Henry Ford, Bill Hewlett & Dave Packard, Steve Jobs & Steve Wozniak, Howard Schultz, Ray Kroc and Richard Branson

Posted by PITHOCRATES - February 25th, 2014

 History 101

(Originally published May 8th, 2012)

Capitalism allows Entrepreneurs to bring their Great Ideas to Life

Entrepreneurs start with an idea.  Of how to do something better.  Or to create something we must have that we don’t yet know about.  They think.  They create.  They have boundless creative energies.  And the economic system that best taps that energy is capitalism.  The efficient use of capital.  Using capital to make profits.  And then using those profits to make capital.  So these ideas of genius that flicker in someone’s head can take root.  And grow.  Creating jobs.  And taxable economic activity.  Creating wealth for investors and workers.  Improving the general economy.  Pulling us out of recessions.  Improving our standard of living.  And making the world a better place.  Because of an idea.  That capitalism brought to life.

Entrepreneurs Risked Capital to bring Great Things to Market and to Create Jobs

Henry Ford established the Detroit Automobile Company in 1899.  Which failed.  He reorganized it into the Henry Ford Company in 1901.  Ford had a fight with his financial backers.  And quit.  Taking the Ford name with him.  And $900.  The Henry Ford Company was renamed Cadillac and went on to great success.  Ford tried again and partnered with Alexander Malcomson.  After running short of funds they reorganized and incorporated Ford Motor Company in 1903 with 12 investors.  The company was successful.  Some internal friction and an unexpected death of the president put Ford in charge.  Ford Motor built the Model A, the Model K and the Model S.  Then came the Model T.  And the moving assembly line.  Mass production greatly increased the number of cars he could build.  But it was monotonous work for the assembly line worker.  Turnover was high.  So to keep good workers he doubled pay in 1914 and reduced the 9-hour shift to 8 hours.  This increased productivity and lowered the cost per Model T.  Allowing those who built the cars to buy what they built.  In 2011 the Ford Motor Company employed approximately 164,000 people worldwide.

Bill Hewlett and Dave Packard established Hewlett-Packard (HP) in 1939.  In a garage.  They raised $538 in start-up capital.  In that garage they created their first successful commercial product.  A precision audio oscillator.  Used in electronic testing.  It was better and cheaper than the competition.  Walt Disney Productions bought this oscillator to certify Fantasound surround sound systems in theaters playing the Disney movie Fantasia.  From this garage HP grew and gave us calculators, desktop and laptop computers, inkjet and laser printers, all-in-one multifunction printer/scanner/faxes, digital cameras, etc.  In 2010 HP employed approximately 324,600 employees worldwide.  (Steve Wozniak was working for HP when he designed the Apple I.  Which he helped fund by selling his HP calculator.  Wozniak offered his design to HP.  They passed.)

Steve Jobs had an idea to sell a computer.  He convinced his friend since high school, Steve Wozniak, to join him.  They sold some of their things to raise some capital.  Jobs sold his Volkswagen van.  Wozniak sold his HP scientific calculator.  They raised about $1,300.  And formed Apple.  They created the Apple I home computer in 1976 in Steve Jobs’ garage.  From these humble beginnings Apple gave us the iPad, iPhone, iPod, iMac, MacBook, Mac Pro and iTunes.  In 2011 Apple had approximately 60,400 full time employees.

Jerry Baldwin, Zev Siegl, and Gordon Bowker opened the first Starbucks in 1971 in Seattle, Washington.  About 10 years later Howard Schultz drank his first cup of Starbucks coffee.  And he liked it.  Within a year he joined Starbucks.  Within another year while traveling in Italy he experienced the Italian coffeehouse.  He loved it.  And had an idea.  Bring the Italian coffeehouse to America.  A place to meet people in the community and converse.  Sort of like a bar.  Only where the people stayed sober.  Soon millions of people were enjoying these tasty and expensive coffee beverages at Starbucks throughout the world.  In 2011 Starbucks employed approximately 149,000 people.

Ray Kroc sold Prince Castle Multi-Mixer milk shakes mixers to a couple of brothers who owned a restaurant.  Who made hamburgers fast.  Richard and Maurice McDonald had implemented the Speedee Service System.  It was the dawn of fast food.  Kroc was impressed.  Facing tough competition in the mixer business he opened a McDonald’s franchise in 1955.  Bringing the grand total of McDonald’s restaurants to 9.  He would go on to buy out the McDonald brothers (some would say unscrupulously).  Today there are over 30,000 stores worldwide.  In 2010 McDonald’s employed approximately 400,000 people.

Richard Branson started a magazine at 16.  He then sold records out of a church crypt at discount prices.  The beginning of Virgin Records.  In 1971 he opened a record store.  He launched a record label in 1972.  And a recording studio.  Signing the Sex Pistols.  And Culture Club.  In 1984 he formed an airline.  Virgin Atlantic Airways.  In 1999 he went into the cellular phone business.  Virgin Mobile.  In 2004 he founded Virgin Galactic.  To enter the space tourism business.  His Virgin Group now totals some 400 companies.  And employs about 50,000 people.

The Decline of Capitalism and the Rise of the Welfare State caused the European Sovereign Debt Crisis

And we could go on.  For every big corporation out there will have a similar beginning.  Corporations that use capital efficiently.  Bringing great things to market.  Introducing us to new things.  Always making our lives better.  And more comfortable.  One thing you will not find is a great success story like this starting in the Soviet Union.  The People’s Republic of China (back in the days of Mao Zedong).  East Germany (before the Berlin Wall fell).  North Korea.  Or Cuba.  No.  The command economies of communist countries basically froze in time.  Where there was no innovation.  No ideas brought to life.  Because the government kind of frowned on that sort of thing.

There is a reason why the West won the Cold War.  And why we won that war without the Warsaw Pack and NATO forces fighting World War III.  And why was this?  Because we didn’t need to.  For the communist world simply could not withstand the forces of living well in the West.  Whenever they could their people escaped to the West.  To escape their nasty, short and brutish lives.  In the command economies of their communist states.  Where the state planners failed to provide for their people.  Even failing to feed their people.  The Soviet Union, the People’s Republic of China and North Korea all suffered population reducing famines.  But not in the West.  Where we are not only well fed.  But our poor suffer from obesity.  Which is not a good thing.  But it sure beats dying in a famine.

