We engaged on several subjects about what it takes to be successful. I am scientist, engineer, computer programmer and financial analyst. I have a bend for the quantitative that is great for puzzles and understanding how things work.

But I have struggled with the “why” things work. Particularly the “why” people do the things they do.

She had a different point of view. I didn’t quite get it until she sent me this 2009 TED video by Simon Sinek. (A shorten version can be here.)

I am inspired.

Thank you.

In an arm-length transaction the unions would negotiate with management for a share of the corporate profits.  If the company pays too much of its resources to shareholders, management, or union, then the company goes out of business. There is an inherent requirement in union negotiations that they do not try to take an excess share of profits because in doing so, they will eventually destroy the company and themselves.

Governments have no profits; they just have tax- and fee-based revenues. The control and use of the taxing authority of the government resides in the elected officials. An elected official that is beholden to a public-service union (or any other subsidy receiving industry) is not dealing in an arms-length transaction in negotiating with the unions for their pay and benefits.

In a polarized political environment, this “corrupt” situation is exacerbated because both the unions and the elected official are fighting for their paychecks. If the elected official loses their elected position, they lose their paycheck, power, and podium for advancement. There is a direct benefit for the union-leaning politician to give more pay to the unions so the unions can give more direct campaign contributions, as well as support the politician through volunteer efforts. This effect more tightly weds the favored politician to the union because each are fighting for their preservation against those tax-payers who would direct the available tax revenues to other uses.

This is not a theoretical possibility, but in fact the reality of today’s political environment. Public service unions were the largest single supplier of election funds in the 2008 elections outside of the political parties themselves. These funds were given almost completely to the Democrats, who promised to continue to support their pay and benefits.

This is a “corrupt” system, where corrupt is defined as being unsupportable in the long-run because eventually the tax revenues can not support the system and the system collapses upon itself. See Greece’s current economic conditions for an example of what happens in the long-run if this system is allowed to become entrenched.

The same problem extents to any industrial group seeking subsidies or other transfer payments from the government, whether it is the oil & gas industry, the farming industry, etc.  If those payments are used to lobby or elect political representation, it is bad for democracy, it is bad for the economy, and most importantly it is very bad for tax paying citizens.

It is very bad for citizens because this is a corruption of the democratic system required to maintain economic balance and longevity to any civil society.

Updated March 14, 2011:
In Wisconsin, police and firefighting unions are threatening to boycott businesses that do not support their efforts to over-turn the recent Wisconsin laws.

The subtle long-term threat about which I wrote has moved into direct threats against citizens from the civil servants responsible for protecting those citizens.

Free association is a guaranteed right in this country. No one has suggested otherwise in any of the reasonable debates about public service unions.

The police and firefighter unions were explicitly excluded from the new Wisconsin laws. Yet, the police and firefighter unions are leading the threats against businesses if they do not sign a petition to rescind these laws.

“Corruption” has taken on a new definition with respect to the impact of public service lobbying on democracy.

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Currency trading is a difficult business, and it always takes me some work to understand it.

In the absence of government intervention in the currency markets (Central Bank), monetary policy (Central Bank), and internal fiscal policy (Government Budgets), the value of a countries currency should fluctuate based on the import/export ratios and perceived future productivity growth relative to other currencies.

In the real world, Central Banks and Governmental Budgetary policies tend to cause (wild) variations around the long-term trends.

In the case of the Iraqi Dinar (IQD), there does not appear to be an active exchange in the currency, cleared by a central bank.  This means it is closed to currency traders.  However, there does seem to be rampant speculation in the currency by individuals.  These individuals buy actual dinars in limited quantities.  They hold this currency in hopes of selling it back for more dollars in the future than what they paid.

Playing the currency market in this fashion has some higher costs than through the currency spot and futures markets mediated by foreign exchanges and central banks.  The first risk is that the bid/ask spread is likely to be much higher.  If $1 buys 1000 Dinars from a local Bank, then it may take >1500 Dinars to buy back that same dollar at the same Bank.  Playing in real currency is typically very expensive in currency investing.

