Wall Street Bailout: The World’s Largest Sovereign Wealth Fund?

More than 20 countries have set up sovereign wealth funds while a dozen more have expressed interest in establishing them. Many of these sovereign wealth funds are picking up stakes in U.S. companies, which is raising concerns about the need for regulating them. Up until the $700 billion bailout, which effectively is a U.S. Treasury-directed fund, the United States did not have a sovereign wealth fund.

This fund is the world’s largest, beating the $600 billion sovereign wealth fund of the oil-rich emirate of Abu Dhabi in the United Arab Emirates.

The fund has many characteristics of sovereign wealth funds. It endorses the latest trend – the most powerful financial entities are not risk-happy investment banks but state-sponsored investment entities that are more cautious.

So far, the United States government has stayed away from investing in the markets. The fund presumes that the government must play a crucial role in deciding how best to deploy a nation’s investment capital.

Critics have long argued that sovereign funds be allowed the privilege of holding positions in public companies when the U.S. government did not do so. When the fund was approved by Congress, it took the sting out of this argument. But there is a difference between this fund and sovereign wealth funds. Sovereign wealth funds invest surplus funds, and in many cases they are doing so abroad for the purpose of financial diversification. The money for this fund has to be borrowed by the Treasury: $700 billion. It will only be investing in the United States. It will make no investments abroad.

The mandate to the fund is clear - avoid further financial collapse by extending a lifeline to U.S. institutions hobbled by their exposure to toxic mortgage assets. This is similar to the goal of sovereign wealth funds – advancing national economic goals. The only difference is that sovereign wealth funds openly state that their goals are political. This fund on the other hand seeks the best prices for the assets it buys.

There are some who feel that the fund does not resemble a sovereign wealth fund, but some sovereign wealth funds are beginning to look like the fund. The present credit crisis is not restricted to the U.S. alone. It is having a worldwide impact. There is tremendous pressure of many of the sovereign wealth funds to come to the rescue of home markets that have wobbled in recent months.

The U.S. Treasury fund’s mandate will run out after two years. But the government might have other ideas if, at the end of two years, it has more than $1 trillion in assets - it has the benefit of starting to buy at what may well be the rock bottom. It could become a permanent fund, and its mandate could be broadened to allow it to invest abroad. It would then become a full-fledged sovereign wealth fund.

Warren Buffet’s Appeal to Our Dead Consumer Culture: ‘Buy American’

In an op-ed piece of October 17’s New York Times world-famous entrepreneur and financier Warren Buffet urged American investors to return to the stock market and bet on the long term future success of the United States. “Buy American,” Buffett’s headline reads. “I am.”

The essay was a vote of confidence from a successful guy at a time when America badly needs a vote of confidence from somewhere, anywhere, for anything.

But is Buffett’s advice valid?

The gist of Buffett’s analysis is that when markets tumble, the best time to buy stocks has historically been before recessionary effects hit the broader economy. As Buffett explains it,

During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.

Or, if you need a more shorthand rule of thumb: “Be fearful when others are greedy, and be greedy when others are fearful.”

It’s hard not to like Warren Buffett, a guy who admitted openly on a recent televised interview that 1) his clerical staff pays higher income taxes than he does, and 2) that’s not right. No, he’s not out pestering the IRS to accept additional taxes from him as a mea culpa, but he does go out of his way to encourage Americans, to back American businesses, and to responsibly critique U.S. government policies, all the while managing to still enrich Warren Buffett in the process.

If there’s such a thing as an Everyman CEO, Buffett is the guy.

Still, many analysts see hard times ahead for the U.S. for many decades, not just many years. While it’s true that ‘buy low, sell high’ is still a decent way to conduct yourself in regard to the stock market, it’s also true (and Buffett admits it in the NYT essay) that the U.S. could be in for a prolonged decline before we see a Renaissance. What that means is that unless you are young and careful with what you purchase, this might not be a great time to jump into the stock market: Not because America will never come back–of course it will come back eventually–but because you may or may not be around when it does, and you may or may not pick the company that will thrive in whatever nation America is about to become.

