Binge Drinking and the Difficulty of Changing Course

Psychiatrist Paul Steinberg wrote an interesting op-ed article in the New York Times about the permanent effects of binge drinking on the human brain. He discusses the results of experiments with lab rats that indicate that a period of heavy drinking causes difficulties in not learning, but specifically relearning.

When put into a tub of water and forced to continue swimming until they find a platform on which to stand, the sober former binge-drinking rats and the normal control rats (who had never been exposed to alcohol) learned how to find the platform equally well. But when the experimenters abruptly moved the platform, the two groups of rats had remarkably different performances. The rats without previous exposure to alcohol, after some brief circling, were able to find the new location. The former binge-drinking rats, however, were unable to find the new platform; they became confused and kept circling the site of the old platform.

The article is written as a general warning for the forthcoming new year's eve celebrations, but it also contains a choice of words that really beg for an association with a certain individual case.

The binges activate an inflammatory response in rat brains rather than a pure regrowth of normal neuronal cells. Even after longstanding sobriety this inflammatory response translates into a tendency to stay the course, a diminished capacity for relearning and maladaptive decision-making.

Maybe it's not intentional, but I could not avoid making the association to GWB.

The article has some comforting tips for recovering. Exercise has been shown to help recovery in rats. Maybe I should adjust my attitudes to exercise. I could do with some additional relearning capacity.

Nobody Knows?

Here is a hilarious quote from The Economist:

Nobody yet knows whether the extreme borrowing in the credit boom was a sensible result of the powerful new machinery of debt, or the sort of excess still unwinding in Japan.

That certainly is a tough thing to decide, but I do think that a lot of people have at least a pretty strong hunch about it.

Oil Depetion in Mexico

The Economist wrote about the problems that the world is facing with the rapidly depleting Mexican oil fields, especially the giant field Cantarell:

This flawed behemoth is now in “a race against time” to compensate for Cantarell, says Fabio Barbosa, an energy specialist at Mexico's National Autonomous University. It is a race that Pemex seems likely to lose. In a document released in December setting out its strategy for the next five years, the energy ministry forecast that total oil production would decline to 2.5m b/d unless policies were reformed, and would remain roughly constant even if the industry were liberalised.

This is partly the result of two wasted decades in which governments have milked Pemex of cash which it might otherwise have invested. That has begun to change: investment in exploration and production doubled between 2000 and 2006 (though much of the increase came through federal debt guarantees to private contractors). Mexico's president, Felipe Calderón, has pushed through a reform of public finances that will cut the royalty Pemex pays from 79 centavos on every peso of oil it extracts to 71.5 centavos by 2012. The company expects its capital spending to rise in 2008 by 20% in real terms.

This is correct in a certain sense. Additional investments might have kept up the trend of production levels. But think about this: Does it really make much sense to spend enormous amounts of money to accelerate the already high rate of depletion? Does it make sense for Pemex to invest heavily so that it can drain its reserves dry even faster?

Crude oil is a non-renewable resource with a finite supply. At some point there comes a time when it doesn't make any sense to keep increasing up the output, as this would have a negative effect on the return to investment. A higher flow rate from a heavily depleted resource base means a lower flow rate later on, with an ever increasing cost for keeping up the rate up.

Many oil producers are entering a phase where additional investments to uphold rates of extraction just don't make any sense. It will actually make economic sense to leave as much oil as possible to the future, where prices will be significantly higher. The producers will ultimately try to maximize the total value that they can extract from the remaining reserves, and all investments will be directed at increasing the ultimate volume of recovery instead of maximizing the rate of production.

Many economists are feverishly trying to debunk the idea of a global peak of oil production in the near term. They claim that developments in engineering and economic incentives will keep the rates of extraction on an upward slope virtually forever. This is a fallacy of demand driving the supply, which was true in the earlier years of oil production. Nowadays, the roles of supply and demand are rapidly reversing, and there is a whole new situation of increasing competition for a stagnating supply.

The truth is that it makes perfect economic sense for individual producers to let the flow steadily wind down from a peak level, which is determined by economic and geological circumstances. From that point on, the rate of extraction can be increased through political decisions that have nothing to do with economics and everything to do with geopolitics.

