Wednesday, October 13, 2010
Anytime up until 25 years ago. This is when the town and all of its citizens found out that they wanted more than the American Dream could offer.
The story starts in 1985. A newcomer walks into Bernie’s, the local bar. This pilgrim’s name is Sam.
Sam had just inherited what seemed to be a limitless amount of income from a family trust that had been set up in 1776 by his ancestors.
Sam enjoyed the people and the town. So he stayed. He came to Bernie’s every night and bought drinks for the patrons. He made many friends.
Sam liked the attention he received from this generosity and through the years bought more and more drinks for the house. Eventually it became a ritual for him to pay for everyone’s drinks from 7pm until the bar closed at two in the morning.
He continued to draw more and more from the family trust that was set up to last forever.
By all rights, with prudent management the trust could have lasted forever because it was a vast amount of wealth.
Sam loved the attention. And everyone loved Sam. They voted him the figurehead of the bar. This came with a title. Whenever he entered the bar he was always affectionately hailed as Uncle Sam.
One day, Ms. Bair, the conservator accountant of Sam’s trust, started to become worried. Sam was spending a lot of money. If the spending kept increasing, the principle that was lovingly placed in the trust 200 years ago by his ancestors would start to diminish.
Ms. Bair said that she was proud of Sam for helping his friends but it would be best if he didn’t increase the spending any further. This prudence would insure that the trust could provide income forever.
“Besides”, the accountant added, “if you went broke, it would hurt your friends a lot more than one free drink each evening."
This made sense but it was a worry for Sam. So it became a topic of conversation among his friends at the bar.
One of his friends at the bar was a young man named Klugman.
Everyone loved Klugman, almost as much as Sam. He was handsome and articulate and a wonderful story teller.
Sam would buy the drinks and Klugman would speak of the prosperity that lay in the future.
Klugman was a dreamer. This attribute was perfectly suited for his trade as an economist. His job was to consult with business owners and show why they needed to borrow money to grow bigger.
That’s what economists do.
And for a time, the local businesses did grow bigger and bigger, thanks to Sam and Klugman and the bar.
As Sam spent money at the bar, the patrons spent less buying drinks. In this way everyone had more money to spend on other things, except for Sam of course. But he didn’t care.
This additional money flowed though the local economy. Everyone’s businesses grew. Everyone was happy. Everything was perfect.
But the problem with unrelenting perfection is that it eventually becomes average.
Over time the economy stabilized. Businesses stopped growing at a rapid pace but continued to borrow at the behest of Klugman.
At night in the bar Klugman spun even bigger tales of the prosperity in the future.
Because that’s what economists do.
And being an economist Klugman felt that this slowdown in business was becoming serious. His clients that borrowed money to grow their businesses were having trouble paying their loans. He felt the local economy had to be stimulated back to the growth trend that was established when Sam came to town.
He had a talk with Sam and explained that it was imperative that Sam buy more drinks in the bar. “Maybe you could start buying drinks at six o’clock instead of seven.” Klugman urged. "This would save everyone money that they could spend in the local economy."
Klugman promised that this would only be temporary. Local businesses only needed a temporary jumpstart to begin growing again.
The next day Sam explained Klugman’s theory to Ms. Bair. After she stopped laughing the accountant tried to suggest that buying more drinks for bad businessmen that incurred too much debt didn't seem like a viable solution.
"The businesspeople of this town need to live within their means today and not worry so much about tomorrow." Ms. Bair suggested.
This was the nature of an accountant. Today was more important than tomorrow.
Ms. Bair didn’t want to talk about tomorrow as Klugman worried about nothing else.
Sam needed another opinion.
He went to see his friend Mr. Hoenig who was the town banker. Mr. Hoenig seldom came to the bar and always paid for his own drinks. This made Hoenig the only man in the bar that didn’t take advantage of Sam’s kindness.
Sam posed his concerns to his friend. The banker tried to reply in a way his young guest could understand.
