Saturday, January 30, 2010

The Karma Cafe

There is a restaurant in Japan that is a little different. You stand in a line, place an order, and pay for your order, but you don’t get what you ordered. You get whatever the person in front of you ordered. Likewise, the person behind you gets to eat what you ordered.

How like life itself. Perhaps a good time to reflect, Jesus placed the order and paid the price so that I, a man condemned to death, might live. What are the implications of this model for his followers?

Here is the link to the story.

Matthew 7:12 (NIV)

So in everything, do to others what you would have them do to you, for this sums up the Law and the Prophets.

P.S. Thanks to Seth Godin's blog for the link

Friday, January 29, 2010

Children and Money (True Story)

I know a man who has two sons. The elder son just graduated from engineering school with a perfect 4.0 average, amazing. Here are some bits from his story. While the elder son was still in high school, his father told him that there was a certain sum of money set aside for his education and that an equal amount had been set aside for his brother. This amount of money would cover most but not all of a four year degree at an affordable public institution. The father went on to state that was all the money he could afford. When it was gone there would be no more. He went on to tell his son that he could send the money to the university of his son’s choice until it was all gone or if the son could earn scholarships he could keep the money. He told his son that he could then use the remaining money to put a down payment on a house or buy a new car. The son pursued scholarship money with visions of expensive sports cars dancing in his young head.

His father counseled him to start in a local community college rather than going directly to a large state school. The father listened to a university administrator explain that she wanted more transfer students and fewer freshmen at her particular engineering school. She was tired of being a failed babysitter. She wished to spend more of the state’s resources on producing engineers and less on shielding irresponsible children from the consequences of their bad behavior. The boy listened to his father and received a full academic scholarship to a local community college.

He didn’t listen to his father because he was a dutiful son or because he believed his old man was a fount of wisdom. He listened because his father was paying him $10.00 an hour to listen to him talk about particularly important subjects. During these sessions if the son acted bored or rebellious, his father would remind him, “Hey, I’m paying you $10.00 an hour to listen to this, so shut up and listen.”

During one of these $10.00 an hour sessions, at 11:00 on a Friday night, he drove his son to a place just outside of a college campus where he knew the local police set up a trap to catch students for driving under the influence. After watching several arrests, the father noted with some satisfaction, his son was beginning to believe that perhaps his old man was not a completely hopeless fool.

After completing a two year degree, the son, as advised by his father, applied to a large state school and once again he received a full academic scholarship. The boy complained about his social life. In the child’s defense, the social life of a serious engineering student does make a medieval monastery look like a convention in Las Vegas. His father managed to convince him that the payoff would come in marriage. Women want to marry successful men with good jobs and sizable bank accounts. Remember, that education fund is still untapped and growing.

Just a few weeks ago, the boy graduated with a BS in engineering from a large well known state school. His father explained to his son, that now with his perfect academic record, he can apply to any elite college in the country and they will pay him to attend graduate school. The boy has not yet decided to take the next step in his life, but much to his father’s bewilderment, the young man is considering a change in direction. Instead of seeking a graduate degree in engineering, he is looking into the possibility of medical school. The father shrugs his shoulders and shakes his head in disbelief, but he looks very happy and very proud.

The younger son is still in high school. His latest career aspiration was to become a professional poker player. Fortunately, his father has successfully dissuaded his son from pursuing this path.

The story is still unfolding.

Saturday, January 23, 2010

Counting Our Chickens Before They Hatch

I tell you, the economy is bad.
How bad is it?
The economy is so bad, that I bought a toaster oven and my free gift with the purchase was a bank.

I am looking at a gloomy series of charts. From the end of 1999 to the end of 2009, the S&P suffered a 23% loss measured in American dollars. During those ten years, the tech bust dropped the value of the S&P by 50%. Then the housing bubble and the financial crisis dropped the S&P by 56% from its peak value in October 2007. If you measure the drop in the S&P during the past decade in Euros, the loss is 47%, measured in gold, 80%. Every year the dollar is losing value to other currencies and commodities even as the markets gyrate.

The retirement calculators often suggest 8% as an average annual return on investment and 3% as an average rate of inflation. The actual return on investment over the last 10 years would average -2.7%. It is harder to get an accurate measure of inflation because our government economists keep changing the definition of their indices in order to make the political party in power appear more successful. However, looking at a ten year moving average of the Consumer Price Index over the course of the last decade, 3% does look like a pretty good number. Our national debt seems to be approaching a mathematical singularity, an infinite increase over a finite period of time. Do you want to bet that the value of the American dollar will continue to drop at a modest 3% per year?

