Real World Finance$

6 a.m. this morning, the alarm goes off and NPR starts playing.  Market news comes on and the first thing I hear is about how markets in Asia and Europe have gone down while I was sleeping.  Because of that, they are saying the US market is going to go down today too.  Guess what, it did!

I guess I’m still not sure why people continue to sell off stocks at such a loss.  What is everyone afraid of?  In reality, no one loses money in the stock market until they sell their shares.  Those who are in retirement and selling now are the ones hardest hit.  The rest of us have no reason to panic and sell.

Should the stock price of a financial institute on the brink go down?  Sure.  Does the stock price going down have any real effect on whether the business will survive?  Not a bit.  The company doesn’t rely on the price of the stock to do business.  A piece of stock was sold to the general public as a right to future earnings of the company.  If they company isn’t going bankrupt tomorrow, then they will have future earnings and the stock price should be worth something.

Should we use the stock market index to determine the value of our economy?  No.  If more people were taking a long term look at company profits, the prices of the stocks in general would reflect their value.  Instead, people are panicking about a single point in time and taking a sky is falling mentality.  We tend to do just the opposite when things are good as well.  Just because times are good doesn’t mean they always will be.  A more moderate approach is needed.

The current stock market downturn is nothing more than the pendulum swinging the opposite direction.  When times are good we buy buy buy because everything is going up and it’s always going to do that of course.  When times are bad we sell sell sell because everything is going down and it’s always going to do that of course.  It’s those people who have the sense to do just the opposite that are the true wealthy investors.  They buy low during panicked selling and happily sell at overinflated prices when everyone is euphoric.  These prices we see today aren’t truly indicative of the value of the companies, only the present panicked fear of those who think the sky is falling.  For the market to be truly making this big a decline there have to be 2 things.

1. People who are scare and willing to sell their stocks to take a known loss now rather than an unknown in the future
2. People who are willing to relieve the people above of their fears knowing they can sell things back to them at a much higher price in a few years when their mood swings the other way.

Hopefully, you can be part of the second group.

Something has been bugging me for a while in all this credit crisis we’ve been having.  The government keeps doing what they can to stimulate the economy and get us out of the credit crunch.  They keep trying to get more money into the hand of the banks to free up the credit market and more money into the hands of consumers to encourage us to spend.

Isn’t it the spending that got us into trouble in the first place?  It was too much credit that lead to the defaults that worked it’s way up to banks not wanting to lend money to each other.  If Americans had been saving more of their income and spending  less, then the banks wouldn’t have reached this crisis in the first place.

Of course, if that had happened, our economy wouldn’t have had the great boom we have experienced the last decade or so.  If avoiding the bust means avoiding the boom, I think we should consider that option.  But, let me run through the scenario to make sure I’ve got this right:

1. Economy is booming and people are spending more money than they make, borrowing the rest from the bank.
2. The banks lend out lots more money to people than the people are putting into the bank to save.
3. Banks run out of money to lend because the lent it all out already.
4. Banks go under.
5. The government gives the bank more money to try and stimulate the economy back into a boom (see #1)

Maybe it’s  just me, but I’m thinking we need to consider how to get out  of this little cycle.

Madam X over at My Open Wallet just posted some information on The Candidates’ Economic Proposals: IRA & 401k Withdrawals.  Both McCain and Obama seem to think allowing people to withdraw their 401(k) or IRA funds early with no penalty will help stimulate the economy by getting people money to spend to cover this difficult time.

Excuse me, but aren’t those funds in the stock market?  Doesn’t the average consumer typically judge our economy by whether the stock market is up or down?  So, you think that allowing people to take MORE money out of the market without being penalized is going to HELP?  I’m flabbergasted is all I can say.

What a great way to really send the stock market into an all out tail spin.  People who are already afraid of the market would now have access to pull everything out causing an even further decline.  Their worst fears will be realized as a self fulfilling prophecy.

Does this idea scare other people as much as it scares me?

Want to be in a booming business during this current real estate and mortgage affair?  Check out this story I heard yesterday on NPR titled Foreclosures Keep Locksmiths in High Demand.  The story follows around a DC area locksmith as he spends long days and weekends working for banks changing the locks on newly foreclosed homes. 