“Every businessperson has a place and a time in the economy” he stated. “Bankers live in the past. We are the caretakers of our town’s savings. This is the excess production that becomes a store of wealth. We use a businessperson’s history to determine if they are a suitable guardian of the town’s stored wealth. So we must always live in the past. I can only guess about the future, the same as you”.
Then he interjected “Accountants view the world through their balance sheet which is nothing more that a snapshot of the present. They are not as interested in tomorrow.”
“And, as you have surmised, our friend Klugman lives on the expectation of income. Economists sell business people risk in the future”
“But who can help me?” asked Sam.
“Well it appears you want a forecast” Mr. Hoenig said, “only Economists and Astrologers will give you a prediction of the future. Although some are better than others, I have found that in the aggregate both are correct about 50% of the time. So one could argue that a coin flip has similar predictive value at much less expense”
“But let me suggest that you talk with my friend Mr. Volcker. You will find him at the park everyday feeding the birds.”
“Can I ask one more question Mr. Hoenig? How come you never allow me to buy you a drink?”
Mr. Hoenig knew the answer would be hard for Sam to understand but he made this attempt:
"Sam, although I am happy to drink with you I cannot accept the cool aid that you and Bernie provide. Each free drink from you would distort my view of the market. If the small window for which I view the future becomes cloudy. Then I am lost. As I have said before, I live in the past."
Mr. Hoenig could see that Sam was even more confused so he made another attempt,
“Sam you are not a businessperson or an investor in this town. You are a disinterested third party in our economy. Very much like a government who’s spending is random. You do not add production or efficiency to the market. Production and efficiency is only added by the competition of the market participants. For an economy to work properly neighbors must be competitors. This is the only way in which scarce resources can be allocated correctly. This is only way that productivity can be created and then captured. And hopefully some of this captured productivity or 'savings' is given to me for safekeeping.”
He still didn't quite understand why Mr. Hoenig would not accept his generosity. But they were friends and that was all that concerned Sam.
The fact of the matter was that Mr. Hoenig was Sam's only true friend.
They said goodbye as Sam made his way to the park. Mr. Volcker was there as he was every day, feeding the birds.
Mr. Volcker, like Sam had just appeared in town one day. Mr. Volcker would never talk about his past or anyone’s past for that matter. He would only speak in riddles about the future.
Some speculated that he was a general who was a hero in battle. Others said he was a rich investor that gave up his wealth to live the simple life. There were other stories even more fabulous and truth be told, all these stories had some basis in fact.
Sam said hello and posed his concern to Mr. Volcker.
Mr. Volcker reiterated what Sam had already learned. Bankers must live in the past, accountants must live in the present and economists attempt to sell the future.
“But” Sam said, “Who is the best person to give me advice on the future”.
“Again, I must agree with Mr. Hoenig” said Mr. Volcker, “There is no one that can give you good advice about the future”.
“But do you know what lies in the future?” ask Sam.
“Of course I do son. But I will not tell you. There are others that could tell you too but they will be mute like me”.
“In the long run, a good businessperson is the only one that can accurately predict the future. And they will never tell you what they know for it would distort their market.”
He continued, “I am much like you, a traveler that came to take respite in this town. But I would like to note that I exist in this economy and you don't. Even though my fortune pales in comparison to yours. The fact is, I have earned it myself therefore it holds much, much more value.”
“If you ask me for advice, my suggestion is that you leave this town. You have no wants or needs that allow you to benefit this town or these people.”
“But how can I leave all of my friends?” cried Sam.
“These people are not your friends” retorted Volcker, “You do not exist to them, other than a free drink. You do not have a business, you do not invest for profit and you do not consume. You are only used by people that are incapable of surviving in the market. Therefore you distort the market. No matter how much wealth you bring to our town it will have no effect in the long run. When you are gone your wealth will be just a memory”
Volcker grew tired of the talk and focused on his wards, the swans.
Sam said goodbye and headed back to Bernie’s
Klugman was already at the bar holding court. Slapping backs and spinning tales.
Sam explained to his friend about his day and expressed his worry.
