Setser: Real Export Growth Stalls

What would we do without Brad Setser to give us a hard, analytical look at trade and international funds flows? Setser tells us that the headline news on the trade deficit, namely, that it shrank in March, is misleading. When you dig deeper, and in particular pull out petroleum-related flows, it reveals that real export growth is stalling, which is not good at all, given the supposedly weak dollar.

You'd never detect that worrisome pattern from the mainstream press. It treated the trade release as entirely good news, as the Wall Street Journal illustrates:

U.S. trade deficit narrowed more than expected in March as imports of cars and crude oil dropped amid record-high oil prices and a weak economy.

The March deficit was smaller than Wall Street expectations. Economists surveyed by Dow Jones Newswires had estimated a $61.50 billion shortfall.

The decrease in the trade gap followed two straight months of widening deficits, and suggests that trade contributed more to first-quarter gross domestic product than initially estimated.

The Journal's Economics Blog, with the headline "Economists React: ‘Huge Support’ From Trade" had the experts giving a similarly upbeat reading. Some examples:

The trade balance improved in March despite a sharp spike in oil prices. Non-oil imports fell much more substantially than exports declined. On a trend basis, imports have been slowing while exports continue to climb, boosted by the weak dollar. The trend changed in 2007 with exports now growing more strongly than imports. This has reduced the trade deficit from its record 2006 level. However, because imports are still more than 40% larger than exports and oil prices are continuing to climb, progress on narrowing the trade deficit has been slow and irregular. –Steven A. Wood, Insight Economics

Trade continues to be a huge support for the U.S. economy. Export demand is holding up well, despite the setback in March, which was mostly due to a temporary drop in aircraft. Meanwhile, much of the slowdown in U.S. domestic spending is being passed on to the rest of the world through lower imports. Global Insight anticipates that U.S. domestic demand will rise only 0.3% this year, but that GDP will rise 1.2% due to improved net exports. –Nigel Gault, Global Insight

Note that the more cautious and nuanced comments came later in that post.

Setser, by contrast, said that there "wasn't much to like" in the March report. Ouch. A lot of experts had hoped that the falling dollar would cushion the blow of a weakening economy via more robust exports. And while commodity producers and manufacturers are doing well, we now live in a service economy. Even if the dollar weakens further, the US has sent much of its manufacturing abroad, and we now lack skilled workers and relevant equipment. How long would it take, say, to increase furniture manufacture here (my ex-Ethan Allen sources say there was no inherent reason the US could not have remained competitive in high end furniture production). Who would be willing to bet the dollar will remain cheap long enough for that sort of investment to pay off?

From Setser:

Yes, the headline deficit fell relative to February, but February looks to have been a blip. The rolling 3m deficit has been stable at around $59.5b since December. And much of the fall in the deficit came from a big fall in the volume of imported petroleum. Petrol imports (in volume terms) were running ahead of last year’s pace in January and February. March brought the year to date total down below last year’s total, as the volume of imported crude was about 15% lower than the volume of imported crude last March. The fall in volume was large enough to offset a rise in price. The price of imported crude jumped from $84.76 to $89.85, but the seasonally adjusted US petrol import bill still fell by $2.2b, from $37.4b to $35.2b.

The real problem though was on the export side. Export growth looks to be slowing. The headline nominal growth numbers look good.....But if the rise in agricultural exports and exports of industrial supplies (petrol, chemicals, metals) is stripped out, export growth was only up 5.2% in nominal terms. That is a warning sign.

A plot of real goods exports and imports shows a small monthly fall in exports in March.*



The data bounces around a lot, but it certainly seems that the pace of growth in real US goods exports is slowing. March real goods exports fell back below their level last June (see Exhibit 10). .....

Interjection: the gap between the 5.2% nominal increase versus the real decline also suggests manufacturers are increasing margins rather than seeking to use the price advantage to gain market share.

Dollar depreciation helps, but a slowing world economy hurts. Countries that are spending more on oil may have a bit less to spend on other goods. Plus, in some sectors the US may be hitting capacity constraints …

The improvement in the nominal trade balance – plotted on a rolling 12m basis* – also has stalled.



It isn’t hard to see why: oil

And there is more bad news in the pipeline. Project out $89 a barrel oil for the remainder of the year and the oil balance deteriorates by over $100 billion in 2008. Project out $110 a barrel oil and the oil balance deteriorates by over $200 billion in 2008. The average price of imported oil in q1 of 07 was only $52 a barrel; the average price for all of 2007 was only $64.27 a barrel. That calculation, by the way, assumes that the volume of petrol the US imports continues to fall slowly.

One other point:

The improvement in the US trade balance with China (the deficit was $2.2 billion smaller in q1 2008 than in q1 2007) comes far more from the fact that US imports from China have essentially stopped growing.

Brad, re China, it might be also be the toxic toys and heparin. It's anecdotal, but my suburban buddies told me no one bought toys for their kids this Christmas. Instead, it was electronic games, DVDs, bikes, sporting equipment, anything but. I'm avoiding scallops and tilapia, both of which are imported heavily from China and are chock full of pollutants.

Do You Love Your Investments Too Much?

I must admit that I have never fallen in love with an investment. Yet per the summary of an article in International Journal of Psychoanalysis (hat tip 2ubh, investors are prone to "emotional inflation" similar to what people experience in romantic relationships.

But the piece leaves key questions unanswered: do depressives or paranoid schizoids make better investors? Are hair-trigger traders and bears quietly suffering from an inability to form normal attachments to their holdings?

From UCL (University College London):

Investors get carried away with excitement and wishful ‘phantasies’ as the stock market soars, suppressing negative emotions which would otherwise warn them of the high risk of what they are doing, according to a new study led by UCL (University College London). Economic models fail to factor in the emotions and unconscious mental life that drive human behaviour in conditions where the future is uncertain says the study, which argues that banks and financial institutions should be as wary of ‘emotional inflation’ as they are fiscal inflation.

The paper, published in this month’s issue of the International Journal of Psychoanalysis, explores how unconscious mental life should be integrated into economic decision-making models, where emotions and ‘phantasies’ – unconscious desires, drives and motives – are among the driving forces behind market bubbles and bursts.

Visiting Professor David Tuckett, UCL Psychoanalysis Unit, says: “Feelings and unconscious ‘phantasies’ are important; it is not simply a question of being rational when trading. The market is dominated by rational and intelligent professionals, but the most attractive investments involve guesses about an uncertain future and uncertainty creates feelings. When there are exciting new investments whose outcome is unsure, the most professional investors can get caught up in the ‘everybody else is doing it, so should I’ wave which leads first to underestimating, and then after panic and the burst of a bubble, to overestimating the risks of an investment.