In a recent edition of the Wall Street Journal, Jason Zweig observes that, “A nationwide survey last year found that investors expect the U.S. stock market to return an annual average of 13.7% over the next 10 years.”

His commentary on this little factoid, “What are we smoking and when will we stop.”

The article goes on to observe that over the years tax increase and inflation subtract 5% to 7% from our returns. That means the American investor would need a 20% average annual return on their investments in order to meet their expectations.

In the words of the eccentric wide receiver, Chad Ochocinco, “Child, please!”

The author also asked some respected experts what guaranteed rate of return after taxes and inflation would be realistically acceptable. John C. Bogle, founder of the Vanguard Group of mutual funds replied, 2.5%. Elroy Dimson of London Business School, an expert on the history of market returns: 0.5%.

That brings us back to the retirement calculators that tell me I have to work another 3 years. That is assuming I can beat taxes and inflation by 2% or 3% every year for the rest of my life. This is quite an assumption given our rising national debt, a terribly sick housing market, and the death of the notion that our economy can be driven forever by consumption without the creation of any wealth.

Sunday, January 17, 2010

No Easy Answers

My wife just returned home after spending several weeks with her mother in Atlanta. The future of her church is one of the subjects that have been causing my mother-in-law intense grief and pain. At one time this church was one of the largest wealthiest churches in Atlanta. Unfortunately, the pastor most responsible for the success of this church also sowed the seeds for its destruction. Although he was a superstar Baptist platform preacher, one of the best I have ever heard, his grotesque mismanagement of church finances eventually led to his dismissal and the beginning of the church’s decline. Today the church is smaller than and not as wealthy as in years past. The pastor, leadership, and members of the congregation are facing some tough decisions.

Over 50 years ago, the church began as a satellite of a downtown church in the budding suburbs of a growing Atlanta. Today the church building is no longer located in the suburbs. Its large physical plant occupies an insanely valuable piece of real estate in a prime commercial area of the city. The church buildings are aging, requiring more and more money to keep them in repair. The congregation is smaller and no longer needs such a large physical plant. I expect that the geographic center of the current membership is somewhere miles to the North of the church’s current location. The logical move would be to sell the building for an obscene amount of money, use the proceeds to build a new more practical structure in a better location, and put the balance into new ministries for the new members.

But it isn’t that easy. My mother-in-law has been a member of that church almost from the beginning. She just missed charter membership by a couple of months. Her husband was a deacon, Sunday school teacher, and pillar of that church for about 50 years. They invested their entire adult life in that church and that church building, their time, their treasure, and their emotional energy. My mother-in-law saw her children grow up in that building and attended her husband’s memorial service in that building. Even though her physical condition has made it impossible to attend services for a number of years, she has continued to support the church in her prayers and with her money. The thought that her church will not occupy that piece of property after her passing is more than she can bear.

I saw this same scenario once before. One of my oldest and closest friends is the son of a Baptist preacher. His father earned a Ph.D. in theology from a German university in the years following World War II. He possessed both an extraordinarily powerful intellect and an electrifying personality. When I met him he was the pastor of one of the largest and wealthiest churches in another southern city. A similar story, an ancient decrepit building with no parking in a downtown neighborhood populated primarily by vagrants and winos. Along with the majority of the leadership and members, he planned a move to the edge of town where the new suburbs were exploding. He successfully built a beautiful modern building and moved most of the congregation into the new structure. Of course the years have proven they made the right decision. The church has prospered.

This success came at a price. Elderly, powerful, and wealthy members of the church in that other city could not accept the concept that God could be worshipped at a new location. It spite of their pastor’s best efforts, efforts that were well beyond the call of duty, the church split. He continued to pastor at the new location until he was convinced the crisis had passed, then he moved on. His health, both emotional and physical was broken. He was never the same man again.

Sometimes there are no easy answers. Doing the right thing does not matter because it is the source of too much pain in the heart of another. Sometimes following the Golden Rule could lead to a less than optimum outcome.