Sadly, though, the West is moving towards the state planning of their one time communist foes.  Social democracies are pushing nations in the European Union to bankruptcy.  Japan’s generous welfare state is about to implode as an aging population begins to retire.  Even in the United States there has been a growth of government into the private sector economy like never before.  Which is causing the Great Recession to linger on.  As it caused Japan’s lost decade to become two decades.  And counting.  As it is prolonging the European sovereign debt crisis.  With no end in sight.  The cause of all their problems?  The decline of capitalism.  And the rise of the welfare state.  Which just kills the entrepreneurial spirit.  And the creation of jobs.  Which is one cure for all that ails these countries.  And the only one.  For only robust economic activity can pull a country out of recession.  And for that you need new jobs.  And the entrepreneurial spirit.  In short, you need capitalism.

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Businesses and Jobs tend to move from Countries with High Regulatory Costs to ones with Low Regulatory Costs

Posted by PITHOCRATES - February 23rd, 2014

Week in Review

A business is an investment.  Business owners invest capital and labor to make money.  Just like people buy government bonds to make money.  Of course, investing in government bonds is safe but it doesn’t create any jobs.  So we prefer when investors invest in a business.  Because a business will create jobs.

So where would investors prefer to risk their money?   That depends on the expected return on investment.  Historically there was always more money to be made in a business.  But higher regulatory costs have reduced that return on investment.  Leading a lot of investors to turn to government bonds.  Or to move their businesses to another country.  One with a less costly regulatory environment (see The rich world needs to cut red tape to encourage business posted 2/22/2014 on The Economist).

Singapore has come out on top as the least burdensome for the past eight years (see chart 3), whereas many EU countries are bumping along near the bottom. Of the 148 countries surveyed in 2013, Spain was ranked 125th, France 130th, Portugal 132nd, Greece 144th and Italy 146th.

Americans who complain about the Obama administration’s unhelpfulness towards business will also note ruefully that over the past seven years their country has slipped from 23rd to 80th place…

Broadly speaking, in recent years emerging markets seem to have been cutting their red tape whereas the rich world has been strengthening its regulatory regime…

But not all labour laws are equally useful. In much of Europe the problem is that regulations designed to protect existing workers from unfair dismissal often make employers reluctant to take on new ones. One international executive recounts the tale of a French worker who had been with his employer for just three years but was entitled to five years’ compensation for dismissal. “We wouldn’t put anyone in France if we can possibly avoid it,” the executive said…

The danger is that, once European companies come to expand capacity again, they may do so outside the euro zone, where employment contracts are more flexible and wages and social costs are lower…

The EU not only has inflexible labour markets and high costs; it has slower growth prospects than most emerging markets. That will tempt many businesses to move elsewhere. “Western Europe is at a severe disadvantage because of the costs when you have to restructure your operations,” says Martin Sorrell, the boss of WPP. By contrast, Singapore has a low tax rate, a light regulatory regime and an enviable location at the heart of Asia. Sir Martin thinks some multinationals will eventually move their headquarters to the city-state.

The best way to protect workers is with a robust economy.  Not regulations.  If you lower the tax burden and regulatory costs the return on investment on businesses will soar past the return on investment from government bonds.  And investors would put their money into businesses to make more money.  This is how you help workers get better pay and benefits.  You create such economic activity that there are more jobs than people to fill them.  Forcing employers to offer higher wages and better benefits.  The way it was when the United States became the number one economy in the world.  Not the way it is currently in the EU.  Or the United States.  Where the Great Recession lingers on.  Thanks to an anti-business economic climate.  And the mother of all costly regulatory policies.  Obamacare.

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Abject Ignorance of things Economic is Destroying our Health Care System

Posted by PITHOCRATES - January 18th, 2014

Week in Review

The problem in America these days is the mass ignorance of the people.  Thanks to a public school system that does not educate but programs our children to be good Democrat voters.  Higher education taken over by the leftist radicals of the Sixties that forever changed the curriculum to teach our children to distrust capitalism and love government.  When controlled by Democrats, of course.  And people who are for some reason respected for their economic prowess who are absolutely clueless on things economic (see The Daily Show Nails Why Healthcare Will Never Work As A Free Market by Christina Sterbenz posted 1/18/2014 on Business Insider).

Steven Brill, author of Time’s in-depth healthcare analysis “Bitter Pill,” appeared on The Daily Show this week to discuss his opinion of Obamacare.

Brill’s work exploded his career into a love-hate relationship with Obamacare, now leading to a book. Speaking with Jon Stewart, Brill certainly made his criticisms known but we also feel like he pinpointed exactly why healthcare just can’t work as a free market.

Brill told the story of a cancer patient forced to pay $13,700 out-of-pocket, up-front for transfusion of a drug. And that cost only constituted part of a greater $83,000 payment. Brill claims, however, the drug only cost the pharmaceutical company $300.

Stewart came back at Brill with the typical, conservative argument — creating a free market for healthcare where patients pick-and-choose their coverage to create competition and therefore, better options.

“Everyone says, well it’s a marketplace. That guy [the cancer patient] has no choice in buying that drug. His doctor told him, ‘This will save your life. You don’t take it, you’re gonna die,'” Brill responded.

He further argued free markets must host two aspects — a balance between buyers and sellers and secondly, knowledge — neither of which the current U.S. system offers.

“That cancer drug has a patent. That is a monopoly that the government has given the drug company. There is no other drug. That’s the drug,” Brill said.

Jon Stewart is a comedian.  So one can almost forgive his ignorance.  But you’d think a person writing for a publication with the word ‘business’ in its name would actually understand business.  But the author hasn’t a clue.  It’s not her fault.  It’s because of the politicizing of our educational system.  As her dual degrees in journalism and public affairs would have taught her squat about the classical, Austrian or the Chicago school of economics.  Instead filling her head with Keynesian nonsense.  The one economic school embraced by power-hungry governments everywhere that has a proven track record of failure.  For it was Keynesian policies that gave us the Great Depression, the stagflation of the 1970s, the dot-com bubble and recession of the late 1990s/early 2000s and the Great Recession.  Where massive government spending did not pull the economy out of recession but only made things worse.