Buying Power Disparities and Corporate Profits

The Economist wrote yesterday about the prospects for corporate profits in 2008:

The big question is not whether 2008 profit estimates will have to be revised down; they almost certainly will. It is whether this shift marks a short-term cyclical setback or something more structural as profits retreat from the 40-year-high share of economic output that they notched up in 2006.

The optimists argued that profits could stay high because the balance of power had moved in favour of capital and away from labour, thanks to the globalisation of the workforce. But perhaps profits had been boosted by accommodating monetary policy, a credit boom and the associated surge in asset prices. In other words, financial services may have dragged the rest of corporate America up. If the credit crunch has a long-lasting effect, the banks may end up dragging corporate America back down again.

This imbalance of earnings between capital and labor is going to be corrected eventually. Since the 1970's, the proportion of income that is earned by the labor force has been declining. Corporate profits are taking an ever higher chunk of the GDP in most developed countries.

The sound idea of Henry Ford, that workers should be able to afford the things they are producing has been completely neglected. The fundamental unsustainability of this disparity has been masked by ever growing levels of consumer debt.

Now we are seeing the results of this unsustainable development. The average American consumer is now at the end of his ability to go any further into debt. American levels of consumption have not been truly affordable in years, which has been reflected in the huge current account deficit. Now the American current account deficit is starting to morph into a significant capital account deficit. The capital account deficit for the third quarter (published Dec 17) is probably going to be huge, in the tens of billions of dollars, due to the loss of credit since August.

A reduction of western over-consumption is probably unavoidable. It might even be considered a welcome development for ecological sustainability, but the level of compensation for workers in the developing world has to pick up quickly so that they can absorb a significant part of the existing production without too much panicky destruction of productive capacity that would be caused by a rapid deflationary wipe-out of fictitious capital.

There are two possibilities. Either the proportion of global GDP that is earned by the workforce is increased through wage negotiations, or there will be a significant deflationary trend that will take care of it.

Buying power disparities will be corrected through either wage adjustments or price adjustments, or a combination of both. Protracted abuse of under-paid workforce will eventually result in a loss of wellbeing for all of us.

Hedge Funds and Low-Frequency Volatility

The Economist writes in an article titled "Crunch Time":

Perhaps this will be the pattern for markets for some time: a breathtaking switchback ride as risk-seeking investors try to take advantage of short-term trends (and by their actions, make those trends more vicious). But that does raise the question of why volatility was so low in the period 2004-2006. After all, plenty of hedge funds were in existence during that period.

Volatility was not low in 2004-2006. It was extreme. Prices were rising everywhere, especially in the housing sector. This is a form of volatility, also known as a crack up boom. Prices going up fast, later coming down just as fast or even quicker. What is that if not volatility?

This kind of volatility just happens to have a bit lower frequency. But it's the amplitude that really matters.

Hedge funds where going fast in 2004-2006. They were just all running in the same direction. Now they are acting like headless chickens until the herd finds a direction again, but they have to keep running even faster in order to make up their existing losses.

The usual hedge fund payment structures are a very strong incentive to using Martingale strategies, due to the "high water marks" in their payment structures. The managers' fees are stopped until all losses are recovered, even from unreasonably high speculative peaks.

This is of course completely reasonable. The managers have already been paid for the peak. Paying for it again would actually encourage volatility. Many hedge fund managers have instead decided to just call it quits instead of trying in vain to reach former highs, leaving the managers paid at the top and the investors paid at the bottom.

The economy reflects exactly the kind of behavior that these payment structures encourage. A long hard push to the top. What comes after that, doesn't matter. The managers have already been paid. If investors want fund managers to think about their interests, they should make the managers share the losses as well as the profits.

Providers of leverage should be extremely careful at this situation. Hedge funds will not stop after losing investor equity. They will eat right into margin debt if they are let to.

Pretty soon they will all settle into a direction opposite to that in 2004-2006. They will plow the market deep underground until they change direction again in a similarly disorderly way.