Felix Salmon

The damage already done by the debt ceiling debate

Felix Salmon
Jul 14, 2011 17:55 UTC

Listen to anybody on Capitol Hill, and they’ll tell you that the debt ceiling debate is turning into a complete disaster, with the Republican rank and file such an inchoate mess that it increasingly seems as though no deal will get done at all. Look at the Treasury market, however, where the 10-year bond currently yields something less than 3%, and it looks decidedly sanguine; short-term debt maturing shortly after the drop-dead date of August 2 is similarly unaffected by the news from Washington.

Megan McCardle thinks this shows a “giant disconnect” between Wall Street and Washington — things which Wall Street thinks are easy turn out in reality to be extremely hard, and things which any Wall Streeter would just do as a matter of course can be de facto impossible when political posturing starts getting in the way.

I’m not sure the disconnect is all that huge, for a couple of reasons. For one thing, US default risk is impossible to hedge. US default is an end-of-the-world event, and markets by their nature can’t price such things. Conceptually, there’s no point in buying something which pays off if the world ends, since the world will have ended at that point, and in any case your counterparty won’t be able to make good on the contract.

On top of that, remember that we already hit the debt ceiling on May 16two months ago. Since then, the amount of outstanding Treasury securities — a number which normally rises steadily — has been stuck at $14.3 trillion. The fact that supply of Treasuries has been artificially constrained by the debt ceiling has surely, at the margin, helped to support prices.

And more generally there are still a lot of individuals and institutions who want to buy Treasury bonds. That number might have been falling in recent weeks, but it’s still large. The U.S. is not facing the kind of emergency we’re seeing in the eurozone, where countries want to borrow money but no one’s willing to lend to them. If Treasury asks to borrow money from the markets, the markets will always lend it money; the only question is how much interest they will charge.

This is where McArdle goes awry, incidentally: she’s worried that any new debt issued after August 2 won’t be able to find buyers if Congress doesn’t raise the debt ceiling. But there will always be buyers, and there will always be buyers at yields very, very close to the secondary-market price for Treasury bonds. Treasury bonds are fungible, and to underscore that fact Treasury could easily just reopen old bond issuances instead of creating new ones. That would ensure that there was no way of telling the difference between bonds issued “legally” and bonds issued after the debt ceiling was breached.

Even if Treasury can still sell bonds, however, that doesn’t mean for a minute that breaching the debt ceiling is something which should be considered possible for the purposes of the current negotiation. Tools like the 14th Amendment or even crazier loopholes like coin seignorage would be signs of the utter failure of the US political system and civil society. And that alone could mean the loss of America’s status as a safe haven and a reserve currency. The present value of such a loss? Much bigger than $2 trillion. (Coin seignorage, if you’re wondering, is the right that Treasury has to mint a couple of one-ounce, $1 trillion coins and deposit those coins in its account at the New York Fed. It could then withdraw cash from that Fed account to make all the payments it wanted.)

This is one reason why I worry a lot about clever ideas like Mitch McConnell’s plan to get the debt limit raised through a novel use of the Presidential veto — or, for that matter, Matt Yglesias’s even cleverer plan for Democrats to game the McConnell scheme. McConnell is one of Congress’ foremost tacticians, but cunning tactics on either side of the aisle are the last thing that anybody needs right now.

When Bob Rubin did a nifty sidestep around Congress and magicked Mexico’s bailout billions from some dusty account no one knew about, he was playing a dangerous game. When Hank Paulson and Ben Bernanke stretched the limits of their powers almost beyond the legal breaking point during the financial crisis, their actions were understandable but also set yet another precedent. And so now, when there’s no immediate emergency at all, people are looking to the executive branch to find a way to do the right thing, and thereby giving Congress implicit permission to play out and generally behave with all the maturity of a group of rampaging destructive adolescents.

The base-case scenario is, still, that the debt ceiling will be raised, somehow. But already an enormous amount of damage has been done: the US Congress has demonstrated clearly that it can’t be trusted to govern the country in a responsible manner. And the tail-risk implications for markets are huge. Think of the speed with which the Egyptian government collapsed earlier this year, or the incredible downward velocity of News Corporation right now. When you build up large stocks of mistrust and ill will, nothing can happen for a very long time. But when something does happen, it’s much quicker and much worse than anybody could have anticipated. The markets might not be punishing the US government at the moment. But the mistrust and ill will is there, believe me. And when it appears, it will appear with a vengeance.


