For Iran, escalation might actually work
With the world still slugging through the second act of the Great Recession, few scenarios cause more chills to run down the spines of Washington policymakers than a potential war with Iran. Although it is difficult to envision Iran emerging victorious from such a conflict, the outcome would be all but pyrrhic for the US: oil prices (potentially reaching $200 per barrel) would grind the economy to a halt, and the only hole bigger than the ones made by the USAF’s bunker-busting bombs, would be the budget hole caused by another hot war in the Middle East, one which in the worst case scenario would be bigger, longer and bloodier than those being waged in Iraq or Afghanistan. But perhaps what scares the pants off the Obama administration is the war’s total unpredictability: it only takes one surprise attack by Israel to launch a series of events which could lead into an unmitigated disaster. Many people have wondered whether such a scenario could be “contained”; that is, leave Israel and Iran slugging it out among themselves. Certainly that would limit the diplomatic fallout, and leave the US to worry on more important domestic matters during a crucial election year.
But as I will show in this post, such a scenario appears unrealistic. Once the first bomb falls, the US will be sucked in it, just like a limited tactical nuclear strike during the Cold War would have inevitably escalated into all out exchange. My analysis will be capped by a simple game theoretical model which will make the outcome clearer for those of you who are more numerically inclined. Continue reading
“Gentlemen prefer bonds” – Andrew Mellon (1855-1937)
They rock your markets
Ever since the global financial crisis exploded a few years back, the bond market has been at the forefront of the media’s attention after decades of always playing second fiddle to the stock market. Be it sub-prime mortgage bonds which were tearing holes out of investment banks’ balance sheets in 2007 and 2008, or Greek sovereign bonds on the verge of default, people are finally waking up to the importance of the bond market within the global economy. But besides being the largest and most important financial market in modern capitalism, the bond market can tell us a lot about the current and future state of the economy in ways that the Dow Jones or Nasdaq could not. And despite the jargon, they are not so difficult to understand. So, without further ado, here’s all you wanted to know about the bond market, in a language you can read (which is English, a language seemingly lost to many economists).
What is a bond?
In the simplest sense, a bond is basically debt. What makes a bond different from other types of debt (say, a loan) is that a bond is tradable, just like any other security such as a stock. So for example, a company can go to a bank and get a $1 million dollar loan, or he can issue $1 million dollars’ worth of bonds (say, 1,000 bonds worth $1,000 apiece) to a potentially limitless range of investors. Bonds are generally preferred over loans as a form of debt because you can issue more of it at one go (no bank is ever going to give anyone a $10 billion loan!), and because it is generally cheaper than a loan. This is because there is less risk attached to it from the lender’s perspective. Whereas the risk of a loan defaulting is borne entirely by the bank that issued it, the risk of a bond defaulting is spread across dozens of bondholders, none of which owns the full amount of the issuance (i.e. no-one bought all those bonds). As a result, a bond will likely fetch a lower interest rate than an equivalent loan, which is clearly better for the issuer. The flip side is that bond issuance is only feasible for government and medium/large firms: a small and relatively unknown firm needs to convince dozens of investors who probably know nothing about the company to buy its bonds. Continue reading