Wednesday, January 13, 2010

Friction, Baby

Q. What do you think of global warming?

A. I think it would be a good idea!

Another day, another day of snow here in the southeast of England. The snowmen built by the Macro boys a week ago are still standing (albeit with a Quasimodo-like posture), and still the white stuff comes down. It seems as if Macro Man has seen more snow this winter than in the dozen prior winters combined. Small wonder that "global warming" has morphed into "climate change"!

Now, one might have thought that after a week's worth of snow, an additional inch or two would not have been too big of a deal. Fat chance! The 45 minute delay on today's morning service was put down to "slippery rail conditions." Funny....Macro Man was under the assumption that minimizing friction was one the engineering requirements of the modern electrified rail system.

Regardless, if there is insufficient friction on Britain's rail network, Macro Man's old mates in China are providing some. As if mocking your author for pooh-poohing their "decisive" move on bill yields yesterday, PBOC announced that they were raising banks' required reserve ratio to 16% (from 15.5%) scant hours after yesterday's post.

Now, in the grand scheme of things, this doesn't mean a whole lot. Before the onset of the financial crisis, these types of announcements a) used to throw markets in a tizzy for a few hours, and b) generated little meaningful impact. And to be sure, the PBOC hit the tape suggesting that policy was going to remain supportive of the ongoing recovery.

That having been said, there seems to be little dispute that the policy mix in China has been little short of an orgy of liquidity, as Macro Man observed six months ago. And if we combine the signalling mechanism brought about by:

a) this RRR hike
b) measures designed to curb property speculation
c) the introduction of equity index and futures and short selling in the A share market

we might well find that there is an impact on asset prices. It is perhaps notable that since bank lending growth was dialled down in H2 of last year, the Shanghai Comp has gone more or less nowhere. A sustained, if modest withdrawl of liquidity could encourage a dive below the bottom of the wedge below.
While taking A share risk is not necessarily that easy, punters can easily short H shares via Hong Kong-listed futures. The charts look broadly similar, and while A shares may lead the way to the downside it is difficult to believe that H shares won't suffer if onshore equities dump.

There's also been decent interest in paying Chinese rates via non-deliverable swaps. While this trade looks great optically (2y NDIRS rates are just over 3% for a double digit growth economy!), Macro Man is less certain that the trade will work because

a) interest rates are a sadly seldom-used policy instrument in China
b) carry is sharply negative
c) there is a lot priced in; 2y NDIRS have retraced much of their decline from the mid-'08 highs (when inflation was high, oil was $145/bbl, the 'Comp was close to its highs and activity was chugging merrily along.)

And what of the currency? Ah, good question. Macro Man would love nothing more than to be wrong in his non-prediction of no move in H1, but he stands by his call. Unlike fiddling with property regulations and inducing a bit of selling in stocks, moving the currency probably would have deeper macroeconomic implications....not only for the trade surplus, but also for liqudity conditions (if PBOC is "forced" to intervene heavily and is unable to sterlilize all of it.)

Introducing a bit of friction into asset markets is one thing. Giving into Western demands for currency strength (amidst a rising drumbeat of tarriffs, no less!) and potentially threatening the jobs or marginal unskilled labourers is something else. Macro Man remains sceptical. And so, from his perch, if one has a "China tightening" itch that requires a good scratch, the equity trade is the implement that will do the best job.


Anonymous said...

The euro and gbp have decoupled from the spoos. gbp up and spoos down? what be up wit dat?

Tim said...

1) Global warming became climate change due to the fact that the warming does not in fact have to be Global for the climate to be warming. This winter/summer (North/South) has been characterised by extremes in both hemispheres. Greenland is having a very mild winter, we are not. Places like Athens have experienced record high winter temps, Melbourne record high summer ones. All down to ENSO I suspect. We need to be careful not to confuse climate with weather. If you imagine a world with only two points then the climate would be the average of them both. If the temeratures at (A,B) went from (10,10) to (8,13) then the climate would have warmed even if A had got colder.
2) Clearly we try to minimize friction apart from the point where the wheels meet the tracks, where we try to maximise it (sort of). Otherwise the wheels would just spin uselessly as there would be no transmission of power. Maybe Trains should have alternative skid & fans to propel themselves on ice.
3) There is an 'A' share ETF listed in HK which can be borrowed.