Salmon isn’t much of a negotiator and I wouldn’t want him anywhere near crucial negotiation. I could see his palms sweat and his eyes twitch in between sentences.

The big problem with this piece is it isolates out the debt ceiling from the debt. That wrenches the current negotiations out of the context of federal government spending and taxation. That’s a killing mistake and makes this piece worthless.

Let me add some of that back in and maybe Salmon can start to make sense of what’s going on.

The USFG is projected by everyone to take rapidly increasing shares of the US GNP under even very optimistic assumptions. That’s a certain catastrophe for this economy: economists estimate that 25-35% of GNP for all levels of government maximizes growth. Under Democratic proposals and baselines, the USFG takes at least that amount, just for itself, for decades to come. That is a catastrophe for economic growth: it entombs our economy in a permanent rotting decay.

That problem isn’t solved with more tax revenue, it is exacerbated. Because it is certain that politician-weasels will spend every penny of revenue and use more revenue to leverage even more spending. There is NO prospect that Obama or the Democrats would make any substantial spending cuts in the foreseeable future. The Obama budget that was unanimously defeated this Spring increased spending across the board, in fact.

The debt is a related, but distinct issue from the total portion of the economy that politicians take to hand over to their cronies. And escalating debt also crushes the future by undermining economic growth. More importantly, my son is 1 year old and unless we take action, his life chances will be substantially undermined. He and your sons and daughters will be handed massive debt that they will have to pay back. That is, by my account, evil. What sort of moral disaster thinks its ok to consume today and force their children to pay for that consumption the rest of their lives? Evil.

This moment is a chance to do something meaningful about both of those problems. To scale back the size of the federal government and to meaningfully lower federal debt. Felix Salmon, Megan McCardle, Harry Reid, and Barack Obama need to think things through, this one time, and do the right thing, this one time. Instead of what they are doing.

Posted by Mikor | Report as abusive

Does John Boehner know what paychecks are made of?

Felix Salmon
Jul 8, 2011 13:25 UTC

It’s incredibly difficult to work out what is the most depressing part of today’s truly gruesome jobs report. The shrinking number of people in the labor force? The rise in U-6, broad underemployment, to 16.2%? The sharp spike in the newly unemployed? The downward revisions to April and May? The downtick in total hours worked? Maybe it’s the way that people leaving government jobs, for whatever reason, are finding it impossible to find new jobs in the private sector.

For me, it’s none of these things — it’s not, in fact, anything inside the report at all. Instead, it’s the reaction to the report from John Boehner:

“The American people are still asking the question: where are the jobs? Today’s report is more evidence that the misguided ‘stimulus’ spending binge, excessive regulations, and an overwhelming national debt continue to hold back private-sector job creation in our country. Legislation that raises taxes on small business job creators, fails to cut spending by a larger amount than a debt limit hike, or fails to restrain future spending will only make things worse – and won’t pass the House. Republicans are focused on jobs, and are ready to stop Washington from spending money it doesn’t have and make serious changes to the way we spend taxpayer dollars. We hope our Democratic counterparts will join us and seize this opportunity to do something big for our economy and our future, and help get Americans back to work.”

Opinions of the budget deficit and the national debt differ — some people think they’re a huge and important issue which needs to be dealt with in an urgent and serious way, while others think that the whole issue is overblown and that the debt is doing little if any harm at all to the US economy. But whichever side you stand on that debate, it’s downright bonkers to think that, at the margin, government spending reduces job creation, while pushing for ever-larger spending cuts is the way to be “focused on jobs”.

As Paul Krugman has explained extremely well, the economics of the deficit are not entirely obvious, and the president is no natural Keynsian.

The president just doesn’t like the kind of people who tell him counterintuitive things, who say that the government is not like a family, that it’s not right for the government to tighten its belt when Americans are tightening theirs, that unemployment is not caused by lack of the right skills. Certainly just about all the people who might have tried to make that argument have left the administration or are leaving soon…

To commenters saying that I need to have dinner with the president, or vice versa — been there, done that, didn’t help.

But if Krugman’s Keynsianism is unintuitive, the Republican stance on jobs is downright incomprehensible. Paychecks are made of money: they’re spending. If you spend less, you get fewer and smaller paychecks.

“Spend less money, create more jobs” is the kind of world one normally finds only in Woody Allen movies, and it’s a profoundly unserious stance for any politician to take. Spending cuts, whether they’re implemented by the public sector or the private sector, are never going to create jobs. And there’s simply no magical ju-jitsu whereby government spending cuts get reversed and amplified, becoming larger private-sector spending increases.

