Thursday, October 30, 2014

Will the Fed's Fear of Deflation Lead to Rampant Inflation?

The financial pages these days it is easy to see that deflation is the major worry among the world's central bankers including the U.S. Federal Reserve.  The word "deflation" also turns up in articles and interviews with financial advisers.  The price of gold is down and few financial advisers are providing advice or strategies for dealing with inflation.

While there is no question that much of the world economy, including to some extent the U.S. economy and to a much greater extent the European economies, is suffering to some degree from deflation, there is an inflation time bomb lurking just over the horizon.

While I generally don't pay much attention to the doom and gloom concerns of Glenn Beck, I did find myself in full agreement with him this past Tuesday when, on the Sean Hannity show he made reference to the trillions of dollars worth of reserves the U.S. Federal Reserve and other Central Banks have been pumping into the world's banking system since the start of today's ongoing recession.

These trillions of dollars of reserves are new money created by central banks out of thin air and deposited into the world's banks.  While digitally created deposits, this money is basically no different than the massive amounts of paper money printed by the post World War I government in Germany.  The excessive printing of money by the German government resulted in  hyperinflation which led to the rise of Hitler and his Nazi party.

One other difference between the digital funds the world's central banks have deposited into banks and the paper money printed by the post World War I German Weimar Republic is that the digital funds are not circulating but are sitting on bank balance sheets as excess reserves.  So far banks have been hanging on to these funds and not loaning them out due to fear of another financial crises in which they might need these excess reserves to remain solvent.

While central banks intent at the start of the 2007-08 financial crisis was to shore up bank reserves with the injections, subsequent central bank efforts have been an attempt to increase the amount of money in circulation by providing banks with more money to lend.  However, banks have continued to remain cautious and have kept most of this new money as reserves.

The ongoing recession that has resulted from the financial crisis at the start of President Obama's term has been due to people being a fearful as the banks about a future crisis.  Just as the banks have kept the injected funds in reserve, people have been cautious about spending and have used much of their money to pay down debt and build up savings.  This has slowed the circulation of money which has led to fewer sales of goods and services.  This slow down in economic activity has led to layoffs and a reluctance to expand and hire more workers by employers.

This slowdown in the rate of spending by consumers has led to deflation which has prolonged the 2007-08 recession. Deflation is basically a reduction in the amount of money in the economy due to people hanging on to it rather than spending it.  They standard Keynesian policy response is to try to ignite some  inflation (the opposite of deflation).

According to a report on CNBC at the start of the financial crisis, the total amount of new money the world's central banks injected into banks as reserves exceeded the total amount of money in circulation in the world economy at that time.  Since then more money has been created and injected into bank reserves.

What central banks have been trying to do is get banks to move some of this money into the economies of their nations by loaning it out.  This injection of new money into circulation would result in some inflation which would off set or cancel out the deflation and get the world's economy moving and growing again.

However, the real problem is lack of confidence by consumers and business in the Obama Administration's tax and regulatory policies and fear that these will lead to another economic downturn.  In such a climate most people are being cautious and accumulating cash by cutting spending.

Creating money and putting it into the economy via the banking system is a traditional monetary tool for stimulating an ailing economy.  Central banks can also do the reverse and pull reserves out of the banking system which results in banks having less money to loan which forces economic growth to slow when the central bankers feel inflation is accelerating at to rapid a pace.  However, using monetary policy to stimulate or slow down an economy is not an exact science and considerable economic damage is frequently the result of these efforts.

The problem today is that if peoples confidence returns and banks respond by increasing lending there is the possibility that we will go from today's current deflation to rapidly increasing inflation.  If central banks stay focused on deflation and hesitate to act quickly, rampant inflation could result.  On the other hand, if central banks hit the monetary breaks too soon and too hard, the economy could fall back into a recession. 










Thursday, October 23, 2014

Political Risk that Threatens Retirees Social Security

It is campaign season and the airways are full of political commercials.  Fortunately for the politicians truth-in-advertising laws do not apply to campaign ads.  If political ad were held to the same standard as commercial ads, they would be scarce on television.

A recent television spot by the Democratic Congressional Campaign Committee supporting Arizona Congressman Ron Barber in his campaign against challenger Martha McSally is not only guilty of the typical distortion of an opponent but goes a step further by implying that Social Security is a retirement savings program.

In the ad a middle aged woman accuses McSally of trying to destroy Social Security by privatizing it.

