Wednesday, December 29, 2010

The Secret to Making Itsy Bitsy Bargains Add Up

Any halfway decent shopper knows of small bargains that keep a little more cash in your pocket, or add a few bucks to your bank balance. For example:

Twin bladed razors. Twin bladed razors, either of the disposable variety or the replaceable blades--are much, much, as in much, cheaper than razors with three, four or five blades. If you keep your eyes peeled, you might find generic twin-bladed razors for one-tenth (as in 1/10) the price of something with more blades. And none of the mega-multiple bladed razors are ten times better or last ten times longer than twin-bladed razors. Why pay $2.50 or more for a razor?

Non-perishables on sale. Non-perishable foods with long shelf lives, such as tuna, peanut butter, and pasta, should be bought in quantity when on sale. Unless you live in a tiny home with no storage space, never pay full retail for non-perishable foods you eat often.

Home cooking. Learn to cook, and you'll save lots of money. In addition, you'll probably put less sugar, fat, salt, msg and other bad stuff in your meals, so your health care costs may be lower. For more, see

Prepaid cell-phone service. Contrary to popular depiction in the mass media, most Americans don't walk around with their faces buried in smart phones, stumbling into light poles and fire hydrants as they text away furiously or catch up on their favorite soaps. Keep a record of how much you actually use your cell phone. A prepaid plan, where you pay for a fixed amount of minutes, may actually be much cheaper than the standard all-you-can-text-and-call plan.

Regular coffee. Lattes are an expensive way to gain weight. Regular coffee, especially without sugar or cream, can give you a nice caffeine boost without larding up your bottom.

Of course, you can think of many other examples of small savings. For more ideas on smart spending, see

How can you make all these small economies add up? By sweeping your checking account every month. Have a savings account (or maybe a money market account) in the same bank where you have a checking account. At the end of each month, transfer all extra funds from the checking account to the savings account. For example, let's say you keep a minimum of $1,000 in your checking account, either because you want a buffer against overdrafts or because it helps you avoid banking fees. If, because of your smart money management, there is $1,125 in the checking account at the end of the month, move $125 into the savings account. Avoid spending the money in the savings account (except to make investments or in dire emergencies). This monthly account sweep prevents you from frittering away the fruits of your frugality. Over time, the swept amounts grow and compound. Compounding is your best financial friend. See By separating the money you save from the money you'll spend, you become richer. And that's better than the alternative.

Wednesday, December 22, 2010

Will the Fed's Easy Money Slow the Economy--Again?

It is widely believed (albeit not at the Fed) that easy money policies by the central bank have contributed substantially to the asset bubbles and busts of the past decade. Tech stocks, real estate, consumer credit (remember the days when anyone with a pulse and a signature could get a loan?), and commodities (especially oil) all boomed and busted partly because of low interest rates fostered by the Fed. Each cycle enriched financial markets insiders, but weakened consumers and the broader economy. Nevertheless, the Fed is at it again with quantitative easing (i.e., buying Treasury securities in the open market) and history may be repeating itself.

Oil prices have risen above $90 a barrel, and predictions for $100 oil are becoming fashionable. Regular gas is more than $3.00 a gallon. Metals prices have been rising, and today's Wall Street Journal (P. C1) reports that holdings of metals have become concentrated, suggesting a flare-up of speculative buying. With the economy still struggling to climb out of the septic tank, the liquidity the Fed has been pouring into the financial system apparently isn't being used to build factories or develop software, or for badly needed repairs of bridges and highways. It evidently is going into short term financial market plays, the same kind of stuff that's bedeviled the economy for the past decade.

The Fed wants inflation to stimulate consumer spending. It may well get a dose of inflation this year, if oil and other commodities prices keep rising. But that isn't beneficial inflation. As gasoline, heating oil, diesel and aviation fuel go up, consumers spend more on energy and less on everything else. Oil producers get wealthier (perhaps increasing funding for Iran's nuclear weapons program), while American businesses struggle to keep sales up. Hiring may slow, retarding the recovery of employment levels. The economy could stumble. This is what happened in 2008 and it could easily happen again.

Just when everyone thought fiscal stimulus was dead, the Republicans ignored the mandate from voters in the recent mid-term elections and agreed to a tax deal with President Obama that increased the federal deficit. Okay, so the increase was necessary to give tax relief to the wealthiest Americans, who are major targets of campaign fundraisers now that the Supreme Court has ruled that political sugar daddyism is a Constitutional right. But it demonstrates that fiscal expansiveness lives. John Maynard Keynes' legacy may yet be vindicated by the GOP.

The Fed has powerful monetary tools. These tools, however, can have powerful unintended consequences. Need the Fed pile on with more easy money?

As a bank regulator, the Fed has appropriately been leaning on its regulatees to be more prudent. Perhaps, just perhaps, it ought to consider whether prudence might not be a weapon in its monetary arsenal as well.

Monday, December 20, 2010

An Omen of Financial Stress?

