Sunday, November 29, 2009

A Prayer for Those Who Seek Employment

This is the first time I have ever attemped to write a formal prayer. It will be obvious I have been checking out Anglican and Catholic web sites. It seems like we Protestants are lacking in this area.

Lord God, Judge of our nation, we your people have sinned in thought, word, and deed. We have pursued our own desires, we have ignored your holy laws, and we have engaged in wickedness before your throne. Now, as our country and the world faces a time of great economic distress, we come before you in prayer, knowing you to be a merciful God who forgives sins and who restores those who repent of their sins.

Heavenly Father, there are many in our midst who suffer want and anxiety from a lack of work. Unable to provide for their families, their children suffer. Lord God, we would ask you to provide reasonable, meaningful, and appropriate jobs to those who seek honest employment. We would ask you to grant to them who suffer in this time, a just wage for their labors that they might care for their families in the manner that you have established in your Holy Word.

Merciful Father, we would ask that you guide and strengthen the hearts of all those who seek employment. We would ask you to grant them a special measure of strength, patience, and trust in your Goodness as they seek to best use their abilities in honest labor.

We pray for our political leaders and for those who command corporations both great and small. We would ask you to fill them with your wisdom and a spirit of mercy, so that mindful of your righteous judgment, they would make good decisions for the use of both public and private wealth. Lord God, touch their hearts, so that those who are able, would be willing to provide opportunities to their unemployed brothers and sisters to use their skills, abilities, and energy in a manner that would truly bring blessings upon us all.

Almighty God, we would ask that you speak to your Church and to the people who are named by your name. Teach us how to best share your bounty with others in a manner that would glorify your name and bring your blessings to many.

Holy Father, we confess that you are our great refuge in times of trouble. We confess that in your Holy Word you have both directed us to offer our prayers for sustenance and you have promised to provide for our daily needs. We ask that all people, those who walk in your light and those who walk in darkness, those who have suffered loss in this time and those who have been blessed would turn to you and call out your name so that we might be forgiven and once again see your blessings fall upon this nation.

We ask these things in the Holy name of Jesus our Savior. Amen

Thursday, November 26, 2009

The Latest Internet Scam

On this past Monday I bought a door gasket for my dishwasher from an Internet parts house. They had an excellent web site. I put in the brand and model number of my dishwasher and it spit back several exploded drawings. I clicked on the drawing containing the door assembly, then clicked on the gasket, and went to checkout. There was nothing unusual until I completed the order. Then a new window opened asking me to take a survey. The hook was $100 in free gifts. I assumed this would be discount coupons on future purchases. I was in a good mood and happy with the service so I went ahead with the survey. I began to get suspicious when I noticed a number of the questions did not apply to an appliance parts house. I then noticed the window was from a third party, not the vendor. I thought, “I guess they are just using a generic survey service.” I finished the survey and was given the opportunity to get some magazine subscriptions. This was supposedly free but there were some prices on the magazines. I have a house full of magazines, books, and catalogues. The last thing in the world I want is another magazine adding to this clutter. At this point my fraud antennae started waggling around a bit and I exited the window. This action returned me to the appliance parts house page for a next action.

The following day a friend of this blog gave me some information on a new Internet scam. I had just about stepped into it.

The following information comes from an article by Lolita Baldor (AP). A week before, the Senate Commerce Committee blasted the unethical business practices of three Internet companies Affinion, Vertrue, and Webloyalty for using aggressive sales tactics to scam millions of customers. Just before the sales confirmation appears on a legitimate Web purchase, the customer is offered a cash back coupon, a movie ticket, or some other reward. When the consumer clicks on the offer, believing it to be a part of their purchase and that company’s website, the vendor sends ALL OF THEIR CREDIT CARD AND PERSONAL INFORMATION from the legitimate purchase to the third party. If the customer accepts the offer, they have just joined one or more subscription services. These services charge monthly fees for bogus offers. The customer never notices it until mystery charges begin appearing on their credit card statements.

What is really despicable about this practice is that reputable companies are taking kickbacks from Affinion, Vertrue, and Webloyalty. The following information comes from Senator John D. Rockefeller report dated November 17, 2009. It concerns a Senate investigation of the aforementioned three companies.

“First of all, we expect the merchants we do business with on the Internet to treat us honestly and fairly. We expect online merchants to clearly explain their prices and terms to us, so we know what exactly we’re getting if we decide to spend our money at their websites. And when we agree to buy something from them, we expect merchants to protect our credit card and other financial information that we share with them. That’s why it’s so disturbing to me to learn through investigation what’s happening to millions of American consumers every day who are shopping on the Internet.”

