Ben Harper's I Don't Believe a Word You Say

Sometimes I think it is healthy to have a good dose of skepticism. It has always been the people that doubt the normal way of thinking that make great discoveries. The following video is a rocking way to think about taking a skeptical stance about things. (Mostly, I just like this song).

What the Fed?!

     Recently reading the Wall Street Journal I came across an article that reported the intentions of the Federal Reserve to be more transparent to the public. The Federal Reserve is a government agency that controls the creation of money. There are essentially three ways by which it can exercise this power. 

     First, the Federal Reserve sets the minimum legal reserve requirement. The reserve requirement is the legal power to regulate the minimum fraction of deposits that banks must hold. Banks are free to hold more reserves but they are legally responsible to have at least the minimum required reserve. 

     Next, the Federal Reserve can set the discount rate for banks to borrow reserves. It determines the interest rates that banks must pay if they do borrow from the Federal Reserve. It is important to note that the Federal Reserve itself does not set interest rates in the open market. It sets the rates from which banks can borrow in order to meet the reserve requirements. Interest rates themselves are set by the market.

     Third, the Federal Reserve engages in open market operations. This is the most frequently used method for changing the money supply. When the Federal Reserve participates in an open market operation, it buys or sells United States government bonds. These Treasury bills or Treasury bonds are issued by the United States Treasury in order to fund federal government deficits. When the Federal Reserve wants to increase the amount of money in circulation it uses currency to buy T-bills from private agents in the open market. On the other hand, a sale of bonds in the open market by the Federal Reserve decreases the money supply.

     The main point of this article was that the Ben Bernanke wants these main actions to be more transparent.

Trading! (Money, Money, Money)

Last semester I participated in a stock trading simulation tournament with my finance core classmates.  The game was a fun opportunity to put into practice many of the principles that we learn about day to day in the finance program. I ended up doing pretty well and posted 20% returns on the four-month period. I realize that those are above normal returns, and some may call in luck. During the same period the S&P 500 remained flat. I am a believer that the in the short term stock prices are somewhat random and disconnected from actual economic value added by the companies.  But I also subscribe to the value-investing thesis that future cash flows are worth something today and that the market does not valuing some firms appropriately.

In order to build a portfolio, I stuck to fundamental analysis and I probably had a bit of an advantage over some of the other students because I have been working at a mutual fund shop on a part time basis for the past two years or so. I am responsible for the financial analysis of various small cap companies owned in the value fund managed by my boss. So, before this game even started, I had a pretty good idea of which stocks would have been good plays in a game such as this.  I picked deep value stocks to build my portfolio because I knew that in order to win a game such as this, you would have to find stocks that were a little more volatile. For that reason I picked smaller companies that were severely undervalued for whatever reason (obviously the market didn’t think they were undervalued, but according to my fundamental analysis, I came to the conclusion that future cash flows demanded a higher valuation).

My best stock pick was Research in Motion, which I held for the whole period. It was up almost 80% over the four months. My basic thesis was that even though the market hated the stock, it was trading at about 60% of its liquidation valuation. On top of that, if the company could manage to make a comeback then future cash flows would demand a valuation of at least 3-4 times what it was trading at. The market was rooting against it, so I picked it up (perhaps on a speculative basis, but it certainly paid off). The rest of my stock picks had similar theses, but still haven’t realized the same amount of price appreciation. I picked up a few of my positions on price contingent orders. I used buy limit orders to purchase American International Group. I shorted LinkedIn also due to its fundamental analysis, but I realize this is risky business because the market might have crazy ideas about a stock for quite some time. Normally I wouldn’t short a stock unless I could also match it with some put options to minimize my downside risk. I didn’t make any money shorting this stock and I was probably at a net loss after accounting for the costs associated with shorting a stock.

I also put a slight amount of money into a Vangaurd REIT Index ETF on the idea that the housing market was on a recovery. Not much happened with this position. I don’t really like ETF’s because of their higher correlation with the market as a whole. In my opinion, diversification is a double-edged sword. It can obviously help protect your portfolio against idiosyncratic risks, but it can also take makes market returns the best-case scenario. I am willing to take on more firm specific risk in the hope that I can find long-term returns that beat the market. The academics tend to refute this idea and might consider it elementary, but to that I respond, nobody ever got rich by settling for market returns. Another one of my strategies for the game was to max out my marginal account. I wanted to be as levered as possible in order to amplify my returns. I wanted to be in first place or last place – and I ended up being in both at different times. Luckily I ended up on top to finish the game off. 