Something strange is happening in the short end of the Treasury securities market. Treasuries maturing in about 1 month are yielding around 0.01%. Just a couple of weeks ago, yields were above 0.10%. Perhaps this may all seem like peanuts (and it is, if you have, say, $10,000 invested). But a yield of 0.01% was last seen during the dark days of the credit crunch in late 2008 and in 2009, when the world's banking system faced a funding crisis. Such a low yield signified that no one trusted anything except the obligations of the U.S. government; that investors didn't care about getting a return. They just want to keep their money safe. The recent 90% plus drop in the short end of the Treasury yield curve in less than two weeks may be a sign that something is rotten somewhere.

Economists and other fortune tellers are raising their estimates for growth next year. Stock prognosticators are full of holiday cheer, predicting rosy returns for stocks in 2011. Consumers may be loosening their purse strings a bit for this year's holiday season. Recent tax legislation will widen the deficit for next year, ensuring that the federal spending spigot won't slow down. All systems are go, it would seem. What's to get stressed about?

Euro Mess. The European response to the Euro bloc sovereign debt crisis, generously assessed, has been tentative and muddled. The only clear impact has been to transfer risk of loss to European taxpayers and give the can a hard kick down the road. The continued uncertainty makes the U.S. greenback look good by comparison (once again demonstrating that it's easy to lose faith in America, until you look at the rest of the world). If you're going to dump Euros for dollars, it makes sense to buy the short end of the Treasury yield curve, where you're not competing against the Fed's quantitative easing program.

One group of potentially nervous investors would be money market funds that hold commercial paper of banks in shaky Euro bloc nations, like Greece and Portugal. Amazingly, in spite of the money market fund credit crunch in 2008, many money market funds bought this foreign issued commercial paper. (One wonders what happened to prudence, but then again prudence is something isn't brought up in polite company.) Those money market funds now may be quietly easing out of Euro bloc bank commercial paper and shifting into Treasuries before year end, when they'd have to disclose their holdings to investors.

Muni Mess. The muni market has fallen, about 5% in the past month. That may not sound like much, but if you held munis and it was your 5%, you'd be peeved. The future for munis isn't pretty. The federally subsidized Build America Bonds program turns into a pumpkin at the end of this year, and there won't be a fairy godmother for it next year. That means states and municipalities will face the harsh winds of the muni market without a quick fix from Uncle Sam. Many financially troubled states are still struggling with their budget problems. To make things worse, questions over states' pension accounting could compel larger state contributions to employee pension funds. Muni investors with battered portfolio syndrome may be seeking a port in the growing storm and heading for the safety of Treasuries.

Bond Mess. The bond market has fallen since early November, when the Fed formally announced its quantitative easing program. Investors who bet that QE would extend the 30 year bull market in bonds may now suspect that this time, things really are different. Those that aren't ready for the quicksands of the stock market may be parking at the short end of the Treasury curve, waiting to see whither the winds blow.

It's unclear that any of this will push the financial system back into the septic tank. Any analysis of that question would require information about who's holding what exposures in the derivatives markets. (Query: are major banks holding the hot tamale because they took the wrong end of the wrong credit default swaps?) But those markets are as opaque as ever, notwithstanding the enactment of the Dodd-Frank financial reform legislation this past summer. All we know is that the short end of the Treasury yield curve is at 0.01%, and the last time that happened, canaries in the mine were gasping.

Sunday, December 19, 2010

Year End Financial Checkup

Before you become too friendly with the nearest bowl of eggnog, give your finances a quick year end checkup. That way, you can roll into the new year hungover, perhaps, but with some idea of where you are financially and where you want to go. Admittedly, money issues bring less cheer than the bubbly stuff that makes the cork pop. Ignoring one's finances, though, won't lead to wealth.

A lot of year end financial advice focuses on tax planning or prognostications for next year. Like many things, though, a solid foundation in financial basics is more important than doing some transactions that invite an IRS audit or believing in the latest self-appointed soothsayer. Get the basics right and other things become easier.

Calculate your net worth. This is the where sound financial planning begins. If you don't know where you stand, you can't tell if you're making progress (or losing ground). If things are going well, you can give yourself a pat on the back. If not, save more and perhaps change what you're doing. Calculate your net worth every three months. For more, see

Ensure adequate cash reserves. Make sure you have at least six months worth of living expenses set aside in an emergency cash fund that you never tap except during a crisis. Better yet, considering today's continuing albeit not-officially-recognized recession, have nine or twelve months of living expenses set aside. Unemployment remains a serious problem. Even though high ranking government officials are quick to tout even a tiny smidgen of improvement in employment levels, lots of people are still being laid off. Thrifty squirrels are the ones that survive winter.

Review portfolio diversification. Your portfolio's asset allocation may have changed as a result of market shifts. Most recently, bonds have been falling (contrary to every effort of the Federal Reserve to push them higher), while stocks have been rising. Consider whether you should adjust your allocations.

You may have different asset allocations for different pools of assets. The way you diversify a college fund for your kid(s) could be different from the ideal asset allocation for retirement savings. Keep these differences in mind.