In addition to taking a response by McSally to a reporter's question out of context, it goes on to say:

We worked hard. Played by the rules.  But then you have Martha McSally who wanted to risk ALL THE SAVINGS [emphasis mine] we earned over a lifetime.

Ad's Wording is Deceptive

This wording is very deceptive but it is also a deception that Social Security's supporters have been promoting to the American public since the Social Security legislation was passed in 1935.  While its supporters have always talked in public about Social Security as if it was a pension type retirement plan, the reality is that it has always been nothing more than a just another income transfer program. 

The lady in the Democratic Congressional Campaign Committee uses the words risk all the savings which implies that the Social Security taxes paid by workers and their employers are a form of retirement savings.  However, Social Security  payments to retirees are not like payments from a pension fund or a 401(k) or other type of retirement savings accounts. 

First, those who pay into and eventually  qualify to receive Social Security payments when they retire have no legally protected contractual right to Social Security benefits.  This is in contrast to the other sources of retirement income listed above in which participants have a contractual or ownership right to income from these plans.

In two separate cases (Helvering vs Davis in 1937 and Flemming vs Nesor in 1960) the U.S. Supreme Court  ruled in the first case that Social Security is NOT a retirement savings or pension plan but, instead, a simple welfare plan where one group (workers and their employers) are taxed to raise funds to give to another group (retired workers).  In the second case it ruled that people who pay Social Security taxes have no contractual right to the money taken from them by the tax or to any income generated by that money.

Secondly, the reference to savings in the campaign ad is deceptive since the money taken from workers' paychecks by the Social Security tax is not put into an account for each worker.  There are no savings to lose for the simple reason that the money taken from current workers and their employers is immediately transferred as payments to current retirees. 

When a worker retires, the Social Security payments that person receives comes from taxes on those still working and NOT from funds collected and stored in an account during that worker's working years.


Social Security Law Can be Repealed by a Simple Vote of Congress
 
Social Security is a law like any other law and, as such, can be changed or repealed by a simple majority vote by Congress.  Further, since the Social Security program, like any other program that requires the spending of money, relies on Congress to authorize funds for it to spend, payments can be stopped without actually repealing the law. 

A simple majority in the House of Representatives  voting NOT to approve it funding would halt Social Security payments to retirees for that year - however, existing workers would still have the Social Security tax deducted from their paychecks every payday.

What keeps Social Security from being repealed or not funded is the fact that millions of retirees depend upon Social Security for much of their retirement income.  Not only do these retirees vote but their voting age children and grandchildren also vote and these younger voters don't want to see their retired parents and grandparents thrown out into the streets.

Demographic Change Could Result in Repeal of Social Security

However, as I described in my article Social Security's Achilles Heel, I point out that the introduction of IRA and 401(k) accounts in the latter part of the 20th Century has made many retirees less dependent upon Social Security for retirement income. 

While these retirees probably won't advocate ending Social Security many of them won't be motivated to actively oppose repeal.  Meanwhile many younger workers who are struggling financially and want relief from Social Security taxes and whose parents or grandparents are not financially dependent upon Social Security will actively support repeal. 

Politicians, like other people, want to keep their jobs and, once a majority of voters want to have Social Security repealed, politicians will change their stand and vote to repeal.  This is the political risk that Social Security faces and this risk may come to the forefront sooner rather than later.



Thursday, October 16, 2014

A Japanese Company Limits Outbreak of Ebola Among Workers on its Liberian Rubber Farm

The lead editorial on today's Wall Street Journal's editorial page titled The Ebola Twilight of Public Institutions is a scathing critique of modern big government.

The focus of the editorial and a related piece by Daniel Henninger (A Year of Living on the Brink) on a nearby page was the failure of modern big government to live up to its basic responsibility to protect its citizens. The thrust of both articles was that big government has become more focused on expanding and promoting itself than on its citizens. 

The mishandling of the growing Ebola epidemic by both the U.S. Centers for Disease Control (CDC) and the UN's World Health Organization (WHO) were cited as specific current examples of this failure of big gvernment.


Start of the Ebola Epidemic  


In December 2013 cases of people infected with the Ebola virus began occurring in the West African nation of Guinea.  The disease soon spread neighboring Liberia and Sierra Leone and soon reached epidemic proportions in Liberia.

As early as March 2014 both the United Nations' World Health Organization (WHO) and the U.S. Centers for Disease Control (CDC) were reporting about 9,000 cases of the disease in Africa, especially Liberia.