“Market investors’ relationships to their assets and shares are akin to love-hate relationships with our partners. Just as in a relationship where the future is unexpected, as the market fluctuates you have to be prepared to suffer uncertainty and anxiety and go through good times and bad times with your shares. You can adopt one of two frames of mind. In one, the depressive, individuals can be aware of their love and hate and gradually learn to trust and bear anxiety. In the other, the paranoid schizoid, the anxiety is not tolerated and has to be detached, so the object of love is idealised while its potential for disappointment is ‘split’ off and made unconscious.

“What happens in a bubble is that investors detach themselves from anxiety and lose touch with being cautious. More or less rationalised wishful thinking then allows them to take on much more risk than they actually realise, something about which they feel ashamed and persecuted, but rarely genuinely guilty, when a bubble bursts. Again, like falling in idealised love, at first you notice only the best qualities of your beloved, but when everything becomes real you become deflated and it is the flaws and problems that persecute you and which you blame.

“Lack of understanding of the vital role of emotion in decision-making, and the typical practices of financial institutions, make it difficult to contain emotional inflation and excessive risk-taking, particularly if it is innovative. Those who join a new and growing venture are rewarded and those who stay out are punished. Institutions and individuals don’t want to miss out and regulators are wary of stifling innovation. If other investors are doing it, clients might say ‘why aren’t you doing it too, because they’re making more money than we are’.”

Links 5/10/08

You’ve Seen the YouTube Video; Now Try the Documentary New York Times. In case you aren't one of the 30 million who has seen Battle at Kruger.

U.K. turns CCTV, terrorism laws on pooping dogs CNet. Note it has been determined that the CCTV does not deter crime, so it's nice to learn it is useful for something.

Notes on the High End Rich Toscano. A few sightings on the degree of distress in high-end real estate.

Home repossessions to double this year for mortgage defaulters Times Online

First ink, now blood Economist. The prospects for investment and commercial bank layoffs.

The Healthiest Part of the Financial-Services World Felix Salmon

James Galbraith vs. Paul Krugman Mark Thoma

What if we'd been on the gold standard? James Hamilton, Econbrowser

Antidote du jour:

Whopper Du Jour

From the New York Times:

“Taxpayers shouldn’t be taking on the risk of foreclosure,” said Tony Fratto, a White House spokesman.

A little late to try to prevent that....

Microsoft Still Trying Evade the Rule of Law (EU Antitrust Edtion)

Someone needs to tell Microsoft to behave.

By way of background, in December 2004, Microsoft lost its final appeal on an EU antitrust case in which it was found guilty of tying its operating system to its media player, undermining competition and hurting consumer choice, and for failing to give rivals the information they needed to compete fairly in the market for server software, The Redmond company was fined a record $613 million.

To address the server complaint, Microsoft was ordered to license technical information to enable outside companies to design products that would run well on Windows (called API, the application program interface). Note that this isn't a particularly onerous request. Microsoft makes that sort of information available for free except in areas where it is trying to leverage its monopoly.

Microsoft acted in less than good faith through this entire exercise. It appeared to be delaying rather than complying. For example, Microsoft was asked to propose royalties for its API. Now consider Microsoft's response: up to 5.95% of revenues. The EU's technical expert, Neil Barrett, who was recommended by Microsoft, calculated that it would take software companies 7 years to recover their development costs. Now how many products last 7 years? And in particular, how many software products last for 7 years? Cost recovery looks like a fantasy. Barrett determined that even a 1% royalty would be too high, and 0% would be more appropriate.

In September 2007, the European Court of First Instance, in a starkly worded summary read to a courtroom of about 150 journalists and lawyers here, ordered Microsoft to obey a March 2004 commission order and upheld the €497.2 million, or $689.4 million, fine against the company.

In October, Microsoft negotiated a settlement of open items, giving every indication that it would submit to the court's ruling. As the Financial Times reported:

Microsoft finally admitted defeat in its three-year battle with the European Commission on Monday, as the US software giant agreed to comply with the regulator’s landmark finding that it was abusing its dominance of the market.

“I welcome the fact that Microsoft has finally undertaken concrete steps to ensure full compliance with the 2004 decision,” Neelie Kroes, competition commissioner, told a press conference in Brussels. “It is regrettable that Microsoft has only complied after a considerable delay, two court decisions and the imposition of daily penalty payments,” she said.

Under the deal reached between Ms Kroes and Steve Ballmer, the chief executive of Microsoft, early on Monday morning, the company will make it much easier for rivals to use its technology to develop their own programmes.

Microsoft also said it would not appeal the decisive September ruling by the European Court of First Instance, which upheld the Commission’s finding that Microsoft had broken EU competition rules. It ends three years of resistance that has cost €777.5m in fines.

Yet in February, the EU competition commission fined Microsoft $1.4 billion (€899m) for failing to adhere to the court decision:

The fine comes days after the world's biggest software group announced it would open parts of its software to rival companies in an attempt to assuage competition authorities.

But that move received a lukewarm reception in Brussels, where regulators have expressed scepticism about Microsoft's promise to make its Windows operating system and other big-selling software more open and transparent....

"The Commission has stuck to its guns," said John Pheasant, partner at Hogan & Hartson, an international law firm. "It also appears that the [European] Commission has not been swayed or deflected by the recent announcements by Microsoft."....

The Commission required Microsoft to offer such information on "reasonable terms," but subsequently complained that the royalty rates demanded by Microsoft over the next three years amounted to "unreasonable pricing". Microsoft fought the decision for several years but dropped its appeal after a top EU court ruled in favour of regulators last September

.
Now at the eleventh hour, right before the deadline for appeals is about to expire, Microsoft effectively repudiates the settlement and files an appeal. Yet incredibly, the press, even the usually reliable Financial Times, fails to note that this is a 180 degree change in its pretenses of being compliant. Again, from the Financial Times:

Microsoft said on Friday it would appeal against the record-breaking $1.4bn (€899m) fine imposed by Brussels two months ago because of the software group’s failure to comply with demands that it end anticompetitive business practices.

In a statement, the world’s biggest software group said that it was asking the European Court of First Instance to annul the European Commission’s February decision in which it imposed the penalty.

“We are filing this appeal in a constructive effort to seek clarity from the court,” Microsoft said in a statement....

Some independent competition specialists said openly that they believed there were grounds for an appeal – particularly since the Commission had never spelt out what it considered to be a reasonable charge for the patent licences. For example, Denis Waelbroeck, a partner at Ashurst, on Friday welcomed the move because he believed that there were “procedural inadequacies” in the approach taken by the Commission.