Here is a list of reputable Web vendors who have all received more than $10,000,000 in kickbacks from these disreputable companies. (Exhibit 4 from the Senate’s Investigation)
Redcats USA
US Airways

Here is a partial list of vendors who received between $1,000,000 and $10,000,000 in kickbacks.

Airtran Airways
American Greetings
Barnes and Noble
Continental Airlines
J.C. Whitney
Lillian Vernon
Miles Kimball
Pizza Hut
Time Life
Victoria’s Secret

If what I was offered was something I really wanted, I might have bitten the hook. I am still nervous that something might get charged to my card by these scoundrels. I will call my credit card service every few days over the next couple of weeks and listen to the nice robot man recite my last five transactions until I am satisfied that I am completely in the clear. May God protect us and deliver us from such snares.

Two from Proverbs

Proverbs 13:11 (NIV)

Dishonest money dwindles away, but he who gathers money little by little makes it grow.

Proverbs 21:6 (NIV)

A fortune made by a lying tongue is a fleeting vapor and a deadly snare.

Saturday, November 21, 2009

Playin' Small Ball

Playing small ball, Larry Hite managed to turn a $2 million managed account into $800million in eight years. Here is a quote from Larry Hite worth your consideration.

“Never risk more than 1% of your total equity in any one trade. By risking 1%, I am indifferent to any individual trade. Keeping your risk small and constant is absolutely critical. I have two basic rules about winning in trading as well as in life:

1.If you don't bet, you can't win.
2.If you lose all your chips, you can't bet.”

Small ball is the traditional offensive strategy in baseball. It is based on the assumptions that it easier to score a run with a man on base than with no men on base and that it easier to score from third base than it is from first base. Therefore, small ball concentrates on getting men on base. Managers using this strategy are perfectly willing to make sacrifice plays in order to advance a runner who is already on base. In recent years, innovations such as the designated hitter in the American League, smaller parks designed to increase the number of homeruns, the “juiced” ball that comes off the bat at a higher rate of speed, and steroids have made the long ball more important, but Major League Baseball teams are still playing small ball. In Japan small ball is the only way to play the game.

People like to watch homeruns both in life and in baseball. Small ball can be soooo boring. I want to hear about the man who bet his life savings on the initial public offering of Cisco, sold before the crash in 2000, and retired to Maui. The story about a man who bought shares in Coca Cola and 20 other blue chip stocks over a 20 year time frame with about ½ of his savings and then retired in North Carolina is boring by comparison.

I am trying to play small ball with my savings. I am willing to make sacrifices, such a driving a 13 year old car when I can afford to pay cash for a new vehicle, in order to get some money invested my Schwab Money Market account. Once I get that money on base, I look for opportunities and buy a little of this or a little of that in order to advance that money to second base. Sometimes I get lucky. I am able “steal” a base, as in a matter a months I watch one of my investments jump 50% or more. When I get nervous because the market seems too high or my investments are getting out of balance I bring some of the money on home and put it into an investment grade bond fund or treasuries.

During the recent unpleasantness I was buying all the way down. I was buying 70% stocks for my retirement account at work and adding small amounts to the core holdings in my self directed account. It is very scary to buy some stock, loose some money, then buy some more stock, and loose some more money. I was trying to increase the numbers of shares I owned, lower the cost of an average share, and buy dividends for the future. Dividends, by the way, are where it is at. In a perfect world, it would be wonderful to be able to live on just the interest and dividends from your investments. Imagine, never worrying about touching your principal. This strategy seems to working pretty well even in a disastrous economy. I took a beating on General Electric, but generally small ball is working as advertised.

I have watched the market jump something like 60% since the lows of this past March. During the past month or two I have started pulling some of my winnings off the table both because I believe the market to be overvalued and because my stock holdings are exceeding 55%* of my investments. This is small ball. If I was playing long ball I would be pulling all my winnings off the table. Unfortunately, my crystal ball did not come with an instruction manual so I can not state with certainty what the future might hold.

I wish I was younger, smarter, and richer. Unfortunately, I did not start a serious effort to learn about investments until I was about 50 years old. If you are young, start today. Time is your friend, particularly if you choose to play small ball.

And, Hey! Let’s be extra careful out there.

* The old conventional wisdom stated that an individual investor should hold his age in bonds, certificates of deposit, and cash. Hence, at 58 I should have 58% in fixed income investments and 42% in stocks. The new conventional wisdom states that these figures are too conservative given the risk of inflation. The new rule of thumb states that the individual investor should have either 110 or 115 minus their age in stocks. Hence, I should be holding 52% or 57% in stocks at any given time. I have decided keeping my stock holdings (including gold) under 55% sounds about right. I am shooting for 5% in gold but I have not yet reached this goal.

