RSY: Buy 400 shares CODI at $16.24

As expected last week, Rock Solid Yields {RSY} portfolio was a little over bought and was ready for a correction. IVR took the biggest loss for the portfolio. That is expected to some degree since just past ex-dividend dates theoretically drop by their dividend amount at least, and IVR had a dividend of $1.00 on the ex-dividend date of the 28th.

Compass Diversified Holdings {CODI-Services: Business Services} recently ranked highest in a modified RSY search using MyStockFinder stock search tool. It provides an excellent dividend yield of around 8.5% and that is projected to continue. It has a great ranking for insider buying which makes it eligible for inclusion in our "Top 10 Insider Buying Stocks" {available for silver level members}. The forensic accounting scores are conservative and have a consistency over the past year. The next ex-dividend date should come around the middle of October as they have consistently done that for the past 4 years. It's Sabrient's earnings score is nearly twice it's industry score and well above the S&P score which is based on past performance as well as expected earnings growth going forward. This looks like a good one to add to the RSY portfolio and the portfolio will put in a limit order of 400 shares at a limit price of $16.24 {GTC}. This is above the closing price but avoids any surprises to the upside that a market order could do.
Buy 400 shares CODI at $16.24.

Unknown Dividend Plays

Compass Diversified: Dividend Is Okay, But for How Long ? -- Seeking Alpha
Seeking Alpha Article

ISM July 2010 & Data|Can Exports dig Us out of this Recession?

It is always important when analyzing data to consider the relevance and importance of such numbers. So, before looking at the numbers from the lastest ISM reports, let us look at what Briefing.com states about the ISM manufacturing reports at Economic Releases: Ism Index. Under the title "Big Picture" it states the following:

This is a highly overrated index. It is merely a survey of purchasing managers. It is a diffusion index, which means that it reflects the number of people saying conditions are better compared to the number saying conditions are worse. It does not weight for size of the firm, or for the degree of better/worse. It can therefore underestimate conditions if there is a great deal of strength in a few firms. The data have thus not been either a good forecasting tool or a good read on current conditions during this business cycle. It must be recognized that the index is not hard data of any kind, but simply a survey that provides broad indications of trends.

Obviously any report can be overrated if interpreted in the wrong way. One way this report seems to be over used and misinterpreted is by relative changes in the index instead of considering the "breakevens" in practice. For example if the headline ISM index drops by 6 points it is significantly more important if it drops from above 50 to below 50 than if the index drops from the 60s to 50s range. The first signifying a reversal of growth and the second a slowing of the growth rate which might actually be good. That is, instead of an overheated economy with growing number of bottlenecks it may signify a stable growth trajectory.

Since the reports are based on sentiment, then it is true that biases are a big factor to consider but that is also its strength as we are trying to have forward looking indicators of the strength and direction of the overall economy, and this should always be taken along with a look at the "Non-manufacturing ISM" reports also. While it may not be as good at forecasting as Briefing.com may desire, it has provided us clues as to what is not likely to happen. For example, they have not so far indicated a double-dip recession. Inflation for a while has been a concern but that trend has reversed and most indicators show a "slowing economy". It is also worth pointing out that perceptions create reality and what people's sentiment is now about the future is likely to be created in reality.

But it is an important consideration that the index is not weighted by size of firm or the degree of sentiment. Since the reports have been around for a long time {since 1931}, changing the reports now may not be a good idea but it might be nice to have "weighted scores" versus the standard unweighted scores. On some of the individual indicators, they indicate not only the breakdown of the industries that are expanding, contracting and staying the same, but also percentages of firms responding in the three categories. This can help indicate broad expansion or more narrowed. With these things in mind let us proceed to the latest reports.

ISM Reports:
Overall the reports are positive but most definitely no indication of an overheating economy. The links used in this portion of the post are:
1. ISM - Media Release: July 2010 Manufacturing ISM Report On Business®
2. Econoday Report: ISM Mfg Index August 2, 2010
3. ISM - Media Release: July 2010 Non-Manufacturing ISM Report On Business®
4. Econoday Report: ISM Non-Mfg Index August 4, 2010

Both headline indexes were solidly in positive territory with manufacturing {PMI} at 55.5 and non-manufacturing {NMI} at 54.3 which signified 12 months of positive growth for the PMI and positive growth for the 2010 year for NMI. The PMI went down by .7%, but the NMI increased by .5% which showed signs of convergence in the economy, that is slow but steady growth. What may be more significant is that both indexes were above consensus at 54 for PMI and 53 for NMI. NMI was even above the range of 52.8 to 54.0, while PMI was at the top of the consensus range of 52.5 to 55.5. Overall the experts had expected a slower growth rate for July. The respondent statements for the most part on the manufacturing was down and could signify an even slower growth in the future with Fabricated Metal Products respondent being the one positive voice. The non-manufacturing on the other hand was mostly positive or lukewarm at worst.

One significant aspect that has changed in the reports since the June reports is that "Commodities in Short Supply" for both sectors is reporting shortages, while last month no shortages were reported. The non-manufacturing shortages seem of little consequence but manufacturing stated that "Capacitors; Electrical Components; and Titanium Dioxide" were in short supply. Already the list of commodities with rising prices is getting longer and it has greater numbers in the parentheses (number of consecutive months of rising prices). Under neoclassical economics of supply and demand, shortages would indicate greater price pressures to clear the market and some of those commodities already show signs of rising prices. Either way these "bottlenecks" could create a drag on the economy. While sectoral rising {or declining} prices signify to the market to adjust, if too many or too rigid of constraints could prevent the necessary adjustments in the economy. Arguably the labor markets are indicating rigidity in a variety of ways including labor migration has been muted partially because of the housing crisis.

