Opinion

Felix Salmon

When bonds don’t trade

Felix Salmon
Nov 5, 2013 22:12 UTC

In the September issue of Euromoney, Peter Lee has a huge investigation into what he calls “the great bond liquidity drought”. The landing page for the story features subscriber-only links to the whole thing, as well as free-to-access links to various sections. But it also neatly summarizes the problem a single paragraph:

Liquidity is drying up across the bond markets. Regulations designed to curtail banks’ leverage have had the unintended consequence of also sharply reducing their ability and willingness to make markets in corporate and even government debt. New regulations on the leverage ratio that will reduce banks’ repo funding books threaten to make matters even worse and to spread the drought from credit markets to rates, the underpinning of all financial markets. Secondary markets are close to a breakdown that will soon imperil the primary markets on which companies and sovereigns depend for funding. All that is masking the decay is the extraordinary actions of central banks.

Here’s a chart from Citigroup which helps show at least part of the story:

Loss of Shock Absorbing Capacity.jpg

This chart doesn’t just cover Citigroup, it covers all bond broker-dealers. They massively increased their inventory of bonds during the 2000s bubble — but so did everybody else: total credit assets were raising substantially over that period. Then, after the financial crisis, came the great divergence. Broker-dealers retreated from the market, even as investors continued to seek the safety of bonds. So while broker-dealers were about half the size of the credit mutual fund industry in 2007, according to the quantity of assets they owned, today they’re only about 1/20th of the size. And those broker-dealers are still the only real liquidity providers in the market. If you want to buy or sell a bond on the secondary market, there’s really only one way to do it: phone a bunch of broker-dealers, ask them to make you a market, and either accept the best price you find, or don’t.

Lee’s article makes a very strong case that the only way out of this problem is for buy-side institutions to start trading directly with each other, since the broker-dealers have enough to be able to provide good service only to their very best clients. But neither of the two buy-side bond market giants (Blackrock and Pimco) seem to have been able to make such a system work, and although the MarketAxess system is growing fast, there isn’t going to be any fundamental change unless and until bond investors start making buy/sell markets of their own. Which is simply not going to happen: bond investors don’t tend to think in terms of opportunistic trading, precisely because their portfolios are so illiquid. What’s more, the ability to make a two-way market is contingent on the ability to buy one name when you sell another, which is not something anybody can reliably count on being able to do any more.

In other words, we’re living through a vicious cycle: the less liquid the market gets, the less ability there is for anybody to make markets, which in turn just worsens the liquidity problem. And things are only going to get worse still if and when QE goes away.

The implications, as Lee says, are enormous. The whole point of bonds is that they’re tradable: you don’t need to hold them to maturity. But increasingly you do need to hold them to maturity, since finding a buyer for your inventory is extremely difficult — especially if you’re investing in size. This is one reason why the two big bond investors arguably pose a systemic risk: if either one of them were to suffer substantial withdrawals, the selling pressure on the market would be so enormous that the entire bond market could pretty much cease to work. It’s already extremely difficult for bond funds to grow without changing their risk profile: while it’s possible to buy large positions in the primary market, it’s basically impossible to continue to add to those positions as your fund increases in size.

Part of the problem is the degree to which the market is fragmented: GE has more than 1,000 separate bond issues, while Citigroup has almost 2,000. (Both of them, of course, have only one equity security outstanding.) But there’s little incentive for companies to issuer fewer separate bonds, since the primary market is the one place where the bond market actually seems to work. And besides, if the bond market becomes harder to navigate, companies always have the option of going to the loan market instead, or raising equity instead of debt.

For sovereigns, however, the fate of the bond market is of paramount importance: they have to be able to issue debt, even as major banks are withdrawing from the markets entirely. And sovereign bonds are being hit just as badly as corporate bonds by the liquidity drought:

Traders say that without moving the price the markets might still absorb a large customer order for €250 million in German Bunds, maybe €100 million in French government bonds, perhaps €50 million in Italy and €25 million in Spain.

In Portugal, which has no direct market access of its own, Lee adds, it’s almost impossible to buy a position of any size at all without moving the market, with even the benchmark 10-year bond gapping out as much as 100 basis points on minimal underlying volume.

The result is that the bond market is going to have to contend with more than just rising rates over the next few years: it’s going to have to deal with rising illiquidity premiums as well. A bond yield will be the benchmark rate, plus the credit spread, plus the illiquidity premium, and it’s going to become impossible to disentangle the last two variables, especially when benchmark government bonds themselves are often quite illiquid. The effect on aggregate global borrowing costs could add up to trillions of dollars, and severely crimp the ability of the bond markets to finance growth.

Still, over time, those extra trillions of dollars are going to find their way into the pockets of bond investors: an illiquidity premium is still a premium. It’s never nice to see rates rise, but once they’ve risen, the extra yield will surely be very welcome to savers. And for the time being, at least, borrowing costs are not really a problem for most issuers with market access. If companies have to pay an extra 50bp to borrow money, so be it — they’ll live.

Sovereigns, however, are another story — they need to borrow in size, and they have historically relied on liquidity issues to ensure that they get the cheapest possible rate. (That’s the main reason why US Treasury bonds have the lowest yields in the world, on a swapped-into-dollars basis: it’s all about the liquidity, not the credit risk.) The great bond liquidity drought is arriving at the worst possible moment for G20 sovereigns which are already struggling with unprecedented levels of bonded debt. It’s always liquidity that kills you, not insolvency: it’s the inability to roll over your debts as they come due. Which means that the next wave of sovereign debt defaults might come even sooner than many analysts currently fear.

COMMENT

What happened to the old days? There was a New York Bond Ticker that displayed bond trades on the NYSE. Amex bond trades appeared on the Amex ticker. S&P published a book with all the bond’s characteristics and their symbols. The previous day’s trades were displayed in the New York Times with prices and yields and whether they were trading flat or not. You could get a quote for a bond on the Quotron that your broker would honor. In short, what is wrong with trading bonds on an exchange?

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Is this the end of the art-market bubble?

Felix Salmon
Nov 4, 2013 07:32 UTC

One of my pet distinctions is the one between a bubble and a speculative bubble. All speculative bubbles are bubbles, but not all bubbles are speculative. In the markets, the late-90s dot-com bubble was speculative: it was based on the greater-fool theory that even if you were overpaying today, you’d be able to sell to an ever greater fool tomorrow, and make lots of money. A speculative bubble is fueled by flippers — people who don’t much care for or about what they’re buying, but who reckon that whatever it is, they’ll be able to sell it at a nice profit. So the Miami condo bubble of the mid-00s was speculative, while the current Miami real-estate market, which is nearly as hot, isn’t.

Non-speculative bubbles are often fueled by FOMO: you spend more than you can really afford on an apartment today, because you have a very rational fear that if you wait any longer, you’ll never be able to afford a place to live, no matter how much you stretch. And one way of ensuring that speculative bubbles never take place is to put lots of friction in the system: no one will ever buy-to-flip a grand NYC co-op apartment, for instance, because New York’s co-op boards are very good at preventing such activity, and making life miserable for would-be flippers.

