How are things, really?

How are things, really?

I speak with hundreds of people every year. Most are trying to figure out where their particular cog fits into the greater, global, capitalist machine. 

Some people seek me out to share their ideas and business plans, others ask the kind of questions that people always ask someone who served on a business school faculty. Many have already achieved financial success, others are just starting out.

I take these calls in part because they offer me the opportunity to ask a lot of questions to a widely disparate group of people. I get to consider what is going on in the world from many different perspectives. 

Studs Terkel

The result is a Studs Terkel view of the global marketplace.  In Working, Terkel told the stories of various working individuals to paint a picture of the complex relationships that people have with their jobs and with their employers.

Every year I get to hear the stories told by hundreds of business owners and executives, founders of start-ups and investors of all sizes. No two stories are exactly alike.

What are they saying now? As always people see what they want to see. 

There should be a lot of fear, doubt and hesitancy when a pandemic of this magnitude slows the markets so quickly, especially when so much of economic activity has simply been turned off. There are clearly a great many people who are suffering from the effects of the virus if not the virus itself.

No one should minimize the overall economic effects. A great many businesses will go out of business. A great many of the people who are now unemployed will never be rehired to the same job.

Overall, most of the people with whom I am speaking are realists and therefore optimistic.  Rational people understand that if they stay indoors they, and their family members are not likely to contract the virus or die from it. Rational people count their blessings at times like this.

Some people are complaining that working from home is too difficult because their kids are under foot or need their attention.  If you can’t make your kids understand that you need some “alone time” to get your work done, that is on you, not them. 

I wrote my first book after my kids went to bed, often working between midnight and 3AM.  Why? Because I wanted to write a book and I knew I would not get it done if I made excuses.

There are a lot of people sitting at home binge watching this or that which is fine. There are also people who are taking courses online, brushing up on accounting or marketing because when this is over, they want to start a business or get a better job. 

I got a packaged delivered yesterday and asked the delivery man how things were going. He replied over his shoulder that he had been laid off and very happy to have this new job. In his mind, despite being laid off and earning less, his glass was half full.  

You cannot turn on the TV without seeing the incredible jobs being done by doctors, nurses and first responders. They are true heroes.

But we also need to recognize the 20 something working as a cashier in the local market. She told me that all her regular customers are like family.  She has no idea why the market has no eggs as chickens are obviously still laying them. But she has a kind, uplifting word for everyone who passes through her line. “This will be over soon” she told me, “and then we will see what those chickens were up to.”      

Make no mistake, this will end.  Your life, after it is over, will largely depend upon how you act now.

I got a call this week from a former client, a chef who I helped to raise the money for his restaurant a few years back, He wanted the name of a good bankruptcy lawyer because he knows he is not going to be able to re-open. A lot of blood, sweat and tears down the drain.

At the same time, he asked me to help him start raising funds for the new restaurant he wants to open next year, That is the thing about Americans, when the shit knocks us on our ass, we get up, dust ourselves off and keep going.

He truly feels badly for the wait staff and kitchen crew he just laid off.  But he also understands that they got paid from the first day the restaurant was open. It took a year until he could draw his first check. That is the nature of capitalism. Business owners take the risks that create the jobs for others.

Worker Bees

How are things, really?

I read an opinion piece this week end by a disgruntled “influencer“ who was up in arms that the government was bailing out banks and profiteers and not the poor, worker bees who actually do the work.  These people, he reminded us, live paycheck to paycheck and have no savings.

He is certainly correct about that, but that is not the banks’ fault. They are always happy to open a small savings accounts.  It is up to the worker bees to spend a little less and save a little more. That advice has been around since I was in grade school.

I feel really bad for the author who apparently feels helpless because nothing bad has ever happened in his lifetime. I watched friends pulled into war, to die in the jungle. Shit happens and it happens to every generation.

I spent 5 months living on the cancer floor of a major hospital. When this passes, visit the cancer patients in your local hospital, many have no visitors. If there was ever a time to count all your blessings, this is it.

The most important lesson I learned from my experience with cancer is that the only thing that you can do in life is to play the hand you are dealt. If you are afraid or angry right now well that too, is on you. 

If you do nothing else in the next few weeks you can help out your neighbors. I don’t have to tell you why you should do that, you all went to Sunday school. You will be amazed how helping others will help you realize how fortunate you are.

And please ignore the angry political types of all persuasions on TV who are jumping up and down screaming and assigning blame to others. If this group would just sit down and shut the hell up they might be pleasantly surprised to see all the decent people around the US who are quietly giving each other a helping hand. 

That is what is really going on.

If you’d like to discuss this or anything related, then please contact me directly HERE

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Girl Scout Cookies – America’s Unicorn

girl scouts

As January winds down, the Girl Scouts will once again demonstrate their high level of business acumen and begin their annual cookie sales. Business schools and MBA programs love case studies of businesses that are remarkably successful. I am always amazed that these professors do not pay more attention to the Girls Scout’s cookie sales program. 

The Girl Scouts have been selling cookies for more than a century. To say that they have it down pat would be an understatement.

You can laugh it off, but in about 8 weeks from start to finish the Girl Scouts will sell and deliver about 200 million units and take in about $1 billion in sales. I know Fortune 500 companies that do not come close.  In fact, I know Senior VPs at Fortune 500 companies that would call the Scout’s attempt to deliver that many units in that short a period of time a logistical nightmare. One told me that even thinking about it would make him reach for the antacids he keeps in his desk drawer. 

What is the secret to the Girls Scouts display of logistics perfection? Their mothers already have way too much on their plates to screw around.  Just get them sold, get them delivered and move on, one Scout’s mother told me as she was chaperoning her second daughter around the neighborhood. That phrase should be on a sign on the wall in the office of every sales manager and operations manager in America.

The entire operation is a model of efficiency. I have ordered quite a few boxes over the years. They always deliver exactly what I ordered exactly when they promised. My Amazon Prime deliveries often go to the house across the street.

The cookies themselves are manufactured in two bakeries. They are of high quality and consistent year to year. Over the years they have eliminated some that did not sell well and introduced others.  

Personally I have a thing for Samoas. Maybe it is the combination of chocolate and coconut; the sweetness and the texture.  I have been known to munch my way through an entire box during the NBA All-Star weekend.  If they ever eliminate Samoas from the menu I think it will represent a decline in Western civilization.

People do not appreciate the value of a box of Girl Scout cookies as a business tool. I have a friend who worked in the back office of the trading department of one of the large banks.  Each year he has 10 cases of Girl Scout cookies delivered and stacked up against the wall in the trading room.  He tells me that the traders, in their thousand dollar suits and $300 shoes literally climb over each other to get a box. He told me that some of the traders who don’t know his name and are not certain what exactly he does, refer to him as the “cookie guy”. He is certain that his yearly largess has raised his status at the bank. 

There are a lot of anecdotal stories about cookie sales. Back in the 1980s, one Scout sold so many boxes that it got her an invitation to visit the White House. While waiting to meet Pres. Reagan she found herself waiting in an ante room with Secretary of State George Schultz.   When Schultz complemented her on her achievement, she reportedly responded by asking Schultz if he wanted to buy some.  Do you need a better example of the phrase “never stop hustling”? 

This particular Scout went on to sell more than 100,000 boxes in her Girl Scout career and while still a teenager gave lectures to adults at sales conventions. Her success was not from going door to door but by setting up a table in the DC metro during rush hour. She told the salesmen at the convention to go where the customers are and not wait for the customers to come to you.  

