Some infinities are bigger than others

I just watched Fault in our Stars and of course started searching for the title of this post on Google. First a beautiful quote from this movie (Spoiler alert, if you haven't watched the movie).

In Hazel’s voice, Green writes,

“There are infinite numbers between 0 and 1. There’s .1 and .12 and .112 and an infinite collection of others. Of course, there is a bigger infinite set of numbers between 0 and 2, or between 0 and a million. Some infinities are bigger than other infinities.… I cannot tell you how grateful I am for our little infinity. You gave me forever within the numbered days, and I’m grateful.”

This quote actually touches me personally.....We'll leave that philosophy :)

But guess what, mathematically she is wrong. Yes Cantor proved that some infinities are bigger than other's but it was not the infinities between 0 and 1 or 0 and 2 or 0 and a million (infinities between all three of these are actually equal).

It was for example, infinities between counting numbers compared with real numbers that are unequal. Check the following link on science360.com. It has an awesome description. You may want to watch the video below first before reading the link on science360.com.

Cantor's Infinity Proof on science360.com

Someone might question why I am gathering what's already available on internet on my own blog? Well, because I don't want to forget this. Anytime, I browse my own blog, it's going to remind me of Cantor's infinity proof which I intend to teach my kid as soon as he is ready to understand (my elder one is still only 5).

Scottish Referendum

I wish I was good enough to write about it but here is Paul Krugman's article on Scottish Referendum. This is one of the many reasons why he is my favorite living Economists.

http://www.nytimes.com/2014/09/08/opinion/paul-krugman-scots-what-the-heck.html?_r=1

Difference in Economic Growth and Wages

I have been spending a lot of time on quora lately and I really like the website. If you are following the topics of your interest, you get to learn a great deal by reading some very intelligent questions and diverse set of pretty intelligent answers. Here is one question that someone asked today and I thought I'll share it here, so it is not lost in grand scheme of "quora".

http://www.quora.com/Why-do-corporate-profits-grow-at-an-average-rate-of-7-10-percent-while-the-economy-grows-at-only-2-3-percent

And here is my personal activity mostly related to questions on Economics.

http://www.quora.com/Muhammad-Imad-Quershi

How to Automate Dialing in Webex Conference

I know this is an Economics blog but I think this is something that many people would find useful. When dialing into webex, we go through a tedious process of entering conference id and access id which in many cases is same for your weekly meetings. It is even more frustrating when you have to dial into your own meeting number which you conduct several times in a week. So this is a small way to automate your calling which I learned from my boss recently and I thought of sharing this.

Assume following conference call settings for your own webex.

Dial in number: 1-888-123-4567

Host Access ID: 987654

Attendee ID: 543210

PIN: 1234

Now to automate dialing into this Webex and avoid manually entering these numbers each time, do this.

On your notepad or calendar on iPhone or Android, enter following (assuming above numbers) if this is your own conference (on iPhone today you cannot enter commas thats why you need an editor for this and copy paste. May be you can enter commas in Android phone keypad. In that case just do it directly):

18881234567,,987654#,,1234#

Copy and paste it on your phone keypad and create a contact. Dial in. You should be able to dial into conference automatically.

If you are an attendee into this conference, then process for you would be:

18881234567,,543210#,,#

Again, paste it on your keypad and then just create a contact and dial in.

If you are still wondering, those commas are required to add a pause.

Gold Prices

Gold market recently saw a "crash" last week. Not since 1980 had we witnessed a one day fall like this. But was this a surprise? I bought some gold coins between 2005 and 2007 between $598 to $750 from bulliondirect.com (I regretted buying it for $750 but I was new - it was a lesson). Then since the great recession when Fed started pumping money in to the market and investors still afraid to invest anywhere, prices in gold went up due to high demand. This high demand was due to high expectation of inflation due to fed's actions, aversion to hold cash and aversion to invest in stock or bond market (consider current yields in the bond market). So gold went up. But at the end of the day, it is just a commodity. Its price is determined by supply and demand. In 2011 I sold my gold around $1550 per coin.

The reason I sold my gold was because all signs pointed towards gold being over priced. It was clear that Feds actions and high risk equity market was driving prices up. But some day that was going to end. Nobody knows when that will happen. I don't either. If I had known then I would have preferred to keep my gold and sell them when it reached its peak over $2000. But there was one thing I knew for sure. That gold is over priced and it had to come down to its real price. What is that real price? I wish I know. But Fed is still pumping money - to the tune of $85B per month. Interest rates are still low. When that changes, QE3 ends and interest rates go up, investors will take out money from gold and buy securities that offer higher interest or perhaps invest in stocks assuming Feds assistance will accompany a better market (for a given risk you'll have better returns than now). This means investors will sell their gold, thereby increasing the supply of gold and reducing its price. A strong dollar will also mean that gold which is traded in dollars should be adjusted for new price of dollar. How much will that price be. I don't know. We'll sit and watch. But I am not touching gold until Feds fund rate is at a level where Fed says we don't plan to increase the rate anymore (I think its going to be around 3.5 to 4%).