Pastors frequently observe that their churches should grow because they are living things. This is true. However, it is the nature of living things to grow old, to suffer illness, to die, and to decay. That is not an easy truth to face. It is hard to accept that I am not the man I was 30 years ago. My heart no longer performs as it should, something in my lower back will no longer allow me to pick up a 150 pound pan of rivets as I once did, and arthritis limits the motions of my knees. I fear that the day might come when my mind no longer works as it should. In that day can I pray, “O God, grant that I may understand that it is You (provided only my faith is strong enough) who are painfully parting the fibers of my being in order to penetrate to the very marrow of my substance and bear me away within yourself.” (Pierre Teilhard de Chardin) Can we, as members, of the Body of Christ, accept that in the end it is not our church but His Church and that the gift of God that we pass on to our children’s children might take a new form, one that is not what was once delightful and dear to us?

Ecclesiastes is one of my favorite books of the Bible, but rather than quoting it again, let me offer a poem by Walt Whitman in honor of my friend’s father. I think his family would like that.

O Captain My Captain by Walt Whitman

O Captain my Captain! our fearful trip is done,
The ship has weathered every rack, the prize we sought is won,
The port is near, the bells I hear, the people all exulting,
While follow eyes the steady keel, the vessel grim and daring;
But O heart! heart! heart!
O the bleeding drops of red,
Where on the deck my Captain lies,
Fallen cold and dead.

O Captain! my Captain! rise up and hear the bells;
Rise up--for you the flag is flung for you the bugle trills,
For you bouquets and ribboned wreaths for you the shores a-crowding,
For you they call, the swaying mass, their eager faces turning;
Here Captain! dear father!
This arm beneath your head!
It is some dream that on the deck,
You've fallen cold and dead.

My Captain does not answer, his lips are pale and still;
My father does not feel my arm, he has no pulse nor will;
The ship is anchored safe and sound, its voyage closed and done;
From fearful trip the victor ship comes in with object won;
Exult O shores, and ring O bells!
But I, with mournful tread,
Walk the deck my Captain lies,
Fallen cold and dead.

Saturday, January 16, 2010

27 Million Americans

Normally I find stuff in my readings that appears to be good blog fodder. I seldom go out looking for subjects, subjects generally find me. This week is different. I have been thinking, praying, and asking others to pray for the unemployed and the underemployed. I wondered if I could find current articles to provide enough background for a new blog post. I found more current articles than I could possibly use for one post. The problems are simply overwhelming.

There are approximately 27 million Americans who are unemployed or underemployed using government definitions that actually mask the true extent of the problem. 15.3 million Americans are unemployed and actively seeking employment. 2.5 million American workers are categorized as “marginally attached,” those who are unemployed but have not actively sought work in the last four weeks. Finally, 9.2 million Americans are working part time jobs because they can not find full time employment.

27 million Americans.

This number does not begin to capture the extent or the seriousness of this problem. It does not include Americans who have simply become so discouraged that they are no longer trying to find a job. It does not include college graduates are flipping burgers or returning to graduate school to wait out the recession (not a bad idea if they can avoid student loans).

The last decade was a bust. After three catastrophes, the internet bubble, the near collapse of the financial system, and the real estate bubble, the stock market ended pretty much where it began the decade. Americans, who are lucky enough to have a job, are working longer hours for less money. The American standard of living has been on the decline for more than one decade. For the first time since the 1930s America did not have a net increase in the number of jobs.

Many of the jobs lost in the current recession will not return in the foreseeable future. The 6 million manufacturing jobs lost in the last decade will not return. The 1.6 million construction jobs lost when the real estate bubble popped will not return, at least not in the next decade. This number does not include real estate sales jobs, or the ½ million jobs lost in the finance and mortgage industry.

Some of the job loss is structural, a byproduct of changing taste and technology. Newspapers are dying as cable news and the internet provide free news on demand, as it is happening. Who wants to pay 50 cents or more for day old news that then has to be carried to the curb in a recycling bin? Digital photography is a revolution that happened faster than anyone predicted. Now photofinishing is a doomed business. Sadly, record stores (note: the use of words gives away my age) are disappearing as MP3 and I Pods are the new norm. These changes would happen, recession or no recession.

Finally, these employment figures are impacting government at all levels. Something like 45 out of 47 states reporting (don’t remember where I saw that number) are suffering from serious drops in revenue. 39 states are looking at serious shortfalls in revenue as the cost of maintaining their social services net increases even as their tax base declines.