More recently there was the story of the Scout who set up her table at the entrance to one of San Francisco’s medical marijuana dispensaries. Yes there was some controversy about a pre-teenager and marijuana. As a parent I had to face the questions from my own kids about what I was doing back in the 1960’s. Still the munchies are the munchies.

But from a purely business standpoint I would say that both of these young women understood their market better than a significant number of the sales people I meet almost daily.  I cannot imagine the sales manager at any Fortune 500 company not extending a job offer to either.

girl scouts

My own experience with superior Girl Scout sales women came a few years back when two neighborhood Girl Scouts, sisters aged 11 and 9 rang my door bell one Saturday. They were chaperoned by their mother. Each was in a well pressed uniform intending to make a sharp presentation. I invited them in and the oldest started her pitch by asking me if I was familiar with Girl Scout cookies and did I have a favorite.  

I professed my fondness for Samoas and ordered 3 boxes. She responded by suggesting that I try some of the other popular flavors. She knew what was in each of them and described how they tasted. She suggested that I should buy a box or two of Thin Mints “to take to the office”. I ordered 3 boxes of those as well.   

She thanked me and filled out the order form which is color coded for the ease of these young sales people. It also significantly sped up the ordering process. 

When I thought we were done her younger sister stepped forward and asked if I would buy some cookies from her as well. I would have needed ice water in my veins to turn down this innocent looking youngster who apparently had seen Glengarry, Glen Ross and taken it to heart. 

I told her that I did not want to buy too many because I was watching my weight. She responded by telling me that I could buy a few boxes and that they would ship them to servicemen serving overseas. That’s right, a 9 year old who had already learned to anticipate a customer’s objections and have an excellent response ready. 

I wrote a check and two weeks later, right on schedule, I took possession of a case of Girl Scout cookies. I swear if these two had been 20 years older they might have saved Lehman Brothers. 

I think more people should take notice of just how successful the Girls Scouts are. Two years ago I found myself having lunch with the founder of a Silicon Valley start-up who exhibited more ego than brains. He spent the better part of the meal telling me how his yet to be launched company was certain to achieve unicorn status. It never did.  

The Girl Scouts, on the other hand, will likely sell a billion dollars worth of cookies this year. They have a well known and ubiquitous product. Their brand, if not as valuable as Coca-Cola, is certainly closer to it than Uber or Airbnb.  Imagine the Girl Scouts as a unicorn without the ego.

There is huge push to give young girls more training in STEM subjects and a great many programs teaching them to write code.  I am a strong advocate for both, but learning to write code becomes less important if you can’t sell it.  As long as there are Girl Scouts selling cookies, the art of salesmanship will never die.

If you’d like to discuss this or anything related, then please contact me directly HERE

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The Beginning of the End for Oil

End for Oil

Every so often I read a single piece of news that gives me a glimpse of the future. I saw a news article last week that reinforced my belief that we are coming to the end of the Age of Oil. 

Oil became the most important commodity in world trade, literally overnight, and specifically on October 19, 1973. Since that date, oil and its price at the well-head have become a central concern of the global markets.    

Since 1973 enormous wealth has been transferred from the US and Europe to the primary oil producers around the Persian and Arabian Gulfs. Far more wealth than the conquistadors removed from the Americas in gold and silver. This wealth was extracted because the producers agreed among themselves to restrict the supply of oil thus keeping the price per barrel sky high. 

A war between Egypt, Syria and Israel began on October 6, 1973. The US Congress were preparing to provide over $2 billion in emergency aid to Israel.  In response, OPEC, the cartel that managed global oil production, instituted an embargo on oil shipments to the United States. The motivation behind the embargo was political, but the effects were most definitely economic.

The embargo halted US oil imports from participating OPEC nations. It changed the lives of all Americans immediately and had lasting effects in the US. It also had an enormous effect on the participating producing states. But for the actions of the cartel and the embargo all those skyscrapers dotting the skylines in all those OPEC countries would never have been built.

The total embargo of oil to the US meant that there was not enough gasoline in the US to go around. I remember standing in long lines trying to buy gasoline when it was available. I remember that purchases were restricted to “odd and even” days corresponding with your license plate.  It was terribly disruptive to everyone in the US and to every US business. 

The US economy was booming. By 1970, the US had just put men on the moon. US factories were operating at near capacity. The Vietnam War was sucking up a lot of labor and materials. By 1973 there was a noticeable uptick in inflation at the wholesale level.

End for Oil

The interstate highway system was largely completed to facilitate and reduce the costs of trucking goods.  Gasoline fueled all of the trucks that moved all of the goods. In 1970, demand for oil in the US outpaced supply for the very first time.

At that time the cost of regular gasoline in suburban New Jersey was about $.25 per gallon. With a fill-up you would get change back from a $5 bill and either Green Stamps or a 12 ounce drinking glass suitable for iced tea or lemonade. Everyone I knew had a cabinet full of those glasses.

Cartels like OPEC are made up of producers who are most effective when they manage the supply together.  OPEC began a series of production cuts in order to bump up the world price of oil. These cuts nearly quadrupled the price of oil from about $3.00 a barrel before the embargo to about $12.00 a barrel in January 1974, i.e. in about 90 days.   

Officially, the embargo ended in March 1974. The higher oil prices, on the other hand, kept going up.  In 1979 the revolution in Iran bumped prices even further upwards. 

Before the end of the decade, US President Jimmy Carter appeared on television urging people to turn down their thermostats and wear sweaters to keep warm at home because heating oil had become very expensive. He also encouraged Americans to “whip inflation” as the price of most goods went up as production and shipping costs rose. 

For the next 40 years US politicians would promise to make the US “energy independent” again. 

The increased price was also a boon to the large oil companies who profited from the increased price as well.  There were several notable mergers and the resulting behemoths became among the largest companies in the world. Oil had become a “bell-weather” commodity.

In the 1970s and 1980s there was the thought that US domestic production might again surpass domestic US demand. There was a substantial amount of drilling within the US, much of it incentivized by favorable tax treatment. I recall reviewing financing documents for shallow oil wells in Pennsylvania, deep wells in Texas, gas wells in Louisiana and shale oil in Colorado.

The large oil companies had earned so much that they could afford to engage in much more expensive, offshore oil drilling in the Gulf of Mexico and the North Sea. The pipeline from the North Slope in Alaska did not come on line until 1977, but eventually added 1 million barrels a day of crude oil to the supply.

At the same time, the US government lowered the maximum highway speed limit to 55 miles per hour. The auto industry sold a lot of smaller, more gas efficient vehicles.  With all that drilling, conservation and efficiency the price per barrel of oil should have come down. It never did.

Over the ensuing years, the global price pushed through $30 per barrel to $60 and more.  Only recently has the US actually produced more oil in a month than its residents used and not by very much.

There were people in the oil industry and the government who thought that we might “run out of oil” and who spread that thought as a justification for drilling anywhere and everywhere. That certainly seemed plausible in the 1980s when the memories of the embargo and its shortages were still fresh and the internal combustion engine had no competitors.  

People have been talking about electric powered vehicles since before the 1973 embargo.  In the 1980s and into the 2000s they were still a work-in-progress. No one really had tangible proof that we would replace the internal combustion engine in the 21st Century.

End for Oil

What I read last week told me that electric vehicles have finally arrived.

Last week, Tesla Motors announced that they had delivered over 360,000 vehicles in 2019 and are on a path to deliver more than 400,000 vehicles in 2020.  Other companies also deliver electric vehicles to customers and more companies are poised to get into the market. Some will succeed; others fail.

