Taking economic rage too far

Many people are enraged at the bonuses received by executives that have destroyed their companies.  That makes total sense.  If a bonus isn’t for performance, what is it for? 
 
I am concerned though about the latest supposed scandal with AIG.  Rewards were given to top performers in the form of expensive retreats, or that is the story.
 
If those were in fact top performers getting rewarded, as opposed to parasites, cancelling their reward for true performance, after it has been granted, is a dangerous precedent when the motive is PR rather than economics.  Star performers usually have strong egos and if you kill their incentive they will either walk or become disgruntled and perform worse. 
 
Stripping a business of the elements that are performing, for the sake of costs savings, is a false economy.  That can be the last nail in the coffin of a business that is struggling if you send the message to the top performers that they are not wanted. 

Two trillion in Monopoly money evaporate- what did you expect

In addition to regular currency and credit which has become in effect an additional form of currency, there are a lot of transactions based on the nominal equity that are just play money until somebody gives real money for it. 
 
There is one underlying problem in the situation that is nobody’s fault in particular and that is that the baby boomer demographic was going to cause a big jump in the market that wasn’t based on much other than the availability of their money, followed by a tremendous crash when they tried to cash in.  Whether that played a part in any of what went on it hard to say, but that was going to happen.  Apart from the economic issues and bad accounting leading to the fall of the markets, the drop was inevitable.
 
For that two trillion dollars that have supposedly disappeared to have ever been cashed in and changed from play money into real money without dropping the market, the investors with that two trillion would have to find replacement investors who would spend two trillion real dollars for two trillion in play money in the hope that it would continue to go to higher levels of play money that could then be bought out by some other schmucks.   For demographic reasons that wasn’t very realistic. 
 
The boomers and the others along for the ride got a whole lot of paper equity with the problem that there could never be any significant draw on it, because that would drop the market and destroy the equity.  The money can only go out as fast as the money comes in, or the market will go down.   Hourding all of the wealth into a relatively small amount of the population who then invest in play money has a self defeating effect.  They become victims of their own success because there aren’t enough people with real money that aren’t already in the market to buy them out and convert the play money back into real money. 
 
 
From January 1995 onwards the chart becomes completely erratic with tremendous increases.  The Dow had a ceiling at about 1000 points until about the end of 1982.
Then there are increases that are roughly linear until 1995, with some jumps and corrections on the way.  Note in the big crash of 1987 that while the Dow "lost" a quarter of its value, it just returned to the line.  The Dow went up to 2.5 times the value in 3 years at that time.  That doesn’t make any sense and it had to come down.
 
Project the line from January 1985 to January 1995 or so forward and we get around 7500 at the present day. Look at the most recent relevant minimum on the chart, September 2002 at 7591 and you are about the same.  These are both things that stock market analysts would normally see as indicators of a possible floor at 7500. 
 
If you only look at, say, the charts for the past ten years all that you will see is a bunch of smoke and mirrors because you have to go back more than ten years to correlate the overall market with anything.  The market got too flooded with money.
 
Part of the original idea behind the Dow I think is supposed to be that those companies are so huge that their well being is a good indicator of the well being of companies everywhere, the numbers should not be erratic like smaller companies.  The idea that these companies could double in value every couple of years is preposterous at their size.  They would take over the entire world in a very short time if that were the case.  For companies of that size to double in real value between 1994 and the present would be quite an achievement.   
 
The analysis of the overall market though is distinct from the analysis of company specifics and the dire straights of some companies may well drive the market below 7500.   I’d give at least a 60% chance that the Dow falls below 7600 within the next year.  If it drops further than 7000 for a significant time, it is hard to say what will happen.  Play money with fantasy accounting is a brutal combination and I suspect that the market will ultimately go under 7000, although I do see a good chance for a floor at 7500 based on trader’s market analysis kicking in apart from the merits. 
 
I am annoyed at the federal reserve for lowering interest rates, a way of prolonging the recovery.  I’m also annoyed at them gifting liquidity without strings.  They give away money in the anticipation that the banks will extend the liquidity to customers, but the banks hourd it instead.  Any monies so extended beyond the normal should require some degree of reciprocity from the banks, at least as far as continuing to supply money to reliable customers.   When the banks keep demanding more so that they can extend credit, then don’t do what they said they would, that is a scam that should perhaps itself be investigated. 
 