Search cost and price taker market

A while back, I was having an argument with a friend over how Walmart sells products cheaper than its competitors. Someone had told him that the quality of Tide that you buy from Kroger is better than what you'd buy from Walmart. I tried to convince him unsuccessfully, that something like this is impossible since companies like Consumer Reports thrive on this kind of news. If this was true, then somebody would have tested the difference in quality and reported it long ago. Besides, a company size of Walmart cannot tolerate that one of its supplier would give it an inferior product, because it will literally bring down the whole business. Imagine if you find out that the Tide you are getting from Walmart is lower quality. Are you going to buy Tropicana from Walmart anymore? How about M&M's? Doritos? Gillete shaving foam? Over the counter medicine? At the end of the day, it's not only Tide that's cheaper at Walmart but pretty much everything. Although, I have seen lately that Meijers and Target are catching up (competition always catches up) and for most of the similar items you can get prices similar to what you would pay at Walmart.

That being said how is it that Walmart is able to get lower costs from its suppliers. If you are running a small grocery store in your neighborhood (aka mom and pop store) then your cost of Tide or other products sold at Walmart is probably close to Walmart's prices. A simple answer that everyone knows is that this happens because of huge buying power that comes from buying in bulk quantitites. When Walmart buys products from its suppliers, it reduces bulk of their shipping and handling  costs, thereby reducing the cost of product for Walmart. But what else happens? There is something called search cost which is the cost of finding a buyer. I'll try to explain here what search cost is and how it affects the price you pay at the counter.

Imagine you are a farmer who grows corn. Now you have a harvest season and you started harvesting corn. You have ten thousand bushels of corn to sell (in real world its a lot more). Also assume that there are no commodity markets. Now you started selling your corn right outside your farm. You have distributed flyers in your neighborhood and people you know and posted flyers around the city that you are selling corn at $5 a bushel. Some customer came and bought two bushels. Another bought five and another one and so on. You estimate that at this speed you will sell your corn in 4 months. During this four month you will accrue  storage cost and your money will be tied up in that corn on which you can start earning interest (assuming you invest your savings) if you can get that cash today. Let's assume that a buyer stops by at your farm one day and offers to buy all remaining 8000 bushels of corn. But he says he is not going to pay you $5. Instead he will offer $3 per bushel and starting next year he will buy all your harvest.So you don't have to spend your money searching for a buyer. This reduces your search cost significantly. It will get you your money early, some of which you can use to buy bonds and earn interest. Commodity markets play the role of this person. A farmer does not decide the price of corn. He just takes his corn to the market and he has to take whatever the price is offered at the market, or he can just take his corn back. These markets are called price taker markets. These markets reduce his search cost significantly, however the price he is offered is not the same anymore.

This is exactly what happens when P&G sells its Tide to Walmart. Walmart has reduced P&G's cost of selling Tide. It has reduced the cost associated with finding a buyer. Yes P&G still has to market the product and run ad's on TV. But it has to do that even when Kroger or other mom and pop stores are selling it. But Walmart has reduced the cost of distribuing the product. Through Walmart, P&G can reach millions of customers. In the absence of Walmart, P&G will have to spend a significant amount of money to be able to reach all these customers and that will be reflected in the price you pay at the counter. So why can't P&G sell Tide to Kroger at the same price as Walmart? Well, first of all Kroger does not reduce the search cost for P&G as Walmart. And we don't know if Kroger is getting the same deal as Walmart. May be it is getting the same deal as Walmart but it may have other overheads that are higher than Walmart which increases the cost for you when you buy products from Kroger. May be you get better service at Kroger than Walmart which is reflected in higher prices than Walmart.

Search cost is one of the main reasons why we are able to buy cheap products at Walmart. Internet has redcued our search cost. Imagine what you'd have to do if there was no craigslist, no product reviews, no ebay and no amazon and of course no Google. By reducing our search cost, Internet has reduced the over all cost of the products for us. We can compare prices and reviews for products and services by just typing few words on Google. Imagine what you'd have to do for similar information if there was no Internet.

I don't need to give more examples but search cost is significant and it has a huge affect on the prices we pay. If a particular retailer can figure out a way to reduce search cost then it doesn't mean that the product he is selling with same labels is inferior.

How Technology Affects Business

Someone recently asked me this question. While the question seems relatively easy to answer, I was amazed by the vastness of the things that I could think of. And then I realized that based on personal experiences, the answer can vary considerably. Here I will list the technologies that I could think of, have changed the way we do business, technologies that have fostered new companies and drove some businesses out of the market place. I will also discuss two of my favorite companies glassdoor and linkedin which are changing the dynamics of skilled labor market.

While it is always difficult to notice a change as it occurs gradually but an easier way to understand what has changed in our lives due to technology, just imagine how we did business ten years ago and how we do it today. Think about the percentage of online purchases you have done in last year and try to compare that with what you did back in 2002. Some great companies like Circuit city have gone bankrupt because they were not able to adapt to the changing market place. Best buy is in no better shape and I personally would not be surprised at all if Best Buy declares bankruptcy in next couple of years or even sooner. It is already closing several stores across US as part of restructuring its business. That being said, I think a failed business like Circuit City and Best buy has to do with more than just new technology. While Amazon definitely has grabbed a big chunk of Best buy customers, but there is more to the story than just online competition. Otherwise, how do you explain the continuous growth of Bed, Bath and Beyond? It has at least just as much competition as Best Buy. In my opinion the answer lies in customer service. I do not have any market surveys but in 2003 I decided I would never go back to Best Buy and I have not. Similarly sites like craigslist have faciliated a used goods market and reduced search costs to virtually zero, thereby eliminating some buyers who would have otherwise bought new products from brick and mortar stores. This not only has affected the retailers but also the manufacturers. Combine all this with review websites like Yelp and Google reviews who have significantly reduced information asymmetry, you have a consumer who is more informed and could make better decisions about the products or services he or she is in the market for. So, in case of Best Buy, what technology has done is that it has provided consumers an alternate reseller of the same products at not only a cheaper price but also good and reliable service. They not only pay lower prices for same products but also do not have to deal with an associate who is more interested in selling warranties and extra services that the buyer believes he does not want especially after reading reviews on websites like yelp. If it was only for technology and online competition that Best Buy was going down, then I would ask a simple question and that is "Explain Bed, Bath and Beyond to me?".