Why does this pharmaceutical company have a patent?  Or perhaps a better question would be why do we have this one cancer drug?  Why is it that this one pharmaceutical company developed a cancer drug that works that no other pharmaceutical company or government developed?  Because of that patent.  The only reason they poured hundreds of millions of dollars into research and development and paid massive liability insurance premiums for taking a huge risk to put a drug onto the market that may harm or kill people.  They do this on the CHANCE that they may develop at least one successful drug that will pay all of their past costs for this one drug, the costs for the countless drugs that failed AND a profit for their investors.  Who took a huge risk investing, giving this pharmaceutical company the money to pay all of their employees over the years it took to come up with at least one drug that wasn’t a loser.

Does the author of this article work for free?  No.  Of course not.  She has bills.  As we all do.  Even the people working at pharmaceutical companies.  Who don’t work there for free.  Even if the vast majority of their work produces nothing that their employer can sell their employer still pays them.  Thanks to their investors who give them the money to do so until they can actually sell something.  But their investors do this only because of the CHANCE that this pharmaceutical will develop that miracle drug that everyone wants.  A miracle drug that would never come into being if it weren’t for investors who were willing to risk losing huge amounts of money.  Something only rich investors can afford to do.

Health care worked as a free market before General Motors made it an employee benefit thanks to FDR’s ceiling on wages.  Once people stopped paying for what they received all free market forces left the health care system.  And costs began to rise.  This whole “healthcare just can’t work as a free market” is a product of the dumbing down of our educational system.  One that produces people who don’t know the difference between insurance and health care.  Insurance protects our assets against a catastrophic and UNEXPECTED loss.  Like when Lloyds of London started selling marine insurance at that coffee shop.  Every shipper paid a small premium to protect against a POTENTIAL sinking and loss of cargo.  A POTENTIAL financial loss.  Not every ship sank, though.  In fact, most ships did not.  Which is why that little bit from everyone was able to pay the financial loss of the few that did.  For the ships that didn’t sink the shippers paid every other cost they incurred to ship things across those perilous oceans.

This is how insurance works.  Which isn’t how our current health insurance works.  Where people don’t expect to pay for anything out-of-pocket.  Not the unexpected catastrophic costs.  Or the EXPECTED small costs that everyone can budget for in their personal lives.  Childhood vaccinations, annual checkups, flu shots, childbirth, etc.  Even the unexpected things that have a low cost.  Like the stitches required when a child falls off of a bike.  Things that would cost less than someone’s annual cellular costs.  Or things that people can plan and save for (like a house, a car or a child).  When we pay these things out-of-pocket there are market forces in play.  For a doctor is not going to charge someone they’ve been seeing for years as much as a faceless insurance company.  Even today some doctors will waive some fees to help some of their long-time patients during a time of financial hardship.  Because there is a relationship between doctor and patient.

When we pay out-of-pocket doctors can’t charge as much.  Because they need patients.  If they charge too much their patients may find another good doctor that charges a little less.  Perhaps a younger one trying to establish a practice.  These are market forces.  Just like there are everywhere else in the economy.  Even a cancer patient requiring an expensive wonder drug would contribute to market forces if there was true insurance in our health care system.  Cancer is an unexpected and catastrophic cost.  But not everyone gets cancer.  Everyone would pay a small fee to insure against a financial loss that can result from cancer.  Where that little bit from everyone was able to pay the financial loss of the unfortunate few that receive a cancer diagnosis.  Because only a few from a large pool would incur this financial loss insurers would compete against other insurers for this business.  Just like they do to insure houses.  And ships crossing perilous oceans.

Health care would work better in the free market.  It doesn’t today because government changed that.  Starting with FDR putting a ceiling on wages.  Which forced employers to offer generous benefits to get the best workers to work for them when they couldn’t offer them more pay.  This was the beginning.  Now the health insurance industry is so bastardized that it doesn’t even resemble insurance anymore.  It’s just a massive cost transfer from one group of people to another.  Instead of a pooling of money to insure against financial risk.  For the few unexpected and catastrophic costs we could not afford and budget for to pay out-of-pocket.

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President Obama is Good for Wall Street but Bad for Main Street.

Posted by PITHOCRATES - December 8th, 2013

Week in Review

The unemployment rate fell from 7.3 to 7.0 in November (see Table A-1. Employment status of the civilian population by sex and age).  With the government reporting 203,000 jobs created.  The economy must be turning around.  Things are getting better.  Especially for rich people (see Not fully inflated posted 12/7/2013 on The Economist).

TALK of bubbles is in the air again. The Dow Jones Industrial Average has hit an all-time high. A loss-making technology firm (Twitter) has floated its shares on a flood of investor demand. Private-equity groups are buying companies using amounts of debt not seen since 2008. A record price (more than $50m) has just been set for a penthouse in Manhattan. A triptych by Francis Bacon became the most expensive piece of art sold at an auction when Christie’s flogged it for $142.4m last month. Robert Shiller of Yale University, who correctly identified bubbles in tech stocks in the late 1990s and in property in the 2000s, has expressed unease about giddy American share valuations.

All this suggests that wealthy investors have become increasingly confident.

The rich sure are getting richer under President Obama.  But that’s Wall Street.  Where if you have friends in Washington you do well.  And Wall Street has a lot of friends in the Obama administration.  But what about Main Street?  How are the rest of us doing?  Who don’t have friends in Washington looking out for us?  Well, when President Obama took office there were 80,507,000 that were NOT in the labor force.  Under the economic policies of President Obama this number rose to 91,273,000.  Meaning that President Obama has destroyed 10,766,000 jobs since he became president.  It will take another 53 months at this pace to replace the jobs President Obama’s policies destroyed.  Or 4.42 years.