Go over your benefits. Make sure you understand where you stand with Social Security and, if you have a pension, with your pension benefits. Maybe you don't believe either will be around by the time you retire. Well, people thought the same thing 30 and 40 years ago, and they're now retiring with Social Security and, sometimes, pension benefits. Figure out how to maximize your benefits. Then, maximize them as much as possible.

Review privacy. The Internet, by all indications, is becoming less private by the day. In an implicit but sharp rebuke to the private sector for its failure to display even a modicum of propriety, U.S. government regulators are now talking about setting federal standards for online privacy. Think about limiting your use of the Internet for financial matters (this includes banking, stock trading, online shopping and other online use of credit cards, debit cards, bank account numbers, and other financial transactions). The less often you do financial transactions on the Internet, the fewer opportunities you give bad guys to steal your money and/or identity. The Internet is unquestionably a convenience, but being robbed by cybercrooks can be highly inconvenient. If you must do transactions online, use the best security measures available.

A report in this weekend's Wall Street Journal (P. C1) indicates that smart phones (like the iPhone and Android) may be significantly less secure than computers. Apparently, some apps may sneak off with your name and other highly personal information without telling you or getting your permission. Avoid doing financial transactions on a smart phone, at least until security is greatly improved. If you must do financial transactions on your smart phone, check account balances and activity often. This means at least weekly and perhaps even daily for your bank accounts, credit card accounts and whatever accounts you use through your smart phone.

A cyberthief can make off with savings you took years to accumulate. Protect yourself.

Think about saving more. One of the best protections you have against an uncertain future is a nice, warm, fuzzy and large pool of savings. The more you save, the sooner you'll be able to retire and the nicer your retirement lifestyle will be. See and

Thursday, December 16, 2010

The Miracle of the Assumption of the Debt

Once upon a time, the peoples of a continent decided to cast the money changers from their lands. They struggled and strove for many a year, after decades creating an economic and monetary union. Then they rested, thinking it was a mighty union.

But humankind had not cast avarice, envy, corruption or deceit from their souls. Cunning and crafty investments were begat, which were multiplied by the chicanery of money changers and the mendacity of borrowers. A few voices cried out in the wilderness, warning of the dangers of cupidity and the trickery of false prophets who promised endless wealth and prosperity from borrowing and spending.

But the people continued to dream of opulence, and worshiped debt all the more. The flow of guileful investments became a flood, and the wickedness of these investments emerged as a rising potential for default. Many peoples of the monetary union were threatened with calamity. They were sore afraid.

They turned to the wealthy northerly people of the union, and pleaded for manna. The northerly people, who felt as if they were being asked to feed a multitude with a few fishes and loaves, hesitated, protesting that the yoke of a bailout would be difficult and the burden heavy. They said that the spendthrifts in the union were reaping the harvest of their extravagance, and that the deluge of bad debt was punishment for their covetousness. But the high priests of the monetary union proclaimed that if the northerly people failed to render aid, trumpets would sound, and chaos and darkness would cover the Earth.

The northerly people did not see themselves as a shepherd feeding his flock. They insisted that the profligate in the monetary union cease their avaricious ways and purify their national budgets of deficits. They demanded that lenders bear some losses and be made to wash the feet of lepers. To protect the prosperity they had worked hard to attain, the northerly people offered only temporary assistance, making no commitments beyond three years.

The waters of the deluge of bad debt kept rising, threatening more and more peoples of the monetary union. Soothsayers prophesied swarms of locusts, plagues, poisonous serpents, and the wrath of the bond markets. From the skies came flashes of lightning and peals of thunder.

The northerly people trembled, and as the twelve days of Christmas approached announced they would join with the rest of the monetary union to build an ark, a permanent fund to support the common currency. While many details of this covenant remain to be worked out, the ark appears intended to save all the peoples of the monetary union.

The good tidings swept across the continent. Debtors were elated and shouted to one another, "Fear not. For unto us is borne this day by others the burdens of our debts. Our iniquity is pardoned. Hallelujah!"

It was a miracle, the miracle of the assumption of the debt. While the waters of the deluge of bad debt have yet to part, if the monetary union can truly be fiscally moral, and not morally hazardous, it may indeed attain a state of grace.

Tuesday, December 14, 2010

How Tight Money is Hindering Recovery

It is axiomatic among students of financial history that tight money policies by central banks aggravated the economic downturn of the 1930s and pushed the world from a deep recession into the Great Depression. Policy makers, especially the Federal Reserve, have sworn on many stacks of many books to avoid the mistakes of the 1930s by maintaining an easy credit policy. Yet credit is tight, in some respects very tight. While the tightness isn't pushing us into a depression, it makes recovery very difficult. At its meeting today, the Fed Open Market Committee promised to keep short term rates at zero as far into the future as one can imagine, and to continue its program of quantitative easing by buying longer term U.S. Treasuries. Its accommodations, however, will do little to ease credit conditions.