This is one reason why I’ve long said that even if there is a bubble in the contemporary-art world (and I think there is), it’s not a speculative bubble. The people spending millions of dollars on trophy art aren’t buying to flip; the people selling aren’t selling to make a fast buck. Rather, they’re selling because of one of the “three Ds”: death, divorce, debt. The exceptions to this rule are dealers, of course, along with a small number of collectors who are so active they start becoming quasi-dealers in their own right. If you’re well connected in the art world and willing to make an opportunistic purchase, then you’ll probably be willing to make an opportunistic sale as well, when the price is right.

But right now, I’m beginning to see indications that things are changing: if you look at this month’s big contemporary art auctions, you’ll see quite a lot of art being flipped, including art being flipped by one of the biggest collectors of them all, Stevie Cohen. According to Carol Vogel and Peter Lattman in the NYT, Cohen is selling a Gerhard Richter which he bought from the Pace Gallery last year, along with “about a dozen other pieces, mostly at Sotheby’s, that he acquired in recent years at art fairs and auctions”.

On top of Cohen’s works, Vogel has found other pieces being flipped this month, including Three Studies of Lucian Freud, by Francis Bacon, which “was purchased by a consortium from a private collector in Italy within the past 12 months”; and Apocalypse Now, by Christopher Wool, which was sold by David Ganek very recently. Between them, the Richter, the Bacon, and the Wool are going to account for a substantial percentage of the total amount of money spent at auction this season, which means that auction totals are increasingly comprised of short-term trades, as opposed to sales from individuals and families who have owned the objects for many years.

(Incidentally, talking of auction totals, Vogel mentions “Christie’s record $495 million postwar and contemporary art auction just six months ago” at the top of her piece. In nominal dollars, that auction was indeed the largest ever. But the NYT now only uses the word “record” for real records, not nominal ones — and Christie’s November 2006 Impressionist and modern sale raised $570 million in today’s money.)

It’s rare for people in the art world to buy a piece and then immediately consign it to auction. It’s common for works of art to be sold in the primary market for well below their auction value — but precisely because it is so common, there are lots of rules and protocols which mitigate against such things happening. When work is being sold at below-market rates, there’s naturally a lot of demand for it, which means that dealers can pick exactly which buyers they want. And if any buyer dares to flip such a work, he knows he’ll be blacklisted from then on in. Instead, if a buyer wants to sell a work he bought from a gallery, he always asks the gallery first.

As for work on the secondary market, well, dealers do occasionally find themselves a bargain. But they normally take their time and try to find a buyer themselves, because if they consign to auction, the auction house will take about 12% of the final sale price, in the form of buyer’s commission. If you’re a dealer selling a painting, you’re much better off finding that buyer yourself, and persuading him to pay the full amount to you directly. In order for flipping at auction to make sense, the buyers at auction have to be rich naifs who are hard to find through normal channels.

So what does all this very public flipping mean for the contemporary art market? Four possibilities present themselves.

Firstly, galleries don’t have faith in their own prices. If Cohen is auctioning off works he bought from galleries, it’s fair to assume that he gave all of those galleries the opportunity to buy back the pieces first — and that they declined. On top of that, one of the notable things about Cohen’s Richter is that it is coming to auction with an estimate of $15 million to $20 million, which is below the $20 million he’s reported to have paid for it in 2012. Cohen is a trader, who marks to market: of all people, he’s going to worry the least about taking a loss. But he also wouldn’t sell now if he thought there was serious potential for price appreciation.

Secondly, we might be seeing the smart money rushing to the exits. They could make more money selling privately — but that takes time, and maybe they don’t think that they have time.

Thirdly, it’s possible that the auction houses are doing something which Dan Loeb accused Sotheby’s of in his recent letter:

Based on discussions with market participants, it is our understanding that it has been Sotheby’s who has most aggressively competed on margin, often by rebating all of the seller’s commission and, in certain instances, much of the buyer’s premium to consignors of contested works.

While it’s relatively commonplace for auction houses to charge big sellers no commission on their works, it’s very uncommon for the auction house to share any of the buyer’s premium with the seller. But if that’s happening, that might explain why the sellers are suddenly more willing to use the auction houses as a place to sell their works.

Finally, the quality of the buyers at auction might be weakening, with art-world types being replaced by — for lack of a better word — rich chumps. Auction houses, with their global reach and transparent sale system — the highest bidder always wins — are naturally better suited than art dealers to find collectors who are new to the scene and looking for trophies. And if dealers want to sell to such individuals, they might be forced to go the auction route.

What’s interesting about all four of these possibilities is that they all suggest the same thing — that the contemporary-art bubble is entering its final stages. When a bubble becomes speculative, it becomes much more dangerous, and fragile, and short-lived. This bubble is a robust one: it has been going for many years, gathering momentum all the way. Even the financial crisis barely made it stop for a breather. But if we see another record-breaking season in New York this week, don’t take that as a bullish sign. It could just be that we’re entering a period of feverish selling.

Update: Kathryn Tully wonders whether the art bubble has already started to deflate.

COMMENT

“Stevie Cohen?”

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Is Amazon bad for publishers?

Felix Salmon
Nov 3, 2013 17:58 UTC

Duff McDonald has a wonderful review of Brad Stone’s new book on Amazon in the NYT; he’s a fantastic nonfiction book reviewer. There is one part of the review, however, which could do with a bit more explanation:

Bezos does appear to revel in outwitting even his best partners. The publishing industry, for example, still doesn’t quite know how it willingly gave him the sword with which he would slice off its head…

Publishers were shocked when he sandbagged them with $9.99 e-book pricing in 2007. Where had they been?*

It’s something of an article of faith, in book-publishing circles, that Amazon has been a Bad Thing for the book publishing industry. And certainly it is an article of faith in this review. (Authors, by contrast seem to have gotten more upset at Google than at Amazon.)

What I can’t ever recall seeing, however, is a clear and concise encapsulation of the publishing industry’s beef with Amazon. How is Bezos supposed to have sliced off their head?

I come at this from what might be an overly naive position. Firstly, and most obviously, Amazon has made it vastly easier to buy and to read books. Anybody with a smartphone, anybody with an internet connection, can now order any book in print, and get it delivered straight to their door, in any moment of enthusiasm. If they’re even more impatient, or prefer e-books to physical books, they can even buy the book and start reading it in seconds. I can’t see how that can possibly be anything but great news for the publishing industry.

McDonald makes it seem — and I think he’s right about this — that the industry’s main problem with Amazon is the fact that it discounts aggressively, and sometimes sells books (both physical and electronic) for less than the amount that it’s charged by the publishers. In other words, it subsidizes book purchases, something any industry ought to embrace with open arms. And this industry thinks it some kind of mortal threat?

When e-books started being a real mass-market phenomenon, I do recall a reasonably recondite debate about consumer expectations. Amazon was selling those books at $9.99 apiece, which meant that it took a loss on every purchase, but which also meant that more people were buying them — and, of course, were buying the devices on which to read them. This might have been nefarious if Amazon were making money on selling kindles, but it wasn’t, it was selling those, too, at a loss. It just wanted to bring e-books to as many people as possible — and was willing to make a substantial investment to do so.