One Large Company Takes Action to Protect its Workers
 
While WHO and the CDC began issuing reassuring press releases, one private company, Firestone Liberia, had a worker on its large rubber farm come down with the disease in March of 2014.

The company, which is owned by Japan's Bridgestone Group, immediately sprung into action to both contain the outbreak in its area as well as treat those with the disease, most of whom were current or retired employees and their families.  

When the first Ebola victim appeared at the company's clinic the management team on site sprang into action.  Turning to their computers they quickly learned all they could about Ebola from Internet searches.  

Two shipping containers were converted to isolation centers for victims.  Teachers at the company's school visited student's homes to educate families on how to protect themselves from the disease as well as how to detect it and seek treatment immediately.   Janitors were trained on how to bury victims of the disease while company surveyors mapped the locations of outbreaks which enabled managers to isolate and halt the spread of the disease.

The rubber farm owned by Firestone Liberia covers some 185 square miles of land.  It employs 8,500 Liberian workers.  In addition to the workers the area also contains their families who comprise an additional 71,500 people.  These plus some others not associated with the company comprise a large population scattered over a sizable area. 

To date 71 people in this community have contracted the disease, a small number compared to the number of victims in neighboring areas where the disease is running unchecked.  More encouraging is the fact that as of last month there have been no new cases of the disease in the Firestone community.

Following the success of its subsidiary in combating the disease, the Bridgestone Group itself recently announced the donation of one million dollars to help fight the spread of the disease in West Africa.

The actions by Bridgstone and its employees shows that the private sector is better at handling problems like Ebola than are sprawling government bureaucracies.

Thursday, October 09, 2014

Christopher Columbus - Portrait of a 16th Century Entreprenur



Today, October 9th is celebrated as Leif Erikson Day in the United States.  


Leif Erikson was the Viking sailor who founded what is believed to be the first European settlement in the New World.  The colony, known as Vineland because of the abundance of wild grapevines, was located in what is now L'Anse-aux-Meadows in the Canadian province of Newfoundland.

However, it is not Leif Erikson but the later Italian explorer, Christopher Columbus, who has been honored with a nearby holiday that falls near the Leif Erikson holiday each year on the second Monday in October, that
is today's focus. 


While both men are remembered as great explorers and discoverers they were really a couple of ambitious fellows trying to make a living and get ahead financially. This is especially true of Christopher Columbus who, if he were alive today, would be considered an entrepreneur in the new tech economy.

Experience and Research Combine into a Plan to Find a New Route to Asia

Contrary to myth, Columbus did not set out to prove the world was round. Like most educated people, Columbus was familiar with the writings of both the ancient Greek mathematician Eratosthines of Cyrene (276 BC to 195 BC) and the Egyptian mathematician and writer Claudius Ptolemy (90 AD to 168 AD) both of whom not only produced mathematical proof that the world was round but also came up with estimates of the earth's circumference that were relatively close to its actual circumference. Ptolemy also produced a map of the world showing Europe and Asia and the Atlantic ocean in between.

Columbus also believed that one could reach Asia by sailing west across the Atlantic. This was also accepted as possible by most educated people at the time. There two practical objections to sailing west to Asia. First, the distance between the two continents was not known which opened the possibility that a ship could run out of food and water before reaching land. Second, navigation and map tools were still quite primitive which meant that, once out of sight of land, it became very difficult to determine one's location which could result in aimless sailing until running out of supplies.

Christopher Columbus had gone to sea as a teenager and, as an adult was an experienced sailor and navigator. He had experience sailing in both the Mediterranean and Atlantic. In the Atlantic he had sailed on voyages south along the African coast, west to the Azores and Canary Islands and north as far as England and possibly Ireland and Iceland. 

Columbus Had Extensive Network of Contacts and Connections

Like many of today's entrepreneurs Christopher Columbus  appears to have had good networking skills.  He used his networking skills to gather information and knowledge from the numerous sailors he encountered in his travels.  His network also came to include scholars, businessmen and those with political connections.  This gave him access not only to people in power but also libraries and archives where he increased his knowledge of geography, cartography and navigation.

His marriage in 1478 or 1479 to Felipa Perestello e Moniz (or Felipa Moniz Perstello) the daughter of a somewhat impoverished but respected Portuguese noble who had been appointed governor of the Maderias Islands by Prince Henry the Navigator not only gave him access to people with access to the royal court of Portugal and later Spain but, according to some historians, to Bartolomeo Perestrello's personal archive of charts and other materials relating to sailing and navigation.

