Economic Ignorance

National Embarrassment

The current leader of the Labour Party in New Zealand, Andrew Little appears to be more than a few sandwiches short of a picnic.  His career before becoming a professional politician consisted of being a union manager.  His commercial experience is, to put it kindly, somewhat limited.  But he is steeped in the ideology of class warfare--workers versus the capitalists and that sort of thing.

We find ourselves embarrassed by the apparent ignorance of the man.  He often shows that he has little clue about how three quarters of the rest of the population think, live, and act.  For Andy, it's all about class warfare: the oppressed proletariat versus the capitalist pigs.

He is at present promoting a bill in Parliament, the Healthy Homes Guarantees Bill.  This would require landlords to ensure that all rental homes are warm and dry, and that each home must have a heating source.  When it was pointed out to Andy that this would inevitably mean that rents would go up, Andy fiercely denied that would be the case, unless the respective landlords were rapacious and greedy.

One cannot miss the slime of class warfare oozing forth.

Paradigm Shifts Put Entrenched, Privileged Business at Risk

Monopolists and Rent Seekers

Various investment gurus, Warren Buffet included, have sometimes described the best investment opportunities come when one discovers a business protected by a wide, deep moat.  The barriers to competition are high.  The business in question is market dominant.  Such businesses are able to operate as a virtual monopoly.  They sit at the toll bridges over the moat and click each passing  ticket to pecuniary advantage.  If you can find a business like that buy it.  It will reward you handsomely.

But, and it is a big "but", all too often such wide-moat businesses are allowed to exist because they are protected by perverse government rules, regulations, and laws.  Competitors are not able to enter the market and drain the moat.  It is not that they themselves are not efficient, or their service or products are sub-standard, it is more that the incumbent company is protected by unjust and perverse laws rather than the loyalty of free consumers.

A market place and economy which truly respects the property rights of all citizens will abhor state licensing, rules, and regulations which impede competitors coming into the market.  When competition is free and open, watch the feather-bedded monopolies collapse; watch the water levels in the moats drain away.

One such case being played out right now is in the taxi industry, facing competition from Uber.  New York is providing an instructive example.

New York’s Taxi King Is Going Down

People don’t deserve to be millionaires because they can get government to let them pick people’s pockets.

By Jared Meyer 

The Federalist

Evgeny “Gene” Freidman is no fan of Uber. The increasing popularity of this vehicle-for-hire (or ridesharing) company has lost him millions of dollars. He has even asked New York City taxpayers for a bailout. As difficult as bailing out the big banks was to swallow, bailing out a taxi mogul—who at one point owned more than 1,000 New York City taxi medallions—is an even harder sell. A bailout would be especially outrageous considering that Freidman and his financial backers are actively working to make consumers pay more for fewer options.

Freidman reluctantly took over his father’s modest yellow taxi business as a young man. He brought his experience in Russian finance to the industry, and started to accumulate increasing numbers of taxi medallions using highly leveraged financing. Freidman expanded a company with just a few taxis into a conglomeration of three- to five-car mini-fleets. 

As Freidman’s taxi empire grew, he expanded into other cities, including New Orleans, Philadelphia, and Chicago. He gained control of hundreds more medallions that are also now in financial trouble. His willingness to bid on practically any medallion that came up for sale helped drive a rapid increase in medallion prices across the country.

Subprime Taxi Medallions

This model can work when times are good but, as the housing crisis showed, it has its dangers. It works until another technology emerges, consumers move on, and funding dries up.  This is where Uber comes in. Competition from Uber has left investors wondering how much the company will grow and what further effects its growth will have on taxis’ market share. While yellow taxi medallions were selling for $1.32 million as recently as May 2013, now they may be worth as little as $650,000.

This drastic drop in price has made the banks and credit unions that fund Freidman’s vast enterprise nervous. For example, his companies still owe around $750,000 for each medallion financed by Citibank. Without new loans to meet existing obligations and expand his fleet, Freidman’s companies became insolvent. This is why he sought the bailout and wants the government to support the medallion market by offering taxpayer-guaranteed loans.

Adding to this financing crunch, the lease rates Freidman now can charge taxi drivers who rent his cars have declined. Many taxi drivers switched to Uber, which offers increased earning potential, flexible work schedules, and improved driver safety. Competition led Freidman to complain that he is no longer able to charge the city’s legal maximum lease rate. This is promising news for drivers, but problematic for Freidman’s income.

There’s Not Much Argument for a Monopoly

Medallions commanded such astronomical prices in New York because yellow taxis had, and still do have, a monopoly on street hails in Manhattan south of the northern boundary of Central Park. Ubers come rapidly, but they are not street hails, because people summon them beforehand with a smartphone. In cities across the country that also use a medallion system, the same reasoning applies. Government restricts the supply of taxis below the level of demand, and medallion owners reap the profits—all at the expense of consumers.

It is not just Freidman’s companies that are in trouble. The banks and credit unions that funded him and other medallion owners are also worried. Just four credit unions hold security interests in over 5,300 medallions, for which they are on the hook for about $2.5 billion. In the face of greater potential losses, these companies have resorted to calling people who work in policy (myself included) to try and convince researchers that Uber is illegal and needs to be banned.

The credit union argument progresses as follows:

1. Yellow taxi medallion owners were granted a monopoly on street hails.
2. For-hire vehicles are only allowed to offer pre-arranged rides.
3. Uber uses street hails, not pre-arranged rides, to connect riders with its driver partners.
4. Therefore, Uber is illegally using street hails, and this infringes on yellow taxi medallion owners’ government-granted monopoly.