The nay-sayers argued that once the public was conditioned into expecting e-books to be priced at $9.99, they would never pay more than that. The publishers didn’t particularly want the first e-books to be sold at such a low price, but Amazon went ahead and implemented its loss-making policy anyway. Remember that Amazon’s ultimate goal was to sell the maximum number of e-books, and, eventually, make lots of money by doing so. So this was just a dispute about short-term tactics: over the long term, the interests of Amazon and the publishers were aligned. (And frankly, Amazon is likely to always get the benefit of the doubt when it comes to “which company has the better sales tactics” questions.)

So here’s my question: what’s the argument which says that Amazon has proved itself to be a mortal, existential threat to the publishing industry? It’s not like Amazon has disintermediated publishers, allowing readers to buy millions of books directly from authors. There’s a very small business along those lines, but I don’t think that’s what publishers are worried about.

The only argument I can think of is the one surrounding physical bookstores. The small, friendly, neighborhood bookstore lives on, romantically, in the minds of most authors, and indeed publishers as well. But customers didn’t love them as much as book types did: that’s why they ended up going to Barnes & Noble instead. And as a result, the number of booksellers declined significantly. Then, just as B&N stomped on the small booksellers, Amazon ended up stomping on B&N. Customers value convenience more than they do any real-world book-buying experience — and while B&N was more convenient than the small stores, Amazon was more convenient than B&N.

The result is that there are fewer real-world triggers which remind us about how wonderful books can be. In a world with lots of small bookshops, you pass such things regularly, and even if you don’t go in and buy something most of those times, at least you’re reminded of their existence, and you nearly always have a good feeling about the store and its ambience. Just about every book reader thinks that bookstores are wonderful, magical places — and, of course, that their contents are wonderful, magical things. As such, small booksellers were the best marketing devices that the publishing industry had. Not through anything they particularly did, so much as just by dint of their simple existence.

It’s a bit like the secret to the continued success of The Economist: it puts a lot of effort into its covers, and those covers are featured prominently on pretty much every newsstand in the world. Even if you’re a subscriber and never buy the magazine at a newsstand, seeing it so regularly in the real world is a great way of reminding you how much you like it. As a result, the next time you pick up your iPad, you’re more likely to read The Economist, and therefore more likely to renew your subscription, when that time comes around. If the number of newsstands in the world fell substantially, that would hurt The Economist much more than its newsstand sales alone might suggest.

Similarly, a world where you’d see a Barnes & Noble in every shopping mall, where you’d see these monster bookstores by the side of every urban highway, was a world which was constantly reminding you of how many books there are, and of how popular those books are. After all, those bookstores were kept in business by a steady stream of book lovers coming in to buy books. In their own way, B&N stores were just as good an advertisement for books in general as were the small booksellers they replaced.

So while there are just as many media-based book discussions as there always were — book reviews, book excerpts, talk shows, radio interviews, that kind of thing — the real-world reminders of the book industry as a whole have definitely shrunk. There are still lots of ways we can find out about individual books that we might want to read — and, thanks to Amazon, it has never been easier to order and read those books. But Amazon’s size and reach isn’t nearly as obvious as the networks of physical stores were — especially since Amazon sells so many different types of things, the sight of an empty Amazon box doesn’t make you think “books” any more. (Although, for historical reasons, the Amazon bookmark in my web browser still says “Amazon.com Books! Earth’s Biggest Bookstore.”)

Still, I don’t think it’s really fair for publishers to blame Amazon for the fact that people like to do their shopping online, and that easily-digitizable content is going to exist mainly in a virtual world rather than the real world. Indeed, there’s an argument that Amazon has saved the publishing industry from going the way of the record labels — that it’s made buying e-books so easy that the number of free pirated versions out there is still tiny. (Amazon has made it easier to find second-hand books, which publishers don’t directly benefit from, but at the same time it’s at the forefront of pushing e-books, which can’t be resold after you’ve bought them. Net-net, let’s call that one a wash.)

Publishers have always been conservative, and Amazon represents a massive change in their industry. What’s more, the move from small booksellers to B&N to Amazon has been a move where the booksellers have ever-increasing amounts of leverage over the publishers; it’s understandable that the publishers don’t like that. But I just can’t believe that Amazon is, or would ever want to be, an existential threat to the publishing industry.

*Update: The blockquote from McDonald’s review was originally longer, and included a section about Amazon matching the prices of “mysterious third-party sellers” in order to justify its price cuts. But McDonald emails to tell me that that section was not about publishers or booksellers, so I’ve taken it out.

COMMENT

handleym99, Amazon’s system of discovery works well for mainstream published books, which is a few thousand titles a year for most people (in their field of interest).

What happens when there are no mainstream publishers, and now there are a 100,000 to 1,000,000 titles to choose among, none of which have any reviews (I’m talking about discovering new authors – old authors will do just fine until book reading slowly becomes irrelevant).

Use advertising? Not correlated to quality. Use reviews? Ha. Think about the quality of reviews when a book by an unknown gets 0.01 reviews on average. You can be almost certain that any review you read is a sympathetic/paid for/faked review at those levels.

Imagine looking for SF novels published this month and getting 50,000 hits. Now, Amazon may well show you some top 50, quantified by how much they pay Amazon. But how many of them will be readable when willingness to promote doesn’t correlate with need to make money?

There’s simply nothing we have to filter the tsunami of the not-publishable-quality material that finds its way on to Amazon. Amazon’s current response is to essentially hide the self-published stuff by unknown authors most of the time, so you don’t get swamped (and on occasion when they don’t, Amazon is useless for finding anything useful, as I found to my sorrow).

We have no tools and no discovery mechanism for finding good books among millions instead of thousands that doesn’t involve a gatekeeper who only cares about promoting what customers will buy, and that’s not nearly a profitable enough industry for Amazon. Far more profitable to sell to the would-be writers.

I’m hoping my apocalypse scenario doesn’t come to pass in the next 10-20 years. But neither anything that Amazon is doing now, nor has incentive to do in future, is likely to prevent it.

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Chart of the day, sovereign precariousness edition

Felix Salmon
Nov 2, 2013 06:42 UTC

precariousness.png

Bond spreads, along with their close cousin credit default swaps, are a beautifully linear measure of sovereign default risk. They go up in a straight and steady line: the higher the number, the riskier the country is perceived to be. And so they’re normally the first and last place that people look when they’re interested in the chances of any given country defaulting.

But of course the world isn’t quite as simple as that, and — as we have learned the hard way — it’s the unexpected defaults which are the most damaging. So I asked Ben Walsh to put together this chart for me, showing a different measure of risk. It’s not a better measure, by any means. Still, it’s an interesting measure all the same, and it’s almost entirely uncorrelated with credit spreads.

The red bars, in this chart, are the credit spreads we’re all familiar with. Countries like France, the UK, Canada, and Germany are considered effectively risk-free, while Spain and South Africa and Italy are riskier, India’s worse, Greece is very bad, and Argentina is truly dreadful.