That brings us to the issues of price changes as respondents stated and ultimately the issues of Inflationistas And Deflationistas. After the dramatic drop in the price index of manufacturing by 20 points in the June report, the index rose slightly {.5%} and was still significantly above 50 at 57.5. The non manufacturing price index continued its downward trend by dropping 1.1% to 52.7 which is still above the 50% mark and indicating rising prices overall. The downward trend started in April with an index high of 64.7. One significant difference in the two reports is that breath of the price changes. The industry groups are about par {manufacturing 10-3, non-manufacturing 9-4 for increases and decreases respectively}, but the percentage break down by respondents shows that under 50% are experiencing same price levels for manufacturing and over 70% for non-manufacturing. Thus a much larger percentage are not affected by changing prices in non-manufacturing. Even if the trend continues in non-manufacturing for lower prices as it dips below 50%, it will be narrowly focused and less likely to cause a cascading deflationary spiral. Either way, there should be little concern for both inflation or deflation according to these numbers.

This does not stop talk from the "deflationistas". Paul Krugman, as the easiest target around, gives us his back of napkin analysis at Trending Toward Deflation with the chart below. First, trending is a very tricky science and as such he presents no supporting information to help his arguments. Secondly, he does not provide any historical data to show that a trend as such would continue through the zero point of completely stable prices. While, I think that such a point is highly unstable and would be more like a knife edge, I am just not certain that momentum would work so easily to create an economy of deflation from long term inflation. I think there has to be an impetus for such transitions. For example, rapid increases in technology or productivity could bring on deflation but that is hardly happening at the present time.

New orders slowed abruptly in July, in what is the key headline of the Institute For Supply Management report. New orders fell to 53.5, still above 50 to indicate month-to-month growth but down five points from June to indicate a significantly slower rate of growth. The 53.5 reading is the lowest since the manufacturing sector emerged from recession this time last year. Backlog orders also slowed, to 54.5 for a 2-1/2 point decline and its lowest reading since December.

That was the introductory paragraph from Econoday for the manufacturing sectors. It is one of the reasons for looking beyond just the headline numbers as this could signify even slower growth in the preceding quarters or possibly a double dip recession. But on the positive side the non-manufacturing increased by 2.3% to 56.7 and overall the non-manufacturing had a good report as Econoday stated:

This report is a big positive given the prospect from prior reports for gradual slowing. The double dip is still on hold.

One of the positive aspects of the report on non-manufacturing sectors was employment, as it edged above the 50 mark again, which was twice in 3 months. This signifying that there is no trend but at least treading water. For the 8th consecutive month the employment index for manufacturing was above 50% {positive job growth} at 58.6% which was a rise of 0.8%.

Can Exports dig Us out of this Recession?
Last month, the manufacturing import and export indexes were roughly the same levels with imports slightly higher. This has reversed this month as exports edged higher at 56.5% {+0.5} and imports dropping 4% points to 52.5%. While the non-manufacturing sectors {services} has less effect on balance of trade, the report still was positive as new export orders surged ahead of the break even of 50% with a 4 point gain to a total of 52%, and import index staying below 50 at the same rate as last month of 48%.

Those are certainly positive signs for the question posed above and it is certainly possible. It is a question that I have been asking on this blog for quite some time. Now, it looks like the Democrats and especially Obama also think this might be the answer, as this article from the Washington Post talks about at New Democratic strategy for creating jobs focuses on a boost in manufacturing. But the Democrats have the obstacle of their base not being so keen on "free trade" and more trade agreements. Luckily, I have not heard any more news on Obama's pledge to renegotiate the NAFTA treaty. The Wall Street Journal blog stated the union opposition in the following manner, "Even if the White House may see the benefit of more bilateral trade deals, the administration risks losing support from a core supporter–unions–if it presses forward on a raft of FTAs." at Trade Deals {are} Vital to Meet Obama’s Export Goal. The opening paragraphs also frame the issues in the following manner.

U.S. trade and business groups are skeptical the U.S. can double exports without the Obama administration signing a raft of new free trade agreements.

Although President Barack Obama’s administration is pushing ahead with a South Korean FTA, officials say their strategy focuses less on bilateral deals and more on boosting exports through promotion and more rigorous enforcement of trade rules.

While I fully support any endeavor at expanding trade, I seriously doubt and are skeptical about those two initiatives will do much good. First, all countries are "promoting" export trade and we are already in many ways. Demonizing businesses and claiming that we subsidize outsourcing of jobs is not likely to promote exports also. Secondly, not likely to win friends and influence people {countries} by taking them to the teacher and complaining about them. Trading partners are not likely to give us more without us also giving up something also. Talking is not likely to lead to spontaneous open markets for US manufacturing.

Adam Ozimek thinks it is more like trying to bring back
Glory days. It should be apparent that the US is a post industrial society and we are not going back but that does not mean that exports and thus manufacturing can not lead the way to economic recovery. Three international economists from the Centre for Economic Policy Research {VOX} ask the question Can the US raise employment with more exports?. Their paper is based on standard economic theories which even from the opening their statement provides the framework for their analysis.

Can increasing US exports create US jobs? Manufactures dominate US exports, but US manufacturing employment is declining. This column suggests that increased US exports are unlikely to lead to dramatic manufacturing employment gains, but employment in related services sectors may improve.

The US economy has shifted from production to services.