Nemo Incognito said...

Or you could buy some protection on chinese property names via either single name CDS or the Asia Itraxx HY index. -ve carry but very high beta given that half the index is property last time i checked.

Anonymous said...


Burning witches shares the same scientific rigour as 'manmade' climate change.

'Global warming' died in 2009 along with the IPCC.

You should have cuddled up with a copy of 'popular delusions and the madness of crowds' over the holidays.

Anonymous said...

It appears there be 2 schools on what transpires upon peg break – “the 99% one” whereby currency hypothetically appreciates vs. the other side and then “the 1% one” that sees Voldy’s favorite toy depreciating due to breaking the peg after it so successfully imported all the exported bubbles.

Given that Voldy has in fact diversified holdings out of MBS into bonds of a shorter maturity type, bills & some real stuff as the other side were toying with flipping 401Ks & IRAs into annuities of some sort whilst all the elevators have in fact been heading down (@ various speeds) …

…any thoughts?

Anonymous said...

Tim, in case you haven't noticed this is a forum of financial market professionals and traders. The manmade global warming scare is a hoax perpetrated by anti-capitalist ideologues. Maybe you would feel more at home at the Daily Kos?

Anonymous said...

Slippery conditions -- the problem is that when the trains break in slippery conditions, the wheels slide instead of rolling to a stop. This flattens the train wheels; so to avoid this, they have to slow down the trains.

Donlast said...

Trains with square wheels. That's a thought.

"We apologise for the delay in the 8.33 am to London Bridge but as a result of technical failure its wheels have gone square".

Donlast said...

On a more serious note, The VIX has come to a dead stop in the nether regions; over 50% of US stocks are above their 50 dma; and bullish sentiment is at a very high level.

There couldn't be a better warning go to the Exit marked equities than if PIMCO shouted "Fire".

Crisis Management said...

Greek PM: "No Way" Greece Will Leave Euro Or Seek IMF Aid

A malaprop: You shall not press down upon the brow of labor this crown of thorns, you shall not crucify Greece upon a cross of Euros.

Bill Gross said...


Anonymous said...

So financial market pros can't have an opinion on global warming?
Actually if it's happening (and I don't care how much you foam at the mouth, the scientific evidence is probably slightly in favour of its existence) you probably should have an opinion on it, the idea being that it's a pretty big deal.

Macro Man said...

FWIW, I have little interest in sparking an environmental debate in this space. My own observation is that the warming debate resembles the inflation/deflation debate that perhaps more of us are familiar witth; there are dogmatists on either side of the fence, and the reality almost certainly lies somewhere in between them.

leftback said...

I would offer that most healthy debates (such as those regularly carried out here on inflation v deflation) are best conducted with a great deal of macro and micro data that can be used as evidence, something that is usually absent from the on-line debates on environmental matters.

Clearly, the melting of the polar ice caps and the holes in the ozone layer are real phenomena of some significance that we need to keep an eye on, and we are lucky enough to have people who are trained to do that. I'm quite happy to leave this to them without worrying about the significance of an occasional cold day. Now, let's avoid the dogma and get back to our regularly scheduled program...

Ian said...

Some downside here in commodities? Maybe China pulls the bid for a while to stick a finger to the West....

Anonymous said...

yes, downside risk is there with Cu at 7500 earlier this week and a 82 in CL1,now < 80 on the stock data. It all feels a bit vulnerable up here. Having said that, I'm not sure the bears are gonna take over the bulls in flooring the commods. Too much money chasing low(er) levels to jump on board again.

leftback said...

Seems as though the gradual moves by China to tighten policy, the evidence of considerable supply and the prospect of a modestly firmer dollar on even slightly improving US employment numbers do indeed pose multiple and growing risk for many commodities and the associated currencies and carry trades. As usual, the only unknown is WHEN?

Anonymous said...

On China + commods: yes, their spec trading + stocks + profit taking is major driver in copper. Don't see the same in crude. What China buys daily plus their annual demand growth is pretty much in the price. They do build strategic stock (on- shore tanks) but that extra demand is also in the price. CL1 still more driven by US stocks,demand,outlook,products in contango storage,us$ value,index funds,mrkt makers,options,etc..
The wti/us$ correl also seems to have come off a bit recently from its high levels.

Anonymous said...

