Category Archives: Economics

Putting Emergency Funds Aside

On Thursday, 12/5/13, Andrew Blackman, writing in the Wall Street Journal, took on the conventional wisdom of having an emergency fund equal to 6 months of expenses and that those funds be in a bank account. He suggested as possible alternatives: a 5 year CD (with a low withdrawal penalty) and a diversified equity portfolio. While the first one would be fine, the latter just puts more money into the broker’s pockets in place of it going into banker’s pockets.

Why not start at the root?

The six month figure sounds fine, but as a starting point not an ending.

Why should we not go back to the source to find the funds needed?

True, if you are an “At Will” employee and the employer may come to you at any time and say that you are not needed you need six months of reserves. However, what if you know you will receive at least some number of weeks or months in the form of a severance package? How about unemployment insurance? Shouldn’t those sums be subtracted from the six months figure to reduce the need for the six months cash reserve and let people feel better about investing in alternative ways.

Science??? When is it Science and when Not?

An article in the Wall Street Journal the other day about mistakes doctors make reminded me that I was supposed to write this blog about what is science.

My definition of science is that it is a discipline that always produces the same results when carried out in the same way.

Two hydrogen atoms and one oxygen atom always equals water. If you substitute nitrogen for hydrogen you always get “laughing gas.”

Drop a weighted object from the roof and it will hit the ground in exactly the same amount of time each and every time.

Take a number of jelly beans and add a like number and you always have twice as many jelly beans.

Medicine isn’t that way. We are all slightly different and what works to stop the coughing in one person may not stop it in another. Yes, there are areas of medicine that are replicable, surgery for example, but, on the whole that’s not true.

Economy is not a science. If it were, three different economists with conflicting theories would not have all received Noble prizes for their work.

Which takes us to the investing area. There are those who, to convince clients that the plan they have devised for the client is going to work 95% of the time use some formula or other – very often the “Monte Carlo Simulation.” The problem is that the input is based on extrapolated historical results. Now, since we have no crystal ball to look ahead it behooves us to study historical information to give us information to use in moving forward. We do that when we drive somewhere. Route one has taken us 30 minutes, route two 35 and route three 50 minutes. So we take route one. Sometimes an accident creates a situation where route one takes an hour. That’s life. Well, in investing the same is true. We use historical data and recognize it will work sometimes. However, we don’t want to gamble on that information as if it were a holy grail. We want to use historical input and do not want to drive “looking through the rear view mirror”.

As advisors we want to do the best for you and we also want to make you feel comfortable. Just don’t get too comfortable.

"Wall Street" Is Not Doing Its Job

The article in today’s Wall Street Journal about a pioneer in computer trading assailing the practices that are now being employed by “Wall Street” to make profits for the firm and the wealthy who can afford to take advantage of these transactions is the fuse for this blog.
There was a time, not too long ago when “Wall Street” served the function of lending to start-up firms. Nurturing them, and then taking them public. Not only creating wealth for the owners of the business, but, permitting the businesses to grow and create jobs. No more.
The roll of lending to new businesses has transitioned to private equity firms. That is neither good nor bad, except they are not really interested in the company that will not bring a new technology to market or in some other way be a bonanza.
What it does it to leave the manufacturer of a better chair, stove, appliance, etc out in the cold.
What does that mean for the country? It means no job growth.
What does it mean for the “Wall Street” firms?
It means they are looking in the universities for the brightest computer engineers to design programs to make money for themselves and their wealthiest clients. Doing nothing for the country or for the economy.

How to Deflate a Gold Bubble (That Might Not Even Exist) By STEVEN M. DAVIDOFF

Following is the article by Mr. Davidoff in The New York Times Deal B%k.
He writes much better than I do so I’ve taken the liberty and copied his article into the blog. My comments are made by reinforcing his points with italics and bold.

How to Deflate a Gold Bubble (That Might Not Even Exist) By STEVEN M. DAVIDOFF

Gold is caught in a frenzy.
The price of gold reached a record high of $1,917.90 an ounce last week, not adjusted for inflation, and then promptly plummeted by about $120 an ounce. The volatile trading is again spurring claims that gold is in a bubble, one that will pop badly.
As with past booms in housing prices and Internet stocks, the four-year surge in gold prices raises the same fundamental questions for market regulators. How should they react? Should they react at all? How do they even know if a bubble exists?

It is clear that speculation has been driving gold’s rise. People are buying gold as either a hedge against inflation or economic calamity or solely because they think the price will rise. As evidence of this speculation, the World Gold Council reports that demand for gold bullion bars more than doubled from 2009, to about 850 metric tons a year. This is largely gold that is bought and sits there as people wait for price increases. Indeed, demand for gold in industry and for jewelry has actually declined by 18 percent from 2004, to about 2,500 metric tons a year, according to the World Gold Council.

This speculation is aided by the financial revolution. Previously, gold could be bought by retail investors only through dealers and street shops. Now anyone can go on the Internet, click and buy gold in the market through exchange traded funds. These funds will buy gold on the investor’s behalf, and now hold about 2,250 metric tons of gold — or nearly a year’s worth of output.

Speculation alone doesn’t necessarily mean that gold is in a bubble. Gold is historically viewed as a protection against inflation and tumultuous economic times. It is a way to diversify a portfolio and hedge these risks. The price rise can be explained by people’s rational betting that these phenomena will occur. This is particularly true in light of the heightened risks to the economy because of events in Europe and the still-lingering effects from the financial crisis in the United States.

But like paper money, gold is worth only what people believe it is worth, and because of this, it is sometimes referred to as the barbarous relic. You can’t eat gold. Its industrial uses are limited. If someone else doesn’t assign the same value to gold that you do, you are out of luck. For those who predict it will be valuable if society completely collapses, guns and canned goods might come in handier.

