The Undercover Economist

An interview with Tim Harford, and economist at the World Bank, a columnist with the Financial Times, and author of "The Undercover Economist: Exposing Why the Rich Are Rich, the Poor Are Poor--and Why You Can Never Buy a Decent Used Car!" talks about his experience in economics and how bringing down trade barriers can help the world's poor and help you the consumer.

It really is a fascinating interview. I'm not sure if I agree with his emphasis on environmental implications of trade barriers nor his assumption that bureaucracies can be successful, but he does make some excellent observations on basic economics and ways that can affect you and the third world producer.

One particularly interesting bit is about what Tim calls, "Price Targeting," but what economists call third Degree Price discrimination:

There are some coffee chains in the U.K. who are charging markups of about 20 cents on a fair trade cappuccino. And the natural assumption of the customer is that that 20 cents is going to go to some poor farmer in Guatemala.

But actually hardly any of it does. It's not because the company is stealing the money. It'’s because there is just not that much coffee in a cappuccino. And while the farmer is getting much more money for his coffee, most of that 20 cents is markup. Just pure extra profit that goes to the cappuccino seller.

So I'm not saying don'’t buy fair trade coffee. I'’m just saying the reason they offer fair trade coffee is not because they support fair trade. It is because it maximizes their profits.

And it is a similar thing with organic food. A lot of people like to buy organic food for various reasons. Some people say it is better for the environment. And some people say it is better for their health. Some people say it tastes better. I don'’t have a strong opinion on any of this. I have not studied the evidence. What I do know is that the markup is higher on organic food. Substantially higher.

Organic food is more expensive to produce. But most of the costs of getting something on the supermarket shelves -- staff time, electricity, rent, distribution costs -- they are not actually the raw cost of the produce. And I argue that in many supermarkets you will see organic food priced with much more substantial markup. And it is deliberately separated away from the conventional food because that would make the price comparison too obvious, too sobering.

And so I went to my local health foods store with a clipboard taking all kinds of notes. And one of the things I noticed was you can get your conventional bananas and you can get your organic bananas. You get your conventional apples and you get your organic apples. You'’ll never see them next to each other.

You might see the organic garlic next to the conventional onions and the organic bananas next to the conventional apples. You won't see the organic apples next to the conventional apples.

Another interesting facet he talks about is his work with the World Bank and a project called "Doing Business." This program ranks countries on how easy it is to do business within them. They count how many signatures it takes to sell or move goods, or how easy it is to seek capital, or sell good abroad. Their website is here.

The article is fascinating and goes into a number of economic areas. I might have to check into this book further. Read the inteview and let me know what you think.

Debunking the "Overpaid CEO" Myth

I came across this interesting article about CEO's not really making a substantially different wage than their employees. Apparently, the AFL-CIO has produced a pamphlet charging CEOs with making more than 431 times the average worker. Alan Reynolds dissects this charge and explains why it simply isn't true.

Managing Personal Wealth Quiz Part 3 (Final)

The last quiz of the class.

1. With regard to REITs,
a. Why do their dividends typically exceed their reported income?

REITs invest in real estate and then trade on the stock market like stocks. However, their business is real estate. The cause of dividends that exceed income is based on depreciation. Real Estate for the most part "appreciates" in value. REITs can restate the value of the real estate and capitalize on the appreciation. This coupled with rents received as income can allow a REIT to have a higher dividend than the "income" from rents.

b. Why is this useful to investors?

Because part of the dividend is based on the appreciation of the assets, there are no taxes on this appreciation until the asset is sold. This can have the effect of lowering the overall tax burden of the investor or at least deferring it to a future time.

2. What is an advantage of converting some of your wealth at retirement
into an immediate or deferred annuity?

An advantage of converting wealth to an annuity when retirement comes around, is that the annuity will pay you a "wage" and that is an easy way to manage money. In retirement, people normally don't want to hassle with figuring out how much they have to withdraw from their funds. The annuity simplifies things so that the retiree can enjoy their retirement.

3. How can one avoid probate?

There are currently different ways to avoid probate when one passes away. The easiest is to give a lot of your money away before you die. You do pay gift taxes, but it might not be as much a hassle as probate. You can also create trusts that have rules in the way they handle money and are independent of your will and thus avoid probate.

4. How can one avoid estate taxes?

In order to avoid estate taxes, again gifts are a way to not pay estate taxes, you just pay gift tax. Life insurance can also avoid estate taxes if it is set up in a Irrevocable Life Insurance trust. A joint account with the beneficiary will avoid taxes on everything the beneficiary has a claim to (usually half).

University of Iowa Henry Fund

This past weekend during my managing personal wealth class, we heard from Todd Houge, who teaches the Applied Securities Management class at the University of Iowa. In that class the students manage a fund called the Henry Fund.

The students put a lot of work into the class and have to research companies in order to make buy and sell decisions (following the firm foundation theory of stocks). The best part about this is that the research reports are posted online. These are well written and extremely in-depth reports that consider a lot of economic factors in order to come to their conclusions. Check out their reports here.

The fund is also quite successful. They have beaten the S&P500 by 2.5% since the fund started. Dr. Houge attributes this to the high turnover of students (they take the class for one year). This might contribute to a lesser bias towards stocks, because the students weren't the ones who bought them. None of them can say, "But I don't want to sell that one! It's going places!"

Check it out and let me know what you think.

Two Opposing Theories of Stocks

According to the book, A Random Walk Down Wall Street, by Burton Malkiel, there are two philosophies when it comes to ways to view the stock market and individual stock value. These are labeled "The Firm-Foundation Theory" and "The Castle-In-the-Air Theory." Let's look at them individually.

The firm foundation theory believes that a share in a company (a stock) has an inherent value. More importantly, you can discover that inherent value by inputting some numbers from the company's financial statements and calculating it. This is called fundamental analysis and includes the techniques of looking at the future cashflows of the company, calculating the present value of those cash flows and then dividing by the number of shares. The value you get, should be what the stock should be worth.

This is useful, because you if the stock price is actually higher, than you can guess it will fall back to its "inherent" value; conversely if it is lower, than you should buy, because the stock will rise to its inherent value. This sounds pretty good, but according to Malkiel, if we examine it closely, we start to see that it might not work.

First of all, you have to make hundreds of assumptions in order to calculate the future cashflows of the company. You have to make economic assumptions, such as where will interest rates be in the future? How about other economic variables like fuel prices, inflation, etc? Do these things affect the company you are looking at?

Another factor that is disheartening is normally, the final value you arrive at is never right. If you realize that, you will be farther than most. Now, what you have to do is determine if the market price is really the inherent value or if your assumptions are correct. Sensitivity analysis helps with this a little, but even then does this help you pick winning stocks? Malkiel says, "no."

The second theory is the "Castle-in-the-air" theory. The basis of this theory is that stock prices are not based on a rational number such as inherent value, but more on what people believe the stock should be worth. The theory speculates that investors' emotions and other personal issues can strongly affect their buying and selling decisions, and this is what really has an effect on the market price. If you can figure out their psychology, then you can beat the market. An implied belief also means that every time a stock is sold, it is being sold to a "sucker." The seller is just trying to sell the stock to someone who is willing to buy it at a higher price, not because of inherent value, but because the that buyer thinks the stock will go higher, while the seller does not.

Technical analysis uses this philosophy. These are people that study charts to find patterns in a stocks movement in the past, in order to predict the future. Rather than assume that stocks have inherent value and that their cashflows predict the value, they believe that indicators such as volume traded and the direction of the price charted can predict the future price. These people have patterns that they rely on and look for when analyzing a company. Malkiel shows that with different studies conducted, this doesn't hold much water.

So what does Malkiel think? He believes that the stock market is a "random walk" and that there is no way to predict individual prices into the future. He thinks that you can hold a broad portfolio (such as an index fund) and do better than people trying to beat the market. Why? Because the market in general, is moving up and providing a return. Each of the individual stocks are in the market and "you will not be compensated for risk you take that you can diversify away." That's true in the long run and most of us invest in stocks to plan for retirement.

This is a great book, not specifically for these opinions but because even though Malkiel believes that an index fund is the way to go, he still surveys every other product out there from futures to REITs to fine art investment and gives his opinion on it in simple to understand prose. If you're interested in stocks, you should check it out.