He says he’s seen everything from the really nice, big brick homes to a small duplex in the ghetto.  It’s hitting everyone.  His routine is to get into the house by picking the lock.  It seems that foreclosed owners at least think to lock the door when they leave, and take the keys with them!  After getting in the house, he marches through checking all the rooms and closets for signs of people still in the house since he doesn’t want someone surprising him while he works (it has been known to happen evidently).

It was sad to hear him walk through a house and point out where carpet had been ripped up, appliances removed (dishwashers and the like that should have stayed) and just some of the general destruction people will do to their former home before they leave.  One house even still had a room full of children’s toys and pictures of the kids playing still stuck to the fridge. 

A booming business to be sure in these times, but one that would certainly take it’s toll on your psyche.  The story is less than 10 minutes long and I think it’s well worth a listen to hear the foreclosure market from the front lines.  These are the first guys there when a home is foreclosed, within hours.  The bankers and mortgage brokers don’t see the people from this view point I can assure you.

I had wanted to do a book review on a monthly basis this year.  I had a book in mind for February, but it was on hold for me at the library until just last week, so I’m in process of reading it for March.  To give you some good reading and catch up a bit, I thought I would share another one I had read recently.

A noteworthy review of this book as listed on Amazon simply said “Required reading.”  That review was by Steven Levitt, author of Freakonomics, my last book review.  Several other reviewers of this book say it is even better than Levitt’s book.  I believe it’s a matter of perspective.  Freakonomics was a little more entertaining and The Undercover Economist (affiliate link), by Tim Harford, is a bit more educational, so, take your pick.

 This book gets really good right from the start.  The first chapter is entitled, “Who Pays for your Coffee?”  While I’m not a coffee drinker myself, it was very intriguing to understand his analysis.  He delves into the old real estate motto of “location, location, location” buy showing why Starbucks seems to be on every corner and how they can do that and still charge $5 for a cup of coffee.

He also delves into the idea of “Free Trade” coffee.  I’ve seen this at some stores around where I live.  Places typically charge slightly more for a cup of Free Trade coffee than regular.  It is supposed to be a charge so that they can pay a higher amount for coffee grown in poor countries to help the farms grow.  Harford here suggests the actual amount of difference they pay for the pound of coffee versus how much coffee they can brew and charge extra for is way out of whack.  It seems the coffee vendor is making a huge extra profit on the Free Trade cups and is only passing slightly more on to the farmer.  Lucky for him, his favorite coffee shop no longer charges a different price.

Later chapters swim into topics of your local grocery store  and on into the reasons poor countries stay poor (that chapter alone should be read if you read no other part of this book). 

As you can tell so far, my book reviews won’t be your typical personal finance related books.  I believe that a strong understanding of markets and economics will help you to make smarter money and buying decisions.  I highly recommend you add this book to your reading list.  I pick mine up from my local library.

If heard this comment a number of times from friends, co-workers and students of mine.  I heard it most 6 months or so ago when there was talk about how much US Currency China has in its reserves.  A couple of my students said that China could just put those billions of US currency back in the market and our economy would be toast.  To some extent that is true, but we often forget to look at the full consequences.  What happens to China if the US economy goes in the tank?

According to the CIA Factbook for China, their estimated GDP (the value of all goods and services produced in a country in a given year) based on exchange rate is about $3.249 Trillion US Dollars.  Of that, $1.221 Trillion is exported to one country or another.  The US makes up 21% of all exports (which equates to $256.41 Billion).  So, the value of our exports make up 7.89% of the total production in China. 

First, it puts things in perspective a bit to see that we are importing less than 8% of the goods and services that China produces in a year (and our store shelves are full of stuff made in China).  As a matter of fact, only 37.6% of the Chinese GDP is made for export.  There is still a LOT of products staying in country for their own consumption.