The bigger risk is that one day, the Central Bank and/or Government decides that the current currency is worthless and that they are printing new currency.  All holders of old currency must exchange this currency for new currency at an official exchange rate.  This is called a revaluation.  South North Korea did this last year at the end of 2009 and limited the amount of old currency one could exchange, effectively wiping out the savings of millions of residents.  Oh and by the way, foreign owners of the currency got nothing.

It is unclear that the Iraqi government would take such a drastic measure as limiting the amount of currency that can be exchange, or who may actually exchange the old currency for new.  But this is a risk that must be acknowledged in currency trading.

The most highly discussed possibility with the Dinar is a revaluation without limitation (do a Google search on Iraqi Dinar).  This means that all non-counterfeit currency will be exchangeable at the new exchange rate.  The non-counterfeit qualifier here is important because there seems to be rampant counterfeiting occurring in the Dinar.  If you are buying actual currency and have no way to assure that it is non-counterfeit, you run the risk of losing your investment on the revaluation.

A “clean” revaluation is simply exchanging one set of old notes for a fixed set of new notes, i.e. 100 old Dinars = 1 new Dinar.  In such a revaluation, there is no change in the relative value of dollars that will be purchased after the exchange, i.e. there is no appreciation in the currency investment in dollar term.  If $1 buys 1000 Dinars before the revaluation, then $1 will buy 10 Dinars after the revaluation.

The point here is that currency revaluation is very different that currency appreciation.  It is akin to a stock split, or in this case a reverse stock split.  If the underlying fundamentals of the currency are not likely to change then the relative value of the currency is not likely to change on a revaluation (assuming the other currency is stable).

The official exchange rate from the Iraqi Central Bank appears to be 1170 IQD to $1 (http://en.wikipedia.org/wiki/Iraqi_dinar).  However, this may not represent the actual “street value” of the Dinar, which may factor into any revaluation.  In reviewing a possible investment in actual dinars, let’s look at a commodity price comparison for implied exchange rates.

A quick look at sugar prices in the commodity markets from December suggests that the “real” exchange rate of Dinars is close to 1,755 IQD per $1 (This comparison is quick, dirty and suspect because I just used data that I found on the web.  Your results may vary.) –

Refined White Sugar (RWS)
50 kg (Dinars, IQD)               65,800
1 kg (Dinars, IQD)                  1,316

Spot Market (RWS)
1 kg ($)                                   0.75

Implied Conversion 1,755 Dinars per $1

Local Bank Sold 1,250,000 (IQD) for $1307.50 (December 14, 2010)
or
Local Bank Sold 956 (IQD) for $1

The purchase of Dinars at a local bank with US$ would buy approximately 54% of the Dinars that could have been purchased on the streets of Baghdad.  This does not appear to be a good exchange rate from which to make currency investments, and is probably a function of the bid/ask spread problems I mentioned earlier, as well as the fact that Florida Bank probably has to work off “official” exchange rates in acquiring the currency for a customer.

Outside of revaluation, official exchange rates, and bid/ask spreads, there are other risks in Iraq that must be considered.  These include civil war and continued problems with oil exports.  At the same time the county needs to rebuild its infrastructure, elevating imports.  These will hurt the long-term trends in Iraq’s internal productivity growth as well as its expected import/export ratios.  This would suggest a flat to decreasing Dinar relative to other more stable currencies.

Buying Iraqi Dinars from a local bank using dollars is a bet on Iraq versus the U.S. with some extreme bid/ask spread and high risk.  It appears to be a poor investment choice at this time.

But that’s just my opinion…

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If I were to make a guess, I would think we see a top side ceiling of 12,500 from today’s levels. We will probably bounce off this ceiling a number of times over the next year.

I think we are stuck in 1978-1980 cycle. Unpopular democratic president, lots of uncertainty, high unemployment, and loose monetary policy.

DOW Industrial Average on November 8, 2010. The graph shows the period of 1975 to 1980.

The keys are the loose monetary policy combined with high uncertainty. The money only gets into the hands of large corporations or well capitalized companies. These are not the “engines” of innovations, so asset prices get bid up and cash leaks into the system.

