You should need a license to take out a mortgage

In The Atlantic, Moisés Naím points to a recent study that poses three simple questions on personal finance:

1. Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After five years, how much do you think you would have in the account if you left the money to grow? A) more than $102; B) exactly $102; C) less than $102; D) do not know; refuse to answer.

2. Imagine that the interest rate on your savings account is 1 percent per year and inflation is 2 percent per year. After one year, would you be able to buy A) more than, B) exactly the same as, or C) less than today with the money in this account?; D) do not know; refuse to answer.

3. Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.” A) true; B) false; C) do not know; refuse to answer. [The Atlantic]

These questions were asked to people around the world, and the correct answers are A, C, and B. Did you get them all right? If you did — congratulations, you understand the basics of how interest ratesinflation, and portfolio diversification work. Most people surveyed around the world didn’t.

In Russia, 96 percent of those surveyed failed to answer the three questions correctly. In the U.S., 70 percent failed. The highest performing countries were Germany where 47 percent failed and Switzerland, where 50 percent did. But this isn’t rocket science. The questions reflected basic financial concepts that are essential for saving for the future, using credit cards, taking on a student loan, purchasing a home, investing, and building up a pension.

Worse than this, Americans also showed overconfidence in their abilities. Asked to rank their financial knowledge on a scale of 1 (very low) to 7 (very high), 70 percent of Americans surveyed ranked themselves at level 4 or higher. Yet only 30 percent answered the questions correctly.

These surveys provide some pretty scary food for thought, because uninformed, overconfident people are more prone to make bad decisions that endanger their own financial health and the wider economy. As this paper from the World Bank shows, individuals who are financially literate have better financial situations.

Read More At TheWeek.com

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Bread & Circuses & Antiprosperity

If I was a mathematical economist — and I have very, very good reason not to be — I would try to create a formal model for what I call antiprosperity.

What is antiprosperity? It is a strange effect. I hypothesise thus: as nations (and to a lesser extent, people) become more prosperous, they tend toward greater fragility. In other words, fat times create weakness. This is not a universal law, because there are some exceptions. It is more of a tendency. The children of the strong, the hard-working or the wealthy often grow up lazy and stupid and conceited. People who keep winning don’t learn about their weaknesses, and without being aware of their weaknesses their weaknesses can fester and develop into glaring cracks.

An example of antiprosperity is the global system of derivatives. By creating a system of side bets, market participants could “hedge” against any undesired eventualities (for example, shopping chains dependent upon high consumer turnout could create an option on weather — if the weather was poor, and thus their sales were down, the option would payoff, mitigating their losses). By 2008, over $1 quadrillion of derivatives had been created to hedge against inflation, rate spikes, weather, price changes, defaults on debt, climate change, and almost anything imaginable. The problem was that if a counter-party with a large amount of derivatives on their balance sheet fails, then those “assets” become worthless. Any liabilities go unpaid, and so other companies who have agreed to contracts with the bust counter-party may themselves become illiquid due to their losses with the bust counter-party. This can quickly cascade into systemic meltdown. So, to recap, a system designed to “stabilise” global markets — and, let us not forget, was once prophesied as the end to systemic risk — ends up destroying them through unprecedented systemic risk..

I am still trying to understand what causes this mechanism. I think human life tends to be characterised by a steady process of building and breaking. As we learn skills we face setbacks, and failures, we learn from our mistakes and we fix our weaknesses. Humans once had no choice but to work for their food.  Taking away this gradual process — say, by creating a system that guarantees a constant and steady stream of food that requires no work to fulfil — creates a weakness, because the skills necessary to fulfil the pre-existing need become rusty. Western civilisation has become so good at feeding itself that it creates huge surpluses of goods and food. People don’t need to learn to feed themselves. Many people — who take the welfare route to “prosperity” (left-wing readers — yes, this includes bankers, defence contractors, and other corporate welfare recipients) — don’t even need to learn to work. They just suck up the handout and go on their merry way.