Where is the tight money? Everywhere. Mortgage loans are subject to strict underwriting requirements, which may be getting stricter as the real estate market continues to soften. Credit cards are issued only to customers with sterling credit ratings. Business lending may be easing slightly, but the smaller businesses that can't directly access capital markets (like the S&P 500) find that bank credit is somewhere between almost inaccessible and absolutely unattainable.

The tightness of money is a reaction to the credit binge of the 2000s, when anyone with a pulse and a signature could get a loan. After the financial tsunami of 2008, banks, regulators and mortgage underwriters like Fannie Mae and Freddie Mac found prudence in their hearts. With the fervor of the newly converted, they now hew to the straight and narrow, dribbling pinches of credit only to right-thinking, clean living, pure-hearted borrowers who've never said a cuss word in their lives.

The tightness of credit is good for taxpayers, who are directly or indirectly on the hook for just about every liability of every bank in America (and perhaps some banks in Europe if the Euro crisis isn't resolved soon). And it's good for rebuilding America's balance sheet. The nation's banks, consumers and governments all are deleveraging, and another credit bingeapalooza is the last thing we need. Relaxing credit standards to accelerate economic recovery could easily foster a faux prosperity that would collapse when reality inevitably trumps fantasy.

The Fed's easy money isn't being loaned out much. To a large degree, it sits in banks' accounts at their local Federal Reserve bank, where it likely serves as a buffer against real estate losses the banks are afraid they'll have to book. The Fed surely knows this. So what is it doing, triggering battered savers syndrome from sea to shining sea? One suspects that it's deliberately trying to create inflation, in order to scare catatonic consumers into spending. The Fed's nightmare is deflation, which can inhibit consumer spending and thereby worsen a downturn. Instill the fear of inflation and consumers presumably will buy in order to avoid higher prices later.

The theory may be tidy. But what if consumers are afraid of losing their jobs? A new high-end washer/dryer combo won't make you feel very good if you're laid off the week after it's delivered. Even with the threat of inflation, consumers may choose to save (and invest in the best inflationary hedge they can find). The Fed has to contemplate the limits of monetary policy, and consider whether it's doing more harm than good. Its quantitative easing program has driven long term interest rates up, raising mortgage rates, cutting off refinancings and reducing the pool of qualified buyers of homes. That, in turn, may push real estate prices lower and cause credit standards to tighten even more. In other words, quantitative easing may be making credit tighter--and retarding recovery.

At the same time, if quantitative easing does trigger inflation, we could end up with much dreaded 1970s style stagflation. Then, leisure suits might come back, multiplying the horror of the situation.

In matters economic, the law of unintended consequences is remorseless and inflexible. Its judgments are rendered swiftly, with nary a thought given to mercy. The Fed normally likes to keep all its options open. But this time it seems hellbent on spending $600 billion smackeroos on Treasury securities, come something or shinola. The Fed is steering the toboggan toward slippery slopes. Hang on tight.

Sunday, December 12, 2010

Still Searching for the Gold Standard

Contrary to popular belief, the gold standard lives on. Not as a linkage of paper currency to a precious metal, but as the human search for certainty in the value of currency. And the results today are as convoluted as earlier experiences with the gold standard.

The gold standard--making a unit of a paper currency convertible into a fixed amount of gold--was used first and foremost to provide assurance against uncontrolled printing of money and the inflation that could follow. Such inflation could be created by whoever issued the paper money--be it a bank or a government--and gold convertibility was seen as stabilizing the value of the currency.

Gold, however, doesn't ensure absolute certainty of value. When large amounts of gold become available (from mining or other sources), price inflation can result. The Spanish conquest of much of Central and South America in the 1500s resulted in massive amounts of Aztec and Incan gold and silver flowing to Spain. Price inflation followed, even though Spain used gold and silver currency.

Gold as a reserve for paper currencies has not always provided a foundation for stability. In the 1930s, central banks protecting the gold standard acted too conservatively to combat the growing economic depression. In doing so, they may have aggravated the deflation that resulted from the stock market crash and accompanying economic downturn, which in turn hindered recovery from the depression. Eventually, the U.S. and other nations had to devalue their currencies to help foster recovery. What happened here was that the nation issuing the currency had gone into a depression and the real world value of its currency had correspondingly fallen. The conversion value of its currency into gold had not changed, so the currency was overvalued and deflation ensued. Ultimately, the gold standard did not prevent paper currencies from falling in value because paper currencies takes their true value from the economic strength of the issuing nation.

Gold can serve as a currency because people think it's valuable and accept it as a medium of exchange. The same is true for anything people accept as valuable--tobacco, cotton, deer skins, beaver pelts, sea shells, and American cigarettes all have served as currency at various times and in various places.

People want their currency to be stable. It doesn't really matter what is used as currency. Most currency today consists of electronic entries in computer systems. But people believe these little bits and bytes of data have value, so they accept them as a medium of exchange.