1000 Hits

Well, it looks like we're approaching 1,000 hits to Cashtalk.

There are 134 posts and you can view other statistics about the site here.

We are always looking for new people to contribute to the conversation so if you have a passion to learn about money and especially are willing to share what you learn, let me know!

On this occasion, too, I'm linking to the first post at Cashtalk here. Have a good weekend, enjoy and prosper!

Some Tax Cuts Passed by House; Need to Extend Capital Gains Tax Decrease

According to the Washington Post, the U.S. Congress passed 3 consecutive bills creating tax cuts for different groups of constituents. The tax bills are:

• Create an economic zone in the Gulf Coast area affected by the hurricanes. This would allow businesses to deduct almost everything from their taxes, in order to provide incentive to start businesses in the region. Certain businesses are exempt such as gambling, hot tubs (?), country clubs, etc. Also, the bill would allow the states of Louisiana, Mississippi and Alabama to be granted tax exempt Bond status for bonds related to rebuilding.
• Allow members of the military to claim their combat pay for an income credit.
• Increase the lower limit of the AMT, so less "middle class" people will be burdened by this alternative to the Income Tax.

The bill I'm particularly interested in is the extension of the capital gains tax decrease (from 20% to 15%) and the dividend tax rate (38.5% to 15%). Both of these have encouraged investment or at least made it less difficult. The Congress is expected to vote today to extend this temporary tax decrease.

Worst CEO in 2005

Take Two Interactive's CEO, Paul Eibler has just won the worst CEO of 2005 award as written up in Marketwatch. I am particularly interested in this stock because it was a part of my purchases when we did the stock market game. I also include video games among my hobbies.

Of note, specifically to Brett, is that Krispy Kreme's CEO, Stephen Cooper, was one of the CEO's in the running.

Why did Paul Eibler win this dubious honor? Under his leadership, Take Two has not made earnings projections for the last 4 quarters and has had to cut earnings by 60%!

Foreigner Tax

In August of 2000, I arrived at my new job in Shanghai, China. I was hired to teach English, Business and Communication at Shanghai University. My Chinese language skills were extremely poor and the only thing I knew about their culture was what I had read in travel logs or watched on National Geographic.

Fortunately, when I went over, I wasn't alone. My friend Jake went with me and together we tackled the task of learning about our new home (in addition to writing lesson plans and conducting classes). What we soon discovered, in going about our daily lives, was the presence of what we called, "Foreigner Tax."

This was the premium that sellers would immediately add to the thing we were trying to obtain (food, transportation, etc.) as soon as they saw our blue eyes and our "non-Chinese-y-ness." Normally the tax ranged from 20% to 150% higher than what the locals would pay for the exact same thing. It didn't help that we could barely speak Chinese and most of our communication was either sign language or with long pauses as we looked up the correct words in the phrase book.

One particularly heinous use of the foreigner tax was during a trip to Qingdao (Americans could probably readily identify it by the British spelling of Tsingtao and the fact that the Chinese beer with the same name comes from there) in Shandong province. Jake and I went out to eat at a street stall, which had a variety of fresh seafood and vegetables that they were willing to cook into whatever dish you could imagine. Jake and I picked a few we recognized and said the Chinese words for the dishes we expected. Nothing too exotic.

The dishes arrived and they were pretty tasty. We each had a beer, too. Finally we said the Chinese words, "Mai dan," which means "Bring the bill." We were expecting maybe 40 to 60 yuan for the meal (based on what we had been paying elsewhere for similar dishes). The cook came over and said, "350 yuan."

As some of you may know, that is the yearly wage of some Chinese and the monthly wage of most. We were shocked. We looked at each other trying to figure out what to do. We didn't have that much money on us at the time, plus we knew the "Foreigner tax" was coming into play in a major way. By this time our Chinese had improved somewhat, so we turned to the people next to us and asked them how much they thought we should pay. They whispered, "40 yuan maybe a little more." The cook saw this and she started screaming at them in Chinese. They quickly turned back to their food and ignored us.

The cook kept pestering us and a small crowd was beginning to gather as we were arguing that 350 yuan was ridiculous. At least I think that's what we were saying. Finally, Jake pulled out a 100 yuan note, threw it on the table and said, "Run!" So we ran. And ran. I don't think they chased us that far, but we were determined to get away.

That was an extreme example, but typical of the "tax" I often had to endure. I was charged foreigner tax less and less as I learned more and more Chinese and more about the culture, especially the fair cost of things. If the vendor tried to raise the price, I would say that it was too high and I could go around the corner and get if for a better price. This type of bargaining usually brought the price down quickly to a more reasonable level.

As I learned to listen more, too, I heard that the Chinese often talk with each other about what a fair price is for something. It was not uncommon to hear two classmates chatting about what one of them paid for a shirt, or what the other paid for a new handbag. They were constantly sharing information about where to get the best deals and what a good deal was. If I ever told them I bought something, they would immediately ask me for the price and then when I told them, they informed me I paid too much and I should have gone to so and so.

We all pay foreigner tax no matter where we live. Having returned to the U.S. from China, I think I would now call the foreigner tax the "Ignorance Tax." The less we know about something, the more likely we are to get "ripped off" or pay too much for it. The purpose of this website is to learn more about money and the best ways to spend it (or save or invest it) without getting "ripped off." So let's all continue to share our experiences with each other here, just like the Chinese, so that we can stop paying "Foreigner Tax" and erase our ignorance about money.

Managing Personal Wealth Quiz Part 2

1. Historically, what has been the impact (positive or negative) of inflation on stock returns:
a. In the short run? In the short term, stocks might be eroded by high inflation, but the definition of short can change this. During the late 70's and early 80's high inflation eroded a lot of the gains from stocks, but had people held those stocks, they would have come out ahead. How did this happen? Inflation causes higher interest rates, which in turn, drive down the prices of stocks (and bonds).
b. In the long run? In the long run, stocks have held up very well against inflation, meaning they have returned a higher return than what inflation would erode. In general, portfolio values have doubled every 10 years.

2. What does the Capital Asset Pricing Model (CAPM) say that tells us we should NOT buy individual stocks for our don't be poor objective?
CAPM is a way to determine the return necessary for a company to be seen as a worthy investment (or if a project is worth investing in). What it does, is measure the overall risk of the investment (this works because higher risk should equal higher returns and vice versa). It takes the "risk free" rate (usually a treasury bill rate) and the beta (the risk of the stock) and adds the market risk. By buying an individual stock, we are taking on a portion of risk that can be "diversified away" by holding a higher number of stocks with low correlation of movement to each other. If you don't want to be poor, than don't take on risk that can be diversified away (you won't be paid for it anyway).

3. If the P/E ratio for the stock market is 20, what would Siegel's reasoning tell us to expect (approximately) for the long-term rate of return for stocks?
Jeremy Siegel, in his book Stocks for the Long Run, believes that the P/E ratio is not a good indicator of longterm performance. At a multiple of 20, that would equal about a 5% (1/20) growth in stocks. He believes that a low 20's number for the entire market is justified based on historical data.

4. How can I be assured that an exchange traded fund (ETF) will trade at a price that is very close to the value of the index it tracks?
ETFs are similar to mutual funds in that they try to buy all of the stocks in the index they track. Because the authorized participant (AP) has the financial capital to buy these stocks, they are also in charge of making sure the price of the ETF shares match the equivalent fraction of the all of the stocks. If the price of the ETF rises, the AP sells more shares, bringing the price down. If the price falls, the ETF buys back the shares to keep the price the same. Either way the AP is making money.

India, China and the Coming "White Collar" Apocalypse

Last spring I read a book by Tom Peters called Re-Imagine! where he asks his readers to think about business and their own jobs differently. In the book he is excited that in the near future, people will be hired on a temporary basis for their talents and what they can accomplish, not because of where they live or who they know. He "imagines" a world where traditional businesses are no longer relevant. His vision of business in the very near future is that of independent contractors coming together for a "project" and when the project is done, moving on to the next one.

He writes that businesses stockpiling people and using a "brick and mortar" approach is a thing of the past. He foresees a White-Collar apocalypse similar to the blue-collar apocalypse that happened in the 80's, when machines and technology eliminated a lot of redundant or inefficient "line jobs." He foresees the same thing happening to middle class, office staff of most companies and has many examples to show that he might be on to something.