Now look at another aspect of how technology has affected the businesses. How we were getting our news ten or fifteen years ago and how do we get it today? This has literally drove some newspapers out of business. However, Wall St Journal while going through a difficult period has adjusted and its future still looks bright. Here we can give Wall St Journal the benefit of being a leading player in a niche market but I don't think excuses given by Chicago Tribune or similar companies have much weight. Tribune said that it needed to go into bankruptcy protection so it can adapt its marketing to the new technology. The question is, what took it so long? Why didn't they do it when they could have done it without going into bankruptcy protection. In the beginning of this paragraph I said, think about how we were getting our news ten or fifteen years ago and how we are getting it today. I didn't said think how we were getting our news last year because this change like all other changes has been gradual over a number of years. It is not an over night change. So, technology definitely drove newspapers out of business including some really big names but it was because of poor management and their failure to adjust when they could have rather than technology alone. Management of these news companies had an option to change and adapt to new technologies and they decided to do nothing.

Next I would like to talk about mobile computing. How smartphones have changed everything we do today. While Blackberry has been around for a longtime (it probably won't be for too long), love or hate, it was actually Apple that revolutnized the smartphone industry. Today we have two dominant players, Apple and Google, who have the biggest share of smartphone market. Thousands or probably millions of apps are downloaded everyday around the world. While developers have financially benefited from the smartphone revolution, smartphones, since still in growing phase are revolutionizing the way we do traditional business. Many people today deposit checks using their smartphones, they buy and sell shares and use their phones as GPS. There are several free apps which provide voice activated navigation including new social media GPS app called Waze. Going into the details of how waze works is out of the scope of this discussion but would you be surprised if Garmin or other GPS companies run into financial difficulties. What about paid apps like the one provided by your cellular service provider? Should your service provider make these apps free and make money in the same way as other apps are making? Well may be or may be not, because these big companies have higher cost and it may not worth it for them to get into advertising business using apps. But one thing is for sure, sooner than later, people will not be paying $10 monthly fee for their GPS app so they can either drop it altogether or try to market their service having a free mapping application. Verizon already does that. AT&T does not. Discussion about mobile technology would be incomplete if we don't talk about location based services. Today, many small businesses have grown because they show up on result when you are searching for certain type of business around you. Not only that they show up, their star ratings based on their reviews also shows up next to their names and if product or services are rated high by consumers then this further helps increase sales for the business. What this does is that it makes good businesses more profitable and bad businesses will eventually be driven out of business. Great thing for us consumers.

Another business affected due to new technology is TV and Video. Blockbuster, your neighborhood video store is history and Netflix, the company responsible to drive blockbuster into bankruptcy, itself is having a difficult time to grow its business. You can watch your favorite TV shows on hulu, while many people also spend a lot of time on youtube. You just have twenty four hours in a day. If you want to watch newly released movies, you can go to your nearest Walgreen's or a grocery store and get it from Redbox. Cable operators are another segment of business affected by this change but due to their monopoly and high barriers to entry into this business, they are still doing fine. However, I wouldn't be surprised if Comcast or some other cable provider is having problems in retaining customers due to internet and the rumored Apple TV.

If you work in technology and even if you don't, chances are you have heard the term cloud (computing). Many companies including Google, Amazon and Microsft are offering cloud services. It basically allows customers to let cloud providers host services including web services if they so desire. Cloud computing has enabled small businesses who cannot afford a technology infrastructure of their own to benefit from technology. For example, health care sector which has traditionally lagged in benefiting from technology can now use cloud services and improve its customer service and reduce cost by having online records, referrals, appointments, prescriptions and much more. And they can do all this without having any technology infrastruture and very few to no technical staff of their own. While still growing, it is well known that this is a very lucrative market which has tremendous potential for growth. In case you haven't already noticed, soon you'll start noticing changes in how your physicians and hospitals will be handling your prescriptions, appointments, referrals and other data inclduing billing. In case you don't know, Netflix runs on Amazon's EC2 cloud.