What hasn't changed from the days of the traditional gold standard is the desire for certainty. And that's the problem. The Euro bloc, in which 16 nations have adopted the Euro as a common currency, is simply a reincarnation of the gold standard. By adopting the same currency, issued by a central bank that supposedly must limit its responsibilities to maintaining the value of that currency, the Euro bloc nations hope for an island of stability in the raging seas of the currency markets. But these nations can't reach Avalon unless all members row their oars together and pull their own weight. That hasn't been happening and the ship is foundering.

China and other nations that link the values of their currencies to the U.S. dollar also seek to create a latter day gold standard. Although now a distant memory, there was a time (the 1970s and 1980s) when the dollar was seen in some parts of the world as rock solid. In the Soviet Union and Communist China, U.S. currency was coveted and hoarded, while local currencies were regarded with suspicion and disdain (China has a long history of currency inflation). As China integrated market forces into its economy, it linked its currency to the dollar, not as an export weapon so much as an anchor against inflation. Some Latin American nations that struggled with inflation did the same thing at various times. (Most notable among these were Argentina and Mexico.)

China's dollar link was crucial to its ability to grow. It removed the risks of currency fluctuations, encouraging American businesses to invest in China. The Chinese very much wanted American investment in order to obtain American know how and technology. The intellectual capital gained by China from American (and other foreign) investment leveraged its rate of growth. On its own, China could never have achieved prosperity as quickly as it did.

Of course, as China grew, its currency became more valuable in relation to the dollar and China's dollar link conferred an exporting advantage that is now essential to its economic model. Despite increasing inflation and foreign political pressure, the Chinese want to protect their exporters, because they don't have internal markets to substitute for the export markets they would lose from a stronger yuan. To combat inflation, the Chinese have employed alternatives, such as higher reserve requirements for their banks, price controls, consumer subsidies and sales from state food reserves (the latter a tradition from the days of dynastic China).

Americans shouldn't think that their own government isn't implicated in China's search for a contemporary gold standard. The U.S. government was for a time quiescent about China's exchange rate policies in order to encourage China to ally itself with America against the Soviets, and to open up China to U.S. investment. Moreover, the inflow of inexpensive Chinese goods has helped keep inflation low in America, which in turn permitted low interest rates and booming real estate values. Okay, so not everything turned out wonderfully, but the 2008 financial crisis wasn't the fault of the Chinese. Indeed, they lost money investing in American mortgage-backed securities.

In spite of the financial turmoil of the past three years, Europeans and Asians still cling to their gold standards, looking for certainty in the value of currencies. Gold standards can have short term benefits. Long term, economic conditions change and so do currency values. The squabbles of the Euro bloc over bailouts, quantitative easing, haircuts for creditors and the growing disquiet of German taxpayers, are a struggle over who will bear the costs of maintaining Europe's latter day gold standard. China's accumulation of a vast hoard of U.S. debt securities (and their attendant investment risks), along with the fiscal costs of consumer subsidies and state-owned food stocks, are China's costs of maintaining its 21st Century gold standard.

The gold standard protects savers, investors and creditors. Pure fiat currencies tend to favor borrowers and spenders. Thus creditor nations prefer a gold standard. Borrowing nations argue for free-floating currency rates. A gold standard doesn't necessarily favor exporters--they are better off or not depending on where the exchange or conversion rate is set. The Euro bloc includes both creditor nations and borrowing nations; hence the conflicts that may yet cause the Euro to collapse. The dollar bloc similarly includes creditor nations and borrowing nations; its tensions, too, are palpable.

Ultimately, there is no permanent gold standard or other absolute reservoir of value. The never-ending quest for certainty is trumped by the incessant process of change, mutation and evolution in the economy. (See But the process of human advancement can be said to be a long struggle for certainty. Deliverance from the vicissitudes of hunting and gathering, the extremes of the weather, the unpredictability of farming, the dangers of aggressive peoples, the horrors of plagues and other deadly illnesses, the volatility of the business cycle, and the capriciousness of financial markets all underlie the imperative for human advancement. All the bug-eyed, rifle-cleaning, ridge-dwelling, fringe group wackos panting for the gold standard can wipe the drool from the sides of their mouths and rest easy. It's alive and kicking, and will continue to bedevil central banks, high ranking government officials, policy makers, business executives, and the rest of us as far into the future as one can see.

Friday, December 10, 2010

Even in Ponzi Schemes, the Rich End Up Richer

If you're going to invest in a Ponzi scheme, look for the biggest and most exclusive ones. Find scams in which really wealthy people and large, prominent financial institutions are involved. A swindle in the Hamptons or Palm Beach is a much better choice than a scam in Moline, Ill. or Tulsa, Okla. Why? Look at what's happening in the Bernie Madoff case.