The Commission, however, responded on Friday by saying that it was “confident that the decision to impose the penalty was legally sound”.

The decision to file an appeal will also do nothing to ease the strained relations between the Commission and the company – which appear to have deteriorated again after failed efforts to reach some kind of “global settlement” late last year.

In January, the Commission announced that it was opening a fresh investigation into suspicions that Microsoft had abused market dominance of its Office software, and also whether it had illegally linked its Internet Explorer system to Windows. According to lawyers in Brussels, this probe is actively moving forward with information requests circulating.

It's too bad appeals courts can't increase fines. The one imposed on Microsoft was 60% of the maximum permitted; if I were a judge, I'd want to throw the book at them.

Why? The discussion about royalties is spurious; the Commission's expert said 1% was too high and zero might be appropriate. If Microsoft had had any good faith interest in putting this matter behind them, it would have proposed a royalty and put the onus on the EU to object.

I can't fathom what Microsoft thinks it will gain from this exercise, save delaying compliance with the EU's demands and annoying the regulator, which has issues far more important to Microsoft still before it. I am not a lawyer, but the issue of the level of royalties is not a basis for overturning the decision. The fine will stand and the interest will accrue. The most Microsoft can gain is to be able to charge a higher level within the 0% to 1% range. And this may be simply an artifact of the EU's drafting (the parameters were discussed in the trial, but the ruling itself indeed did not specify a level. Thus Microsoft at best will score a Phyrric victory.

Before readers assume Microsoft must have some advantage it can gain from this, consider: the coverage of Microsoft's antitrust trial in the US revealed that the company had an inept legal strategy. Some believed that Gates must have refused to listen to his advisors. Worse, the Redmond firm repeatedly showed its contempt for the court, repeatedly making statements that strained credulity.

Microsoft escaped tough penalties in the US only by a fluke. Judge Thomas Penfield Jackson was clearly disgusted by the Redmond's company's dissembling and was prepared to throw the book at them, but because he made the mistake of talking to the press substantively before the penalty phase was concluded, he was replaced by a cautious and clueless jurist, Colleen Kollar-Kotelly.

Microsoft just does not get it. The company seems not to understand that it is subject to the rule of law and has to comply when ordered to. Yes, Steve, there really are organizations out there that are bigger, tougher, and more determined than you are.

Is the Commodities Boom Driven by Speculation?

The question above may seem foolish. Oil has just passed $124 a barrel despite improvement in the dollar. Commodities prices are moving less in lockstep than before (gold and wheat in particular have backed off significantly from their highs) suggesting that buying is not the result of the basic materials version of a land grab. Opinion among economists, at least those polled by the Wall Street Journal, is unusually united: 89% think that skyrocketing commodity prices are the result of fundamentals, not too much cash chasing too few raw materials.

Yet bubble-like enthusiasm abounds. Tim Iacono pointed to a Money Magazine cover as proof that the end of the commodities run was not too far away. However, we have yet to see the storied counter-indicator, a Business Week cover story. In fact, Business Week ran an op-ed by Ed Wallace, "There is No Gas Shortage," that pointed out that inventories were growing, which in combination with rising prices, suggests some speculative hoarding:

Gasoline reserves on hand are at the highest levels since the early 1990s, which is remarkable considering the nation's refineries have been cutting back on the production of gasoline because their margins have declined. In fact, average gasoline reserves on hand have risen since this past October, while oil reserves in this country have gone up virtually every week this year—and only fog in the Houston Ship Channel that kept oil tankers from unloading their crude one week kept it from being every week.....

In January of this year, the U.S. used 4% less petroleum than we did a year ago. (Oil demand was down 3.2% in February.) Furthermore, demand has been falling slowly since July of last year. Ronald Bailey of Reason Online has pointed out that worldwide production of oil has risen 2.5% in the first quarter, while worldwide demand has grown by only 2%. Production is expected to increase by 3.3% in the second quarter, and by as much as 4.1% by the third quarter. The net result is that the U.S. daily buffer for oil production against demand, which was a paltry 1.5 million barrels as recently as 2005, is now up to 3 million barrels in excess capacity today.....

"The [oil] fundamentals are no problem. They are the same as they were when oil was selling for $60 a barrel, which is in itself quite a unique phenomenon." — Jeroen van der Veer, chief executive officer, Royal Dutch Shell; Washington Post, Apr. 11, 2008.

But what is intriguing is that commodities veterans are distressed by recent market action. They seem more inclined than outsiders and newbies to point to the role in the bull market not of fundamentals but of new cash and perhaps more important, new vehicles, such as ETFs.

Reader Michael e-mailed us an paper and a series of posts by Michael Frankfurter, a commodities industry analyst (the article was co-authored with Davide Accomazzo of Pepperdine). The posts are broader in focus and discuss the "financialization" of commodities. As we will see soon enough, this development has worrisome parallels to recent history in real estate, with an asset intended primarily for use increasingly treated as an investment vehicle.

An old Wall Street saw illustrates the dangers of this approach:

On a slow afternoon, trader A decided to open a market for a can of sardines. Bidding started at $1. B bought it for $2 and sold it to C for $3. D and E decided to get into the act, with the result that E became the owner for $5.

E decided to open the can and discovered the sardines had gone bad. He went back to A to get his money back, protesting that the sardines were rotten. A smiled broadly, and said, " You don't understand. Those were trading sardines, not eating sardines."

The paper, "Is Managed Futures an Asset Class? The Search for the Beta of Commodity Futures," has some disconcerting findings from the standpoint of investors. It says that the normal risk/return paradigms of securities markets do not operate in commodities markets, nor do the pricing models for commodities offer an adequate substitute:

Our research indicates that these models have inherent shortcomings in being able to pinpoint a definitive source of structural risk premium within the complexity of the commodity futures markets. We hypothesize that the classic arbitrage pricing theory contains circular logic, and as a consequence, its natural state is disequilibrium, not equilibrium. We extend this hypothesis to suggest that the term structure of the futures price curve, while indicative of a potential roll return benefit, in fact implies a complex series of roll yield permutations. Similarly, the hedging response function elicits a behavioral risk management mechanism, and therefore, corroborates social reflexivity. Such models are inter-related and each reflects certain qualities and dynamics within the overall futures market paradigm.