Because the America that existed up until this month? That nation is effectively gone now.

What we are witnessing right now is for all intents and purposes the decline of an empire. How far will we fall? The most positive estimates have the U.S. going through a severe recession with a continued drop in housing prices, rising unemployment, and frequent government intervention through 2010 at least and possibly longer. Those are the optimists.

Pessimistic forecasts invoke Mad Max movies and survivalist nightmares.

I think the truth will, as usual, be somewhere in the middle, with the downturn being more severe than predicted in the press but less apocalyptic than predicted by the conspiracy theorists. Will some people find ways to get rich during these difficult times? Yes. Some people always do. The Chinese sign for crisis is also the sign for opportunity (whether it really is or not!) and so on and so forth.

But will most of us prosper?


Most of us will be lucky to hang on to what we have, and any little bit of money left over will probably not be spent on stocks. Not for a long time.

What that means is that, while the stock market may be close to bottoming out at this point (who can say?), and while certain stocks might be worth buying right now for that reason (which stocks, even Buffett isn’t saying), the ability of most people to buy anything is going to go away for a long, long time, starting this Christmas if not sooner.

We are likely to see a stock market bottom, whenever it comes, followed by years of flat-lined market activity. Gains will be modest and unpredictable. Old standbys will go the way of the dinosaur and some surprising start-ups will briefly appear like shooting stars. Good guessers with lots of cash will be rewarded, but most people will just hang on until whomever we are going to be as a nation emerges clearly out of the 2008 smoke and carnage.

Many have made a credible case that the housing bubble was really an extension of the tech bubble and that, by replacing one bubble with another, we only forestalled and worsened the effects of an economic crisis that has been building for decades, not years. Manufacturing is no longer the foundation upon which the American middle class builds its wealth and security. We have been hemorrhaging manufacturing jobs, and a lingering distaste among many for the abuses of the labor movement that led to the disappearance of Jimmy Hoffa and the coronation of Ronald Reagan continues to keep us from doing what we need to do to shore up wages and opportunities. It’s fine to have beliefs, economic or otherwise, but here’s a fact that flies in the face of fiscal dogmatism: People can’t spend money they don’t have.

Not anymore they can’t, anyway. Not with credit markets frozen and jobs disappearing into the October mist like so many spectral visitors from America Past. With Christmas approaching, retail chains where I live are laying off employees.

Anyway you slice it, our “consumer culture” seems to be DOA. A victim of fiscal cardiac arrest.

So what does America do now? We don’t make things. We’ve lost the tech battle to China and India. We’ve tapped out our oil. Our young people are uneducated and unwell. And the final death rattle of a declining culture–rampant consumerism–is about to become a morality tale told to children around the wood stoves of the future by grandparents who lived through The Crash of 2008.

I appreciate Buffett’s encouragement, his faith in American business, and his willingness to step forward as a cheerleader right now. But I submit that the crisis we are facing is not so much a financial or economic one as it is an identity crisis, the biggest identity crisis we have faced as a nation since the Civil War.

Who are we and who do want to become?

The answers to these critical questions will determine our future prosperity.

Let’s hope and pray we get them right.

What Can the Art Market Tell Us About Our Economy?

When compared to more traditional investment options, the contemporary art market is highly inefficient – but this hasn’t dampened the enthusiasm of buyers and investors.

The contemporary art market has left its critics standing. Many presumed that it would be one of the crisis’ first victims as collectors tightened their purse strings and investors redirected their funds to safer areas. Yet somehow, the art market has boomed beyond expectation.

It is ironic that, in this period of economic turbulence, this inefficient little market has become more stable than the giant financial institutions. On the same day that Lehman Brothers filed for bankruptcy, Sotheby’s auction house raised nearly $100 million for the work of British artist Damien Hirst.

Many in the media have viewed the art market’s boom with suspicion since the start of the crisis, and they have been keen to pounce every time a market correction occurs – corrections are to be expected from any fast-growing market. They have presented the market’s success as a mystery and suggested that the market has somehow become disconnected from the underlying economy.

But the art market is not disconnected – it cannot be. Rather, it is a perfect reflection of the current state of the global economy.