And then there’s the blue bars, which are related to the concept of a “sudden stop”: when all the windows close, and a country simply can’t borrow money any more. Such things can arrive with astonishing speed: the markets, in general, will only lend if they think that everybody else is willing to lend. So it’s easy for them to shut down very quickly indeed.

The blue bars are also related to the fact that sovereign creditworthiness, at least as the markets understand it these days, is not really a measure of a country’s ability to pay off its debts in a timely fashion. Japan is a highly creditworthy country, but it also has public debt of a quadrillion yen. Which, it is safe to say, it will not be able to pay off at any point in the foreseeable future.

In order to be considered creditworthy, even to the point of being considered risk-free, all you need to be able to do is roll over your debts, as they come due. There’s something scarily self-fulfilling about this state of affairs: if it’s all one big confidence game, then the minute that a country for whatever reason becomes unable to continue to borrow money, then catastrophe is imminent. And, as we saw during the debt-ceiling debacle, there are a lot of reasons why a country might become unable to continue to borrow money.

In a forthcoming paper, Lee Buchheit, the Cleary Gottlieb partner and godfather of sovereign debt restructuring, writes this:

No purchaser of a sovereign debt instrument today does so in the hope and expectation that when the debt matures the borrower will have the money to repay it. The purchaser does so in the hope and expectation that when the instrument matures the borrower will be able to borrow the money from somebody else in order to repay it. This is a crucial distinction. If by sovereign creditworthiness we mean that a sovereign is expected to be able to generate enough revenue from taxes or other sources to repay its debts as they fall due, then most countries are utterly insolvent…

We have allowed a financial system to develop for sovereigns that assumes a more or less perpetual state of benignity — in the debtor country, in the region, in the global economic and political environment and even in the natural world. A disturbance in any of these areas, if it frightens investors sufficiently, risks interrupting the expectation of refinancing that defines sovereign creditworthiness. Many sovereign borrowers would last only a few months, some only a few weeks, if shut off from the ability to refinance their maturing debts. Denied continued market access, they would burn through their reserves with frightening speed.

This is the idea behind the “hang time” measure in the chart above. What we did was to take a country’s primary deficit — the amount it needs to borrow every year to finance its operations — and add on its total annual debt service. We then took that number and divided it into the country’s total foreign reserves, to get an idea for the length of time that sovereign reserves would be able to fund not only operations, but also all of the country’s debt service requirements.

The results are quite startling. Some countries do extremely well on this measure: Russia, for instance has a primary surplus which is higher than its annual debt service, so it could quite happily continue to service its debt in perpetuity, even in the event of a sudden stop. And Argentina looks very healthy on this measure as well: it has a hang time of 280 weeks, or well over five years. Germany and Brazil would both last about three years; even Portugal would last more than a year. But the UK would run out of money in six months, the US would go bust in 17 weeks, and France has just nine weeks’ worth of reserves. Japan would have only about 14 days.

Of course, countries like Japan and the UK borrow overwhelmingly in their own currencies, and can always, if push comes to shove, print more of it. The US is in the same boat — and, to boot, has the exorbitant privilege of printing the world’s reserve currency. Where fiscal solutions fail, monetary solutions are likely to look attractive. But the chart does show how incredibly fiscally precarious many of the world’s safest credits really are.

COMMENT

This is not really the right analysis. A primary deficit can usually mostly be funded locally since the bulk of the expenditures are denominated in local currency. Reserves need to be sufficient to fulfill the demand of foreign exchange (imports, external debt). Fx reserves do not represent the money that the government can go to to fund its local deficits.

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There’s no global wine shortage

Felix Salmon
Nov 1, 2013 07:04 UTC

Have you heard about the global wine shortage? Of course you have: it’s been covered in pretty much every media outlet imaginable, but Roberto Ferdman’s piece for Quartz (“A global wine shortage could soon be upon us”) was one of the first, and also one of the most detailed. Still, it was the classic single-source article: it basically took one Morgan Stanley report, reproduced a bunch of the key charts, and added a clickbaity headline.

The charts, on their face, tell a pretty clear story, especially this one:

But if you look closely at the Morgan Stanley report, it starts to look less like a dispassionate analysis of supply and demand dynamics in the wine world, and more like an aggressively-argued attempt to put forward one particular investment thesis as strongly as possible. What’s more, the investment thesis is not, particularly, based on the existence of any present or future wine shortage; it’s simply trying to present the idea that demand for Australian wine exports is likely to rise, and to justify the fact that  a company called Treasury Wine Estates is the bank’s “top Australian consumer pick”. (The report was written by Morgan Stanley Australia.)

For instance, the scary chart above is actually this rather less scary chart, tweaked a little:

To create the first chart, Morgan Stanley just took the second chart, added 300 million cases to the red line, and then — this is pretty cunning — simply deleted 2013 altogether, so that the uptick at the end disappears. (The 300 million number is Morgan Stanley’s estimate of the annual demand for “non-wine uses” of wine.)

Although the first chart is scarier than the second chart, even the second chart does a little bait-and-switch, which you can only find by looking at the sourcing note at the bottom of the page. The numbers for the charts come from OIV, the Organisation Internationale de la Vigne et du Vin, including the estimate for 2012 production and consumption. But the 2013 estimate, showing a modest increase in production, is not the OIV estimate; it’s the Morgan Stanley estimate. And what Morgan Stanley doesn’t tell you is that the OIV estimate for 2013 is much higher. Here are the OIV charts:

These charts are less polished, but are actually much more useful. (They also have different units from the Morgan Stanley charts: they’re measured in million hectoliters, which is 100 million liters, while Morgan Stanley uses million unit cases, which is 9 million liters. So when Morgan Stanley says that 300 million unit cases are used for non-wine consumption, that works out at about 33 million hectoliters.)

For one thing, the OIV charts draw sensible straight lines between points, instead of turning them into elegant curves which make the trend seem continuous. The trend is not continuous: these are annual figures per vintage, and each vintage is a unique, separate event. What’s more, while the amount of wine that will be drunk and produced in 2013 is not yet entirely clear. So OIV gives a range of possibilities, while being reasonably certain that wine production is going to increase substantially this year, by somewhere between 7.1% and 10.5%. Morgan Stanley, by contrast, gives no rationale at all for the fact that it has a forecast which is much lower than OIV’s; indeed, nowhere in the Morgan Stanley report is its 2013 forecast ever even quantified.

Add it all up, and the OIV actually concludes, quite explicitly, that the production-consumption difference for wine will “be higher than the estimated industrial needs” in 2013, for the first time since 2007. In other words, far from entering a period of global wine shortage, it looks like the 2008-2012 period of shortage is actually ending.

This global wine shortage, then, just simply isn’t real. Don’t take my word for it: ask the wine trade. Stacy Finz of the San Francisco Chronicle asked a bunch of industry types about the Morgan Stanley report, and none of them took it seriously; Victoria Moore of the Telegraph conducted a similar operation in Europe, and came to much the same conclusion.