This is how Main Street is doing.  Not good.   Unlike the rich.  Who are doing very well buying and selling assets by borrowing cheap money.  Courtesy of the Federal Reserve’s quantitative easing.  Basically printing money.  Making more of it available to borrow.  And because there is so much available to borrow interest rates are near zero.  Allowing the rich to borrow all the money they need to buy and sell assets with.  And as the Fed devalues the dollar it takes more of them to buy those assets.  Allowing the rich to reap huge profits when they sell.  Following the simple strategy of ‘buy low’ and ‘sell high’.  But that inflation also raises the prices of our groceries.  Which consume a larger portion of our paychecks.  Which makes us, those on Main Street, poorer.

President Obama.  Good for Wall Street.  Bad for Main Street.

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Quantitative Easing, Inflation and Gold

Posted by PITHOCRATES - September 23rd, 2013

Economics 101

The FOMC makes Money out of Nothing to Buy the Bonds for their Quantitative Easing

The Federal Open Market Committee (FOMC) decided to keep their quantitative easing.  Their monthly $85 billion purchase of Treasury Securities and mortgage bonds.  To stimulate the economy.  Which hasn’t stimulated the economy.  But it has greatly expanded the money supply.

When people buy Treasury Securities and mortgage bonds they have to first work and save up the money.  Then when they buy these investments they no longer have that money.  It’s how we buy things.  We exchange money for things.  So we can have the money or the things.  But never both.

Unless you’re the federal government.  That has the power to print money.  When they make these monthly $85 million purchases of Treasury Securities and mortgage bonds they pay for them with an electronic transfer of money.  They add money to the account of the holders of the Treasury Securities and mortgage bonds.  And that’s it.  They subtract no money from their ledgers.  Because they ‘printed’ that money.  Just made it out of nothing.  Literally.

The Danger of a highly Inflated and Devalued Currency is that it loses its Purchasing Power and People lose Faith in It

The Secret Service protects our presidents.  Ironically, the president that created the Secret Service was assassinated.  Abraham Lincoln.  Who created it not to protect presidents.  But to combat a great threat to the country.  Counterfeiting.  The scourge of paper money.

During the American Revolutionary War the Continental Congress had no hard money (i.e., precious metals) to pay the Continental Army.  So they resorted to printing paper money.  Igniting massive inflation.  The more money they printed the greater the inflation.  And the greater they devalued the dollar.  Requiring more and more of them to buy what they once did.  Until no one would accept them in payment anymore.  Forcing the army to take what they needed from the people.  Leaving behind IOUs for the Congress to honor.  Once they figured out how to do that.

This is the danger of a highly inflated and devalued currency.  It loses its purchasing power.  Until it gets so weak that the people lose faith in it.  And refuse to accept it anymore.  Returning to the barter system instead.  Trading things that hold their value for other valuable things.  But the barter system has high search costs.  It takes a lot of time for people to find each other that can trade with each other.  Greatly reducing economic activity.  And crashing a nation’s economy.  Which is what Abraham Lincoln wanted to prevent.  And why a lot of America’s enemies have tried to flood the American economy with counterfeit bills.

The Hard-Money Prices remained Relatively Constant during the Inflationary Periods of the Revolutionary War

With the FOMC’s decision to continue their quantitative easing the stock market soared.  As investors were instead expecting a ‘tapering’.  A reduction in their purchases of Treasury Securities and mortgage bonds.  And if the government stopped creating this money out of nothing to buy bonds from these investors these investors could not continue to buy and sell in the market like they were doing.  Pocketing handsome profits in the process.  Which is why they were so happy to hear the FOMC would continue their currency devaluation to continue buying like they had been.

But this continued currency devaluation has a down side.  For it can’t go on forever.  There will come a point when it ignites inflation.  Causing prices to soar.  Requiring more and more dollars to buy what they once bought before.  So with this possibility on the horizon and with continued currency devaluation some people were taking steps to protect their assets.  Especially their cash.  For there is nothing worse than having a lot of cash when it’s losing its purchasing power at an alarming rate.  So they convert that cash into something that holds it value better.  Such as precious metals.  Which is why when the dollar tanked (after the FOMC decision) the price of gold surged.

So what’s the difference between gold and paper money?  Well, the government can’t print gold.  They can’t create gold out of nothing and add it to someone’s account.  So they can’t devalue gold.  And because of this gold will hold its value during inflationary periods.  Which was why during the Revolutionary War people sold things with two prices.  One was in paper Continental Dollars.  With these prices increasing sometimes daily.  And one in hard money (i.e., precious metals).  The hard money prices remained relatively constant.  Even during the inflationary periods of the Revolutionary War.

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Economic Indicators

Posted by PITHOCRATES - May 20th, 2013

Economics 101

To Better Understand the Economy we should Study the Economic Indicators Investors Study

If you’ve lost your job you have a pretty good idea about the state of the economy.  It’s bad.  An unemployed person is like a soldier in the trench.  He or she doesn’t need to examine any data to understand what’s happening in the economy.  They know firsthand how bad things are.  But generals far behind the lines don’t have that up close and personal economic experience.  So they have to examine data to understand what’s going on.  Just as government officials, investors and economic prognosticators have to examine data.  Giving them an understanding of the state of the economy.  So they can know what the unemployed know.  The economy sucks.

Government officials want positive economic data so they can say their policies are working.  Whether they are or not.  In fact, they will parse the data to serve them politically.  When necessary.  Such as during the run-up to an election.  So their reports on the economy are not always, how should we say, full of truthiness.  For they can take some bad economic data and put a positive spin on it.  Completely changing the meaning of the data.  The unemployed won’t believe the rosy picture they’re painting.  But those in the trenches may.  And those in the rear with the gear.  After all, they have jobs.  So things don’t really seem that bad to them.

No, for a better picture of the economy you should listen to the people with skin in the game.  Those who are making bets on the economy.  Investors.  And business owners.  Who are risking their money.  And if we look at what they look at we can get a better understanding of the economy.  See what bothers them.  What pleases them.  And what excites them.  So what do they look at?  Economic data we call economic indicators.  Because they indicate the health of the economy.  And give an idea of what the future holds.  There are a lot of economic indicators.  The government compiles most of them.  They each give a little piece of the economic puzzle.  And when you put them together you see the bigger picture.