Enterprise of the Indies - Columbus' Business Plan

Sometime after his marriage, Columbus began formulating a plan, which came to be known as Enterprise of the Indies. 

In this plan Columbus described how he planned to sail west to Asia along with evidence showing how this could be accomplished. He also provided details and the costs of what would be needed for the venture as well as detailed estimates of the profits to be made from the venture. Finally, the plan included what he personally expected from the venture. 

In addition to one-tenth of revenue to be earned from the sale of products shipped from Asia to Spain via the new trade route, he also demanded that he be given the rank of Admiral of the Ocean, as well as Viceroy and Governor of the Indies. These titles and revenues were to be ongoing and passed on to his descendants.

The Enterprise of the Indies was a business plan designed to get investors to invest in his venture. Columbus traveled around Europe, especially Portugal and Spain, meeting not only with monarchs but others who whose support could influence a monarch to provide other political and financial backing needed to launch the enterprise.

Christopher Columbus Raises Funds and Other Backing Needed for the Voyage
 
In the end it was Luis de Santangel, royal treasurer to King Ferdinand ("Spain" at that time was the Kingdom of Castile which was ruled by Queen Isabella and the Kingdom of Aragon ruled by King Ferdinand, these two kingdoms were later united into one along with other areas to make modern Spain but this was not in the lifetime of Ferdinand and Isabella) and a member of a banking family, who got the two monarchs to put aside the objections of their other advisers and reconsider the plan by Columbus. De Santangel argued that the potential return on the investment was so much greater than the initial investment that it was worth the risk.


Part of the contribution by the two monarchs was their requiring that certain people in the sea port city of Palos provide Columbus with two ships as well as join Columbus in his voyage. 

Whether this order applied directly to Martin Alonso Pinzon and his family or to others in the town as well is unclear. In addition to being experienced seafarers and ship builders the family was well known and wealthy. Martin or the family not only provided the ships but Martin also contributed a half a million maravedis toward the cost of the first voyage of Columbus. This was half the amount Ferdinand and Isabella contributed and came to one-eighth of the total cost of the voyage.

Martin Pinzon and His Contribution
 
Martin and his two brothers, Francisco and Vincent Yanez, sailed with Columbus on the first voyage. Martin commanded the Pinta with Francisco as master and the youngest brother, Vincent, commanding the Nina. Martin, as one of the leading members of the area was instrumental in recruiting skilled local sailors for the voyage.

While they started out as close partners, Columbus and Martin Pinzon became bitter rivals following their arrival in the New Wold and their return to Spain. 

Finally, in addition to the financing by the monarchs and Pinzons, Columbus is also supposed to have contributed personal funds to the voyage. A syndicate consisting of the Seville branches of seven Genovese banks also made a sizable contribution to the cost of the first voyage. 

The contribution by the monarchs, Columbus and Martin Pinzon were obviously equity investments in the project. 

As to the Genovese banks it is unclear as to whether their contribution was in the form of loans or equity investments on behalf of their owners or clients.

Gains and Losses by Columbus

While Christopher Columbus was smart and successful in his endeavor to find a new route to Asia, he wasn't without his faults.  

In researching his life one finds more than a trace of greed and egotism.  The profits, rewards and titles he requested were not only excessive but also unrealistic.  

Seeking a ten percent return on an investment is reasonable.  But demanding ten percent of all revenues from trade on the route he proposed to find was excessive especially since he was demanding this for himself and his heirs in perpetuity.  

The royal titles and positions he demanded for himself and heirs in perpetuity were also unrealistic.

These demands kept the King of Portugal from backing him and initially kept the Spanish monarchs from backing him.  It was only the financial acumen of Luis de Santangel, Treasurer to King Ferdinand, that saved Columbus after being first turned down by Ferdinand and Isabella. 

Despite his brilliance in devising and carrying out his plan, Columbus was naive to believe that the monarchs would actually live up to their part of the bargain they agreed to.  Just as ambitious politicians today don't hesitate dump supporters and reverse positions when it becomes inconvenient so too were monarchs of old.  

Finally, these faults hurt and distracted Columbus in the long run.  While he made three more voyages to the New World he was also forced to spend time and energy in legal battles and in other disputes. 

Like other successful entrepreneurs, Columbus was a good promoter and this served to help sell his plan and get backing for his successful first voyage.  Later activities in this area probably helped to spread his fame and keep his name and success alive in the ages since.