Believing that we can educate our way out of this catastrophe is simple nonsense. As I have mentioned once before. I thought I was a pretty smart fellow until I returned to engineering school and ran into courses like Calculus and Thermodynamics. Since I was paying my own way and never ever wanted to return to a factory, I was highly motivated. I was 30 years old, married, and a Christian so I did not suffer from the typical undergraduate distractions offered by beer, sex, drugs, and rock and roll. Still engineering school durn near killed me. I realized that most of the folks who worked with me in the saw chain factory could never make through computer science courses or any other training that could offer them what were the “new jobs” of the 1980s. Today we have a backlog of unemployed computer programmers. These people are young, healthy, and experienced. They can not find jobs. Who is going to hire a 50 year old assembly line worker with a network certificate and no experience when they can have a better employee who will work for less money?

In a recent article posted on CNBC’s web site, hardly a source of right wing opinion, the author made some of the same points I mentioned in my review of The Return of Depression Economics by Paul Krugman.

“A potential wave of new regulation and higher taxes may be scaring many businesses from hiring, prolonging any rebound in employment, say business groups and economists. “The prospect of increased federal and state regulation and taxes has been particularly disruptive to the hiring plans of small- and medium-sized businesses, which have historically generated about two-thirds of the nation's jobs.

"I don't really see the private sector hiring much in the next few months," says Brian Bethune, an economist at Global Insight. "For the small-business sector there is just too much uncertainty about what happens beyond 2010."

It is a time for prayer and repentance.

Psalm 102
[1] Hear my prayer, O LORD, and let my cry come unto thee.
[2] Hide not thy face from me in the day when I am in trouble; incline thine ear unto me: in the day when I call answer me speedily.
[3] For my days are consumed like smoke, and my bones are burned as an hearth.
[4] My heart is smitten, and withered like grass; so that I forget to eat my bread.
[5] By reason of the voice of my groaning my bones cleave to my skin.
[6] I am like a pelican of the wilderness: I am like an owl of the desert.
[7] I watch, and am as a sparrow alone upon the house top.
[8] Mine enemies reproach me all the day; and they that are mad against me are sworn against me.
[9] For I have eaten ashes like bread, and mingled my drink with weeping,
[10] Because of thine indignation and thy wrath: for thou hast lifted me up, and cast me down.
[11] My days are like a shadow that declineth; and I am withered like grass.
[12] But thou, O LORD, shalt endure for ever; and thy remembrance unto all generations.
[13] Thou shalt arise, and have mercy upon Zion: for the time to favour her, yea, the set time, is come.
[14] For thy servants take pleasure in her stones, and favour the dust thereof.
[15] So the heathen shall fear the name of the LORD, and all the kings of the earth thy glory.
[16] When the LORD shall build up Zion, he shall appear in his glory.
[17] He will regard the prayer of the destitute, and not despise their prayer.
[18] This shall be written for the generation to come: and the people which shall be created shall praise the LORD.
[19] For he hath looked down from the height of his sanctuary; from heaven did the LORD behold the earth;

Sunday, January 10, 2010

Ah, Grasshopper

The Chinese have a saying, “Understanding others, that is wisdom. Understanding yourself, that is enlightenment.” For those of you who remember Kung Fu, the TV series, feel free to do your best Master Po imitation and add, “Ah, grasshopper.”

On the long annual Christmas tour of Georgia I listened to Master Your Money Type by Jordan Goodman. Goodman is a financial journalist, author, radio personality, and speaker. He claims that after talking with thousands of people about personal financial problems, he believes that most of us can be categorized as falling into one (or more) of the six following psychological money types. No, it isn’t science, but I believe this book would be a useful and entertaining starting point for many individuals, as they tread the path to financial self awareness. My wife, who is not at all interested in such topics, enjoyed listening to the book.

1) Coasters
2) Debt desperadoes
3) High rollers
4) Ostriches
5) Squirrels
6) Strivers

It is hard to indentify my own blind spots. If I could do so, they would not be blind spots. Yet we all have them. We have a basic financial operating system that is reinforced by our upbringing and our experiences. Often our understanding of these experiences is so skewed by our worldview that we continue to believe strongly in our prejudices even when the evidence is all to the contrary. I believe the technical term for this psychological phenomenon is cognitive dissonance.

According the Jordan, I am probably something like ½ coaster and ½ squirrel. My wife would probably increase the squirrel percentage to something like 2/3.

Coasters are, “organized, responsible, and focused on stability.” They tend to be well informed and generally they are doing the right thing and getting good results. Because coasters are doing most things right, they tend to ignore the things that make them uncomfortable and avoid taking steps in new financial directions. For example, I have never written a will, or a living will, or established medical power of attorney, all things I rather not think about. I excuse my behavior by observing that if I die, everything except my 13 year old Honda is jointly owned. My wife can continue to operate without me without any legal hassles. True enough, but what if we both die?