With respect to managed futures, it is an observable materialization of behavioral finance, where risk, return, leverage and skill operate un-tethered from the anchor of an accurate representation of beta. In other words, it defies rational expectations equilibrium, the efficient market hypothesis and allied models - the CAPM, arbitrage pricing theory or otherwise - to single-handedly isolate a persistent source of return without that source eventually slipping away.

The article provide a nice survey of the issues surrounding CAPM and its successors, and then reminds us of why commodities are traded:

The secondary benefit provided by the futures market is that it functions as a mechanism for transparent price discovery and liquidity, which therefore mitigates price volatility. The primary benefit provided by these markets, however, is that it allows commercial producers, distributors and consumers of an underlying cash commodity to hedge. This reduces the risk of adverse price fluctuations that may impact business operations, which in turn theoretically results in increased ‘capacity utilization.’

And bear in mind, there are more prosaic reasons to be cautious about commodities. From the first in a series of three posts by Frankfurter,

Futures and forward contracts are intrinsically different instruments than securities which are derived from the capital markets (e.g., fixed income or equities). This is underappreciated.

Derivatives are risk management tools, a “zero-sum game,” fundamentally different from the “rising tide raises all ships” concept of the capital formation markets. While, there is an established theoretical basis and considerable empirical evidence that link investment in capital market assets to positive expected returns over time, notwithstanding the recent surge in commodity prices, the same cannot be said about commodities.

With that as a backdrop, let's then turn to Frankfurter's third post, "The Mysterious Case of the Commodity Conundrum, Securitization of Commodities, and Systemic Concerns." His case is straightforward: financialization of commodities, including the growth of OTC markets, is pushing prices well out of line with fundamentals (note I have excerpted his key points; the piece provides far more evidence):

Rising prices and a widespread bull market in commodities should indicate that there is a growing scarcity of hard assets. However, traditional forces of supply and demand cannot fully account for recent prices.

To be precise, the normal price-inventory relationship has been altered. This is the assertion of an expanding list of bona fide hedgers, commodity professionals and economists. Specifically, dynamics have changed because securitized commodity-linked instruments are now considered an investment rather than risk management tools. Of late, this has been causing a self-perpetuating feedback loop of ever higher prices.

That means a bubble. Back to Frankfurter:

In a statement to the CFTC, Tom Buis, president of National Farmers Union, testified, “If [farmers] can't market their crops at these higher prices, we've got a train wreck coming that's going to be greater than anything we've ever seen in agriculture.” Billy Dunavant, head of cotton merchant Dunavant Enterprises, was more blunt, “The market is broken, it's out of whack—someone has to step in and give some relief.”

Even CFTC Commissioner Jill Sommers acknowledged charges that speculators are skewing the market, in an apparent turnaround from the CFTC statement of April 21st which implied that commodity markets are functioning properly.....

the predominant view is currently biased to commodities as an investment hedge against inflation and speculators as an easy scapegoat for all the world's commodity woes.

Unfortunately, this thinking is a self-fulfilling prophecy which ultimately may feed into a negative economic cycle where legitimate commercials are squeezed out of business thereby reducing supply, protectionism gains traction, trade breaks down, hoarding ensues, riots occur and wars erupt over access.

This may sound alarmist, but industry insiders are not buying into the one-size fits all answer that emerging economies are the primary factor driving up prices from the demand side, reinforced by supply-side shocks and peak production fears. In a slowing global economy hit by a major credit crisis and reeling from a falling dollar, it is likely that money flows seeking safe haven in hard assets is the key driver of recent volatility.....

Even if one accepts all the arguments that there is an economic shift in fundamentals which has resulted in rising commodity demand in emerging economies, as well as arguments that there are supply-side constraints bottle-necking commodity production, it is imprudent to deny that this perfect storm has been accompanied by a paradigm shift in how the commodity markets have historically operated.

We've been hear before… Economic problems related to OTC derivatives first occurred n 1994 which included the bankruptcy of Orange County , in 1998 with the collapse of Long-Term Capital Management, then during the California electricity crisis of 2000 and 2001 due to market manipulation by Enron, and most recently the credit crisis as a result of mortgage securitization repackaged into complex derivatives.

This history should not be misconstrued, however. Derivative products in themselves are not necessarily the problem. Rather, it is the unregulated environment in which such instruments are traded, and the lack of a cohesive infrastructure to manage the trading, clearing and mark-to-market pricing of such instruments. The regulated futures industry, on the other hand, provides a robust alternative model for trading derivatives.

An aside: perhaps I have been asleep at the switch, but aside from a mention in a New York Times article of a AIG, which manages commodity funds, entering directly into a contract with a farmer, I have not seem any mention in the mainstream media about OTC commodity trading, yet Frankfurter indicates this is a significant and growing factor. I wonder if this oversight is leading to incomplete analysis.

Back to Frankfurter:

Unfortunately, the most important tool of the CFTC to monitor potential market manipulation and excessive speculation, the Commitment of Traders (COT) report, was materially impacted by the CFMA [Commodity Futures Modernization Act of 2000]. In fact, this cornerstone of market surveillance has been so severely damaged as to make reliance on it nearly useless, and those who cite COT as justification for a balance between speculators and hedgers, not credible.....

The CFTC's ability to monitor the commodity markets was further eroded when the CFTC permitted the Intercontinental Exchange (ICE) to use its trading terminals in the United States for the trading of U.S. commodity futures contracts on the ICE futures exchange in London . Subsequently, ICE Futures allowed traders in the United States to use ICE terminals in the United States to trade its synthetic futures contracts on the ICE Futures London exchange. This allowed unregistered funds to effectively bypass registration.

According to the U.S. Senate Staff Report, “Despite the use by U.S. traders of trading terminals within the United States to trade U.S. oil, gasoline, and heating oil futures contracts, the CFTC has not asserted any jurisdiction over the trading of these contracts. Persons within the United States seeking to trade key U.S. energy commodities… now can avoid all U.S. market oversight or reporting requirements by routing their trades through the ICE Futures exchange in London instead of the NYMEX in New York.”......

In addition to the issue of index funds accumulating long positions and thereby imputing an upward bias to commodities, there is another opportunity for market manipulation with respect to the construction and rebalancing of prominent commodity benchmarks such as the Goldman Sachs Commodity Index (GSCI).

As reported by the New York Times on September 30, 2006 Goldman Sachs significantly readjusted in August of that year the GSCI's gasoline weighting. Index products tracking the GSCI, and representing an estimated $60 billion in institutional investor funds, were forced to rebalance their portfolios resulting in an unwinding of positions. Originally, unleaded gasoline made up 8.75 percent of the GSCI as of 6/30/2006 , but this was changed to just 2.3 percent, representing a sell-off of more than $6 billion in futures contracts.