They do a good job providing some thoughts on the reasons service sectors may benefit more from increases in manufacturing output than actually the manufacturing employment. But let me expand their ideas and bring up 3 reasons that support their contentions.
1. Using simple Keynesian models, any autonomous spending will produce a rippling effect on the economy through the multiplier effect. Increased investment in manufacturing has the same initial effect than an exogenous spending increase by government, but can provide more long term growth potentials.
2. Spillover effects on different sectors of the economy can increase productivity in other sectors and expand their respective output levels. The economists discuss these issues within the framework of upstream and downstream sectors of the economy to manufacturing. While spillovers are a general phenomenon, the more exact economic concept occurring here is linkages. Overall manufacturing tends to have the most "linkages" to other sectors of the economy, and thus they are the easy and most likely candidate for development policies. The economists show how this effect is dramatic with their graph on employment in the three economic segments with manufacturing and its upstream and downstream linkages.

3. As productivity in the manufacturing {also farming and resource extraction} sectors increases, this raises the GDP and thus per capita GDP. There is a strong correlation between higher productivity in manufacturing and the average workers pay. The authors provide another important correlation in stating the following.

It is also worth noting that previous research has found that the share of services as an input to a country’s manufacturing exports is significantly correlated with the country’s per capita income (Francois and Woerz 2008).

That is basically self evident, that as more value is added to the end products then income increases. Either theory points out that instead of dreading the demise of the manufacturing job, we should praise the rise in productivity as ultimately we all benefit from this. Most praise the productivity of the American farmer and this same should go for the manufacturers of the US.




---------------------------------
Talking to Mozart about how rapid economic growth is temporary

Why the Doomsayers Are Wrong - WSJ.com

AEI - The Rising Threat of Deflation

July ISM factory index slows to lowest 2010 level - MarketWatch

Misc. Links:
Econoday Report: Construction Spending August 2, 2010

Marginal Revolution: Negative Equity in Underwater Homes

EEF : Manufacturing performance exceeding expectations but road ahead to diverge– EEF/BDO report

We’re Still #1 (Unfortunately)-Compares this recession with others including "Great Depression".

Underneath the GDP report

Mish's Global Economic Trend Analysis: ADP vs. BLS Job Reports - Who to Believe?

Economics Bloggers Turn Sour - The Entrepreneurial Mind
.....................................
Economist's View: "Make it in America"

“Make it in America” bills will advance U.S. manufacturing Robert E. Scott

German recovery: Betting on exports | The Economist

Lessons from Argentina

The title link goes to the PDF file of the report from CEPR entitled Lessons from Argentina: New Paper Looks at Economic Policy in Argentina's High-Growth Recovery. While I appreciate the Center for Economic and Policy Research work at bringing economic issues from Lower Income Countries (LICs), I see their literature as promoting isolationism and autocracy for all countries even if to the detriment to other regional countries. Import substitution policies have not done a good job even if the goals are well intentioned. I also think that Dean Baker is a Dweeb and also P2. Although Dean's latest report on the health of the USA was pretty balanced at Exports and Structures Drive Third Quarter GDP Growth.

Argentina’s current economic expansion is now more than five and a half years old, and has far exceeded the expectations of most economists and the business media. Despite a record sovereign debt default of $100 billion in December 2001 and a financial collapse, the economy began growing just three months after the default and has enjoyed uninterrupted growth since then. The country's GDP during this period has grown by more than 50 percent, making Argentina the fastest growing economy in the western hemisphere during this time. In the process, more than 11 million people, in a country of 39 million have been pulled back onto the positive side of the poverty line. Furthermore, this recovery was accomplished without any help from the international financial institutions that had (led by the International Monetary Fund) provided tens of billions of dollars in
loans prior to the collapse; and with the use of unorthodox macroeconomic policies.

Yes, the numbers look simply spectacular as the graphs and data in the paper show. But let us look further at the analysis...

It was one of the worst economic crises in the history of Argentina, and was not resolvable under the economic policies to which the government at that time was committed.2 Most importantly, the "convertibility system" under which the Argentine peso was fixed at a one-to-one exchange rate with the dollar, had long been an unbearable burden for the economy, a strait-jacket with regard to monetary policy, and had become unsustainable. Both the exchange rate and the economy were being maintained through increasing international borrowing, which piled up an unsustainable public debt burden.

I can not imagine that the IMF would be promoting such policies. Most of the reports I read says the IMF would like to see floating exchange rates or at least a peg that is tied to a basket of currencies. And especially not a hard peg at one to one conversions with another currency.

However, relatively little of Argentina's growth over the last five years is a result of exports or of the favorable prices of Argentina's exports on world markets. This must be emphasized because the contrary is widely believed, and this mistaken assumption has often been used to dismiss the success or importance of the recovery, or to cast it as an unsustainable "commodity export boom." Table 1 shows the relative contributions of the various components of GDP to economic growth, for three phases of the recovery.5 It can be seen that exports played a major role only for the first six months of the recovery (the first phase), when the economy grew at just a 1.3 percent annual rate.

Yes as the paper tries to point out that growth was actually more in other segments over the 5 years, but I would say the most important aspect is what sector of the economy is going to lead. Without this massive and substantial increase in Net Exports as percentage change in contributions to the GDP of 239% for the first time period used then the recovery would not have gotten off the ground. Simple as that.

I would doubt that people would dismiss the recovery because of exports and I think export booms can be sustainable even if a lot of it is in commodities.