My wine-making contacts raised more than an eyebrow at the ready, steady, panic news.

“Tell them to come to the Languedoc if they are worried,” said one. “I think I can help them out.”

Another noted that it is still possible to buy hectares of good vineyard in parts of France and Spain for less than the cost of planting one. In other words, the price of some wine is still lower than its true cost of production, an indication that the balance of supply and demand is still favouring the demanders, not the suppliers.

The Morgan Stanley report paints a picture of a long-term secular downward trend in area under vine, which is running straight into a long-term secular upward trend in global demand for wine. But reality is more complicated than that: thanks to a combination of technology and global warming, an acre of vines can reliably produce more wine, and better wine, than it ever did in the 1970s. And of course if demand for wine really does start consistently exceeding supply, then there’s no reason why area under vine can’t stop going down and start going up.

But never mind all that: the Morgan Stanley report has numbers and charts, and journalists are very bad at being skeptical when faced with such things. Even Finz’s Chronicle article, which sensibly poured cold water on the report, ends with a “Wine by the numbers” box which simply reproduces all of Morgan Stanley’s flawed figures. And besides, the debunkings are never going to go viral in the way that the original “wine shortage!” articles did.

As analysts have known since long before Henry Blodget was covering Amazon, the way to make a splash is to come out with a bold, headline-worthy thesis. Morgan Stanley did exactly that with this report, and I’m sure succeeded beyond their wildest dreams. I’m sure they’ve been celebrating their PR coup all week — probably with sparkling wine of some description.

COMMENT

A splendid insight-Interestingly the link to Morgan- Stanley does not go through – Felix can you provide the reference ?- I am unable to get to the report and look at it. The fact that Frederico Castellucci affirmed your post must make you feel good!

Posted by Oddsonwine | Report as abusive

Pedantry and numeracy in journalism

Felix Salmon
Oct 31, 2013 06:27 UTC

Anthony DeRosa retweeted this photo on Wednesday morning, which came with the caption “Math is difficult for many journalists”. I was genuinely confused: I couldn’t see any math errors in the screenshot. So I asked DeRosa where the error was. He replied:

Just as I couldn’t see a math error, I couldn’t see anything remotely egregious. Thus began quite a long Twitter conversation, large parts of which DeRosa Storified for me. I proved very bad at getting my point across in tweets, so I promised to explain everything in this post.

The problem that DeRosa had with the stories about the Norwegian man with bitcoin, it turns out, was that they didn’t agree on exactly how many dollars’ worth of bitcoin he bought back in 2009. Some said $22, some said $26, some said $27. That discrepancy, in and of itself, was proof enough, for DeRosa, that many journalists were committing an “egregious error”.

Now the facts of the story were not in dispute at all. The Norwegian man spent 150 Norwegian krone on bitcoin in 2009 while writing a thesis on encryption, forgot about them, and then, in April 2013, during full bitcoin fever, discovered that his digital wallet contained coins worth some 5 million krone. Nice! In dollar terms, his investment went from being worth about $25 to being worth about $900,000.

But DeRosa wanted to know exactly how much the coins were worth at purchase: if one journalist said $22 and another said $26, then at least one of them, and possibly both, were, in his eyes, clearly wrong. You needed to be looking at multiple versions of the story to even see that there was a disparity here — but that’s exactly what DeRosa was doing. And rather than simply ask why there was a disparity, he decided that the individual journalists were doing something very bad.

It turns out that the reason for the disparity is very simple: the dollar-krone exchange rate fluctuated quite a lot in 2009, and it was unclear exactly when the bitcoins were purchased, so no one knows exactly how much the coins were worth, in dollar terms, when purchased. They might have been worth $22, or they might have been worth $27. Really, it doesn’t make any difference: the man made a profit of well over $850,000 whatever his initial investment was.

But there’s a superficial exactness to numbers that doesn’t exist in words, and so people have a tendency to believe that all numbers are much more precise than in fact they are. If the Labor Department releases a report saying that payrolls rose by 148,000 in September, then a reporter who said that payrolls rose by 150,000 would be considered to have her facts wrong — even though the headline number is only accurate to within 100,000 people either way. The actual number of new jobs could easily be anywhere between 44,000 and 252,000 — and indeed there’s a 5% chance that it’s outside even that large range. But because everybody insists on one hard number, one hard number is what they get.

One of the most important skills in financial journalism is numeracy — having a basic feel for numbers. In this case, the reporters covering the story got the numbers right: they should be applauded for that, rather than having brickbats thrown at them. After all, it’s not hard to find examples of reporters getting numbers very wrong. Consider this story, from the New York Post, under the headline “Verizon increases cell bills 7.1% for 95M customers”:

Verizon didn’t sign up as many new cell phone customers in the third quarter as Wall Street expected — but it still earned more than forecast as it managed to increase the average bill of its 95.2 million wireless customers by 7.1 percent.

The average Verizon Wireless bill jumped to $155.75 a month as of Sept. 30 from $154.63 last year, the company said Thursday.

Now that is a math error — and evidence of deep innumeracy on the part of the journalist who wrote it, as well as a whole series of editors. If you want to work out exactly what the increase is, in percentage terms, of going from $154.63 to $155.75, then you might need a calculator. But if you were numerate, you would know intuitively that it’s very small, on the order of 1%, and that it’s nowhere near 7%. If you get a result of 7.1%, then that means you’ve pressed a wrong button somewhere, and you should do your sums again.

The problem is that we naturally associate numbers with mathematics, and mathematics with accuracy — and we therefore assume that whenever we see a number, we’re dealing with something which is either right or wrong — just as it was in elementary-school arithmetic. When numbers describe the real world, however, they always have error bars; they’re basically shorthand for a probability distribution. So long as the number that’s printed is plausibly somewhere reasonably likely to be in the fat bit of the distribution, it doesn’t make sense for critics like DeRosa to call it out for being inaccurate. After all, pretty much all numbers are inaccurate, especially if you’re trying to measure something (like the value of a certain number of bitcoins) in terms of something else (like dollars). Journalists should work on the basis of the identity of indiscernibles: so long as the meaning of the story isn’t changed, the exact number being used really doesn’t matter.

Let’s say that you saw various news reports about an event, and that different words were used to describe the weather: some said it was “cold”, others “brisk”, others “frosty”, others “wintry”, and so on. You wouldn’t raise an eyebrow: you’d see that they were all describing the same thing, in slightly different language, and you wouldn’t demand an explanation for the “discrepancy”. Well, numbers in news articles behave like words: they’re trying to describe the state of the world. That’s why the NYT has banned the use of “record” or “largest” unless inflation is taken into account. What matters is not the mathematical relationship between abstract numbers, but rather the state of the world that is being described.

In the case of the bitcoin, there was never any doubt about what was being described, and so the journalism did exactly what it was meant to do. There are far too many real problems with genuinely flawed news articles for critics to start playing “gotcha” whenever they see a couple of numbers which say exactly the same thing, even if they’re not mathematically identical.