If the third premise is true, this argument could hold some rule-of-law water. It is not. The law governing New York City’s street hails date back to the Haas Act of 1937. This law restricted the number of New York yellow taxi medallions to 16,900, which was lowered and now stands at 13,437—even though the city’s population has grown by over 20 percent since 1940.

The Haas Act also set the stage for other common carrier regulations that apply to the taxi industry. These regulations place substantial limits and requirements on taxi owners and drivers in exchange for their monopoly privileges. For example, the city’s Transportation and Limousine Commission sets fare prices, and fares cannot change with increased demand for rides. This is one of the main reasons it is so difficult to hail a taxi in the rain or at the beginning of rush hour.

Updating regulations takes time, but New York City taxis were finally granted the ability to accept ride requests from smartphones (e-hails) early this year. Once taxis were allowed to accept e-hails, something they needed to compete with new technologies, four credit unions argued that the technology was now off-limits for Uber—the company that had popularized e-hails. They sued New York City for infringing upon medallion holders’ monopoly privileges.

This makes no sense. How can a decades-old law covering street hails be construed to cover ride requests made through smartphones? Anyone who has tried to hail a taxi on the side of the road, and then used Uber, knows that the two experiences are vastly different. Simply put, holding your hand up is not the same as pressing a button on your phone.

How to Save Taxis Without Squeezing People

The path forward is not to ban ridesharing or bail medallion owners out. It is to make taxis more like Ubers. This takes more than simply allowing taxis to accept e-hails. Rather, the only ways to save taxis are greater flexibility in pricing and service and increased competition.

As Uber’s rise has made obvious, when the crucial aspect of competition is missing from markets, established companies do not have to worry about improving their services to attract and keep customers. Regulations need to be continually modified and updated in light of new technology.  There is no reason to require New York taxis to have expensive (and annoying) Taxi TVs. Pointless mandates such as this only increase the cost of taxi rides.

Even with a relaxed regulatory framework that embraces ridesharing and competition, taxis will still have an advantage. No one is talking about taking away New York City’s yellow taxi monopoly on street hails. Applying antiquated laws and regulations to new technology is what laid the groundwork for the rise of Uber and other ridesharing services in the first place.

Everyone Shouldn’t Pay for Some People’s Bad Bets

Credit unions oppose allowing Uber to grow because they want to protect their investments. The Queens County Supreme Court ruled against the credit unions last month. The court found that the credit unions did not have a cause of action against the city and its Transportation and Limousine Commission. This was a major win for Uber and consumers, but a death-knell for Freidman’s business and its financers.

The whole yellow taxi financing model is crashing, along with medallion prices. After the ruling, Montauk Credit Union, one of the plaintiffs, was seized by the New York State Department of Financial Services because of “unsafe and unsound conditions.” The day that New York City’s proposed cap on Uber’s growth was defeated, 22 of Freidman’s mini-fleet companies filed for bankruptcy.

Even if medallion holders such as Freidman lost a lot of money, it does not follow that the public should subsidize their losses. The returns from a yellow taxi medallion in cities such as Philadelphia, Chicago, or New York far outpaced the stock market or gold for many years. The values of these medallions about doubled in each city from 2009 to 2013.

Investments carry risk, as Freidman knows from his background in finance. He made a poor calculation that the Manhattan yellow taxi street hail monopoly would continue to provide him enough future cash flow to satisfy bankers, who would loan him more money to expand his fleet. Freidman and his investors have no claim to a taxpayer-funded bailout to cover their poor business decisions. Perhaps they should consider investing in Uber instead.

Jared Meyer is a fellow at Economics21 at the Manhattan Institute for Policy Research. You can follow him on Twitter @JaredMeyer10.

Ruminations On "MRP"

How "Mighty" is Mighty River Power?

In New Zealand the government is selling down 49 percent of some Crown owned businesses.  The objective is to reduce government borrowing and debt service.  It is all part of the drive to get the country back into fiscal surplus within a couple of years or so.  This objective is laudable and to be strongly commended.

The first of the businesses to be floated is Mighty River Power ("MRP"), a state owned electricity generator and retailer. The float looking like being wildly popular.  We are not so sure. 

All investments have positives and negatives. MRP is no exception. It can be assessed on a long term basis versus a short term basis.  Probably on a short-term basis the share price will appreciate.  Share demand hangover will likely contribute to post-float demand. Who knows?  But on a longer term basis more serious questions about the company emerge.

Letter From America (About the Great Market Crash of 2012)

So, how's your green energy stock doing?

A fool and his money are easily parted.  Overreaching, arrogant scientists, bureaucrats, legislators, and media are more foolish than most. So they are more easily parted with money than most.  Which is poetic justice, apart from one great problem.  The money they so easily parted with was actually ours and our children's.  They has squandered, wasted, speculated upon, and gambled with our money, and recklessly borrowed our children's for their rash speculations.  

The great investment crash of 2012 was not the housing market, nor the derivatives market, nor Wall Street speculators--it was green energy.  The market has crashed by ninety percent!

This from the Washington Post.

Euro Break Up Being Priced Already

Watching the Smart Money

One of the issues being discussed at this blog is the survival of the Euro.  It is obvious that financial markets get really jittery when the break-up of the Euro portends.  Equally obvious is the relief rallies in markets when the risk-du-jour fades and the survival of the Euro is assured for another week or so.

What is often missed is that the smart money has already decided the Euro is going to break up.  When we refer to "smart money" we don't mean the billions upon billions traded daily in global stock markets and bond markets.   We mean instead the banks, investors, and companies putting real money (their own capital) at risk in actual trading of goods and services in Europe.  These participants are dealing with reality as best they are able to discern it, not speculation, rumours, or apocalyptic visions.

A recent article in The Blaze by Becket Adams looks at what the "smart money" is doing in Europe.

