Why the Stock Market is so Good when the Economy is so Bad

Posted by PITHOCRATES - March 31st, 2014

Economics 101

No One is going to get Rich by Buying and Selling only one Share of Stock

It takes money to make money.  I’m sure we all heard that before.  If you want to ‘flip’ a house you need money for a down payment to get a mortgage first.  If you want to start a business you need to save up some money first.  Or borrow it from a family member.  And if you want to get rich by playing the stock market you need money.  A lot of money.  Because you only make money by selling stocks.  And before you can sell them you have to buy them.

Stock prices may go up and down a lot.  But over a period of time the average stock price may only increase a little bit.  So if you bought one share of stock at, say, $35 and sold it later at, say, $37.50 that’s a gain of 7.14%.  Which is pretty impressive.  Just try to earn that with a savings account at a bank.  Of course, you only made a whopping $2.50.  So no one is going to get rich by buying and selling only one share of stock.

However, if you bought 10,000 shares of a stock at $35/share and then sold it later at $37.50 that’s a whole other story.  Your initial stock purchase will cost you $350,000.  And that stock will sell for $375,000 at $37.50/share.  Giving you a gain of $25,000.  Let’s say you make 6 buys and sells in a year like this with the same money.  You buy some stock, hold it a month or so and then sell it.  Then you use that money to buy some more stock, hold it for a month or so and then sell it.  Assuming you replicate the same 7.14% stock gain through all of these transactions the total gain will come to $150,000.  And if you used no more than your original investment of $350,000 during that year that $350,000 will have given you a return on investment of 42.9%.  This is why the rich get richer.  Because they have the money to make money.  Of course, if stock prices move the other way investors can have losses as big as these gains.

Rich Investors benefit most from the Fed’s Quantitative Easing that gives us Near-Zero Interest Rates

Rich investors can make an even higher return on investment by borrowing from a brokerage house.  He or she can open a margin account.  Deposit something of value in it (money, stocks, option, etc.) and use that value as collateral.  This isn’t exactly how it works but it will serve as an illustration.  In our example an investor could open a margin account with a value of $175,000.  So instead of spending $350,000 the investor can borrow $175,000 from the broker and add it to his or her $175,000.  Bringing the total stock investment to $350,000.  Earning that $25,000 by risking half of the previous amount.  Bringing the return on investment to 116.7%.  But these big returns come with even bigger risks.  For if your stock loses value it can make your losses as big as those gains.

Some investors borrow money entirely to make money.  Such as carry trades.  Where an investor will borrow a currency from a low-interest rate country to invest in the currency of a higher-interest rate country.  For example, they could borrow a foreign currency at a near zero interest rate (like the Japanese yen).  Convert that money into U.S. dollars.  And then use that money to buy an American treasury bond paying, say, 2%.  So they basically borrow money for free to invest.  Making a return on investment without using any of his or her money.  However, these carry trades can be very risky.  For if the yen gains value against the U.S. dollar the investor will have to pay back more yen than they borrowed.  Wiping out any gain they made.  Perhaps even turning that gain into a loss.  And a small swing in the exchange rate can create a huge loss.

So there is big money to make in the stock market.  Making money with money.  And investors can make even more money when they borrow money.  Making money with other people’s money.  Something rich investors like doing.  Something rich investors can do because they are rich.  For having money means you don’t have to use your money to make money.  Because having money gives you collateral.  The ability to use other people’s money.  At very attractive interest rates.  In fact, it’s these rich investors that benefit most from the Fed’s quantitative easing that is giving us near-zero interest rates.

People on Wall Street are having the Time of their Lives during the Obama Administration

We are in the worst economic recovery since that following the Great Depression.  Yet the stock market is doing very well.  Investors are making a lot of money.  At a time when businesses are not hiring.  The labor force participation rate has fallen to levels not seen since the Seventies.  People can’t find full-time jobs.  Some are working a part-time job because that’s all they can find.  Some are working 2 part-time jobs.  Or more.  Others have just given up trying to find a full-time job.  People the Bureau of Labor Statistics (BLS) no longer counts when calculating the unemployment rate.