Finally I'll talk about my favorite topic and it is labor market. How is technology affecting labor market for skilled labor? We talked about how product reviews on websites like Yelp are affecting consumer's buying habits. Similarly company reviews on glassdoor are affecting labor market, though its affect may not be as visible today as it might be ten years from now. With company reviews on glassdoor, skilled labor has much more information about prospective employer. If companies have not already started noticing this, they'll soon realize how their employer brand is being affected by sites like glassdoor. We'll see exactly the same effects in labor market as what we are seeing in consumer market. Employers with good reviews and good reputation will be able to attract best talent and those with not so good reputation will get not so good talent. This in the long run will affect their products and services and ultimately their returns. Would you hire a consulting company if it has significantly higher number of unhappy employees? I can't speak for everyone but if I am submitting a resume for a position I am interested in, the first thing I do is look for its glassdoor reviews. And if a company is rated 2 star by its employees then I just tell myself that I can do better than this. Linkedin on the other hand has changed the way people search for jobs and recruiters search for talent. Connections on linkedin have facilitated networking enabling job market candidates to connect with recruiters who specialize in the area they are looking for a new job.

This is an amazing long list and no doubt quite incomplete. In conclusion I would only say that businesses that failed due to technology did so because of poor management. We are moving towards an economy where effecient and good businesses thrive and poorly managed businesses are driven out. Customer service has become more and more important and unless you have a monopoly and high barriers to entry for new competition, you want to make sure that your customers remain happy or word will get out much sooner than you think and it might be either too late or it may cost you a fortune to fix the issue and correct the image. Consumers are biggest winners of all this change and overall society has benefited from technological advances.

Microsoft's new tablet: Surface

Microsoft announced its new tablet computer on Monday, June 18th 2012. Tablet will be available in two different versions, basic and pro with one running an ARM processor and the other running an intel based processor.

I think it is safe to say that the purpose of this product is to offer competition to Apple's IPad or in general enter the fast growing tablet market. One of the things I studied in my Marketing class during my MBA was that, while good Marketing is important to launch a new product and help its adaption, but for long term success of a product, it should also be backed by a good product.

You can see the spec differences between iPad and Microsoft surface here. In this post, I'll just discuss the possibility of success of this product. But let me first share a small story.

In "The Art of Strategy", one of the authors Barry Nalebuff, describes a story from one of his Cambridge University's May Balls that he attended. There was a casino in the ball and each participant was given £20 worth of chips. The participant with most chips by the end of the night will be given tickets to the next year's ball. Barry led the ball with £700 and the next closest person had £300. The game was roulette. The lady running second bet all her money on a multiple of three. The chance of winning is 12/37 as the wheel is numbered from 0 to 36. If she wins, she'll triples her money to £900. Barry should have simply copied her bet and placed £300 on the same number. If she wins, then Barry also wins and will be ahead of her by £400. If she loses, Barry still wins by £400. Already knowing her bet, all Barry has to do is copy her bet. Barry does otherwise, she hits her number and wins the tickets to next years ball.


Although the situation that Microsoft faces here is different including the fact that Microsoft is the new entrant and no leader but one thing Microsoft could have done here was to copy Apple's marketing strategy. I think it miserably failed. The product they announced using Apple's marketing strategy of secrecy will not be available until October. What's the point of secret event again? We don't know what the price will be (I am talking about a number). Resolution is not even the same as the existing iPad, forget about the next year's version. Something we cannot blame Microsoft, albeit important is the number of apps and a developer's network like Apple. Combine all these things and I think, Microsoft Surface at best will provide reasonable alternative to competing Android tablets and at worst can face the same fate as Zune (although there will be fewer chances of that).

Facebook's recent IPO

I wrote about why I wouldn't buy facebook stock if it values the company at $100B. Friday's IPO did exactly the same and I stayed on the sideline. Shares of facebook traded between the offering price of $38 to $45 before settling down to $38 at the market close.

Today the shares closed 10 percent below Friday's closing price. The biggest question that comes to my mind right now is how much did the underwriters lost? I am guessing some people might lose their jobs. Additional 25% shares were offered just couple of days before the IPO and offering price increased from $36 to $38 (of course Morgan Stanley enjoyed additional fee). On the flip side, facebook investors and employees who dumped their shares in this IPO were the smartest ones and should have every reason to rejoice.

Future of Cable TV providers

Someone recently asked a good question.

• What’s the future of entertainment for a cable provider like Comcast?

Although Comcast also provides Internet and voice services, but for now I'll only focus on it content distribution service, aka cable TV. To analyze the future of Cable TV be it Comcast or AT&T, let's see the threats this business face. From a high level, I think there are following threats to Cable TV which all arise from internet (technology)

• Websites like hulu.com
• Netflix
• Rumored Apple TV
• Content creators who now also distribute content on internet, through their own websites
• youtube

Let's look at these threats in order. I am going to refer to the concept of long tail. If you are not familiar with it, then please read it here.

Hulu, founded in 2007, has support from NBCUniversal, News Corporation, The Walt Disney Company as they are its part owner. It has partnership with 350 content providers. Its user base is constantly expanding. Many providers who don't provide their shows on hulu, still have links available on hulu that will take you to their website where you can watch the show. One such example is "Unforgettable" from CBS. In this particular case we see that content provider is also distributing it through its own website, falling into our category 4 above.

Netflix which started as a movie subscription service in 1997, now offers online streaming of its movie service. It has also started streaming TV shows just like hulu. Although TV content currently provided by either hulu or Netflix nowhere nears what viwers get through Cable TV, but these providers are constantly increasing the content they provide, so although some years but it seems like it is now a matter of time when virtually everything provided by Cable TV would be available on hulu and Netflix combined.