Someone sent me an article (posted in the comments section) by Gary North, an investor, who has a similar view to that of Tom Peters. He sees the development of China and India as some of the causes for this inevitable cataclysm. He cites that 300,000 computer engineers graduate school every year within India. Not only is there an abundant supply, but they are willing to work for $400 a month. Bill Gates spoke to a graduating class of Indian professionals this week. Gary North mentions that Bill Gates doesn't speak much in public, and when he does, you know that he sees value in it. He sees the future.

To me, this perfectly illustrates the idea of the potential implementation of comparative advantage. The U.S. can no longer compete with software engineers from India, so why not use less resources to have an Indian national program software and take the money you save and invest it into a technology or specialization that we can then turn around and sell to India? With the new tech or specialty, you train the Americans who lost their jobs to the Indian. Free trade is a wonderful thing.

I have to confess that I am slightly worried about my own white-collar job, but I am also excited about the potential of a society where people are hired for their talent and the merit of their work is what they are worth. As Tom Peters would say, "You are a 'rock star' in the world of business. You can make deals, continue learning your trade, and sell your trade on a completely open market." Scary, yet exciting.

Productivity Up 4.7% in the U.S.

It looks like Americans are doing more with their time than originally expected. This is certainly good news for the economy as it makes it more likely that people will use their dollars (or Euros or Pounds) to hire Americans to do jobs, as their dollars will go further than in other countries.

The Tragedy of the Commons: Illustrated through the Ivory Trade

What is the "tradgedy of the commons?" An interesting article illustrates this economic idea through examples in the ivory trade (or lack thereof). A game involving rabbits also tries to illustrate the idea.

Why is this idea important to you? It opens up ideas for ways of protecting the environment using capitalistic ways and means. I'm not sure if I'm sold on it yet, but read about it and let me know what you think about it.

Comparative Advantage Game

I stumbled across this game when reading about Avocados in Mexico. In a simple manner, it explains and demonstrates comparative advantage, a key basis for the argument for Free Trade. Play the game (it takes about 5 minutes) and see how compartive advantage can work even for someone who is disadvantaged when it comes to trading.

When you come to the conclusion of the game, you will see a link that explains more about comparative advantage and recomends readings on the topic.

Mexican Avocados and Chinese Shoes

Wow! The example in this article from A World Connected is very similar to my example in the Free Trade/Fair Trade post. Peter Mork, an economist, who is writing a book about how economics effects people on a day-to-day basis, writes a charming and real account of his experience in Uruapan, Mexico, where Avocados are the primary crop and economy. He calls attention to the limits the U.S. used to have on Mexican Avocados and how that hurt the people of Uruapan. Today, Mexican Avocado trade in the U.S. is less restricted (they can now be sold in 47 states year-round).

This quote sums it up quite nicely:

"...couldn'’t all this theory be summed up into one simple question: Where was the justice in the fact that I was allowed to buy an avocado from someone named Richard in Fallbrook, California, but not from Ricardo simply because he lived in Uruapan, Mexico? Should the random chance of being born on the opposite side of a border restrict our association in that way?"

"I, living in San Diego, want guacamole and Ricardo, living in Uruapan, wants to sell me his avocados. Why should anyone have the power to stop this peaceful exchange?"

What I appreciate about the article, and Mr. Mork highlights it, is that the Mexicans are dealing with their own protectionist issues with China, specifically concerning shoes. They ban Chinese shoes in order to protect their own shoe industry. Obviously this is quite ironic, as the people of Uruapan try to gain entry to the markets of the U.S., the people of China are shut out of Mexico.

Mr. Mork talks about conversations he has with some of the locals in seeing if they understand the irony in their situation:

"When I explained that I wanted to write about how economics affects real people and gave the example of how avocados from Uruapan cannot be sold in my home state of California, not only did the confused looks leave their faces but it generally changed into one of enthusiasm. Residents from Sonora to Chiapas would say 'That'’s a great thing to write about. Why aren'’t Mexicans allowed to sell their avocados in California?'” It was easy for many to relate with growers in Michoacan and see the injustice in our laws.

Alas, I did not receive a similar reaction when talking about Chinese shoes. Even after pointing out the similarities between California growers lobbying politicians to ban the import of Mexican avocados and shoe makers in Leon lobbying politicians to ban the import of Chinese shoes, many were not convinced. '“It'’s different though,'” I would hear people say, '“We need those laws. The Chinese can make everything so cheap.'"

Mr. Mork rightfully points out that if free trade is allowed across these borders (U.S., China, and Mexico, and every other border for that matter) then people will be better off. Goods will be produced cheaper and therefore cost less. This allows consumers to spend less and use the excess money to invest in their own economy. The slow and inefficient industries will wither and die and the stronger, specialized industries will grow. As Mr. Mork alludes to, it is a "win win" situation for everybody.

Is the Media Creating a Housing Bubble Myth?

An interesting article here from the Free Market Project discusses the media's attempts at painting a picture of a national housing bubble. What is striking to me is the way the media (as cited by the article) ignores comments from the Federal Reserve Chairman and other sources like the Commerce Department.

Here's the summary of points the article makes:

• A Bubble?: Fed Chairman Alan Greenspan has denied the existence of a national housing bubble for several years, but the media have used the term repeatedly.

• Strong Gains: The increase in real estate values the past five years has not resembled the rapid rise typically seen in a bubble. In 2000, the national median existing-home value was $139,000. This grew to $215,900 by the third quarter of 2005 – a 55-percent nominal increase but a 34-percent inflation-adjusted gain.

• Home Sales Still Going Up: New home sales jumped another 13 percent in October. While sales of existing homes were down 2.7 percent from September, the median national price rose to $218,000, a 16.6 percent increase since October 2004.

So perhaps there isn't a housing bubble. I suppose only time will tell.

Most Americans Hold an "Unfavorable" Opinion of Wal-Mart

Agent Disco pointed out to me that a poll released last week conducted by Zogby International, shows that an amazingly high 55% of people feel they have an "unfavorable" view of Wal-Mart.

Rather than chalking this up to everybody hating Wal-mart, I'd like to propose that what this really demonstrates is an obvious bias against Wal-mart in the media. The question that got people to answer "unfavorably" is "In general, thinking back on what you have recently seen, heard or read about Wal-Mart [bold is my emphasis] in the last few months, does it make you much more favorable, somewhat more favorable, somewhat less favorable, or much less favorable toward Wal-Mart?"

While it is fairly obvious that there is a group of people in the world who hate Wal-mart and everything it stands for and believe that it is one of the signs of the coming apocalypse, most people in America do their shopping there. An article in Variety today broadcast that over a half-million Garth Brooks CDs were sold at Wal-mart online through pre-orders and one day of sales (Nov 25th). That's right. One day.

We've had our own debates here on the site about the virtues and vices of Wal-mart. Some of the criticisms are valid. They used to treat their suppliers like trash. They'd sign one up for an order of 1 million units a month, then when the supplier geared his or her production line to produce that many, they'd come back and say, "We've found another supplier that will beat your price. Can you match or beat them?" That sounds like cold-hearted business to me. But they've also done a lot of beneficial things for our whole country. There has been talk that Wal-mart has had an enormous effect on keeping inflation low in the last decade. Just under half the people in the US visit Wal-mart every week (138 million).

So why do people, the media and special interest groups pick on them? I think it is because they are successful. They demonstrate what happens when someone (Sam Walton) has a good idea and the perseverance to realize that idea. And I think that the media resents that such a large company can do so many good things for people. The result of this is more negative coverage which, in turn stirs up people into believing that Wal-mart is a "big, bad giant" that needs to be reined in. What they may not realize is that by punishing Wal-mart (or other similar service and goods companies) they are really punishing themselves, by giving themselves less choice and forcing them to pay more and thus have less money.

I'd love to hear your disagreements.

Should You Buy a Warranty on that Purchase?

I came across this interesting article on CNET.com about whether or not to buy an extended warranty or service contract when you purchase an electronic item. The article has some good considerations, but ultimately, the answer is "no."

