side… except for former Fed chairman Paul Volker who raised rates and killed inflation back in the early 1980s, and saved the dollar in the process… but this isn’t the 1980s… and that option seems unlikely. The last nine years in a row have been ‘up’ years for precious metals in U.S. dollar terms… and, considering the current situation, chances are 2010 should also be an up year. However there is a significant probability that governments could lose control over the economy due to some unexpected, unforeseen Black Swan event like a 9/11 attack. They still are not able to bring unemployment under control.

Barron’s editorial (01/18/2010) refers to research funded by the MacArthur Foundation, and deliberated by 21 experts on U.S. fiscal policies for two years. The final outcome is the publication of the book titled, Choosing the Nation’s Fiscal Future, also available on the website http://www.nap.org. The conclusion is essentially the same as in the article I wrote, Sweat Think, and Philosophize, dated September 2008 and posted on http://www.nalandainternational.org. With the increasing debt load due to the expanded health care and social security programs vastly more burdensome than the debt for World War II- the more likely outcome could be wild inflation, or being forced to borrow in another currency at a much higher interest rate. So in matters of investment, one needs to be cautious, nimble, and agile. It is indeed a good idea to store essential commodities. In an inflationary climate, it would become difficult to buy them since they become unavailable quickly. Maybe your own intuition, dear friend, could help you propel through this crisis the country is going through.

(Navin Doshi, Jan, 17th, 2010)
(Mr. Doshi is a writer, trader and philanthropist. His articles are posted at http://www.nalandainternational.org)

Weakening Dollar In a Civilization Shift by Navin Doshi

WEAKENING DOLLAR, IN A CIVILIZATION SHIFT

(By Navin Doshi)

In ancient times, gold coins circulated far and wide across the globe just as paper currency does today.  Even after the birth of paper currency, the gold standard for paper money ensured its stability.  Between the Waterloo battle in 1815 and the Great Depression of the 1930s, the pound sterling ruled, but it was still convertible into gold.  Even in the 20^th Century from the Depression years to the late 1960s, the dollar could be converted into gold.  In fact, section 19 of this country’s founding monetary legislation, the Coinage Act of 1792, prescribed the death penalty for any official who fraudulently debased the people’s money. The act was later repealed because Keynesians opposed it. Today, however, there is no backing for the U.S. dollar except the hollow faith of the U.S. government.  The world is rapidly losing respect for the dollar, and our currency now resembles General Motors in that our best days are behind us.

Let us turn our attention to the economic views of Keynes and Mises discussed in my earlier article on the dollar to get a deeper understanding of our current economic problems. The two men represent a pair of opposites in the realm of economics.  In a recession, Keynes encouraged government spending to stimulate the economy, while Mises opposed government intervention. Would Keynes be wrong today?  In short, yes. Keynes’ support of uncontrolled government expenditures would worsen the current situation, although it is occasionally good to have a controlled elastic currency at the government’s disposal. The pure paper currency monetary system of Keynes creates “black holes” of secrecy and violent volatility that results in unjust imbalances.  As we have shifted drastically in the direction of fiscal recklessness bringing us closer to potential hyperinflation, we need to restore a balance and harmony with a return to sound principles of saving and investment in productive assets. America has consumed more than it has produced since 1976, as measured by the trade balance, which amounts to a deficit of 32 years and counting.

If the rulers of the country keep printing money for their advantage, purchasing power is sure to fall in proportion to the increase in paper currency. If the inflation rate is much higher than the interest rate, purchasing power will keep dwindling.  However, if the interest rate is much higher than the inflation rate, the currency is bound to become stronger reminiscent of the 1980s.  Money flows to where it is treated the best, where returns are high. Holders of American bonds are being penalized with a negative real return, causing significant capital flowing away from America.