The technology that makes these vehicles possible has apparently evolved to the point that the vehicles are accepted by the public and are priced within a normal, commercial range.  The technology will continue to evolve to make these electric vehicles even less expensive. On board batteries will be lighter, longer lasting and cheaper. Re-charge time will be shortened to minutes. At some point in the next 10 or 20 years, there will be more electric cars and trucks manufactured each year than gas powered vehicles.

The real impetus for the changeover will come from the trucking and package delivery industry. The US Postal Service is already reviewing prototypes for electric powered delivery vans. UPS, Amazon and other companies operating fleets will also make the switch.  It does not make good economic sense for these companies to continue to buy gasoline. Instead they will operate the fleet during the day and plug it in overnight.

It should not be difficult to imagine that a company like Amazon might run an all electric fleet and at the same time own acres of solar arrays putting the equivalent of the electricity that they use back into the grid.  Tesla is positioned to sell the idea that customers might charge their cars for free if they generate solar power from the roof tiles and solar panels that they also sell.

It is not unreasonable to assume that there will be more than 10 or 20 million fully electric cars and trucks on the road by 2030 or 2035. That may be conservative. The last large automotive production lines for internal combustion engines are likely to close long before the end of this century.

What may hasten the demise of the gasoline powered automobile is the cartel itself. As demand declines, the cartel is more likely than not to continue to reduce production to maintain the high price for as long as it can. As the cartel cuts production, smaller members will begin to bail out because they will want to sell more than their allotment.

If you happen to stop over in Riyadh or Dubai take a look at their high rise skylines. Cartels do not last forever. The effects of a successful cartel can have a significant impact on global markets and global politics for many decades after they end.

If you’d like to discuss this or anything related, then please contact me directly HERE

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Sex in Economics

sex in economics

When I was teaching Economics back in the 1990s, I was fortunate to have students who had gone to high school in dozens of different countries. These students had different experiences and had functioned in markets that were often driven by local custom and culture. Their questions and comments helped me to understand a lot about the expanding global marketplace.

When I wanted to create an example to illustrate the application of a theory that I was trying to explain, I always tried to create one that everyone would understand regardless of their country of origin. Consequently, I often talked about sex. 

I admit up front that this may have contributed to my being ranked as one of the more popular members of the adjunct faculty at the university. It also seemed to keep the students awake, which, when teaching a subject like Economics can be task number one.

Economics

Classical economics teaches that consumers are rational. It teaches that because most consumers have a limited amount of money to spend each month, they will organize their spending accordingly. First, they will allocate their funds to necessities (rent, food, clothing, and transportation) and then to items that are necessary but which can be put off (dentist, auto repairs). Any funds that are left over can be spent on items that the consumer may want to buy, but could literally live without (sporting events, vacations). 

In order to get the most “bang” from the bucks they have, consumers should be good shoppers.  They should compare the prices of like products and purchase the least expensive ones that suit their needs. In theory, it is a rational process throughout.

Most consumers acknowledge they should allocate some of their monthly earnings to savings, but few will. Most also acknowledge that they should spend no more than they earn each month.  In practice, that effectively went out of style with the advent of the credit card.

Today, the market is awash in consumer debt, a factor that the classical economists could not consider.

I tried to focus the students on the underlying question: “How could they induce consumers to make an irrational decision to buy their product?”  These were, after all, business school students. 

For most products the answer is advertising. The modern “in your face” daily onslaught of ads that encourage people to purchase products were also not considered by the classical economists for obvious reasons.  The textbook I used, followed the classical view, which, to my thinking, might not give students the whole picture.  

The purpose of any advertisement is to make consumers purchase the product. Many ads will stress a product’s “value” which speaks to our rational side.  But even those ads will frequently feature attractive people making the pitch.  Using actors who are “attractive” does not change the message. But it is likely to get more eyeballs on the ad. 

Sex Sells

Indeed much about advertising is rooted in sex. There is a constant, undisputed theme in advertising: “sex sells”.

sex in economics

I could not, in my mind, conjure up a source of more irrational behavior than the human sex drive. It is not “just the things we do for love”. Sex and our desire for it motivates a huge portion of the spending that people do, even if they have limited funds that might rationally be spent elsewhere. 

For example, sex is at the root of the global fashion and cosmetics industries. These represent trillions of dollars of annual commerce.  And it is not new. Evidence of consumers’ desire for fashion, cosmetics and adornments goes back into pre-history. 

Why would anyone teach that consumer purchases were rational when so much of it was driven by irrational emotions?  And this does not even touch purchases that are made based on other emotional responses such as fear, greed or envy. I thought that perhaps the rational consumer of the textbook who was focused on the price might be a myth. 

I caught up with Richard Posner’s Sex and Reason (1992) a few years after it was published. His well researched and well presented book came to the conclusion that the human sex drive was rooted in our biology and that acting upon it was perfectly rationale behavior.  

I still have difficulty in reconciling the perfectly rational price theory with less than rational human behavior.  Over time I have come to believe that the latter might actually be underestimated as the determining factor for our purchase decisions. In this regards, I think that business school students might need a lot more sex, at least in their curriculum. 

I liked to challenge my students. I asked the class why so many consumers would reach for a fragrance that was priced at $350 per bottle. People buy fragrances to attract a partner for sex. Would not a fragrance that cost $60 get the job done? 

Vegas Baby

I would ask: If a sex worker in Las Vegas charges $500 to perform a sex act when a sex worker in Brazil might charge $20 for the same service, what can you infer from this data? Yes it is about overhead and what the market will bear, but it is also an introduction to globalization. Change sex worker to software developer and you will see what I mean.

sex in economics

Cable television and the internet itself were once brand new technologies that were slowly beginning to find acceptance from the general public.  In both cases each got an early shot in the arm from one source, pornography.

On cable, networks like HBO screened soft core porn after midnight. It is what made the cost of cable acceptable to many new viewers and indeed what attracted many new viewers. Data at the time suggested that a lot of people liked to watch in bed. If you need a reference go to Wikipedia and look up Sylvia Kristel. 

I think that everyone knows that there is a lot of porn on the internet, but not everyone appreciates how large a business it represents. MindGeek, parent of Pornhub, does not report its revenues but measuring them in the billions would not seem inappropriate. It may not be as large in gross sales as Amazon, but MindGeek’s cost of goods is minimal. 

Sex is even prevalent in finance. I wrote an article about crowdfunding back in 2015 when it was still new and I was just beginning to look at it with a critical eye.  Investment crowdfunding was and is about getting people to look at your offering.

I wrote at the time: “If eyeballs are what you need to successfully crowdfund a company, it would seem logical then that the easiest company to crowdfund might be one selling a line of lingerie. No crowdfunding consultant worth his/her fee would likely tell the company not to include its product catalog in its presentation to investors if that catalog had pictures of models wearing lingerie.” About one year later a lingerie company in London started a crowdfunding campaign that followed that advice and raised all of the funds that they were seeking.  

Sex, Drugs and Rock n’ Roll

The music industry certainly uses sex to make sales. I grew up at a time when Elvis Presley appeared on television from the waist up because much of the audience had “issues” with the way in which he moved his hips.  Currently, it’s obvious that much of the music and entertainment industries have seen that portion of the audience as far out of the mainstream. A music video without some sexual reference? Hard to find near the top of the charts.  

A few years back, I caught an interview of Mick Jagger that was being conducted by a business reporter. Jagger has flaunted sex and sexuality throughout a very long career. The Rolling Stones were starting a tour and the topic was the economics of touring.

mick jagger

Jagger suggested that the tour itself would probably net the band over $100 million, not counting the record sales. The reporter asked how the band could achieve that kind of financial success from traveling around and playing music. Let’s face it, very few musical groups have had that kind of sustained success.