Boehner’s rhetoric, here, is a cynical play on our nation’s economic illiteracy. But the jobs crisis is far too big and too important to become a tactical political football. Now more than ever, it’s the job of government to come together and to do something constructive to create high-quality, long-term employment. Fast. Instead, the House majority is giving us aggressively harmful stupidity. Today’s a bad day in the annals of job statistics. But it’s equally bad in the annals of public service.



BP and fracking and the enviroment are of concern to everyone, myself included, that’s why oil drilling and shale gas exploration are heavily regulated. I’m not for one instant saying that they should be unregulated.

I was challenging the obvious fallacy that regulations don’t affect investment and employment.

In some instances regulation might actually increase employment. In my state they have reduced the number of lobster traps allowed per lobster licence several times. This has allowed more people to make a living in the lobster business at the expense of the really ambitious hard working lobstermen that use to fish 16 hours a day 6 days a week.

@DanHess total kudos to your ideas. I agree with your assessment that energy scarcity will dwarf all current issues much sooner than many expect. Lets change some regulations and put wind turbines up in all but the most critical envriomental areas of my state and solar farms in all but the most critical areas of the arid southwest.

Posted by y2kurtus | Report as abusive

Can employment ever catch up with productivity?

Felix Salmon
Jun 22, 2011 18:19 UTC

I moderated a panel on financial innovation yesterday, about which more when I get the video. But there was a lot of talk of leverage, which is the hidden turbo-charger in a lot of financial innovations, from credit default swaps to structured investment vehicles. And there was a general consensus that if you want to create prosperity and jobs, then leverage is in principle a good thing: more debt means more growth which means more prosperity. For a prime example, see this post from Gregory White, who reckons that whenever household debt is going down rather than up, “the economy will stink.”

In reality, however, things are rather more complicated. And Jared Bernstein has a great post up explaining one of the big problems: Over the past 30 years or so, unemployment has been high, compared to the previous 30 years, when unemployment was low. When unemployment is low, productivity gains go to labor; when unemployment is high, they go to capital. And that’s a big reason why median family incomes have been massively lagging productivity growth since 1979, even though the two moved pretty much in lockstep during the postwar period.

The challenge I put to the panel yesterday was to come up with an innovation which produces more growth with less leverage, after an entire generation in which debt has been growing much faster than GDP. Better yet, come up with an innovation which produces more jobs with less leverage. We still have healthy productivity growth. How do we channel that into employment, rather than dividends for plutocrats? The fund managers and CEOs on my panel weren’t much help on that front. But that’s the real challenge facing developed economies today, and I suspect that if we look at Germany, we might be able to find a few clues.


Having moved from Australia to Germany almost 2 years ago the main differences that Felix might be referring to:

- a strong school education system with equivalent quality universities (that don’t leave students with crippling debts) or pervasive apprenticeships (in all industries, not just traditional “hand work” ones)

- a distaste for debt. People here prefer cash (or the electronic version thereof) and it’s quite common to be unable to use a credit card. A modest mortgage is the limit most people undertake and unmanageable credit card debts are a rarity. This seems to extend to companies too which leads me to…

- a preference for organic growth. The Mittelstand are mentioned so often because these are small-medium companies who punch above their weight in their respective markets but still maintain a focus on longevity all the while compensating all employees generously. In most cases they avoid taking on debt which allows them to ride out cyclical events better although they do get some help from…

- government initiatives like “kürzarbeit” (literally “short work”) helps to smooth out the impact of the business cycle on employment. Businesses reduce hours instead of laying people off and employees get some assistance from the government. The business wins by retaining skilled staff, the employees win by not being laid off and the government wins by spending less than full unemployment benefits.

Posted by MartinBarry | Report as abusive

Charts of the day: The rise in structural unemployment

Felix Salmon
Jun 20, 2011 18:28 UTC

Is this jobless recovery a peculiarly American phenomenon? This chart, from a new paper seeking to unentangle cyclical from structural unemployment, would suggest that it possibly is:


I find these numbers quite shocking: after all, it’s hardly as though countries like the UK and Portugal have emerged from the recession unscathed. But the US increase in unemployment over the course of the recession was more than double the increase anywhere else.