Friday, November 20, 2009

The Confucian Work Ethic?

There are principles that God has placed in the universe. They work for Christians. They work for non-Christians. There are no guarantees in life but there are principles and there are probabilities. If you choose to act in harmony with those principles you increase the probability of success and happiness no mater who you might be or what you believe. This was true in Solomon’s time and it is proving true in this recession.

In a recent article in USA Today Haya El Nasser observes that cultural factors help limit the recessions impact. Currently unemployment in the United States is running at 10.2%, but Asian unemployment is running at about 7.5%, a significant statistical difference. In fact Asians have the lowest unemployment rate of any American racial group. The reasons can be found in cultural strengths imbedded in family structure and values. Our parents destroyed the extended family in America with the social and geographic mobility we experienced in the years following World War II. My prayer is that the Church in America finds a way to reinvent the extended family.

Education is a family value in many Asian cultures. I have read that homework is sometimes a family affair. The entire family sits around the table. If the parents can’t speak English very well they expect their children to teach them the language even as they are helping them do their homework. Older siblings are expected to help their younger brothers and sisters. Learning is a family affair and those with advanced degrees are reverenced especially if they are teachers.

From the article:

"Asians in the United States, both native born Asians and Asian immigrants, have higher educational levels than other groups," says Alan Berube, senior fellow and research director of the Brookings Institution's Metropolitan Policy Program. A recent Labor Department report on the work force shows a greater proportion of Asians than other racial or ethnic groups in management, professional and related occupations — jobs that require more schooling and are high-paying. About 47% work in management or professional jobs compared with 35% for the U.S. work force as a whole.”

Asian unemployment is also low because their work ethic is extremely strong, so strong that it is now being termed the Confucian work ethic by sociologists. John Calvin, eat your heart out. The article points out that there is significant evidence that if Asian Americans loose their jobs they are quick to take lower paying work, even if they are grossly over qualified. Sometimes they take jobs within their family’s business.

The Chinese have a history of family enterprise that predates this nation by thousands of years. In one article Peter Drucker discusses the Offshore Chinese family corporation. He claims such organizations are run more like a highland clan than any normal business. In various other articles, the author mentions family owned and operated entities such as the Rothchild banking empire, the Dupont Chemical Corporation, and the traditional Mafia family. All these organizations have at least some similarities to the Chinese clan corporation. I checked out these observations with a Chinese coworker. It turns out his wife is a distant cousin related to one of these combines.

Such corporations are based on Confucian concepts of duty, loyalty, and mutual obligations and operated for the good of the clan, the entire clan. In Chinese history the government was often so corrupt that the only trust was between family members. If a mandarin had a problem with a family business, they had no legal recourse. Therefore, it was important that a businessman could give a bag of diamonds to a cousin for safekeeping and then reasonably expect to have them returned intact in a year or so after the crisis abated. In such organizations the clan chieftain controls all the assets of the corporation. He is also responsible for all the family members even cousins, nieces, and nephews removed by several generations. The chieftain is not however, a dictator. His actions are reviewed by senior family members and younger family members who have been given positions of great responsibility.

In a nutshell, education (particularly in a technical or health care field), plus a strong work ethic, plus a supportive extended family equals a high probability of survival or even success. Solomon and Confucius both understood these truths. Maybe it is time for the Church in America to relearn what first made us strong. Phyllis Tickle in her commentaries on the state of the Church in America, observes that we lost something when adult children and grandchildren no longer eat Sunday dinner at grandmother’s house. During these dinners grandmother might ask one of her grandchildren what they learned in Sunday school. God help the son or daughter if the grandchild’s response was, “We didn’t go to church today.”

Ecclesiastes Chapter 4

[5] The fool foldeth his hands together, and eateth his own flesh.
[6] Better is an handful with quietness, than both the hands full with travail and vexation of spirit.
[7] Then I returned, and I saw vanity under the sun.
[8] There is one alone, and there is not a second; yea, he hath neither child nor brother: yet is there no end of all his labour; neither is his eye satisfied with riches; neither saith he, For whom do I labour, and bereave my soul of good? This is also vanity, yea, it is a sore travail.
[9] Two are better than one; because they have a good reward for their labour.
[10] For if they fall, the one will lift up his fellow: but woe to him that is alone when he falleth; for he hath not another to help him up.
[11] Again, if two lie together, then they have heat: but how can one be warm alone?
[12] And if one prevail against him, two shall withstand him; and a threefold cord is not quickly broken.