During this period exports grew at a 6.6 percent annual rate and accounted for 71.3 percent of GDP growth. Imports dropped by more than 30 percent and therefore accounted for 167.8 percent of GDP growth during this period. Thus net exports (exports minus imports) accounted for 239.1 percent of GDP growth during the first six months of the recovery. This was countered mainly by declining consumption, with private consumption falling at a 5.1 percent annual rate.

Much of what I already mentioned but notice the significant drop in consumption. In most Structural Adjustment Programs (SAP) this is one of the key policies the IMF is trying to incorporate, i.e. reducing the Absorption of the economy and thus reduce inflationary pressures. And of course these policies get the most controversy.

However, in this phase exports did contribute more than in the previous period, accounting for about 16.2 percent of growth; although imports grew faster, resulting in a negative contribution for net exports. Over the entire recovery through the first half of this year, exports accounted for about 13.6 percent of economic growth, and net exports (exports minus imports) contributed a negative 10.9 percent.

Still a respectable and important part of the overall growth of the economy and allowed needed inputs for capital accumulation also. Nothing here voids the idea that the engine starter for the recovery was export growth. Without at least one sector being the first, I can not imagine that any recovery would have been possible.

The economy reached its pre-recession level of real GDP in the first quarter of 2005. As of the second quarter this year, GDP was 20.8 percent higher than this previous peak. Since the beginning of the recovery, real (inflation-adjusted) GDP has grown by 50.9 percent, averaging 9.7 percent annually. All this is worth noting partly because Argentina’s rapid expansion is still sometimes dismissed as little more than a rebound from a deep recession.

Again I would never dismiss a recovery just because of countervailing factors, just that after a severe depression, you would expect that at least some strong rebound effect would kick in eventually. Since the factors of production have not gone to rot in the short term, we would expect some recovery in industrial capacity at least.

A number of government policies seem to have contributed to Argentina's rapid and robust recovery. This is often overlooked, possibly because some of these policy choices are considered controversial. Perhaps the most important of these policies was the government's exchange rate policy. This was important from the second quarter of 2002, when the government strengthened
foreign exchange controls and intervened in the foreign exchange market in order to stabilize the currency. At first, the problem was that the peso was too low, as a result of significant exchange rate "overshooting" (see Figure 2) that brought the nominal rate to 3.6 pesos/US dollar in May of 2002. The devaluation had caused a sharp spike in inflation, which was then running at a more than 28 percent annual rate. It was important for the government to stabilize the nominal exchange rate –
not only to help stabilize inflation but also the financial system. This was done primarily through interventions in the foreign exchange markets (selling dollars), and also by restricting the outflow of pesos from the banking system. The government also required that dollars from export revenues exceeding $1 million had to be turned over to the central bank, thus increasing the supply of dollars that the central bank could use at this time to stabilize the peso.8 These exchange controls were therefore also an important part of the process of stabilizing the exchange rate, and therefore of the economic recovery.

Sorry for so much text here, but wanted to give the context for the ideas. I think it is funny to say there is controversy and then go into exchange rate regimes that I see very little controversy in what was done. Argentina went off the pegged exchange rates and went to a managed float or a managed band, which most economists consider a good policy overall-including IMF staff. The foreign exchange controls that were strengthened is controversial but so is no restrictions. So this is an issue that is mostly empirical than strictly theoretical, that is the degree of freedoms of capital is more of a numerical consideration.

The Argentine government's policy of pursuing a stable and competitive exchange rate was and remains unorthodox and controversial. The conventional wisdom among central bankers today is that the central bank should not target the exchange rate, and most central banks would not do it. Most Central banks may target inflation itself, or intermediate variables such as short-term interest rates and monetary aggregates, but not the exchange rate. It is generally believed to be incompatible
with controlling interest rates in the domestic economy, in an economy with open capital markets. However, this is not true if there is an excess supply of foreign exchange at the central bank's target exchange rate. The Argentine government has also been able to sterilize its interventions in the foreign exchange market by issuing bonds in the domestic market, and it turns out that this policy is also sustainable.10 Also, the prevailing orthodoxy is that central banks should be independent of the government.

I have seen some support such monetary targets, but I fear if the world economy becomes in a crisis or even regionally to its partners it could have spill-over effects. But everything I have read seems to not correspond that sterilization will work over the long term. Either the central bank will run out of reserves or reserves will explode and then cause inflation. Again with a managed float then maybe such concerns can be negated. Lastly, yes independence for the central bank is of the utmost importance I see. Politicians like Hugo will see the central bank as a source of free funds to promote socialism and ultimately hyper-inflation is the result.
Did you also note from the graph above that the currency was actually more unstable after the stabilization as before the default period. And this does draw into question the hard pegging that was before the crisis.

Another important policy concerns the default and renegotiation of the government's external debt.
As noted above, the expectation that Argentina would pay a large and continuing cost for its default did not materialize. On the contrary, the default appears to have been necessary for the country to change its macroeconomic policies so as to restore economic growth. Before the default, the government was focused on tightening its fiscal and monetary policies in a futile – and, probably impossible – attempt to restore credibility among its creditors, an effort that included maintaining the convertibility system. The default enabled the government to pursue a new set of ultimately successful macroeconomic policies.

Good that they suffered no cost for the defaults and this subsidized time did allow them to get their house in order. So being the pragmatist, I will applaud any effort to get back on track, but to imply that the IMF and others did not help out is false even if the actions were beyond their control. By Argentina not paying its debts it was allowed to transfer monies to productive uses in the economy. This is one reason that the IMF has implemented HIPC funding, with realization that overburdening debt for developing countries can prevent growth and development.

