Of water and leverage

Though there is no way to eliminate completely downturns in markets, the ongoing credit crunch has proven a major truth that ought to have already been known and ought not have been taken for granted: neither borrowers nor lenders can operate without a leverage ratio.

Both consumers and firms use credit to facilitate investment. Basic macroeconomics shows investment provides greater returns than savings. However, there are two competing orthodoxies: savings as collateral provides a good entrepot to a loan, and sometimes borrowing costs alone justify borrowing. In the latter case, if the Federal Reserve lowered interest rates, even if a balance sheet is already heavily geared, there would be a greater economic opportunity cost to inaction. Yet, a steadfast adherence to this aspect of basic economics while ignoring the need for market correction has partly precipitated the current malaise.

For households, debt to income ratios are and have been alarmingly high since the internet bubble days of the late 1990s. To stave off the effects of recession after the market crash in 2001, lowering interest rates kept firms and households afloat, but they had unintended knock-on effects such as flipping the yield curve, perpetuating the cheap money period, which fueled the housing bubble. What are we left with?

A cheap currency, for starters, may be good for boosting exports, but newfound competitiveness of American commodities abroad will never become big enough to dent the trade deficit. Secondly, laxer lending conditions allowed displacement of risk, but a market can absorb only so much wealth or debt. Moreover, even the modelers of fancy financial instruments are not entirely certain about who will be left holding the bag and when. Picture a lake filled with various sized boats. Imagine a fleet of submarines got into the lake and began offensive maneuvers. Pretend all the boats try to tack against the onslaught. Some displacements would naturally be greater than others, and would suck the smaller vessels down into the wake of the largest. If there are enough torpedoes, no ship is too big to sink. That is the extent of the credit crunch.

Perhaps the most alarming thing about the subprime fiasco is that a significant majority of mortgagees pay the banks on time. To put this in perspective, subprime loans, at their height, still amounted to only 2.6% of the aggregate mortgage market. This shows how scary the level of contagion is. What would motivate creditors to loan the money in the first place and then repackage blocks of these loans to hedge the risk of default?

The answer to both questions lies in American bankruptcy laws which favor the borrower over the creditor. However, by trying to displace risk, creditors in essence became borrowers themselves, and this has left some of them scrambling for a spot at the Fed's discount window. For investment and commercial banks, adopting a generally accepted leverage ratio provides institutions with much needed credibility in the wake of misdeeds and bungles of the past fifteen years. Moreover, the ratio provides an objective standard for pricing and assumption of risk.

Innovation of financial instruments is a good thing, on balance. Availability of credit is a good thing, in toto. However, without having if not de jure, at least de facto leverage ratios to provide a necessary constraint, then knee-jerk regulation and government bail-outs are the alternative. Economically, this means death. Without a credible penalty within the market for reckless practices, then moral hazard prevails. To restore economic order, some will lose, few will disproportionately gain. However, the lesson all should learn is that avoiding recession is a quest for the Holy Grail. Rather, the objective all ought to strive for is to become recession proof. That is, to paraphrase Warren Buffett, either not to swim naked in the first place, or at least have the bathing suit we doffed close in hand, because the tide always goes out.

V-grooves for Victory

Rumor has it that the USGA and the R&A will consider changing permissible groove specifications. Such a modification will have immediate knock-on effects on ball technology primarily. Since limitations on equipment have the most tangible effects on the professional and elite level amateur game, then any new golf ball, like many equipment innovations, would have to pass muster with the best players. Tour players receive big endorsement deals, for name and brand recognition translate into profit typically. Since the mass market provides the revenue and profit bases, manufacturers must build a brand and do so through the snob effect. Even casual players prefer to play at least the name brand of the world's best players. The public does not have to play the same exact ball as tour or club professionals, but brand recognition is vital to financial gain. Even if a manufacturer designs a ball well-suited to the average player, it might not sell if Tour players shun the professional's counterpart. Titleist has a huge share of the ball market though its NXT or DT ball may not be as good as a competitor's product for the average player. So, how could changing the rules on grooves end golf's live ball era, fundamentally an integral aspect to the game's expansion?

 

Deep, square grooves have more surface area. Hence, at impact, extra friction causes the ball to spin more. If a golf ball is struck properly - compressed, - the grooves shear the outer cover. A hard-edged metal surface traveling at high speed over a short interval will do that to a rubber. On its website, the USGA states, "The USGA continually tests golf equipment at its Research and Test Center in Far Hills, N.J., for conformity to the Rules. Without such rigorous equipment testing and research programs, advances in technology could soon overtake skill as the major factor in success." If it deemed that square grooves violate this principle, and irons would have to have V-grooves, ball manufacturers will scramble to adjust their product line. Since V-grooves will have less surface area and consequently generate less spin, harder-covered golf balls, which travel further and spin less, will fall out of favor. 

 

Either changing groove requirements or changing ball specifications have the ultimate desired effect of limiting ball flight. The difference lies in the sequence of who will have to convert first. If the ball must become softer, club makers will change to V-grooves so good players can control ball flight more consistently without tearing the cover. Conversely, if V-grooves go into effect, then hard covered balls will not allow players to control distance reliably. The decision to restrict grooves rather than directly limiting the ball ought to be a market based one. Whichever way causes less shock to the market and adversely impacts manufacturers and players of all stripes least, then that is the correct remedy. 

