Book review - The Undercover Economist

I found The Undercover Economist by Tim Harford to be useful, interesting and, unusually for a book on the "dismal science", entertaining. It gave very clear and straightforward explanations on a range of economic subjects including scarcity and its effect on prices, externalities and how to regulate them, international trade and the impact of trade barriers and an explanation of why some countries have grown richer while others remain poor (or get poorer). What gives this book an edge is that the economic explanations are linked to practical everyday issues relevant to most of us as workers, consumers and investors.

While the issues discussed were generally familiar to me, the explanations were helpful in clarifying my thinking on several issues (especially the sections on how to deal with externalities). Many of these are issues of which investors should have at least a basic understanding. For example, property investors should read the chapter on scarcity. One subject that I would like to read more about is game theory - something about which I know very little.

I had one minor gripe - I found the incorrect use of grammar mildly irritating. I must be getting overly pedantic in my old age.

I preferred The Undercover Economist to Freakonomics. While Freakonomics was also an enjoyable and very interesting read, The Undercover Economist was of greater relevance to me as an investor and a consumer.

World Wealth Report - some comments

The weekend rolled around and I finally had a chance to finish reading the Capgemini Merrill lynch World Wealth Report. The report provides some insight into how the world's wealthy manage their money and, possibly, some tips for the rest of us.

1.HNWIs are responsive to current and impending economic conditions. This is no surprise as most people respond to what they are experiencing and what they anticipate will happen in the future. One interesting observation was that HNWIs are anticipated to reduce their real estate allocations in the face of rising interest rates.

2. HNWIs increased their exposure to private equity funds at the expense of investing in hedge funds. In part this shift in allocations was driven by the superior returns of private equity funds and in part by hedge funds increasing their fees.

3.Ultra HNWIs often made investing decisions ahead of market trends. As a group, ultra HNWIs were more diversified, more sophisticated and more aggressive with their investments than the HNWI group as a whole. In particular, ultra HNWIs had a much greater exposre to alternative asset classes. Tax efficiency was a notable feature of the typical ultra HNWI's approach to investing.

4.HNWIs continued to diversify their holdings internationally and reduced their exposure to North America. The report suggests that the trend of reallocation of investments away from North America and Western Europe to Asia Pacific and emerging markets will continue.

5.61% of HNWIs are aged 56 or over. This compares with 15% of the world's population as a whole. This indicates that time is one of the key factors in achieving financial wealth is time.

I draw three conclusions from my review of the report:

(i) Getting to HNWI status takes time. (This is not a surprise.)
(ii) Alternative asset classes deserve more consideration.
(iii) Investments need to be constantly reviewed and reallocated in response to anticiapted future conditions - a higher degree of risk has to be assumed.

Interest rates and inflation

The Federal Reserve (and other central banks) has raised interest rates in response to concerns over inflation. The question is whether raising interest rates should slow inflation? I have considerable reservations with the suggestion that raising interest rates alone will stop inflation.

If the inflation was caused by rampant consumer demand and capital investment, raising interest rates could be expected to slow demand because consumers and investors alike have to pay more to service their debts and the additional money spent on servicing debt is not available for other uses. However, rising demand only represents part of the inflation story.

Only part of the current bout of inflation is due to rising global demand for commodities which has driven up the prices of things like industrial metals and energy products. However, there is evidence to suggest that, so far, demand has been relatively inelastic. For example, Alan Greenspan recently commented that there was no evidence to suggest that rising petrol prices had affected consumer demand for petrol.

The the other part of the story behind the inflation numbers is liquidity and the money supply. Central banks around the world have been inceasing the money supply at a rate that has fueled inflation. If the Federal Reserve and other central banks are serious about taming inflation, they will slow the growth in the money supply and tighten liquidity. Of course, tightening liquidity will have other conseqences so they will need to strike a balance between bringing inflation under control and avoiding a recession (or, at least, acheiving a soft landing).