As a result, gasoline fell 82 cent in the wholesale market over a four-week period, an unprecedented move; and crude oil, which in July 2006 traded over $79 per barrel for August delivery—at the time an all-time record—subsequently fell to around $56 by January 2007.

Many at the time argued that these moves were due to fundamentals, but… it should also be noted that the U.S. was in the midst of mid-term elections with Republicans facing a major fight to retain control over both Houses. According to a Gallup poll at the time, 42% of respondents thought that the Bush administration “deliberately manipulated the price of gasoline so that it would decrease before the elections.”

We've also discussed other games Goldman plays with the GSCI, most notably "date rape", which costs investors in that index a stunning 150 basis points a month.

Frankfurter again:

There are, however, three concerns as a result of the securitization of gold, which can also be applied to commodity-linked ETFs generally:

The first is that increasing gold prices act reflexively upon investor sentiment as an indicator of inflationary pressures, therefore resulting in more gold accumulation and dollar dumping—a vicious feedback loop.

The second concern, while an indirect case in point, is that the securitization of gold bullion demonstrates how easy it is for a cash commodity to be hoarded, effectively taking the supply of that hard asset off the market. Theoretically, forward contracting by investors is causing the perception of inadequate supply due to perceived increase in demand...

Third, the StreetTracks gold ETF broke the mold and open the floodgates for additional securitizations of commodities in the U.S.....these vehicles ended up doing an end-run around the CFTC by exploiting the loopholes in the CFMA.

This is only a fairly small sampling from the posts (see parts one, two, and three) which includes citations at the end of the final offering.

Joseph Stiglitz Lambasts Inflation Targeting

In Project Syndicate (hat tip Mark Thoma), Joseph Stiglitz takes on an increasingly common approach among central banks, namely, to announce a formal target for inflation and use interest rate policy to attempt to achieve it. Note the US does not use this approach, although one of the Fed's responsibilities is to maintain price stability. One justification for inflation targets is greater transparency. Letting market participants know what deviations might trigger a policy response is thought to encourage a certain amount of restraint among private sector actors. It also means fewer surprises when monetary authorities raise and lower rates.

Despite the seeming logic of inflation targeting, I've never been comfortable with it. Bizarrely, it seems an offshoot of Friedman's dictates, although it's precisely the sort of thing the monetarist would have ridiculed. Friedman advocated setting strict monetary growth targets (although before his death he retreated somewhat):

Nothing that I have observed in recent decades has led me to change my mind about the desirability of a monetary rule which simply increased the quantity of money at a fixed rate month after month, year after year. That rule would get rid of the mistakes and that is probably about all you could expect to get from a monetary system.

By contrast, Friedman was critical of using interest rates as a guide, perhaps based on his study of the Depression, when the central bank mistakenly saw low rates as a sign of permissive monetary policy, when in fact real rates were high, and the tightening turned a downturn into a disaster.

My impression, from afar, is that the authorities, having used monetary targets for a bit (I recall how the everyone on Wall Street fixated on the money supply announcement every Thursday at 4:00 during Volcker's tenure) came to find having a target of some sort useful and gravitated towards inflation targeting. I've never understood it, having never seen neither any compelling arguments in its favor nor any empirical support.

Stiglitz confirms my suspicions as to the lack of any sound basis for this practice. His article, "The urgent need to abandon inflation targeting." focuses on the mistakes it can generate in a setting like ours, when many countries are experience inflation due to rising costs of imported commodities. Increasing interest rates in, say, Poland will have no impact on prices set in global markets. To achieve the desired inflation level will require having domestic goods greatly undershoot the target via an overly aggressive rate increase.

Tease Stiglitz's logic out: if central banks stick to their targets, rather than yielding to domestic pressures, this means that the commodity price rise, which should dampen growth in and of itself, will lead to overly restrictive monetary policies in many countries and will worsen an international slowdown. That of course assumes that the authorities have the political will and clout to inflict that much pain, but the potential is clearly there.

From Project Syndicate:

The world’s central bankers are a close-knit club, given to fads and fashions. In the early 1980s, they fell under the spell of monetarism....After monetarism was discredited — at great cost to those countries that succumbed to it — the quest began for a new mantra.

The answer came in the form of “inflation targeting”, which says that whenever price growth exceeds a target level, interest rates should be raised. This crude recipe is based on little economic theory or empirical evidence; there is no reason to expect that regardless of the source of inflation, the best response is to increase interest rates....(Among the list of those who have officially adopted inflation targeting are: Israel, the Czech Republic, Poland, Brazil, Chile, Colombia, SA, Thailand, Korea, Mexico, Hungary, Peru, the Philippines, Slovakia, Indonesia, Romania, New Zealand, Canada, the UK, Sweden, Australia, Iceland and Norway.)

Today, inflation targeting is being put to the test — and it will almost certainly fail. Developing countries currently face higher rates of inflation, not because of poorer macro-management, but because oil and food prices are soaring, and these items represent a much larger share of the average household budget than in rich countries. In China, for example, inflation is approaching 8% or more. In Vietnam, it is expected to approach 18,2% this year, and in India it is 5,8% . By contrast, US inflation stands at 3%. Does that mean that these developing countries should raise their interest rates far more than the US?
Inflation in these countries is, for the most part, imported. Raising interest rates won’t have much effect on the international price of grains or fuel. Indeed, given the size of the US economy, a slowdown there might conceivably have a far bigger effect on global prices than a slowdown in any developing country, which suggests that, from a global perspective, US interest rates, and not those in developing countries, should be raised.

So long as developing countries remain integrated into the global economy — and do not take measures to restrain the impact of international prices on domestic prices — domestic prices of rice and other grains are bound to rise markedly when international prices do.

Raising interest rates can reduce aggregate demand, which can slow the economy and tame increases in prices of some goods and services, especially nontraded goods and services. But, unless taken to an intolerable level, these measures by themselves cannot bring inflation down to the targeted levels. For example, even if global energy and food prices increase at a more moderate rate than now — for example, 20% per year — and get reflected in domestic prices, bringing the overall inflation rate to, say, 3% would require markedly falling prices elsewhere. That would almost surely entail a marked economic slowdown and high unemployment. The cure would be worse than the disease.

So, what should be done? First, politicians, or central bankers, should not be blamed for imported inflation, just as we should not give them credit for low inflation when the global environment is benign.

Second, we must recognise that high prices can cause enormous stress, especially for poorer people . Riots and protests in some developing countries are just the worst manifestation of this.