Asset inflation gets built into expectations, but the velocity of turnover in fixed assets remains low, i.e. business will still be operating below capacity but prices still rise. GDP grows but not at levels required to significantly reduce unemployment.

We’re seeing spot bubbles for tech companies, but the cash is not well distributed. Mainly coming from large investment funds and little tiny funds. Medium size funds are getting crushed. I think this effect is related to the greater markets. The liquidity is concentrated in the giants, with some very small players living well off big crumbs. This is a symptom of an inefficient distribution of cash into the economic system.

The caveat to this is the US demographics. The population is aging, changing asset allocation may continue to bid up bond prices keeping yields low and perhaps goosing the stock market.

Given the uncertainty, I don’t think this increases liquidity to the general economy. Banks will continue to hold on to the cash as they try to build up their balance sheets.

Look to the fed to change tactics later next year as QE II doesn’t goose the economy as much as they would like. They could change the rules on banks holding reserves at the fed, making it more expensive to hold reserves versus lending the money. This might actually goose the economy, but will also drive inflation as cash floods into the system. The increase in inflation expectation acts as a barrier to market upside beyond the 12,500 level.

The world-wide bailout of Greece would be funny were it not so indicative of attitudes by some that you can take more from an economic system than can be created by its participants.

The Greek problem is in a large part the result of the inadvertent corruption of democracy when those who want to use the productive capabilities of others are given unfettered power to do so. This power can accrete slowly, sometimes over decades, but when it starts, it is very hard to stop.

In this case, the Greek bureaucracy began to exert control over the taxing and spending powers of the government by (legal and illegal) contributions to elected officials who supported their desire for more money and benefits. These contributions were collected from their members’ salaries; salaries that were paid for by tax and bond revenues assessed by the elected officials. Union members naturally supported the increase in their salaries and benefits packages. This, of course, also led to the collection of greater union dues, which in turn led to greater contributions to elected officials who would raise tax and bond revenues to pay union members.

This corruption of the control of resources within the Greek society created a positive feedback loop for tax increases and bureaucratic expenses that drained their economic resources. The situation of allowing people who directly depend on tax and bond receipts to elect the officials responsible for determining the assessment of taxes and the selling of bonds is analogous to “putting the kids in charge of the cookie jar”.

George Will has a great article on the recent mess.  In it he states -

Greece represents a perverse aspiration — a society with (in the words of Wisconsin Republican Rep. Paul Ryan) “more takers than makers,” more people taking benefits from government than there are people making goods and services that produce the social surplus that funds government. By socializing the consequences of Greece’s misgovernment, Europe has become the world’s leading producer of a toxic product — moral hazard. The dishonesty and indiscipline of a nation with 2.6 percent of the eurozone’s economic product have moved nations with the other 97.4 percent — and the United States and the International Monetary Fund — to say, essentially: The consequences of such vices cannot be quarantined, so we are all hostages to one another and hence no nation will be allowed to sink beneath the weight of its recklessness.

Recklessness will proliferate.

Those with kids understand that the risk of putting the kids in charge of the cookie jar is not that they will eat all the cookies. Instead the greater risk is that their lack of self-control will make them sick, and in turn, may cause greater problems for those around them.

It is not the child’s fault for eating all the cookies when we put them in charge of the cookie jar; rather it is the adult-in-charge’s fault for enabling them with the opportunity to do so.

In Greece, the “children” have taken to the streets to murder private sector employees because they were told they could no longer have everything they wanted. Whose fault is this? The children or their enablers.

Adults in our society need to learn the word, “No.” and we need to use it.

Could this happen here? The answer is it already has in California. The following is from a Wall Street Journal Op-Ed by David Crane -

In 1999 then California Governor Gray Davis signed into law a bill that represented the largest issuance of non-voter-approved debt in the state’s history. The bill SB 400 granted billions of dollars in retroactive pension boosts to state employees, allowing retirements as young as age 50 with lifetime pensions of up to 90% of final year salaries. The California Public Employees’ Retirement System sold the pension boost to the state legislature by promising that “no increase over current employer contributions is needed for these benefit improvements” and that Calpers would “remain fully funded.” They also claimed that enhanced pensions would not cost taxpayers “a dime” because investment bets would cover the expense.