The Argentine government was subject to considerable pressure from the IMF in the years following the debt default to offer better terms to the defaulted foreign creditors (see below). But in
the end, a debt swap in 2005 was arranged that took 67.3 billion of foreign external debt off the books. This was a record 65.6 percent "haircut" and was very important to Argentina's recovery. This can be seen by the reduction of the overall public debt, which the swap combined with the rapid economic growth reduced the public debt from 127.3 percent of GDP in 2004 to 62 percent today (see Table 2).

So this haircut was not considered a subsidy? Sounds like the international community including the IMF did a lot to help Argentina to recover.

Two unorthodox taxes levied by the government were also important to the recovery. One was an new export tax which allowed the government to get some of the windfall profits that exporters received as a result of the devaluation. The other tax was already in existence: a tax on financial transactions. As Frenkel and Rapetti (2007) have noted,12 the two taxes together pulled in about 2.7 percent of GDP, and were responsible for almost the whole national primary budget surplus in 2004. It is also worth noting, as can be seen in Table 2, that real short-term interest rates have been negative throughout most of the recovery (since 2003).

Well golly gee wiz! Maybe exports would have done a better job without a drag on that sector. And this opens the possibility that they actually were driving the economy since they had nice growth with a disincentive tacked on. I prefer no export taxes but it is something that should be looked at more closely especially when concerning commodity exports. Thus most of the fiscal balancing of the budget was accomplished on the backs of the export sector. And we do remember that balancing the Fiscal Budget is important in SAPs and considered an important aspect of all those economic theories like Neoliberalism.

As far as the financial tax scheme the writer does not give us any indication of how it is implemented. But as far as negative real interest rates we have covered that quite extensively here with regard to 'financial repression' and Ronald McKinnon. But the actual numbers as I read them are 2003:5.1%, 2004:2.3%, 2005:-3.2, 2006:-2%, and 200:-0.2|

Another policy that contributed to the recovery was a program that provided a monthly stipend (150 pesos) to heads of households who were unemployed with children of up to 18 years-old (or disabled of any age), and to those where the head of the household was ill. At its height (2003), the program reached 20 percent of all households, with 97.6 percent of beneficiaries under the poverty line. 13

The writer here goes to great length to explain how well the social safety net worked, and I applaud that. But how does this program help the recovery? Now it may have made structural adjustments more feasible for the general public but increasing consumption at a time when absorption needs to be reduced does not seem to help the economy out of the depression.

While recognizing that steps must
be taken to bring inflationary expectations under control, and avoid a wage-price spiral, the government is willing to live with double-digit inflation for some time as a tradeoff for the rapid real growth of the economy and its enormous positive impact on poverty, employment, and income distribution.

Yes some cultures/economies live more freely with higher levels of inflation without causing much problems. India is an exception to this from much of South America, where nearly segment of the economy wants a low and stable inflation rate. So I am not as hard on Hugo Chavez on his inflation rates as others are but since he has destroyed the independence of the central bank, this is a portent for hyperinflation.

As more countries become more independent of the IMF and allied IFI's and governments, the "policy space" for different and potentially more successful macroeconomic and other economic policies will expand. In Argentina's case, as we have seen, the IMF was opposed to most of the major economic policies that contributed to the country's rapid economic recovery. Argentina's break with the Fund was therefore one of its most important decisions, and one that may prove to have lessons for other developing countries as well.

The last portions of the paper talk about the IMF mostly. And yes some of the criticisms are legitimate, but I see them not so much as problems but just signs that maybe the IMF has lost it meaning in the present international economic environment. But I still see that many of the tools the IMF have developed over the years should be of use to the general welfare of the world economy. Such as the monitoring and technical assistance they provide to member countries. How the IMF finances such ventures is anyones guess.

Markets W/O States|Stateless Markets

I have been engrossed in a discussion about Zero-Sum Games and then the question came up that 'can markets be formed without the control of the Government'? I do make a distinct and important difference between the formation of a Government that creates rules and laws that enables and facilitates the peaceful trade between peoples and that what it is called as the State or as I like to call it "Police State". I use that phrase since it gives the importance that this State not only manages the functioning of government but also has a force beyond what people voluntarily provide in government functions-like volunteer firefighters. The inspiration for the above distinctions comes from a book by Albert J. Nock called Our Enemy, The State. From the link: His Classic Critique Distinguishing 'Government' from the 'STATE'.

So I got to thinking of times that neither Governments or States are there to administer rules for trade, and this is what this post tries to do. One of the most ubiquitous trade that happens without intervention is the actions of young people that look for odd jobs and such. Obviously it takes a certain person to willingly rip off a young person. Social norms are the binding force that prevents most contracts from being broken. Word of mouth and community discussions usual ferret out the people that are likely to take advantage of even the simplest contracts. Our conversations got a little interesting around here.

...It is the police state that perverts markets. You are right that drug dealers do not have property rights that the courts will support. But if there was no penalties for individuals to trade then adults would behave like adults and trade. Many trades in our society are below the level that Police want to get involved in. Just get the wrong change at a store and see if you get your money back. The local person that mows lawns for a few dollars, does he need the state to protect his rights?

Before passing prohibition, many people made moonshine and traded but only with passing of the constitution did it make it profitable for criminals to get involved. I would suggest you read the book "Free Market Environmentalism". RR

This self quote brings us to another way of looking at this as the issue of what happens when Police States try to prevent trade between consenting adults. The following is from Arnold Kling, an economist that I truly look up to.