Advocates of trade liberalisation touted its advantages; but they were never fully honest about its risks, against which markets typically fail to provide adequate insurance. When it comes to agriculture, developed countries, such as the US and European Union members, insulate both consumers and farmers from these risks....Many are imposing emergency measures like export taxes or bans, which help their own citizens, but at the expense of those elsewhere.

If we are to avoid an even stronger backlash against globalisation, the west must respond quickly. Biofuel subsidies, which have encouraged the shift of land from producing food into energy, must be repealed. Some of the billions spent to subsidise western farmers should now be spent to help poorer developing countries meet their basic food and energy needs.

Most importantly, both developing and developed countries need to abandon inflation targeting. The struggle to meet rising food and energy prices is hard enough. The weaker economy and higher unemployment that inflation targeting brings won’t have much effect on inflation; it will only make the task of surviving in these conditions more difficult.

Citi Mulls Sale of $400 Billion of Assets

I'm in danger of sticking my neck out, but is it possible that Virkram Pandit, Citi's CEO, is doing a good job?

It's way too early to make a call. The markets and stock watcher have the attention span of a fruit fly, when corporate successes are built slowly, and the less fanfare, the greater the odds of good outcomes.

I was prepared to dismiss Pandit, who was clearly a battlefield promotion, relatively new to Citi, and with experience that could be argued to be less relevant than it seemed. Yes, he had headed much of the institutional side of Morgan Stanley (investment banking, fixed income, and alternative investments), but he was running a well managed (by Wall Street standards) operation during a bullish period. He didn't have any experience in some of Citis' major operations, such as retail, insurance, credit cards, nor had he ever run anything approaching Citi's scale. And that's before getting to the not-trivial detail that he inherited an organization in crisis.

From the outside, Pandit appears to be moving methodically but with sufficient speed to tackle the megabank's problems. I like some of his calls, admittedly because they conform with my prejudices; time will tell whether they were astute or not.

The first was that Pandit called on Hewlett Packard, rather than a consulting firm or PR powerhouse, or corporate fixer, to get advice on how to deal with demands to break up the bank (aside: Citi issued a denial, but the wording implies that Citi did not pay fees to HP). While Citi is clearly too unweildy and some aggressive pruning is in order, Wall Street goes overboard with the idea of separating companies into tidy pure plays or hiving pieces off that can be sold easily. For instance, I have serious reservations about the idea of selling Citi's credit card business. At this point in the cycle, it would fetch a terrible price. Conversely, customer profitability in retail banking correlates with how many products they decide to buy, and the best time to make the cross-sell is when they open an account. A card business thus makes sense as part of a retail banking operation.

Second is that Pandit appears set to announce plans to exit non-core businesses. Of course, the proof is in the pudding of how "non-core" is defined, and asset sales were expected to help the financial giant strengthen its damaged equity base.

So nothing exceptional from Pandit so far, but the absence of apparent major errors is encouraging. The real test is going to be whether he has the foresight and skill not only to repair the firm's financials, but to make progress in the far more difficult task of shifting the bank's culture and incentives.

Also note the complete absence of Robert Rubin. I cynically assume that the wily former risk arb sees only downside in getting involved in the "fix Citi" program. But he has also argued for asset sales, more aggressive that what Pandit appears to have on offer. So there may be more complicated reasons for Rubin's exceedingly low profile.

From the Financial Times:

Citigroup will on Friday identify as much as $400bn in non-core assets that could be sold as part of plans to reduce costs and restore profit growth to double-digit rates, according to people close to the situation.

At a long-awaited meeting with Wall Street analysts, Vikram Pandit, Citi’s chief executive, also plans to confirm his pledge, first disclosed in the Financial Times, to cut Citi’s cost base of over $60bn by about 20 per cent.

Despite his desire to prune Citi’s balance sheet aggressively, Mr Pandit will use the meeting to rebuff calls for a break-up of the company, say sources familiar with his thinking. They say he will defend Citi’s “universal banking model” combining consumer and wholesale banking.

Mr Pandit is likely to say that about 20 per cent of Citi’s $2,000bn-plus balance sheet consists of “legacy” assets – entire businesses or trading positions outside its core businesses in commercial, consumer and investment banking.

The sale of the assets is likely to take years, and some of the non-core holdings may never be sold, according to people close to the situation. Nevertheless, Mr Pandit’s decision to classify such a large portion of the balance sheet as non-core highlights his determination to root out underperforming businesses.

Links 5/9/08

Meat in a low-carbon world BBC. On the difficulties of trying to eat an environmentally friendly diet.

Repossession orders at record high as homeowners struggle Times Online

EMU is more unworkable than ever Ambrose Evans-Pritchard, Telegraph

The US: Your masters of the universe William J Astore, Asia Times. On the deeper meaning of the Air Force's new slogan, "Above All."

From the Runway to the Road: Terrafugia Redefines the Flying Car—Make that Drivable Airplane xconomy

Economic Suicide Amitai Etzioni, Huffington Post

Whistle-blowback CFO.com

The de facto nationalization of the global financial system Brad Setser

Antidote du jour:

The New Imperialist: China to Buy Agricultural Land Abroad

The great imperial struggles of the 1800s were over control of strategic or otherwise prized resources, and the hostilities they generated helped stoke World Wars I and II. Many believe the Iraq war was all about oil.

China is considering adopting a contemporary variant of the colonial model. A Ministry of Agriculture proposal suggests that rather than conquer territory to secure needed farmland, it could simply buy it up. But this path proves likes to engender resistance from the locals in countries with conquered occupied investee sites. This might work if done quietly, with local players acting as fronts. But this program will have to be very large scale to achieve its desired aims, which is improving food security, which makes keeping a low profile well nigh impossible.

And does China really think it can export food from large tracts of land abroad if the natives are hungry? There are major risks, such as governments asserting eminent domain to repatriate property and sabotage of transport.

China is concentrating its efforts on Africa and South America. In many areas, the control of the central government is weak. Will China wind up employing local mercenaries to secure its interests? It will be interesting to watch this initiative play out.

From the Financial Times:

Chinese companies will be encouraged to buy farmland abroad, particularly in Africa and South America, to help guarantee food security under a plan being considered by Beijing.

A proposal drafted by the Ministry of Agriculture would make supporting offshore land acquisition by domestic agricultural companies a central government policy. Beijing already has similar policies to boost offshore investment by state-owned banks, manufacturers and oil companies, but offshore agricultural investment has so far been limited to a few small projects.

If approved, the plan could face intense opposition abroad given surging global food prices and deforestation fears. However an official close to the deliberations said it was likely to be adopted.....