Saturday, November 14, 2009

Walk Like an Egyptian

“Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful.”
Warren Buffett

You know the story. One night the Pharaoh of Egypt dreamed that he was standing by a river. He saw seven fine healthy cows climb out of the river. They were followed by seven ugly sick looking cows. The sick looking cows then ate the healthy animals, but they didn’t get any better. Then Pharaoh dreamed a second dream. Seven ears of perfect grain grew up out of the ground. They were followed by a plant with seven ears of grain that looked to be blighted by the desert winds. Then the bad ears of grain ate the good ears. Pretty weird, huh? This dream made no sense to either Pharaoh or his priests or his magicians.

However, his chief butler remembered a guy he met in prison, a Jew who could interpret dreams and predict the future. Most likely, the chief butler also remembered his promise to this Jew who told him he would live and return to Pharaoh’s favor. As the butler promised, he told Pharaoh about the man, Joseph, who claimed to be innocent of the rape charges that sent him to prison, the man who could see into the future.

Joseph was dragged out of prison, cleaned up a bit, and presented to Pharaoh. Interestingly, Joseph did not claim credit for his abilities but gave the glory to God, a little different than when he was that bratty little brother who told his siblings they would bow down before him. He then told Pharaoh the meaning of the dream. Egypt would have seven flush years followed by seven years of famine. Joseph also presented a solution. He encouraged Pharaoh to put aside 20% of the nation’s harvest for the coming years of famine.

Pharaoh knew a good thing when he heard it. He put Joseph in charge of the project, in fact he put Joseph in charge of the kingdom as his Chief Operating Office. Joseph managed to save and store so much grain, the Egyptian quit trying to keep track of it. The numbers were just too large. Then the predicted famine hit the Middle East. Since Egypt was the only country that had a grain supply, the entire world beat a path to Joseph’s door and he made his boss the richest man in the world.

What a concept! Save money during the good years so that it is available during the bad years. In America, we do just the opposite. During the 1970s, those wretched years of stagflation, Americans saved about 10% of their disposable incomes. As the economy boomed during the last half of the 1980s that rate began to drop and continued to drop until in 2005 the number went negative. The consumers of an entire nation were spending more than they were making, complete insanity. This was all being fueled by the real estate bubble. Boosted by favorable legislation and easy credit, the homeowner watched his house, his biggest expense, turn into his best investment. Flush with this new equity, the homeowner turned his new found store of wealth into an ATM by means of second mortgages and Home Equity Lines of Credit (HELOC). Then it was October 2008 and the skinny sickly cows of financial catastrophe gobbled up our fat healthy looking economy. Now the savings rate is climbing. It reached 5% in the second quarter but it is starting to slip again, probably as a result of the cash for clunkers program and the government bonus for first time home buyers. Generally, Americans are paying down their debts, saving for a rainy day, and learning that frugality is the new cool. No more are we saying, “Mastercard, I’m bored.” It is a little late, the fat cow is gone, but a little too late is much better than nothing.

What if Americans learned to save money when times were good? What if the government put aside a surplus for years of pain? What if corporations and even churches built a store of wealth during boom times. Think of the opportunities. Corporations could pick up valuable assets for pennies on the dollar. During times of distress, the Church could become the center of benevolence that God intended.

Let’s end with one more quote from Warren Buffett.

“You only find out who is swimming naked when the tide goes out.”

Note: I do not particularly recommend Robert Kiyosaki. However, the idea for this post came from his latest article on Yahoo Financial.

Wednesday, November 11, 2009

Perfect Knowledge? Perfect Peace?

People are moving back and rebuilding New Orleans, even after Katrina. It is a certainty New Orleans will suffer another catastrophic flood. The only question is when. Civil engineers have been sounding the warnings for decades. A class 4 or 5 hurricane could cause massive breaches in the levees surrounding New Orleans. A major flood on the Mississippi could cause the same sort of disaster or wipe out the dam system that keeps the Mississippi from heading down the Atchafalaya river basin. This would isolate New Orleans from the Gulf of Mexico thus ending its reason for existence. Any kind of flood could cause the failure of the system of levees that protects the city from Lake Pontchartrain. A system of levees and dams that could guarantee the safety of New Orleans is a technological impossibility. The city is built on a sea of mud. There is no bedrock. Therefore, the higher and heavier the levee, the faster it will sink into the mud. The American Society of Civil Engineers observes, “Large portions of Orleans, St. Bernard, and Jefferson parishes are currently below sea level — and continue to sink. New Orleans is built on thousands of feet of soft sand, silt, and clay. Subsidence, or settling of the ground surface, occurs naturally due to the consolidation and oxidation of organic soils (called “marsh” in New Orleans) and local groundwater pumping. In the past, flooding and deposition of sediments from the Mississippi River counterbalanced the natural subsidence, leaving southeast Louisiana at or above sea level. However, due to major flood control structures being built upstream on the Mississippi River and levees being built around New Orleans, fresh layers of sediment are not replenishing the ground lost by subsidence.” Substantial portions of the city are below sea level and they continue to sink. Technology can not change this fact. Yet, people live in New Orleans. Much to my amazement they consider it an acceptable risk.