New Art Investors

A new breed of collector is stalking the auction house: many corporate investors have increased their exposure to fine art in an attempt to diversify away from the financial markets. You would be forgiven for presuming that art is a high risk investment considering the subjective nature of art appreciation, yet corporate investors have brought with them more reliable valuation methods to an industry reliant on historical post-auction data.

A whole industry has sprung up around the needs of these corporate investors: there are now a number of fine art funds that trade artwork as you would any other commodity and indexes with which to more accurately anticipate future trends. Earlier this year, intelligence provider Artprice.com launched its Art Market Confidence Index, aimed at providing serious investors with more reliable metrics for the art market.

Many buyers are using art purely as a tool for financial gain which, in turn, has pushed up the price of the market. It is sad that the growth of the market has made it difficult for legitimate museums and public galleries to purchase new stock; a larger proportion of our international art heritage is finding its way into private collections. Of course, private collections are nothing new, but is the financial motivation behind the purchase (and therefore the price) changing the way we look at art? Should we be worried when art becomes nothing more than a commodity?

New Art Collectors

Salvation comes from an unlikely source. The image of the elitist western collector is slowly being eclipsed by the cash-rich Russian oligarch – reportedly, a third of the buyers at the Damien Hirst auction mentioned above were from the ex-Soviet Union.

These new Russian buyers have injected the art market with liquidity. Although the investment potential of art may influence their purchases, their primary interest is aesthetic – they are in search of unique and sophisticated items to complement their luxurious lifestyles and new-found wealth.

The art market has boomed because it has attracted these new breeds of investor and buyer. In this respect, the art market has not disconnected itself from the realities of the global economy – rather, it reflects the global shift in economic power: western capital is moving away from financial institutions into other areas, oil and gas-rich BRIC countries have a major economic advantage and investments from cash-rich countries are cushioning the downturn in certain sectors.

Perhaps the ultimate lesson to be learned about our economic system is that, given time, all bubbles burst. Time will tell.

Senate Investigation: Major Financial Institutions Helped Hedge Funds Avoid Taxes

A year long probe by Senate Permanent Subcommittee on Investigations which relied on internal bank documents and emails has found that some of the nation’s biggest investment banks and brokerage firms including Morgan Stanley, Citigroup, Lehman Brothers, and Merrill Lynch & Co marketed allegedly abusive transactions that helped foreign hedge fund investments avoid withholding taxes imposed on dividends paid by U.S. companies over the past decade. These funds are liable for tax on the dividends they receive from investments in the U.S. at a rate of 30%. The amount of tax avoided could well be in billions of dollars.

The banks actually competed with one another to dream up complex transactions for foreign hedge funds to avoid taxes. The probe also found that some of the internal communications show that the bank officials were concerned that they could run into trouble with the Internal Revenue Service (IRS).

The results of the probe clearly highlight the failure of the IRS and Treasury Department to enforce the law. The banks entered into agreements to give the hedge funds the economic value of dividends, without actually triggering a withholding tax on dividend payments. The foreign hedge funds would sell their stock to an U.S. investment bank just before a dividend was to be paid and simultaneously enter into a swap arrangement with that bank to retain the economics of stock ownership. The U.S. bank paid the foreign hedge fund a dividend equivalent but did not withhold any taxes. The funds technically didn’t own the shares. A few days later, the hedge funds would repurchase the stock from the U.S. bank.

The $32 billion special dividend by Microsoft in 2004 is said to be the trigger that spurred the investment banks and brokerage firms to sell products that would allow their hedge fund clients to avoid paying the associated taxes.

The investigation had some effect. Merrill Lynch & Co stopped doing some of the deals after the committee began its investigation although the investment bank claimed that it acted in good faith when it advised its clients – foreign hedge funds – and it acted appropriately under existing tax law. Citigroup voluntarily approached the IRS and paid $24 million in withholding taxes after an internal audit.

One of the beneficiaries of such transactions – Maverick Capital Management – estimated that such deals helped it avoid $95 million in taxes over an eight-year period.