Conflicts of Interest

Big Brother Shareholder

Mighty River Power will be a dirty float.  The Prime Minister, John Key has confirmed it.  The dirt in this float usefully illustrates how governments "do" commerce badly. 

Firstly, let's paint the more general picture, before addressing the dirt.  For governments, politics matter: their real constituency is not the owners of a business, but the voters whom they must either impress or placate.  Governments always stand ready and willing to trade off the rights of property owners, making them the fall-guys for the "greater good" which just happens to be the good of the current governing political party.

SS Facebook Floats Then Sinks

Take the Money and Run

Did you get some Facebook shares?  Well, good for you.  You will now be part of the glorious rags to riches story.  But maybe not.

There are some uncomfortable rapids ahead.  Firstly, an old sage once observed that only fools and horses buy initial public offerings (IPO's).  OK, so you are going to miss a bargain occasionally.  But the whole purpose of a public offering in almost every case is to dress the company up for sale, hype it, promote it, tell all the goods news that is to come so as to get the best possible share price. IPO's parade mutton dressed as lamb.

Thus with Facebook. And that leads to our second point: Facebook shares at the IPO were priced at one hundred times current earnings.  That means, if earnings stayed the same as today, you would have to hold the shares one hundred years just to earn back the price you paid--let alone get a return on your investment.  Care to hang around that long?  No, of course not, you say.  Why not?

Siren Songs of Populism and Easy Money

Becoming Serfs in Our Own Country

Economic xenophobes.  Welcome to the wonderful world of New Zealand populist politics.  Actually, it's a bit worse than that.  We are economic racist xenophobes. How cute to see the Green party revealing its anti-Chinese prejudice on the matter.  This from Kiwiblog:

When Bill English is over in Australia talking about how more and more Australian companies want to invest in New Zealand, and no politician says a word. But then you have a Chinese leader visit and promote investment from China, and the Greens rush out a press release. It is absolutely playing to xenophobia. Not all opposition is xenophobic, but much of it is – and politicians play to it.

But, there is an argument on the other side to be made.  The Prime Minister, John Key has said that he does not want a New Zealand where citizens are serfs in their own country.  That is a powerfully visceral line.  It raises a spectre that is not unrealistic at all.

Re-Thinking the Sale of Crafar Farms

Unintended Consequences

The decision of High Court Justice Miller to introduce a new interpretation of  legislation pertaining to overseas buyers of New Zealand assets will no doubt be scrutinised carefully in a number of quarters.  What appears at first glance is yet another activist decision by a Judge who interpreted the law to mean what he thought would be a better outcome for New Zealand.  If so, the Justice changed from being a judge to a political advocate.

The Smart Money

Buyer Beware

We have been approached by several folk wondering about the investment wisdom of buying some of the state owned electricity companies when they come on the block.  On the surface of it, power companies usually provide stable income flows, a good dividend stream, and solid earnings growth.  The stuff blue chips are made of.

But--there is always a but--let's not neglect the big-picture, or helicopter view.

Descendants of a Mad Emperor

 Fiddling While Rome Burns

Here is Bill Gross--one of the more sane and sage voices in investment markets today.  He explains why the debt situation in the US is much worse than that in Greece. It will drown us all.  Politicians not facing up to this reality are beneath contempt, guilty of a swingeing dereliction of duty on the grandest of scales.  How long must we endure political leaders attempting to lead by focus groups? 

Such politicians either perpetually back up or follow the herd.  Either way they are supine vacillating fools, not leaders.

A Fool and His Money are Easily Parted

Not Worth a Tilt

Not long ago we were cutting down through Ashhurst on our way to the Manawatu Gorge, and then on to Mangatainoka (you will all know what that's famous for) and eventually Carterton.  Those of you who have travelled this route will know that as you approach the Gorge it is wind-turbine city.  Since someone else was driving, we were able to count the number of turbines we could see that were not turning.  Seven.  Seven broken down turbines--at a quick glance.

To fix them requires a 600 tonne capacity crane--trucked out into the wop wops.  Access roads have to be maintained on some of the steepest country in New Zealand.  Slips and washouts are common.

The New Zealand Herald has a piece on maintenance being done at the Makara West Wind Farm, the country's largest.  It has 62 turbines.  It went live on April 29th, 2009.  So it is almost exactly two years old, operationally speaking.

Grumpy

A Different Form of Fun

New Zealand does not have many resident bears (economically speaking).  Bernard Hickey is about the only one.  The vast majority of economists and investment market sages have a pollyannaish "she'll be right" attitude, possibly because they believe so strongly in the competence and power of the State to make things right.

It is refreshing to read Hickey.  He has a happy knack of pointing out the elephants in the room which his colleagues have chosen not to see or to dismiss and inconsequential.  Here is his most recent column in the NZ Herald.

Well Said . . .

 Kiwi Cargo Cult

Here is Bruce Wills of Federated Farmers commenting on the prospect that New Zealand dairy farms are going to be sold to offshore interests:

Bruce Wills, who heads the lobby group's meat and fibre division, agrees the stance is purely pragmatic. But it is also necessary, he insists, if farming is to have a future. A former banker and valuer, he notes that debt has more than doubled in the agricultural sector over the past seven years to around $47 billion.

Wills agrees the Chinese seem to be taking a long-term view of the value of New Zealand farmland, given their concerns about feeding their own population. Although Fonterra is doing its best to capitalise on the same trend, most Kiwi farmers simply can't afford to take a similar long-term view, he says.

While a few dairy farmers are indeed creaming it, most are still deeply mired in debt, says Wills.

The More Things Change . . .