Drug Prohibition
What difference does it make whether you address substance abuse with taxes, as we do with alcohol and tobacco, or with prohibition, as we do with cocaine and heroin? There is a sense in which the two approaches lead to similar results--an increase in price and a reduction in available supply. However, the tax maintains order while prohibition produces disorder.

As Richard E. Wagner points out in the essay quoted at the beginning of this article, the spontaneous order of the market can adapt to a tax relatively easily. However, when government tries to control supply, disorder emerges. Profit opportunities are created in crime and corruption. Compare the crime and mayhem in the market for drugs with that in the market for cigarettes. Or compare the disorder that resulted from alcohol Prohibition with the order that prevails today.

So governments can enhance a market but it takes a lot for a State to prevent such trade actions. A phenomenon that even Communist Countries have problems controlling. Which ironically shows that even Libertarian Economists (actually a Masonomist) believe in libertarian paternalism. Of course this assumes that the social good of minor manipulation of the market is better than just letting the markets solve the problems.

Before the US States were even established, settlers, farmers, ranchers and others had to resolve property rights issues. This was especially true with regard to water rights. The following link entitled Montana Water Rights has a good history of what techniques were used in Montana (Pages 1-10) and more broadly across the Western States. I remembered this from the book Free Market Environmentalism by Anderson and Leal. They also write for PERC.

Another area that is getting more attention lately is ungoverned areas of Africa with the rise in discussions of Africom. One market that is doing well is Telecommunications as the article Telecoms thriving in lawless Somalia shows. Even in lawless areas telecommunication is important. As I see it the capital that is used in building up networks has very low value for most to try and steal, but provides an important service that nearly everyone needs including the ones with more power. Incentives are low to steal but the benefits are high. The structure is almost like roads, how many people try to steal a road?

The Development of the U.S. Currency System has a short excerpt on Barter and commodity money:

The best known form of commodity money among the Native Americans is the wampum: beads of polished shells strung in strands, belts or sashes. The use of wampum was widespread in North America and it became one of the major forms of commodity money used extensively by the American colonies (established by the French, English and Spaniard).

The reason that wampum and other forms of commodity were used as a medium of exchange is because the colonial governments in Europe fear that the colonies will become financially independent if they have the power to coin money. As a result, wampum became a money substitute (in the colonies) together with beaver skins, tobacco, corn, rice, and other commodities.

Without getting into a specific tribe and type of trade, I would conclude that forms of government were non-existent or failed to be formalized for most issues like trade.

And lastly humans are basically cooperative beings and thus cooperation results better returns than competition or in other words playing the Scorpion in trade will not likely result in very high returns. I found the following paper (PDF) really interesting: Cooperation versus Competition.

Among cooperative populations, Generous TFT is sometimes the dominant strategy, but much more frequently, an altogether different strategy, the Pavlov strategy, dominates.8 A Pavlov player cooperates after experiencing a reward or a punishment and never otherwise. After experiencing a reward for mutual cooperation (3 points each), the two players repeat the former cooperative move; after being punished for mutual defection (1 point each), they both switch to cooperation; after getting away with a unilateral defection (5 points), a player repeats the defecting move; and after being subject to the sucker’s payoff for unilaterally cooperating (0 points), a player reacts by defecting. At first, this rule may seem odd: It tells you to defect if your coplayer’s move was different from your move in the previous round. A second glance reveals that the rule makes sense: The Pavlov rule tells you to stick to your former move if it earned you a high payoff but change your behavior if it brought you a low return.

Basically then society needs governments only for occasional protections from The Scorpions as in the parable of the Scorpion and the Frog. And even the approach by Gandhi may not be enough to prevent the Scorpions from getting the upper hand...

Currency Composition of Official Foreign Exchange Reserves (COFER)PDF

Claims in US Dollars for 4th quarter 2006 (in Millions of US dollars):
2,156,357

out of total worldwide allocated as reported by COFER:
3,330,454

Is that "The Reserve Currency" of the world.

How about Euro:
859,214

Claims in US dollars:
Industrial:
994,770

Developing countries:
1,161,586

Thus the developing countries have more US dollar reserves than industrialized countries.

Links:
Currency Composition of Official Foreign Exchange Reserves (COFER)

Kuwaiti Dinar

This seems to be a tempest in a teapot, but wanted to see what others here think about the situations with the Kuwaiti Dinar and maybe more broadly in the GCC union.
Kuwait abandons US dollar currency peg

Kuwait on Sunday removed its currency peg to the US dollar, throwing plans for a Gulf currency union by 2010 into doubt and raising the prospect that other oil-producing states might abandon long-held dollar pegs.

Sheikh Salem Abdelaziz Al Sabah, governor of the Central Bank of Kuwait, told the official Kuwait news agency that the decision had been made owing to the "detrimental effects of the pegging system to the national economy".

Since late last year, Kuwaiti officials have hinted that the country would revert to a basket of currencies to prevent the sliding dollar increasing the cost of imports, which has stoked inflation to more than 4 per cent, double the historic average. This has encouraged speculators to plough billions of dollars into the dinar over the past few months, betting that the central bank would allow the dinar to appreciate.

On Sunday, the dinar traded up 0.4 per cent as the central bank replaced the peg with a basket of undisclosed currencies. The central bank had allowed the currency to vary up to 3.5 per cent from the peg, but the dinar had been at the top end of the approved trading band for a year owing to the continuing weakness of the dollar and the strength of Kuwait's oil-driven economy.

The dollar is expected to make up about 75-80 per cent of the new basket, reducing the third largest Arab oil exporter's exposure to the weakening dollar.