With a Rise in Housing Starts a Rise in Durable Goods should Follow Creating a lot of New Jobs

As far as economic indicators go retail sales is a big one.  Because consumer spending is the vast majority of economic activity in the new Keynesian economy.  (John Maynard Keynes changed the way governments intervene in the private sector economy in the early 20th century.)  Keynesians believe consumer spending is everything.  Which is why governments everywhere inflate their money supplies.  To keep their interest rates artificially low.  To encourage people to borrow money.  And spend.  When they do retail sales increase.  Signaling a healthy economy.  When they fall it may mean a recession is coming.  Of course, if retail spending rises more than expected investors get nervous.  Because it could mean inflation is coming.  Which the government will try to prevent by raising interest rates.  Thus cooling the economy.  And hopefully sending it into a soft landing.  But more often than not they send it into recession.

Another economic indicator is housing starts.  A lot of economic activity comes from building houses.  Building them generates a lot.  And furnishing them generates even more.  So governments are always trying to do everything within their power to encourage new housing.  They keep interest rates artificially low.  Encouraging people to get mortgages.  And they’ve pressured lenders to lower their lending standards.  To get more people with bad credit (or no credit) into houses.  Which led to subprime lending.  The subprime mortgage crisis.  And the Great Recession.  So more housing starts can be good.  But too many housing starts can be bad.  Generally, though, if they are increasing it’s a sign of an improving economy.

Before Keynesian economics the prevailing school of economic thought was classical economics.  Which we used to make America the world’s number one economic power.  Unlike Keynesians in the classical school we looked higher in the stages of productions.  Where real economic activity took place.  Raw material extraction.  Industrial processing.  Manufacturing.  And wholesaling.  An enormous amount of activity before you reach the consumer level.  All of these higher order economic activities fed into the making of durable goods.  Those things we bought to fill those new houses.  Which is why we like rising housing starts.  Because a rise in durable goods should follow.  And when we’re producing more durable goods we’re employing more people.  Making the durable goods economic indicator a very useful one.

One should Always be Skeptical when the Government says their Policies are Improving the Economy

The Producer Price Index (PPI) tells us how the prices are moving above the consumer level.  So if the PPI is rising it tells us the costs to produce consumer goods are rising.  And these higher costs will flow down the stages of production to the consumer level.  Causing a rise in consumer prices.  So the PPI forecasts what will happen to the CPI.  The consumer price index.  When it rises it means inflation is entering the picture.  Which the government will try to prevent by raising interest rates.  To cool the economy down.  And lower the prices at both the consumer and producer level.  Again, trying to send the economy into a soft landing.  But usually sending it into recession.  Which is why investors pay close attention to the PPI.  So they can get an idea of what will happen to the CPI.  So they can buy and sell (stocks and/or bonds) accordingly.

The rest of us can get an idea of what these investors think about the economy by following the Dow Jones Industrial Average (DJIA).  Which is the weighted ‘average’ of 30 stocks.  (We calculate it by dividing the sum of the 30 stock prices by a divisor that factors in all stock splits and changes of companies in the Dow 30).  As a company does well in a growing economy its stock price grows.  And if investors like what they see in other economic indicators they bid up the stock price even further.  So a rising DJIA indicates that investors believe the economy is doing well.  And will probably even improve.  But sometimes investors have a little irrational exuberance.  Such as during the dot-com bubble in the Nineties.  Where they poured money into any company that had anything to do with the Internet.  Making a huge bet that they found the next Bill Gates or Steve Jobs.  Of course, when that blind hope faded and reality set in those inflated stock prices came crashing down to reality.  Causing a long and painful recession in the early 2000s.  So even investors don’t always get it right.

When the dot-com bubble burst it threw a lot of people out of a job.  Increasing the unemployment rate.  Another big economic indicator.  But one that can be massaged by the government.  For they only count people out of a full-time job who are looking for full-time work.  The official unemployment rate (what we call the U-3 rate) doesn’t count people who gave up looking for work.  Or people who took a couple of part-time jobs to make ends meet.  A more accurate unemployment rate is the U-6 rate that counts these people.  For while the official unemployment rate fell below 8% during the run-up to the 2012 election the U-6 rate was showing a much poorer economic picture.  And the labor force participation rate showed an even poorer economic picture.  The labor force participation rate shows the percentage of people who could be working who were actually working.  So the lower this is the worse the economy.  The higher it is the better the economy.  So while the president highlighted the fall of the U-3 rate below 8% as a sign of an improving economy the labor force participation rate showed it was the worst economy since the Seventies.  Something the unemployed could easily understand.  But those who had a job believed the less than honest U-3 economic indicator.  Believed the president was making the economy better.  When, in fact, he had made it worse.  Which is why one should always be skeptical when the government says their policies are improving the economy.  For they are more concerned about winning the next election than the people toiling away in the trenches.

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Capital Markets, IPO, Bubbles and Stock Market Crashes

Posted by PITHOCRATES - April 22nd, 2013

Economics 101

Entrepreneurs turn to Venture Capitalists because they Need a Lot of Money Fast

It takes money to make money.  Anyone who ever started a business knows this only too well.  For starting a money-making business takes money.  A lot of it.  New business owners will use their lifesavings.  Mortgage their home.  Borrow from their parents.  Or if they have a really good business plan and own a house with a lot of equity built up in it they may be able to get a loan from a bank.  Or find a cosigner who is willing to pledge some collateral to secure a loan.

Once the business is up and running they depend on business profits to pay the bills.  And service their debt.  If the business struggles they turn to other sources of financing.  They pay their bills slower.  They use credit cards.  They draw down their line of credit at their bank.  They go back to a parent and borrow more money.  A lot of businesses fail at this point.  But some survive.  And their profits not only pay their bills and service their debt.  But these profits can sustain growth.