When a Snake Oiler Meets Venality

We have seen this before! In the early noughties a troop of investment banking marketers descended upon New Zealand and Australia, flogging structured finance instruments. Some wore pinstripe suits, spoke in plummy accents and hailed out of London. Others wore braces, loud ties, and hailed out of New York. They were selling "collateralised debt obligations" (don't you just love the euphemistic jargon), parcelled up into various risk tranches, each with respective credit-ratings and various statistical models assuring us that the risks of default were exceedingly low. And all this was being wrapped into managed funds, so that retail investors, the proverbial mums and dads, could get a slice of the heady action. And they did--in their thousands.

One had the distinct impression that it was the last gasp hurrah of a glorious party. Go out and flog this stuff one last time. Go to the end of the world, to the antipodes, to the colonies, where the gullible still reside. Sell and run. And they did and did. Now, when it all collapsed, shrieks were heard, blaming rotten and corrupt America for letting this happen.

But now it is a case of "fool me once, shame on you; fool me twice, shame on me". Bloomberg has reported that Illinois, that bastion of fiscal rectitude, has been struggling to find US citizens, pension funds, and institutions to buy its debt and fund its profligate entitlement, featherbedding, pay-off, deficit spending. So, guess what? The braces and loud ties have been dusted off again, and off shore the bond salesmen have trooped. A seven-country road show, with lights, bells, whistles, and back-slapping.

And, lo and behold, the stupid punters are once again stumping up their money. Lending to the most corrupt political establishment in the US! Why? Who would be so stupid?

The seven-country visit worked. The state sold one-fifth of the federally subsidized securities abroad the next month, tapping investors who are the fastest-growing source of borrowed cash for U.S. municipalities. Illinois, with the lowest credit rating of any state from Moody’s Investors Service, dangled yields higher than Mexico, which defaulted on debt in 1982, and Portugal, which costs more to insure against missed payments.

“U.S. states are among the cheapest sovereign credits in the world,” said Patrick Brett, a Citigroup banker who marketed the Illinois securities overseas. “You’re actually picking up a good amount of spread for arguably better credits relative to equivalently rated corporates and sovereigns.”

Don't you just love that language from Mr Brett of Citigroup: "arguably better credits relative to equivalently rated corporates and sovereigns . . ." This is a euphemism for "spin, spin, spin". If Illinois credit was sound, US investors would have picked it up. Because there is a real smell about state and local body deficits in the US--the smell of desperation--the locals know the risks and know that Illinois is the most intractably wretched, they fear the worst, and avoid them.

But, those greedy gullible overseas investors just cannot resist loud ties and braces. And we ask, who is the more culpable? Is it the dissembling snake oiler from Citigroup? Or is the greedy, smart-timing investor. But we are sure of this: when it all blows up, everyone will be unanimous that there is only one culpable entity in the dock--the big, evil investment banker. And those throwing the biggest, sharpest stones will be the oh-so-easily gulled investors who foolishly lent money to the most corrupt political establishment in the US, but whose venality willed them into a suspension of disbelief and prudence at the time.

Irrational Exuberance

Housing Bubbles and Cool Calculations

We are all aware that kiwis have willingly deluded themselves into thinking that residential housing is a yellow brick road to wealth. Actually, for a long, long time they have been quite right. But it is unsustainable. It is pyrrhic prosperity. Smart folk will be very aware of this and will be planning accordingly.

Now, in these matters timing is always critical. As Keynes once observed, "the market can stay irrational far longer than you can stay solvent". In other words, an investment market or asset may be way, way out of synch with fair value, but a return to reasonable prices may take years, decades, even generations. If you get exposed by betting the family farm or the household silver on the "market" pirouetting nimbly from irrationality to rationality--without considering that it may take decades to happen--you are speculating. Don't complain if the markets fail to perform within your required time frame.

Residential housing investment is a case in point. Let's be clear on what a rational market in residential housing would "look like". In case you missed it, a residential house is, well, a house, a building. And buildings depreciate over time, as does all plant and equipment. Houses eventually need maintenance and repairs. They wear out. They have to be replaced. This means that a ten year old house should be worth less than on the day it was first built. In general terms the land on which the house is built could be expected to appreciate in value over time because there is a finite and limited supply of land. There is only so much of it in NZ. Moreover, land never wears out (unless you are living in an area subject to coastal erosion).

So, a rational housing market should see the land on which the house is built increase in value over time, due to limited supply, while the house built upon the land decrease in value over time. But this is not the experience of New Zealanders in general. They have an expectation that whatever one pays for a house today, it will be worth more in three to five years time. This is a cultural axiom beyond dispute. It is a financial nostrum which only a fool would deny. Consequently, New Zealanders believe that housing is "safe" in financial terms. They are prepared to take considerable financial risks to own it. Even if they have to mortgage up their lives, in the end it will pay off as their house rises in value over time.

But it remains a fools paradise. Inflation--caused by a general increase in the supply of money--obscures the real fall in value of houses over time. A ten percent rise in market value of a house might actually be a five percent decline in real value by the time inflation is taken into account. Inflation is annoying in that it sends the wrong price signals that obscure real value.

But a far more significant factor distorting the housing market in this country, making it an irrational bubble, is the artificial limits upon the supply of housing. It is this which has worked more than any other factor to create a distorted, protected, housing market. The supply of houses has been artificially restrained not by a shortage of timber or other construction materials, but by local and central government restrictions upon house building. The Resource Management Act and local government town plans have restrained the supply of houses, reducing their supply, thereby jacking up prices of existing houses. This in turn has led to the nostrum that houses always rise in value. In the living memory of most people they have.

So, when you bet the family silver on a house you are probably going to be OK. Unless you are the one caught when the bubble bursts. But what would cause the bubble to burst?