As we recover from the collapse of the stock and real estate markets, there seems to be a renewed interest in risk analysis. Richard Young’s sustainable Portfolio Income chart shows the value of a portfolio invested 50% in fixed income and 50% in stocks rebalanced annually. Distributions are assumed to grow at the annual rate of inflation. A portfolio invested 50–50 in 1946 with a 4% withdrawal rate would have lasted for 53 years, a 5% withdraw rate would have lasted 34 years, a 6% withdraw rate would have lasted 26 years, but the past is not the future. Likewise, Schwab came up with the same 4% withdraw rule of thumb, not based on past performance but based on running sophisticated Monte Carlo simulations in order to develop a 90% confidence level in their results. In an email message to their customers, Schwab admitted that years like 2008, a once in a lifetime event (we hope), could not be covered by a 90% confidence level. If I had been an average investor and if I retired in 2008, I would be in extremely serious trouble. When the market withdraws 18% of your holdings (50% bonds 50% stocks) in a single year, the 4% rule obviously goes out the window.

Most of the predictive tools available to folks like you and me are termed deterministic. That means, as I plan my retirement, I pick a life expectancy, an average rate of inflation (often 5% is recommended), and an average rate of return (often 8% is recommended) on investments. I plug the numbers into the website and read the results. Since I can not predict my life expectancy, inflation for the next 30 years, or what the stocks I buy and sell might do or not do, these results are really not worth too much, but they are better than nothing.

A Monte Carlo simulation is more sophisticated. Most Sunday mornings I drive approximately 17 miles from Poolesville to Derwood. I make one stop to buy cheap gas at the 7-11 store. On average this odyssey takes about 35 minutes but it can take 7 or 8 minutes more or less than average based primarily on how I hit the traffic lights. I do not always start at the exact same minute. If I am running late, I drive a little faster. If I am running early, I slow down. I could develop a Monte Carlo simulation that would model my behavior and mathematically verify an average time for the Sunday morning commute. A random number generator would give a starting time, information from the computer system that controls traffic lights in Montgomery County would run a subroutine providing stop/go information to the main program, and the computer could spit out the results of 10,000 commutes in a matter of minutes. But did the program account for deer hits, accidents, and construction projects? Probably not. If get stuck in a once in 100 year event, like the time a truck flipped on I-95 releasing scores of pigs from their cages, my simulation results go out the window. In that case the road was shut down for hours while emergency personnel recaptured the surviving animals.

Systems engineering obsesses about catastrophic single point failures. If the failure of a single part can result in the complete destruction of a massively complex system, this is considered a serious design flaw. Redundant subsystems are often added to prevent an entire systems failure, like the O ring seals on the booster motors of the space shuttle. The failure of one piece of plastic destroyed a system worth tens of millions of dollars and killed 7 astronauts. These unlikely events keep system engineers awake at night. To locate these problems and correct them before they can occur, thousands of simulations involving all sorts of unlikely, “what if?” scenarios are considered and designs are modified based on the frequency of the event, the consequences of the event, and the cost of preventing the failure.

Probably 4% withdraw is about as good a model as I can hope for, as I plan my retirement. How does this work? Let us say a couple has traditional pensions totaling $20,000 a year and expects an inflation adjusted income of $25,000 a year from Social Security. If this couple wishes to retire on an income of $70,000 a year, they will need an additional $25,000 a year generated by their investments. $25,000 ÷ 0.04 = $625,000. To avoid a single point failure, diversify. At one point in time putting all your money into Enron stock looked like a pretty good idea. However, the bankruptcy of that wicked company destroyed thousands of innocent investors. A portfolio with 10% in Enron stock would have been hurt but would survive. A portfolio with 5% in Enron stock would be embarrassed but would not have suffered any grievous, irreparable harm.

Of course the problem is that we humans, the machines we construct, and the computer simulations we write all lack perfect knowledge. Chess is a game in which both players know the position of every piece on the board and the complete history of the game. Chess computers can and have been programmed so well that one of them, Deep Blue, defeated the World’s Champion in an exhibition match. Poker is a game in which no player has perfect knowledge of either the opponents’ cards or the motivations behind their betting strategies. For this reason, attempts to program a computer to play poker with human adversaries have been failures.