The move comes as oil-rich but food-poor countries in the Middle East and north Africa explore similar options....

China has about 40 per cent of the world’s farmers but just 9 per cent of the world’s arable land....China is still a net exporter of agricultural commodities but is increasingly reliant on soybean imports and is about to become a net buyer of corn.....

Some countries would find it particularly problematic if Beijing supported Chinese firms to use Chinese labour on land bought or rented abroad – common practice for most companies operating overseas.

WSJ Survey: Economists Say Energy, Food Price Rises Driven By Fundamentals

A Wall Street Journal survey of 53 economists found the great majority said that the spike in food and energy prices is the result of supply and demand, not speculation. At the same time, the average forecast among this group is that oil will be at $93 a barrel by year end. While the article does not elaborate, one has to assume it is due to an expected slowdown in emerging economies as the impact of the US recession starts to hit China and India.

From the Journal:

Fifty-one percent of the respondents said demand from China and India was the prime factor in soaring energy prices, and 41% said demand was the chief contributor to rising food costs. Constrained supply was cited second most-often; 20% blamed supply problems for higher food prices and 15% for increasing energy prices.

"It's a combination of demand and supply issues," said Joseph Carson of AllianceBernstein.

But while most of the analysts attributed the food and energy costs to fundamental trends, 11% of the economists see a potential bubble driven by speculation. "Commodity markets have become a strange safe haven, with prices well out of line with underlying market fundamentals," said Diane Swonk of Mesirow Financial. "I am dumbfounded that a report like Friday's employment report triggered a rally in oil prices... Just plain ridiculous."....

The survey.... showed that the economists, on average, expect the price of crude to fall to about $105 a barrel by the end of next month from the current record-high levels above $120 and to decrease to about $93 by the end of the year. Their expectations for overall inflation continue to rise. They expect the consumer price index, which rose 4% year-over-year in March, to increase 3.6% in June compared with a year earlier.

I have trouble reconciling the consensus 25% fall in the price of oil in a mere seven months with changes in fundamentals, but I'm not the one doing the forecasting.

"Blame the Models"

One of our pet interests has been how the use of mathematics and models can unwittingly enable people to fool themselves. We see this regularly when working on deals. The model for the target business' performance somehow becomes more real than the company. When the numbers don't work, if you can come up with a good sounding rationale for tweaking them, presto! Suddenly everything in hunky dory. No wonder over 60% (some studies say as high as 75%) of all deals fail.

Our colleague Susan Webber, in an article about the corporate obsession with metrics, made some pertinent observations:

Metrics presuppose that situations are orderly, predictable, and rational. When that tenet collides with situations that are chaotic, nonlinear, and subject to the force of personalities, that faith—the belief in the sanctity of numbers—often trumps seemingly irrefutable facts. At that point, the addiction begins to have real-world consequences. Business managers must recognize the limitations of metrics.

Mind you, I’m not arguing that metrics and measurement are inherently bad things. To note just one example, a well-structured performance measurement system is essential to the well-being of large enterprises. But quantitative measures can be and frequently are used naively. It’s all too easy to abdicate judgment to the output of a model or scorecard.

Jon Danielsson at VoxEU takes this viewpoint further in an article that discusses a pervasive cognitive dissonance among trading operations and their regulators. They know that statistical models have major shortcomings, particularly in underestimating the odds of catastrophic losses, which is precisely what they are supposed to help avoid. While the conventional response has been to try to devise better models, Danielsson argues that that line of thinking is wrongheaded.

For Danielsson makes a fundamental point: what matters is management; the models are secondary. For reasons I cannot fathom (perhaps the rise of the PC and the ease of slicing and dicing data), qualitative assessments are seen as inferior to quantitative ones. But for a regulator to understand the robustness of a company's management practices requires more scrutiny than has been fashionable of late. And it also requires better regulators.

From VoxEU:

In response to financial turmoil, supervisors are demanding more risk calculations. But model-driven mispricing produced the crisis, and risk models don’t perform during crisis conditions. The belief that a really complicated statistical model must be right is merely foolish sophistication.

A well-known American economist, drafted during World War II to work in the US Army meteorological service in England, got a phone call from a general in May 1944 asking for the weather forecast for Normandy in early June. The economist replied that it was impossible to forecast weather that far into the future. The general wholeheartedly agreed but nevertheless needed the number now for planning purposes.

Similar logic lies at the heart of the current crisis

Statistical modelling increasingly drives decision-making in the financial system while at the same time significant questions remain about model reliability and whether market participants trust these models. If we ask practitioners, regulators, or academics what they think of the quality of the statistical models underpinning pricing and risk analysis, their response is frequently negative. At the same time, many of these same individuals have no qualms about an ever-increasing use of models, not only for internal risk control but especially for the assessment of systemic risk and therefore the regulation of financial institutions.1 To have numbers seems to be more important than whether the numbers are reliable. This is a paradox. How can we simultaneously mistrust models and advocate their use?.....

Underpinning this whole process is a view that sophistication implies quality: a really complicated statistical model must be right. That might be true if the laws of physics were akin to the statistical laws of finance. However finance is not physics, it is more complex, see e.g. Danielsson (2002).

In physics the phenomena being measured does not generally change with measurement. In the finance that is not true. Financial modelling changes the statistical laws governing the financial system in real-time. The reason is that market participants react to measurements and therefore change the underlying statistical processes. The modellers are always playing catch-up with each other. This becomes especially pronounced when the financial system gets into a crisis.
This is a phenomena we call endogenous risk, which emphasises the importance of interactions between institutions in determining market outcomes. Day-to-day, when everything is calm, we can ignore endogenous risk. In crisis, we cannot. And that is when the models fail.

This does not mean that models are without merits. On the contrary, they have a valuable use in the internal risk management processes of financial institutions, where the focus is on relatively frequent small events. The reliability of models designed for such purposes is readily assessed by a technique called backtesting, which is fundamental to the risk management process and is a key component in the Basel Accords.

Most models used to assess the probability of small frequent events can also be used to forecast the probability of large infrequent events. However, such extrapolation is inappropriate. Not only are the models calibrated and tested with particular events in mind, but it is impossible to tailor model quality to large infrequent events nor to assess the quality of such forecasts.

Taken to the extreme, I have seen banks required to calculate the risk of annual losses once every thousand years, the so-called 99.9% annual losses. However, the fact that we can get such numbers does not mean the numbers mean anything. The problem is that we cannot backtest at such extreme frequencies. Similar arguments apply to many other calculations such as expected shortfall or tail value-at-risk. Fundamental to the scientific process is verification, in our case backtesting. Neither the 99.9% models, nor most tail value-at-risk models can be backtested and therefore cannot be considered scientific.