The main reason is because the warranty is seen by the retailer as pure profit. Often times the warranty only covers a period where the good in question has a low probability of breaking down. Even if you extend the warranty on your car, the amount of money you pay could be placed in a savings account or investment and when the machine or electronic good does break, you could withdraw it to pay for the repairs or buy a new one.

The article does mention that you should take into considerationt the price of the thing you are buying. A plasma screen TV costs a couple thousand dollars and a fraction of that for peace of mind is worth it, according to the article. The problem I see, is that often times the warranty on something like that isn't "$10 or $20 more." It could be $500 dollars for a 2 year extdended warranty. Placed in a good interest producing account, and you would probably have enough money to cover any repairs, if they in fact need to occur. The odds are against there even being a need, in which case, you keep the money.

The article also points out that manufacturers often times offer a warranty that is sufficient to find out if there are no inherent flaws or errors in the purchase. If I buy a TV and get it home and it doesn't work, then I can usually (almost always) take it right back for a replacement or a refund. Most problems occur well within this short time, normally a month.

So when you are out shopping this "holiday" season, think twice about accepting the warranty push from that sales clerk. It may just be wasted money.

More on Checking Accounts

Another article here from Bankrate.com that compares checking accounts across banks. The nice thing with the MMAs I talked about in the last post is that you can often link these to your checking account, so you can move money from the MMA into your checking account, often by visiting the website and clicking your mouse a few times.

The article comes up with some astonishing facts given the previous post: the average amount to open a checking account is $445.54 and the average minimum balance for an account is $2,296.

I understand that you may have grown attached to your bank, but some of these requirements are downright ridiculous. Take control of your money and find the best deal.

Get a High Interest Savings/Checking Account and Let Your Liquidity Work for You

A friend of mine pointed out to me that some banks are beginning to raise their savings/checking/MMA (money market account) rates. Right now, I belong to a credit union, that until this weekend, I thought had a fairly competitive rate of 2.45% a year on its money market savings account, with a minimum required balance of $2,500.

The friend of mine pointed out the site, Bankrate.com, which compares savings rates, mortgage rates and other liquid investment tool rates across financial institutions. He also told me about GMAC (A division of GM) which is offering a MMA with an annual rate of 4.10% a year! Also, in this particular case, the minimum balance is $500.

If we compare the interest on a balance of $5,000 in each of the institutions, the credit union would provide me with $123.89 of interest in a year (compounded monthly). If the $5,000 were deposited with GM, then I would earn $205.08 (compounded daily!!!). By keeping the money in the credit union, I am losing $81.19 a year!

Now, because of the higher interest rates that MMAs often provide, there are restrictions that apply. Notably that you may only make 6 withdrawls a month. Using it to pay your bills or as a checking account would incur penalties and fees, but if you have some money, and you aren't sure what to do with it, or you want to keep it in case of an emergency, I highly recommend placing it into a MMA. I know I will.

Fair Trade or Free Trade?

You may have encountered the idea of "Fair Trade" or "Free Trade" in your daily life. Perhaps you were in the local grocery store looking for some herbal tea and noticed a sticker on the box or bag that said "Fair Trade Certified," or something along those lines. Perhaps you've read the newspaper about the WTO and "Globalization" and "Free Trade." Maybe you have a preference for one or the other. Or maybe, like me you're not quite sure of the difference between them, nor their importance to our lives as citizens in a prosperous country or as consumers.

Let's start with some definitions. Free Trade is the idea that trade should be unimpeded by excessive rules and regulations, usually established by governments. These governments create tariffs on goods they see as a threat to their own, domestic industries. The high tariffs prevent or at least make it harder for other countries' goods to be sold in the particular country. This of course makes it easier for domestic industries to compete amongst themselves (they don't have to compete on the world market for domestic customers).

Fair Trade takes the idea of free trade a bit further. Proponents of fair trade believe that free trade doesn't quite cut it. They think that trade should also be "fair." This might mean that rather than eliminating a tariff as a solution to helping a poorer trading partner, they would advocate paying more for the good, to ensure the producer gets a "fair" price. The problem (as the Economist points out) is that the definition of "Fair" is often quite subjective. Frederic Bastiat, a 19th-century French satirist, once observed that the sun offered unfair competition to candle makers. If windows could be boarded up during the day, he argued, more jobs could be created making candles. You can see where this line of thinking might take you.

Most Free Trade agreements were facilitated by meetings with richer countries and agreements that they would lower tariff rates from around 40% down to 4% on manufactured goods. This has been a boon for consumers. Think of cars, for example. Imagine not being able to purchase a Toyota, Honda, Mercedes, etc. Even though these cars tend to have an arguably higher quality rating than domestic brands, with high tariffs in place, you would have to pay a higher premium for them, most of which is used to pay the import taxes to the government. Think of how happy Ford or GM might be at higher tariffs on foreign cars. They wouldn't have to try very hard to produce a competitive car, because they know the consumer might consider price a major factor in their purchasing decision.

While manufacturing has benefited around the world due to the lessening of restrictions, world-wide agriculture has been severely retarded by high tariffs, mostly from developed countries. This hurts developing and third-world economies as farming is usually one of the only ways they can make money (textiles and clothing are also other markets they are often shut out of). An example from an article here (also posted in the comments section) cites the sugar industry as having a particularly nasty lobby that contributes money to politicians in order to ensure that tariffs on sugar in America and Europe remain quite high. As a result, consumers (you and me) pay quite a high premium on sugar, that if we had access to the world market price, sugar would be 90% cheaper. You might be thinking that you don't buy sugar very often and that it doesn't really affect you, but think again. The sugar that goes into candy, bread, sauces, etc. is all being bought at higher prices. Lower these prices, by buying sugar on the world market (and thus supporting poorer farmers from Africa, South America and Asia), and you would naturally decrease the price of a lot of consumer consumables made with sugar. You can help people and still be selfish!

You may have pegged me as a free-trade advocate or as a pro-globalization nut, but I would say that I'm a consumer advocate above all. And with that in mind, I'm not totally opposed to fair-trade, as long as I (and other consumers) have a choice in the matter.

Common advocacy for Fair-trade might be identified closely with the coffee and tea industries of the world. According to the International Coffee Organization, there are over 25 million coffee growers/producers in the world. A lot of times coffee can account for over 75% of a country's export income. Companies like Cafe Direct work with farmers from countries that don't have access to the richer markets and help advertise their coffee. This newly branded "Fair Trade Coffee" sells at a premium compared to other coffees, because the consumer is paying for the price of producing the coffee, plus a "social premium" that covers the cost of living in the country where the coffee was produced, a measure preventing the producer from taking on too much debt, and enough to help the farmer/co-op to improve their operation.

If a consumer wants to help poorer people who are trying to make a living in a world where tariffs and unfair rules are preventing them from getting a fair price, then I applaud them. One of the nice things about living in a free, capitalist society, is that the choice to buy fair-trade goods is available.

However, I think that when it gets right down to it, I would prefer the "Free-trade" approach and have governments lower their barriers to entry and have a truly global market available for all types of goods and services. This would allow countries to specialize in the types of manufacturing or agriculture (or services) that their talents, geography, and culture would best support. This idea is called comparative advantage (a great practical example concerning Country Alpha and Country Omega is highlighted in the link). This idea is extremely important when it comes to understanding the benefits of Free-trade.

I was talking with two different friends at two different times. One had recently returned from Peru on a humanitarian mission and the other had lived in Mexico during her years in college. The friend who had been to Peru lamented the encroaching presence of Wal-mart and McDonalds and the friend who lived in Mexico thought that globalization was destroying their simple way of life; their "culture," as she put it.

Both arguments, to me seem quite selfish, and are based on the idea that the people of these different countries want to continue to live in the poverty they currently find themselves in. The people in Mexico (where she lived) had to live in mud huts and electricity was a luxury. Their major crop was corn of which they mostly grew enough to survive on. She said they couldn't sell it because they wouldn't be paid much. Imagine if trade barriers in the United States for corn were erased. Those people in Mexico might be able to sell their corn on the open market for less than what it costs an American farmer to grow it.