Macro Man, while I can appreciate the comparison with the inflation/deflation debate at a superficial level the significant distinction is that with climate change there are scientists debating not economists. And that difference is chalk and cheese when it comes to substance.


Anonymous said...

Great inro - trains - friction genius

Anonymous said...

Macroman, when looking at fx do you guys run your own FEER estimates or do you get them somewhere else?

Greg said...

I think the climate debate is actually a good metaphor of what is wrong with markets.

Any true scientific "fact" needs to be verified versus a control -- usually a neutral "do nothing" case. Name the planet exactly like earth in every way that is being used to show what temperature(s) the earth would be experiencing without fossil fuels / man's existence?

Its quack science, no matter how many PhDs get involved.

In the markets, we have all been indoctrinated with Black Scholes, VaR, regression models and other "science" that relies on normal distributions -- even though that distribution clearly does not describe what actually happens.

Decades of people talking about fat tails and skew does nothing to disuade the smart @ss academic types from shoving their models on us.

Lets assume there are no commissions, no bid/ask spread, and no taxes -- and see what our academic models predict!

And the grand daddy of them all: rational markets. Love, war, genocide, humanitarian aid, charity, greed, fear, lust, etc, etc -- but somehow humans become infinitely rational when they trade securities.

True science can benefit humankind, but the stuff that passes for science today lacks rigor and process, and is too often perverted for political ends

Steve said...

What kills me is how political climate change is. If you're liberal you think the world is warming, if you're conservative you don't.

I agree that there COULD be SOME manmade effect, but it's probably dwarfed by the sun and the oceans, and why we would want to spend trillions on something as nebulous as that--especially now--is beyond me.

RB said...

"the significant distinction is that with climate change there are scientists debating not economists"

I'd go one further - you do not have to assume rational man in your complex systems analysis. Geophysics is more appropriate.

Greg said...

Every commenter on this blog has had a snake oil salesman try to sell a trading system / pricing model that predicts the S&P, FTSE, EURUSD rate, etc with an R2 of 99 and if you act right now I'll throw in an indicator that forecasts USDJPY for free!

This gave rise to all the questions on the CFA exam (and others) about overfitting data, insufficient sample size, correlation does not equal causality, etc.

And many statistics classes cite the example of Coca-Cola "causing" malaria in the 1950s. Sounds crazy now, but LOTS of people believed it back when. Turns out, sunny / hot weather causes people to be thirsty, and also causes more mosquitos to breed.

In the end, climate change is no more "science" than the coca-cola hysteria. The models are no different than the overfit trading models hawked on late night TV.

If human kind had a good understanding of weather patterns, why can't we forecast the weather around NYC or London a month in advance? How foolish and hysterical does one have to believe that a snake oil salesman can forecast global weather 50 or 100 **years** from now?

The leaked e-mails from England prove the scientific process is not being followed, and data is being carefully selected to reach a pre-determined "conclusion".

Its not science -- its politics. The same people who have always hated oil companies also support global warming.

People in finance should have seen this climate hoax for what it was. Instead, we were too busy deluding ourselves about the infinite accuracy of our own VaR models-- thus justifying our leveraging up 30-1 or more. The risk is under control! we assured ourselves with our quack risk science

RB said...

Greg, you can still make statements about 10-year returns with 95% confidence interval bounds (such as S&P will yield (3% +/- 3%) annualized real returns from today over the next ten years). Such a wide variance does not make it a useful projection. Similarly temperature increases currently forecast have a high variance, but some of the objections raised here are similar to that raised in the evolution-intelligent design debate and speak to the impossibility of science, not the science itself. Specifically with regards to your comment about weather forecast, I have here a paper from which I quote:
-----begin quote
Projections of how anticipated changes in greenhouse
gases and aerosols will influence climate over
time scales of several decades to centuries (dec–cen)
can be considered primarily as “boundary condition
problems” (Fig. 2). Such model-based projections seek
to describe climate trends, not the details of individual
days, seasons, or years.In contrast, daily weather
forecasts and shorter-term SI climate predictions [e.g.,
El Niño–Southern Oscillation (ENSO) forecasts] can
be thought of as “initial value problems,” for which
detailed knowledge of the observed current conditions
are crucially needed to define the starting point
(the initial conditions). Lorenz (1963) demonstrated
how, even if one possessed a hypothetically perfect
numerical model representing all of the physical
processes completely and without error, unavoidable
uncertainties in the initial conditions will invariably
grow and contaminate the numerical simulation of
transient weather systems. This sensitivity to initial
conditions (sometimes referred to as the “butterfly
effect”) limits to about 2 weeks the time period
over which even a perfect model could yield skillful
weather forecasts. When considering El Niño, a quasioscillatory
phenomenon that evolves more slowly than
synoptic weather systems, skillful numerical forecasts
of monthly mean or seasonal mean conditions (Shukla
1984) can be made with a lead time of 6–12 months
(Kirtman et al. 2002).
-- end quote
Authors: Meehl et al. Oct. 2009