We do however see increasing demands from supervisors for exactly the calculation of such numbers as a response to the crisis. Of course the underlying motivation is the worthwhile goal of trying to quantify financial stability and systemic risk. However, exploiting the banks’ internal models for this purpose is not the right way to do it. The internal models were not designed with this in mind and to do this calculation is a drain on the banks’ risk management resources. It is the lazy way out. If we don't understand how the system works, generating numbers may give us comfort. But the numbers do not imply understanding.

Indeed, the current crisis took everybody by surprise in spite of all the sophisticated models, all the stress testing, and all the numbers. I think the primary lesson from the crisis is that the financial institutions that had a good handle on liquidity risk management came out best. It was management and internal processes that mattered – not model quality. Indeed, the problem created by the conduits cannot be solved by models, but the problem could have been prevented by better management and especially better regulations.

With these facts increasingly understood, it is incomprehensible to me why supervisors are increasingly advocating the use of models in assessing the risk of individual institutions and financial stability. If model-driven mispricing enabled the crisis to happen, what makes us believe that the future models will be any better?

Therefore one of the most important lessons from the crisis has been the exposure of the unreliability of models and the importance of management. The view frequently expressed by supervisors that the solution to a problem like the subprime crisis is Basel II is not really true. The reason is that Basel II is based on modelling. What is missing is for the supervisors and the central banks to understand the products being traded in the markets and have an idea of the magnitude, potential for systemic risk, and interactions between institutions and endogenous risk, coupled with a willingness to act when necessary. In this crisis the key problem lies with bank supervision and central banking, as well as the banks themselves.

Desperate Measures: India Closes Soyabean Oil, Potatoes Exchanges to Fight Inflation

India has halted futures trading in certain types of commodities in an effort to combat inflation by reducing speculation. Observers argue this is likely to be ineffective, arguing that the price rise is fundamentally driven.

It is true that just about every major economy ex the US and Japan is suffering from inflation (and most Americans think inflation is worse than the Consumer Price Index indicates). It is also true that new institutional and retail cash continues to move into commodities, which says the concerns about speculation aren't baseless (although soyabean oil, rubber, and potatoes, which are not included in the GSCI or other indices favored by financial investors, are not obvious candidates for new financial entrants. Morevoer foreign funds are not permitted to participate in India's exchanges).

India is hardly alone in trying to dampen frothy-looking markets. The Wall Street Journal reports that a Senate bill to dampen speculation by increasing cash collateral requirements has earned the disapproval of James Newsome, the acting head of the CFTC. Newsome argues that the new rules would simply drive trading to other exchanges. That may well be true, but governmental concern about burgeoning commodities prices is so widespread that a coordinated attack, such as a joint rise in margin requirements, isn't out of the question.

From Bloomberg:

India, the world's second-largest buyer of vegetable oils, banned futures trading in soybean oil, rubber, chick peas and potatoes as the government intensified efforts to cool inflation that's at the highest in more than three years.

Trading has been halted for at least four months from today...

Communist allies of Prime Minister Manmohan Singh want to ban futures trading in cooking oil, sugar and other commodities, saying speculators are driving up prices. Still, the order comes a week after a government-appointed panel found no evidence a 2007 ban on wheat and rice futures curbed prices of the grains....

The government-appointed panel chaired by economist Abhijit Sen last month didn't recommend extending the ban to other food commodities, saying there was no conclusive evidence to suggest futures trading contributed to price increases.

``Prices may start to rise again if supply-side constraints are not eased,'' Si Kannan, associate vice president at Kotak Commodity Services in Mumbai, said by phone. ``The ban is a short-term measure.''

India's inflation accelerated to 7.57 percent in the week ended April 19, the fastest pace in more than three years....

Domestic traders, producers and consuming companies are the main participants in India's commodity exchanges, compared with the 13 million people in the country who invest in stocks. Overseas funds aren't allowed to trade Indian commodity futures.

Blogging, the Cathedral and the Bazaar

Gods, sometimes I am horrifically slow on the uptake.

Felix Salmon continues a discussion with Dean Rotbart that effectively started at the econobloggers' panel at the Milken Institute. Dean was the moderator, and did a very good job in generating a lively session (something I must say that was absent on most of the presentations I saw) by having a go at us. For the most part, he took the traditional journalism view (he is a 23 year veteran of the Wall Street Journal) and implied that bloggers collectively weren't reliable sources of information, since we weren't fact checked (for instance), subject to any review, particularly regarding sources (he went after Paul Kedrosky for posting a rumor, clearly presented as such, on the Microsoft pursuit of Yahoo).

At the time, I didn't pay much note to Dean's persistence (I figured he might like to take a provocative stance as a moderator), but per his continuing conversation with Felix via Felix's blog, he appears to be fundamentally uncomfortable with the nature of blogging, and his reservations are no doubt widely shared in his profession. Felix, of course, will have none of it:

Dean Rotbart is full of bright ideas....:

Let's establish a non-profit, volunteer board of people to recommend standards for financial bloggers...
Second, let's establish a annual awards recognition for econobloggers who bring honor to their craft...

Not me.

I'm going to bash this horse just a little bit further...Blogging is not a craft...It's a medium, a conversation, a babble. Its very variety is its strength.

I emailed Dean yesterday:

Your main argument seems to be that journalists are better at being journalists than bloggers are. And you're right about that. But that's not what blogs are for, and it's not what we claim to do. It's a bit like complaining about your hairdresser who gave you a little scalp massage after washing your hair, on the grounds that you can get a much better scalp massage from a qualified masseur.

The lightbulb went off only today. This debate has very strong parallels to the arguments between traditional software developers and the open source crowd. Admittedly, there are also big differences, because developers are out to address very specific needs with code, while (one hates to say it) the purposes of journalism and blogging are less clear cut. Journalists like to think that their job is to inform, but what does that mean, exactly? Like it or not, a fair bit of entertainment has also crept into the profession. And perhaps most important, the decision of what is and isn't newsworthy is very much swayed by a media outlet's posture, prevailing social/community values, and (the dirty secret) the need to play by the rules of access journalism.

Similarly, developers are a more homegeneous group than bloggers and their readerships, and they come to a development project with a results orientation. Nevertheless, the discomfort, the suspicion, the disbelief with which some mainstream journalists regard bloggers is very much like the continuing (but abating) reservations about open source code.

Looking back at Eric Raymond's classic on the open source movement, "The Cathe