A real depression. A really serious economic depression, lasting ten or so years, goes through phases. The first is the rapid contraction due to firms laying off staff and going bankrupt. Unemployment rises, spending falls, and credit contracts. The fall of demand and the turning off of the money-spigots means that prices fall, cash is king, bargains can be found. This is the first phase.

The second phase is the contraction of central and local government. Tax revenues drop sharply; limits upon government borrowing are reached; and government spending cuts begin.

It is at this point that local municipal governments start to wake up and smell the sewage. First up they realise that they have swathes of land which they had bought up in the halcyon days for one grand project or another. It is lying vacant; there is no revenue for the council being generated. Secondly, as indigent people are forced out of their houses, they "inherit" a bunch of houses due to non-payment of local government rates.

It gradually dawns on local bodies that a growing housing stock is a good thing. Querulous greenie voices fade to whimpers. Local bodies become pro-development and a building boom commences. But, every new residential house completed, lowers the value of the existing housing stock. Depreciation--a rational economic force--kicks in. A more sane and stable housing market develops--but one which sees the artificial wealth which people believed they held in ever appreciating residential property ebbs away. This is the third phase of a really serious depression.

Everyone is poorer. The fourth phase is when it dawns on the entire populace that the only way wealth can be created and sustained is to produce marketable goods and services at a profit. In other words, we have to work and earn our way out of economic recession. Then--and only then--a sustainable recovery begins.

In New Zealand, folks can makes lots of money from housing. If you are one of them, just keep reminding yourself that you have been fortunate and that it will not last. Warn your children.

Here's a good rule of thumb. Assume that the life of your current house is fifty years. Then it will be bulldozed and a new one constructed on the site. Look at your original QV statement and subtract the unimproved land value. The residual is the house value. If the house is ten years old, consider it depreciated by 20 percent. In other words the economic value of the house is worth one fifth less than its original sale price, if it is ten years old.

Such calculations will serve to keep you economically rational when you consider the residential housing market.

A Hard Fight From Here . . .

Economic Hangovers From the Debt Binge

The IMF has just published its latest Global Financial Stability Report. It makes explicit what we have always known, ever since the Great Credit Crunch of 2008. The past two years have seen a massive transference of risk from the private, non-government sector to the public or government sector.

All over the world governments have "bailed out" their banks, commercial enterprises, and households. The term "bailed out" is really misleading, because all that has occurred is that liability and debt has been transferred from private sector balance sheets to the balance sheets of governments, which in the end will be paid for by those same households and businesses (or at least their successors). The debt will be paid either through inflation or taxation or both. But, according to the IMF, the expansion of debt on sovereign balance sheets is not going to lessen any time soon.

But the biggest threats have moved from the private to the public sectors in advanced economies. Governments not only took on many of the bad assets from private institutions but due to the recession face continuing heavy borrowing needs for the next few years. Slow growth in the real economy and high unemployment will retard tax revenues and require higher government spending—such as on unemployment benefits and job creation activities.

“In spite of recent improvements in the outlook and the health of the global financial system, stability is not yet assured,” Viñals said a news conference April 20. “If the legacy of the present crisis and emerging sovereign risks are not addressed, we run the very real risk of undermining the recovery and extending the financial crisis into a new phase.”

For the present, the risks have passed over the banks to governments, and banks have survived. So risks of systemic bank collapse have been avoided for the present. We can all breathe easier. Or can we?

Improving economic and financial conditions have helped private bank balance sheets in advanced economies. The IMF sharply reduced its estimate of the writedowns or loan loss provisions banks will have to take—or have taken—to account for bad loans and securities on their books. The improving quality of bank assets means that banks will probably need less capital than previously estimated to absorb losses. But banks still will face funding difficulties in the next few years, as their bonds mature and the special government assistance programs are withdrawn.

Two problems will persist over the next few years, according to the IMF. Firstly, the vast expansion of government will inevitably crowd out the private sector's innovation, efficiency-on-the-ground, and access to inexpensive capital. Governments will be soaking up more and more capital to fund their bail-outs, borrowings, and increased spending. There is a world of productive difference between borrowing to expand a business, on the one hand, and borrowing to fund the life-style of entitlement classes, on the other.

The IMF warned that the increase in sovereign risk can hit banking systems and the real economy that produces goods, services, and jobs. Even with weaker private credit demand, governments could crowd out business and household borrowers, retarding recovery.

Secondly, bank lending to the private sector is going to remain subdued for several years to come. This is because banks are continuing to write off bad assets, improve their balance sheets, rebuild capital reserves, and pay back their government loans. Moreover, interest rates are going to rise due to governments competing to borrow more and more money to fund their deficits. What most people don't realise is that banks usually make more money in low interest rate conditions, than higher. Thus, not only will banks not be lending as much, they will make less on what lending is undertaken.

Although the worst of the credit contraction may be over, banks are unlikely to boost lending substantially in the near term—both because of the continuing overhang of bad assets that remain on their books and the funding pressures they will face. Moreover the withdrawal of the special government support will further constrain bank lending.

Although private credit demand remains modest—households and businesses continue to reduce their debt levels—sovereign borrowing threatens to overwhelm it, potentially driving up interest rates, forcing private demand to shrink, or both.

What are the implications? Economic recovery in New Zealand is likely to be anaemic. Tax revenues will remain subdued--risking longer, more protracted fiscal deficits. A foresighted and smart government would take an axe to government spending, would curtail payments to the entitled classes, would sell off commercial enterprises owned by the state, and would do all within its power to reduce deficits. At the same time, smart government would systematically drive down tax rates to encourage activity in the productive economy. We will see just how smart the present National government is come next election.