Jagger responded that he had just paid attention in school. The response made me smile. He is a graduate of the London School of Economics.    

I hope that my students were paying attention too.

If you’d like to discuss this or anything related, then please contact me directly HERE

Or you can book a time to talk HERE

The Job Market at Mid-Century

It is that time of year when students are celebrating high school graduations and college commencements.  Many are looking for jobs and I am starting to get some resumes from students looking for a little help. Students graduating this month are likely to expect that they will still be employed for at least the next 30 years. I am not so certain they will.

I also needed to buy a graduation present or two. I would usually go to the mall, but this year I opted to buy the presents online.  While I appreciate the convenience, I also appreciate what my decision means to the job market.

On-line shopping is one of those fundamental shifts in the way we do business.  By mid-century and likely before there will be no need for consumers to come face to face with a clerk or salesperson for most of the items they buy every week.  Those jobs will disappear and the retail space that those businesses occupy will have to be repurposed.     

Malls were no different than the Roman Forum in the first century or the bazaar in Istanbul in the Middle Ages. They were an “old” model that always had the customers physically coming to the sellers, originally to inspect the goods, exchange payment and cart the goods away. Into the mid-1990s retail malls were a gathering place and an iconic cultural symbol.  Just twenty years later hundreds of malls are closing or filing for bankruptcy every year. 

Amazon has proved that it can favorably compete with brick and mortar stores. The simple fact is that the stores will always require higher costs for labor and overhead.  Given Amazon’s growth and profitability, only those retail stores that provide a personal service (like barbers) are likely to survive. Even those may become “we bring it to you” mobile enterprises.

Amazon has already deployed robots in its warehouse and distribution center operations.  Based upon technology that is in the market today or about to be introduced, Amazon will likely become a series of fully automated distribution centers. Robots will take goods manufactured elsewhere from shipping containers delivered to the loading dock, move them, store them, sort them, package them and ship them out to consumers.  All of the billing and record keeping will be done automatically.  All the trucks will be become autonomous with no drivers. 

Jobs at all levels are being turned over to robots.  I believe that before mid-century people who call themselves truck drivers or bus drivers will disappear.  Longshoreman are not needed if pallets or containers can be on-loaded and off-loaded without them.  Retail clerks will disappear. 

If you call a large company for customer service today, you are likely to speak with a machine.  Bank tellers and customer facing bank officers are already on the way out.  Billions of dollars worth of investment portfolios are selected by “robo-advisors”.

The lectures on supply and demand that I gave to my Economics classes can be had today on-line from the author of the textbook I used or a professor at Harvard or the London School of Economics who is much more qualified than I to teach the course.  Why do we need high schools or colleges (buildings or teachers) when virtually any subject can be taught on line?

This trend of reducing the amount any company will spend on human labor will certainly continue.  There is nothing new about technology changing the world. New technology is often disruptive to any legacy industry and the people who work in it.  

There has always been a mantra that says that new technologies, especially disruptive technologies that obliterate jobs in some industries “always” create new jobs in new industries.  I think that mantra needs to be examined.  I am not certain that “always” includes the next 30 years.

For example, I do not believe that by mid-century the internal combustion engine will be the primary source of power for the transport of goods and people.  I expect that all vehicles will have electric engines, powered to some extent by solar panels on the roof or another non-fossil fuel source.   Alternative sources of energy like solar will continue to get cheaper and cheaper and electric engines will dominate.  

In the normal course jobs can be expected to be lost in the oilfields and replaced by jobs in the solar industries.  But will they? We are at the cusp of an era when a great many jobs that go back to antiquity will be turned over to machines that can “think” about what they are doing.  

Something as basic as farming will be turned over to machines that will plant and grow corn, harvest it, ship it to factories that will process it into cornflakes, re-package it and ship it to consumers all without human labor.  Even the graphic design and color of the packaging may be determined by analytics and algorithms without human participation.  

Today you can construct a house with a 3D printer. By mid-century machines may be printing thousands of new homes every hour. 3D printers print a lot of other things as well. It is impossible to imagine how this technology may develop in the next 30 years, but I do not think it far-fetched to consider factories full of 3D printers printing out more 3D printers.  

All of this is very deflationary and potentially very disruptive. 

If all this comes to pass a lot of people who are employed today may find their jobs automated by mid-century and potentially much sooner.  Which raises the question that the Economics teacher in me needs to ask: if we un-employ tens of millions of people, who will be able to afford to buy the cornflakes or the homes? 

In theory as the costs come down, prices for cornflakes and the many other things that adopt this technology should also come down.  But you still need to have job in order to buy anything. If all these jobs do disappear, exactly what will people do to earn a living?

What I find interesting is that a lot of people seem to think that the skill students graduating today need to have to earn a living is to know how to write computer code.  If anything, that recommendation points out another macroeconomic trend, globalization that is also disruptive and also deflationary.  Code itself will become more and more commoditized and coders in Mumbai and a dozen other developing markets will ultimately produce most of the code at a much cheaper price than coders in Silicon Valley, Seattle or Boston because their overhead and cost of living is significantly cheaper.

I have seen studies that suggest as many as one-half of the jobs that people are doing today may be automated by mid-century. If that is even close to being true, buckle up, it is going to be a bumpy ride.  I can state without reservation that this year’s graduating classes, next year’s and the one a year after are not preparing for this change in the job market in any way. I doubt that anyone knows where to begin.

Re-visiting Prohibition

R

Next January will mark the 100th Anniversary of the start of Prohibition. It is one of the least talked about and poorly studied events in US history. Very little has been written about it, especially by economists, but I have always found the subject to be interesting.

Americans have always had “issues” with the consumption of alcohol.  Laws restricting its manufacture and sale go back to the colonial period.  The temperance movement of the 19th Century is most often seen as a “moral crusade” or political battle.  Prohibition itself is often viewed through the lens of the speakeasy lifestyle.  As with most great movements much of the forces behind it were based in more practical issues.  

The real issue about alcohol in US politics and economics has always been about taxes. The very first tax levied by the brand new US Government in 1791 was a tax on the manufacture of alcoholic beverages. .The new Congress thought it was a good way to raise money to pay off the Revolutionary War debt.The tax was not well received especially by the people who were making and selling the product. 

Farmers in Western Pennsylvania and Kentucky were growing grain, distilling it into whiskey and shipping it east. Even back then it was a very profitable business. They saw the tax as the governments’ attempt to put its hand into their pockets.The farmers’ response to this tax was an armed rebellion against the United States. 

How big was the rebellion? The US Government sent 13,000 troops to quell it. There were no armed battles and the rebels disbursed. But many people still refused to pay the tax and more than one tax collector was physically assaulted.

The whiskey excise tax was the largest source of tax revenue in the early years of the U.S. and a substantial and reliable source of tax revenue throughout the 19th Century.  As the population grew, total consumption also grew and the total tax revenue collected each year kept going up with it.

Women were at the forefront of the temperance movement for a number of reasons. They were rarely the bread winners in their family and having the male breadwinner too drunk to work or injured because they were drinking on the job was not in women’s financial interests. Time spent at the local pub meant time away from the family and drinking has always been associated with gambling and prostitution, neither of which enhanced marital life. Drunken husbands also had a way of physically and mentally abusing their wives. For. many women Prohibition was a practical remedy for a practical problem.

The temperance movement was an amalgam of women’s groups and mostly Protestant churches or affiliated religious organizations. The movement was well organized. It claimed millions of supporters across the country. The goal was to outlaw the manufacture and sale of alcohol everywhere in the US.