Greg said...

RB -- you are either a shrewd politician or a lawyer (same thing really).

None of my arguments had ANYTHING to do with evolution - intelligent design. Your argument is an old court room trick used by slime ball lawyers to confuse juries.

Of course one can make "statements" that the S&P will reach whatever level with a 95% confidence level -- sell side analysts do so all the time. That doesn't mean there is even a shred of validity to the forecasts -- and it doesn't make the forecast into science

Goldman Sach's Abby Cohen has been forecasting S&P 1700 now for decades. That book "Dow 30,000" was very popular. Neither forecast was science

The earth is warmer than it was 500 years ago. Its colder than it was 1000 years ago. Neither statement proves any trend -- and neither statement proves or disproves any influence by man's activities.

The very fact that you are arguing your pro-global warming view using political / lawyer tactics is just further proof that science has nothing to do with the debate.

Its politics. You hate oil companies and want to tax / nationalize them. Great. You are entitled to your opinion as much as anyone else

But don't commit fraud and mislabel label your political opinion as science.

leftback said...

"If you're liberal you think the world is warming, if you're conservative you don't."

This is absurd. The oceans ARE undoubtedly warmer (you are surely not denying the measurements?), I mean it's a bloody thermometer, it's not rocket science. So since it is warmer, does that mean that everyone is liberal?

Come on people, get a grip and stay rational. Noisy series, underlying trends, recency bias, cognitive dissonance, for goodness sake use a little bit more of your cortical connectivity. Next thing you'll be telling me that the Earth is flat and lies at the center of the universe and that you're going to elect President Palin because you heard it all on FOX.

RB said...

Sorry if I offended you with my analogy - I used it to cite another case where there is no control or detailed history possible. Still, my point was that in a closed system, you could say that ultimately you will reach State B based on physics but decadal predictions may not be very accurate based on existing knowledge but that is also no excuse for giving up and trying not to estimate. Heck, what do I know - I just want to steal somebody else's money.

Greg said...

RB -- I never said anyone should give up TRYING to estimate / forecast the weather.

I said the climate debate is 100% politics, 0% science. The data is sketchy (digital thermometers were not available except the last decade or two). The models are nothing more than overfit junk based on the historical flawed data. There is no control case -- making it impossible to assign causality even if the model had validity.

Forecasting tomorrow's weather is an educated guess (yes GUESS) based mostly on looking what weather patterns are "up wind" of your location. That tactic generally gives you a good guess of tomorrow's weather, but push it out more than 2-3 days and the accuracy falls to what you would expect from rolling a dice.

Forecasting the weather over a more extended period is what many fields call GIGO -- garbage in, garbage out. Incomplete data plugged into flawed overfit models yields nothing that can be called science.

Leftback's comment further illustrates the ignorance of people who perpetuate this "science" nonsense. Viewing a thermometer in the ocean is not straight forward as taking your child's temperature.

The buoy's used to measure ocean temperatures move around -- you aren't measuring the same space over time. Even if the buoys had GPS (and away from the US coastline, most still do not have GPS) ... ocean currents are moving the water in which the buoy is floating.

If the temperature changes, it could mean the water is warming. It could mean ocean currents have changed. It could mean salinity levels have changed. It could mean a large fish just urinated next to the thermometer.

If you compare this temp reading to an analog thermometer reading taken decades ago -- the error term on the analog thermometer is +/- 4 degrees. And that's before you consider the ships back then did not have GPS and the readings were taken at "approximate" depths as measured from a pitching deck.

You can't compare those two numbers and derive anything "scientific". Its garbage in, garbage out.

If we had comparable data (digital thermometer readings at constant depths / locations) from decades / centuries past -- then we might be able to infer that the oceans were warming.