This is the only reason why the unemployment rate has fallen.  If you add the number of people who have left the labor force since President Obama took office to the number the BLS reports as unemployed it would bring the unemployment rate up to 13.7% ((10,459,000 + 10,854,000)/155,724,000) at the end of February.  So the economy is still horrible.  No secret to those struggling in it.  And the median family who has seen their income fall.  So why is the stock market doing so well when businesses are not?  When profitable businesses operations typically drive the stock market?  For when businesses do well they grow and hire more people.  But businesses aren’t growing and hiring more people.  So if it’s not profitable businesses operations raising stock prices what is?  Just how are the rich getting richer when the economy as a whole is stuck in the worst economic recovery since that following the Great Depression?

Because of near zero interest rates.  The Fed has lowered interest rates to near zero to purportedly stimulate the economy.  Which it hasn’t.  When they could lower interest rates no more they started their quantitative easing.  Printing money to buy bonds on the open market.  Flooding the economy with cheap money.  But people aren’t borrowing it.  Because the employment picture is so poor that they just aren’t spending money.  Either because they don’t have a job.  Only have a part time job.  Or are terrified they may lose their job.  And if they do lose their job the last thing they want when unemployed is a lot of debt they can’t service.  And then there’s Obamacare.  Forcing people to buy costly insurance.  Leaving them less to spend on other things.  And increasing the cost of doing business.  Another reason not to hire people.

So the economy is going nowhere.  And because of the bad economy businesses have no intentions of spending or expanding.  So they don’t need any of that cheap money.  So where is it going?  Wall Street.  The only people who are borrowing and spending money.  They’re taking that super cheap money and they’re using it to buy and sell stocks.  They’re buying and selling like never before.  Making huge profits.  Thanks to other people’s money.  This is what is raising stock prices.  Not profitable businesses operations.  But investors bidding up stock prices with borrowed money.  The people on Wall Street are having the time of their lives during the Obama administration.  Because the Obama administration’s policies favor the rich on Wall Street.  Whose only worry these days is if the Fed stops printing money.  Which will raise interest rates.  And end the drunken orgy on Wall Street.  Which is why whenever it appears the Fed will taper (i.e., print less money each month) their quantitative easing because the economy is ‘showing signs of improvement’ investors panic and start selling.  In a rush to lock in their earnings before the stock prices they inflated come crashing down to reality.  For without that ‘free’ money from the Fed the orgy of buying will come to an end.  And no one wants to be the one holding on to those inflated stocks when the bubble bursts.  When there will be no more buyers.  At least, when there will be no more buyers willing to buy at those inflated stock prices.  Which is why investors today hate good economic news.  For there is nothing worse for an investor in the Obama economy than a good economy.

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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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Canadian Liberals don’t Like Wal-Mart Either

Posted by PITHOCRATES - February 15th, 2014

Week in Review

People just don’t hate Wal-Mart in the United States.  The Canadians don’t like them either.  Or, at least, some Canadians (see Developer backs away from plan to put Walmart in Kensington Market by BRUCE LAREGINA AND TARA PERKINS posted 2/13/2014 on The Globe and Mail).

Kensington Market appears to have won the war against Walmart.

The latest pitch to the city from RioCan, the real-estate company developing a site near Bathurst and Nassau streets, no longer includes a big-box Walmart and would shrink the project’s retail area…

“We pushed back hard on this,” said Mr. Layton, who has advocated against Walmart for nearly two and a half years. “The pressure put on Walmart and RioCan from our community backed them off from putting it in our area…”

“As a resident of Kensington Market for my entire life, it looks like a wonderful compromise,” she said. “They were potentially a threat for the businesses in not only Kensington, but in Little Italy and Chinatown as well.

Social democracies everywhere decry capitalism.  And businesses.  Because all they care about are profits.  Which they amass by gouging people with high prices.  This is unfair. And cruel.  People deserve low prices.  Enter government to fetter unfettered capitalism.  To make it fair.  And in the case here that means making sure the local businesses can continue to sell at higher prices.

A business making a profit with high prices is a bad thing.  Unless a Wal-Mart threatens to come in and offer a greater variety of goods at lower prices.  Which will benefit the people.  By proving jobs with better benefits than most Mom and Pop shops can provide.  And allowing people’s paychecks to go farther thanks to those low prices.  But they can’t have that in Kensington Market.  Or any big Democrat U.S. city.  Because Wal-Mart does these wonderful things with a nonunion workforce.  And that’s something liberals just can’t have.  Even if it means higher prices for the people.

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Lee Harvey Oswald is the Godfather of Today’s American Left

Posted by PITHOCRATES - November 24th, 2013

Week in Review

The assassination of JFK ruined this country.  Because it gave us LBJ and his liberal agenda (see If Kennedy lived: Imagining a different fate for JFK (and Johnson) 50 years later by Jeff Zeleny, Richard Coolidge and Jordyn Phelps posted 11/20/2013 on Yahoo! News).