Third on my list is the rumored Apple TV. This is definitely the one that Cable TV industry should be most frightened of. Apple changed the music industry forever with its famous iPod combined with iTunes library. If and when Apple comes with its TV which some people are already calling iScreen, chances are it will be a game changer for TV industry in General and Cable TV industry in particular. Imagine an equivalent of iTunes for TV.

Fourth on my list are the content providers who have also started to distribute their contents from their own websites. For example if I want to watch my favorite john stewart's daily show, I don't have to stay up late and watch it on TV anymore. I can watch it at my own convenience either on hulu or on dailyshow.com. Now, I don't exactly know the deal between hulu and comedy central for revenue sharing but I am assuming Comedy Central makes more money when I watch the show on their website, giving them an incentive that viewers watch their show on their own website rather than hulu. Then we have, other providers like CBS who stream several of their shows online on their own website.

Lastly, I mentioned youtube. Now this may not sound like a real competitor to Cable TV but youtube recently has made some pretty good changes with its advertising model. It has also started a movie streaming service which is rather expensive. I wouldn't be surprised if Google partners with content providers to provide shows and movies on youtube just like hulu.

For those who are familiar with the concept of Long Tail know that most people don't need what is provided by Cable providers. Every person has its own niche and hulu, youtube, Netflix and websites of particular TV shows, ESPN.com and its live streaming and similar services can now fill those several niches, leaving very little market for Cable TV providers. Only 6 years ago, Cable TV providers had mostly other providers as their competitors. That is not the case anymore. In fact competition from other providers is not as cut throat as it is from several of these players serving these niche areas. I mean how do you beat free?

One of the things that Comcast and other cable TV providers like AT&T are already doing is bundling their services. These providers provide internet, so they are using their advantage as Internet service provider to bundle these other services. But, how long can they sustain it? There are providers like dish network who don't bundle these services so a customer can only get TV from them and go to a different provider for internet.

This is a never ending discussion but at the end I think the real threat to cable TV business comes from specialty providers who are all serving their own niche. Comcast is adapting well by providing on demand features to its Cable customers. To keep up with this emerging competition, it will need to match services while not increasing prices at the same time. This can affect its bottom line and to maintain profits, it needs to find ways to either cut costs or find new areas to generate revenue. Looking at last 10 years of Comcast, it seems like the company has not grown at all and in my opinion it is the pressure from competition we discussed above that is eating its potential profits.

I think future for Comcast is not all that rosy. It will face challenges in growing and worse retaining its customer base. It should continue to increase its partnership with content providers to increase services to tablets and mobile devices. This would be similar to WatchESPN. But if rumored Apple TV is true then partnering with Apple, if Apple looks for a partner, can be a jackpot because the other option will increasingly look like RIMM or Nokia.

Novica.com

I was searching for a poncho for my wife when I found this website. Novica works with artisans around the world in developing countries to bring their products directly to the consumers. There is a network of people employed in each country Novica works, which helps connect and find these skilled individuals which adds to the cost of the products. But when you look at most products on this website, you'd see that the items are very unique and difficult to find else where and are very reasonably priced when you consider the fact how much work is done into bringing these products to the market. They'll look even cheaper when you compare them with what you'd pay at Nordstrom or Von Maur. Yes, that's the kind of quality products you get at Novica.

The site also works with people in developed countries to help the artists and artisans get loans at zero percent which can help these people grow their business. If you already don't know about it, I highly recommend you check their website.

What Amazon can do with Wish List

I think wish list is one of amazon's great feature. Most of the time, people use this feature to add items they intend to buy. While this helps increase sales, amazon has not done much to use this list.

Pricing is one of my favorite subjects and I think a lot about prices. In case of amazon's wish list, I think amazon should add an attribute in a user's wish list that says notify me when the item is price x or lower. And then amazon can analyze the list of all users for each item and find the price point where it can make the best profit. Then if it makes good business sense, then lower the price on that item for 24 to 48 hours and send an email to users notifying them of the new price on the product in their wish list for a limited period of time.

Calculation of the price point may be more complex. People will likely report lower prices than they are willing to pay so amazon might want to notify people when the price is x percent higher than they said they would buy an item for. But the idea remains the same. Amazon can use the wish list to increase its profits and its currently not doing so.

How China Undervalues its currency

Congress in last couple of years has stressed more and more to pressure China to ease restrictions on its currency. In my post about currency exchange, I explained how the value of currency affects exports and imports of a country. Based on that discussion, we know that when a currency is devalued, its exports increase. So when China undervalues its currency, it helps keeps Chinese products cheap and helps its exports.

In my post about currency exchange I explained how foreign exchange market determines the price of a currency. So how is it that the price of Chinese Yuan is not determined by the foreign exchange market. The answer is because Chinese government through People's bank of China controls how much Yuan is going to flow into the market, effectively controlling the price of Yuan.

Let's see this through an example. Assume there is a factory in China that supplies some product X which is sold to the US. Now the US buyer will make its payments in USD to this factory for the product X. But this factory needs Yuan to pay its employees, to buy raw material (if its not imported), pay for factory bills, taxes and other similar expenses. So the factory will go to People's bank of China and exchange its USD for Yuan. This is where Chinese government control comes in and it decides the price of Yuan. This USD, and similar hundreds of millions (billions per year) end up in Chinese reserves  and significant portion of this USD is used to buys US government bonds, making Chinese government the biggest, US lender.