Kuwait dropped its currency basket in 2003, adopting a dollar peg as part of the Gulf Co-operation Council countries' drive to create a unified economic block with a single currency by 2010. But doubts over the ability of the GCC economies to harmonise have arisen, with one member of the six-nation council, Oman, saying it would not meet the convergence criteria.

"There have already been a lot of question marks over currency union taking place; this raises an additional one," said Simon Williams, an economist with HSBC in Dubai.

Kuwait's move may come as a surprise to other GCC states, such as Saudi Arabia and Bahrain, which have been repeating their commitment to the peg in recent weeks, saying that any revaluation should be agreed collectively by the GCC.

Mr Williams did not believe other GCC states would follow suit on revaluation quickly, as these countries have clung to dollar pegs since the early 1980s.

But other GCC states - Saudi Arabia, the United Arab Emirates, Bahrain, Qatar and Oman - are studying the move as an option to mitigate dollar weakness.

Really nothing of major ground-breaking stuff.
Pegging a nations currency eliminates or so severely restricts monetary policy to make it nearly ineffective, thus exposing the country to the whims of the world wide economic fluctuations-especially with respect to inflation.

So 0.4 percent is really nothing. And even after the basket is changed it will still contain 75-80% US dollars. So a little less trading in dollars to maintain its basket equilibrium.

But a country of Kuwait should not peg its currency unless it is trying to join a monetary union. It might be interesting looking more into the GCC. As I remember a monetary union has a lead country that pegs its currency to another stable currency (US Dollar) or a basket and all others countries peg to that lead country.
Kuwait reviewing exchange rate, dollar peg

BENEFITS OF THE PEG
“Inflation is one of the drivers,” Humaidhi said, adding the government expected annualised inflation in 2007 to match the 3.1 per cent recorded last year. “Kuwait moved from a basket (of currencies) to the dollar. We are considering whether this is the right idea and what benefits we are from getting this,” he said.

Kuwait switched the dinar’s peg from a basket of currencies to the dollar in 2003 to prepare for monetary union with Saudi Arabia, the United Arab Emirates and three other Gulf oil producers. With the monetary union timetable in doubt after Oman, one of the six, opted last year not to meet the 2010 deadline, speculation has grown that some Gulf states would revalue their currencies. Kuwait was named as the top candidate for a revaluation in a Reuters poll of analysts in March. Standard Chartered’s Brice said he expected Kuwait to revalue the dinar by 1 per cent. Deutsche Bank expects the currency to appreciate 3 per cent in six months.

Speculators piled pressure on the dinar in the runup to a Gulf central bankers meeting in April that was expected to hammer out a deal to revive the monetary union plan. The talks ended inconclusively. In March Kuwait’s central bank warned speculators against betting on an appreciation of the dinar and followed up by cutting key interest rates to make dinar-denominated assets less attractive.

But the one thing about having a peg or in this case a trading band, speculators such as George Soros have a one way sure bet. This does not look to be much of a reward though at 4% for a 6 month span. Now it becomes a question if the real interest rates are higher than the rest of the world.

And the last sentence is funny since cutting interest rates could lead to inflation and defeating the purpose of changing the exchange regime.

And what does the IMF think:

"Significant progress toward regional integration has already been achieved through elimination of barriers to free movement of goods, services, capital, and national labor; and a common external tariff. All GCC countries continue to have strong macroeconomic fundamentals characterized by large surpluses in the fiscal and external current account positions, credible pegged exchange regimes, and low nominal interest rate environments. I continue to strongly support the objective of establishing a GCC monetary union by 2010. Achieving this important objective within the agreed timeframe will however require accelerating the preparatory work to put in place the necessary institutional framework and infrastructure. The Fund stands ready to assist by providing policy advice and technical assistance in our areas of its expertise." IMF Managing Director Rodrigo de Rato Welcomes the Large Investment Programs in the GCC Countries and Highlights the Importance of Planned Monetary Union

A very nice review of the economy of Kuwait is from the IMF of course:
Kuwait: 2006 Article IV Consultation—Staff Report;

Puerto Rico: Divergence not Convergence

The title link is to a chapter of a doctoral dissertation in economics by Fernando Lefort in June 1997. The basic economic theory he is working with is convergence theory. This is broadly defined as the farther away an economy is from the steady state level compared to it closest trading partners (other states), then the fastest the growth will be relative to the distance from the steady state. Steady state refers to the level of GDP that is relatively stable and growing at a steady pace. Much as what is expected of a mature economy such as the USA in this case. And this appears evident in that the Chinese economy is growing fast to catch up with the USA but by theory this growth rate will decrease as it approaches its steady state. But for Fernando's explanation:

In general, the level of technology can be affected by government policies and regulations that distort the markets and by the degree of integration with other economies with other technologies. The savings rate can be considered to be exogenous or can be endogenously determined by the underlying preference parameters. After completing its transitional dynamics, an economy reaches its long-run level of per capita income when the different per capita variables start growing at the same constant rate of growth given by the rate of exogenous technological progress. At that point, the economy is said to be in steady state, and its level of per capita income is known to be the steady state level.

Consider a group of economies that, because of cultural, political or physical proximity, share the same steady state value of per capita income. The neoclassical model of growth predicts that the countries with lower initial levels of per capita income will have higher rates of per capita income growth. Poorer economies will tend to converge or catch-up to wealthier ones, in per capita terms, if their economies differ only because of initial conditions. Thus, the theory of absolute convergence: of two economies aspiring to the same steady state levels, the economy with the lower, initial level of income will grow faster.