This is one path.  Entrepreneurs with a brilliant new invention may need a lot of money fast.  To pay for land, a large building for manufacturing, equipment and tooling, energy, waste disposal, packaging, distribution and sales.  And all the people in production and management.  This is just too much money for someone’s lifesavings or a home mortgage to pay for.  So they turn to venture capital.  Investors who will take a huge risk and pay these costs in return for a share of the profits.  And the huge windfall when taking the company public.  If the company doesn’t fail before going public.

The Common Stockholders take the Biggest Risk of All who Finance a Business

As a company grows they need more financing.  And they turn to the capital markets.  To issue bonds.  A large loan broken up into smaller pieces that many bond purchasers can buy.  Each bond paying a fixed interest rate in return for these buyers (i.e., creditors) taking a risk.  Businesses have to redeem their bonds one day (i.e., repay this loan).  Which they don’t have to do with stocks.  The other way businesses raise money in the capital markets.   When owners take their business public they are selling it to investors.  This initial public offering (IPO) of stock brings in money to the business that they don’t have to pay back.  What they give up for this wealth of funding is some control of their business.  The investors who buy this stock get dividends (similar to interest) and voting rights in exchange for taking this risk.  And the chance to reap huge capital gains.

The common stockholders take the biggest risk in financing a business.  (Preferred stockholders fall between bondholders and common stockholders in terms of risk, get a fixed dividend but no voting rights.)  In exchange for that risk they get voting rights.  They elect the board of directors.  Who hire the company’s officers.  So they have the largest say in how the business does its business.  Because they have the largest stake in the company.  After all, they own it.  Which is why businesses work hard to please their common stockholders.  For if they don’t they can lose their job.

During profitable times the board of directors may vote to increase the dividend on the common stock.  But if the business is not doing well they may vote to reduce the dividend.  Or suspend it entirely.  What will worry stockholders, though, more than a reduced dividend is a falling stock price.  For stockholders make a lot of money by buying and selling their shares of stock.  And if the price of their stock falls while they’re holding it they will not be able to sell it without taking a loss on their investment.  So a reduced dividend may be the least of their worries.  As they are far more concerned about what is causing the value of their stock to fall.

Investors make Money by Buying and Selling Stocks based on this Simple Adage, “Buy Low, Sell High.”

A business only gets money from investors from the IPO.  Once investors buy this stock they can sell it in the secondary market.  This is what drives the Dow Jones Industrial Average.  This buying and selling of stocks between investors on the secondary market.  A business gets no additional funding from these transactions.  But they watch the price of their stock very closely.  For it can affect their ability to get new financing.  Creditors don’t want to take all of the risk.  Neither do investors. They want to see a mix of debt (bonds) and equity (stocks).  And if the stock price falls it will be difficult for them to raise money by issuing more stock.  Forcing them to issue more bonds.  Increasing the risk of the creditors.  Which raises the bond interest rate they must pay to attract creditors.  Which makes it hard for the business to raise money to finance operations when their stock price falls.  Not to mention putting the jobs of executive management at risk.

Why?  Because this is not why venture capitalists risk their money.  It is not why investors buy stock in an IPO.  They take these great risks to make money.  Not to lose money.  And the way they expect to get rich is with a rising stock price.  Business owners and their early financers get a share of the stock at the IPO.  For their risk-taking.  And the higher the stock trades for after the IPO the richer they get.  When the stock price settles down after a meteoric rise following the IPO the entrepreneurs and their venture capitalists can sell their stock at the prevailing market price and become incredibly rich.  Thanks to a huge capital gain in the price of the stock.  At least, that is the plan.

But what causes this huge capital gain?  The expectations of future profitability of the new public company.  It’s not about what it is doing today.  But what investors think they will be doing tomorrow.  If they believe that their new product will be the next thing everyone must have investors will want to own that stock before everyone starts buying those things.  So they can take that meteoric rise along with the stock price.  As this new product produces record profits for this business.  So everyone will bid up the price because the investors must have this stock.  Just as they are sure consumers will feel they must have what this business sells.  When there are a lot of companies competing in the same technology market all of these tech stock prices can rise to great heights.  As everyone is taking a big bet that the company they’re buying into will make that next big thing everyone must have.  Causing these stocks to become overvalued.  As these investors’ enthusiasm gets the better of them.  And when reality sets in it can be devastating.

Investors make money by buying and selling stocks.  The key to making wealth is this simple adage, “Buy low, sell high.”  Which means you don’t want to be holding a stock when its price is falling.  So what is an investor to do?  Sell when it could only be a momentary correction before continuing its meteoric rise?  Missing out on a huge capital gain?  Or hold on to it waiting for it to continue its meteoric rise?  Only to see the bottom fall out causing a great financial loss?  The kind of loss that has made investors jump out of a window?  Tough decision.  With painful consequences if an investor decides wrong.  Sometimes it’s just not one individual investor.  If a group of stocks are overvalued.  If there is a bubble in the stock market.  And it bursts.  Look out.  The losses will be huge as many overvalued stocks come crashing down.  Causing a stock market crash.  A recession.  A Great Recession.  Even a Great Depression.

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People attack Pharmaceuticals and can’t Understand why they Get Out of the Drug-Making Business

Posted by PITHOCRATES - April 21st, 2013

Week in Review

Everyone hates the pharmaceuticals.  Because they don’t make life-saving drugs cheap enough.  And they don’t bring them to market quickly enough.  But when people need a new antibiotic that can take on a superbug who do they come running to?  Those evil and vile pharmaceuticals.  And they beg them to do what no one else can.  Save lives by bringing new drugs to market.  Of course when they do rush a drug to market and it hurts some people then everyone hates the pharmaceuticals.  For not taking the time to make sure the drug was safe before rushing it to market.  Just to make a buck.

Pharmaceuticals just can’t win.  They’re damned if they do.  And damned if they don’t.  It’s a wonder any of them stay in the business (see Antibiotic progress on superbugs called ‘alarmingly slow’ posted 4/21/2013 on CBC News).

Both biological and economic factors hinder the development of new antibiotics, Murray said. Yet new drugs are needed for resistant infections that continue to increase in frequency, causing significant illness and mortality, the society noted…

Wright’s team has some promising leads on potential antibiotics, but they can’t find a drug company willing to spend the money to get the drugs to market.