By 1856 they had succeeded in doing so in 12 states and dozens of rural counties. It was a remarkable political feat for a group of like-minded citizens the majority of which were women and could not vote.

As the country moved west after the Civil War and new communities grew along the railroad right of way, saloons were often the first structures built and always a fixture in any new town. Many of those towns had more saloons than churches and many communities in America still do. 

As the 19th Century went on, there were more and more immigrants from Germany who began brewing beer in the mid-west grain belt. These brewers also developed a new business model.The breweries often would help to build or finance a local saloon in exchange for being the only beer offered in it. It was an early version of franchising.

Especially in urban areas, saloons were often a focal meeting place of the local immigrant communities. Saloons or taverns had always been places to drink and discuss politics. They also became known as places where politicians could meet and do business with voters and constituents.   Given that saloons were so prevalent, it is somewhat remarkable that the “drys” prevailed.  

By the turn of the 20th Century there were “wets” and “drys” in both political parties. Neither of the major political parties took a formal position one way or another but momentum for prohibition was growing. Competing products, like soft drinks, began lobbying for prohibition especially at the state and local levels. Eventually there were more “drys” than “wets” in the US Congress and the die was cast.

What actually paved the way for the ultimate success of the prohibitionists was the income tax which was enacted specifically to replace the excise tax on whiskey. Once that was in place, Congress in 1918 passed the 18th Amendment to the US Constitution, it was ratified in 1919 and the enabling legislation, the Volstead Act, began to put Prohibition into action in January 1920. 

The social benefits of prohibition derive from a reduced consumption of alcohol. They include a reduction of alcohol related health issues, less public disruption caused by inebriated citizens, and probably some additional domestic peace. Productivity at work rose as work related injuries and absenteeism decreased. But a lot of people never stopped drinking.  

Whatever romanticized image of Prohibition you may glean from Hollywood, it was not just fashionable people partying in a fashionable speakeasy near Times Square. During Prohibition thousands of poorer people died drinking homemade alcoholic concoctions.Manufacturing and bootlegging turned intolarge,  and profitable, albeit illegal ,businesses.

Still most people bought one bottle at a time from a family member or acquaintance. Everyone knew that they were breaking the law and no one really cared.

Overall enforcement was very difficult. Corrupting judges, politicians and law enforcement was part of the business model for the larger players. Small, person to person, transactions were almost impossible to detect.  It demonstrated to a lot of people that if you were willing to break the law, you were likely to get away with it.  

The Depression killed Prohibition. Roosevelt came into office in 1933 with big spending plans and declining revenue from the income tax as millions of people were out of work. Repealing Prohibition to allow all of the existing illegal transactions back into the mainstream and re-instating the excise tax was a no-brainer. And that is exactly what Congress did.

The post-WWII baby boomers have had alcohol integrated into mainstream family life.   Alcohol is a significant part of the socializing that the baby-boomers do. A drink after work or a beer around the barbeque is modern day normalcy.

The social issues today are the same as always. Excessive drinking frequently shows up in studies of marital problems, spousal abuse and petty crimes. According to the CDC: “Drinking too much can harm your health. Excessive alcohol use led to approximately 88,000 deaths and 2.5 million years of potential life lost (YPLL) each year in the United States from 2006 – 2010, shortening the lives of those who died by an average of 30 years. Further, excessive drinking was responsible for 1 in 10 deaths among working-age adults aged 20-64 years. The economic costs of excessive alcohol consumption in 2010 were estimated at $249 billion, or $2.05 a drink.”

Today most alcoholic beverages are served up by large multi-brand, multi-national conglomerates.   Mass media advertising has made them ubiquitous. It is virtually impossible to watch a sporting event and not see ads for alcoholic beverages.

The US government still collects a tax on every can and bottle. The tax on alcohol today makes up about 12% of the total excise tax revenue and a very small amount of the US Government’s overall income.  Not even the tax collector really cares any more.

Most studies of Prohibition overlook the seemingly constant demand for the product, even when the consumers knew that it was illegal to purchase and consume it.  The simple truth is that banning anything is not a viable policy.  America prides itself as being a nation of laws. Prohibition demonstrated that a wide swath of the population was willing to say: let the laws be damned.  

Start-ups Don’t Have to Fail

I think that it is patently absurd for people to accept the fact that 90% of start-ups will fail in their first year or two.  That number screams that the market for new business formation is not efficient.  Economics teaches that markets hate inefficiency and always strive to do better. But this is one statistic that never seems to change.

I have read quite a few books and a lot of articles written by so-called experts dissecting why start-ups fail and how to make them succeed.  Much of it is nonsense.

There are really only three primary reasons why a new business will fail; 1) the owner lacks basic business acumen; 2) the business is under-capitalized and 3) the business misread the market. All can and should be avoided if the entrepreneur knows what he/she is doing.  Usually lack of experience and the ability to run the business profitably is what leads to the failure.  There are a lot of would-be entrepreneurs who do not know what a successful business looks like or how to run one.

It is hard to find an article that discourages entrepreneurs and entrepreneurship. But some people need to be discouraged because they do not have what it takes.  Fortunately, most of those people could learn what they need to know even though most will not.

When I was teaching economics I used the example of a restaurant, specifically a small pizza parlor, as a way of demonstrating how profitable a restaurant or any business can be.  Of all start-ups, restaurants often top the list of those that fail most often and more quickly than other businesses. That should not be.

In the example, the restaurant’s owner stops on his way to work to buy the ingredients that he needs, flour, cheese, tomato paste, pepperoni, etc. to make the pizzas.  If he opens his shop at 11AM, he can convert all of those ingredients into pizzas and back into cash, at a healthy mark-up, by the time he closes that evening. That type of rapid inventory turn-over is almost impossible to get in any other business.

Customers at a pizza parlor are not expecting table cloths and fancy décor so overhead can be kept to a minimum. Since the pizzas come out of the oven one or two at a time, the wait staff can handle more tables than the staff at other restaurants. They may use paper plates and paper cups eliminating the cost of a dishwasher. In most cases, advertising can be done cheaply with signage, flyers and coupons.

Couple that with the fact that the other product the restaurant sells, fountain soft drinks, has a huge mark-up and you can see why a small pizza restaurant can make a lot of money.  If he owner is really smart, he will add a soft serve ice cream dispenser as well because it also has a very high mark-up and will substantially increase the total amount of sales and profit per customer.

The further away the restaurant gets from this simple model, the greater the chance that it will fail.  Nothing about this discussion has a lot to do with the pizza or how good it is. It is all about the numbers, especially money in and out; how to maximize the former and minimize the latter.

The problem with most people who start a restaurant is that they plan the menu around what they want to serve or what they think they need to serve to attract customers, not on how much money they will make. Likewise, most start-ups focus on their product. But they also need to keep their eyes on the numbers. That is where start-ups succeed or fail.

The real lesson here for any business and especially start-ups is that what you are doing is a business. To make it work you need to be focused on the bottom line. If you cannot operate the business at a profit, it cannot succeed.  So why do 90% of start-ups fail: because their expenses are greater than their income.

When someone asks me what I consider to be essential for any new business, I always include an adequate bookkeeping system so the business owner can easily keep track of cash flow, inventory turn-over, etc. It is very difficult to find that suggestion on the list of start-up essentials in any of the hundreds of articles on the subject in Inc. or Entrepreneur Magazine.

The best advice for any start-up would be to “work smart and spend your time and your money wisely”.   That is especially true if you are looking for investors. Investors are expecting you to make money and they are expecting that you have what it takes to run a business and that you know what you are doing.