 

However, golf as a game, a sport, and an industry are at crossroads, and none of these entities are exclusive of the other two. For the game with deep traditional roots, staunching the march of science is imperative. As a sport with myriad ways of producing good scores, favoring one type of player nullifies the nuances which make it appealing in the first place. As an industry staking much to compete in a crowded marketplace, it has its own precession problem regarding growth. Is it better to attract many new consumers with the show of strength first and then convert them to the virtues of skill? Is it better to place be honest and stress that the point of the game is to get the ball in the hole? Through any limitation of ball flight, interest will wane as the spectacle of the power game recedes. Yet, by not addressing the distance issue, the stewards of the game risk alienating purists and traditionalists. Unfortunately, the solution is not determined entirely on the margin. 

 

It is not as simple as whether it is more profitable to keep appealing to core customers or to market to new ones. The growth of the game depends as much on access as it does on clever marketing gimmicks or a superstar. The USGA has the dual mission of maintaining competitiveness and being 'for the good of the game.' To fulfill the latter obligation, it shirks the former. That would be only for the good of the industry. Eight years after Titleist first released the Pro-V1, enough statistical data and anecdotal evidence about the power game merit a rethink on equipment. Vi et arte, strength and skill in Latin, is the motto of the Royal Dornoch Golf Club as well as other clubs in Britain and Ireland. Significant, for in tandem, they comprise the keys to having a good game.

Kool-Aid, Now in Gold Flavor

Fears surrounding the plunging dollar have sent some scurrying to history books for a remedy. Some, such as one-time presidential hopeful Ron Paul, have strongly questioned the merits of a fiat currency and insist upon a return to the gold standard. Before proceeding, please permit some definitions first and clarification second. essential to understanding the debate over currency. First, fiat money is backed by an implicit guarantee of the issuer. This contrasts to commodity money which represents a fixed value of a commodity per unit of exchange. Second, the United States eliminated the gold standard in 1933. It did not die in 1973 when the Bretton Woods agreement on fixed exchange rates collapsed.

 

So why did the US and Britain shift from commodity money to fiat money? Britain needed to fund a war. Faced with malaise, the American federal government opted to stimulate the economy through New Deal spending programs. Neither nation could have funded the ambitious scope and scale of those projects without access to credit and raising debt. Financial markets have matured and become virtually perfectly competitive, and returning to commodity money would diminish the advances markets have made since the dissolution of the Bretton Woods accord. Returning to the gold standard comes with other problems. 

 

Starting with the outside in, what would it mean to American trading partners? Whatever fixed value the government may give the dollar would upset one of its chief trading partners. Universal satisfaction and agreement in the WTO, let alone the EU or China, is as likely as getting a room of random people to agree on pizza toppings. Moreover, valuation would reflect current economic conditions. How would it affect existing debt? What would be the knock-on effects on emerging market nations or the global exchange rate mechanism? Such a move would isolate America when it can least afford to do so. 

 

Next, what about the role the central bank would play in maintaining price stability and applying monetary policy? How free would the FOMC be to set interest rates to respond to price signals? Could a Federal Reserve beholden to the gold standard coordinate security sales and short term lending with the ECB, BOJ, or Bank of England in the event of credit constraints? 

 

Furthermore, the rate of technological advancement of production techniques as well as goods and serviced traded has accelerated more than the ability to fill treasury coffers with shiny stuff. In the absence of sufficient shiny stuff, debt service and necessary discretionary spending on defense, infrastructure, and law enforcement - the essential services of government - would become increasingly burdensome. 

 

How come the status quid pro has so much cachet? Perceived and actual malfeasance by financiers has prompted this reaction. A commodity currency, return to the gold standard in particular, would forestall repeats of recent events such as the subprime fiasco, the concomitant central bank bailouts, and the moral hazard precedent. What advantage does gold have in the 21st century that it lacked in the 20th?

 

In the good old days of gold, the preferred method of economic stimulus was war. If we lacked a commodity, and a weaker country had it, then we used to expropriate it by politics through other means. Though globalisation signals cut-throat, cost competition to some, the WTO, customs unions, and trade forums show that cooperation produces greater returns for all. Moreover, gold did not provide the stabilizing anchor during the industrial age. In the information age, a currency backed by gold will be held back by gold. 

 

While all fiat currencies have failed throughout American history, commodity currency does not guarantee a strong currency. Price instability and inflation were the lag effects of the Hume gold transfer mechanism. As exports grew, the flows of gold into a country increased, the economy expanded, and strengthened the currency. Hence, its citizens could consume more imports. However, when the currency became so strong that the export market shunned the newly high prices, the economy would slide into recession. How is this an advantage?

 

Beyond circumstantial evidence and the fact that fiat currency has failed in the past, little substantiates that a gold standard to the dollar would provide a palliative to the imbalances of speculative bubbles, reckless borrowing and spending, and the ills of the current credit market. Moreover, without having sorted the extent of the present credit crisis, a return to the gold standard would be dangerous. Even if the US returned to the gold standard, how long could it manage it while maintaining a negative trade balance and a high propensity to import? 

 

For all the purported stability, gold standard advocates seem to forget the currency runs, economic panics, and the social cleavages between debtors and creditors. The crucial question is what does a weak currency represent? High imports, high consumption, high public and consumer debt. If atavistic Americans cling to dollar strength and supremacy, then consumers, firms, and government must learn what anyone trying to get fit already knows: lay off the sweets, especially the Kool-Aid.