The result of the probe raises one very important question – where does the loyalty of these investment banks and brokerage firms lie? They are American companies who have reaped all the benefits of being American companies. They have openly helped foreign hedge funds flout U.S. tax laws. Is there something called patriotism or is it profit at any cost?

America’s Aging Workforce: It’s Time for Employers to Accept Reality

The current financial crisis in the U.S. is hitting everyone hard, perhaps not least the older population. Many in this age group will have taken early retirement in recent years and may now be starting to feel the pinch due to unexpected price rises. Some of these seniors, along with others who just miss the activity and companionship of the workplace, may be considering a return to work on a full or part-time basis.

In fact, the trend towards earlier retirement in recent decades means that the U.S. has a large non-economically active older population in their 60s and early 70s, many of whom hold valuable skills and experience and who enjoy much higher levels of health and fitness at this stage of life than any earlier generation.
Increasingly, employers will need to tap into this older labor pool in order to ease recruitment difficulties. Demographic changes, including a falling birthrate and the aging of the U.S. population, mean that fewer young people are now entering the labor force. As the first cohort of the baby boomer generation reaches retirement age this year, the labor force can be expected to shrink considerably within a short period of time, even taking into account a continuing influx of immigrants.

Aging Workforce

Moreover, the workforce itself is aging, as reflected in the U.S. Bureau of Labor Market Statistics’ data on the employment participation of different age groups. Between 1977 and 2007, it is reported, there was a 101% increase in the employment of workers aged 65 and above, compared with a 59% increase in total employment. By 2016, it is estimated, the number of workers aged 55 to 65 will increase by 36.5%, while the number of workers aged 65 and over will increase by more than 80%, with the latter group accounting for more than 6% of the total labor force by that time.

Simple supply and demand considerations, therefore, suggest that future employment opportunities for older people will be good. Moreover, a raft of legislative and policy changes over recent decades, including the Age Discrimination in Employment Act (ADEA) of 1967 and the elimination of mandatory retirement in 1986, have also theoretically improved recruitment and retention prospects for the country’s seniors.

Yet there is evidence that age discrimination on the part of employers is rampant in the U.S., hindering not only the opportunity for older people to improve their finances but also potentially hampering the ability of the labor market to adjust to the demographic changes. Equal Employment Opportunity Commission statistics show a vast increase in age discrimination lawsuits in recent years, while research studies also provide evidence that age discrimination is widespread, at least in terms of recruitment and displacement, if not in terms of earnings. However, this is often very subtle and more difficult to prove than other forms of discrimination; for this reason it is likely that the statistics vastly under-estimate its true extent.

Benefits of Retirement-Age Workers

Studies have suggested that many employers are reluctant to hire older workers as they fear higher healthcare and insurance costs and hold concerns about their abilities and likely productivity. In fact, while there is some evidence that physical strength steadily declines after the age of 40, research has also indicated that there is little deterioration in mental faculties until over the age of 70. Moreover, published case studies of organizations in the U.S. and Europe that actively recruit and retain older workers, including McDonalds and the book retailer Borders, provide evidence of many benefits of such policies, such as lower rates of absenteeism, lower turnover, higher profits and improved customer satisfaction.

The increased employment of older workers is also likely to bring wider economic benefits to the U.S. by helping to ease the burden on the Social Security and pensions schemes resulting from early retirement patterns and the increased lifespan of Americans. A remaining barrier, however, is the restrictive pension scheme regulations which often deter older people from continuing to work beyond retirement age or re-entering the workforce. The U.S. may be well-advised to consider adopting the type of gradual retirement programs already in place in many Scandinavian and European countries.


Adams, S.J. & Neumark, D. (2002). Age Discrimination in U.S. Labor Markets: A Review of the Evidence. Public Policy Institute of California Working Paper No. 2002-8.

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Conference Board of Canada (2006). Canada’s Demographic Revolution Adjusting to an Aging Population.

Crampton, S.M. & Hodge, J.W. (2007). Age Discrimination and Downsizing. The Business Review 7, 1, 341-347.

Dychtwald, K., Erickson, T.J. & Morison, R. (2006). Workforce Crisis : How to Beat the Coming Shortage of Skills and Talent. Harvard Business School Press.