That said, the US has historically has a much lower rate of structural unemployment than most of these other countries: the level of unemployment which is baked in to economic reality, before cyclical factors move it temporarily up and down. And what I fear is that the Great Recession has moved the US towards European levels of structural employment, without any kind of Euro-style social safety net.

Here are the charts for what’s happened to structural unemployment in the US. The red lines are the official employment rate; the blue lines are the structural employment rate. The first chart shows the unemployment rate overall; the next four break it down into people unemployed for less than five weeks; people unemployed for between five and 14 weeks; people unemployed for between 15 and 26 weeks; and the long-term unemployed who have been out of work for more than six months.


What’s going on here is pretty clear. For short-term unemployment, little has changed: the structural rate has been around 2% for decades. But look at any of these charts and they show structural unemployment at an all-time high, with the situation getting much worse the longer the duration of unemployment. Overall, the structural rate of unemployment is now more than 8%, which means that we’ll only dip below that level temporarily, during cyclical upturns.

Measuring structural unemployment is, of course, more of an art than a science, and I’d be astonished if any economist agreed with all of the figures in this paper. That said, it’s entirely intuitive to believe that structural unemployment rose significantly over the course of the recession, and that it’s now painfully high. And that the Obama Administration is, to a first approximation, doing absolutely nothing to address this crisis head-on.


“America no longer has much work for someone who hasn’t gone to college, but has a strong back and strong muscles and is willing to work hard.”

Unless you’re an illegal alien, in which case you are one of the Chosen People.

By the way, America no longer has much work for people in a lot of white collar professions as well.

Posted by lsjogren | Report as abusive

When will incomes return to their 2006 level?

Felix Salmon
Jun 9, 2011 16:41 UTC

What happens if, instead of measuring GDP by adding up all the money spent in the country, you measure it by adding up all the money earned in the country? Theoretically, the two measures are identical, but in practice, there can be differences. Justin Wolfers has this chart:


The red line, here, is a more reliable measure of national income than the blue line, which is the official GDP number. And it gives a sobering indication of just how devastating the Great Recession was: a drop of more than 7% in real GDP per capita between the end of 2006 and the end of 2009, with most of that decline taking place before the collapse of Lehman Brothers and the subsequent financial crisis.

Writes Wolfers:

It’s going to take a long while to return to where we were back in 2006. Most forecasters are expecting GDP to grow by around 3 percent, implying per-capita growth closer to two percent. At those rates, average incomes in 2013 will (finally!) be back around the levels of 2006.

I’d note that “average”, here, refers to the mean, not the median. The effect of Ben Bernanke’s monetary policy has been to funnel large amounts of income to bankers and plutocrats, even as the employment situation remains woeful, so you can be sure that median incomes are going to take significantly longer to return to their 2006 level than mean incomes. They’ll get there eventually, I’m sure. But it could take a decade.


If you go to BEA.gov they have all of the gdp, income and corporate profits numbers. The Brookings paper is explaining why earlier estimates of GDP calculated from income data ended up being a better predictor of actual GDP than the early estimates of GDP based on expenditures. So basically it’s better at producing a more accurate delta in the short term, less accurate in overall sizing with more time and data to get expenditure data. And one of the main data points they have is that trend growth of GDP (i) was more accurate in the late 1990s when early GDP (e) numbers were underestimating growth. Still just because this trend was true in the past doesn’t mean it will continue to be true in the future, in this case hopefully the GDP (i) numbers have been underestimating growth and overestimated the decline.

Posted by tuckerm | Report as abusive

Chart of the day: GDP growth and volatility

Felix Salmon
Jun 8, 2011 19:09 UTC

Alan Taylor has one of those op-eds today which is crying out for a chart. He’s comparing DMs, developed markets, to EMs, emerging markets*:

A central macroeconomic indicator, gross domestic product growth and its volatility, speaks to the reversal of fortune. Circa 1970, EMs exhibited high mean and high variance relative to DMs; but after 1980 this risk-reward combination evaporated as EMs suffered a lost decade. But from the 1990s EM growth picked up and volatility moderated; DM growth slowed and, after the crisis, volatility spiked.

What does this look like in graphical form? Here’s the chart, which is taken from a recent Morgan Stanley research report:


As with any chart where time isn’t on the x-axis, this is very interesting and also takes a little time to fully comprehend. Basically, if you look at the DM line — that’s the dark blue one, representing developed economies — you see average growth rates declining steadily all the way from 1980 through the present day. That was something we accepted during the Great Moderation, kidding ourselves that even though we weren’t growing as fast as the emerging world, at least we were growing with very low volatility.