The consumer benefits because now they have more money to buy other things with, the Mexican farmer benefits because they have income to which they can buy electricity, more land to farm, or what they deem necessary. The loser is the American farmer. Currently the source of the most opposition (or fill in whatever industry worker you want: textiles, furniture, cars, anything). They are the ones that want tariffs. They are the ones complaining about losing their jobs to the Chinese or Indians (or Mexicans in the above case). What people need to understand is that because the farmer can't produce the corn at a value to the consumer, they can now do something else. They can learn how to program computers or work in sales. Or maybe they can find jobs as consultants to the farmers in Mexico. The point is that the economy is dynamic and that because both economies have gained from the loss of the inefficiency there is now more resources, money, time to hire that unemployed farmer to do something more productive or relevant to the comparative advantage of the United States.

Free-trade, in my opinion, is the way to end world-wide poverty (or at least come pretty close). Allow people to produce goods at a truly fair price and begin to specialize their economies for the benefit of the whole world. Let consumers spend less on goods that can be produced by those specialized economies and then use the money saved to increase the specialization of their own country.

Two articles here talk about Fair Trade and Free Trade from differing perspectives. Read them and let me know what you think of the whole affair.

My First Job

My first job outside of babysitting for a few dollars and helping out with the little league snack shack was as a lifeguard. I took some classes at a community college and earned my Red Cross Lifeguard card and then a Water Safety Instructor card.

I was reminded of this when I read an article by one of my favorite economists, Walter Williams. He talks about minimum wage jobs and how important they are for the economy and for developing and teaching skills. During my time as a lifeguard, I needed to be responsible for a pool full of children swimming. I also learned how to plan a lesson and deliver it in a meaningful way when I was teaching swim lessons. Williams makes the point that a lot of people would not want to have a job at McDonalds, Wal-mart, or even as a lifeguard (believe me, it isn't as glamorous as Baywatch makes it seem. It's actually quite boring.), but the jobs help people develop. He then goes on to list a number of famous or successful people that got their start working at McDonalds.

What was your first job? Did you find that it provided you with a strong foundation for what you are doing now?

Here is a picture of the last 5 days of Google trading.  

Google Shares Drop

I beginning to find that Google is a popular topic on this blog. I think I am drawn to it because of its semi-unconventional way of doing things. I also like the way the company is attacking major competitors (Microsoft for one) with relatively little advertising for itself. In fact, Google has never advertised, at least in the traditional sense. Word spreads on websites and on webpages. I remember I was in college the first time I heard about Google. I thought the name was stupid, but when I finally got around to looking at it, I never went back (I had been an Excite or Yahoo! search engine user previously).

Yesterday, Google's shares dropped 4.7%. People think it is because of the "poor" start to the Christmas shopping orgy, but I'm beginning to think that Google might be a part of a bubble.

When you look at Google's P/E ratio, you see quite a high number. This is not normally a good sign. Today, the number is right around 80. Last week it was about 100. What is a P/E ratio? At the basic level it is the price of the stock divided by the earnings per share. What does that mean for you, the investor? It would take 100 years for Google to be able to create the earnings that its shares are trading at. Is this a rare occurance? No. Growth stocks or new companies with a lot of potential for growth often have higher multiples. The stock's price reflects the potential future earnings (remember a stocks price can be determined by the present value of all of the future dividends). But sometimes, people get excited about stocks and bid the price higher than what the company can produce, even at an accelerated growth rate. Sooner or later, as history has shown (just look at the stockmarket crash/recession of 2001) the price comes down. I'll explore this idea a little more in my next post.

Capital Gains Tax Set to Increase

A lot of the reasons why people have been investing in the stock market lately is that in 2003, the capital gains tax, originally set at 35% was lowered to 15%. Some have credited this tax cut with saving the economy and causing the post 9-11 recession to be a lot less of an impact on our economy than it could have been. Unfortunately, the tax is scheduled to revert to 35% in 2008.

Dividend income and estate taxes are also scheduled to revert to their pre-2003 levels in the next few years. "What? A few years?" Yes, I know there is still some time, but even with only a few years away, the effect that a tax rise is imminent will have negative effects on the market, most likely causing a number of investors to sell their stocks to take advantage of a lower tax rate.

Read this article at Tech Central Station for more information.

Xbox360 Tries to Knock Sony Off its Pedestal

A great article here from the Economist about the gaming industry, a $20 billion a year market. You may have heard that the Xbox 360 was released last week to lines of people and even some social unrest (when customers at a Wal-mart attacked the manager after he changed the rules for getting one of the entertainment consoles).

The article goes into some detail about the video game industry, especially the strategy behind the big three players (Sony, Nintendo, and Microsoft). Microsoft is in second place, but the jump needed to take first is formidable.

One factor I thought interesting, was that the manufacturers usually sell the consoles at a loss hoping to recoup their investment through the sales of peripheral devices. Another interesting fact is that the fight over standards (blu-ray or HD-DVD for example) seems to be what is really initiating Microsoft's forays into this market.

The Current Income Tax Hurts the US Economy

An article speculates that the income tax Americans pay costs them $500 billion in time and money just to come up with the money.

Put another way in the article, it takes 5.8 billion hours for Americans to figure out how much they owe and ensure it is delivered by April 15th. That time, when looking at the opportunity cost, is worth the equivalent of 2.77 million people quiting the work force. That's right. 2.77 million people working a regular work week with vacations during the year is equal to 5.8 billion hours of wasted time!

Why do we have to shoulder this burden? Businesses (included in the above numbers) have to make decisions, not based on what it good for the business, but also whether there are any tax benefits or penalties to those decisions. Again, if we look at opportunity cost, we can see that this burden is costing the business time and money and potentially higher growth rates because it has to consider tax implications.

Moreover, the article claims, that businesses pass on the burden to the consumer. Of every dollar spent, 22 cents is, on average, used for paying the business' taxes.

John Linder (R - GA), has proposed the Fair Tax (H.R. 25) in order to remedy some of these uneccessary burdens. Read about the Fair Tax here.

The Other Beta

The promise and perils of "beta" in a technology product's lifecycle, profiled here. Also in the comments.

"I deplore it as a consumer; I admire it as a marketing professional," said Peter Sealey, a marketing professor at the University of California at Berkeley and former chief marketing officer at Coca-Cola Co. "I can't come up with anything else in the entire marketing world where marketers knowingly introduce a flawed or inadequate product [and] it helps grow your user base."

The Other P/E

Sometimes it cracks me up to read or watch the "pros" as they attempt to predict where the market is heading. Strike that: it always cracks me up.

I like to think that I don't walk around with my head completely in the sand, but I have long ago stopped paying much attention to the various indicators and gauges that supposedly tell me what to do with my money. Seldom are they right, often are they contradictory (let's play a game... you give me one pundit's outlook on the market, and I'll find a diametrically opposing view in 30 seconds or less or will buy you a lottery ticket), and always are they carefully constructed: pulling just the right information over just the right period of time, to support just the right outlook the pundit's firm is marketing to their client base at the time.

Here's a new one I've never run across: Citigroup's Panic/Euphoria Model, or "The Other P/E". Read it and post where you think the market is heading between now and the end of the year. Up, down, or even. Your guess is as good as anyone else's, I'm sure.

Start Thinking About Taxes

I know. It isn't April yet, but in order to make sure that we aren't over-taxed by the government, we should be thinking about taxes and ways we can avoid unnecessary taxation throughout the year. I came across the Anderson Financial Group's webpage with a wealth of information about taxes and different ways to shelter money from taxes, including retirement tools such as the 401(k) and IRA, to the educational savings account or creating a corporation.

Visit the site and click on the "Tax Center" link in order to read about the different options available to you. Let me know what you think, too.

Managing Personal Wealth Quiz

I'm currently taking an accelerated class in personal wealth management. Every week, the instructor sends out a quiz. I thought I would post the questions and my answers here in order to share the financial information. Most of the questions and answers are vague, but if you have any questions about the topics, please post them in the comments and I'll try to be more specific.

1. BRIEFLY, why do I prefer "don't be poor in retirement"rather than "maximize your wealth" as the primary overall objective in Wealth Management?
Don't be poor in retirement is an obtainable goal. Maximizing wealth is nigh on impossible unless you make every right decision and buy and sell at the exact right moments. Obviously by not being poor and meeting that goal, you can then set higher goals, but it is good "not to be poor."