The housing sector--that long favoured engine for debt fuelled enrichment--will likely remain subdued for several years, unless immigration sharply increases, pushing up demand for houses. Household debt reduction is likely to continue, particularly as interest rates rise.

All in all, if the IMF is right, the next five years in New Zealand are likely to be the economic equivalent of a prolonged enervated weakness due to lingering fevers and infections--sort of like a national economic equivalent of Tapanui Flu. But, at a micro-level, well capitalised businesses, with sound (but not flashy) leadership, with good cash flows are likely to do very well, thank you. However, the get-rich-quick, flash Harry, golden chained, mover and shaker types that used to frequent the Ponsonby and Parnell bars, boasting of their latest deal are likely to become an extinct species.

Hopefully our political representatives at central and local government levels will get the message. The last thing we need is politicians with "visionary" ideas, promising to create "Party Central" on decrepit wharves. If President Reagan was right, and the most dangerous sentence in the English language is, "I'm from the government, and I'm here to help," surely the second most dangerous must be, "I'm from the government and I have a really big bright idea."

Some New Year Investment Resolutions

Bernard Madoff is an Object Lesson

As the year comes to an end, most people who have had investments are probably licking wounds. With the S&P index down 40 percent for the year, few investors would have escaped. So, adversity is always a good time to learn some good lessons, and learn them well.

Here are some possible New Year investment resolutions.

If it sounds too good to be true, it probably is. How often have we heard that proverb? Yet still people get suckered and end up losing lots of money. Big returns mean big risks, and big risks kill.

Bernard Madoff is a name unknown to us until recently. We had never heard of him. However, those in an exclusive and very wealthy niche group had not only heard of him, they invested money in his securities business. The returns he provided his investors were outstanding. When you are running a Ponzi scheme you can manufacture extraordinary returns, as long as new investors keep walking in the door and your existing clients leave their money with you. You take your new clients' money and use it to pay out returns to your existing clients—everyone is happy, until the scheme collapses. And getting good returns is the very best way to attract new clients. The prospect of high returns always draws investors like bees to the honey pot.

If you throw in a dose of generosity and charitable works, the lure becomes irresistible. People love to make good money with a clear conscience. Madoff was well known in charitable circles; he was a generous donor; many charities invested with him. The fact that so much good was being done was one more reason not to look the gift horse in the mouth.

But apparently no-one knew how he was able to achieve such good returns. The smart people were the dumb ones who could not figure out how he did it, and declined to invest in something they did not understand. And apparently there were quite a few who made the “no” decision.

That leads us to our second investment maxim: we should never invest in something we don't understand. What we mean is, you do not understand how the money is being made, or where the returns are coming from. Some have applied this maxim in such a way they would never invest in a business where they did not understand how the product was made, or the particular technology, or whatever. But this is not necessarily what we mean. we may not understand all the in's and out's of how a computer works—but we know what functions a computer performs, why people find it has utility, and why they buy them. Therefore, even though we don't understand all the science represented in a personal computer, we know how Dell or HP make money.

But generally the more complex a business is, the more difficult it is to understand, the less attractive it should be as an investment. Once again the dumb money is the smart money. If people had applied this maxim they never would have invested with Bernard Madoff.

But there is a third investment maxim that would have been helpful. Never take advice—ever. Always make your own decisions, and hold yourself completely accountable for the decisions made. If you lose money, it is your fault—no-one else's. Never, ever hand over the control of your investments to someone else who will make the decisions for you. And never invest in something because someone else told you it was a good idea.

The buck has got to stop with each one of us. That helps us focus the mind. Now, we do not mean, of course, that you ought not to listen to others' views and opinions, but in the end you yourself have to be certain that the investment is sound. If we end up investing because of the recommendation of the broker or the adviser or the relative, or the other person who we believe is smart, don't invest.

Professional investment advisers will always be biased towards recommending what will sell. Investments with high returns are very easy to sell. Never trust their advice. We are not implying that all investment advisers are crooked or dishonest, as Madoff clearly has been, but that they are in business to make money, and money depends upon transacting investments, and there is an inevitable bias towards those investments which are easy to transact. The advisers may genuinely believe in the merit of the investment. They may recommend it honestly. But stay away from it—unless you understand it thoroughly, and you yourself come to believe in its merits. Let's remember, the dumb money is the smart money: don't try to make our dumb money smart by listening to advisers who we (and they) believe are smarter than us.

A good test is to ask yourself whom you would blame if you lost all your money on an investment. If it is someone other than yourself, the chances are you have probably invested very unwisely.

Drowning in a Sea of Panic

Is Breathless Panting Appropriate?

The world appears to be gripped by a spate of catastrophism where disaster is seen on every hand and from every quarter. Most of these catastrophies are figments of imagination, but they continue to provoke and fascinate, alarm and entertain—in the same way that horror movies do.

In New Zealand we have not escaped. While the gloss has gone off global warming as the catastrophe du jour—as the world has cooled over the past ten years—it has been replaced by a vision of an economic armageddon. Once more the world as we know it apparently is coming to an end. Several opinion leaders have been urging the rival political parties to “wake up” and realise just how dire our situation is, and to take appropriate action. If it were not so pathetic, one would almost die laughing at journalist, John Campbell's breathless panting, as he pleaded with the Helen Clark and John Key to demonstrate they had some understanding of just how serious things were. “Don't you realise we are all about to die,” one could almost hear him saying.

Even the normally measured Fran O'Sullivan—who has more than a clue about matters financial and economic—has succumbed, arguing that the urgent exigencies of the moment called for a “war cabinet” where both Labour and National would suspend political hostilities and work together for the salvation and protection of the nation.