“Well Sam, I know that life is not worth living without friends. And we are your friends. And I also know that life involves risk. Speaking of which why is your capital placed in such ridiculously safe investments?” Klugman harangued.
As an accountant, Ms. Bair had always demanded that Sam’s money be 100% safe in the present. Ms. Bair told Sam that the local economy was very dependent on his spending so his money must not be tied to his neighbors. It must be placed in very safe bonds with a touch of equity in foreign lands.
In this way Sam’s money would always be there for him no matter what happened to the local economy. She had tried to explain that Sam was not a businessman or an investor and therefore not in a position to take risks.
“This is the crux of the argument” stated Klugman. Why can’t you take the same risk as your neighbors? Aren’t we are all in this together?"
But the fact was that Sam was not a businessman and he was not an investor or even a consumer. He was a disinterested third party that didn’t care what he earned or what he spent.
As an economist Klugman’s job was to sell his picture of the future to businessmen. So it was easy to convince a disinterested third party to do just about anything. Especially since this person considered him a friend.
The next day Sam told Ms. Bair what he wanted. She was to follow Klugman’s advice and invest his trust in the local community.
He loved this area and its people so it made sense to invest his money in the town.
And with this investment the local businesses and the economy boomed.
Sam began to make so much profit that Klugman suggested that Sam start buying drinks at 6 o’clock, then 4 o’clock then 2 o’clock. How could Sam argue, Klugman had been right before.
The wealth of the town grew at a phenomenal pace. Sam’s income increased so quickly that the bar was always open and drinks were always free.
The local economy boomed like never before. Businesses grew and took on new debt and then grew some more.
It was undeniable that Klugman was correct and Ms. Bair, Mr Hoenig and Mr. Volcker were wrong.
Klugman became a hero in the town.
(If you think like an economist, this is where the story ends. The short term is all that matters. As Lord Keynes said, “in the long run we are all dead”.)
(the story will continue for everyone else)
There came a time when the local business growth started to slow. And because Sam’s trust was invested in local business equity and not in safe bonds his income stopped.
Sam started dipping into the principle of the trust that was lovingly set aside 200 years ago, the money that should have lasted forever.
Common sense told Sam that there was only one thing to do. He must reduce his spending in the bar down to the amount that the accountant had recommended. This was the only sensible long term solution. Local business owners would have to stop their excessive borrowing and get though this economic downturn by themselves.
Also, it seemed to Sam that some of the local business owners were horrible at what they did and shouldn’t be in business at all. They spent all their time at the bar as they borrowed more and more money from Sam.
If the bad business owners shut down, wouldn’t the other owners prosper?
And if they wanted drinks, Sam was happy to provide them in the evening. It just didn’t seem right that they should borrow money from Sam with no hope of paying it back as they spend all of their time in the bar.
When Klugman heard that Sam was considering slowing his spending at the bar, he became enraged.
Sam must keep up his spending. Everyone depended on him. It didn’t matter if some business owners were absolutely terrible at their trade; it was heartless of Sam to put them out of business.
“Remember, we are all in this together.”
So it went. Sam spent his principle as the economy stagnated. There were too many businesspeople servicing too few customers.
And everyone spent too much time at the bar.
As always happens with imprudent spending, the money disappeared as if it had never existed.
Sam lost the trust that was handed down lovingly for 15 generations.
He still comes to Bernie's everyday, but never drinks. He just takes his same old seat at the bar and stares off into the distance. He is mostly ignored by all except when stories of the boom are discussed.
He does not exist in the town’s economy today. And if you believed Mr. Volcker he never really existed in the first place. Except as a distortion in the market.
In the town, many of the local businesses that were created to feed the boom either closed down or moved away.
The local economy is back to average. The town is exactly as before.
Back to what our ancestors would call the American Dream.
When they get together at Bernie’s, the people who lived through the boom never seem happy. They long for the golden days of unbridled prosperity and of course they miss the free drinks.
This lament stops when Klugman comes into the bar. He spins tall tales of a future of growth and riches.