COMMENT

“Let’s say that you saw various news reports about an event, and that different words were used to describe the weather: some said it was “cold”, others “brisk”, others “frosty”, others “wintry”, and so on. You wouldn’t raise an eyebrow: you’d see that they were all describing the same thing, in slightly different language, and you wouldn’t demand an explanation for the “discrepancy”. Well, numbers in news articles behave like words: they’re trying to describe the state of the world.”

THIS.

As a scientist, I see the same thing in science journalism. Science is actually mixed here: sometimes that third decimal place is very important, and other times it doesn’t matter at all. The key is knowing which is which; when the important details are qualitative and when they’re quantitative.

So what I see in popular arguments over (particular controversial science subjects), I see a lot of people being pedantic over some number that doesn’t matter that much, or *not* being pedantic over a one that does. The truth is, the layperson can’t know the difference, because they don’t have the depth of knowledge in the subject or the experience with science to know what’s important and what’s not.

And there’s another connection with what you’re saying, Felix: Many people have this expectation that science (like math) is all about that 3rd, 5th, or Nth decimal place, and if the scientist gets that decimal place wrong, well, then, their conclusions are also all “wrong”. That’s generally really not the case, but again, it comes from a lack of actual experience with math and science. And the layperson’s tendency is definitely towards pedantry, rather than actually understanding the (generally qualitative) picture of what’s actually happening in a physical system.

Pedantry where it doesn’t belong: it has the side effect of working quite well with one’s confirmation bias, since it allows you considerable flexibility in what kind of data you accept as true, or not.

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The red-blue divide in personal finance

Felix Salmon
Oct 30, 2013 21:16 UTC

Helaine Olen has a fantastic piece on Dave Ramsey in Pacific Standard, giving a very clear view of what he does and where his program falls short. I recently wrote about Ramsey’s investment advice for Money — the blog post is here — and the Money headline was “Save like Dave… Just don’t invest like him”. So there’s a disconnect between my view of Ramsey and Olen’s: while I think his saving and debt-reduction advice is sensible and valuable, she thinks it falls short in many key ways.

Olen’s main point is undeniably true: that when enormous numbers of Americans find themselves in financial difficulties, the problem is probably more systemic than it is one of a failure of self-discipline. Ramsey used to be a real estate speculator, and he thinks of debt and leverage as being pretty much the same thing — something to be avoided. Ramsey ended up moving into a much less capital-intensive industry, and made his fortune in media, rather than in property; he’s had much more success without debt than he had with it. But the people who pay hundreds of dollars for Ramsey’s advice aren’t using debt as leverage: they just don’t have enough money to make ends meet, and therefore need to borrow the difference. Here’s Olen:

Adjusted for inflation, median household income in America fell by seven percent between 1999 and 2010. At the same time, the costs of child rearing, health care, education, and housing continued their decades-long climb. In 2012 alone, the average family’s medical bills went up by 7.2 percent. And the deflated housing bubble hasn’t stop rents from climbing…

Economic volatility is an overwhelming fact for millions of Americans; willpower is finite; and gazelle intensity takes its toll. “Ramsey never talks about the cost of [his strategies],” Barrett-Fox continues. “He does not have good advice for people who have low incomes and are against the wall. If they lose a job, he doesn’t really have anything for those folks.”

Olen says that the self-help industry “leads people to believe that they are to blame for failures that are more truthfully the result of political, economic, and social trends”, and that “larger forces overwhelm” the best efforts of many people who try to take responsibility for their own finances.

Olen is right about all of this, but I’m more sympathetic to Ramsey than she is. For one thing, depressing stories about stagnating wages and the pincered lower-middle class, while important from a policy perspective, don’t actually do anything for the individuals being pinched. And if you don’t have any means of paying back the money that you’re borrowing, then it’s not a good idea to borrow money. Your reasons for going into debt might be perfectly understandable, but even Elizabeth Warren wouldn’t recommend you actually do so. And once you’re in debt, you need some kind of plan to get out of it.

That plan might be bankruptcy — but most of the time, it won’t be. Olen is quite right that bankruptcy should be on the menu of options for everybody struggling with a large debt load, and that Ramsey’s absolutism on the subject — he is opposed in all circumstances — is unhelpful.

But here’s the thing: Ramsey is a devout Christian, talking to an extremely conservative (and Conservative) audience. Most self-help operations, Dave Ramsey’s very much included, work by reinforcing the priors of their audience. Ramsey’s message, based in the Bible and self-reliance, is a familiar one, especially in the red states. Ramsey’s followers are attuned to his message precisely because, on some level, he’s telling them something they already know.

That explains Ramsey’s stance on bankruptcy: he doesn’t want to be counterintuitive in any way. Financial sophisticates understand the utility of bankruptcy — but Ramsey, pretty much by definition, is not addressing financial sophisticates. Successful personal-finance gurus tend to be strict authority figures, and they’re not going to say anything which might be considered to be enabling, or to suggest that debt can ever be simply written off at a low cost. Ramsey’s stern statement that bankruptcy is not an option is easy to understand, and helps to keep his followers on his well-trodden path out of debt. Gurus don’t like giving options: they like hard-and-fast rules. And if you’re following Ramsey’s rules, you’re not going to file for bankruptcy.

In many ways, Ramsey is the counter-Olen. While Olen, writing for a lefty west-coast magazine, blames society for the woes of the poor and indebted, Ramsey, addressing a much more conservative audience, preaches the do-it-yourself gospel. In a way, it’s impressive that they agree as much as they do. Olen, for instance, does concede that paying off your smallest debt balances first does seem to work well in practice, even if it doesn’t necessarily make sense on a mathematical level. (Again, Ramsey is here pushing his followers in the direction which feels most natural to them, to the benefit of them both.)

And if America is going to become a more financially healthy country, it is going to have to address its money problems on both the individual and the policy level. The Pew Charitable Trusts have just released a huge report on payday lending, with some very sensible ideas about how it should be regulated nationwide. That’s a great policy recommendation, and I daresay Dave Ramsey might even approve of it. But at the same time, the discipline of the Ramsey method really does work on an individual level. So let’s not snipe too much at his gospel. His investment advice is bad, and his saving-and-paying-down-debt advice can be simplistic. But on net, Ramsey is improving the plight of millions of America’s households. Which has got to be a good thing.

COMMENT

Ramsey unapologetically argues that the poor and the indebted are “weak-willed, self-indulgent, and stupid”. He claims that income inequality is a myth – even though the proof is in the proverbial pudding, backed by significant research. Should we not forget that it was that data, when made public, that spawned the Occupy movement? Here is first-hand evidence that corporations, CEOs and the 1% need to respond to the public. Though the Occupy movements failed to affect change (because of corruption so deep, and assumptions about the 99% so egregious) it made one message clear: people are watching. And, with the use of technology, their views, actions and thoughts go viral. It also made clear that instead of listening, the wealthy were more intent on arguing about their right to wealth instead of how we could bridge the ever-expanding gap.