Kantarci, T. & Van Soest (2008). Gradual Retirement: Preferences and Limitations. De Economist, 156, 2; 113-144.

MacNicol, J. (2006) Age Discrimination: An Historical and Contemporary Analysis, Cambridge: Cambridge University Press.

McMahan, S. & Philips, K. (1999) America’s Ageing Workforce: Ergonomic solutions for reducing the risk of CTDS. American Journal of Health Studies 15, 199-202.

Santora, J.C. & Seaton, W.J. (2008). Age Discrimination: Alive and Well in the Workplace? The Academy of Management Perspectives 22, 2, 103.

Turner, J.A. (2008) Work Options for Older Americans: Employee Benefits for the Era of Living Longer. Benefits Quarterly, 24, 3, 20-26.

U.S. Bureau of Labor Statistics (2008). Spotlight on Statistics: Older Workers. July 2008. Retrieved from http://www.bls.gov/spotlight/2008/older_workers/

Financial Bailouts: Is the U.S. on the Road to Socialism? (Part 1)

All nation-states reside somewhere on the continuum between laissez-faire and total-state central planning. No country is completely capitalist and no country (with the possible exception of North Korea) is entirely socialist. So how are we to define roughly “capitalist” and “socialist” countries? Where is the dividing line? How do we know if we are still a capitalist country?

Ludwig von Mises said the difference between a roughly capitalist country and roughly socialist one was a functioning stock market. In a socialist country, Mises said a market simply could not function. With the recent unprecedented interventions into the economy, the stock market isn’t functioning. Is this a temporary setback or have we passed a crucial threshold into socialism?

In this first of a two-part blog series, I will examine how the American system compares to the 10 planks of Karl Marx’s Communist Manifesto . According to Marx, these were the ten preconditions a country needed to meet before transitioning from capitalism to socialism.

1. Abolition of property in land and application of all rents of land to public purposes.

We still use the term “real estate,” which is derived from the historic “royal estate,” meaning that royalty (the government) was the true owner of all lands. Although the U.S. has a noble history of homesteading and laissez-faire, we now impose property taxes on the supposedly private property of individuals and evict them if they don’t pay. That sounds an awful lot like the rent system of feudalism and Marx’s manifesto.

Eminent domain further calls into question whether people really own their land. The Constitution, itself a step away from the comparative laissez-faire of the Articles of Confederation, gave the federal government the authority to seize private property for public purposes. Now, thanks to the Supreme Court’s Kelo Decision, government at all levels can take “your” land and give it to Wal-Mart for the “public purpose” of “economic development.”

2. A heavy progressive or graduated income tax.

Although the top marginal tax rates have dropped considerably from the peaks above 90%, the graduated income tax is a staple of the U.S. economic order. Barack Obama would raise taxes on the wealthiest, making the tax code more “progressive,” but John McCain wouldn’t undo the progressivism of the code: it’s here to stay.

3. Abolition of all right of inheritance.

We still have the right to transfer property upon our deaths, but that right is subject to taxation. Still, not “all rights” of inheritance have been abolished, so I guess we fail to meet Marx’s third condition.

4. Confiscation of the property of all emigrants and rebels.

We don’t quite meet the grade here, either. No one dare act in open rebellion to the all-powerful federal government — we haven’t had any “rebels” since the War Between the States, in which the North followed Marx’s prescription and confiscated the property of rebels. Marx, it is said, was an admirer of Lincoln.

5. Centralization of credit in the hands of the State, by means of a national bank with State capital and an exclusive monopoly.

There’s no ambiguity whatsoever here: we have exactly the system Marx envisioned in the Communist Manifesto. And what’s more, there’s literally no disagreement on the matter between the nation’s dominant political parties.

Credit is centralized in the hands of the Federal Reserve, the country’s national bank. The Federal Reserve System acts as a cartel with an exclusive monopoly on credit and money creation. Thus, the government can easily fund pseudo-Marxist schemes via its printing presses — which has allowed it to cut back on Marx’s heavy progressive tax code. Even Marx could not have imagined the willingness with which people all over the world trade real goods and services for essentially worthless paper notes. In this area, we’ve out-Marxed Marx!