There are still thousands of articles about how to pitch VCs for funding. Over all VCs fund very few companies each year and many thousands of entrepreneurs are trying to get their attention because that is what the articles tell them to do.  Pitching to VCs may be the single biggest waste of time and money that any start-up does, especially so if you have to get on an airplane to make your pitch.

On the other hand, boot strapping can be very hard and the lack of cash can hold you back, delay your progress and cause you to fail just when you were beginning to succeed.  It is a lot easier to focus on your business when there is money in the bank to pay the bills.

Being able to raise seed capital so that you can focus and move forward is also an indication of other people’s evaluation of you and what you are attempting to do.  Feedback from potential investors on your seed round is important. Comments and suggestions, especially negative ones, will help you move forward.

Fund raising for start-ups has become remarkably easy with the JOBS Act and equity crowdfunding.  There is a lot of money available. It works for most start-ups because they can control the process and make it work.  I started walking companies through the process 3 years ago. Feel free to contact me if you are considering raising capital through crowdfunding or are raising capital and never considered crowdfunding.

A start-up is not a start-up until it starts-up.  Every business begins when it makes its first sale. It is a lot more difficult to raise funds for a pre-revenue company versus one which has a product already being sold. Pre-revenue you need a great business plan and a team to carry out your plan.  A good idea for a new business is important but execution is everything.

Given that financing a pre-revenue company is difficult, no one should plan on doing it twice; once to build your prototype product and again to launch it.  So an article that suggests that should raise money to create a  MVP (minimum viable prototype) and then again to take it to market is not really not helpful.   If you are going to raise seed capital to get your company off the ground, you should raise enough to get your product into the market, sustain your company until it is profitable, cover the costs of raising more money to help it grow and usually a small reserve in case things do not go exactly to plan.

There seems to be another stream of start-up gospel that suggests if you want to succeed you need to disrupt the market or solve a problem that nags the market. It is vitally important that you understand your market but you do not have to disrupt anything.

Nothing about the pizza parlor solves any specific problems that cannot already be solved in the marketplace. There is no new technology; no bells and whistles; no Blockchain.  While in a competitive market like New York City everyone knows a good slice from a not so good slice, I have waited on line at pizza parlors in small college towns around the US for some really mediocre pizza.

I look at a lot of pitch decks and I speak with a lot of entrepreneurs. Sometimes I can tell that the person just does not have what it takes to operate a successful business.  When that happens, I usually ask a lot of questions. How will the business operate post-launch? What are the sales goals month to month and where will the sales come from?  Where is your break-even point?

From day-one, the focus needs to be not on just starting up but staying open. The reason that 90% of start-ups fail is a lack of execution by the founders. If every entrepreneur focused on running the business well, that number would plummet.

If you are thinking about opening your own business, take a moment to have a slice a pizza and consider why that pizza parlor is successful.  Do that for fifty businesses. Look at what they are doing right and what you would do better.  Quantify how much more money the business would make if they did things your way.

Once you can analyze what makes other businesses successful, you will on the road to making your own business successful as well.  Sadly, the vast majority of people who are considering their own start-up would fail at this exercise. That, more than anything is why the 90% failure rate for start-ups is with us year after year.

 

 

Fixing CalPERS

Although it rarely comes up in mainstream financial media there is an enormous problem in the US with underfunded public pension funds. Unless this problem is addressed, it will have a serious impact on millions of pensioners and on the overall economy. Politicians will inevitably cut benefits which they will perceive is the only avenue open to them.

The California Public Employees Retirement System (CalPERS) is by far the largest pension fund at $326 billion. CalPERS provides pension and medical benefits for approximately 1.9 million state and municipal employees and retired employees in California.

CalPERS’ investment record can be described as lousy. By January 2009 before the financial markets had even bottomed out, its assets had declined in value by almost 30% from the preceding year and a half.  A lot of people saw the bubble rising before 2008. What was CalPERS thinking?

At that time the fund had about 65% of the dollars needed to pay the benefits it was obligated to pay. By June 2016 it was funded at almost 77%.  The fund posted an 11.2% return for 2016-2017 and is projecting an 8.7% return for its fiscal year 2017-2018.  Still, today it estimates that it is back to having $70 for every $100 it will eventually pay out. This is in the midst of a raging bull market when the DJIA more than doubled.

The fund needs to do a lot better if it is going to keep up with the pension demands of an increasing number of retirees who are living longer and increased medical and pharmaceutical costs for its aging population. Understanding why this happened is the first step to fixing it.

I do not want to mince words. The problem is that CalPERS is managed by a bloated bureaucracy of state employees and overseen by a board made up of largely incompetent political hacks.  In many ways just hiring professional managers would go a long way to solving the problems.  (No I do not expect this article will lead to a lucrative consulting contract. Telling the truth rarely does.)

Part of the problem can be attributed to the diversification policy being used. You cannot invest over $300 billion in just a handful of stocks but diversification for the sake of diversification is not the answer either.

In its last annual report, the fund reported that it held more than 1 million shares each of Chevron and Disney. Both are solid, blue chip, dividend paying California based companies.  No one would suggest either is a bad long term investment.

At the same time the fund owns hundreds of other equities, some well know and many not so well known.  Most pay no dividends. In more than a few cases the fund held only a few thousand shares of some of these companies. For a fund this size to own 5000 shares of small companies hoping that their price will increase $5 or $10 it is not worth the cost of a cadre of analysts to follow them.

CalPERS employs about 400 analysts all of whom are state employees and most will get a pension when they retire.  While they are not the most expensive analysts in the world (and they do not have to be) neither are they Wall Street’s best and brightest.

The portfolio also contains bonds issued by foreign companies and foreign governments.  There is nothing wrong with that, per se, but do we really need CalPERS to employ analysts to follow the economies of Chile, Germany and France?

Suggestion No. 1:  CalPERS could consolidate its portfolio a little, do away with smaller positions and foreign offerings and lay off a few analysts. There are individuals teaching economics and finance on the faculties of UCLA, Berkley and other state schools who are already employed by the state and who already get a state pension.  A blue ribbon panel composed of some of these individuals to help CalPERS see where the economy and the markets are going might help CalPERS avoid a substantial loss when the markets get ready to correct again (like now).

But that is just a start.

CalPERS seems to have a love /hate relationship with hedge funds and private equity managers.  In 2014 it announced that was going to begin severing relationships with its private equity and hedge funds, citing the high cost associated with these private managers. At the time these funds represented about 10% of its total portfolio — including $4 billion of hedge funds and $31 billion of private equity.

A year later, CalPERS disclosed that it still paid $700 million in performance fees to private equity firms and that it had paid a whopping $3.4 billion in fees since 1990. CalPERS justified the fees by pointing to the $34 billion in profits it made from these funds in the same period. Despite its promise to cut down on private equity funds, the fund was still invested in more than 280 funds at the end June 2015. In its most recent annual report, CalPERS cites the private equity funds as the most profitable segment of its portfolio.

Suggestion No.2 If CalPERS is considering investing a few hundred million dollars in a private equity fund, shouldn’t the fees be negotiable? Perhaps the legislature should step in and cap the fees that can be paid to a hedge fund or private equity manager.  No one can suggest that any private equity firm is going to say no to an investment of that size and the savings would go right to CalPERS’ bottom line.