Because that’s what economists do.
Everyone brightens up and talks of tomorrow,
and the next boom that will be even bigger than the last.
(If you are anyone but an accountant this is where the story ends.)
Thanks for reading
It is hard for one to gauge the size of the bubble that Sam created if one only listens to the reactions from the story’s participants.
Sam’s fortune was immense. Before its demise it was valued at 10 trillion dollars.
When Sam came wandering in, there were 10 bars in town. As Sam started to buy drinks at Bernie’s the other bars were immediately forced to close. Very quickly Bernie’s bar, like any other business that is subsidized by a disinterested entity, learned to raise it prices. Toward the end well drinks and beer were going for upwards of $10,000 a glass. But since there was no cost to the patrons, most drank the finest Champagne at $100,000 a glass even if they liked beer better.
Of course it is needless to say that billions of dollars of alcohol made its way out the back door to be resold in other towns, states and countries. This black market employed tens of thousand of people. Billions, perhaps trillions of dollars of income went untaxed.
Bernie’s bar ended up enveloping 4 square miles of the downtown area and could serve 300,000 people in an evening. So at the peak of the bubble, tens of billions of dollars could run through the bar in a night.
Obviously US Dollars could not be used to handle the transactions so everything was handled through credit with Sam’s expenses being sent directly to Ms. Bair’s staff of 1,000 accountants and wire transfers going back to the creditor’s offshore bank accounts.
With the growth of an economy than ran on debt, high interest was a necessity. 100% a week was not uncommon.
The town could be compared to gold rush Dawson City on steroids. Gas was $1000 a gallon, a meal in a restaurant was $10,000 and a room at one of the 1000 hotels in the area went for $50,000 a night.
Many that lived outside the 100 square mile area of easy commute while tipsy chose to move closer to the bar.
At the peak of the bubble this real estate had no value. There were not enough zeros on any number that could purchase a square foot of land.
As that is how it was sold.
Ms. Bair and Mr. Hoenig continually tried to get Sam to understand the enormity of what was happening.
Mr. Hoenig never did accept a free drink. But one must not feel empathy as his bank was making profits of $100 billion a year.
Mr. Hoenig could clearly see the problem and sold his loans to speculators before the bust for 500 cents on the dollar. Today of course all these loans are worth nothing.
Presently his bank is the only healthy one in the area.
Klugman never sensed that anything was wrong until the very end. His economic forecasting business still thrives.
Mr. Volcker is the only person in the story that never changed his lifestyle before, during or after the crash.
He continues to feed the birds in the park and enjoys going to work every day.
Friday, October 8, 2010
Now There's Something You Don't See Every Day
Well today the yield on the 5 year treasury sailed below the 1.1% mark which is 42% below the lowest yield in the past 70 years. This insanity by The Federal Reserve is being applauded by the stock market as the Dow spiked over the 11,000 mark today.
Investors have very, very short memories I suppose.
We are destined to have episodes of once in a lifetime madness every few months or so.
I feel it is appropriate to completely remove myself from the 50% long position that I accumulated during the market swoon to 1022 in the S & P in July.
It is very likely that the market will go up in the next few months driven by the speculative madness that is being induced by The Federal Reserve.
But for me the rewards at the end of this market run don't seem to warrant the risks.
The markets are being driven by rumors that our government will continue to sell our kids down the river with a never ending stream of currency debasement, market manipulation and intergenerational theft through massive unsustainable government debt.
We are trying to grow our economy by starting a currency war with the rest of the world.
By borrowing trillions of dollars that mathematically our government can never pay back.
By using this borrowed money to make the government bigger and thus starve the private sector.
By creating the most unsound investment markets in the history of our country.
By bailing out wild speculation at the expense of prudent savers.
And by funneling ever more money to the wealthy and away from the working classes.
All of this at the direction of our government subsidized political economists that don't understand what is happening, but are happy to suggest that ever more borrowing and speculation are absolutely the solution to our country's historically high level of debt.