“Funding is the challenging thing,” Wright lamented.

The infectious disease society found that most of the large drug companies have left the antibiotic business. The group has proposed tax credits to encourage the remaining pharmaceutical companies to conduct the expensive clinical trials needed to test antibiotic candidates…

“One would like to think that the pharmaceutical industry has motives in mind that are to benefit health care and human kind in general. Sadly, I think their bottom line is a business,” said Simor, who has no shares or interest in the pharmaceutical industry.

Expensive clinical trials?  What, you mean they weren’t lying when they say it takes a lot of money to bring a new drug to market?  If so why are we always accusing them of charging too much for their drugs?  I mean, someone has to pay for all of those lawsuits.  As well as those clinical trials.  And there is only one thing that can.  The price per pill.

Yes, they are more concerned about their bottom line than benefitting human kind.  Because they can’t force their highly skilled people to work for free.  Most countries have labor laws against that sort of thing.  And because they have to pay for these people years before they can sell any drugs they are working on someone has to pay them in the mean time.  And these people are investors.  Who take the risk of paying people for years of work even though what they’re working on may be nothing but a dead-end that produces no revenue.  Which happens a lot.  So the drugs that actually make it to market have to pay for themselves.  And all of those dead-ends.

Capitalism makes those miracle drugs possible.  And the proof of that is that they need these drug companies to bring these drugs to market.  For the state cannot.  Because the state doesn’t know anything about risk taking.  The only thing they know is how to raise taxes to pay for an inefficient bureaucracy.  While a private drug company knows how to get an investor to pay for an efficient business plan.  Capitalism brings new drugs to market.  And when you attack capitalism too much (higher taxes, more regulations, no relief from frivolous lawsuits, etc.) those who wish to make a profit may get out of the drug-making business.

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Wall Street is Doing Well because the Fed’s Inflationary Policies keep Raising Prices

Posted by PITHOCRATES - March 9th, 2013

Week in Review

Investors like rising stock prices.  They don’t like falling stock prices.  Which is why Wall Street likes inflation.  And fear deflation.  Even though the economy is still sluggish with more and more people dropping out of the labor market (which is why the unemployment rate fell) investors are bullish.  Because of the Federal Reserve and all of their quantitative easing.

The more the Fed increases the money supply the more inflation there will be.  Investors like that.  Because inflation increases prices.  Such as the prices of their stocks.  As well as gasoline and groceries.  Making the current economic times odd.  For the stock market recently reached a record high.  Even though the labor participation rate (see THE EMPLOYMENT SITUATION —FEBRUARY 2013, page 4) continues to fall.  It is now at 63.5%.  Which means 89,304,000 people are not in the labor force.  A record high.  But you wouldn’t know this by looking at the official unemployment rate.  Or the stock market (see Stocks And Inflation: The End Of An (Abnormal) Affair? by James Picerno posted 3/69/2013 on Seeking Alpha).

The positive correlation between the market’s inflation forecast and the stock prices appears a bit looser these days, but it’s premature to declare that the link has been broken…

Normally, rising/high inflation doesn’t inspire the bulls. But the last several years have been less than normal in terms of the macro backdrop. The crowd has remained worried about disinflation/deflation, which means that signs of higher inflation in the future have soothed anxious traders…

And why not?  For when have inflationary policies ever caused an asset bubble? That burst into a long and painful recession?  Except the housing bubble that brought about the 1990-91 recession.  The dot-com bubble that brought about the 2000-01 recession.  And that other housing bubble that brought about the 2007-09 recession.  AKA The Great Recession.  So there is no worry that these record highs in stock prices aren’t just another bubble.  Just waiting to burst.  Bringing on another deflationary recession.  I mean, what are the odds of that happening again?

Actually, the chances are pretty good that 2013 will have a very painful recession.  Because we don’t have any real economic growth.  These gains in the stock market aren’t because businesses are expanding and hiring.  Not with a falling labor participation rate.  No.  For all intents and purposes we are still in the 2007-09 recession.  Only we should probably call it the 2007-(end date to be determined) recession.  Because the president’s economic policies haven’t helped the economy yet.  And probably never will.

There’s no reason to believe that the fifth year will be any better than the previous four years.  In fact, it will probably be worse.  In fact one would almost get the impression that he is not trying to help the economy.  But, instead, trying to destroy the Republican Party.  So he can win the House of Representatives back in 2014.  So he can pass even more anti-business policies.  To transform the country into something it was never before.  Less prosperous than communist China.

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Tax Cuts, Roaring Twenties, Farm Prices, Smoot-Hawley Tariff, Stock Market Crash, New Deal, Great Depression and the Great Recession

Posted by PITHOCRATES - November 6th, 2012

History 101

(Originally published March 20, 2012)

Tax Cuts and the Small Government Policies of Harding and Coolidge gave us the Roaring Twenties

Keynesians blame the long duration of the Great Depression (1929-1939) on the government clinging to the gold standard.  Even renowned monetarist economist Milton Friedman agrees.  Though that’s about the only agreement between Keynesians and Friedman.   Their arguments are that the US could have reduced the length and severity of the Great Depression if they had only abandoned the gold standard.  And adopted Keynesian policies.  Deficit spending.  Just like they did in the Seventies.  The decade where we had both high unemployment and high inflation.  Stagflation.  Something that’s not supposed to happen under Keynesian economics.  So when it did they blamed the oil shocks of the Seventies.  Not their orgy of spending.  Or their high taxes.  And they feel the same way about the Great Depression.

Funny.  How one price shock (oil) can devastate all businesses in the US economy.  So much so that it stalled job creation.  And caused high unemployment.  Despite the government printing and spending money to create jobs.  And to provide government benefits so recipients could use those benefits to stimulate economic activity.  All of that government spending failed to pull the country out of one bad recession.  Because of that one price shock on the cost of doing business.  Yet no one talks about the all out assault on business starting in the Hoover administration that continued and expanded through the Roosevelt administration.