Then the crisis hit, and GDP volatility hit levels unprecedented in recent economic history, at least in the developed world, with standard deviations moving up towards 3 percentage points.

Meanwhile, the emerging world has a much higher mean growth rate — around 9%, compared to the developed world’s 3.5% or so — which has been rising steadily in recent years even as volatility in that growth rate has declined towards developed-world levels. Emerging-market GDP volatility isn’t yet lower than developed-world GDP volatility, but it’s close. And given the tiny difference in volatility, the enormous gap in absolute size is all the more striking.

This chart, in a nutshell, explains why American companies are all falling over themselves to make inroads in China, and other emerging markets. They’ve had strong growth for a while, but now they’re pretty stable, too. Here’s Taylor, again:

What would have been your reaction, circa 2006, to someone peddling the following forecast? There would soon erupt the worst, synchronised global financial crisis in 80 years, or possibly ever. World trade would start to collapse as fast as in 1929-31. Many developed markets (DMs) would experience deep recessions, the costliest banking crisis ever and would stagger toward fiscal calamity. But – guess what! – emerging markets (EMs), after a brief panic, would sail on unscathed. They would have no significant crises: currencies, banks and fiscal positions would retain stability. A two-track recovery would take EM growth on to a trajectory away from a troubling slump in the DM world.

That world might not have seemed likely five years ago. But it’s the world we’re living in today. And it’s the base case scenario for the foreseeable future, too.

*Update: In response to inboulder, in the comments, here’s the list of the countries used, from page 11 of the PDF:

List of EM countries and ISO codes: Taiwan (TWN), India (IND), Indonesia (IDN), Korea (KOR), Malaysia (MYS), China (CHN), Singapore (SGP), Hong Kong (HKG), Thailand (THA), Brazil (BRA), Mexico (MEX), Peru (PER), Colombia (COL), Argentina (ARG), Venezuela (VEN), Chile (CHL), Russia (RUS), Poland (POL), Czech Republic (CZE), Hungary (HUN), Romania (ROU), Ukraine (UKR), Turkey (TUR), Israel (ISR), SA (ZAF).

List of DM countries and ISO codes: United States of America (USA), Germany (DEU), France (FRA), Italy (ITA), Spain (ESP), Japan (JPN), United Kingdom (GBR), Canada (CAN), Sweden (SWE), Australia (AUS), New Zealand (NZL), Austria (AUT), Belgium (BEL), Denmark (DNK), Finland (FIN), Greece (GRC), Iceland (ISL), Ireland (IRL), Luxemburg (LUX), Netherlands (NLD), Norway (NOR), Portugal (PRT), Switzerland (CHE).


I’m still curious about the formula of GDP Volatility. Is the formula lagged variable from spesific period? If we count the GDP volatility of country in period, does it mean we will have one value? or variate values of years?

Posted by Vinland | Report as abusive

A weaker dollar doesn’t mean you’re earning less

Felix Salmon
May 5, 2011 21:54 UTC

Matt Yglesias says that there’s no difference between currency depreciation and real wage cuts:

Your wages are denominated in dollars, so if the value of a dollar declines your real wages decline. Currency depreciation isn’t an alternative to real wage cuts, it’s a mechanism by which real wages can be cut.

This isn’t really true, unless you’re being paid in dollars and living abroad. On a trade-weighted basis, the dollar has declined by about 11% in the past 10 months or so. Does that mean that my real wages have fallen by 11% in less than a year? Should responsible employers wanting to keep their employees’ wages constant on a real basis have given them all an 11% pay hike in dollar terms? Of course not.

In order to convert nominal dollars into real dollars, you use inflation, not any change in the value of the dollar. When the dollar depreciates, sometimes that shows up in inflation — and sometimes it doesn’t. After all, the dollar has been depreciating pretty steadily for a decade now, without any sign of inflation picking up.

What a cheaper dollar does do is make US workers cheaper relative to their foreign competitors. That doesn’t mean those workers are taking a real wage cut, any more than productivity increases are real wage cuts. But it can still improve the quality of life here in the US. The Treasury secretary loves to intone that a strong dollar is in the national interest. And maybe in some senses it is. But in other senses, a weak dollar can be very useful indeed for boosting employment and growth.