I bet you know by now where I am going to end this essay, with the author of perfect knowledge and perfect peace.

Psalms 23

[1] The LORD is my shepherd; I shall not want.
[2] He maketh me to lie down in green pastures: he leadeth me beside the still waters.
[3] He restoreth my soul: he leadeth me in the paths of righteousness for his name's sake.
[4] Yea, though I walk through the valley of the shadow of death, I will fear no evil: for thou art with me; thy rod and thy staff they comfort me.
[5] Thou preparest a table before me in the presence of mine enemies: thou anointest my head with oil; my cup runneth over.
[6] Surely goodness and mercy shall follow me all the days of my life: and I will dwell in the house of the LORD for ever.

Sunday, November 8, 2009

But Only Speak The Word and We Will be Healed

Back on Labor Day U3, the official unemployment rate stood at 9.7% and U6, the more accurate measure that includes marginally attached and those forced to work less than full time, stood at 16.8%. The latest measures released on this past Friday are U3 at 10.2% and today U6 stands at 17.5%. Some economists consider an official unemployment rate in excess of 10% to be the difference between a recession and a depression. More importantly, our monetary institutions have built safeguards into our financial system to cover up to 10% unemployment. A sustained unemployment rate beyond 10% will result in more bankruptcies, foreclosures, and credit card defaults than the banks can cover. This might require another massive public bail out we can not afford.

Long term unemployment has other costs including suicides, divorces, spousal abuse, alcoholism, and depression. Unemployment has not topped 10% since 1983. Back then Americans were carrying much less debt and were unemployed for fewer weeks than has been the case in this recession. In addition, in 1983 the automobile companies covered most of their employees’ salary even during layoffs. Those days are gone forever.

I do not see a source for new wealth creating jobs. We have sent our factory jobs to China, we are sending our white collar and some of our professional jobs such as computer programming to India, and in the past 5 years we have overbuilt both residential and commercial real estate. Some estimate that even without considering future commercial bankruptcies or residential foreclosures it will take 15 years to absorb the oversupply in the construction trades.

As a nation, we really need to seek God’s wisdom and his mercy. More than ever, today is a day for prayer.

A Confession of Sin from the Book of Common Prayer

Almighty and most merciful Father; we have erred and strayed from thy ways like lost sheep. We have followed too much the devices and desires of our own hearts. We have offended against thy holy laws. We have left undone those things which we ought to have done; and we have done those things which we ought not to have done; and there is no health in us.

But thou O Lord, have mercy upon us, miserable offenders. Spare thou those, O God, who confess their faults. Restore thou those who are penitent; according to thy promises declared unto mankind in Christ Jesus our Lord. And grant, O most merciful Father for his sake; that we may hereafter live a godly, righteous, and sober life, to the glory of thy holy Name.


Saturday, November 7, 2009

The Nature of Money (Part II)

It started innocently enough, at least in Western Europe. I can’t speak to the Caliphate, China, or India. Vincenzo, a goldsmith living somewhere, most likely in Italy, built a vault to hold his stock of precious metal and perhaps even hired a solider or two to guard his stash. Bumpus, his neighbor, had two gold coins buried under the hog trough. Bumpus, while suffering from insomnia one night, thought, “Perhaps my gold might be safer in the goldsmith’s vault.” He offered Vincenzo three chickens and two dozen eggs to store his gold coins in the vault. Vincenzo accepted the offer, took the coins, issued Bumpus a signed receipt for his gold, and locked it up in the vault.

Time passes. Bumpus prospers and wants to buy a small piece of land adjacent to his pathetic farm. After the negotiations are complete, the landowner wants Bumpus to pay the agreed upon price, two pieces of gold. The peasant shows the landowner his receipt from Vincenzo. The landowner, knowing Vincenzo to be a man of his word, accepts the paper, goes down to the vault, verifies its validity, and walks home happy to leave his gold right where it sits. Two peasants and a goldsmith have just invented paper money.

Time passes. Vincenzo’s son, Ludovico now runs the family business. The Count of Bahjoria, the local bigwig, has a wife who wants to build an addition to their castle but he can’t get enough money out of tax revenues. He calls Ludovico to his office and offers a portion of his tax revenues plus a return of principal if the goldsmith would kindly lend him enough of his gold stash to complete the project. This is going to take more money than Ludovico personally owns, but being a more sophisticated businessman than his father, Ludovico writes the Count a bill for more gold than he owns but less than is held in his vault. They have just invented fractional reserve banking.