Irving Picard, the trustee in bankruptcy for the case, has collected about $1.5 billion so far. The time for him to file claims to recover money for injured investors is expiring, and he has recently brought a flurry of additional cases. Big banks, like J.P. Morgan Chase, UBS and HSBC, have been sued. Other financial firms and people that may have fed investors into the scheme have been targeted. Overall, Picard has filed claims for over $50 billion recently. Since he reportedly estimates actual cash losses from the scheme in the range of $20 million, he's trying to collect more than the actual losses (evidently on the theory that some actors, like those soliciting or providing investors, may have liability for damages). His chances of recovering 100 cents on the dollar of actual losses is likely to be low, and the chances to obtain damages probably lower. Nevertheless, many of the recently named defendants are important players in the financial services industry with reputations to protect. If their cases go to trial, unflattering information about them might be revealed in court. They could have strong incentives to settle. Many of them, like the large financial institutions, can't claim inability to pay. That means they will have to pay something.

We're still a long way from the end of the Madoff case. But his victims, who two years ago may have thought they had lost everything, may receive non-pathetic recoveries. For many, recovering 20 or 25 cents on the dollar could bring a little champagne and a new leased Mercedes into their lives. The Bentley may not reappear. But dog food (other than for the pet) could be dropped from the grocery budget.

In the grand scheme of things, being duped in a big and brazen scam of the wealthy is better than being ripped off by a guy selling investments in the parking lot of a big box store. When the wealthy are victimized, other wealthy people and large institutions can possibly be made defendants. Such defendants will often be inclined to settle. Con artists who practice their chicanery in middle class settings are likely to spend the money as fast as it comes in, and there's nothing to collect when the house of cards collapses. Even when victimized by con artists, it would seem, the rich end up richer than everyone else.

Tuesday, December 7, 2010

The Balanced Federal Budget: Easy Come, Easy Go

If you keep up with the news, you might remember something about balancing the federal budget. Like maybe some commission chaired by a couple of old guys made a proposal for the government to stop borrowing so much g.d. money. But that austerity stuff is so last week. Economic stimulus has come back into vogue, and the smart set in Washington is doing the supply side shuffle. President Obama has been accused of being Keynesian. But he offloaded his outdated economic advisers and has apparently gone Reaganesque. His deal with Congressional Republicans for a two-year extension of the Bush II tax cuts, a one-year 2% cut in Social Security taxes, plus an extension of unemployment benefits for another 13 months, guarantees that the federal deficit will yaw wide or wider. A mild version of the federal estate tax (35% with a $5 million exemption) is supposed to be reinstated. But the parameters of this tax are designed to raise less money than the increase in the deficit this deal will foster.

The Democrats in Congress, who seemed to have dallied with the notion that they and the President belonged to the same party, are ripsh . . . well, very upset, about being excluded from the President's back door negotiations with Republicans. That, evidently, is the price those frumpy Dems pay for not being au courant. Wanting to have the pre-Bush tax brackets apply to people who made $250,000 plus, or, heck, even just those at $1 million or more, makes the Dems strangely look prudent. Oh well, federal debt securities really are soignee, if you look at them the right way.

The concept of this deal as economic stimulus produces cognitive dissonance. Since the deal would continue the status quo (the Bush tax cuts being currently effective and unemployment benefits having continued through November), and add only a 2% Social Security tax cut while reimposing an estate tax, the new deal (small caps intended) doesn't change much. And the government can't cut spending, can it? Because spending cuts would reduce stimulus, and stimulus is now all the rage.

Sure, the President and Republicans would say that they are serious about deficit reduction and the current deficits are just a temporary measure while the economy is swooning. But, in Washington, temporary measures that benefit important constituencies tend to have long life spans. Federal agricultural price subsidies, to take an example, were a temporary measure instituted when Franklin Delano Roosevelt was jauntily waving his cigarette holder. They still live on like welfare queens that never have a health problem.

If you listen closely, you might hear a little mouse in the corner of the Oval Office clearing its throat and muttering something about voodoo economics. Somehow, one gets the sense that somewhere, someone has made a doll called American prosperity and has a pin posed over it. The new supply side economics aren't like the Laffer yucks of yore. We now have a Federal Reserve that never saw an interest rate it didn't want to bash down (although that's turned into a game of whack-a-mole with today's rising rates). Plus a federal government that never misses a chance to borrow. The Fed is, more or less, monetizing the federal debt (i.e., printing money to buy federal debt, which brings a risk of inflation), although it would vehemently deny doing so. Having the First National Bank of Accommodation fund the giddiest of big spenders may well be a formula for disaster. And depression. The bond market dropped today. Stocks bought into the hype for most of the trading day, but sobered up as the market closed.

Tea Partiers and other pro-Republican voters from the mid-term elections might be fighting a touch of queasiness in their tummies. There isn't much in this deal for them. Ambitious Democrats are surely making preliminary estimates of their chances in the 2012 presidential primaries, and might be quietly chatting with a fund raiser or two. The President and the Republicans are trying to pitch their proposal as bipartisanship. But, in truth, it's just an old-fashioned political deal, like the kind made in the smoke-filled back rooms of yesteryear, done more to avoid problems (like reinstatement of the higher pre-Bush tax rates) than to accomplish anything. And like so many back room deals, it may ultimately create more problems than it solves.