Historian Jeff Greenfield imagines how history would have changed if Lee Harvey Oswald hadn’t been successful in firing a fatal shot to Kennedy 50 years ago. It’s the latest alternative history from Greenfield in his new book, “If Kennedy Lived: The First and Second Terms of President John F. Kennedy.”

Greenfield, who re-examined the political realities that were present prior to the assassination, told “The Fine Print” he believes that Kennedy’s survival would have likely meant the demise of then-Vice President Lyndon Johnson’s political career.

“The moment John Kennedy was shot, quite literally, LIFE Magazine — a very important medium back then — was launching a huge investigation into how this public servant had accumulated a $14 million net worth, and the answer wasn’t pretty,” Greenfield said of Johnson. “It had to do with radio and TV licenses, and something close to extortion.”

The investigation was halted once Kennedy died, Greenfield said, “Because it would’ve been too much of a shock to the system.” But in Greenfield’s alternate history, the investigation grows into a scandal for Johnson, and Kennedy ultimately replaces him in his second term.

So who gained the most with JFK’s assassination?  Liberals.  For in JFK’s December 14, 1962 speech to the Economic Club of New York he sounded more like Ronald Reagan than LBJ.  Where he championed private spending, not government spending.  He favored tax cuts over tax credits to stimulate the economy.  He talked about increasing consumer spending via personal tax cuts.  And using corporate and personal tax cuts to increase investment and profits.  Yes, he talked about businesses making more profits.  So they would hire more.  Something no liberal would say.

Instead of the Ronald Reagan-like JFK we got one of the most corrupt politicians ever to become president.  LBJ.  According to LIFE Magazine.  And the greatest explosion of the welfare state since the New Deal.  The Great Society.  Turning the U.S. away from capitalism and towards European-style social democracy.

This is the great tragedy of the JFK assassination.  Thanks to that anti-capitalist, Cuba-loving, America-hating assassin who had once defected to the Soviet Union.  A nation long admired by liberals since the day of Joseph Stalin.  This is the great tragedy the leftist communist Lee Harvey Oswald gave us.  Lee Harvey Oswald gave us LBJ, the Great Society and the rise of state-capitalism in the United States.  Everything liberals want.  And conservatives eschew.  Making Lee Harvey Oswald the godfather of today’s American left.

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The Profit Incentive has made Air Travel Safe and Crashes Rare

Posted by PITHOCRATES - July 7th, 2013

Week in Review

During the height of the Cold War people feared the might of the Soviet Union.  And nuclear war.  As those were scary days.  For the Soviet Union had some awesome military power.  And was the only nation that could threaten the United States.  But you know what was even scarier?  Flying on a Soviet jetliner.

The Soviet Union lost the Cold War because communism is a terrible economic system.  The Soviets couldn’t feed their people.  Or keep enough toilet paper and soap on store shelves.  As their command economy did such a horrible job in allocating scarce resources that have alternative uses.  So you never had the best of anything in the Soviet Union.  Which is why people from the West dreaded flying into the Soviet Union on Soviet jetliners.  For they had a tendency to crash.  The Soviets stole as much technology from the West to improve their technology as they could.  And many of their aircraft designs looked similar to those in the West.  But they were Soviet made.  And Soviet maintained.  In the same economic system that couldn’t keep toilet paper or soap on store shelves.

The problem with the Soviet Union was that there was no profit incentive.  When money is at stake everything is better.  Like in the West.  But when you don’t have profits you don’t have to please customers.  And you don’t.  Everything is like standing in line waiting to renew your driver’s license.  And if a plane crashes it doesn’t change anything.  Planes will keep flying as they were before.  And everyone’s pay will be the same as before.  So everyone will do the minimum.  Just enough to avoid punishment.  This is why Soviet air travel was among the most dangerous air travel in the world.

This past Saturday there was an Asiana Air 777 that crashed while landing at San Francisco International Airport.  Of the approximate 300 on board 2 people died.  Some were injured.  While many were able to walk away from the crash.  Cable television has been covering this nearly 24/7 since the crash.  Even though only two people died (a terrible tragedy but a tragedy that could have been far worse).  And one of them may have been accidentally driven over by the first responders arriving on scene.  Why the intense media coverage?  Because accidents like this are so rare these days.  Especially when they involve big airplanes.  And the 777 is about as big as they come.