Next time, I’ll look at the remaining five planks:

  • Centralization of the means of communication and transport in the hands of the State.
  • Extension of factories and instruments of production owned by the State; the bringing into cultivation of waste-lands; and the improvement of the soil generally in accordance with a common plan.
  • Equal liability of all to labour. Establishment of industrial armies, especially for agriculture.
  • Combination of agriculture with manufacturing industries; gradual abolition of the distinction between town and country, by a more equable distribution of the population over the country.
  • Free education for all children in public schools. Abolition of children’s factory labour in its present form. Combination of education with industrial production.

Collapse of Auction Rate Securities Market Under Investigation by Justice Department

An auction rate security generally refers to a debt instrument with a long-term nominal maturity for which the interest rate is regularly reset through periodic auctions. It allows issuers to borrow for the long-term but at lower, short-term interest rates.

The auction-rate securities market involved investors buying and selling instruments that resembled corporate debt whose interest rates were reset at regular auctions, some as frequently as once a week. They were sold as being safe as cash.

Over the years, auction-rate securities became popular among investors looking for cash-like options with slightly higher yields than money-market funds and certificates of deposit. The investments—in reality, long-term bonds—were considered more like short-term debt because they could usually be sold at weekly or monthly auctions.

In August 2007, investors began pulling out of the auction-rate-securities market. It seized up earlier this year when Wall Street firms who kept auctions from failing by stepping in to buy any unpurchased securities stopped supporting the market en masse, leaving millions of investors without access to investments they believed were nearly as liquid as cash. Tens of thousands of investors nationwide — including institutional and individual investors, cities and towns, charities and small businesses — were left holding damaged, illiquid securities when the market collapsed.

The U.S. Justice Department is now ramping up criminal investigations into the collapse of the auction rate securities market. Federal prosecutors in Brooklyn,New York , are looking at whether Lehman Brothers Holdings Inc. defrauded its clients by dumping auction-rate securities into their accounts before the market broke down despite knowing the market could collapse. The prosecutors are probing Lehman’s handling of investments for two brothers, Brian Maher and Basil Maher. The brothers sold their family’s billion-dollar shipping business and invested some of the proceeds with Lehman. They lost access to $286 million that was tied up in the securities when the auction-rate market collapsed. Another issue being probed is whether the firm used clients’ money to purchase the securities to prop up auctions that might otherwise fail.

Federal Prosecutors are also probing the role of UBS employee David Shulman to decide whether to charge him with insider trading for selling his own holdings of auction-rate securities ahead of that market’s collapse. Shulman ran the auction rate securities business for UBS. As the credit crisis began to scare away buyers for many types of securities, UBS began to buy up the securities so that the auctions, which the firm ran, wouldn’t fail. Shulman was under pressure from UBS executives to reduce the firm’s holdings of the product, and he allegedly helped mobilize UBS brokers to sell more of the securities to customers as safe cash alternatives, despite his knowledge that the market may not hold up. Around the same time, Shulman sold more than $6 million of his own inventory of auction rate securities.

So far, most investigations have been about the role played by institutions and banks. These investigations are among the first to look at whether individuals committed crimes as the market collapsed in the credit crisis – a step in the right direction.

Chaos Theory in the Financial World: A New Trend in Central Banks’ Monetary Policies (Part I)

On the surface it seems simple enough. The Federal Open Market Committee (FOMC) of the Federal Reserve adjusts interest rates to manage both inflation and the economy. When inflation rises, the FOMC raises rates, which limits the money supply, raises the cost of credit and slows economic expansion to a manageable level. When inflation falls, the FOMC lowers interest rates, which (in theory, at least) floods the markets with money, lowers the cost of credit and encourages economic expansion beyond its current level. Central banks from Sweden to Australia follow this model, which has been standard practice for the past decade and more.

So if it’s that simple, why can’t central bankers agree amongst themselves? Why was it that, as recently as August, when the Bank of England’s Monetary Policy Committee held its scheduled meeting, seven members voted for no rate change, one voted for a hike and one voted for a cut?