Gold’s relative uselessness has helped spur talk of a bubble. The problem for regulators is whether this speculation is natural, prudent hedging or people irrationally piling ever more into a bubbly asset.

After all, Alan Greenspan, the former Federal Reserve chairman, speculated that the stock market might be “irrationally exuberant” in 1996, well before the actual bubble took hold. As with the Internet bubble, we will know if a bubble truly existed only if and when gold falls.

In his book “Irrational Exuberance,” Robert J. Shiller of Yale University tried to set forth a test for spotting bubbles. Bubbles are created when people buy in to the next great thing. They accept that this is a game-changing asset — like housing or the Internet — that cannot fail. As more people buy the asset, the speculation and frenzy increase

According to Professor Shiller, a crucial driver of a bubble in today’s modern age is the Internet and media.

If you watch cable television, it would certainly appear that gold is in a bubble. Commercials abound for buying gold. Commentators on CNBC talk about gold hitting $2,400 an ounce, which would be a genuine record (the previous high of $850 in 1980 would be about $2,300 today, adjusted for inflation). In fairness, other CNBC commentators have said that this is foolish and that gold prices are too high. Still, the marketing of gold to the masses is an ominous sign.

Even after the downturn in prices last week, it is not clear if gold has hit its peak. Is gold still being driven by fundamentals or is it a speculators’ delight?

Because of this uncertainty, regulators have acted as hesitantly as they did in the case of the Internet and housing bubbles. The Chicago Mercantile Exchange recently raised margin requirements for gold, the amount of money you can borrow to buy gold. The Singapore exchange also raised margin requirements last week. Other exchanges in other countries have not acted similarly, leading to differences that will drive gold trading to those markets.

The Commodity Futures Trading Commission, the primary regulator of the gold market in the United States, does not appear to want to act. The agency is following form, as it also refused to act forcefully when oil jumped to more than $145 a barrel in 2008. It seems hesitant to quash speculation. The commodities regulator, though, could force American exchanges to further raise margin requirements, reducing leverage and the ability of investors to buy more gold. The agency would also have to act to limit the gold acquired individually and by the E.T.F.’s. All of these measures would have to be coordinated and put into effect on a global basis.

Those would also be very aggressive acts to attack a problem that some say doesn’t even exist. This analysis could be applied to other commodities that have had huge run-ups in past years, including oil, food and other metals like silver.

In other words, not only is it hard to spot a bubble, but the measures to fight it, like restrictions on leverage and holdings, are hard and controversial to put into effect. Limiting the type of media barrages we see is also impossible in a free society.
Yet if regulators are going to stop the next bubble, they will need to act aggressively. Of course, they shouldn’t act in every circumstance, but when we see volatility and speculation as is the case of gold, acting to curb these forces through limiting leverage in cooperation with international regulators would be a prudent course. This would ensure that if a crash does come, it does not have aftereffects on banks and other institutions. Even if the Commodity Futures Trading Commission is hesitant to take such steps, it could, as an initial foray, take to the media to try to “talk down” the speculation.

Otherwise, we’re left hoping, without much basis, that people have learned that this time will not be different, something not much in evidence in the case of gold.

From the Wall Street Journal

“Workers, in short, now can be hired “just in time.” And many employers apparently don’t think it’s time yet.” – What’s Wrong With America’s Job Engine?* This article will be available to non-subscribers of the Online Journal for up to seven days

What used to be a method for reducing the cost of inventory has become a way of dealing with employees.

Articles from the New York Times

“look at what we know about the American economy and, almost as important, what we do not.

One of the tricky things about the subject is that almost nothing is certain in the way that, say, two plus two equals four. Economics — which is at root a study of human behavior — tends to be messier. Because it’s messier, it can be tempting to think that all uncertainty is equal and that we don’t really know anything.

But we do. It’s just that the knowledge tends to come with caveats and nuances. Economic truths may not rise to the level of two plus two equals four, but they are not so different from the knowledge that the earth is round or that smoking causes cancer.

The earth is not perfectly round, of course. Some smokers will never get cancer, while most cancer is not caused by smoking. Yet in the ways that matter most, the earth is still round, and smoking does cause cancer. Both of these facts are illustrative in another way, too: seemingly smart people spent decades denying them.

When it comes to economics, we know that a market economy with a significant government role is the only proven model of success. The United States has outgrown Europe partly because of our greater comfort with market forces. China and India boomed after allowing more of a market economy. On the other hand, unencumbered market forces often lead to disaster, as 1929 and 2008 made clear.”

“We know that the federal government has promised more benefits than it can currently afford. The only way out of this problem involves some combination of tax increases and cuts to Medicare, Social Security and the military. Anyone who won’t get specific about which ones they favor is not a fiscal conservative.

We know this country spends vastly more on health care than any other country — about 75 percent more per person than other rich countries — without getting vastly better results. The waste in our medical system offers the best chance to reduce the deficit without harming our living standards.”

“The real problem with so many of these issues is that the political system is not even trying to find solutions.”

“Perhaps the last refuge for optimists is Churchill’s reputed line: “In the long run, Americans will always do the right thing — after exploring all other alternatives.” The sentiment is nice. It would be comforting to have a little more reason to believe that history was going to repeat itself.”

I don’t want to post the entire piece here, and the subject is …

“A “risk-free return” is central to much modern financial theory. The widely embraced capital asset pricing model.”

BUSINESS DAY | July 27, 2011
Economic Scene: Lessons From the Malaise
Nuances and caveats help to keep the nation from solving some straightforward questions about the economyBUSINESS DAY | July 27, 2011
Reuters Breakingviews: Risk-Free Assets, Undermined
If the credit of the United States and some European countries were downgraded, a big chunk of investment thinking would be shaken up.