Second, suppose a country like China were to flood the market with US Currency and devalue our dollar.  What next?  Well, with a weaker dollar our purchasing power goes down.  That $700 Chinese TV would now cost $1000.  That means we will buy fewer and import fewer of those TVs from China.  So, by devaluing our currency, China cuts demand for it’s own products.  They don’t want a weak dollar because they need us to keep buying their products. 

You can go around the world and find many countries who are in this same situation with the US.  Without the US consumer economy going strong, much of the world will hit tough economic times as well.  That is why you see foreign investors and government entities willing to put forth money to help shore up our lending institutions at the moment.  They know that a drop in our economy will hurt them as well.

As a follow-up to my post yesterday on $4 gas, here’s a link to a recent interview I saw on PBS. 

Nightly Business Report interview with Dallas Fed President Richard Fisher

I found this particular excerpt interesting when I was watching:

I’m concerned also by the way that the futures markets for oils have not proven to be very good indicators of future oil prices.

There you go, right from the horses mouth so to speak. A federal reserve bank president saying that oil futures are not good indicators of future oil prices. It’s not too surprising to be honest. I mean, if it was a good predictor of future prices, then no one would make money or be much interested in trading futures now would they? Futures are merely a projection of future expectations based on current information.

With a global economy, there are a huge number of variables that can never be known.  For instance, what about the price of oil futures the day before and the day after the 9/11 attacks?  One event changed future expectations drastically I’m sure.  But what was the futures prices for that date 6 months prior?  Without knowing the attack would happen and change the world, I’m sure the expectations were way off.

Another thing is something I teach to my graduate Quantitative Analysis students when we look at regression analysis.  When you use a regression line to create a linear equation, it is only a good predictor within the range of data you used for your analysis.  Taking that equation to predict outside the range of your known values (predicting the future, or extrapolating the past) will lead to more and more uncertainty the further you get from your included data set. 

We know that inherently when we watch the weather forecast.  This morning we feel pretty safe with the weather forecast for the rest of the day.  But by the same token, we are not always convinced about the forecast they give us for the upcoming weekend or for next week.  We know that is subject to change. 

Despite our uncertainty with the weather, when we hear some news report that analysts are predicting gas to be $4 a gallon by summer, people seem to take it as truth.  Do we not learn from ourselves? 

Consider my name to be “They” for the purpose of this next statement.  I predict that gas in the US will drop to $2.50 by summer.  Now you can tell all your friends, “I heard they are saying gas will go down to $2.50 by summer.”  You heard it here first!

I’m assuming most of you have either heard or been told by someone that “THEY” say gas is going to be $4 a gallon this summer.  I’ve heard this from more than one co-worker and even my wife.  Before I get all in an uproar and worried, I first like to do my own investigation and find out exactly who “THEY” are that are making the prediction. 

I did a Google search and tried to find an article.  This proved more difficult than you would think as most of the top hits were predictions from back in 2005 after Katrina.  Of course, that prediction didn’t come true, so I’m already taking this with a grain of salt.  I did find this articleon a Reuters news-wire about a week ago.

According to the story, the US Energy Department is expecting $3.40 this summer.  However, there are other “experts” that are predicting much higher ($3.50 to $3.75).  An “expert” with AAA said that $4.00 is a possibility this summer.  I still don’t see anyone actually predicting $4.00 a gallon. 

Even if it did hit $4, with our new (more fuel efficient) car and only having one car for the family, we spend between $70 and $80 a month on gas.  A rise to $4 per gallon will only add maybe $30 a month to our expenses directly, though there may be some additional effect on groceries and other purchased goods.

I heard a couple people talking about the $4 prediction this morning in the break room.  They were all worried.  I posed my situation as using public transportation and that it really wouldn’t bother me at all.  Well, they got all in a huff about I can’t do that because I have to drive 10 miles to get to the metrolink.  Or the bus would take an hour and a half from South County and I have to drive to the bus stop (they obviously don’t know about the express buses). 

I really wanted to tell them that their line of thinking is why gas is so high.  Consumer demand helps drive prices up more than rising oil prices.  People who are unwilling to change their behavior in the face of rising prices give the oil and gas industry free money just for raising prices.  Choose to drive less, choose to move closer to work, find work closer to home, etc.  You have many options to offset your cost of gas if it really bothers you, but you choose to do none of them, so you add to the problem you are complaining about.  It’s sort of like people who don’t vote yet complain about politicians.