Seems to me you are both correct…

A falling dollar will increase the cost of imported goods, but that is only a small piece of GDP. Most of our economy is domestic and unaffected by exchange rates. Notable exceptions are energy (largely imported) and food (enjoys a strong export market).

If we’re worried about the rising food prices, we can stop turning corn into ethanol.

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Felix Salmon
May 4, 2011 18:23 UTC

18 months ago, Groupon didn’t exist. Today, it has over 70 million users in 500-odd different markets, is making more than a billion dollars a year, has dozens if not hundreds of copycat rivals, and is said to be worth as much as $25 billion. What’s going on here? There’s obviously something clever and innovative behind Groupon — but what is it? Given that customers with Groupons are saving lots of money on goods and services, how can this possibly be good for merchants? Is there a catch somewhere? Is TPG’s David Bonderman right when he says that “Groupon doesn’t do anything that four of us with a phone couldn’t do”? Or is there actually something very special about the company?

Bonderman’s thesis is basically that the value of Groupon lies in the company’s business model, and that since barriers to entry are basically zero, there’s therefore no value there. But I don’t buy that. There are significant network effects at play here: the more people Groupon signs up, the more targeted its deals can be. And there’s another social aspect to Groupon’s success I’ll come to in a minute.

But first it’s worth looking at the innovation in the name of the company: the idea that coupons only become activated once a certain minimum number of people have signed up for them. This is essentially a guarantee for the merchant that the needle will be moved, that their effort won’t be wasted. With traditional advertising or even with old-fashioned coupons, a merchant never has any guarantee that they will be noticed or make any difference. But with a Groupon, you know that hundreds of people will be so enticed by your offer that they’re willing to pay real money to access it. That kind of guaranteed engagement is hugely valuable, and more or less unprecedented in the world of marketing and advertising.

Then there’s the twist in the “coupon” part of the name. No longer do merchants pay money for the privilege of giving coupons away for free in local newspapers. Instead, they receive money — half of the total paid up front. There’s something extremely gratifying about being paid to offer discounts to new customers.

But there’s a lot more to Groupon than just groups and coupons. Groupons behave differently for different types of merchants, so let’s just look at one sector, which I think is Groupon’s biggest: restaurants. (One of the reasons that OpenTable’s share price is so high is that there’s a lot of hope it’s going to make serious inroads into this space, where it has certain advantages over Groupon, like being able to target people according to where they’ve eaten in the past.)

The most important aspect of a restaurant Groupon is probably that it’s local. Before Groupon came along, there was no effective way for merchants to reach consumers in their area, while excluding everybody else. If you’re a neighborhood restaurant, you don’t want to entice people who live miles away: you want to reach locals. And while Groupon isn’t quite there yet — especially in New York, where a restaurant more than a few blocks away can feel like a schlep — it’s orders of magnitude better at targeting than anything which came before it. And it’s improving every day.

(Incidentally, one of life’s great mysteries is why the New York Times is spending tens of millions of dollars building and promoting its easily-circumventable paywall, when it could have built a first-rate Groupon clone instead. The NYT has the exact home addresses — and the associated email addresses — of hundreds of thousands of well-heeled newspaper subscribers in a rich city of tiny neighborhoods. It also has a sales force which talks to local businesses regularly. It should own this space in New York City, instead of ceding it to arrivistes from Chicago who have much less specificity as to where exactly their subscribers live.)

Beyond that, there’s an uncommonly large number of ways in which participating in a Groupon deal can benefit a restaurant or other merchant. For one thing, the offer will go out to a targeted group of people in exactly your neighborhood — which means that even if none of them sign up for the deal, they’ll still have seen customized advertising for you, from a company (Groupon) which they trust.

And when a few hundred people have signed up for your deal, you get a huge amount of mindshare from them. Many will redeem the Groupon very quickly, but a lot of them will wait a while, thinking about you in the back of their minds all the time. If a friend asks whether they know a good local restaurant, they might well think of your name even if they haven’t been yet. And after they’ve been, they know exactly where you are and what you serve — information which you want locals to know but which can be very hard to broadcast.

More generally, of course, Groupons provide an important nudge to jolt people out of their day-to-day habits and try something new. A lot of us might see a new place open up and think to ourselves that we should try it some time; a Groupon turns that vague sense into something we really must do if we don’t want to lose the money we spent on the Groupon. By forcing people to pay for their Groupon, restaurants lock in new customers in a way that old-fashioned coupons never could.