This tidal wave of prosperity hides a sickness inside, and we are seeing the first symptoms: overflowing bellies. Why learn the skills necessary to survive in the wilderness when it is easier to sit on your ass, stuffing your face with junk food? After, all the global resource infrastructure that pulls oil out of the ground in the middle east, refines it, ships it in oil tankers to America, and creates petrochemical-based fertilisers that are used to grow crops, produce (what can loosely be described as) food and transport that food to the consumer will always exist, won’t it? Readers are advised to know where their next meal is coming from — and their next meal for six months or a year — if the global system of trade were to break down.

To become stronger we must seek volatility, and to some extent, failure. When I was learning to play the guitar, I didn’t get better by playing pieces I could already play. I got better by seeking out failure by trying to play pieces and measures that were too difficult for me. Failure is beneficial and useful, because we can learn from it. Weakness is beneficial and useful, because we can learn from it.

How can governments and businesses learn the lesson of antiprosperity? Well, Steve Jobs seemed to know a thing or two about it. He was famed for his management style, whereby he lashed employed with vicious criticism to keep them on their toes. Failure and weakness built strength.

Governments should learn to keep welfare nets — both corporate and social — to a minimum. While the vulnerable (e.g. children, the aged, and the severely disabled) should under no circumstances be abandoned, welfare should never become a gold-plated ticket for an easy life. Governments should also peel back barriers to entry and overregulation so that the poor and unemployed can easily become self-employed without having to pass futile certifications, and pay thousands of dollars for licensing.

If we humans cannot avoid the excesses of prosperity, nature is a cruel mistress. What is the punishment for gluttonous obesity? It can become difficult or impossible to find a mate, thus making it difficult or impossible to pass our genes onto the next generation. The obese die younger, and thus turn back into dust sooner than their thinner counterparts.

And so too do societies enamoured with bread, circuses and free lunches. Rome was sacked, and its empire crumbled. Ming China collapsed under the weight of its traditionalism and technophobia. We here in the West — fed fat by the free lunch of petrodollar supremacy, the beauty of globalisation, the power and simplicity of a carbon-driven economy, and the largesse of the state — should heed those warnings. It is estimated that 99.9% of all species that have ever existed are now extinct

Chart of the Decade

This chart tells millions of stories. I’m trying to get my head around its implications.

That’s right: since 1984 (surely an appropriate year) while the elderly have grown their wealth in nominal terms, the young are much worse off both in inflation-adjusted terms, as well as nominal terms (pretty hard to believe given that the money supply has expanded eightfold in the intervening years). So why are the elderly doing over fifty times better than the young when they were only doing ten times better before?

Are young people a stupefied generation coddled by parents and government, addicted to welfare, junk food, drugs and reality TV?

To some extent, but are they any less fiscally and morally responsible than the marijuana-smoking, free-love-embracing, national-debt-accruing baby boom generation? That’s a matter of opinion, but my answer is probably not. Baby boomers hate Ron Paul, while the under-35s seem to love him.

Is it due to government policies that favour the elderly and screw the young?

America is suffering from excessive consumer debt:

Net worth is calculated by subtracting debt from assets. The biggest debt for most people is a mortgage. So having more mortgage debt or less mortgage debt tends to be a pretty good determinant of net worth. (And no — unlike in the United Kingdom and Australia which have a severe problem with housing affordability — housing in the USA is still cheap today priced in wages)

The elderly have very often already paid off their mortgages — no doubt helped by the 1980s and 1990s where both stock prices and house prices grew rapidly. And why did rise so rapidly?

Some say that it came on the back of excessive expansion of the money supply beyond the economy’s productive capacity. But that doesn’t seem quite true:

The money supply grew in tandem with industrial production. This was no bubble, but organic growth (albeit as I have shown before on the back of cheap Chinese goods and cheap Arab energy).

My hypothesis is that the present situation is a product of government expansion.

Here’s government expenditure as a proportion of GDP:

Government spending in democracies very often tends to constitute a transfer of wealth from non-voters to voters (as well as groups that can’t afford lobbyists to groups that can afford lobbyists — perhaps that is one reason why corporate profits are soaring while youth unemployment remains elevated, and why Wall Street banks get bailed out, but delinquent small businesses do not).