I’ll leave you with this excerpt from the article above.  It is about the real effect of gas prices on people and how it is making for a “terrible” life.  Myself, I don’t feel sorry for them.  It’s all about CHOICES!

For Americans like Phyllis Berry, a 31-year-old General Motors factory worker in Cleveland, gasoline costs are starting to hurt.

“I used to fill it up pretty regularly, but now I drive it until the tank is almost empty, looking for the cheapest place to buy gas,” said Berry, who drives a beat-up Chevrolet Caravan. She said that she used to take her four children to the movies four or five times a month. But with the cost of gas, tickets, popcorn and soda adding up to $70, they now go only once a month.

Can only go to the movies with 4 kids once a month! Oh the horror!

This is the third and last post in my International Perspective series.  Each of these was based on a single lunch time conversation at work with co-workers from Brazil and India.  The other posts can be found here:

International Perspective - NAFTA

International Perspective - Consumerism

Our conversation during lunch eventually drifted into the debt of most US consumers.  My colleague from Brazil made the comment, “If you wanted to buy a house back home, you saved and BOUGHT the house, it was paid for.  The same thing with a car, if you needed one you BOUGHT it and it was paid for.”  There is very little access to debt, credit cards, mortgages, etc. in a large part of the world.

My friend from India said something very similar.  “There are very few scholarships to college and no government money to help pay for it.  Your parents sacrifice and pay for your college.  Though they don’t ask, your first thought after graduating with your degree is how fast you can pay them back for your college.”  He said something even more interesting about buying a car or a house, “If you have to borrow money to buy a car or house, you first think about how quickly you can pay off that money.”

Isn’t that amazing?!  They first think about how quickly they can pay off debt, while us greedy Americans typically first thinking about how small we can get the monthly payments!  What a difference in philosophy.  That really stunned me to hear that when I realized what he was saying.  How different would the US economic situation be if consumers were more concerned about how quickly they could pay off debt rather than how long they can stretch it out to keep their payments low?

This is part II of my series on International Perspective.  These are based off of a single 1 hour lunch I had with co-workers who were from Brazil and India.  You can find Part I at the link below:

International Perspective - NAFTA

Our lunch conversation eventually drifted into consumerism here in the US.  Isn’t it strange how so many of us could live on so little money while in college, and can’t seem to get by on our large paychecks later on in life?  To the same token, it’s a sad testament that someone is not able to get by on a minimum wage job in this country while much of the world is able to survive quite well on pay lower than that.  What makes the difference?

The consensus between all 3 of us that day at lunch was the consumer mentality of people in the US.  When you get “old enough” (typically out of HS or College) you are expected to have your own car, your own job and your own place to live.  Add to that the expectations of cable tv, cells phones and the like and the “basic necessities” make up a large chunk of income.

Yet, it many foreign countries, extended families live together for a much longer period of time.  Our “necessities” are either not available at all or are luxury items.  Because of our own consumerism, we have set expectations of peoples possessions that are pushing them to live beyond their own means.  We are making our poor poorer not because they don’t make enough money to survive, but because they don’t make enough money to buy the things that are required of upstanding citizens.

My family has 1 car and no cable or satellite TV.  I can’t tell you the number of times I’ve gotten strange looks or an, “Oh” when I mention that to people.  They truly don’t get that it’s even an option for people.  You HAVE to have a car for each person in the house and you HAVE to have cable tv.  How many conversations at your workplace are about some show that was on a cable channel last night?  I bet it’s a lot more than conversations about that great book I read last week!

The sadness of this all is that our desire to keep up with others and give appearances of being middle class have lead many to buy things they don’t need and can’t afford.  Our financial industry has made that possible with easy credit through credit cards and home equity loans.  We are SUPPOSED to have lots of stuff and with that we are also SUPPOSED to have lots of debt, evidently.  Which leads us straight into tomorrows final discussion on the international perspective of debt.  Swing back in and see what others around the world have to say.