In that sense, from the consumer’s perspective, a Groupon is a commitment device: it’s a way of forcing yourself to do something you really want to try at some point, but know that you might otherwise never get around to. The merchant persuades the consumer to make that commitment right now by making sure that the offer only lasts a very short time — usually only a day or two. The consumer knows that if they don’t buy the Groupon now, they’ve missed their chance.

Groupons can very good at driving traffic during slow periods: I spoke to Will Sanders, of Giorgio’s of Gramercy, and he told me that he timed its Groupon “to create a surge of business in an otherwise soft couple of months after the holidays.” For any kind of business which needs a certain amount of volume to keep ticking over in fallow times, Groupons can be exactly what the doctor ordered.

And although Groupons can be very deeply discounted, merchants can still make money on them. Indeed, in one survey by Utpal Dholakia of Rice University, 66% of merchants offering a Groupon said that the offer was profitable for them in and of itself — not including any subsequent repeat business from new customers.

At Giorgio’s, for instance, diners paid $15 for their Groupon — which gave them $30 of food. But dinner for two at Giorgio’s, with some kind of alcohol, can easily run to $100 or more. So even after knocking $22.50 off the bill (remember that Giorgio’s kept $7.50 of the proceeds of the Groupon), the restaurant would often still make money.

According to one Groupon survey, diners spending their Groupon at a restaurant averaged a check 80% greater than the face value of the Groupon itself. That’s no coincidence: the value of a Groupon is — or should be — carefully calibrated so that it’s hard to spend just the Groupon with no extra cash on top.

Merchants who get that calculation wrong can suffer greatly as a result: if you sell goods for $40, and you send out a Groupon offering $40 of goods for $20, then you’re likely to lose a lot of money very quickly. On the other hand, if your goods cost $100 on average, then you can make money on every redemption.

Does this mean that from a consumer point of view, we should look for deals where we can spend only the amount of the Groupon, and nothing more? Certainly that’s the route to greatest savings, on a percentage-of-total-spend basis. But that doesn’t mean it’s the sensible thing to do.

After all, if you spend good money on a Groupon and then have a meal you don’t like, that’s never going to be much of a bargain. On the other hand, if that Groupon helps you to discover a new neighborhood gem where you go on to become a regular, then that’s a genuine and highly valuable service that it has performed, no matter how much money you spend on your first visit.

If you’re already a regular somewhere, of course, then buying its Groupon is a no-brainer. And the restaurateur won’t begrudge you the savings, either: all restaurant owners want to treat their regulars as well as they can.

But if you don’t know exactly what you’re getting, then the risk is higher — and it’s not just the risk that you won’t like your meal. There’s also the risk of the restaurant being overcrowded with newbies bearing coupons — for that reason, it might be a good idea to wait a couple of weeks before redeeming your Groupon. On the other hand, there’s the opposite risk that your Groupon will expire unused, as you always mean to get around to redeeming it but never do. In which case it’s wasted money for you, and the restaurant doesn’t even get the opportunity to show you what it’s capable of. The only real winner in this case is Groupon itself.

Groupons are particularly attractive for restaurants, where the fixed costs are reasonably high and the profits start arriving only when you reach a certain level of volume. For merchants, by contrast, the deals can be less good: if you’re a bookstore, say, there’s a real risk that people will redeem their Groupon once, with the bookseller losing money on the transaction, and then simply revert to ordering books on Amazon thereafter.

On the other hand, as Giorgio’s Sanders notes, Groupons don’t work for all restaurants. “There are questions of prestige,” he says. “For Daniel, it would raise questions. For us, we’re a neighborhood restaurant, so it works well.”

Which brings me to the other important social aspect of Groupon’s success. For all that digital-marketing types love to talk about creating viral social-media campaigns and the like, social media is at heart a fantastic way for companies to compete on quality rather than marketing glitz. Social media is all about turning word-of-mouth into a tool which is much more powerful than it has ever been from a marketing perspective. And the best way to get great word-of-mouth is to deliver fantastic service. For a small company or even a large company which is great at what it does and never does any marketing per se, social media is a godsend.

And when it comes to the Groupon space, the quality and sophistication of the Groupon or Groupon clone matters a great deal. (One of the downsides, to a merchant, of running a Groupon is that the owners are then inevitably pestered by dozens of Groupon clones, all trying to sell a similar service.)