However, his preoccupation with proving that he had reached Asia and with fighting his critics helped to blind him to the fact he had discovered a new and previously unknown land.  
Others soon figured out that the route Columbus discovered led to a new land and not Asia. One who figured this out and publicized it was a Columbus contemporary, Amerigo Vespucci (who at the time of the first voyage of Columbus was manager of one of the banks that were involved in the financing of that first voyage).  

As a result of of his published accounts of the fact the lands Columbus were a previously unknown landmass rather than Asia, a German mapmaker in 1507, one year after the death of Columbus, published a map of the world on which America, the feminine form of Vespucci's first name, rather than Columbia, appeared as the name of the new lands. 

 


Friday, October 03, 2014

Expanding Airport Parking Options Without Building new Parking Lots or Parking Garages

One of the major differences between economic decisions in a free market and decisions by government bureaucrats in a socialist economic system is that anyone in a free market has freedom to see a perceived need and try to satisfy it while bureaucrats tend to be limited not only to their area of expertise but also limit themselves to the constraints of the status quo.

I saw an example of this on a recent trip which took me across the nation by air.

Once airborne, airplanes are a fast way to travel over a long distance.  However, getting to the airport can be both time consuming and stressful.  This is especially true when one lives in a small city, like Tucson where I live, and decides to take advantage of more choice and often lower fares offered by a major airport in a nearby large city like Phoenix.

While there are often van and bus lines offering reasonably priced service to nearby large airports, there is still the problem of scheduling and parking.  For early morning flights there is the added problem of first, the service not offering service early enough to make the connection and, second, even if they do offer early service this usually requires getting up at one or two in the morning in order to catch a shuttle in time to make your flight.

Driving to the airport is an option but here one has to contend with the congestion that surrounds large airports as well as having to leave your car in some expensive and often distant lot with little security.

A few years ago I discovered some motels near Phoenix Sky Harbor Airport offering free parking to those who spent the night before the flight at their hotel.  This enabled my family and me to drive to Phoenix the night before, get up at a reasonable hour for the flight and take the motel's free shuttle directly to the terminal while leaving our car behind in their lot.

For my wife's and my recent trip only a couple of motels offered this service and the parking was limited to one week while we were going to be gone for three weeks.  With a 7 a.m. flight there was no question of whether or not my wife and I would spend the night before the flight in a motel.  The only question was how to handle the logistics of finding a place to stay, finding convenient long term parking and getting to and from the airport with the least amount of time and stress.

In searching the web for the simplest way to juggle hotel, car, parking and getting to and from the airport to the car with all our luggage I came across an outfit called Global Airport Parking.

Not only did this service provide the simple parking and travel solution I was looking for, I was also intrigued by their business model.

Their website states that they are a national company offering parking services located near both airports and cruise ship ports in cities around the U.S.  However, they appear to be basically a virtual company that doesn't own or lease any of the parking real-estate that they rent out to customers.

Instead, the company contracts with hotels and motels located near airports and cruise ports to rent the unused parking spaces that these establishments have.  For motels much of their clientele are travelers traveling in their own cars.  Thus, with the exception of some in large cities where real-estate is scarce and expensive, parking is provided at no extra charge along with rooms.

Since, it is not common for these establishments to have every room rented every night they usually have some empty parking spaces most of the time.  Also, some of their business travelers don't come with cars which leaves additional spaces available.

Global Airport Parking is thus able to rent these unused parking spaces to travelers like my wife and I who need a place to park our car while flying off to some other vacation destination.

All the motel has to do is judge how much unused parking space they will have at a given time and make that space available to Global Airport Parking to rent out.  In return the motel gets to share in the revenue paid by people leaving their cars in these otherwise unused spots.

The motel also gains from possible additional customers for their rooms as many with early morning departures and/or late evening arrivals also rent a room at the beginning and/or end of their trip as well as renting the parking space for the duration of their trip.  Further, in addition to the potential for additional room rentals the motel also benefits from more potential customers visiting their site and remembering it for future trips requiring motel accommodations.

Finally, in addition to more parking choices for tourists continuing their trip by air or sea and the opportunity for additional marginal revenue for the motels, society also benefits from the fact that the additional parking space for out of town travelers has been created not by bulldozing more land and building more parking structures but by utilizing the existing, but un-used, parking space in motel parking lots.

Another example of how entrepreneurs create more goods and services while utilizing fewer resources.



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