But that still would not establish causality.

Before Leftback mentions the melting polar caps, he should read a few history books. The northwest passage (the waters north of Canada, south of the polar cap) were open when European explorers charted them several centuries ago. When vikings landed on what is now Greenland, they called it "GREEN" land because it wasn't covered in ice like it has been in recent decades. Iceland was covered in ice back then (and isn't right now) -- hence the vikings confusion.

The global climate naturally changes. It always has and we have no reason to believe the global climate will suddenly reach a stable state just because politically motivated people who hate oil companies pass the Kyoto Accord or Copenhagen debacle.

If the Earth really is getting warmer (compared to what "base year"?), we still don't know if that warming is part of the natural cycle or if it is caused by some action of man.

Claiming there is any scientific basis to this argument is fraud. Sighting the opinions of academics who are well documented as very left wing politically does not make their opinions anything more than opinions. That several of these academics were willing to cut corners and corrupt data just proves the total lack of science in the debate.

Its about politics. It always was. And most of the statistical tricks / common errors made in the climate hoax are the same ones used to separate investors from their money year in and year out

RB said...

Greg, Climate scientist political ideology is all over the map with Republican believers and Democratic skeptics - check with Judith Curry of Georgia Tech if you wish. I'd rather not get into the science here, but you are badly mistaken in calling it a fraud.

Greg said...

RB -- your political / lawyer tactics continue...

There are Republicans who don't like oil companies. There are Democrats who do like oil companies. Most voters have some views that lean left and some views that lean right.

Only a political "analyst" would claim the party box checked on the voter registration card explains every opinion a voter has.

Your continued use of political tactics is further proof that the climate hoax is about politics, not science.

But this blog is about macro economics / investing -- and my point was and remains that the same statistical tricks and common usage errors used in the climate hoax are the same tricks used by Wall Street to separate clients from their money.

Where are all the customer's yachts? Well, the customers slept through statistics class. They were easily confused by lawyer tactics and biased "expert" opinions.

They believed one could linearly interpolate the past few years price history indefinitely.

They believed price = value (measurement error = zero?).

They believed pro-forma earnings (much like the data in the recently disclosed climate e-mails).

They believed the ratings agency models (climate models) were infallible.

They never doubted that the brokers (socialists) had a conflict of interest.

Its the same hoax, different wrapper.

RB said...

Yes, it's a hoax. I said it. Now I feel much better. You keep saying it's all politics, politics, and then you turn around and say I inserted the politics. You are a piece of work, Greg. Goodbye!

Greg said...

RB -- apologies if I was not clear. I said you keep arguing politics, not science.

Anyway, the blog is supposed to be about macro economics

ES said...

Well, i guess Leftback should see the global warming/frosting from the bigger perspective:

Anonymous said...

Coming late again and was surprised to see the labeling of the malaria/coke thing as hysteria.
Actually, it was for real, forcing the Co to change the secret ingredients. The same goes with the birth rate and kelps/chimneys... (:

Rossco said...

2823 HK is a relativelt liquid proxy for SHCOMP. Citi is the market maker.

Macro Man said...

Yeah, problem is that some punters (ahem, including yours truly) have trouble trading ETS (let along Nemo's single name CDS), and are forced to trade futures instead.

Greg said...

Anon 3:23 ... the coca cola / malaria scare WAS hysteria and had absolutely no basis what so ever.

Coke did change their "secret" formula, but that happened years earlier. Coke originally contained small amounts of cocaine, which the government required them to remove. That was 2-3 decades before the malaria nonsense

Malaria is carried mostly by mosquitos, not coca cola. Pretty sad that there are still such uneducated people in the world -- and not only do they walk among us, they have internet connections!

In spite of what bank CEOs are doing, I really hope intelligence / merit eventually triumphs over ignorance and cronyism

torrens hume said...

I really enjoy reading your blog. I start my day with it and the FT. Thanks for taking the time to write it. Also appreciate the lack of advertising.

Wanted to agree with you on your China exchange rate call. This week's tightening was the first test of Chinese policy now that China's recovery is solidifying.

The authorities had a clear choice -- a once off revaluation, or a return to the sterilisation policy. Both would reduce inflationary pressure, but the authorities chose the latter. It seems that the objective of policy is to maintain the real exchange rate (along with the consequences).