Now that we know how Chinese government controls the price of Yuan, how does it affect (hurt/benefits) US. First of all, for no change in  income of American consumer they can buy more Chinese goods because they are getting more Yuan than they would in a freely traded Yuan in a foreign exchange market. So American consumer is better off. Then why does Congress and White house has an  issue? Because Congress or White house are not there to help american people. They are there to help those who fund their campaigns. While American people are better off when Chinese government undervalues its Yuan, the American business which is competing against a Chinese business is worse off. So these businesses combine together lobby the government and push for pressure on Chinese government to reevaluate its currency against dollar. This will hurt American consumer because Chinese goods will increase in price but will help American businesses as it would be easier for them to compete now.

This in a nut shell is how Chinese government undervalues its currency and how it affects its trading partners, the biggest of which is US. If you ask me, I'd say let them undervalue their currency as it helps me get cheap products from China.

What Happens to Petrodollars?

In my previous post I explained how currency exchange works. One of the related comment that is often made is that US would suffer an economic disaster if oil exporting countries start demanding payments in Euro. Some say that was the reason for attack on Iraq. In this post, I'll prove why such an action will not affect US economy. Although, a simple question is, given that most oil exporting countries are US enemies, then why they haven't already done so. Until 2008, even Iran which does not have any diplomatic relations with US was selling its oil in USD. Iran now receives its crude oil payments in Euro and has established an Iranian oil bourse where only products that are derived from oil are traded. At this point no trading is done for crude oil in Iranian bourse so all crude is still traded in dollars.

In my previous post on currency exchange I explained how USD at the end of the day is only used in US. Let's look at what happens to the money that Saudi Arabia receives for selling its oil in Dollar. So what do you think Saudi Arabia does with that money? I think most of you would answer that most of it is deposited in banks or invested. But where would that money be invested? Saudi government can buy US treasury bonds with that money if it wants to invest in US. Another option to invest in US would be to invest in US companies by either direct investment or buying stocks. Either way, the money comes to US and its demand or supply is determined by current market conditions. Another option for Saudi Arabia would be to invest it in some other country. In this case lets assume its some country in Europe. Now Saudi Arabia needs Euro for its investment purpose. In this case Saudi Arabia would first trade its dollars for Euro in foreign exchange market where the exchange rate will be determined by market forces as explained in my previous post. Then, it will use the Euro to invest in Europe. Similar scenario will occur for investment in Japan, Korea, Switzerland or any other country. USD will be traded in foreign exchange market for the currency of the country where money is to be invested. Now some people will say that, we think saudis or other oil producers just keep the money and they don't invest. that bring me to my next point which is why all these oil exporting countries which are US enemies, have been trading oil in USD till today.

Why Iran was trading oil in USD up until 2008? Why Iraq up until 2002 was receiving its oil money in dollars. Why didn't Iraq right after the end of first Gulf war in 1991, started demanding its payments in a different currency, let's say German Mark or Swiss Franc? And if Iran and Iraq were/are afraid of US response then why to this day Russia receives its payments for oil in US dollars? Is it also afraid of US sanctions? I am guessing you'd say no, Russia is not afraid of  US. And truth is that answer is much simple. It's just about good business. As much as Iraq or Iran or Libya (during Gaddafi's rule) hate US, they know what is good for business. If they don't get their payments in USD then what is the alternate? Swiss Franc? Where are they going to invest this money? Switzerland albeit a very well managed country, is not an Economy which can absorb the cash that comes from selling oil. Japan which is a distant third (it used to be second largest economy) is not as big as US and its Economy doesn't need most of the money that comes from selling which means, oil producing countries don't need their money in Yen.

So, oil is traded in USD not because US has some monopoly but because of the size of the US economy, it is just good business to trade oil in USD. Due to the economic sanctions against Iran, it can afford to do business in Euro or Yen but for Russia or Saudi Arabia or even Venezuela it is just not good business. At the end of the day, they need to invest or spend the money earned from oil. Last but not least, US economy is still the largest and strongest Economy. And as for the risks associated with economies, we know what happened to Japanese Economy in 90's and what is euro going through currently. By the way, Euro's demise was already predicted by many Economists years ago. This is what Paul Krugman said in 1998

"Here’s how the story has been told: a year or two or three after the introduction of the Euro, a recession develops in part – but only part – of Europe. This creates a conflict of interest between countries with weak economies and populist governments – read Italy, or Spain, or anyway someone from Europe’s slovenly south – and those with strong economies and a steely-eyed commitment to disciplined economic policy – read Germany. The weak economies want low interest rates, and wouldn’t mind a bit of inflation; but Germany is dead set on maintaining price stability at all cost. Nor can Europe deal with “asymmetric shocks” the way the United States does, by transferring workers from depressed areas to prosperous ones: Europeans are reluctant to move even within their countries, let alone across the many language barriers. The result is a ferocious political argument, and perhaps a financial crisis, as markets start to discount the bonds of weaker European governments."

One currency that I did not touch is Chinese Yuan. Simple reason for that is, that China is the biggest US lender. China itself would be the last country who would want oil to be traded in Yuan. I'll write about Chinese Yuan and what US means when it says that China undervalues its currency and that it hurts US exports (It's actually a good thing for US that China undervalues its currency because it helps US consumer. However it hurts those whose owns businesses that compete with Chinese exports to US).

