The web economy blog

Archive for May, 2010

In the world of economics and finance, revolutions occur rarely and are often detected only in hindsight. But what happened on February 19 can safely be called the end of an era in global finance.

On that day, the International Monetary Fund published a policy note that reversed its long-held position on capital controls. Taxes and other restrictions on capital inflows, the IMF’s economists wrote, can be helpful, and they constitute a “legitimate part” of policymakers’ toolkit.

Rediscovering the common sense that had strangely eluded the Fund for two decades, the report noted: “logic suggests that appropriately designed controls on capital inflows could usefully complement” other policies. As late as November of last year, IMF Managing Director Dominique Strauss-Kahn had thrown cold water on Brazil’s efforts to stem inflows of speculative “hot money,” and said that he would not recommend such controls “as a standard prescription.”

So February’s policy note is a stunning reversal – as close as an institution can come to recanting without saying, “Sorry, we messed up.” But it parallels a general shift in economists’ opinion. It is telling, for example, that Simon Johnson, the IMF’s chief economist during 2007-2008, has turned into one of the most ardent supporters of strict controls on domestic and international finance.

The IMF’s policy note makes clear that controls on cross-border financial flows can be not only desirable, but also effective. This is important, because the traditional argument of last resort against capital controls has been that they could not be made to stick. Financial markets would always outsmart the policymakers.

Even if true, evading the controls requires incurring additional costs to move funds in and out of a country – which is precisely what the controls aim to achieve. Otherwise, why would investors and speculators cry bloody murder whenever capital controls are mentioned as a possibility? If they really couldn’t care less, then they shouldn’t care at all.

One justification for capital controls is to prevent inflows of hot money from boosting the value of the home currency excessively, thereby undermining competitiveness. Another is to reduce vulnerability to sudden changes in financial-market sentiment, which can wreak havoc with domestic growth and employment. To its credit, the IMF not only acknowledges this, but it also provides evidence that developing countries with capital controls were hit less badly by the fallout from the sub-prime mortgage meltdown.

The IMF’s change of heart is important, but it needs to be followed by further action. We currently don’t know much about designing capital-control regimes. The taboo that has attached to capital controls has discouraged practical, policy-oriented work that would help governments to manage capital flows directly. There is some empirical research on the consequences of capital controls in countries such as Chile, Colombia, and Malaysia, but very little systematic research on the appropriate menu of options. The IMF can help to fill the gap.

Emerging markets have resorted to a variety of instruments to limit private-sector borrowing abroad: taxes, unremunerated reserve requirements, quantitative restrictions, and verbal persuasion. In view of the sophisticated nature of financial markets, the devil is often in the details – and what works in one setting is unlikely to work well in others.

For example, Taiwan’s use of administrative measures that rely heavily on close monitoring of flows may be inappropriate in settings where bureaucratic capacity is more limited. Similarly, Chilean-style unremunerated reserve requirements may be easier to evade in countries with extensive trading in sophisticated derivatives.

With the stigma on capital controls gone, the IMF should now get to work on developing guidelines on what kind of controls work best and under what circumstances. The IMF provides countries with technical assistance in a wide range of areas: monetary policy, bank regulation, and fiscal consolidation. It is time to add managing the capital account to this list.

With this battle won, the next worthy goal is a global financial transaction tax. Set at a very low level – 0.05% is a commonly mentioned rate – such a tax would raise hundreds of billions of dollars for global public goods while discouraging short-term speculative activities in financial markets.

Support for a global financial-transaction tax is growing. A group of NGOs have rechristened it the “Robin Hood tax,” and have launched a global campaign to promote it, complete with a deliciously biting video clip featuring British actor Bill Nighy  Significantly, the European Union has thrown its weight behind the tax and urged the IMF to pursue it. The only major holdout is the United States, where Treasury Secretary Tim Geithner has made his distaste for the proposal clear.

What made finance so lethal in the past was the combination of economists’ ideas with the political power of banks. The bad news is that big banks retain significant political power. The good news is that the intellectual climate has shifted decisively against them. Shorn of support from economists, the financial industry will have a much harder time preventing the fetish of free finance from being tossed into the dustbin of history.