On Freedom

Recently the Obama Administration released their 2013 budget for Congress to approve. 2012 is also an election year in which the importance of government and the value of freedom are consistently raised by presidential hopefuls. However, Republicans and Democrats alike continue to increase the size of government and encroach upon the freedoms guaranteed to citizens of the United States by the Constitution. Specifically, federal spending continues to grow, as a percentage of gross domestic product, meaning that more of our economic freedoms are being taken by the government. Albert Einstein said, “Everything that is really great and inspiring is created by the individual who can labor in freedom.” In order to remain fiscally responsible, the United States should adopt a Balanced Budget Amendment to protect the economic freedom of its people. The continuing deficit by the federal government in the national budget undermines the economic freedom of the U.S. people by producing egregious taxation to it’s citizens, significantly weakening the value of the dollar, and reducing savings and investment by individuals and corporations alike. 

Taxation is necessary to run an effective government, but irresponsible spending and poor budgeting on the part of the United States government creates erroneous taxation. Currently, U.S. corporate taxes are among the highest in the world. When a company makes a sale, costs are deducted from that revenue and taxes (35% corporate tax) are paid on what’s left over. The income is then distributed to the owners of the businesses who are then in turn taxed (30% income tax or 15% capital gains tax) on the profits that their business made. When they take that money to buy groceries or a car they are taxed yet again (5-10%) in the form of a sales tax. In order for the government to fund its outrageous spending it dips it’s fingers into nearly every transaction that takes place in our economy. Taxation is obviously mandatory and takes money away from citizens to give to the public. As we all know, public goods depreciate faster and are not maintained as well as private property. Individuals who argue that the government has an obligation to promote the economic security of its citizens would rightly be reminded of Benjamin Franklin’s warning, “Those who desire to give up freedom in order to gain security will not have, nor do they deserve, either one.” Government spending cannot and should not replace the individuals right and responsibility to work and create value in society in order to achieve financial security.  By taxing individual’s incomes and corporate profits, the government continues to take a larger share of the economic freedoms of the citizens of the United States. The more the government spends, the more it taxes its citizens, and the more its citizens are taxed, the less economic freedom they retain.

Inflation is another form of taxation which significantly reduces the value of the dollar over time. Even after the trillions of dollars that the government takes in through tax revenue, it is still not enough to cover the outrageous spending budgeted in year after year. The Deficit that we hear so much about is the difference between how much the government spends each year versus the the amount that it takes in. The “National Debt” is the deficit that the federal government has accumulated since the government was founded over two hundred years ago. It is now around 15 trillion dollars which is larger than the U.S. gross domestic product. In oder to fund this deficit, the Federal Government can do two things. First, it can go into debt by issuing bonds in the form of Treasury Bills, or it can have the federal reserve print more money.  When the Federal Reserve prints more money than is currently in circulation, inflation occurs - the more paper bills in circulation, the less value each bill retains. Thus, inflation is another method by which the government can fund it’s spending. However, because inflation devalues the dollar, printing money is just another method whereby the government can tax its citizens. When the government has to go into debt and dilute the value of the dollar in order to match its spending, it is not being financially responsible. Friedrich Nietzsche wrote, “Freedom is the will to be responsible to ourselves.” We as citizens cannot accept the fiscal irresponsibility of the federal government. Simply put, the more money the Federal Reserve prints the less purchasing power the money in our wallets contains. Government spending clearly undermines the economic freedom of it’s citizens by diluting the dollar’s value.  

One of the most fundamental rules of financial welfare is that you should not spend more than you make.  When the government consistently spends more than it takes in from tax revenue  it is clearly breaking this principle. With government spending so high and inflation rates that will make your savings accounts accumulate a net loss over time, there is little incentive for individuals to set money aside. As individuals set money aside, it losses value due to constant inflation of the dollar. It seems to be more wise to spend your paycheck before inflation dilutes its purchasing power. As government spending takes a larger percentage of gross domestic product, businesses have a hard time competing and the market’s growth is slowed. There is less incentive for businesses to invest in plant, property and equipment and grow their business over time. Risk is what has made America great and has also sparked much of the innovation and advancement over the past two hundred years. As Gandhi once taught, “Freedom is not worth having if it does not include the freedom to make mistakes.” With the government so involved in our economy businesses and individuals are less likely to take risk and make investments - it becomes too costly in the form of taxation and debt held by the public. Clearly, government's growing involvement in the economy reduces individual economic freedom and hinders savings and investment.