Fortunately, calmer heads appear to be prevailing.
This is the time for a sober, yet sanguine approach. The real crisis has passed. It is very unlikely to return. The real crisis was the potential collapse of the global banking system that would have severely restricted, if not removed borrowing completely from the world economy. Sound, and well capitalised institutions would have collapsed. This, indeed, was a serious matter—and which, if allowed to play out, would have opened up the possibility of a nineteen thirties style of years of depression.

Given that central banks and governments acted in time, and largely in concert, this crisis has passed. Yes, as we have argued elsewhere, the regulatory regime governing financial institutions needs to be overhauled and brought into the reality of a globalised market place. Yes, greater disclosure and capital adequacy standards need to be enforced. Yes, there needs to be an end to an acceptance of “netting off” as a risk reduction tool for derivatives. Yes, there needs to be capital set against purported “off balance sheet” liabilities, and so forth. Yes, the central bank money spiggots need to be turned down, then off, and the excess emergency liquidity siphoned back out of the system. All this will probably come in due time—and it is not the sort of thing that can be done quickly. It needs careful consideration, lest it create even bigger problems.

But the immediate crisis has passed: governments and central banks have adopted a “whatever it takes” approach, so that in the end banks were able to start lending to each other again, which in turn meant that credit would still flow through the economy. The interbank lending market has now settled down.

So, we now face another “problem”—an economic slowdown, possibly of global dimensions. But this had to happen. Asset and commodity prices had got way beyond market equilibrium, due to the global monetary system being flooded with cheap credit for nearly two decades. Prices have now declined rapidly and substantially; both individuals and businesses are retrenching, spending less, laying off liabilities, cutting back. Economies will shrink as a result. But the end result will be a move to market equilibrium, where prices reflect real (not debt fueled) demand, and real (not debt fueled) supply. Capital will be scarcer; risks will be more threatening; economic activity will wane.

This is not a “problem”. It is a normal, and much needed correction. Eventually, our economy will return to a much more sustainable growth path—more sustainable because it will be based on production, not consumption. New Zealand is actually in not such bad shape. The consumption boom, fueled by rapid house-price appreciation, which in turn was fueled by easy credit conditions owing to Japanese, US, and Europeans being more than willing to lend to our banks, has ended. The price of money is likely to remain quite high for some time. But apart from the construction and related industries this was never economically productive: it was consumption driven.

The party is over, so now we can get down to producing the goods and services that a slower growing world will want to buy. And we have plenty. Yes the adjustment will be somewhat painful, but then so is vigorous exercise. Yes, the adjustment make take three or four years. But it is not the end of the world. John Campbell can stop panting. And we certainly do not need a coalition economic war cabinet.

ChnMind 2:15 The Real Prosperity Gospel

The Goal of Family Financial Self-Sufficiency

In recent years we have seen the emergence of what has been dubbed the “Prosperity Gospel”. At its most crass, the Prosperity Gospel has been a gross perversion of biblical truth for selfish pecuniary gain. Infamous “televangelists” particularly in the United States have proclaimed to their audiences that if they would send in gifts, God would reward them with financial prosperity. Money has flowed in like water. The televangelists have become fabulously wealthy through fleecing their so-called flocks. Their judgment awaits.

This perversion is of the same ilk found in the historical Christian Church, where in the early sixteenth century, indulgences were sold: the object was to raise money for building the Church of St Peter's in Rome; the method was to promise to people that if they gave, they would secure an indulgence for a loved one, so that they would escape the pangs of purgatory and go immediately into heaven. It was this evil which was the immediate cause of the Reformation. Luther's Ninety-five theses were posted on the door of the Castle Church at Wittenburg for debate. They condemned the practice of indulgences. The false Prosperity Gospel has been around for a long, long time.

There are other, less crass forms of the Prosperity Gospel. In some circles it has morphed into a challenge to be an active participant in the life of the church—including in its giving programme—in order to inherit the blessing of God. The blessing of God will include financial blessing. “Give and it shall be given unto you, pressed down, shaken together and running over,” (Luke 6:38) has become a favourite biblical text.

Like all perversions of the truth, there is often an element of original truth which is subsequently perverted. The Prosperity Gospel is no exception.

We have been considering the role and responsibility of one of the key institutions of God's Kingdom, the City of Jerusalem. The Family is a crucial, foundational, fundamental institution of the City. Its central role, function, sovereignty and authority is declared in Scripture. It is protected by God's Law, such that neither Church nor State may subsume, override, or countermand its duties and work.

The role and responsibility of the Family is to provide its members the blessing of the closest and deepest bonds of human fellowship; to act as the core institution to bear, raise, nurture and train children in the faith; and to to be the primary provider of welfare for the members of its own household, its extended household, fellow church members, and to all men.

We have been focusing upon the role and responsibility of the Family to be the centre of welfare and provision for family members at some length deliberately. This is because it is precisely here that modern Athens has subverted and subsumed these familial duties, and transposed them to the secular state. The result has been a growth in statist power, and a weakening of the Family. As the institution of the Family has been weakened, so the Kingdom of God has lost influence and power. The rebuilding of the Kingdom of God in the West requires that the Family—the Christian Family—takes back its legitimate sphere and duties, and recaptures its central social influence. This will not be achieved overnight—it will take several generations, in fact. But it must be done, if the Kingdom is to grow in influence and power over Athens. This is a high, holy, and spiritual calling. It must be done if the Kingdom is to regain the ground that it has lost in the West.

In this regard, we must recover the true biblical position on family and household prosperity.