The Taylor Model

The model generally used to determine the Federal funds rate was first proposed by John Taylor in 1992. This model utilizes a mathematical formula to balance inflation against the optimal rate of economic growth for each nation, with the sum of that equation indicating the proper interest rate necessary to achieve that balance. Because the rates of inflation and growth change over time, the interest rate must change in harmony to accomplish its goals.

However, according to a new school of thought, the Taylor model might be causing the very problems it’s attempting to correct.

One variable the Taylor model seems to miss is outside or unexpected shocks to the economy. Granted that any model flies out the window when the entire financial framework is rocking—you just grab whatever’s closest and hang on. But surely we can do better than ignore the pressures leaning on the markets and causing those shocks?

Of Fractals and Finance

Dr. Charles Ivie, a retired NASA analyst with a keen interest in the mathematics of chaos theory, verbally rubbed his chin when asked that question.

“The trajectory of a rocket is determined by Newton’s laws and by celestial mechanics and is completely deterministic,” he wrote in an email exchange. “Market behavior is more like that of an infinitely branching tree. …The actions of the individual players are multidimensionally recursive. By this I mean that individual investors react to a multitude of events and data elements to make their decisions. And these decisions are not always based on objective reality.”

He’s a rocket scientist; he should know.

Perhaps it’s no coincidence that, since the concepts of fractals and chaos theory have gone mainstream, central bankers have started to wonder if the Heisenberg uncertainty principle might not apply to national-level interest rates. If the very act of observing a phenomenon alters it, do we really know enough to jump in?

“In the case of economics,” Dr. Ivie wrote, “investors don’t just observe, they participate so the alteration of the process is compounded. It is this fact that suggests that economic behavior is mathematically chaotic.”

The new school of thought among central bankers, as suggested by an analyst at Danske Bank, could be called the non-activist school. More concerned with structural-level determinants, such as the switch from hydrocarbons to wind or solar energy and the effect that change will have on their nation’s financial foundation, this non-activist school has less time for short-term variables such as the rate of inflation or economic growth. (Of course, it’s also true that much of the financial distress of the Great Depression was caused by the Federal Reserve’s inaction, meaning they’re damned if they do and damned if they don’t.)

According to this school of thought, the current trembling in our global financial system has its roots in loose monetary policy during and after the 2001 recession. It can be argued that lowering interest rates now not only may not help the situation, it also carries the potential to make it much worse. If the global marketplace is not understood well enough to be quantified—if such an action is even possible—then the more the system is tampered with, the more likely it is that an unknown variable will kick in, resulting in unintended and unwanted complications or an even bigger shock to the system. And the biggest variable of all, human nature and the power of emotions, is harder to calculate than the path of the rockets we sent to the moon.

Thoughts on Game Theory: Why Do Restaurants Serve My Food to Everyone?

As an impartial observer, I’ve often wondered why, when I go to a restaurant in a group and order a dish, do they bring my order along with everyone else’s, and then serve my food that I ordered to everyone on the table! For example, if I order six dumplings, and there are six people in the group, the waiter will casually give each person a dumpling, and I get only one. Whereas I ordered six thinking that I would eat all of them. As a result, my hunger is not satiated.

Also, if I want to eat well, I must have the dishes that others have ordered which I may not like. My wife says that this is good etiquette, and that my not understanding this simple fact highlights my lack of social graces. As a person with a suspicious mind however (and a game theory one at that!), I have a different take on the issue.

When a group goes to a restaurant, either they all share the bill equally or each pays for themselves. It is considered less awkward and simpler if the group (all things being equal), split the bill equally. This means that as an individual, when I want to order something on the menu, the price of whatever I order drops proportionately to the number of people on the table. For example, if an item I want (say king prawns) costs $50, then I will only have to pay $10 if my group has five people.