Perhaps nothing points to the foolish way in which CalPERS invests its money than its history of real estate blunders. CalPERS invested almost $1 billion with home developer Lennar and lost most of it when Lennar went bankrupt. It invested and lost $500 million in Stuyvesant Town, a complex of 56 buildings with 11,000 rental units near the East River in Manhattan.  CalPERS response to this loss was to get back into the NYC real estate market and invest more than $300 million in 787 Fifth Avenue, reported to be the most expensive office building in Manhattan at the time.  Does CalPERS really need to invest in NYC real estate?

Suggestion No, 3.  There is a significant shortage of affordable housing in California. In Silicon Valley there are stories of police and firefighters living in RVs and trailers and school teachers living in their cars. Many of those people pay into CalPERS. CalPERS should consider funding at least 100,000 units (and perhaps a lot more) of affordable housing around the state. That will not really put a dent in the problem but it would be an excellent start.

In addition to the benefit from the construction jobs and the housing for people who need it, it should be obvious that people without a permanent place to live do not buy furniture and appliances.  Creating these permanent communities would certainly boost the sales tax revenue that the counties and municipalities are collecting. A population boost of 5-10,000 people in some smaller counties might create the need to hire more teachers and police who would pay into the CalPERS fund for decades.

More importantly, CalPERS could hold the mortgages on these properties and collect 5% and possibly more on its investment for 25-30 years.  I would think this is a more attractive investment than a bond issued by a foreign corporation even if the bond is rated triple AAA.  It certainly makes more sense than investing in high end office buildings whose tenants will move out when the market tanks.  Low end affordable housing is not sexy but the tenants tend to pay the rent in good markets and bad.

CalPERS also provides medical benefits for about 1.6 million current and retired state and municipal employees.  CalPERS does not break out the costs but it is obvious the skyrocketing costs for prescription drugs must be substantial and probably growing faster than the any other outlay.

Suggestion No.4. Instead of buying generic drugs for plan members, buy a generic drug manufacturer. CalPERS certainly has the money to own or joint venture with an FDA approved manufacturer to produce a lot of the pills it doles out every month.  One or two manufacturing facilities could make 10 or more of the top 20 generic prescriptions and mail them directly to plan beneficiaries who need them. This cuts out the manufacturer’s profit and the profit of at least one middleman. If one half of its plan participants get one prescription per month at a savings of $10 it could bring close to $100 million per year to CalPERS’ bottom line and that is probably conservative. I suspect that Kaiser or one of the other healthcare plans might be willing to take excess production or jump on the chance to invest as well.

People are always telling me that my blog articles expose problems and scams but that I rarely offer solutions or suggestions. At least when I expose a scam some people might not invest and thus not get hurt. The odds of anyone at CalPERS actually reading this are very slim, but who knows, it might actually resonate with someone who matters.

 

Why the Panic of 1893 is Relevant Today

The difference between studying economics and economic history is simple. In the former you learn how markets work and how to work within markets. In economic history you study all the times that the markets failed to work, including the market crashes, depressions and panics. The latter are far more interesting.

When I was teaching economics I would throw in a discussion of a panic or depression just to keep the students awake.  A good financial panic can get and keep your attention in the same way that motorists will never fail to look at two cars parked along the side of the highway that have been involved in an accident.  The more damage to the cars, the more people just cannot look away.

I frequently discussed the Panic of 1893 because it was at the same time a relatively simple and complex affair.  It was the worst economic disaster in the US up to that time and it came at the end of a period of prosperity and expansion the likes of which the US had not previously seen.

The events that led up to the Panic of 1893 and the measures taken by the government to deal with it are all relevant today.  There was a lot being discussed back then that is still being discussed today.

A lot of people who favor crypto-currencies frequently tell me that our current financial system is flawed and doomed because of the crash in 2008. That our economy survived 1893 and was still around to crash in 2008 is an indication of the market’s resiliency.  The reforms that took  place in the century after 1893 only made the US financial system stronger.

During the period 1870-1890 the railroads opened the west and people moved onto the Great Plains.  Farmers, not the industrialists, were the foundation of the US economy and were apparently too busy farming to have children because the food supply actually grew faster than the population.  Wheat was the primary commodity and whether the farmers understood it or not, the price of wheat was very much determined by a global economy.

US farmers borrowed heavily to finance their own farming operations. As production went up, prices came down and the depressed prices made it difficult for them to pay back the banks that had lent them money.  The same was true of cotton farmers in the South. Cotton was a major cash crop both before and after the Civil War. By 1890 the price became depressed as growers in Egypt and India added more and more tonnage to the world markets.

Since the farmers could not sell their wheat or cotton, there was no need to ship it anywhere and railroad revenues also dried up. The Philadelphia and Reading Railroad went bankrupt as did the several other large railroads. All were big employers and unemployment started to climb.  Part of this was due to the fact that as the railroads had been building more and more track and added to capacity that outgrew their market.

A company called National United Cordage which made rope out of hemp also went bankrupt.  The company had sold bonds to finance its operation and used the money to try to corner the market on hemp.  National Cordage was the most actively traded stock on the New York Stock Exchange at the time until rumors that the company had over extended itself caused the lenders to call the bonds and the company collapsed.

As National Cordage and the railroads went under, the stock market became uneasy and crashed.  Somewhere in the neighborhood of 500 banks closed as did thousands of businesses and farms. Unemployment shot up.  By some counts as many as 50% of the able bodied men who had been working in factories in Ohio were out of work.

In 1890 there was a drought in Argentina which killed off the wheat crop. This should have been good for American farmers but was not, for reasons that few people saw coming.  Years later when there was a similar drought and famine in the Ukraine, Herbert Hoover engineered the purchase of wheat from US farmers and shipped it to Russia. That would have helped the farmers in 1893, but no one apparently had the foresight to come up with this solution until 30 years later.

The Argentinean farmers were largely financed by British and European banks. In order to obtain the investment, the banks in Argentina originally hired Baring Brothers, one of the oldest English merchant banks, to assist them.  When I was giving this lecture to my economics students in 1995-1996, Barings had just been put out of business by a single young trader on its derivatives desk in Singapore who had made huge bets with Baring’s money and lost.

Barings was a little smarter in the 1890s because at the same time it was steering its clients into Argentine bonds, it was also buying US treasury bonds which were backed by gold.  European investors, panicked by the losses in South America, began to cash in the US bonds and demand gold as repayment. Almost immediately the US gold reserves fell to 100 million ounces which, by law, they were not supposed to fall below. The government actually borrowed gold from JP Morgan to make up its deficit.

The US was in the midst of a decade long debate about fiat currency.  At the time, fiat meant anything that was not gold or convertible into gold. The primary alternative was silver and many economists disregarded it out of hand simply because it was not gold.  You can only imagine how an economist from in the 1890s would feel about Bitcoins as an alternative currency today.

In 1890 the Congress had passed the Sherman Silver Purchase Act which required the US to purchase silver from mines in Western states. The idea was to deflate that value of US currency so that farmers could re-pay banks with currency that was worth less than it was when they borrowed it.

This encouraged silver mining and an over-supply of silver which helped to reduce the price of silver in the marketplace. It actually got to the point where a $1 Morgan silver coin had only about $.60 worth of silver in it.

The Silver Purchase Act was passed in conjunction with the McKinley Tariff, a very protectionist law that caused taxes on imports to rise dramatically and prices on many common goods to increase.  Certain protected industries such as wool and tin plates did well but overall prices went up for ordinary consumers.

At the time tariffs were the primary source of tax revenue for the US Government because the income tax had not yet been enacted. Tariffs were taxes that impacted small people buying common goods and aided the rich industrialists whose businesses were protected.