In the aftermath of this crash we can see why flying has become so safe under a profit incentive.  Unlike in the former Soviet Union (see Asiana Air Crash May Bring New Safety Regulations in Korea by Kyunghee Park posted 7/7/2013 on Bloomberg).

“Asiana’s accident is going to damage the image of not just Asiana, but all Korean airlines,” said Um Kyung A, an analyst at Shinyoung Securities Co. in Seoul. “It only takes one incident to undermine years of work Korean airlines have made to get a solid, accident-free record. This will prompt the government to call for stricter safety measures…”

Shares of Asiana, South Korea’s second-largest airline, slumped to the lowest level in more than three years in Seoul trading today. The stock plunged as much as 9.6 percent to 4,630 won, the lowest price since April 2010…

All South Korean airlines, including budget carriers, were ordered to ensure safety, the transport ministry said in an e-mailed statement yesterday. The country had no fatal air crashes between December 1999 and July 2011, when an Asiana freighter crashed, the ministry said…

A Korean Air 747-200 cargo plane crashed in December 1999 shortly after taking off from London’s Stansted Airport, killing three of its four crew members on board. That was eight months after the airline’s MD-11 freighter crashed in Shanghai in April and killed eight people, including those on the ground.

The accidents prompted the government to tighten safety standards at Korean airlines, as well as foreign ones flying into the country. It also strengthened regulations on pilot and maintenance licenses.

Pilots were required to be trained and evaluated at an international center, and airlines were required to fly more hours on domestic routes before obtaining a license to fly overseas. The government also strengthened safety regulations at domestic airports.

The U.S. Federal Aviation Administration downgraded South Korea to Category 2 safety rating in August 2001 following the accidents. The rating was restored to Category 1, which allowed Korean carriers to open new routes in the U.S. and resume marketing alliances with American carriers, in December that year.

In the Soviet Union there was no profit incentive as they put people before profits.  Which made Soviet air travel among the most dangerous in the world.  But look at what happens when there is a connection between safety and profits.  After a series of crashes and a downgrade by the U.S. to Category 2 South Korea tightened safety standards.  To improve their safety record.  For the fewer accidents you have the more profitable you will be.  A very strong incentive to be safe.  Which is why South Korea enjoys a better safety record than the Soviet Union ever had.

When people say that we need government to keep us safe from the greed of corporations all we need to do is look at the former Soviet Union.  And how their government failed to keep their flying public as safe as in countries that use a profit incentive.  For no corporation wants to see their stock price fall 9.6 percent.  Have a nation block them from opening new routes into their country.  Or have people perceive that their planes are not safe.  Things the former Soviet Union did not have to worry about.  As the Soviet people had no other alternative but to fly on those dangerous planes.  But there are many airlines flying between Asia and the United States.  And if one has a poor safety record people will book their flight with another airline.  This is what the profit system gives people.  Choice.  Where people can choose not to fly on an unsafe airline.  Something the Soviets couldn’t do.  Because there were no profits in the Soviet Union.

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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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Capitalism puts People First while Socialism puts the State First

Posted by PITHOCRATES - April 20th, 2013

Week in Review

SeaWorld is going public.  In the initial public offering (IPO) filing they discuss the unpleasant business of their animals potentially killing people.  Which has happened in the past.  Of course, they don’t want their animals to kill people.  For it will adversely impact the bottom line (see SeaWorld: Our Investors Should Know That It’s Bad For Business When Our Killer Whales Kill People by Matthew Boesler posted 4/18/2013 on Business Insider).

This incident and similar events that may occur in the future may harm our reputation, reduce attendance and negatively impact our business, financial condition and results of operations.

A lot of people think that if government doesn’t regulate businesses they will wantonly put their customers at risk.  Even killing them with dangerous products or unsafe conditions.  People in government believe this with every fiber of their body.  So they can keep growing the size of government.  Creating ever more government jobs.  And they try to scare people whenever anyone talks about cutting the funding of government.  Saying people will die from these ruthless businesses putting profits before people if they are not there to regulate them.  Which is preposterous.

The SeaWorld’s IPO shows that if you harm your customers you will lose your customers.  And if you lose your customers you will make fewer profits.  Which means the profit incentive makes customers safe.  Because a business knows the more customers they have the more profits they can make.  So they have a financial incentive not to hurt their customers.  Something they didn’t have in the state-owned business of the former Soviet Union.