There is that problem with the artificial scarcity of actual physical money that probably concerns the banks.  To that end, guaranteeing deposits as Europe has done is an idea that looks good.  There is about $2000 in physical U.S. currency per capita physically in the United States, or was 3 years ago. There is probably more now.  If everybody went to their bank today and withdrew $2000, that would probably blow up the entire system.   $2,000 isn’t much.   Even a minor bank run is potentially devastating.  $2,000? Lots of people have a lot more than that.   A small percentage of the population converting savings to cash can cause a major problem.
 
 
 
 

New Monetary System Needed

Dollars and physical currency are easy to follow.  They are also easy to regulate.  Only the Federal Reserve has the right to print US dollars for instance. 
 
There are probably less than a trillion US dollars actually in circulation, probably no more than half a trillion of these in the US. http://en.wikipedia.org/wiki/United_States_dollar
 
Many transactions, especially larger ones, are never actually translated into physical currency.  With cheques, electronic transfers and the like, money can go around and around in paper and the electronic ether between various accounts and the like for a long ways before it gets converted into physical money.
 
Compare the number of physical dollars available with other figures, such as market capitalization http://en.wikipedia.org/wiki/Market_capitalization and even the market capitalization of Exxon http://en.wikipedia.org/wiki/Exxon_Mobil.
 
If you went to buy Exxon with every US dollar in circulation, you might have enough.
 
The Dow Jones Industrial Average companies are supposedly worth something over 10 trillion dollars if you go by market value.  The market bailout passed by congress involves almost as much money as physically exists. 
 
How is all of this possible?
 
Most financial transactions aren’t ultimately backed by paper money any more.  There isn’t enough of it to do that.  Some will eventually come down to paper money, but think about how often we actually use the stuff.  Now with debit cards, a  person can almost exist without touching physical cash. 
 
I think that an age of electronic currency has crept up on us.  We tend to conflate it all as money but that isn’t a perfect analysis.  To the extent that the financial system has become electronic credits going around in circles, we have developed something of a parallel currency.  That is not necessarily a bad thing.  I think that there is an artificial shortage of physical money and electronic currency has jumped in to fill the gap. 
 
The problem is, while we have a Federal Reserve for hard currency, there is no such thing for notional currency, whether in paper or electronic.  There needs to be some sort of regulation of this, although I can’t say that I know what that is.  I do know that if there is a new form of currency that we don’t control in any deliberate fashion, then we place the liquidity of anybody relying on this currency in the hands of either chance or potentially manipulators.   What happens when this currency that we imperfectly understand and which doesn’t have a Reserve bank drys up, because it relies to a certain extent on faith? 
 
In such a case, printing hard money won’t necessarily lead to inflation to the extent that the physical currency liquidity is only picking up the slack from electronic liquidity.   Inflation could result from that anyways if people devalue the dollar because they don’t understand the process.

Good for Wells Fargo – go captitalism

 
One thing that bothers me about the way that the market has been going recently is that it seems like a couple of days after a bank maintains that it is doing fine it collapses and then 15 minutes after it collapses (if it has collapsed) the treasury department has transferred all of it to some other bank in some obviously prearranged deal. 
 
There should at least be some kind of bidding war over the carcass.
 
When there is no bidding war and the assets get sold for peanuts, first of all there is the possibility that this is a government assisted hostile takeover and that fair market value may not be given without an open bidding process, and second the low bid further reduces faith in the markets. 
 
The Wells Fargo bid shows that the assets of the ex-bank are worth fighting over, i.e. it isn’t as bad as it seems.  We need more of that. 
 
And one of the things that I hate most about government is closed bidding systems where they give important deals to their buddies.

Senate passes crappy bill

So the US senate has now passed a bailout bill that is even crappier than the one proposed by the house. 
 
I’m conflicted as to which direction to be cynical in.
 
Since the bill is worse than the original, they may be relying on the house to shoot it down for them.  That way the senators can pretend to have done something.
 
Or if it is an attempt to pass even worse schlock than was shot down, in the hope that added pressure will cause people to switch positions, it is just an abuse of process. 
 
Some sharp thinker in the house should just move to adjourn the session, and if it passes suddenly the bill dies.
 
In Canada, former prime minister Brian Mulroney, the worst prime minister in Canada’s history by a wide margin, nearly destroyed the country with his brinksmanship with two attempts at constitutional amendments that were against the will of the people.   The amendments failed in part because they were incredibly stupid, and also because he created tight artificial deadlines and a pressure-cooker atmosphere that was an affront to all involved.   I see the same sort of gamesmanship occurring right now in the United States.  
 
The net effect of Mulroney’s style of politics was that after he quit, his party only got two seats in the following election and lost status as an officially recognized political party.  
 