Squirrels gather nuts and bury them in the ground. I come by this trait honestly. My father’s family is full of financial squirrels. They get an education, work hard all their life, pay off their debts early, save money, and die. Squirrels understand budgeting, double coupon day at the grocery store, how to find a bargain, balance the checkbook, and most importantly, they know how to spend less than they earn. Sometimes squirrels go through an entire lifetime without ever enjoying any of their money, because they believe that if they enjoy themselves, it will result in financial disaster. Although I have improved over the years, particularly in the area of nice vacations, it is very hard for me to spend money on anything just to enjoy life.

Both coasters and squirrel tend to avoid risk, any risk. Both types tend to keep too much of their money in low interest accounts, guaranteed by the FDIC. Guilty as charged. I did not begin to seriously study and make investments until I was 50 years old, even though I had more than enough money to begin such a program. I thought, “I don’t know what I am doing, what if I make a mistake?” To be honest, I still do not know what I am doing. Management guru Peter Drucker once observed: "Anybody who tells you that he understands the American economy ought to be sent to teach modern dance." Even though I still don’t know how to operate my crystal ball, the results of my studies and efforts at investment have generally been blessed. I try to remain thankful for all that I have been given.

One last thought, I don’t know where I read this little story but here it is anyway. A famous author was invited to be one of the celebrity guests at a billionaire’s party. At the party, another guest told the author, “Our host has made more money in one single day, than you will receive in your entire lifetime.”

The author replied, “That’s OK. I have more money than he does.”

Stunned, his companion replied, “How can that be true? He is one of the richest men in the world!”

The author answered, “I have enough.”

Ah, grasshopper.

Saturday, January 9, 2010

They're Back!

“When CNBC asked him what the one thing he believed young people should be doing about money, his primary advice was to "stay away from credit cards." Paying interest on credit cards not only suggests that you are living beyond your means, but it also means that you are losing money. Both courses of action run contrary to Buffett's philosophy.”

After spending a long holiday weekend with economists in Cloud Cuckoo Land, let me return to Earth, the planet where most of us live. The new consumer protection act outlawing many egregious practices by credit card companies will not go into effect for another month and already they have discovered loopholes in the law that will allow them to exploit Americans who are too poor or too ignorant to find options.

If you are lucky enough to have a fixed interest rate credit card, the banks can no longer raise the interest rate on your existing balance, if you continue to pay your bills on time. However, most Americans have variable interest rate credit cards. Now things start to get a little murky. The rate floats as a function of the Prime Interest Rate or some other such index. As interest rates rise, the rate you pay on your existing balance will also rise. Banks have now added interest “floor rates” into the contractual fine print. Even if the interest rate drops to zero, the credit card company does not have to drop your rate below their set point. In the past the rate was calculated on the basis of the highest index rate in the 30 day billing cycle. Now the banks will use the highest prime rate in the last 90 days as a basis. Experts expect this one little change will cost you $720,000,000 a year. Heads they win. Tails you lose.

The credit card companies have added minimum finance charges to many of your cards. Now if you owe less interest than the minimum, you pay the minimum.

The credit card companies will now be charging late fees that increase with your balance. While the banks advertise the lowest rates, 9 out of 10 of their customers pay the highest fee and that fee is increasing.

The days of having 15 credit cards in your wallet are coming to an end. Card companies are adding inactivity fees. You pay not to use a card, even if you have a pay off agreement with the card company that does not allow you to make new charges to the card. Isn’t that special. The banks are telling us not to cancel credit cards, even if we don’t use them as this would effect our credit rating. There is less to worry about if you don’t exceed 30% of available credit and you pay off that balance off every month.

In the past credit cards charged a foreign transaction fee when a cardholder made a purchase requiring a currency exchange. Now the definition of a foreign transaction fee includes any transaction that touches a foreign bank even if no currency exchange takes place. The typical foreign transaction fee has increased from 2% to 3% over the last five years. I don’t expect this number to go down.

Credit card companies are also changing the rules on balance transfers from one card to a new card and cash advances. The banks are adding minimum charges and have removed fee caps from these transactions. The typical fee is something around 4% with a $20.00 minimum. If you receive a hundred dollar cash advance you will not pay $4.00. You will pay $20.00. One of my good friends has very skillfully played a successful game by shifting her balances to new cards with six month 0% interest rates. It looks like these new changes will stop some of this kind of activity.