Here’s the voter turnout by age in the 2004-2008 Presidential elections:

Older people vote in droves. Politicians want their votes and therefore promise them more free stuff — medicare, medicaid, services — and they vote for whoever offers them the most.

The biggest issue though, is this:

Keynesians may say that this reflects a government’s failure to create jobs for young people. They claim that the problem is that there is not enough money circulating in the economy, and that government can “raise demand” by pumping out more cash. But there is plenty of money in the economy; so much money that Apple have built up a $90 billion cash pile. So much that China has built up a $3 trillion cash pile. So much that banks are holding $1.6 trillion in excess reserves below fractional lending requirements.

More likely is the reality that overregulation and barriers to entry are preventing the unemployed from picking up the slack in the jobs market. As John Stossel reveals in a recent documentary film,  in New York City it costs $1 million to get a licence to drive a taxi. Anyone who wishes to operate a food cart, or run a lemonade stand has to traverse reams of bureaucracy, acquire health and safety certificates, and often pay huge fees  to receive the “necessary” accreditation. While some barriers to entry are necessary (e.g. in medicine), in other fields it is just an unnecessary restraint on useful economic activity. In many American cities it is now illegal even to feed the homeless without government certification and approval. Citizens who defy these regulations face fines, arrest, and even imprisonment.

In a recent article, the Economist noted:

Two forces make American laws too complex. One is hubris. Many lawmakers seem to believe that they can lay down rules to govern every eventuality. Examples range from the merely annoying (eg, a proposed code for nurseries in Colorado that specifies how many crayons each box must contain) to the delusional (eg, the conceit of Dodd-Frank that you can anticipate and ban every nasty trick financiers will dream up in the future). Far from preventing abuses, complexity creates loopholes that the shrewd can abuse with impunity.

The other force that makes American laws complex is lobbying. The government’s drive to micromanage so many activities creates a huge incentive for interest groups to push for special favours. When a bill is hundreds of pages long, it is not hard for congressmen to slip in clauses that benefit their chums and campaign donors. The health-care bill included tons of favours for the pushy. Congress’s last, failed attempt to regulate greenhouse gases was even worse.

Complexity costs money. Sarbanes-Oxley, a law aimed at preventing Enron-style frauds, has made it so difficult to list shares on an American stockmarket that firms increasingly look elsewhere or stay private. America’s share of initial public offerings fell from 67% in 2002 (when Sarbox passed) to 16% last year, despite some benign tweaks to the law. A study for the Small Business Administration, a government body, found that regulations in general add $10,585 in costs per employee. It’s a wonder the jobless rate isn’t even higher than it is.

The truth may be that the inability of the unemployed to become self-employed is the force that is squeezing the jobless most. Certainly, job migration overseas has changed America, but why should it mean continued elevated unemployment? There is enough money to keep the economy flowing so long as there are opportunities for people to make themselves useful in a way that pays. With the crushing burden of overregulation and the problem of barriers to entry, these opportunities are often restricted to large corporations.

These issues of youth unemployment and growing inequality between the generations are critically important. Unemployed and poor swathes of youth have a habit of creating volatility in response to restricted economic opportunity.

Gibson Guitars: A Great American Company

Is over-regulation killing American industry? From NPR:

In the hottest part of an August Tennessee day last Thursday, Gibson Guitar CEO Henry Juszkiewicz stood out in the full sun for 30 minutes and vented to the press about the events of the day before.

“We had a raid,” he said, “with federal marshals that were armed, that came in, evacuated our factory, shut down production, sent our employees home and confiscated wood.”

The raids at two Nashville facilities and one in Memphis recalled a similar raid in Nashville in November 2009, when agents seized a shipment of ebony from Madagascar. They were enforcing the Lacey Act, a century-old endangered species law that was amended in 2008 to include plants as well as animals. But Juszkiewicz says the government won’t tell him exactly how — or if — his company has violated that law.

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