Sunday, December 5, 2010

Looking for Bernie Madoff

If you could get the candid assessment of the financial markets from a lot of investors today, it would probably be something like returns are low and risks are high. That explains why so much money, especially that held by individual investors, remains in bank accounts, money market funds, ultra short bond funds and other relatively low risk places. The financial markets have given us so many unpleasant surprises in the last 3 years, people are afraid the future holds more.

At the same time, with incomes stagnant and inflation increasing (regardless of government statistics and what high ranking government officials claim), many are under pressure to seek higher returns from their savings. There's nothing wrong with looking for a better return. Just remember that, even though we now live in the era of the endless bailout, there still isn't a free lunch. Unless you're a major bank, a sovereign nation, or a very large business corporation. Stocks and lower rated bonds might offer greater potential for profit, but they also offer greater potential for loss. Risk and reward walk hand-in-hand down Wall Street.

Some investment products include guarantees against loss. These often are touted by insurance companies and should be scrutinized closely. The promise against loss is going to cost you. It could be in the form of tight limits on upside returns (i.e., if the product generates a return, the insurance company is going to keep a good portion of it), stiff penalties for early termination or withdrawal, and in other forms. Remember that if the markets perform poorly and your return is zero, even though your losses are also zero, you would have been better off in passbook savings. (That's not a theoretical point; anyone who put money in passbook savings ten years ago instead of stocks is ahead of the market.) While no one knows what the future will bring, investing in a no-lose product doesn't mean you'll win.

Even though many insurance companies might want to sell you a lousy deal, in general they aren't fraudsters. The worst thing you could encounter in your quest for higher returns is the markets magician who claims to consistently produce good, albeit not spectacular yields, day in and day out, year after year. No one can do that, period. If you meet anyone who says he or she can, put your hand on your wallet and run away. Fast. No matter how tempted you are, and no matter how good the sales pitch sounds, don't invest.

The biggest frauds are perpetrated, not because the bad guy lies, but because investors lie to themselves. They convince themselves that lead can indeed be turned into gold. They brush aside contrary evidence and the rationality of naysayers. They want to hear, however improbably, that good returns can be secured with no risk. They seek out the con artists who promise the sun, the stars and the moon.

Bernie Madoff didn't have to find many of his victims. They found him, and they were ready to believe every word of his web of lies. He'll be in prison for the rest of his life. But there are plenty of latter day Bernie's around. Often, the gullible and greedy will find them. As a matter of law, the con artist is liable and should be punished sternly. As a matter of reality, if you go looking for a latter day Bernie Madoff, you'll probably find him. And you'll regret it.

Thursday, December 2, 2010

Where the Deficit Commission Missed the Boat

The National Commission on Fiscal Responsibility and Reform hasn't issued its final proposal (that comes after a vote tomorrow on its contents). But the draft report, available at, shows that the commission missed the boat in several important respects.

End the Bush Wars. The federal deficit has been eliminated three times in the past 100 years: in the 1920s, in the late 1940s and most of the 1950s, and in the 1990s. Each instance followed the conclusion of a major war (World War I, World War II and the Cold War). Wars are expensive, and peace dividends are large. The federal budget hasn't been balanced in over a century without giving peace a chance. The deficit commission made wonky recommendations about putting national security and war spending on budgets, overlooking the fact that nations don't fight wars on a budget. War is an emotional process where combatants spend their way to ruin rather than lose (see fall of the British Empire for more information).

Our national security and military budgets are large, probably larger than the public realizes--many details are obscured in order to keep potential adversaries in the dark. The best way to reduce defense spending is to reduce the reasons for defense spending. America has no real stake fighting the Taliban in order to secure Hamid Karzai's power. And wealth, which he may be enhancing by siphoning off American aid, along with payoffs he reportedly extracts from the Iranians. American troops, it would seem, now fight and die for the greater prosperity of Hamid Karzai. The Taliban haven't tried to launch attacks on America. Al Queda (remember them?), now operationally located in Yemen, is our adversary. American forces should concentrate on the real enemy, and not fight people who would leave us alone if we left them alone.

Nor should U.S. troops maintain a significant presence in Iraq. If Iraq descends into civil war, do we really think American troops will roll out of their bases and intervene? Would the American public stand for more casualties just because the Shiites and Sunnis in Mesopotamia still don't get along after centuries of strife? Some 50,000 American troops remain in Iraq. Bring them home. It's time to end the Bush Wars. They've taken too many lives and too much money, and produced too little. The deficit commission wanted to avoid involving itself in war policy. But balanced budgets and wars don't mix. If we really want to reduce the federal deficit, we have to stop fighting wars that really don't matter to us.

Emphasize innovation, research and development, and growth. The deficit commission acknowledges that innovation, R&D and economic growth are worthy goals. But it does not seem to understand the importance of prosperity to reducing federal deficits. Earlier periods of balanced budgets enjoyed robust expansions of the economy. Growth boosts national income, and therefore tax revenues. Increasing federal cash flow may run counter to the conservative agendas of some commission members, who seem to favor doctrinal parsimony over practicality. But ideology is a poor substitute for results. Cutting and slashing federal spending simply can't reduce the deficit all that much. Boosting federal tax revenues, preferably through accelerated growth, is essential.