Do I sound angry? Yes I am angry. I am angry at the companies that exploit us and I am angry that so many of us don’t do anything to stop this nonsense. Excessive credit, bad debt, is what got us into this mess. Even though American consumer debt is dropping for the first time in my lifetime, it is still at ridiculously high, unsustainable levels.

Please, DON’T BUY THINGS YOU DON’T NEED WITH MONEY YOU DON’T HAVE! Please, don’t give any more money to these scoundrels who have wrecked our economy and hurt so many innocent, naive Americans.

Most of this information came from an article from written by Tamara Holmes

Saturday, January 2, 2010

Babylon is Fallen, Fallen

On the recommendation of a friend at work, I have read The Return of Depression Economics by Paul Krugman, winner of the Nobel Prize in Economics. The book is not an economics text. It is a well written narrative for the educated layman describing a number of economic crises, including causes, governmental responses, and lessons learned. Krugman is a Keynesian and politically liberal. Economists like to consider themselves dispassionate scientists using statistical methodologies to describe and predict the behavior of socio-economic man. Unfortunately, human behavior is not as predictable as that of objects in a Newtonian physics experiment.

Currently there are three major schools of economists. Each of them believes they have an inside track on the truth. Representatives of two of the schools, Keynesian during liberal Democratic administrations and Monetarists during neo-conservative Republican administrations, have had an opportunity to put their hands on the economic control systems of our nation. The Austrian school of economics, favored by libertarians and extreme conservatives, has not yet had a chance to operate the throttle of the nation’s economic engine. I have taken the two introductory courses in economics required in engineering school. I have read a number of popular books by economists (similar to this one) and over the years I have read various statements and critiques of economic theories in the press. I am not an economist, nor do I wish to become an economist. However, the actions they are allowed to take by our politicians have real consequences in the material world. Sometimes these actions are accompanied by unexpected second order effects. I think economists, in spite of their considerable mathematical prowess, are closer to theologians than scientists. I have friends who minister in a variety of different denominations. Each of them is a serious educated Christian. Each of them has encyclopedic knowledge of the scriptures and has read mountains of commentaries and theological masterworks by the great geniuses of the Faith. If I were to put any three of them together in a cage at the same time, I expect the results would be outlawed by Congress as a barbaric blood sport.

Krugman, as a Keynesian, favors direct governmental intervention in the economy. During boom times characterized by irresponsible exuberance, they contend the government should raise taxes and cut spending. During recessions or depressions they believe the government should lower taxes, increase government spending, and fire up the printing presses down at the Department of Treasury. To explain how this works in practice, Krugman presents the model of a babysitting Co-Op. In this particular example one piece of babysitting script is equal to one hour of babysitting services. The participating parents earn script by babysitting and expend script when they want a night on the town. At one point the Co-Op experienced what is called a liquidity trap. No one wanted to expend their babysitting script and the whole thing locked up. The managers of the Co-Op hit upon the Keynesian solution of dumping new pieces of babysitting script into the system. With plenty of script in circulation, the parents once again began to go out rather than hoarding their resources. There is a fatal flaw in this example. There was no devaluation of the currency. One piece of babysitting script was still worth one hour of babysitting services. In our economy the value of the dollar has been intentionally and systematically devalued by the Federal Reserve Bank at the rate of 2% to 3% per year. Over time this adds up. In the 1930s a loaf of quality bread sold for 10 cents. Today the same loaf of bread goes for about $3.50. In the 1930s an ounce of gold was valued at $30.00, today $1,100. Lord John Maynard Keynes, the author’s hero, once observed, “The best way to destroy the capitalist system is to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

In describing a number of different crises prior to our current problems triggered by the collapse of the shadow banking system, derivatives, and subprime mortgages, Krugman does a pretty good job explaining what happened in terms I could understand. However, I was never satisfied with his explanations of why, how to apply the lessons learned to the next crisis, or what any of it had to do with our current economic quagmire. Part of the problem is probably my lack of knowledge in the field of theoretical economics.

Of course Krugman was very much in favor of the bank bailout undertaken by the Bush administration in October 2008 and the subsequent bailouts and stimulus packages offered by the Obama administration. As Milton Friedman observed in a previous crisis, “We are all Keynesians now.” Krugman seems somewhat puzzled that the actions taken by government, while stopping or at least postponing a complete collapse of the world’s economy have not yet had the desired positive effects of increasing available credit and lowering unemployment.