The Scriptures make it very clear that wealth and possessions are a blessing of God. Increase and prosperity come from the Lord. It is a blessing of the Covenant itself. The Lord promises that if we are faithful and obedient, He will be faithful to us, and that He will pour forth His blessing upon us—and His blessing is both covenantal and cultural. Consider the words of the Law:

Then it shall come about, because you listen to these judgments and keep and do them, that the Lord your God will keep with you His covenant and lovingkindness which He swore to your forefathers. And He will love you and bless you and multiply you; He will also bless the fruit of your womb and the fruit of your ground, your grain and your new wine and your oil, the increase of your herd and the young of your flock, in the land which He swore to your forefathers to give you.

You shall be blessed above all peoples; there shall be no male or female barren among you or your cattle. And the Lord will remove from you all sickness; and He will not put on you any of the harmful diseases of Egypt which you have known, but He will lay them on all who hate you.
Deuteronomy 7: 12—15

Note that this abundance is to come about as a result of our forefathers' obedience, faithfulness, loyalty, and obeisance to the Lord. The resulting blessings will certainly come because the Lord has sworn—taken an oath—that He will respond in kind. The Lord will love, bless, and multiply.

And again:

Beware lest you forget the Lord your God by not keeping His commandments and His ordinances and His statutes which I am commanding you today; lest when you have eaten and are satisfied, and have built good houses and lived in them, and when your herds and your flocks multiply, and your silver and gold multiply, and all that you have multiplies, then your hearts become proud . . . (and) you may say in your heart, 'My power and the strength of my hand made me this wealth.'

But you shall remember the Lord your God, for it is He who is giving you power to make wealth, that He may confirm His covenant which He swore to your fathers, as it is this day.
Deuteronomy 8: 11—18

The power to make wealth is a divine confirmation of His covenant: but it will only transpire if God's people remain humble and faithful to Him. If we, as a covenant community, remain poor and dependant, the blessings of the covenant have not yet been confirmed to us.

However, we need to be very clear on how wealth comes to pass. There are only two ways given in Scripture for people to gain wealth: hard work and inheritance. Thus, the wealth and prosperity that was to come to Israel was to be the fruit of work, labour, diligence, skill and persistence. The archetype is Jacob—whose name, we, the Israel of God bear. He went out with nothing but the shirt on his back, and came back a man of substance, the fruit of twenty years of hard and skilful husbandry, in the face of severe obstacles. Work, skill, and diligence are the means of divine blessing. The Lord makes the labour of our hands and minds fruitful and productive. He gives makes our efforts successful as we trust Him, depend upon Him, and work faithfully as He has commanded us.

This is the true Prosperity Gospel—diligent and faithful work in the callings God has given us, looking to the Lord for His blessing, and experiencing His hand multiplying our efforts, despite many trials, hardships, and reversals.

But, what to do with the multiplied wealth? It is the Lord's. We are only stewards of what He has given. We are bound, as households and families, to use wealth as He has directed, in the way He has commanded. And His command is that each family and household strive to become self-sufficient and self-supporting, and have some left over to share with others.

There are four stages in the transition from poverty to self-sufficient wealth. The first stage is where one is unable to earn any income—whether through sickness, ill-fortune, or unemployment. At this point, the family is dependant upon the love and charity of others for sustenance. This was the condition of Naomi and Ruth.

The second stage is when one can earn enough income to meet day-to-day needs (food, clothing, and shelter). This stage is still one of poverty and the family remains at risk. The family and household is living from hand to mouth.

The third stage is where the family is able to earn sufficient income that not only can it meet day-to-day needs, but it can also lay aside funds for capital appreciation. The Christian family needs to recover the discipline of a lifetime of saving—which, in turn, means that present consumption has to be restrained and curtailed. Only then is the family moving out of poverty towards self-sufficiency.

The fourth stage is where sufficient capital has been amassed that it is possible to live comfortably off the income produced from that capital, and that there is sufficient income that some is able to be capitalised back, so that overall wealth is growing.

Most Christian families in our day remain at the second stage—living from hand to mouth. Many Christian families believe that is all the Lord requires. They are mistaken. They need to realise that there is so much further to go, and that it is the responsibility of the head of the household to strive to the utmost to ensure that the household moves to the third and fourth stages. It is their duty. Only then can we begin truly to take up our additional responsibilities to our extended families and to the needy around us.

In moving from the second to the third stage the application of a very useful rule—the seventy-thirty rule—is apposite. When we are consistently applying the seventy-thirty rule to our earned income, then we know we are moving to stage three. Huge progress is being made at this point. Ideally, it should start from the day we earn our first dollar of income, and it should continue throughout our lives.

The seventy-thirty rule is as follows:

Of all the income the Lord gives us through our work and labour, divide it as follows:

10% to be untouched—tithed—and given to the Lord. This should always be done, regardless of our circumstances or penury. It is the biblical way of acknowledging that all we have has actually comes from God's hand. Without this faithful discipline we will not develop the heart of a faithful steward. Until we are faithful in this little thing, the Lord will not entrust us to be faithful in much more.

10% to be untouched—saved—and put to long term capital formation. This capital, except in the direst of emergencies, is not to be touched or consumed; it is eventually to be passed on down to children and grandchildren. In retirement from direct income earning, or in times of unemployment or hardship, income from this capital may be used; but the capital ought to be left perpetually intact--if at all possible.

10% to be saved, but to spend on larger items the household will need in the future (house, furniture, car, etc) or to assist with children's education or family special needs.

70% is to fund current household expenditure.

This is not always possible to achieve, depending upon one's circumstances—but it remains a benchmark and goal. Only as we achieve this consistently can we be confident of moving from stage two to stage three. Getting the household to stage three, and keeping it there, should be the goal of every household head, and all its members. Only then can we say that we are living as the Bible commands—as self-reliant, with some left over to share with those who have need.