This is an instance where the best defense is a good offense. The deficit commission should have placed more emphasis on government policies and programs that would promote growth. More incentives and funding for research and development, including basic research, are needed. Transportation and communications infrastructure need to be repaired and improved. Greater civilian access to technologies developed for military use may offer big payoffs--the Internet and GPS are classic examples of Defense Department projects that evolved into highly valuable civilian sector systems. America's economic future rests on the efficient production and distribution of high value added products and services. The government should do more to move the nation down this path.

Deal with demographics. America's population is aging, and this changing demographic aggravates the problems of financing Social Security and Medicare. The deficit commission doesn't address the demographic question. It says nothing about family friendly policies. Raising kids is a ton of work, but it's a lot better than poverty in old age. The commission says nothing about immigration. Okay, this is a political red hot potato. But the immigration of the past 30 to 40 years is an important reason why America's demographics are still fairly sound, compared to the potentially catastrophic situations in some other industrialized nations. Immigrants are mostly young, and a well thought out policy favoring valuable workers could help significantly to keep America young, and not just at heart.

The deficit commission's parsimonious scoldings land like lumps of coal on the holiday season. Frowning a dour, parental austerity that clashes with America's heritage of optimism and faith in the future, the commission obsesses over myriad wonky prescriptions that bring to mind the over-attentiveness to detail of the Carter Administration and the national self-flagellation it seemed to encourage. In the past, America attained fiscal balance not by diving into policy minutiae but by ending wars, growing through innovation and risk taking, and absorbing the talented, ambitious and hard working from around the globe. Political reality is that many, and probably most, of the commission's proposals won't survive the legislative process. The ones that are enacted will probably leave large deficits in place. We simply can't cut our way to a balanced budget. They're like walks and singles where a home run is needed. We might as well swing for the fences.

Wednesday, December 1, 2010

The Stock Market is Like a Duck Billed Platypus

In today's looney bin of a stock market, what was thought to be truth has turned out to be fiction. And fiction writers couldn't have invented what seems to be true. Here's a sampling.

1. First, ignore all the economists. There are no economists with consistently strong records of predicting the direction of the economy. There are no economic models that explain much of anything. Forget what the economists say.

2. Be a Liberal. If there is one force that has supported the economy and uplifted the markets, it's government. The emergency credit offered by the Fed and central banks of other major economic powers, along with the bailouts and fiscal stimuli provided by the U.S. and other governments, pulled the world economy out of its biggest downswing since the time of Prohibition. Today's revelation that in 2008 and 2009, the Fed loaned out $9 trillion, or $3 trillion, or however one wants to total up the numbers, to support everyone from Goldman Sachs to McDonald's to Europe's central banks illustrates that in times of crisis a strong Fed can make a difference. Whatever one might think of GS or Europe, America without Big Macs and fries with that would be a disaster.

Fair questions have been asked about the Fed's current adventure in quantitative easing. On one level, it is apparently a stock market manipulation designed to induce consumer spending by creating a wealth effect. In general, governments don't manipulate asset values without eventually producing catastrophic consequences (see 2008 real estate crisis for further reading). But today's stock markets embrace governmental action and become deliriously exuberant whenever another bailout or easing is announced.

News reports tonight indicate that the United States is now prepared to join in a bailout of the Euro bloc, since Portugal, Spain and who knows what other countries seem to be in line for a handout. The stock markets should soar at the prospect of another federal giveaway.

3. Mind the debts. The past twenty or so years, a/k/a the Age of Leverage, saw shiploads of bad loans made to home buyers, credit card customers, businesses, nations, states, cities and anyone else not previously mentioned. These debts, in gigantic amounts, remain with us, and lurch around the financial system looking for someone or something to crush. Every time they look like they're circling a victim, the markets shudder. Ireland's recent "rescue" (which was really a rescue of banks holding Irish debt) is illustrative. As before, governments and central banks mounted up and sallied forth, with the William Tell Overture playing in the background. Dealers in the financial markets had a nice profit opportunity, trading the markets down and then up. Investors might have been left feeling like hit-and-run victims. The herd of bad debts will be with us for years. Indeed, as bailout follows bailout, the can is being kicked down the road only to haunt us farther into the future.

4. Statisticapalooza. The markets obsessively fixate on all variety of statistical minutiae, ranging from retail sales results for a single day to self-declared sentiments of consumers to inflation figures that exclude any items that might reveal inflation to the differences in borrowing costs between, say, Belgian and German debt. Small bits of information become large symbols. Rational analysis is kicked into the gutter.

The stock market is like a duck billed platypus. If you look at it, you think it can't be true. But apparently it is. Weirdness is the world. The only certain way to make money is to be the Fed and print it. Everyone else might think about eating cake.