How Currency Exchange Works

This is one of my favorite topics. Many people have misconceptions about how currency exchange works. So here I'll try to explain how it works and try to make it easy to understand. Later in a second post to follow this one, I'll try to explain about what US government means when they say China is deliberately undervaluing its currency. What are the advantages to China and how it hurts US or other trading partners. However this is a very complicated subject, so some basic understanding of Economics principles is required. I will use "Economics: A Survey" as a reference and some real data that I will use is from this book. If I use an example or text from this book, it will be italicized.

To make currency exchange simple, I'll use an example of currency exchange between two countries. Let's say US and Japan. The reason I chose Japan is because both US and Japan are strong economies and both have a lower inflation rate. It will make things simple to understand. Although in recent years Japan has experienced a deflationary cycle but I think its still a good example. Inflation rates for different countries. Let's jump in.

Money is just a commodity like all other commodities that are traded. So the price of one currency in terms of another currency in foreign exchange market is determined by its supply and demand. There are three major components of supply of USD in foreign exchange market.

1. Individuals and companies seeking to buy foreign merchandise (US imports).
2. US citizens and institutions buying foreign financial assets, for example US investment banks buying German bunds or US companies setting up factories or acquiring companies in a foreign country.
3. Foreign owners of US based factors of production seeking to convert their dollar factor into foreign currency.


Similarly demand for dollar has three major components

1. Individual and companies based in foreign countries seeking to buy US merchandise (US exports).
2. Citizens of foreign countries and foreign institutions buying US assets, for example US treasury bonds or foreigners investment in US companies (either through stock market or foreign direct investment)
3. US owners of foreign based factors of production seeking to convert their foreign currency into USD. For example if Apple decides to bring its $85B cash to US it would need to convert money held in foreign currency into USD.

Basically the above mentioned factors decide the price of USD in foreign exchange market. Let's first analyze the affect of inflation on the value of currency in foreign exchange market. Assume two country economy with Japan and US. At 2% inflation rate in the US, all US goods will increase by two percent. So a $100 item would cost $102. Japanese demand for US goods will decrease due to higher prices ($2 more). This means Japanese demand for USD will decrease. Similarly assuming no price changes (inflation) in Japan it will now be cheaper for US citizens to buy Japanese goods. This happens because prior to inflation when US citizens were buying US goods they were giving up $100 worth of Japanese goods. But now they will be giving up $102 worth of Japanese goods (remember no inflation/price changes in Japan). So it makes Japanese goods cheaper. As US citizens seek to buy more Japanese goods, this will increase the supply of USD in foreign exchange market. This will depreciate the value of USD in foreign exchange market. Following tables shows how important the effect of inflation is in the foreign exchange market [source: Economics: A Survey]. Inflation alone accounts for most of the changes in the value of the currency.

Now, let's look at the affect of government borrowing on currency value. Let's say that US government decided to cut taxes but not its budget. Now it has to finance this budget by borrowing more. This will increase interest rates. Higher interest rates will attract foreign investors to invest in US. US citizens who were going to invest in foreign countries are now going to invest in US as they are also attracted by higher return. As foreigners try to invest in US, they will increase the demand for USD and US citizens investing more in US rather than a foreign country will reduce the supply of dollars. Both of these actions will result in dollar getting appreciated in foreign exchange market.

Now here is the fun part. An appreciation in USD means that relative price of US goods has increased for foreigners. Let's say if a Japanese was paying 100 Yen to buy a $1 in US goods, then he might now have to pay 105 Yens to buy $1 in US goods. This will result in a decrease in US exports. Also for US buyers imports will become cheaper.

What this means is that, starting with a balanced budget and trade balance, when government decides to increase borrowing to fund its budget deficit, it increases interest rates, which result in inflow of capital into the country, reduces the outflow of capital, but at the same time increases imports and reduces exports thereby increasing the trade deficit.

I can write pages and pages about this, but in a nut shell, the price of a currency in terms of another currency is determined by three main factors described above. To see whether a currency has appreciated against or depreciated one should look against a basket of currencies to see the real change. For example, to see if USD has really depreciated in foreign exchange market, one should compare USD against not only Yen, but also against Euro, Pound Sterling, Australian Dollar, Canadian Dollar and currencies from similar stronger economies.

In the next post I'll explain what happens to USD that are used for oil trading in international markets and what will happen if countries decide to use a different currency for trading oil. I'll also write about how Chinese government controls the value of Yuan and US government's charge that it manipulates its currency to help its exports (I have already explained above how depreciated currency helps exports).

The Monkey Economy

Every fan of Economics must watch this video. Fascinating.

November's Job Report

Market last week soared based on some positive development in Europe and partly due to the unemployment numbers from November. Unemployment sharply dropped to 8.6%. If you read the unemployment report, you'll find that Non farm payroll increased by 120,000 in November. Out of this 120,000,  50,000 were employed by retail sector. Following is from the BLS, unemployment report.

"Employment in retail trade rose by 50,000 in November, with much of the increase occurring in clothing and clothing accessories stores (+27,000) and in electronics and appliance stores (+5,000). Since reaching an employment trough in December 2009, retailers have added an average of 14,000 jobs per month."


You don't need to be a Nobel winning Economist to realize that most people employed in November are due to the holiday season. I'd like to see the January employment situation before I get excited about the unemployment drop.