Now I have no control whatsoever on what other people order. By not ordering anything expensive, I can’t guarantee that others will do the same. Therefore, it is in my best interests to order everything I want without looking at the price since I will never again get an 80% discount! True, others may share my meal, but in an expensive restaurant, you’re usually not paying for the raw materials of the food itself but for the ambiance, the nicely dressed waiters, etc.Expensive Restaurant

Image Credit: Matt and Kim Rudge

Since we assume that each person in the group is rational and is thinking just like me, they will order expensive things too, and so the total bill turns out to be extremely high. A variation of the prisoner’s dilemma actually.

Of course, if it was decided beforehand that each person will pay for what they order, then I will be much more circumspect about what I decide to eat. I can’t afford to pay $50 for 5 shrimps!

Knowing this, it is in the restaurant’s best interests to ensure that everyone shares the bill equally, since only then will each person go berserk with their orders. Therefore, they must operate in such a way that it becomes very difficult to gauge who has eaten what.

One of the ways to do this is to serve everyone’s dish to everyone under the cloak of “etiquette”. In fact, I won’t be surprised if they invented the practice in the first place since and started calling it Good Manners. Good Manners it may be, but it’s also good business sense.

Of course, if you’re a greedy person and want to sample expensive food that you would never normally eat, you must get into a group of people you don’t know very well and who are not very well off. You must then convince them to go to an expensive restaurant so that you will be the only one to order expensive food and make them share the bill. I would assume you can only do this a couple of times before your group started to feel the pinch.

Sometimes however, a person’s personality can be so captivating and charming that others forgive them. Or say you’re a beautiful woman in the company of four men, they will not only forgive you, but fall all over themselves in fighting over your bill. You can then show how independent you are by paying “your share,” when actually you’ve shifted over all the expensive food’s cost to your lackeys!

Consumerism in the U.S. Healthcare System: Why We All End Up Paying for the Most Expensive Treatments

The theme of my last several posts has been the profit motive inherent in the medical system. Many parties appear to be responsible for this including industry and the physician’s lobby. I submit that the most responsible party is the consumer. The consumer is the one who demands the most advanced procedure, the best medicine, and the “best” doctor. The consumer is the one who demands the best prognosis and a return to the highest function possible.

One example of this is the cyberchondriac who comes in demanding the latest medicine or implant that they have seen on television. You explain to the patient that you feel that the generic medicine is just as good and is cheaper and that you are most comfortable with prescribing it because you are familiar with its side effects. However, they have seen the commercials and they have heard of the snazzy brand name. Additionally, they do not mind paying the exorbitant price of the brand name.

It is not unusual to also have the healthy young asymptomatic patient who would like a routine work up of all of his labs. My feeling is that if you are young and have no symptoms you should have the most inexpensive tests done, if any tests at all. If they are normal then you shouldn’t have anything done for a while. These patients are the kind of patients that want to stay on top of their healthcare and come in for unnecessary tests.

Sometimes there is a patient with knee pain without a history of trauma. The patient wants an MRI when there is ample evidence that the majority of knee pain resolves within six to eight weeks of conservative therapy including icing, NSAIDS, and activity modification. The MRI costs about a thousand dollars, but the patient doesn’t care because his insurance pays for it. Thus he insists to have one and if one is ordered there is a reasonable chance that it might show an equivocal signal in the mensicus. Then an expensive Orthopedic referral is made. If the surgeon is unscrupulous or if the patient insists on having surgery, an arthroscopic procedure is done. And the chain of expensive events goes on and on in this manner, costing the health system a lot of money for an issue that probably would have resolved on its own.

The underlying theme driving the demand of healthcare by the patient is a sense of entitlement. We in the United States don’t understand that if you travel halfway across the globe there are thousands of people dying everyday of disease caused from lack of basic sanitation. But when we have an annoying pimple or wrinkle on our forehead we want to pay several hundred dollars to have it zapped. When we have pain we want and expect our healthcare system to fix us. If we are not fixed then we blame the doctor and the system.

In the end, the most expensive thing is human resources. If we as patients make people work to improve our health it is going to cost money. That cost is worth it when the situation is dire. When it isn’t, the cost is wasteful. As a patient and consumer it is important to understand this concept–making the healthcare system work for you costs everybody a lot of money and makes the system more expensive. We are all intertwined in this manner, whether we want to believe it or not.