His prescription is, of course, more government expenditures and increased regulation of previously unregulated financial entities. To some degree, his faith in Lord Maynard Keynes seems to have blinded him to some rather simple truths.

In an analysis by Richard Young, it is observed that the Federal Reserve Bank is loaning commercial banks money at essentially zero interest rate. The banks can then use this money to buy Treasury notes that pay 3.5%. Young states, “At leverage of 10 to 1, a position in five year Treasuries would net a bank a 20% return on equity with zero credit risk. Why bother lending money to a borrower who may default when you can make 20% in Treasuries?” In an even more simplistic analysis the financial blogger, Mish Shedlock, observes the banks that have been recently and severely burned are in no mood to make more bad loans to individuals or corporations with dubious credit ratings. Responsible citizens with good credit ratings are concerned with the possibility of job loss or the collapse of their 401-K accounts and are in no mood to borrow money except in the most extreme cases. Finally, due to the collapse of the residential housing market, in many cases it is cheaper to rent than to own a primary residence. Why risk foreclosure, a ruined credit rating, and a loss of principal when renting allows you to save money and the freedom to pack your bags and move on to another city in a financial emergency.

No corporation in the private sector is going to hire a new employee unless they are pretty darn certain the presence of that new employee will generate more in profits than in costs. Government stimulus packages have a place in emergency action but they will never create stable wealth producing tax revenue generating jobs. When all the bridges are repaired and all the pot holes have been filled, then what? Not only will those jobs disappear but someone will have to pay back the money that has been borrowed by the government. There are only two ways to repay that debt, taxes or inflation. Neither is a desirable option. Although it is outside the scope of Krugman’s book, I would also add that many of the programs and policies currently working their way through Congress are terrifying to the very businessmen, particularly the small businessmen, who create most of the new jobs in the United States. One of my friends runs a small business. He is a stone mason who is a master artisan rather than a construction worker. Even though he has a wonderful reputation in his industry and has plenty of contracts in this bad economy, he knows that if socialized medicine in its current form is signed into law, he will have to layoff a number of his employees. There is just no way he could pass the additional cost on to his customers.

The aspect of this book that I found most informative and I must say, humbling, is my discovery of just how interconnected and unpredictable the world’s economies have become. A country doing the right things and minding its own business can see its economy destroyed by the unintended second order effects of an action taken in another part of the world. In some cases the very virtuous behavior that creates wealth will attract speculators who will profit from the destruction of something of value that took years to build. The world’s economy is such a complex and nonlinear system I don’t see how economists think they can control it.

Krugman does admit economists face a “trilemma” that seems close to an insolvable problem. He states, “Think of it this way. There are three things that macroeconomic managers want for their economies. They want discretion in monetary policy so that they can fight recessions and curb inflation. They want stable exchange rates so that businesses are not faced with too much uncertainty. And they want to leave international businesses free—in particular, to all people to exchange money however they like—in order to get out of the private sector’s way.”

I am all in favor of regulating things like the shadow banking system that have created our current problems and I do believe that the excesses of the past decade will be regulated in the future. However, I believe the problems we ultimately face, lie not in regulation of banks or the lack of regulation, but in the human heart. No regulations can prevent ingenious greedy men and women from finding ways to circumvent the intention of the law.

Jeremiah 17: 9

The heart is deceitful above all things, and desperately wicked: who can know it?

Friday, January 1, 2010

Looking Forward, Looking Back

It’s that time of year, the time when we choose to look forward into the future and reflect on what happened during the pervious year. So let me share some items from a variety of different sources and give you my reflections, for whatever they might be worth.

At least the readers of Calculated Risk, one of the best financial blogs on the web, are not too optimistic.

57% are looking forward to a double dip recession.

30% expect Gross Domestic Product to grow, but at less than 2%.

40% of their readers expect unemployment to remain between 10% and 11%.

30% of their readers expect unemployment to go over 11%.

Those are pretty gloomy numbers. I can imagine GDP increasing by more than 2%. After all, 2009 was a pretty dismal year for factory utilization, the transportation indices, and unemployment. 2% of crummy is not an unapproachably large number. The unemployment rate concerns me deeply. I just don’t see any new source of wealth producing jobs to replace our abandoned factories and the construction jobs lost in the real estate crash. A Federal stimulus package could give us a momentary bump, but what do we do when the bridges have been repaired and the pot holes have been filled, and who will pay for these projects once they have been completed? Like most of the readers of Calculated Risk, I don’t think I am ready to come out of my bunker mentality just yet. Of course in the strange world of unintended second order effects, I am part of the problem. The economy needs confident, happy consumers buying new American made cars and second homes on the beach or in the mountains, not suspicious old penny pinchers like me.

