Monthly Archive for October, 2008

The Baltic Dry Index and the information value of markets

I have some questions about on the Baltic Dry Index (a rough guide to the price of moving dry goods by sea – more detail available here):

VW: Supply, Demand and Elasticity

Something very interesting happened to the share price of Volkswagen this week.  The FT has the story:

Volkswagen’s shares more than doubled on Monday after Porsche moved to cement its control of Europe’s biggest carmaker and hedge funds, rushing to cover short positions, were forced to buy stock from a shrinking pool of shares in free float.

VW shares rose 147 per cent after Porsche unexpectedly disclosed that through the use of derivatives it had increased its stake in VW from 35 to 74.1 per cent.

[T]he sudden disclosure meant there was a free float of only 5.8 per cent – the state of Lower Saxony owns 20.1 per cent – sparking panic among hedge funds. Many had bet on VW’s share price falling and the rise on Monday led to estimated losses among them of €10bn-€15bn ($12.5bn-$18.8bn).

For my students in EC102, this is interesting because of the shifts in Supply and Demand and the elasticity of those curves.  The buying and selling of shares in companies is a market just like any other.  Here’s an idea of what the Supply and Demand curves for shares in Volkswagen were originally:

Shares in Volkswagen (original)

The quantity is measured as a percentage because you can only ever buy up to 100% of a company.  Notice that the supply curve suddenly rockets upwards at around 45%.  That’s because originally, 55% of the shares of Volkswagen weren’t available for sale.  20% was owned by the state of Lower Saxony and 35% by Porsche, and they weren’t willing to sell at any price [In reality, if you were to offer them enough money, they might have been willing to sell some of their shares, but the point is that it would have had to have been a lot].  We say that for quantities above 45%, the supply of shares was highly, even perfectly, inelastic.

Notice, too, that the demand curve is also extremely inelastic at quite low quantities.  That is because a lot of hedge funds had shorted the VW stock.  Shorting (sometimes called “short selling” or “going short”) is when the investor borrows shares they don’t own in order to sell them at today’s price.  When it comes time to return them, they will buy them on the open market and give them back.  If the price falls over that time, they make money, pocketing the difference between the price they sold at originally and the price they bought at eventually.  A lot of hedge funds were in that in-between time.  They had borrowed and sold the shares, and were then hoping that the price would fall.  The demand at very low quantities was inelastic because they had to buy shares to pay back whoever they’d borrowed them from, no matter which way the price moved or how far.

On Monday, Porsche surprised everybody by announcing that they had (through the use of derivatives like warrants and call options), increased their not-for-sale stake from 35% to a little over 74%.  This meant that instead of 45% of the shares being available for sale on the open market, only 6% were.  It was a shift in the supply curve, like this:

Shares in Volkswagen (new)

Because at such low quantities both supply and demand were very inelastic, the price jumped enormously.  Last week, the price finished on Friday at roughly €211 per share.  By the close of trading on Monday, it had reached €520 per share.  At the close of trading on Tuesday, it was €945 per share.  In fact, during the day on Tuesday it at one point reached €1005 per share, temporarily making it the largest company in the world by market capitalisation!

Who said that first-year economics classes aren’t fun?

When can social change occur?

Somebody much smarter than I am was kind enough to read my little post on Endogenous Growth Theory.  At lunch today, they drew attention to this item that I mentioned:

I’m not aware of anything that tries to model the emergence of ground-breaking discoveries that change the way that the economy works (flight, computers) rather than simply new types of product (iPhone) or improved versions of existing products (iPhone 3G). In essence, it seems important to me that a model of growth include the concept of infrastructure.

The question was raised:

Could it be that times of significant social change have a tendency to coincide with with the introduction (i.e. either the invention or the adoption) of new forms of infrastructure? [*]  A new type of mobile phone hardly changes the world, but the wide-spread adoption of mobile telephony in a country certainly might change the social dynamic in that country.

It’s something to ponder …

[*] My intelligent friend is not an economist and would probably prefer to think of this as a groundbreaking discovery rather than just the development of a new type of infrastructure.

“A Penny Saved is $0.010125 Earned”

From the fabulous Dr. Boli:

Steamfitters and Phrenologists

On the topic of US politics …

There’s a perennial question thrown around by Australian and British politics-watchers (and, no-doubt, by people in lots of other countries too, but I’ve only lived in Australia and Britain):  Why do American elections focus so much on the individual and so little on the proposed policies of the individual?  Why do the American people seem to choose a president on the basis of their leadership skills or their membership of some racial, sexual, social or economic group, while in other Western nations, although the parties are divided to varying degrees by class, the debate and the talking points picked up by the media are mostly matters of policy?

An easy response is to focus on the American executive/legislative divide, but that carries no water for me.  Americans seem to also pick their federal representatives and senators in the same way as they do their president.

The best that I can come up with is to look at differences in political engagement brought about by differences in scale and political integration.  The USA is much bigger (by population) and much less centralised than Australia or Britain.  As a result, the average US citizen is more removed from Washington D.C. than the average Briton is from Whitehall or the average Australian from Canberra.  The greater population hurts engagement by making the individual that much less significant on the national stage – a scaled-up equivalent of Dunbar’s number, if you will.  The decentralisation (greater federalism) serves to focus attention more on the lower levels of government.  The two effects, I believe, reinforce each other.

Americans are great lovers of democracy at levels that we in Australia and Britain might consider ludicrously minuscule and at that level there is real fire in the debates over specific policies.  Individual counties vote on whether to raise local sales tax by 1% in order to increase funding to local public schools.  Elections to school boards decide what gets taught in those schools.

That decentralisation is a deliberate feature of the US political system, explicitly enshrined in the tenth amendment to their constitution.  But when so many matters of policy are decided at the county or state level, all that is left at the federal level are matters of foreign policy and national identity.  It seems no surprise, then, that Americans see the ideal qualities of a president being strength and an ability to “unite the country.”