What Calpers failed to disclose, however, was that (1) the state budget was on the hook for shortfalls should actual investment returns fall short of assumed investment returns, (2) those assumed investment returns implicitly projected the Dow Jones would reach roughly 25,000 by 2009 and 28,000,000 by 2099, unrealistic to say the least (3) shortfalls could turn out to be hundreds of billions of dollars, (4) Calpers’s own employees would benefit from the pension increases and (5) members of Calpers’s board had received contributions from the public employee unions who would benefit from the legislation. Had such a flagrant case of non-disclosure occurred in the private sector, even a sleepy SEC and US Attorney would have noticed.

Let me repeat here. We need to learn the word, “No.” And we need to learn to use it.

Do you add value to the household you run?

Do you add value to the lives of your family?

How do you feel after reading these questions?

Life is giving and taking. You can not live without doing each, but adding value credits a positive balance in the ledger of life.

Plant for the future and add value to life.

Figure 1. Total New and Existing Home Sales and the gap between them (source: The CalculatedRisk blog).

1) The stimulus funding for home buyer tax credits has generated demand for homes, at the expense of draining the pool of future home buyers.  There does not appear to be any political will to extend these credits.  Short-term demand for total homes is likely to fall (Figure 1).

2) Foreclosures and distressed pricing of existing home sales will continue to increase in the mid- to high price ranges, but appear to have peaked overall in 2009.  They will continue to remain at higher than historical levels in the lower price ranges (Figure 2).

Figure 2. California foreclosures (source: The CalculatedRisk blog).

I am personally concerned about the possibility of a double dip recession.  While economic demand is increasing off of last year’s lows, we are not growing top line economy-wide revenues as would have been expected for recessions of this size.

This period looks remarkably like the 1974-1976 period; and the key to housing, and the economy in general, is unemployment. If we stay above 9% through the end of this year, I believe that the economy, and therefore housing, will remain (at best) at anemic levels.

3) The continued high levels of foreclosures, combined with high unemployment, will continue to drive pricing in housing to low levels.  These levels will probably be below replacement costs, and we will continue to see low levels of new homes to existing homes sales ratios (Figure 3).

It took 4 years to reach this level of lows in the new home to existing home sales ratio.  Given the current economic (and political) environment, I would expect that it will take a similar amount of time for new home sale to recover to the long-term average of ~15-20% of existing home sales.  However, return to this level would also be commensurate with a return to total new home sales of about 600,000 to 800,000 units, which is nearly half of the peak in 2005 (Figure 1).

This, of course, is a national average.  Places like Florida, California, Nevada, and Arizona may have a longer recovery period.

A recovery of the new home housing market, to half of its peak, in 4-6 years, will not feel like much of a recovery.  It will feel more like survival.

This was balanced by the two articles in the Wall Street Journal that discuss youth unemployment and the current discussion in Washington, DC of a federal Value Added Tax.

Here’s the gist -

From Daniel Henninger’s article -

The U.S. unemployment rate for workers under 25 years old is about 20%.

This is similar to the perpetual unemployment rate for youth in old Western European nations.

These are the Western European nations that spent the postwar period free of Soviet domination. With that freedom they designed what came to be called the “social-market economy,” a kind of Utopia where a job exists to be protected and the private sector exists mainly to pay for the state’s welfare plans. … In the final month of 2009, these were European unemployment rates for people under 25: Belgium, 22.6; Spain, 44.5; France, 25.2; Italy, 26.2; the U.K., 19; Sweden, 26.9; Finland, 23.5.

Couple these unemployment statistics for youth with this tidbit from the WSJ Editorial Board -

“Answering a question at the New York Historical Society on Tuesday, Mr. Volcker said that a VAT—a consumption tax levied along stages of production—”was not as toxic an idea” as it has been, and that both a VAT and some kind of tax on energy need to be on the table. “If at the end of the day we need to raise taxes, we should raise taxes,” he said.