2. We have several levers to work with in managing personal wealth -- asset allocation, tax structures, etc. Which lever (or 2 levers) are the most under our control and, in that sense, the most powerful.
The two most powerful levers under our control are income and expenses. Of all the things we can control, these two we can control directly. By cutting expenses, we can increase the amount of money we can set aside for reitrement or other financial goals. By increasing income (through moving to a different job) we can also gain additional money for our financial goals.

3. Why do we care about relatively small differences in costs in wealth management?
Unfortunately, a small cost, like 1% of all assets managed can add up considerably over time. Because personal wealth takes a long-term view, 1% can be the difference between thousands of dollars by the time you retire or meet your financial goals.

4. What are the advantages of bond mutual funds? What are the disadvantages?
The advantage of a bond mutual fund is that it provides diversification to someone who wants a wide variety of investments. The disadvantages are that it could carry more risk due to the manager facing the pressure to beat the market. They are also not very liquid. An additional risk is that they are more susceptible to interest rate changes, because there is not necessarily a consistent start/end date for the bonds within the fund.

5. Briefly, what is the advantage of a Roth IRA compared with a traditional IRA?
Roth IRA: Able to invest after-tax dollars. The contribution limits are relatively high for a middle class investor. Can withdraw money for large purchases. Probably the greatest advantage is that you don't pay taxes on the money when you do withdraw it.

Traditional IRA: Must contribute before-tax dollars (set up through the employer). Must pay taxes on the income when it is withdrawn. The same contribution limits that apply to a Roth IRA also apply to the IRA.

6. What are the disadvantages of a tax-deferred annuity (TDA)?
Extremely high costs due to the age of the insurance company (bureaucracy). Fees are generally in the form of a % of holdings. When compared with an index fund, the index tends to return more (mostly because of fees on the TDA).

Follow up: Wal-mart's profits help people

John Stossel, of ABC's 20/20, wrote an op-ed piece here about Wal-mart and the benefits that it provides for all of society, let alone its own workers.

We can debate again the virtues or vices of Wal-mart but what struck me from the article as being particularly interesting was Mr. Stossel's reference to 1900's "Robber Barons" and their perceived problems. Being neither robbers or barons, these people (Vanderbilt and Rockefeller) contributed to society and made people's lives better, all the while getting rich for their trouble.

Another interesting part of the article I picked up on was the reference to Gordon Gecko's speach from Wall Street. He says that business is a zero-sum game: There are winners and losers in every transaction. But when you stop and think about it for a minute you can see from real-world examples and the example with the milk that Stossel provides that this is not true. Businesses create wealth, not only for themselves but for their customers and in turn for society.

Ayn Rand's book, Atlas Shrugged, wholeheartedly subscribes to this business philosophy and her heroes describe this detail at times within the story. I posted an example of one monologue and you can find it here.

Get LinkedIn

A friend of mine, Jacob Schenkel, introduced me to this on-line service called "LinkedIn." It is a "networking" site that helps you keep track of the people you know and what they do. It adds power by keeping track of the connections between all of these people. This allows you as a user to search this network to find people in a job field you might be interested in or maybe find someone who offers a service you (or your company) are interested in securing.

By posting a mini-resume, people you've worked with or you know can give you feedback and "endorsements" of your work. LinkedIn is also connected to major job search engines like Monster.com and CareerBuilder.com. If you find a job on either of these sites, you can search your network for people that might work in the company you are applying to. They are also expanding "linking" LinkedIn with other sites.

From their own site:

LinkedIn Announces Relationship with the AESC
The Association of Executive Search Consultants is the global professional organization for retained executive search firms, representing over 4,000 search professionals in more than 70 countries. Make your information available to AESC member search consultants via the BlueSteps.com executive career management system.

It seems to me that the site works hard to make keeping track of people, finding a job, and just staying in touch a lot easier for anybody. The more people you have in your network, the better (just make sure they are high-quality contacts). Also blog here has posted etiquette for networking on LinkedIn. Some interesting tips are included.

Check it out and send me an email, so I can join your network!

Google launches new service

Google Base has been launched today. It offers the opportunity for people to post anything they want to a large, searchable database. Certain large, on-line retailers, auction sites, and job search companies are beginning to feel the heat and potential pressure of a competitor (*cough* E-bay *cough* Careerbuilder *cough* etc.).

Google's stock is trading just under $400 next to its all-time high of 398$ a share. Will this behemoth ever stop expanding or growing? I hope not.

Causes of inflation: The US Government

Inflation numbers were released today that show inflation is lower than many had first suspected and better than September (last month). A previous post by myself explains inflation and traditional ways of combating it here.

A great article by Walter Williams talks about the causes of inflation. He theorizes that inflation is only caused by an increased supply of money. This, in turn, causes prices to rise. He then asks where the money comes from? The U.S. Government or more precisely, the Federal Reserve board, the organization that controls the production of money and interest rates.

He then goes on to show that the government acutally likes some inflation, because it helps it pay off debt faster. This portion is great:

When inflation is unanticipated, as it so often is, there's a redistribution of wealth from creditors to debtors. If you lend me $100, and over the term of the loan the Federal Reserve increases the money supply in a way that causes inflation, I pay you back with dollars with reduced purchasing power. Since inflation redistributes (steals) wealth from creditors to debtors, it helps us identify inflation's primary beneficiary. That identification is easy if you ask: Who is the nation's largest debtor? If you said, "It's the U.S. government," go to the head of the class.

Einstein Quote

"Compound interest is the most powerful force in the universe."

--Albert Einstein

Bush's Tax Reform Announced. Is This a Step Forward?

President Bush's panel on Tax Reform released their recommendations on November 1. This has caused a number of different groups to respond (some of which I've listed below) in a variety of ways.

Remember, nothing has been implemented yet. These are only suggestions following President Bush' s guidelines of finding an easier way to collect taxes (simplify), and without raising taxes while continuing to collect the same amount. He specified that charitable giving and investments should also be encouraged.

Essentially, what they have suggested seems to be positive (in my own opinion). 75% of tax payers will fall into the lowest bracket which appears to be a %15 income tax. I myself would benefit tremendously as I now pay about 23%.

They have recommended getting rid of the AMT or Alternative Minimum Tax. What this does is force some people to pay a higher tax even if they have deductions on their standard income tax return. This has become a burden for more and more people as they earn more income.

Unfortunately, many deductions would be eliminated. I rent so I wouldn't be affected by this, but mortgage interest would not be a deduction anymore. Instead, you would have deductions based on charitable giving and family size. You would also lose deductions for state taxes.

If you invest your money in housing or the stock market, they would also be lowering capital gains tax and dividend taxes to 15%. This would have a significant effect on encouraging people to invest their money rather than spend it. Related to this, 401(k), IRA's and other pre-tax savings tools would be consolodated into three different accounts, each with a higher cap, effectively providing more incentive for people to plan for the future and save money.

The panel also have decided to forego the suggestion of a national sales tax. I posted a few months ago about this issue and feel that it might still be a better solution, but overall the ideas of the Panel should cut in half the amount we, the citizens, spend on tax software or tax preparers. All this saved money could be invested or used to better our standard of living.

Corporations are also rewarded in the proposal with a decrease in tax rate from 35% to 31.5%. This could have the effect of allowing companies to reinvest the money otherwise spent on taxes.

A great article here produced by the Tax Foundation goes into far more detail on pros and cons and their likely effects.

The Heritage Foundation has also released a critique of the suggestions where they grade each of the individual proposals based on an ideal, business and consumer friendly model. Give it a read.

Robert Novak, a conservative pundit, thinks the plan is dead in the water and is not afraid to tell people here. He believes the people on the commission did not consider all of the options because of their prior political leanings.

Google Starts Book Search Service

Google today launched their "Google Print" search service which searches books the company has scanned. It is causing a bit of controversy due to copyright law, but for the moment, Google has only scanned public domain books.

I've tried the service out and it seems that this is going to be really nice. Google's stock is currently trading at an all time high of $384 a share and has risen 1.34% today.

Iowa Rainforest Project Site

I wanted to link to this blog following the developments related to the Iowa Rainforest Project, a massive undertaking planning on producing a tourist trap/research project that would create an enclosed rainforest in Coralville, Iowa.