I do have to wonder if there is an element of creating a crisis in the sort of issue that the Republicans have previously been [incorrectly] perceived as the best party to handle, things to do with money.   If so that would backfire royally as it destroys the Republican brand.   Even if they fix it [impossible], they own the crisis.

Cooking the books, now with the special SEC sauce

 
Lax accounting standards are one of the main reasons why we get an Enron or a Bear Stearns where a multi-billion dollar corporation evaporates overnight.  There has been insufficient regulatory control of this and that is one of the main causes of the oncoming depression.
 
The SEC has found the perfect solution: legalize cooking the books.   Now if they get their way it will be legal to fudge the value of a thing upwards so as to delay the attribution of losses, presumably so that it will be easier to suck in investors and lenders and keep the bubble going. 
 
Like the bailout, all the solutions seem to be aimed at keeping the various bubbles inflated rather than fixing underlying structural problems.  
 
Making it legal for companies to cook the books, which may provide a complete defence to later criminal and civil proceedings, may well have the opposite from the intended effect.   If the books then become meaningless, they don’t help lenders do their due diligence.  It could make lenders wary of companys that aren’t doing any monkey business and would increase the cost and delay related to due diligence because due diligence would then require always going behind the books and having the lender perform its’ own audit.  In today’s crooked times that might be a good idea in any event, but allowing companies to provide more dubious material is not going to increase lender confidence.
 
Somebody needs to head down to the SEC and fire the lot of them.  Replacing them with farmers with no formal education would probably be an improvement.
 
Of course this is almost certainly tied in with a plan to overvalue the worthless securities that will then be sold to the government if the government is stupid enough to pass the bailout bill and then provide them with an SEC supported defence to any future fraud charges when the US citizens get nothing for their money.
 
 
I actually saw the present disaster coming probably 20 years ago and got the general idea of how things would go down.  There was an article, I think in Time Magazine, about how Coke had turned itself around with some supposed whiz at the helm.   He said that the key to making money was to borrow money and then get a higher return on it.
 
That is true.  If you borrow money at 10% interest and get a 15% return on it you will make money.  But the defect that I saw immediately is that comparing the debt interest with the interest on the investment is comparing apples to oranges.   You get a guaranteed liability but there is nothing guaranteed about the rate of return that you get.  If you are good, yes you probably get a favourable return at the outset.  But the world changes fast.  There could be an economic downturn or other problems and then maybe it is a 5% return and 10% interest.   That can also mean being dependent on loans for cash flow, a dangerous position for any business to be in.   A healthy business can have to firesale assets to generate liquidity if it puts all of its eggs in one basket in this way.
 
Getting that higher return on borrowed money also tends not to happen as often as it is supposed to.  Maybe the star at Coke knew how to pick winners with various assets.  That is often not the case.   We hear a lot of babble about synergies but not about the reverse of synergy, whatever that might be.  Is there even a word for the opposite of synergy? Whatever it is, there is more of it than synergy out there.   Two out of every three mergers out there lose money.  Mergers are mostly about ego- the empire building of the heads of the corporation that buys the other one.   What follows will often be a culture clash.  "Irreconcilable Differences", a book about the clashes between Ross Perot and Roger Smith following the merger of EDS with General Motors may given insight into a lot of things that are wrong with today’s business culture.  When you try to force that "synergy" by crushing the culture of the bought out corporation, you risk killing what made it work and made it profitable.
 
Intangibles have a great effect on the way that a project works and the financial outcome but because they are difficult to measure quantitatively and there may be no way to graph them, the downside risks that they represent are almost always under-represented.  If you treat people like they are wires or circuitry or diodes and interchangeable with one another you will be regularly disappointed.  The effects of these intangibles once manifested of course become measurable.  Business people and the wrong type of MBA types like things that can be graphed and quantified because the apparent inevitability of the consequences predicted in this way leads to increased confidence.  Increased confidence without increased accuracy is dangerous.  Predictions are rarely as inevitable as they are made to appear.
 
And then there are times when you can be pretty sure of an outcome without doing any complicated analysis at all.  You look at the philosophy of borrowing and then investing the borrowed money at a rate of return that isn’t guaranteed and the structure makes it very likely that any business that does this will have a serious rough patch when circumstances are tough and the return drops below the borrowing rate.  If the company is too heavily leveraged when that happens it will go bust.
 
Why is it that big business for the most part doesn’t seem to realize that there is a business cycle, or that the economy evolves over time?  There seems to be awfully little planning for the downturns that always happen.   The downturns also tend to be more severe when there is less regulation, which is why much of the regulation of business came in to being in the first place.