Time passes. The agreement with the Count worked so well Ludovico bought a grand estate just outside of town and sent his son to the University of Paris. His neighbors eyed the goldsmith’s change in lifestyle and grew suspicious. They thought, “What is that rascal, Ludovico, doing with my gold.” They all marched down to the vault and demanded to see their coins. Of course they weren’t there. Not wishing to be lynched, Ludovico explained what was going on and offered to cut his customers in on his profits. Ludovico and the lynch mob have just invented the savings account.

Time passes. Alessandro, Ludovico’s son, now wealthier than the Count, has left the goldsmith business and owns what has become the First Bank of Bahjoria. Wishing to become a nobleman himself, he offers a bribe to the Pope that exceeds his entire stock of gold. He gets away with this for a while, but the Pope wants to field an army against the Baron of Badburg. On the way to the crusades, the Baron decided looting Italy was more rewarding and safer than fighting the Arabs in the Holy Lands. The Italian soldiers want gold. Count Alessandro the Magnificent doesn’t have enough to cover his promissory notes. Word gets out and the lynch mob hangs Alessandro. The Pope, the lynch mob, and Alessandro have just invented a run on the bank.

This sad story has been repeated thousands of times in the last 500 years in locations all over the world. It is pretty much what happened at Citibank and Bear Sterns last year. Although the sons and daughters of Vincenzo are far more sophisticated and are dealing with sums so vast, Galileo himself probably couldn’t comprehend such numbers, nothing has really changed but the faces and the names of the financial instruments. If we return to the original model, a customer paying a banker to store his gold in the banker’s vault, there will not be any money to fuel economic growth. Capitalism needs good debt to survive. The money to create a new industry, like the automobile at the start of the Twentieth Century, simply does not exist. It must be created through some combination of bonds, common or preferred stock, or outright loans. All of these are debt instruments of some sort. As long as everybody behaves ethically everything works just fine. However, history has proven again and again that always some sharp character is going to get a little too greedy and issue bad debt, most recently Collateralized Debt Obligations on bad mortgages and Structured Investment Vehicles that function as banks while avoiding regulations. Eventually this bad debt is discovered, lives are ruined, fortunes are destroyed, and real people like you and me suffer.

Psalm 73

[1] Truly God is good to Israel, even to such as are of a clean heart.
[2] But as for me, my feet were almost gone; my steps had well nigh slipped.
[3] For I was envious at the foolish, when I saw the prosperity of the wicked.
[4] For there are no bands in their death: but their strength is firm.
[5] They are not in trouble as other men; neither are they plagued like other men.
[6] Therefore pride compasseth them about as a chain; violence covereth them as a garment.
[7] Their eyes stand out with fatness: they have more than heart could wish.
[8] They are corrupt, and speak wickedly concerning oppression: they speak loftily.
[9] They set their mouth against the heavens, and their tongue walketh through the earth.
[10] Therefore his people return hither: and waters of a full cup are wrung out to them.
[11] And they say, How doth God know? and is there knowledge in the most High?
[12] Behold, these are the ungodly, who prosper in the world; they increase in riches.
[13] Verily I have cleansed my heart in vain, and washed my hands in innocency.
[14] For all the day long have I been plagued, and chastened every morning.
[15] If I say, I will speak thus; behold, I should offend against the generation of thy children.
[16] When I thought to know this, it was too painful for me;
[17] Until I went into the sanctuary of God; then understood I their end.
[18] Surely thou didst set them in slippery places: thou castedst them down into destruction.
[19] How are they brought into desolation, as in a moment! they are utterly consumed with terrors.
[20] As a dream when one awaketh; so, O Lord, when thou awakest, thou shalt despise their image.
[21] Thus my heart was grieved, and I was pricked in my reins.
[22] So foolish was I, and ignorant: I was as a beast before thee.
[23] Nevertheless I am continually with thee: thou hast holden me by my right hand.
[24] Thou shalt guide me with thy counsel, and afterward receive me to glory.
[25] Whom have I in heaven but thee? and there is none upon earth that I desire beside thee.
[26] My flesh and my heart faileth: but God is the strength of my heart, and my portion for ever.
[27] For, lo, they that are far from thee shall perish: thou hast destroyed all them that go a whoring from thee.
[28] But it is good for me to draw near to God: I have put my trust in the Lord GOD, that I may declare all thy works.