I've been skeptical of the project from the start, primarily because I'm fairly skeptical of the government in general, especially when they announce big spending projects. My main beef with it is: if Iowa really needed a rainforest, wouldn't some enterprising business person come along and build one? Wouldn't he or she charge and make a profit off of it? The answer to both questions is "no." So then, I ask, why do we need this again?

People say that it will provide jobs and increased revenue due to the flocks of tourists that will want to see it. These are benefits (unproven though they are), but I feel guilty spending federal dollars (of which a tiny percentage I myself contributed to) on this "pork project." I certainly wouldn't want someone to use my money and build this in Alabama or Alaska. However, just like all pork projects, this is what happens.

John Stossel wrote a great opinion piece today on just this topic. Click here and give it a read.

Iowans Have the Lowest Insurance Rates

An article in the Press-Citizen cites a survey claiming that in Iowa we have the lowest average insurance rates. In case you're wondering, the average Iowan pays $676 a year. New Jersey, the most expensive state, pays double that, on average. With all the money we save here in Iowa, what should we do? Fill up the tank, of course!

Gold's price is rising. Why? There may not be much left to mine.

You may have received an email/spam touting the wonderful investment opportunity that gold provides. Some investors think that gold is a good hedge against inflation (it really isn't any more). Some people think that gold is one of the worst investments, as it fluctuates often and has a poor record of return in comparison with the S&P 500. An article in the Economist points out that gold has underperformed even inflation of the US Dollar (meaning if you have bought gold in the past, you have actually lost money, as the value of what a dollar could buy drops).

This article in the Independent talks about gold mining and how at this point and technology level, mining companies can barely get an ounce from 30 tons of ore. The price of gold, the article speculates, is primarily driven by increasing demand for jewelry around the world, but also in developing countries like India and China. Does this mean that the price of gold will increase even further? It might, especially if environmental regulators begin to crack down on the use of cyanide in mining.

So should you invest in gold? Keep an eye on demand. If countries like China continue to want more and the supply increasingly becomes depleted, then naturally, like any commodity, the price will rise. You may make some money, but there are also better ways.

Economics Professor Weighs in on Municipal Power

Jane Driscol sent me this article by John Solow, a professor of Economics at the University of Iowa. I took a class with Prof. Solow and while he may not be the most interesting person to listen to, he has some good arguments in this article.

Thursday, October 20, 2005

A 'yes' vote not prudent

During the past several months, supporters of a municipal utility have gone to great lengths to make a political case for a government take-over of facilities of MidAmerican Energy Company, Iowa City's electricity supplier. They have turned what should be a serious public policy question into a referendum on "big business." Now, as citizens face their only opportunity to vote on the issue, Citizens for Public Power claims a "yes" vote allows them to see whether they can come up with a viable business plan.

This is seriously putting the cart before the horse. No intelligent business person would approach a lender or investor without a financial plan, but that is exactly what CPP is doing. Iowa Citians deserve to have the facts in front of them before they decide whether to support this scheme. Yet when pressed for details, CPP's response is, vote "yes" to give us an opportunity to figure that out, trust the City Council to only go forward if the numbers work out, and count on the Iowa Utilities Board to prevent us from making a mistake.

Here are just a few of the biggest questions that ought to be answered before we authorize the City Council to establish a municipal utility:

- What will it cost to buy MidAmerican's distribution system?

The Latham Report assumes it will cost roughly $11 million to purchase the necessary MidAmerican facilities. This is a gross underestimate. More than a decade ago, the Iowa Utilities Board told Sheldon, a town of roughly 5,000, that it would cost residents almost $14 million to purchase the assets they needed to municipalize. How much are we, a city of more than 60,000, going to have to pay?

- Where will Iowa City purchase its electricity, and how much will it have to pay for it?

Iowa City's average load in 2003 was 94 megawatts, and the peak load was roughly 180 megawatts. The companies in the best position to supply this amount of power to Iowa City are, of course, MidAmerican and Alliant. Buying power from more distant utilities is more expensive and less reliable. On hot summer days when power supplies get tight, our municipal utility would lack sufficient secure supply and would have to purchase additional electricity at higher spot-market prices. Or we could build our own peak load generating capacity. What will this cost?

- What other facilities will Iowa City have to build, what additional employees will we have to hire, and how much will that cost?

A municipal utility will need additional facilities, such as a control center and emergency back-up generators. What will this cost? MidAmerican has a staff of 37 people who work around the clock to monitor their power system, a billing department, a customer service department and so on. A municipal utility will have to provide those services as well. How big will that staff be, where will it be housed, what equipment will it require and how much more will this cost?

- Who will provide the service, both on a day-to-day basis and in the event of an emergency?

The IBEW, our electrical workers' union opposes the formation of a municipal utility because its members receive better pay and benefits from MidAmerican than they would as municipal workers. Our local electrical workers have publicly stated they will stay with MidAmerican. Where will a municipal utility find the workers needed to keep our electrical system up and running, and what will it have to pay them? Following the 1998 windstorm, MidAmerican was able to draw workers from surrounding communities and states to restore power, at a cost of more than $1 million, without raising rates. If a similar catastrophe were to occur, how would a municipal utility provide an equally quick response, and at what cost?

Ordinarily, the City Council would study the costs of establishing a municipal utility first. If it chose, the Council would put forth a detailed proposal for establishing a municipal utility, and, under Iowa law, the citizens would vote on whether to "authorize the City Council to establish a municipal utility." By forcing the vote through a referendum, CPP is making the voters use their only opportunity to speak without the facts they need to make an informed choice. CPP says that a "yes" vote is only to allow further study, but we don't need a vote for that. Nothing prevents the City Council from researching the costs of municipal power now.

Starting a municipal utility is not a simple matter. CPP has failed to provide any credible evidence that doing so is in the best interests of Iowa City electric customers. We don't know what we are buying, what we will need to build, what will it cost to buy and operate, and who's going to be in charge.

These fundamental questions need to be answered before we have any idea whether this is a worthwhile endeavor. Until they are answered, it is premature and unwise to authorize the City Council to establish a municipal utility. A "no" vote on Nov. 8 is the prudent course of action for Iowa City voters to take.

John L. Solow is an associate professor of economics at The University of Iowa and a member of the Coalition to Preserve Safe and Reliable Energy.

The article comes from the Iowa City Press-Citizen.

Economics from an Austrian Point of View

A recently released white paper summarizes the view of the Austrian School of economic theory. I must admit that I never knew about this area, but reading the summary (only 4 pages long) gives a good idea their theory. It is often credited with predicting the downfall of the Soviet Union and has inspired many free-market capitalists and entrepreneurs.

Delphi and GM: To Buy or Not to Buy?

Many of you are aware of the recent news about Delphi filing Chapter 11 bankruptcy. A friend of mine who works for Delphi assures me that this is one of the better things that could have happened for the company. He says that the bankruptcy will allow them to renegotiate their union contracts, renegotiate their sales contracts, especially with GM, and remove the enormous pension liabilities they had on their accounting books. He suggests picking up shares of Delphi at a bargain 30 to 40 cents a share and esimates a rise of at least $2.00 a share in the next two years.

There is good news for Delphi in that that no longer have the pension liability. Their new CEO, Steve Miller, has a strong history of working with distressed companies like Bethlehem Steel.

According to the Economist, the combined liability of GM and Delphi's pension liabiltiy is about $450 billion. This is insane and might finally be a wakeup call to people who think that their pensions will be around when they retire. Even more reason to take steps to secure alternate means of retirement protection, like investing in an IRA. But this does not seem to be good news for either company.

GM has also announced that they are negotiating hard with the Union of Auto Workers (UAW) to get concessions and cuts in order to just stay afloat. With falling sales, increased raw material costs, and these continuing liabilities, they may not be around much longer. Some say their chance of filing chapter 11 is at least 30% now that Delphi has done the same.