So what do the writers of financial self help articles tell us to do?

Check out the performance of your portfolio.

Everyone seems fascinated with comparing your returns to the S&P 500. I like to watch two numbers. Is my total net worth, including my house, increasing or decreasing? If it is decreasing, why? If the drop is a one time purchase of something like a car that was planned for and paid for in advance that is OK. Also, if you are retired and your total net worth is dropping at something less that 4%. That too is OK. I also like to watch my dividends grow. If my dividends are growing my stocks are happy. If they are falling, that is not a good thing. For example, I have quite a bit of money sitting around as cash in money market funds that pay trifling, insignificant interest rates. Can I do something better with some of that money and still remain liquid enough to replace the upstairs bathroom or buy a position in some new market opportunity that presents an offer I can’t refuse?

Anything risky in your portfolio?

How much risk can you stand? If you are 20 you can stand a lot of risk. If you are 70 years old, not so much. If you have less than six month take home pay in a rainy day fund, you can not afford to loose any money. If you are worth $300 million dollars, you can gamble $1,000,000 on some pretty questionable schemes and not loose a lot of sleep.

Look at what you are doing with your investments.

Are you a disciplined investor? Almost everyone agrees that investing is best done in a systematic disciplined manner. There is not one best scheme. What you are doing should reflect your personality, age, and overall financial condition. As Doctor Phil might say, “Is it working for you?” I have found a good analogy to explain this concept to women. A 16 year old girl going to a party is going dress differently than a grandmother going to a wedding, but they can both be appropriately dressed for who they are and what they are doing. Two women of the same age can wear very different clothes to the same event and still be making a tasteful fashion statement that reflects who they are. Whatever plan you are working, stick with it. If, for example, you like to use technical analysis to time the market, be certain to set hard stop loss limits on the day you buy the stock and follow your rule for selling even if your stock is increasing in value.


After getting burned when oil prices last crashed in 2008, I am finally learning to preemptively rebalance my portfolio from time to time. Lately, I have been moving money into my two Thrift Savings Plan bond funds to keep my total percentage of stocks within acceptable limits. In my case, I have decided between 50% and 55% in stocks is just about right for me. Right now I think the market is a little overvalued so probably that number should be a little closer to 50%. What I have not learned is how to sell a portion of a position. Last year I added to a number of my positions as the market contracted. This is the very thing a moderately conservative value investor (such as myself) should be doing in a falling market. But I have never been able to bring myself to sell a portion of a position as it rises. If I believe something is getting too hot, I sell all of it. I need to get past this weakness in my behavior. I don’t have enough money in foreign stocks, especially shares in emerging markets. I am some what frightened of investing in countries with a dubious rule of law, crony capitalism that rewards el presidente’s brother in law with the contract to build the new electronics factory, and occasional revolutions followed by the confiscation of private property. I believe the American Century is over. We are past high noon and our sun has begun to sink in the West. China, India, Brazil, Australia, the Asian Tigers, and maybe even somewhere like the Czech Republic look to be the locations of future economic growth, if the world can get through the current crisis. I need to at least take some baby steps in this area.

Set your savings goals for the new year.

How much money do you need to set aside in the next year? What are you planning in the way of large expenses? I hope every reader of this blog who has a 401K is contributing at least enough to grab all the available employer matching funds. Save a dollar and get a second dollar is really an offer you can’t refuse. I hope you all have or are working towards the six month take home pay rainy day fund. I hope you are not carrying a credit card balance. If you are, pay it off. Every dollar that lowers your balance is, in a way, giving you an 11% or more after tax return. How many investments can match paying off a credit card? Not many. My refrigerator is making strange clunking noises. I am told that the starter kit is going bad. I could replace it for $250 but the refrigerator is over 15 years old, something else could go wrong at any time. I know I will need to replace this appliance and that it will cost about $1,000. I know I want to take my wife on a nice vacation to celebrate our 35th anniversary. Her definition of nice will not be cheap, but having an opportunity to enjoy life is one of the reasons to save money.

And don’t forget. Let’s be careful out there.