I’m not suggesting that there be a lack of accountability. Individuals need to practice self-restraint and frugality in their individual lives. But, as long as big money preys on small money, with empty promises of a changing economic landscape that will make their debt manageable after a time, small money will continue to accumulate, and the economic inequality will continue to grow, creating an arcane class system we pity in other countries. Bruce Piasecki says in his book Doing More with Less, “The physical push for doing more with less is born from corporate discipline and personal choice, more than from any kind of government policy.” The public will learn from corporations, but the corporations need to respond to the public, not fight against it. Once there is some harmony there, policies will change.

Anyone who has ever read Doing More With Less would understand that economic inequality and the wealth distribution issue is systemic, and is not – as Ramsey suggests – the result of one’s personality traits. What Piasecki suggests, is Social Response Capitalism. He argues that the poor in fact, do so much with so little. The answer is not simply “self-control of our wallets.” It is about being competitively and creatively frugal, living with less, and redefining the economic infrastructure by responding to societal issues, opinion and financial constraints. Blaming individuals for this mess is ignorant. To solve the problems that prevent financial health you need a bigger view and to employ Piasecki’s “art of competitive frugality”. http://www.doingmorewithlessbook.com
Listen to it here: http://www.amazon.com/Doing-More-Less-Th e-Wealth/dp/B00AETP4TY

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Apple should be like Bloomberg

Felix Salmon
Oct 29, 2013 20:20 UTC

I’m very glad that the WSJ has published today’s debate between Farhad Manjoo and Dennis Berman on the subject of Apple. Manjoo has been writing some very insightful columns about the company, including the one yesterday which explained that Apple has many better options, when it comes to spending its cash, than taking Carl Icahn’s advice and essentially mortgaging the entire pile to conduct a stock buyback.

The Manjoo vs Berman debate displays two important phenomena surrounding nearly all public companies. Firstly, there’s the confusion between a company and a stock; and secondly, there’s the bigger problem with going public in the first place.

Upon going public, every company is doomed to be judged by its share price — and, all too often, it’s doomed for the share price to become more salient, in the public’s mind, than the company itself. Icahn, as a speculative shareholder, has only one interest in this game: he wants the share price to rise, so that he can then sell his shares at a profit. And Berman is, conceptually, on Icahn’s side. He talks about what investors want, and says that if Apple makes a lot of money, “there will be no choice but to give back significant sums to shareholders.” He also likes the idea of Apple racking up vastly more debt than it already has:

Right now, Apple has 30 cents of debt for every dollar it brings in yearly EBITDA. The median figure for the Standard & Poor’s 5000-stock index is $1.90 – or basically six times Apple’s current ratio, according to figures compiled using CapitalIQ. Were Apple to have a median amount, its current debt would move from $17 billion to $108 billion. Is that crazy? No.

In short, Apple’s business model exhibits the rarest traits seen in nature: relatively low capital demands and immense profit generation.

This would be funny, if it weren’t so depressing. Berman concedes that Apple is an extremely rare outlier in the corporate world: it makes a lot of money without having to invest a huge amount up front. Most companies which aren’t Apple, by contrast, have to borrow and invest a huge amount of money before they can start generating earnings. Berman’s bright idea, here, is that if Apple is fortunate enough not to have to go into massive debt to finance its investments, then, er, it should go into massive debt anyway, just because everybody else is doing it.

What good would that huge new debt pile actually serve? Well, it might help increase the share price — or it might not, who knows. (Icahn, for his part, is convinced that the share price will rise either way: he says in his letter to Apple that “the opportunity will not last forever”.) Obviously, it would also burden Apple with billions of dollars of fresh liabilities, in the form of new interest and principal payments. But Berman is unfazed: in his world, liabilities are assets, and assets are liabilities. Seriously: he says, on the liability front, that “the key to keeping Apple sharp will be actually to push more money than comfortable back to shareholders”. And on asset side of the balance sheet, he describes Apple’s cash hoard as “something of a liability”, on the grounds that it is “stranded and unproductive”. (Never mind that even under the Icahn plan, the cash hoard will remain untouched, and be just as stranded and unproductive in future as it is right now.)

This is the mindset of the financial engineer, and while it can make lots of money for corporate raiders, that doesn’t make it a good idea. Berman is a fan of Icahn: “the man doesn’t have stadiums named after himself for no reason,” he writes. Well, yes: the reason is that he spent lots of money to have his name put on those stadiums. He’s a wealthy individual. But Berman seems to think that anything which makes Carl Icahn rich must therefore be the right thing to do.

But here’s the thing: Tim Cook is a caretaker of a company which is designed to be around in perpetuity. Icahn, on the other hand, for all that he claims that “there is nothing short term” about his intentions, still has an exit strategy: he wants to buy low, drive the share price up through shareholder activism, and sell high. Apple should go along with Icahn’s plans only if they increase the long-term value of the company — and it’s pretty obvious that they don’t: Icahn is, at heart, advising Apple to have both large borrowings and a large cash pile at the same time. Which is bonkers.

Manjoo, on the other hand, definitely sees Apple as a company — a company navigating a highly fluid environment, and one where most of its profits come from a single product, the iPhone. Apple needs to stay one step ahead of what consumers want, says Manjoo, and it’s much easier to do that if you’re not saddled with interest payments. Even Manjoo, however, has internalized Silicon Valley’s fetish for endless growth, even when the company in question is already a giant. “What I’m arguing,” writes Manjoo, “is that Apple begin using its cash to act like a different kind of company — that it act like the big-thinking, future-proofing, market-share-buying behemoth it could be… the boldest thing Apple could do with its cash is transform itself into a different kind of company.”

Manjoo’s “different kind of company” is a lower-margin company: one where Apple decides to “give away a lot more free stuff”, and buys market share, or even buys a cellular carrier. This is much less stupid than Berman’s idea. The single most exciting thing about my new iPhone 5s has nothing to do with Apple: instead, it’s T-Mobile’s free international data.

But even Manjoo is working on the assumption that all companies must always want to grow at all times — even if that means becoming “a different kind of company” altogether. Hidden just beneath Manjoo’s writing is a pretty Berman-esque assumption: that the share price should go up rather than down, and that Apple should do everything it can to ensure that outcome. When Manjoo exhorts Apple to “act before trouble hits”, the trouble he has in mind is basically anything which causes the stock price to fall significantly lower than it is already.

So let me put forward an even more radical idea: Apple should just keep on doing exactly what it’s doing. For substantially all of its history, Apple has been a luxury retailer, making beautiful, functional, high-end goods. Its retail stores are in the most expensive neighborhoods, and it never discounts — much like Louis Vuitton. Its products are status symbols. And they can cost eyebrow-raising sums of money: the new Mac Pro, for instance, starts at $3,000 — and that doesn’t even include a screen.

In general, companies are good at doing what they do well, and they’re not good at doing what they don’t do well. That’s one big reason why mergers, and pivots, generally fail. Apple is fantastic at product design, and at maintaining extraordinarily high quality standards on everything it produces. At some points in time, its products touch the public nerve more than they do at other points. No one expects the iPhone’s dominance to last forever: that’s why Apple is trading at about 13 times earnings, while Google’s multiple is more than twice as high. (Don’t even get me started on Amazon.)