Groupon’s CEO, Andrew Mason, attributes his company’s success not to the genius of the idea itself, but rather to Groupon’s ability to execute — to keep both consumers and merchants happy. According to Groupon spokeswoman Julie Mossler, more than 95% of merchants would run their deal again or recommend Groupon to a fellow merchant. (Dholakia’s numbers are lower, but still high.) Keeping that number high is not easy: the company needs to be able to give good quantitative advice to merchants on issues such as where to price the Groupon, where to set the minimum and maximum number to be sold, how to avoid being overwhelmed by a huge influx of bargain-hunters, and the like.

It’s very easy to screw up these things, and if Groupon and similar companies like Gilt Groupe end up having a lot of long-term success, it will be because they put enormous amounts of effort into ongoing customer service, rather than just putting four sales guys in a room with a telephone and putting them on commission. Those brands will get slaughtered by the social-media word-of-mouth machine.

In the popular imagination, then, the idea behind a Groupon is that it attracts new customers to a restaurant, some of whom become regulars and therefore very profitable. Long-term profits from the few, in this model, make up for short-term losses from the many who will never return.

And that is indeed a central part of how Groupon works — it’s just not the only way that restaurants get value from the site. In that sense, restaurants are much like Groupon itself. It makes money on every sale — but it will only see its margins start to rise impressively if and when its merchants start coming back on a regular basis. At that point, the cost of setting up and selling a new deal comes down dramatically, and Groupon’s profits on the deal — after accounting for the cost of their salesperson’s time — rise substantially. Groupon itself, as much as its merchants, is counting on repeat business. And that comes from having a positive reputation which can spread like wildfire over Facebook and other social networks.



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chanel Cambon

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The real reasons for the dollar’s decline

Felix Salmon
May 4, 2011 01:24 UTC

Have you seen what’s happened to the dollar of late? It’s hitting all-time lows on a trade-weighted index. Must be Ben Bernanke’s fault: him and his QE2. Except it really isn’t. And Mark Dow, today, does a great job of explaining not only why the monetary-policy theory is wrong, but also what the real reasons for dollar weakness are.

For one thing, the dollar is basically just back to where it was before the crisis: the recent weakness is to a large degree an unwinding of the flight-to-quality trade we saw when everybody was worried about the world coming to an end. The real decline in the dollar took place between 2002 and 2008, when it went from 110 to 70 on the trade-weighted index. And there wasn’t any QE2 back then.

And if lax monetary policy were the main cause here you’d think that the dollar would be appreciating at the very least against the yen, given how the Bank of Japan is pumping hundreds of billions of dollars into its economy. But in fact the yen is strengthening against the dollar.

Meanwhile, says Dow, there are two “tectonic forces” driving the dollar lower. On the one hand there’s the simple fact that the world had 50 years of wealth creation in the wake of World War II, and much if not most of that saved wealth found itself in dollars. Over the past 10 years or so, however, the need and desire for global savers to hold their wealth in dollars has been evaporating, and citizens around the world — not to mention their central banks — have been much more comfortable holding assets in their own domestic currencies, as well as the euro. That trend is likely to continue:

This stock adjustment will continue until a new equilibrium is found. The dollar is some 63% of global reserves, but the U.S. is now only 20% of global output. I am not suggesting that equilibrium is at 20%, but 40% doesn’t seem like an intellectual stretch.

On top of that is the fact that US workers are massively overpaid compared to their equally-productive and well-educated counterparts in countries all over the world. There are a number of ways that the discrepancy can be narrowed: wages in countries from Slovenia to South Africa could go up; US wages can go down; or the dollar can simply depreciate. Which is a lot easier than nominal or even real wage cuts.

None of this is under the control of the Treasury Secretary or anybody else, no matter how often he repeats that a strong dollar is in the national interest. And the clear implication is that the dollar is going to continue to weaken for the foreseeable future. That’s not going to do much if any harm to the US economy. But it does add a certain amount of fuel to commodity-bubble fires.


Per work by David Ranson, head of research at Wainwright Economics, agreement on the commodities front, but exception on the comment that a weak dollar is not going to do much harm if any to the US economy.

Ben Bernanke’s recent forecast that the surge in commodity prices will be “transitory” merely shows how ignorant a well-trained economist can be. His and President Obama’s views are prime examples of George Orwell’s quip that “there are some ideas so wrong that only a very intelligent person could believe in them.”

Although politicians are aware of the commonly recognized connection between currency weakness and commodity price inflation, they are in denial about the easily demonstrated link between both of these market phenomena and inflation generally.

Luis de Agustin

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