Because of unsustainable government policies and budgets individual economic freedoms are being undermined as a result of increasing taxation, devaluation of the dollar, and a decrease in savings and investment. The Balanced Budget Amendment is a clear and valid solution to check the government and protect the freedoms of individual citizens. I have always believed that I know how to spend my money better than the government does. I am sure you do to. Thomas Paine, an early revolutionary thinker of our nation, wrote, “Those who expect to reap the blessings of freedom must, like men, undergo the fatigue of supporting it.” 

QUICK SURVEY:

What do you think about the US deficit and what do you think should be done about it?

Answer below in the comment box.

Science as a Public Good

     Former Secretary of State, Hilary Clinton, has recently been campaigning for increased funding for scientific research of HIV/AIDS pandemic.  There are obvious costs associated with the extensive research that is needed to find a cure to the HIV virus, which has already led to the deaths of over 30 million people. Those who would benefit from the research include the 60 million people previously infected with the virus as well as 2.6 million people who are infected every year. It is also clear that humanity, as a whole, would be better off with a cure for HIV/AIDS.

     So why is Clinton giving a speech calling for the U.S. and other nations to put money into research that could harness this pandemic? It is clear that there is not enough private funding to support the research needed to develop this science. Certainly, no one single victim of AIDS could put out enough money to find a cure. 

     The consumption of a cure to AIDS would is obviously non-competitive and non-exhaustive. This means that if a cure were discovered, one person’s use would not hinder anyone else’s use of the new cure. Also, due to the nature of the scientific information that the research would produce, consumption of that information would be nonexclusive. Once the information has been produced, anyone can use it. People all around the world can have access to the research information at a marginal cost of almost nothing. 

     What will occur as a result of the nature of information is free riding by those individuals who wait until a cure is discovered and then use that cure to their benefit while not participating in any of the costs. The larger the size of the group, the more likely individuals in that group are to participate in free riding. The inefficiency, of course, is that too little is produced. Everyone wants a cure, but nobody is willing to pay for that cure because someone else will eventually step up and incur the costs. 

     This is typically where the role of government comes into play. The problem in today’s society is that there are many different governments and people in various countries who are inflicted with AIDS. Government’s themselves have incentive to free ride. The U.S. government doesn’t want to pay for the research that the rest of the world will use. Thus, far too little money is being put towards the development of a cure for HIV/AIDS.

Personal Portfolio

     The stock market is completely different than it was just twenty years ago. Computers and technology have changed the way that people invest and information is now a commodity instead of a luxury good. ETF's and Index Funds have been the new way to invest and stock picking and fundamental analysis seems to be a dying way of doing things.

    With the click a a botton, the average Joe can buy and sell stocks from his computer, tablet, or even smart phone. Yet, the market has effectively been flat over the past ten years and I think most people are not interested in investing because they don't believe that it can really be profitable. 

     The good news is that the market has been volatile in the past and it will continue to be volatile in the future. People have made lots of money investing over the years and that is likely never going to change. Those who see the value in investing and put forth the effort to find the best companies will be handsomely rewarded. 

Where in the World?

     We had a guest speaker the other day in my Asset Management class. He is a big time investor who has made a name for himself in commercial real estate and equities. His purpose for visiting the class was to inform us of some of the practices that are used by professionals in the asset management industry. Before we got too far into the discussion, he read to us a letter that he wrote to the President of the United State, Barrak Obama. This letter received no response and was very critical of the way that the economy was being handled.
     We were then told by the speaker that Obamacare raised costs on business by over 5% and as a result there would be lots of people who would be fired or not hired in the first place. America, apparently had lost her glory. People are no longer willing to work for honest wages, they expect hand-outs and government subsidies, and when they are not taken care of, they through a fit. Taxes are so high now in this country that jobs and businesses are moving overseas.
     At this point in the conversation, I raised my hand and asked a simple question: "If things are so bad here in the U.S. where in the world do you suggest we go to become wealthy?" His response was short and somewhat disappointing. There is no better place than here and now. Well, that stinks.