If we look back to the 1980s, Fed chairman Volker squeezed liquidity out of the system by increasing the interest rate. The dollar became one of the strongest currencies with an inflation-adjusted interest rate topping over 10 %, and it remained strong through 2000 with the real interest rate declining gradually to 3.5%.  After 9/11, pessimism and fear dominated, creating an economic slowdown.  The interest rate dropped close to 0%.  With the promise of easy credit, the markets took off in 2003.  However, the dollar was becoming ever weaker.  In a healthy economy, the deficit as a percentage of GDP should be less than 3%.  If it is over 5% of the GDP, the currency is bound to get weaker.  Currently the deficit has soared to over 10 % of GDP and climbing. The dollar, in terms of gold, has gone down below 30%. America had gone through a situation similar to the 2008 financial tsunami when the stock market crashed in 1929, resulting in depression. Newly-elected president Franklin Delano Roosevelt was wise when he didn’t remove the dollar pegged to gold.  All he did was to inflate the economy only once by lowering the peg to gold from $20/oz to $35/oz.  He maintained sufficient discipline to keep a constant purchasing power at $35/oz of gold by maintaining gold as an anchor.

In our time of astronomical deficits, the government issues debt paper to finance the deficits.  The first stage of the money-printing cycle is that investors keep buying.  When the buyers realize the risk associated with the excessive borrowing, they curtail their purchase of the government paper.  The next stage is that the government buys their own paper, also known as “quantitative easing”, or I would call “legalized counterfeiting”.  As the deficit keeps increasing with more and more paper currency printed, the rest of the world realizes the problem, and that is the start of runaway inflation.  During the hyperinflation of the 1980s in Brazil, people would keep the currency in hand for the shortest possible period, spending it in the same hour they received it.  They knew that the next hour the price of essential goods would be higher.

The U.S. is in the middle of a perfect storm that will have significant ripple effects throughout the world.  Currently the unemployment in U.S. is in the double digits, and some estimate true unemployment, including underemployment, at close to 20%.  Bank problems are still not resolved, and those issues will also cause more printing of money.  The toxic debt issue still looms large.  A huge portion of the derivative market, about $500 trillion, is worthless.  So far over 100 U.S. banks have failed.  The FDIC has run out of money. There is a good chance that more than one major bank will fail.  For example, J.P. Morgan holds over $100 billions in derivatives, and if and when those collapse, JPM could face a philosophical death. All of these issues will continue to weaken the dollar over time.  These problems are bound to proliferate worldwide.

There is a significant probability that the world financial system as we know it may not survive, and it will have to be revived in a different form.  Money printing keeps rulers in power for a while, but ultimately they are thrown out because they destroy the economy. Voltaire had said in 1729 that paper money will eventually return to its intrinsic value – zero.  The people have been put in these dire straits by their politicians, and it could take many years to come out of it. As Einstein wisely commented, “don’t expect the people who caused a problem to solve it.”  Matt Taibbi, in the December issue of Rolling Stone magazine, narrates the story of how President elect Obama brought in the same gang of Wall Street who created the financial tsunami of 2008.

Is the world following India in matters of savings and social security?  China is certainly doing it, encouraging their citizens to put their savings in gold and silver. People in the Western countries are doing the same by buying the gold and silver coins. Gold and silver in India represents their IRA and Keogh, the savings for a rainy day, the dowry for a daughter’s wedding, and more. We are shifting from a dollar hegemony to the age-old 5000 year-old system of saving in the form of gold, silver and other tangible assets.  We know that John Paulson, Jim Rogers and many more all over the world, the billionaire fund managers, are making a big bet on gold, silver, and other resources.  Petroleum exporting Arab countries plan to float their own currency calling it “Gulfo” and modeled after the Euro, some time next year, probably backed by the gold reserve.

Ambrose Evans-Pritchard of The London Telegraph narrates the story about the rising economic powers of Asia and the Middle East. They have lost confidence in Western currencies and are replacing them gradually with gold.  Currently, on average, these countries have only about 2.2% of their foreign reserve compared to over 35% for the G-7.  They would have to buy about $700 billion worth of gold to have half (18%) of their foreign reserve at the current price.  The top Chinese banker Zhu Min indicated that they buy gold when the price goes to some support level.  The implication here is that the gold price may drop some but cannot crash.  The rise of the gold price does not seem to be due to the momentum players.  Perhaps it is a civilization shift.  I would call this reversing the direction of the pendulum, the “laws of karma” at work – transfer of wealth from West to East!  Please note that India was one of the richest countries at the end of the 17^th century before Robert Clive from England arrived in India. I would urge you, dear friend, to review the first article on the dollar (Nov 21, 2009), posted on www.nalandainternational.org to get a deeper understanding of current economic matters.

(Navin Doshi, January 10th, 2010)
(Mr. Doshi is a trader, writer, and philanthropist)