Economics & Finance

Costa Rica Economy

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Recently I had an opportunity to travel to Costa Rica. Being a rather boring blogger / analyst type, I thought a lot about the Costa Rica economy.

The Costa Rican dollar is known as the “colon“. Being the finance type, I went out to exchange money into local currency prior to entering the country. Most big local banks like JP Morgan didn’t have colones on hand – although they said that they could order the money and I’d have it in a few days – so they sent me to a specialized currency exchange. At this currency exchange there was a pretty wide “bid / ask” spread, or the difference at which they would purchase currency back from you against what they’d sell it to you for, indicating a rather thinly traded currency. I gave them 300 USD and received a big wad of Costa Rican currency – the common denomination I used was the 2,000 note which was a bit over 4 USD. This is a rate of about 500 colones to the dollar, or each one is worth about 2/10 of a cent.

I spoke to a settler from the US who was a Quaker who opened a cheese factory in Monteverde in the 1950s – he said that the colon was worth about 5 to 6 to the dollar in the 1950s. Thus even while the US dollar has depreciated against other major currencies, such as the Yen, the colon has plummeted from 20 cents on the dollar to .2 cents on the dollar, or to 1% of its “relative” value from the 1950s.

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Too Big and Failed

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Three   Government Sponsored Enterprises (GSEs) stand at the heart of the financial meltdown: Freddie Mac, Fanny Mae and the Federal Home Loan Banks (FHLBanks). Like most people, I knew they were large organizations, but I had no idea how large until I read this article.

From a 2006 conference on the GSEs [PDF-Original,Local Archive] logical page 17:


The report notes (logical page 6):

Make no mistake, these Enterprises are huge.(#10)   As of September, their combined guaranteed MBS and debt outstanding of $4.3 trillion was not much smaller than the $4.9 trillion publicly held debt of the U.S.   If you add in the FHLBanks’ debt, the total of $5.2 trillion well exceeds the publicly held debt of the U.S.

So we had these giant GSEs issuing mortgage-backed securities (MBSs) and generating a level of debt obligation bigger than that of the government that secured them. This was never going to end well.

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Why Don’t We Just Cut China a Check?

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The really stupid thing about Obama’s carbon cap-and-trade system  [h/t Instapundit] is that it will simply relocate more manufacturing to countries that don’t give a damn about global warming.

The growing economies of China, India, and other parts of the world still have people living the lives of preindustrial  subsistence  farmers.  Right now, today, they have people in dire need of food, clothing, shelter, medical care, education, transportation and every other facet of modern life we take for granted.  They don’t give a crap about hypothetical dangers that will hypothetically manifest a century from now.

Such areas will use dense, rich, reliable sources of energy like coal and nuclear to power their factories while we try to smelt iron with windmills. We will be poor and eventually powerless in the face of such competition. Worse, if global warming is a problem, it will happen anyway. Our sacrifices will simply mean we have fewer resources to deal with the problems posed by global warming.  

Obama plans to shut down our carbon-emitting power sources today, decades before we bring their hypothetical  replacements online. If the technology doesn’t work as predicted, where will we be then?

Obama’s plan will be a massive wealth transfer from America to China and India. We will simply be handing them our current and future economic productivity on a platter.  

“Rational” Behavior

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This post and the subsequent discussion prompt me to make a point about the use of the term “rational” in economics and game theory.  

I think the people in the linked posts confuse the common definition of “rational” with the way that economists and game theorists use the term. Economists and game theorists axiomatically define a “rational” choice as one that will give the highest chance of accomplishing a previously defined goal given a specific set of parameters. That choice is defined axiomatically as the “rational” choice. Rational in this context does not mean wise, intelligent, most-good-for-the-most-people or any of the other concepts attached to the word in common speech. For example, in poker, game theory defines a different set of choices as rational depending on whether you want to make a killing, come out even or use the game as a pretext to transfer some money to a friend. Game theory does not comment on which of the three goals constitutes the most rational choice.  

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Clever Mathematicians vs. Financial Risk

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See here (via here).

This is a timeless issue. The specific risk model under discussion isn’t the central issue. It never is. The central issue is that financial-risk models whose effectiveness depends on the accuracy of their assumptions about the distribution of securities-price movements eventually blow up. This is why “portfolio insurance” failed in (helped to precipitate) the 1987 crash, why Long Term Capital Management blew up, why Fannie Mae’s risk estimates vastly understated the real risk and why countless other “value at risk” schemes cause more problems than they mitigate. In simple terms, these schemes assume that in the event of portfolio losses you will be able to sell off your portfolio incrementally without incurring further large losses. In practice, the very fact that your portfolio is experiencing an extreme decline in value means there are no buyers except at lower prices and that further losses are probably inevitable: if the life boats are all on one side of your supposedly unsinkable ship you may still capsize if the passengers move there en masse. This is human nature and can’t be hedged away by invoking clever math, though clever people keep making this mistake (and will keep making it, because human nature doesn’t change).

In the long run the only reliable way to limit the risk in your market portfolio is to structure it so that you don’t lose money if the impossible happens. But this is expensive (insurance usually is), and it’s always tempting to lower your costs, and raise your short-run returns, by assuming you don’t have to worry about 100-year floods. The problem is that 100-year floods occur in financial markets every five or 10 years.

BTW, this is also why the notion of “stress testing” banks is fatally flawed. You cannot assess the risk of loss in a financial portfolio by asking what happens under conditions of moderate, i.e., likely, financial stress. If there is a systematic fatal weakness, however improbable, in your financial system the markets will eventually find it and the system will blow up.