Debt makes sense when you need money to invest today, and can repay that money with a substantial future income stream. Apple is in the exact opposite situation: it needs no money to invest today, while its long-term future income stream is quite uncertain. So it makes sense to save up in flush years, like it has been doing. It will continue to create amazing new products; what’s less clear is whether any of those new products will have the ability to become a world-conquering profit monster like the iPhone. The job of the markets is simply to price the shares accordingly; it’s not the job of management to change the deep structure of the company just to make the markets happy.

Steve Jobs always regretted going public. He raised very little money by doing so, and in return he ended up with people like Carl Icahn constantly second-guessing his decisions. Jobs was good at ignoring such gadflies; his successor, Tim Cook, is a little more shareholder-friendly. But shareholders really do nothing for Apple, which hasn’t had a public stock offering in living memory, and which has so much money now that it can pay its employees large amounts of cash to retain talent, instead of having to force them to gamble with restricted stock units.

In other words, Apple should be run a bit like Bloomberg: as a profitable company which pays well, which concentrates first and foremost on making its product as great as possible, and which doesn’t try to be something it’s not, or allow itself to be distracted with financial engineering. Sometimes its stock will go up, and sometimes its stock will go down. But the company, and its core values, will endure.

COMMENT

In a slight defense of the new Mac Pro, while its price does represent some level of Apple premium, nobody is selling Xeon-class workstations with dual GPUs for real cheap, either.

But as a long-time Apple customer (going back to an Apple II+ in 1979), I’ve been pretty disappointed in the iOSsification of the Mac that’s been happening over the past few years, and having been moving a lot of my work to Linux.

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China’s broken art market

Felix Salmon
Oct 28, 2013 21:11 UTC

When 2011 came to an end, the dominance of Chinese artists in the international league tables was clear, if puzzling. Three of the top five artists, in terms of sales, and both of the top two, were Chinese; Zhang Daqian alone managed to gross more than half a billion dollars at auction that year, the first time any artist had come anywhere near that level.

But no one knew what was really going on. One theory — which the peddlers of art-auction data implicitly supported — was that what you saw was simply the facts of the new art world, and that Chinese artists were suddenly on fire. Another theory was that the auction results were real, but that the relative standings of Chinese and western artists were skewed by the fact that Chinese works were more likely to come up for auction, while western works are more likely to change hands privately. And then there were lots of theories about how the numbers couldn’t be taken at face value at all: one oft-cited article from June 2011 talked about the way in which fine art is used in China as a means of “elegant bribery”.

Now, as Bloomberg comes out with a new league table showing that 8 of the top 20 top-selling artists born since 1980 are Chinese (compared to just four who are American), the NYT unveils its latest huge multimedia project: a deep investigation of the Chinese art market, complete with the revelation that the $65.4 million sale of “Eagle Standing on a Pine Tree” a 1946 ink painting by Qi Baishi, never in fact happened. That was the public auction price, but then the buyer never paid — a very common occurrence, it seems, in China.

So, what’s the truth about the Chinese art market, and has the NYT captured it? For one thing, a good third of the public auction-result data should be simply ignored, on the grounds that the pieces in question never actually sold. This includes, ironically enough, the clever interactive chart in the NYT article itself, showing the best-selling artists in the world from 2006 through 2012. Beautifully tractable databases are like that: even when you know they’re deeply flawed, you still end up using them anyway, because they’re the best thing you’ve got.

What’s more, the velocity of Chinese art is vastly higher than the velocity of western art, where paintings very rarely get resold within a few years of being bought. In China, by contrast, a single painting by Qi Baishi has sold four times at auction in the last 10 years, at prices ranging from $30,000 to $794,000.

The result is twofold: firstly, per-artist totals get artificially boosted by the rate at which works are resold. And secondly, the art market becomes a genuinely speculative bubble (unlike its western counterpart), where people buy just because they think they’ll be able to flip their property for a big profit.

Yes, “elegant bribery” happens as well — where a businessman will gift a work of art to some party official, the official will put it up for auction, and then the businessman will buy it at a very high price, after making sure an underbidder is in place to bid up the final amount. But also, in a country with a savings rate of more than 50%, there’s insatiable demand for just about anything which can be considered an investment:

“A majority of Chinese people do not trust the Chinese stock market,” said Melanie Ouyang Lum, a consultant on Chinese art. “The housing boom has slowed tremendously. A lot of people are looking to art for investment.”

But the main phenomenon behind the NYT story, it seems to me, is a weird and uncomfortable marriage between eastern and western conceptions of where value lies in the art market. The western art market emphasizes originality and authenticity, with the result that everybody wants to buy a relatively small number of important works and important artists. If a work is a fake, then it’s worthless, no matter how beautiful it might be.

In China, by contrast, there’s much less of a premium paid on originality, and many masters came up through the ranks by copying the works of their predecessors. That Qi Baishi painting, for instance, dates only to 1946, but could have been painted at any time in the past few hundred years: its style is timeless. On top of that, art is a manufactured commodity in China, where workshops with hundreds of employees churn out copies of the work of the masters. This makes perfect sense, if what you’re doing is creating something aesthetic to go on the wall. The problems start to arise when the art objects rise in value, according to whether or not someone believes them to be authentic.

My favorite story in the NYT article concerns another master, Zhang Daqian, who visited the University of Michigan Museum of Art in 1967 to view an exhibition of the works of Shitao, a 17th-century painter.

His tour guides were proud to show him the works of such a famous painter, who had died more than two centuries earlier. So they were surprised when Mr. Zhang began to laugh and point to various works on the wall, saying: “I did that! And that.”

“That is how Zhang Daqian talked,” said Marshall Wu, a retired professor at the University of Michigan who first met Mr. Zhang in the 1960s. “You never really knew if he was serious or kidding. But he did a lot of Shitao forgeries.”

Don’t think of the “forgeries” here as being a sophisticated con job: Zhang considered it his job to copy Shitao, and seeing his works hung up in a museum as being Shitao’s simply delighted him. If his painting was as good as the master’s, then it was as valuable as the master’s. And of course Zhang’s “forgeries” are far from worthless: in fact, as original Zhang paintings, they might now be worth more than a Shitao.

But in the auction world, no one pays $65 million for a beautiful object: it also needs to be authentic. Hence the predicament in which the Chinese auction market finds itself. Frankly, I would rather see a world where paintings were judged on their inherent aesthetic qualities, and the identity of the painter didn’t matter. After all, even genuine works of the masters are often painted in whole or in part by their assistants. But the present situation in China is clearly the worst of both possible worlds, both incentivizing and demonizing the copying which has been the heart of Chinese art for centuries. One thing is clear: it’s not sustainable, over the long term. Which means that if you’re speculating in Chinese art, you’d better have your exit planned out. Because the bubble is certain to burst, and it could happen at any time.

COMMENT

Why so quick to nay-say all things from China?
Much of what NYT says about the China art market could equally be said about London and NYC. We are living in a globalized art industry which is not particularly transparent and not particularly well regulated. Why does the media run for its handkerchiefs every time NYT sneezes? Rather than doing their own research and reporting!

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