Friday, November 6, 2009

The Nature of Money

For some reason there seems to be a lot of chatter on the Internet financial pages about the nature of money. What is it? Here is my take on what I have read. Money is anything you want it to be. Money is just a device created by a society to facilitate transactions. It can be Yap stones, wampum beads, clam shells, pieces of paper, or even something as ethereal as electrons lighting the pixels on video screen. The key is belief. Everyone has to agree that Yap stones or a particular piece of paper is a window. As a member of this society, as I look through the particular window called American Dollars I see a new BMW, a vacation in Hawaii, or lunch at McDonalds. Money is ultimately based on something, most often gold or silver. Nixon cut us loose from the gold standard back in 1971. If I remember correctly, the French made a run at the American gold reserve with their stack of dollars. It was dangerously destabilizing. Nixon cut off that nonsense at the knees.

So what is the base of the American dollar? It is nothing but debt. The reality is probably more complex than can be contained in a 500 page book but here is the essence. The American government creates money by creating a debt when the Treasury Department issues a bond. This bond is sold through the Federal Reserve Bank to “primary dealers” who must make bids on this debt through an auction process. Who are these guys? “For example, Daiwa Securities and Mizuho Securities distribute the debt to Japanese buyers. BNP Paribas, Barclays, Deutsche Bank, and RBS Greenwich Capital (a division of the Royal Bank of Scotland) distribute the debt to European buyers. Goldman Sachs, and Citigroup account for many American buyers. Nevertheless, most of these firms compete internationally and in all major financial centers.” (From Wikipedia) Check into high ranking political appointees from both parties and compare their resumes to the list in the last sentence.

Then through the magic of fractional reserve banking, a dollar of debt becomes the basis of a loan that creates more debt. There are mathematical formulas that predict the outcome of such activities based on the amount of money the regulators require the banks to hold. A 10% reserve turns one dollar into nine dollars. If this was being done by someone other than the government it would constitute fraud.

Money is also a commodity that is traded for other commodities. Its value rises and falls over time depending on the supply of money compared to the supply of the goods and services. If the Federal Reserve System and the Government create too much money, its value relative to a gallon of gas drops. It pleases us to call this inflation. In the worst case scenario, the value of the currency drops to zero since it based on nothing but a government promise to pay its debt with interest. This happens fairly often, most recently in Zimbabwe. If the Federal Reserve System creates too few dollars (an unlikely scenario) the value of the dollar increases relative to the supply of goods and services causing deflation. In a worst case scenario this leads to an economic collapse as wages, prices, and profits all decline to nothing. That is happening in this country, today. Trillions and trillions of bad derivative debt has disappeared. The government is doing everything it possibly can to replace that bad debt with new debt that ultimately owed by the American taxpayer to the bond holders, such as the Chinese.

Always, even before there were the economic philosophies we call capitalism and socialism, at some point too many promises to repay some debt or obligations (such as my pension) were made by the powers that be. There simply was not enough gold or potential tax revenue to redeem all these promises, people no longer believed, and the whole edifice came crashing down. Today we live in a castle of debt built on a foundation of thin air. It will unravel in some manner at some point in time. I am just not smart enough to know how or when. Capitalism is based on greed. Socialism is based on envy. Greed and envy are two of the seven deadly sins, but Jesus transcends economic systems. There are wheels within wheels both in the earth and in the powers of the aire, but there are also wheels within wheels in Heavenly places.

Ezekiel 1

[14] And the living creatures ran and returned as the appearance of a flash of lightning.
[15] Now as I beheld the living creatures, behold one wheel upon the earth by the living creatures, with his four faces.
[16] The appearance of the wheels and their work was like unto the colour of a beryl: and they four had one likeness: and their appearance and their work was as it were a wheel in the middle of a wheel.
[17] When they went, they went upon their four sides: and they turned not when they went.
[18] As for their rings, they were so high that they were dreadful; and their rings were full of eyes round about them four.
[19] And when the living creatures went, the wheels went by them: and when the living creatures were lifted up from the earth, the wheels were lifted up.
[20] Whithersoever the spirit was to go, they went, thither was their spirit to go; and the wheels were lifted up over against them: for the spirit of the living creature was in the wheels.
[21] When those went, these went; and when those stood, these stood; and when those were lifted up from the earth, the wheels were lifted up over against them: for the spirit of the living creature was in the wheels.
[22] And the likeness of the firmament upon the heads of the living creature was as the colour of the terrible crystal, stretched forth over their heads above.
[23] And under the firmament were their wings straight, the one toward the other: every one had two, which covered on this side, and every one had two, which covered on that side, their bodies.
[24] And when they went, I heard the noise of their wings, like the noise of great waters, as the voice of the Almighty, the voice of speech, as the noise of an host: when they stood, they let down their wings.