The Zone System was first introduced by Dan Harrington in his highly acclaimed book Harrington on Hold’em, Volume II: The Endgame. The system divides a poker tournament into five different zones based on a player’s stack size as compared to the blinds and antes. Each zone will affect your play and correct strategy will vary dramatically as a result. The ratio of your stack compared to the blinds and antes is referred to as your “M.” For example: You have $750 in chips and the blinds are $25/$50 with no antes. This means that you have 10 times more than the starting pot and your M is 10.

The Green Zone: M is 20 or More

In the Green Zone all weapons are at your disposal and you can play in all different kinds of playing styles. This is the place to be but you must be careful to balance your play in a way that allows you to continue building your stack while simultaneously protecting it. You can afford to play in both a super conservative style as well as in a super aggressive style.

The Yellow Zone: M is 10-20

You can no longer play conservative (tight) poker. The blinds and antes are starting to hurt your stack and you must loosen up your play and take more risks. Certain types of hands become less playable, such as small pairs and small suited connectors. This is because these hands now lack the implied odds necessary to turn a profit: The stacks have to be big in order to achieve this.

The Orange Zone: M is 6-10

You have now lost the ability to make more advanced moves. For example, you can’t come over the top against a raise and a re-raise because, even if you make an all-in raise, your bet will not be big enough to discourage a call from even the weakest of hands.

Your main concern is to be first in whenever you decide to play (unless you have a monster hand like AA-QQ and A-K). You must try to preserve your chips for an all-in move, such as an all-in re-raise when you are in the big blind and suspect a steal. This means that you should not make marginal calls in the big blind or small blind, or limp in with drawing hands the way you could when you were in the Green or Yellow zone.

The Red Zone: M is 1-5

Your only move is basically to move all-in. Even if you make the minimum raise you are pot committed and can’t get away from the hand. If your M is 3 or less then you will most likely be called by any two cards when you make your all-in raise. Small pairs and small suited connectors are again playable but only as a means to making an all-in move. You need to steal as many blinds and antes as possible and hope to get lucky if you are called (most likely you will be the underdog) or pick up a monster hand and hopefully get called.

If you are first in and sitting in a late position you can move all-in with plenty of hands; AA-22, any two cards 10 or bigger, A-x, K-x, Q-x, any suited connector, and any connector if your M is 3 or less (such as 9-8 off-suit and the like).

The Dead Zone: M is less than 1

As implied by the heading, you are as good as out of the tournament and every move you make will be instantly called. You need a lot of luck to get back into the tournament. The most important thing to consider is your play before you enter the Dead Zone. If you have blinded yourself down to this position then you have made a mistake. You should only end up in the Dead Zone by losing a big pot when your stack was bigger than it is now and your opponent had slightly less chips than you had.

You should make your move when you are first in and before the big blind arrives (this means moving in with any two cards when a first-in opportunity arises). This way you at least have some chance of getting the pot heads-up against a random hand.

Here’s the really good news for the web economy over the next decade.  Consumers are spending more and more time online, yet only about 10% of all advertising dollars are spent there.

Let’s assume that, over time, ad spending on a medium becomes roughly proportional to the time consumers spend using that medium. I doubt there are any technologists reading this blog who doubt that in five years most people in industrialized countries will spend 50% or more of their “media time” on the web.  This means there are hundreds of billions of ad revenues waiting to move to the web.

Advertising is usually divided into two categories: direct-response and brand advertising. Direct-response advertising tries to get users to take immediate action. Brand advertising tries to build up positive associations over time in people’s minds. In the past decade, we saw a massive shift of direct response advertising to the web. The main beneficiary of this shift has been Google. We saw far less of a shift of brand advertising to the web.

It is therefore very likely that most of this new ad spending will be brand advertising.  This is why Google, Yahoo and Microsoft are all so intensely focused on display advertising. It is why they paid huge premiums to acquire Doubleclick, Right Media, and Avenue A.

Right now there are lots of inhibitors to brand advertising dollars flowing onto the web. Among them 1) most of the brand dollars are controlled by ad agencies, who seem far more comfortable with traditional media channels, 2) it is hard to know where your online advertising is appearing and whether it is effective, 3) banner ads seem extremely ineffective and are often poorly targeted, 4) big brand advertisers seem scared of user-generated content, today’s major source of ad inventory growth.

But economic logic suggests these problems will be figured out, because advertisers have no choice but to go where the consumers are.