Herbert Hoover may have been a Republican.  But he was no conservative.  He was a big government progressive.  And believed that the federal government should interfere into the free market.  To make things better.  Unlike Warren Harding.  And Calvin Coolidge.  Who believed in a small government, hands-off policy when it came to the economy.  They passed tax cuts.  Following the advice of their treasury secretary.  Andrew Mellon.  Which gave business confidence of what the future would hold.  So they invested.  Expanded production.  And created jobs.  It was these small government policies that gave us the Roaring Twenties.  An economic boom that electrified and modernized the world.  With real economic growth.

If an Oil Shock can prevent Businesses from Responding to Keynesian Policies then so can FDR’s all out War on Business

The Roaring Twenties was a great time to live if you wanted a job.  And wanted to live in the modern era.  Electric power was spreading across the country.  People had electric appliances in their homes.  Radios.  They went to the movies.  Drove cars.  Flew in airplanes.  The Roaring Twenties was a giant leap forward in the standard of living.  Factories with electric power driving electric motors increased productivity.  And reduced air pollution as they replaced coal-fired steam boilers that up to then powered the Industrial Revolution.  This modernization even made it to the farm.  Farmers borrowed heavily to mechanize their farms.  Allowing them to grow more food than ever.  Bumper crops caused farm prices to fall.  Good for consumers.  But not those farmers who borrowed heavily.

Enter Herbert Hoover.  Who wanted to use the power of government to help the farmers.  By forcing Americans to pay higher food prices.  Meanwhile, the Federal Reserve raised interest rates.  Thinking that a boom in the stock market was from speculation and not the real economic growth of the Twenties.  So they contracted the money supply.  Cooling that real economic growth.  And making it very hard to borrow money.  Causing farmers to default on their loans.  Small rural banks that loaned to these farmers failed.  These bank failures spread to other banks.  Weakening the banking system.  Then came the Smoot-Hawley Tariff.  Passed in 1930.  But it was causing business uncertainty as early as 1928.  As the Smoot-Hawley Tariff was going to increase tariffs on just about everything by 30%.  Basically adding a 30% tax on the cost of doing business.  That the businesses would, of course, pass on to consumers.  By raising prices.  Because consumers weren’t getting a corresponding 30% pay hike they, of course, could not buy as much after the Smoot-Hawley Tariff.  Putting a big cramp in sales revenue.  Perhaps even starting an international trade war.  Further cramping sales.  Something investors no doubt took notice of.  Seeing that real economic growth would soon come to a screeching halt.  And when the bill moved through committees in the autumn of 1929 the die was cast.  Investors began the massive selloff on Wall Street.  The Stock Market Crash of 1929.  The so-called starting point of the Great Depression.  Then the Smoot-Hawley Tariff became law.  And the trade war began.  As anticipated.

Of course, the Keynesians ignore this lead up to the Great Depression.  This massive government intrusion into the free market.  And the next president would build on this intrusion into the free market.  Ignoring the success of the small-government and tax cuts of Harding and Coolidge.  As well as ignoring the big-government free-market-intrusion failures of Herbert Hoover.  The New Deal programs of FDR were going to explode government spending to heights never before seen in peace time.  Causing uncertainty like never seen before in the business community.  It was an all out assault on business.  Taxes and regulation that increased the cost of business.  And massive government spending for new benefits and make-work programs.  All paid for by the people who normally create jobs.  Which there wasn’t a lot of during the great Depression.  Thanks to programs like Reconstruction Finance Corporation, Federal Emergency Relief Administration, Civilian Conservation Corps, Homeowners Loan Corporation, Tennessee Valley Authority, Agricultural Adjustment Act, National Industrial Recovery Act, Public Works Administration, Federal Deposit Insurance Corporation, Glass–Steagall Act, Securities Act of 1933, Civil Works Administration, Indian Reorganization Act, Social Security Act, Works Progress Administration, National Labor Relations Act, Federal Crop Insurance Corporation, Surplus Commodities Program, Fair Labor Standards Act, Rural Electrification Administration, Resettlement Administration and Farm Security Administration, etc.  Oil shocks of the Seventies?  If an oil shock can prevent businesses from responding to Keynesian policies then an all out war on business in the Thirties could do the same.  And worse.  Far, far worse.  Which is why the Great Depression lasted 10 years.  Because the government turned what would have been a normal recession into a world-wide calamity.  By trying to interfere with market forces.

Only Real Economic Growth creates Jobs, not Government Programs

The unemployment rate in 1929 was 3.1%.  In 1933 it was 24.9%.  It stayed above 20% until 1936.  Where it fell as low as 14.3% in 1937.  It then went to 19.0%, 17.2% and 14.6% in the next three years.  These numbers stayed horrible throughout the Thirties because the government wouldn’t stop meddling.  Or spending money.  None of the New Deal programs had a significant effect on unemployment.  The New Deal failed to fix the economy the way the New Dealers said it would.  Despite the massive price tag.  So much for super smart government bureaucrats.

What finally pulled us out of the Great Depression?  Adolf Hitler’s conquering of France in 1940.  When American industry received great orders for real economic growth.  From foreign countries.  To build the war material they needed to fight Adolf Hitler.  And the New Deal programs be damned.  There was no time for any more of that nonsense.  So during World War II businesses had a little less uncertainty.  And a backlog of orders.  All the incentive they needed to ramp up American industry.  To make it hum like it once did under Harding and Coolidge.  And they won World War II.  For there was no way Adolf Hitler could match that economic output.  Which made all the difference on the battlefield.

Still there are those who want to blame the gold standard for the Great Depression.  And still support Keynesian policies to tax and spend.  Even today.  Even after 8 years of Ronald Reagan that proved the policies of Harding and Coolidge.  We’re right back to those failed policies of the past.  Massive government spending to stimulate economic activity.  To pull us out of the Great Recession.  And utterly failing.  Where the unemployment rate struggles to get below 9%.  The U-3 unemployment rate, that is.  The rate that doesn’t count everyone who wants full time work.  The rate that counts everyone, the U-6 unemployment rate, currently stands at 14.9%.  Which is above the lowest unemployment rate during the Great Depression.  Proving once again only real economic growth creates jobs.  Not government programs.  No matter how many trillions of dollars the government spends.

So much for super smart government bureaucrats.

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