But the world is not that simple:

However, even the simplest of the neoclassical growth models, the Solow-Swan model, requires a restatement of this implication if all economies do not share the same steady state. What if different countries have different savings rates, population growth rates, or different technologies? It can be shown that economies with higher steady state levels will grow at a higher rate in per capita terms than those striving toward lower steady states. Hence, the theory of conditional convergence (after the revisions of the convergence hypothesis by Barro and Sala-i-Martin (1992), and Mankiw, Romer and Weil (1992)): of two economies with the same initial levels of income, the economy aspiring to the higher steady state will grow faster.

He states three other conditional factors for different steady states (ie different savings rates, population growth rates, or different technologies). But I see that there is more to this gap as these factors alone dictate. More later.

In summary, Puerto Rico showed an outstanding catch-up effect in the early post-WWII period compared to the US, out-performing all other Caribbean and Latin American economies. However, since 1973 Puerto Rico's per capita output growth rate has decreased relative to other economies in the region, and there is no clear indication that it will ever be able to close the income gap with the US.

So it did better than all other Caribbean nations but has not narrowed the divide much since the early 1970's. But it does not look as though divergence is happening or that it is becoming poorer relatively to the USA Per Capita Income.

This result remains largely unchanged after controlling for other determinants of the steady state level of income, such as the percentage of high school graduates in the population, the government's share of income, and the per capita level of federal transfers. The remaining gap between the actual and predicted individual effect for Puerto Rico must be attributed to some other unobservable variable. Differences in technology in a broad sense between Puerto Rico and the mainland US appear as the standard explanation for the gap. The high degree of integration of the Puerto Rican and American economies, however, make it implausible to attribute the gap to differences in the access to particular production techniques or any other purely non-economic factor.

So he is wondering why there is not a convergence to a higher steady state as theory would dictate. Again, he may not be considering all factors in this study.

A remaining candidate is the more obvious difference in political institutions. Puerto Rico is the only economy of the sample without the clear and permanent political status of statehood. The uncertainty about the future political status of the island might certainly have hurt Puerto Rico's ability to induce increases in the stock of capital at the rate predicted by the theory for an economy with initial low income and high steady state level of income.

I agree that politics has a major affect on the growth of any economy and in this he is starting on the theory that statehood would increase the steady state level of income.

I found that the coefficient in the non-statehood variable is large, negative, and significant. Given the initial level of per capita income and the structural composition of their income, the economies of the states have grown on average 2 percentage points faster than those of the territories. Although these results must be interpreted carefully, it is clear they highlight the existence of positive effects of the statehood status for growth.

A little technical but just saying that statehood garnered 2% increase more than expected without statehood. So if a state was growing at 3% per year and then became a state then it should grow at 5% per year.

The evidence found in this paper indicates that Puerto Rico is converging to a lower steady state than the one to which the United States is converging -- a shortfall that has meant Puerto Rico has been growing at a rate around 2.5 percentage points lower than the one we could expect from an economy with its initial level of per-capita income and the steady state level of income of the United States. Simple simulations performed using the convergence rates obtained in this paper show that the per capita income level of Puerto Rico could have been almost twice its actual value by 1994, completely closing the income gap with the poorest states, had Puerto Rico been converging towards Mississippi's actual income level since 1955.

The convergence to a lower steady state than the US implies that the income gap will not be closed just by waiting for it to happen. Unless Puerto Rico's steady state level of income increases substantially, the Puerto Rican economy will never be able to close the income gap with the US. In this sense, there is no meaningful economic reason for postponing the decision about statehood for Puerto Rico.

I agree that there is "no meaningful economic reason for postponing the decision about statehood". But I am not certain in the least it will:

All these examples, however, are minor cases of economic cooperation when compared to the potential for Puerto Rico. Were Puerto Rico to become a state, the convergence effect should guarantee Puerto Rico a higher rate of economic growth and its citizens higher income levels. Through the statehood process, Puerto Rico can become an integral part of the largest and wealthiest economy in the world, resolving once and for the question of political uncertainty associated with commonwealth and thereby fully enjoying the economic benefits of the catch-up process.

In Lefort's study he looked at the 48 lower states and Hawaii. But I see that Puerto Rico first is disjointed from the other states and thus may always lag behind the other states unless it finds it specialty and exploits it. In the continental states the Interstate Highway system prevented any state from being left out of the system but it does not apply to the island states. Even Alaska was helped in WWII by the Alaskan highway system even if it was through Canada. It is natural that the states close to each other would converge more easily than an outlier.

But then why did Alaska and Hawaii converge with the USA mainland? First and most importantly was they both offered something unique to the US. Hawaii had crops that could not easily be grown on the mainland and tourism from the west coast was a major growth industry. While Hawaii is a lone tourist destination for the west coast, Puerto Rico has to compete ferociously for tourism between all other Caribbean islands. The naval ports were unique to Puerto Rico but have been scaled back in recent years. As far as Alaska, I would think that it would even be worse than Mississippi if not for substantial Federal Subsidies in infrastructure and the vast oil and gas reserves.

Secondly, English speaking has been implemented in all 50 states. Not all Puerto Ricans speak or read English proficiently. I think this should be a requirement for Statehood, that to graduate all seniors must pass a proficiency in English exam. Thus a diploma means the same in all 50 states. Now they can teach Spanish all they want and even speak it on the streets, but must be able to converse in and read English.

So in conclusion, I want Puerto Rico to become a state if they also want it, but we should realize that it may never be on par with the mainland unless they find their specialty.

Title link broken so this one should work: Puerto Rico: Divergence not Convergence by Fernando Lefort* June 1997 Executive Summary