The VAT has been a staple of European taxation policies for decades, and high rates of taxation is one of the causal mechanisms of slow economic growth in the countries.

In the middle of the worst economic situation in nearly a century, we are building the economic policies that replicate the social welfare state of old Western Europe.  These policies have led to perpetual under-employment (particularly of youth and immigrants), low economic growth rates, and stratification of the economic classes (i.e. limited upward mobility amongst the economic classes).  Is this the future model of the US economic system?  I hope not.

Long-term economic survival requires a successful risk/reward system that provides opportunities for great success, and great failures.  Why?  Because without a risk/reward system (with both the highs and lows) you get a steady state society that eventually leads to stagnation.  And stagnation of an economic system will eventually lead to its demise.

In short, you can not (over) tax the system to reduce economic disparities; nor can you (over) regulate the economy, and the people, to keep bad things from happening them.  If you do, the system stops working.

Economic policies can be compared to forestry management policies.  Bad forestry management (as practiced in the middle to end of the last century) tries to put out all fires – everywhere – all the time.  The result is that when a fire eventually happens, the dead wood and scrub brush fuel load is so high that the fire burns too intensely hot and destroys the forest.  Good forestry management requires an occasional (small) fire to reduce the fuel load.

Adequate risks and rewards serve this same purpose in the economy.  You cannot reduce the risk of failure (or any other personal catastrophe) to zero.  If you do, the accumulation of bad (dead) wood will burn your (economic) house down.  In addition, a vibrant growing economy, like a forest, needs clear access to resources (like capital) without the choking over-growth of underbrush, deadwood, and over-regulation.

There are some who would argue for an expected increase of 50 basis points in spread widening between treasuries and Mortgage-Backed Securities (MBS). (By the way, Calculating Risk is becoming one of my favorite financial blogs.)

It certainly makes sense to suggest that the price for MBS will fall (and hence yields will rise) once the major buyer of these securities stops buying. However, I don’t think that this will happen, and its a perfect example of why statistics can bite you in the rear when analyzing market trends.

This graph from Politico.com shows the history of 30 yr mortgage rates in relation to 10 yr treasury bonds.

The problem is that it is in the past, and does not reflect the fact that today the GSE’s are wholly-owed subsidiaries of the US Government. The current private market buyers of MBS now consider these bonds to essentially be the same as treasuries (and so does the Congressional Budget Office). Until this changes, the MBS will continue to trade at historically compressed levels compared to treasury bonds, and mortgage rates will continue to remain low.

One could also argue that the recent troubles in the EU may actually cause money to flow into the US fixed income markets, further compressing spreads as foreign buyers of these fixed income securities seek greater yields than are offered on treasuries.

For mortgage rates to significantly change, the following needs to happen – (1) inflation begins to be priced into the market and 10 yr treasury yields go up (maybe), and/or (2) the US Government stops backing the GSEs (unlikely), and/or (3) the Fed starts selling its $1.25 trillion holdings of MBS (again unlikely).

crystal clear that the state’s tax policies are resulting in a significant decline in the state’s wealth.

A more insidious effect is that the study found a

less-robust “in-migration,” the study finds that people who are moving to New Jersey aren’t as wealthy as those leaving.

So why would one care about those wealthy people who want to “escape” paying their “fair share”.

Well for one thing, class warfare is bad. Nobody likes to be called a villain, particularly those who are working hard to be successful for their families, their co-workers, and their communities. Making people feel guilty for being successful is not conducive for a healthy community.

For another, you need a concentration of “excess” wealth to feedback into the local investment of new technology and jobs. Governments do not do this; they redistribute wealth. Individuals and corporations operating in their own self-interest invest in opportunities that create wealth, which as a by-product create additional goods, services, and jobs.

I am not suggesting that we “starve” schools. What I am suggesting is that if you chase out (or otherwise make the community unattractive for those who wish to immigrate into that community) those who are at the head of the bell curve in terms of success, the community will eventually suffer. All one has to do is look at the problems seen in New York, California, and New Jersey.