Why I won't buy facebook at $100B Valuation

According to news reports facebook will be filing an application with SEC for an IPO early next year which might value the company around $100 billion dollars. Before this number came out, I was anxiously waiting for a facebook IPO. I also tried to buy facebook shares through a secondary market but transactions  costs and volumes required to buy in such markets are prohibitively high, preventing people like me from trading in such markets.

That being said, the real issue I have now is facebook's valuation of $100B. Before we determine valuation of facebook, lets look at the current value of other technology giants, their growth opportunities and risks.

I am going to use Market capitalization for these companies at current share price as approximate firm's value. Enterprise value in each case is little less. Firm's value if calculated in each case should come around its Market Cap with the exception of Amazon in my opinion which I believe is valued much higher by the market.

To start with, let's look at Apple. It's the second most valuable company in the world and is valued at $346B at the time of this writing. Market for whatever reason is not anticipating high growth in Apple, which is reflected in its little over 13 P/E ratio. But in my personal opinion, Apple still has a bright future and it is going to grow in foreseeable future at the same rate as it has done in the last decade. I don't need to go into details about Apple's stream of revenue but we know that it offers a diverse set of products and continues to create new markets (for example from IPod to IPhone to IPads. Now prediction is they will revolutionize TV industry). Given my level of expertise, I cannot predict where Apple would be in next ten years but in my humble opinion market is undervaluing Apple at $346B. The biggest risk in investing in Apple at this point is the fact that Steve job's is gone and company needs to prove that it can be just as successful without its visionary founder.

Another similar tech giant is Google. Google is currently valued at $188B. Based on its P/E ratio of 19, we can say that market is expecting Google to grow faster than Apple. Given the diversity of its Products and Services, Google is in a solid position and in my personal opinion its market valuation, reasonably reflects its fair market value. Again Google's revenue stream mainly consists of online advertising revenue, but Google has successfully diversified revenue sources by acquiring youtube, double click and by launching a successful Smartphone operating system Android.

Third tech giant that I would consider is Amazon. Amazon is currently valued at $85.7B while trading at a P/E ratio of over 99. That is huge. Market apparently is expecting a lot of growth in Amazon. In my personal opinion nothing can justify a P/E ratio of 99 unless a company had a particular quarter where it took a huge one time charge, for either acquisition or for any other reason. This however is not true for amazon. In fact, before this quarter's results, Amazon was trading at a P/E ratio of over 120 which in my opinion, in no way, justifies the underlying value of the company. If reader's followed Netflix, they should know by experience, what happens to their investment in companies that are valued so ridiculously high. As for Amazon's revenue stream, we know that its the largest online retailer. Amazon also owns Zappos. Besides it's Kindle book reader, Amazon has recently also entered the tablet market with its new Kindle fire. As Amazon itself calls a technology company rather than a retail company, Amazon has also entered into cloud computing space to increase and diversify its source of revenue stream.

After discussing these three giants, let's look at facebook. Majority of its revenue at this point comes from online ads and some from virtual currency sold on facebook. As for risk to facebook's business, I think people have adapted to facebook and there is a network effect which will make it very difficult for any competitor to come in and beat facebook in social networking. Google has tried it multiple times with Google Plus being its latest attempt, but so far it has failed. I have already written about it and in my opinion Google plus will fail until some privacy policies are drastically changed. That being said, if there is another revolutionary idea that will change how people use internet (it has happened before with facebook being one such revolution), then facebook in its current state stands to lose most. This risk factor and the fact that its revenue stream is not as diversified as other technology giants I discussed above, I think facebook's valuation at $100B is too high, specially when compared to valuation of other tech giants. Unless you are a speculator who is trying to make a stag profit, I think you should stay away from buying facebook at such a high value.

Zappos - 365 Day Price Match Policy

One thing common among great companies is that they don't compete on prices. Competing on prices will mean that there is a high chance that someone will match it and worse beat it. So no, Zappos which I believe is a great company does not offer price match with its competitors. However, if the price of the item you purchased from Zappos went down during one year on Zappos website, they will match it, or rather I should say that it is in their best interest to match that price if a customer requests. I purchased a suitcase last month from Zappos for $207. Just yesterday, I was browsing the website and noticed that the suitcase I paid $207 for is now selling at $142. That's a $65 difference in less than a month. I contacted their live chat agent and she told me that their price match policy is only for 10 days but she'll do it once for me as a courtesy. I appreciated but reminded her that by virtue of Zappos 365 day return policy which included free shipping both ways, they are effectively offering a 365 day price match policy too. She disagreed and I had to explain her that if she refuses to price match in future, I'll simply order the same thing again, won't even open it when it arrives and then send it back with my previous orders receipt as if I was returning the original product that I might already be using. This will get me my price match and will cost Zappos extra money in shipping. Unless Zappos can find a way to tag every single item, they cannot differentiate between two similar pair of shoes or bags or anything. This will require an RFID tag which can be very costly (about 10 cents per item) and will also fly against their practice of exceptional customer service. So, in my opinion, Isabella, you are better off matching that price every time a customer requests as long as it is within 365 days, otherwise you'll end up with an unhappy customer who will figure out a way to get the price match and Zappos will end up losing price match amount plus two way shipping charges.

Stock market is doing great...well may be

This was on Google news today.