China has announced a small revaluation of the renminbi yuan against the dollar, and a move to a managed float, relative to a basket of currencies (apparently this will be like the Australian system of the 1970s, a ‘crawling peg’, with the rate announced on a daily basis). Brad Setser has analysis and links.

I would have thought a revaluation of at least 10 per cent would have been a better idea, giving speculators at least some reason to think the next move might be down, but decisions like this are highly political.

One of the questions that’s puzzled me for a long time is: who would be silly enough to buy US 10-year bonds? Given the massive trade deficit, it’s obvious that the US dollar will have to depreciate a great deal against all its trading partners to restore balance. Despite recent gains, it’s already a long way off its 2002 peak against the euro, and the problem was already apparent then.

The standard answer is that foreign central banks are buying US bonds to prop up the currency and keep their exports going. Reports from the US Treasury International Capital System give some support to this idea – foreign central bank holdings of US government securities have risen sharply. But when you look at the maturity structures reported in Tables 9a and 9b of the Report on Foreign Portfolio Holdings of U.S. Securities (PDF file) something interesting emerges. The median maturity for all holdings of long-term US securities is four years, but for official holdings its only three years. Nearly 75 per cent of all foreign holdings of US securities (and these amounted to $1.3 trillion as of June 2004) are for maturities of less than five years. For private holdings, the median is five years, and 25 per cent are for more than ten years.

This is very puzzling. It looks as if the foreign central banks are keeping their options open. At least if the dollar undergoes an orderly decline, they will be able to unload without too much loss. But private investors are in deep.

If this was equity investment it would be comprehensible – maybe these are people who really have faith in the capacity of the dynamic US economy to generate big profits. But large holdings of long term bonds seem almost impossible to rationalise

Over to you.

I happened to reread a passage from James Surowiecki’s “The Wisdom of Crowds in which he discusses the stock market’s reaction to the Challenger disaster, the crucial point being

Did you know that within minutes of the January 28, 1986 space shuttle, Challenger, disaster, investors started dumping the stocks of four major contractors, Rockwell International, Lockheed, Martin Marietta, and Morton Thiokol, who had participated in its launch? Morton Thiokol’s stock was hit hardest of all … the market was right. Six months after the explosion, the Presidential Commission on the Challenger revealed that the O-ring seals on the booster rockets made by Thiokol became less resilient in the cold weather, creating gaps that allowed the gases to leak out.”

It struck me reading this, that I’d heard of Rockwell, Lockheed and MM in many contexts, but I’d never heard of Morton Thiokol. It turns out that they are a specialist builder of booster rockets and similar items (they’re now a division of ATK).

This seems to suggest a prosaic explanation of the market reaction. Whatever the cause, the space shuttle program was going to be shut for a long time. This would do a bit of damage to everyone involved, but much more to the rocket specialist Thiokol than to the other three big diversified companies.

The ATK website indicates that they still have plenty of shuttle contracts, so it seems as if the faulty O-rings didn’t do them much long-term damage over and above the effect on the shuttle program.

I haven’t got the full book or the study cited there, so it may be that this explanation has already been ruled out in some way, but I thought the easiest way to find it was to post and see what response I got.

The question of whether technological progress is slowing down has been around for a fair while, and is up for discussion again (hat-tip Jack Strocch(. In many sectors of the economy, notably transport, the answer is very clearly “Yes”.

On the other hand, Moore’s Law (speed doubling every 18 months) still seems to hold for computer chips and they are playing an increasingly important role in the economy. So although progress in most areas is slower than the historical average, progress in this central area is faster.

In the end, it all comes down to the long-run price elasticity of demand for computation. If this is less than one, total revenue from the sale of computational services will eventually decline relative to national income, and the ultimate situation will be one where computation is effectively free, but no longer an important source of progress. If the elasticity is greater than one, the computation-based share of GDP will rise over time, as previously separate sectors like music, video and so on are computerised.

My reading of the evidence is that the value so far is very close to one, which accounts for some of the ambiguity surrounding this question

In an illustration of the BlogGeist at work, the issue of using lotteries to allocate scarce tickets to public events has come up in the Monday Message Board here and also at Crooked Timber. At first sight, the dispute over Bob Geldof’s attempts to prevent resale of tickets to Live Aid 8, discussed by Henry Farrell at CT, looks like a classic dispute between hardheaded economists and soft social scientists. In reality it’s nothing of the kind. The critics have not only ignored the issues raised by sociology and other disciplines, they have got their economics wrong.
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I spent yesterday at bobfest a conference and dinner in honour of Bob Gregory, Australia’s leading labour economists, and one of the great figures of the Australian economics professsion. Just about everyone in the profession was there (or so it seemed) and a number of papers were given, some learned, some amusing and some a bit of both. My contribution to proceedings was limited to a song, which is over the fold. This was part of a double act, as Geoff Brennan also sang, (he’s much better than me).

Update The event gave real meaning to “singing for my supper”. Owing to disorganisation, I didn’t get around to paying in advance, and when I asked afterwards, the organiser Bruce Chapman said the song was more than enough. Actually, this isn’t an entirely new experience. There’s a general practice of paying in wine for (otherwise uncompensated) presentations at industry conferences and so on: an echo of the days when rum was Australia’s main unit of account, perhaps.
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That’s a rough estimate of the volume of outstanding contracts in financial derivatives, mainly interest swaps (some year-old and incomplete data here totals $175 trillion). As the name implies, these are usually matched, so that the actual net exposure of any party is a tiny fraction of the gross. But if the counterparty on one side of the swap should default, things could get very nasty. And, given the volume, default on a small proportion of the contracts would overwhelm the resources of the world’s central banks. To get an idea of magnitudes, US GDP is about $11 trillion or 5.5 per cent of outstanding contracts. When Long Term Credit Management went bust in 1998, threatening the stability of the world’s financial system, its gross position totalled $1.25 trillion, or about 0.6 per cent of the amount outstanding today.

Of course, the central bankers and prudential regulators have everything under control, and have simulated all the possible things that can go wrong. As for experimental tests of the stability of the system, we haven’t really had one yet, apart from LTCM. The last time the US financial system came under any real stress was the 1990 recession (or maybe the 1987 crash) at which time the volume of derivatives was maybe $1 trillion.

Still, as Eeyore said in a rather similar situation, “That’s what makes it so terribly interesting. Not really knowing until afterwards”.