One of the interesting things about the Panic of 1893 is that it happened very quickly.  The railroads filed for bankruptcy, the banks closed and the stock market crashed all in a period of about 10 weeks. It led to several years of a deep depression.

Just prior to the 1893 collapse there had been a growing Populist movement that supported an agrarian economy and chastised Eastern elites, banks, railroad interests and gold. The Panic should have helped their cause, but did not. The Populists won 5 states in the Presidential election of 1892 and 9 seats in the House of Representatives in 1894 but had largely faded away by the end of the decade.

Not much in the way of reforms came out of this Panic but it was not the last. The Federal Reserve Act followed the Panic of 1907 when a few hundred more banks failed and securities market regulation and the FDIC originated after the stock market crash in 1929.

What I personally find interesting is that the issues present in 1893, globalization of finance and trade, the over-extension of credit, over supply of commodities and services, droughts, tariffs and protectionism, fiat currency, railroads and transportation, Populism and regional politics and even hemp are still in the headlines and issues surrounding them still on the table.

The overriding lesson is that finance is about trust and value.  It took 100 years after this Panic and several subsequent panics until the phrase “irrational exuberance” entered the economic lexicon but that phrase only explained what we should already have known.  The best lesson of 1893: “Do not build what you cannot use. Do not borrow what you cannot re-pay”.

 

Is Technology Changing Finance?

A lot of people seem to believe that technology will fundamentally change or disrupt finance and the financial markets.  Many, if not most, of those people seem to be developing technology, selling it or using it to sell products to investors and financial consumers.  Most of these people seem to have degrees or backgrounds in technology not finance.

Having a background in technology does not give you an understanding of finance or the financial markets.  You cannot fix or disrupt what you do not understand and the lack of understanding behind many of these products is simply ridiculous.

I only write about the law and the financial markets. I spent my career as an attorney working in and around the financial markets. I also taught Economics and Finance so I have a pretty well rounded idea about how the capital markets work and how they are evolving.

So I feel perfectly justified to call out the many techies who think they understand the financial markets even though they have never worked in the markets or studied finance. Nonetheless many seem hell-bent to create products that they think are making these markets better and are quick to label the products that they sell as “disruptive”.

I call these people the “algorithms fix everything” crowd.  It is an interesting thought, except that these mathematicians have no math to back up much of what they say about finance.

At the same time, there is an ongoing narrative that suggests that everyone who works in the financial markets is evil. I find it amazing how many people actually think that all bankers and stock brokers get up in the morning thinking “who can I screw today?”  I have personally brought more than 1000 claims on behalf of aggrieved investors against Wall Street firms and written a book about some of the really bad things that Wall Street firms can do, but even I know that Wall Street firms are not evil.

The capital markets handle millions of transactions every day involving trillions of dollars and the almost all of those transactions settle with both the buyer and seller happy. Banks and stockbrokers fund schools, universities, roads and hospitals and virtually every company since WWII, again without serious problems or complaints from anyone. Banks aggregate and intermediate capital and over all they do it quite well.  So what, exactly, needs disrupting?

Still there is a never ending stream of new products and services which claim to be revolutionary and which promise to disrupt the capital markets. On closer examination many of these innovations are more hype than substance. Say what you will, there is nothing disruptive here.  A few examples for your consideration:

1) Algorithmic stock trading – This is a good place to start because it is pure technology applied to the existing markets. “Quant” traders use computers to evaluate trends and trading patterns in the market of various securities. They attempt to anticipate the price at which the next trade or subsequent trades will occur.  Logic says that computers should be able to take in more information that is pertinent to stock trading, analyze it almost instantaneously and execute transactions in micro seconds.

It sounds right, but the reality is that all stock trading is binary; every buyer requires a seller. No one buys a stock unless they believe that the price will appreciate; sellers generally will only sell shares when they think the price will appreciate no further. Both sides to any trade cannot be correct.

Analyzing the information or executing faster is of no use unless each trade you make is profitable.  No one has yet figured out how to accomplish that, nor are they likely to do so.  What we are talking about is predicting the future which is difficult to do even if only a micro-second or two ahead.   And please do not suggest that artificial intelligence will change this.  If there is one right answer based on the current information, e.g. buy APPL, then who is going to sell it?

2) Robo investment advisors- These are similar but much less sophisticated. Robo-advisors do not actually attempt to anticipate future market performance. They make investment recommendations based solely on the past performance of the markets. Anyone who has ever bought a mutual fund is required by law to be told that past performance is not a basis for future results. But that is all you get with a robo-advisor.

FINRA did a study of a half dozen robo investment platforms and found that they provided widely divergent portfolios for the same types of investors. No robo is any better than any other and none is really worth anything.

3) Crypto currency- It was a discussion about Bitcoins that was the initial impetus for this article. Aficionados of crypto currency actually think that they are developing an alternative currency for an alternative financial system. People seem to want to just print their own money and on one level I can understand that.  But that level is more of a fantasy than reality.

The reality is that I can buy food or virtually anything else in most places in the world with US currency. Why do we need Bitcoins? What exactly, is their utility?   When I ask that question I get any number of weak responses. More often than not, I get a tirade about banks and/or governments being evil.

What proponents of crypto currencies never want to face is the fact that the crypto currency market has been full of people laundering money from illegal activities.  The banks that crypto currency fans love to hate are required by law to know their customers and have systems in place to prevent money laundering.  It costs money to follow the law and have those systems. It is money that the crypto currency platforms do not want to spend. If there is a common thread in the crypto currency world, it is that people want to skirt or simply ignore the regulations that keep the markets safe and functioning.

4)  Crowdfunding Platforms- Crowdfunding clearly works and works well as evidenced by the significant amount of money that it has raised for real estate and real estate development projects.  At the same time the crowdfunding industry is populated by a great many people who fall into the “I do not care what the rules say, I am in this to make a buck” crowd.  I have written several articles about how some of the crowdfunding platforms do not take the time to properly verify the facts that they give to potential investors.  Due diligence can be expensive and some of the platforms just refuse to spend what it takes to do it correctly.

Crowdfunding replaces the role that stockbrokers typically fulfill in the process of raising capital with a website and do it yourself approach.  With a stockbroker, the company that was seeking capital got that money the vast majority of the time because the brokers were incentivized to sell the shares. With crowdfunding it is very much hit or miss whether the company will get funded. Many of the better crowdfunding platforms charge close to what a brokerage firm would charge and the investors get none of the protections or insurance that they would get with a stockbroker.

5) FinTech and FinApps – I can go to my bank’s website and send a payment to my electric utility company. I can do the same at the utility company’s website. I admit that it is convenient, but it is hardly disruptive.   Remittance companies like PayPal merely move money from my bank to a vendor’s bank.  And PayPal posted a $3 billion profit in the last fiscal quarter.  So they may charge less of a fee per transaction than a bank, but is not essentially different, and again while PayPal holds my money, I get no insurance against hacking or theft.

Apps that allow me to apply for a mortgage on my phone are really doing no more than eliminating a bank employee who would enter the same information from a written application into the bank’s computer. Again, it is convenient but not necessary.  And the money for the mortgage comes from either a bank or stock brokerage firm so there is nothing disruptive here, either.

Is there nothing truly new and disruptive in finance? Of course there is. They deservedly gave the 2006 Nobel Prize in Economics to Muhammad Yunus for developing a system of micro-finance that continues to create millions of entrepreneurs and lift millions more out of poverty. I doubt that one line of computer code was needed.

Micro-finance has the ability to put globalization on steroids.  Who will be disrupted?  Quite of few people with big school pedigrees and enormous student debt who write code to disrupt finance but who never understood finance in the first place.to