Should you buy the Delphi stock? Or even GM? It is risky. Because of the Chapter 11 filing, the people who hold Delphi's bonds get first dibs on any money produced by the company. The shareholders get whatever is left. Any money/dividends paid out to shareholders will only be made after the debt obligations can be settled. Because a stock's value is based on its perceived future dividends, the stock will probably remain low for quite some time (it has actually been delisted from the NYSE. It now trades on a "stock clearning house," basically for pennies on the dollar). Will Delphi rise again? They make good parts, they have a lot of customers, they also might get paid for what their product is worth, now that they can restructure their contracts. Miller also has a fairly good track record. He's even decided to take a salary of $1 a year. I'll let you be the judge.

Run Schools Like a Business

The CEO of Central Educational Center in Georgia writes a commentary about ways to change the public school system to reflect and utilize successful business practices. He cites Jim Collins' book Good to Great as a model for school superindendents and principals to follow. He also mentions supporting teachers more and allowing them to be more independent in the classroom.

At Cashtalk, we value education, particularly when it comes to financial and business-minded topics. We also believe that there is a lot to be learned from the "real" world, like business. Through education, you empower yourself to control your destiny. Without teachers and a system that supports them, this becomes more difficult. Consider the ideas by Russ Moore and get involved in improving your local schools.

Rising Inflation and Some Suggestions on How to Deal With It

According to the Washington Post, consumer prices have risen faster in September than they have in the last 25 years (1.2% in one month). Obviously if you've been around in the United States, you can guess that Hurricane Katrina cuased most of this increase becuase of the effects from rising fuel costs (12% last month). This in turn has an effect on the price of goods that are transported across the U.S., like food.

Inflation is a reality that most people are aware is inescapable. What I ask myself is, "is there a way to avoid it or protect my money from it?" Inflation destroys cash. Or more accurately, it destroys your purchasing power. The longer you hold money with inflation as a consideration, the less that money can buy.

So how can I protect myself from inflation? Well, first you could look at investing. Normally, when you invest in stocks, bonds, mutal funds, etc. they generally have a higher return than what the inflationary rate is. There are even inflation-linked indexes that gaurantee a higher rate of return than the inflation rate. What these options boil down to is this: if you own something tangible with a commonly perceived value, you can beat inflation.

If you have ideas on how to beat inflation, please post them in the comments section.

Municipal this, Municipal that...

(Sigh) Okay. I just came across this article at Wired.com written by Jennifer Granick, a Stanford University Law School Professor. She is an advocate for municipally funded Wi-Fi access, or as she puts it, "free wireless internet access." She equates this service with public toilets, drinking fountains and park benches. She also states that the only major argument against this is its potential for abuse (i.e. people downloading illegal material, hacking, etc.).

I would like to propose that an even greater argument strikes through the heart of her primary assumption that we are entitled to free Wi-Fi: "nothing in life is free." I find it preposterous that she believes Wi-Fi could be deemed a "need" that our city council members or mayor should have an obligation to provide to their constituents for "free."

Let's take a macroeconomical perspective for a moment and look at a hypothetical procedure for setting up this "free" service. First, the city would need to purchase the infrastructure from the current providers or another wholesaler (roughly in hundreds of millions of dollars). Then they would have to install that infrastructure (wireless servers with enough power to broadcast over the air) and maintain it (a line item in the city budget). I don't know about your own experience, but at my company, our servers occasionally crash and maintenance is constantly being done on them. Finally the true cost to you. Perhaps a few cents added to the city sales tax, or maybe a few dollars onto the property tax, or maybe just an overt "Wi-Fi" tax on your next tax return. Any way you slice it, you're going to pay. And what I find even more outrageous is that not everybody has Wi-Fi; I sure don't and I don't want to pay for someone else to have it.

This isn't a need. It's a want and a frivolous one at that. In the cities considering these proposals, you already have service providers, sometimes more than one (which is a good thing if you believe in competitive capitalism). In Iowa City, you can go to a local coffee shop or Panera Bread Company. They provide the service for free because they know it will lure customers who will in turn buy products to help subsidize that "free" service. This, in my opinion is the route to go. If there is a demand, a private company will provide. Obviously in Ms. Granick's hometown, there is a demand because there are two companies offering the service that the city wants to grab.

Sure, some municipal power companies charge less than the going rate, some municipal telephone companies have great service, but people are always paying for it in the end and why take a gamble? These companies don't necessarily innovate and bring out new products (Plus, water, power, sewage, garbage disposal and the such are needs of a city). The private sector is usually the driving force behind innovation. All those revenues and profits they're making is the motivating factor to better their products, make them cheaper, and expand their service. When was the last time a municipal utility came out with a revolutionary breakthrough in the way they do business?

Ms. Granick looks to the government to solve her problems and make her life better. I look to myself and those with a track record for success.

Baseline Budgeting: A Contemporary Illustration

Have you ever heard of basline budgeting? The majority of programs funded by the federal government use this principle to determine how much their budgets will be in subsequent years.
Because of the recent hurricanes in the southern United States, President Bush has asked Congress to "slash spending," in order to provide monetary relief without raising taxes. I applaud President Bush for not forcing me or a business to pay extra for this burden. Critics of the president say that the programs he is cutting are necessary and that any cuts will cause mass riots, millions to go hungry and countless others to be homeless. While I'm not sure about those claims, if we look at the details of these "cuts" we will find that they really aren't spending cuts at all. They are, in fact, a decrease in the amount of the budget increase.

Citizens Against Government Waste (CAGW) is a non-profit group that monitors the budget Congress submits and the President signs every year. They point out wasteful spending and unnecessary programs that our representatives sometimes sneak into the budget. They also point out ways to cut spending and thus have the Federal Government be less a burden to the common citizen.

CAGW points out that Baseline Budgeting is a way for Congress to increase spending when they really claim to be decreasing it. How does it work? Let's say that a specific department, let's say, the Agriculture Department's foodstamps program is expected to grow $100 million next year. In fact, we project that its need will grow $100 million every year. But this year we only increase its budget by $30 million. The headlines will exclaim that we just cut $70 million out of the Ag. Dept. budget! The example in the link says its like expecting to gain 100 pounds, only gaining 75 and then claiming to have lost 25 pounds! Absurd!

Well, the foodstamps program is in fact a nice target for the Congress to do such a cut. Last year, $2.1 billion went unclaimed and unused. Why? This article claims that it is because of lack of knowledge or language difficulties. My guess is that the budget has continually increased irregardless of the number of people that actually need or use this subsidy. This practice should stop!

So how should Congress go about finding the proposed $62 billion in aid without raising taxes? House Majority Leader Tom Delay (R -TX), after increasing the budget deficit up to over $400 billion with the proposed aid, said he would be willing to accept suggestions on locations to cut. The Cato Institute, a free-market think-tank, has offered these suggestions. While these are legitimate cuts, even decreasing the total amount of Baseline Budgeting increases would be sure to find the $62 billion.

A worthy (and wise) goal of any individual, business or organization is to have a balanced budget. What you spend should only equal what you take in. I myself have a balanced budget and it is treating me well. It is also responsible. Is it possible to balance the Federal Budget without raising taxes? Yes. Another paper, dated 1995 has seven suggestions on finding ways to keep the government in line and prevent such frivolous spending and irresponsibility. It is as relevant today as it was then.

Next time you hear about spending cuts and the horrors that might befall us all if they are allowed, remember baseline budgeting and look into the issue some more to be sure that the Congress or other special interest groups aren't pulling the wool over our eyes.

Retailing Uneasy About the Near Future

An article in the Economist points out a worldwide trend of consumer confidence dropping. In Germany consumer confidence has dropped for its third straight month. In America, confidence is down in October almost 15%. Retailers are worried about this trend, especially as the Christmas spending orgy, er, "buying season" nears.

The thing I find most useful in the article is that from the perspective of the consumer the growing retail establishment and their catering to the specific tastes of the consumer (mostly because the market is growing more competitive) is a real boon for consumer advocacy. The article talks about Target comissioning their own fashion designers and other stores around the world are looking at local fashion providers instead of Chinese imports, because they are more timely and in tune with finicky "consumer trends." Wal-mart is looking into carrying organic foods to compete with some specialty chains. Wal-mart is also exploring the idea of having consumers send their digital photos to them over the internet, to be produced and picked up within the hour at their local store. Brilliant!

Each of these efforts will most likely decrease the overall costs of these traditional "specialty" goods and bring their prices down to earth. And with lower prices comes greater economic value for our hard-earned dollars.