There was no fear of losing customers in the former Soviet Union if they killed their customers with faulty products.  Because there was no competition.  Just layer upon layer of bureaucrats.  And no one sued the ruling communists in the Soviet Union.  They may sacrifice the occasional bureaucrat if the outside world was aware of some incident.  But it was just another tragedy in the Soviet Union and life went on.  The people just had to put up with substandard quality.  And accept the occasional deaths.

Why?  Because in socialism where they put people before profits they actually put the state before the people.  Where bureaucrats protect themselves.  And other bureaucrats.  Because their state jobs are all that matter.  While in a country where there is capitalism the profit incentive puts people before the state.  Because any person felt mistreated by a business could simply take their business elsewhere.  Which forces businesses to bend over backward to please their customers.  Something you just don’t experience while renewing your driver’s license.

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FT166: “Multiculturalism celebrates are differences while breeding anti-American terrorists.” —Old Pithy

Posted by PITHOCRATES - April 19th, 2013

Fundamental Truth

The Entrepreneurial Spirit gave America the Economic Prowess to spend the Soviet Union into the Ash Heap of History

Immigrants used to come to the United States with great enthusiasm.  They were excited that they were going to be an American.  They wanted to assimilate.  They learned their American history.  Better than most people born in the United States.  When they took the oath of citizenship a euphoric joy filled them.  For having fulfilled their greatest dream.  If they heard their family members speak the language of their birth country they rebuked them sternly.  And told them, “We’re American now.  Speak English.”

Yes, there was great pride in becoming an American.  As immigrants saw America as Ronald Reagan saw it.  A shining city upon a hill.  Whose beacon light guides freedom-loving people everywhere.  People in the Old World yearned for the freedom of the New World.  Religious freedom.  Freedom from an oppressive government.  Economic freedom.  Where everyone had the same chance to be whatever they wanted to be no matter who their parents were.  For in America there was no privilege.  Just hard work.  And the ability to keep the fruit of all your labors.  This is the American dream.  This is why they came to this shining city upon a hill.

Immigrants wanted to assimilate.  They wanted to think of themselves as Americans.  For it meant something.  Something special.  It meant you were a citizen of the greatest country in the world.  For individual liberty unleashed great prosperity.  An entrepreneurial spirit.  American ingenuity.  Making America the leader in new technology.  Making work less tedious.  And life more enjoyable.  Giving America the highest standard of living.  Great food surpluses that let America feed the world.  And the military power to defeat Nazism and stand up to communism.  And the economic prowess to spend the Soviet Union into the ash heap of history.

Our Public Schools teach our Children that we Stole the Land from the Native Americans and got Rich on Slave Labor

People came to America to be Americans.  They remembered their culture.  But their culture did not identify who they were.  They were Americans.  Not hyphenated Americans.  As Theodore Roosevelt said, “In this country we have no place for hyphenated Americans.”  We were not Italian-Americans.  We were not Polish-Americans.  We were not Irish-Americans.  We were not German-Americans.  We were Americans.

Our public schools once taught our children about the Founding.  The abuses of European monarchies.  Unjust taxation.  And the perverse powers of privilege.  Things the Founding Fathers found abhorrent.  The Founding Fathers knew the history of Greece and Rome.  King John and Magna Carta.  And the English Civil War was not that distant from their time.  They were students of the Enlightenment.  They read Adam Smith.  Believed in laissez-faire economics.  And championed limited government.  When they formed a new country they drew from this vast pool of knowledge.  And made the greatest country in the world.  One with religious freedom but based on Judeo-Christian values.  A country so great that rulers of other nations wanted to hinder its ascension to further greatness.  While the people living under those rulers wanted to be Americans.

This experiment in self-government had some growing pains.  We were not perfect.  But we were far more perfect than any other government out there.  But our public schools don’t teach that today.  Instead, they teach our children that the Founders stole the land from the Native Americans.  That we stole our southern land and California from the Mexicans.  Who gained their independence from Spain who colonized these lands.  Land they had stolen from the native people who were living on it at the time.  (Interestingly, when the Mexicans gained their independence from a European power the land belonged to the Mexicans.  But when the Americans gained their independence from a European power the land belonged to someone else.)  That we stole Cuba and the Philippines from the Spanish.  Who stole it from the people living on these lands when they arrived and stole it.  Yet it is the Americans who were an imperialist power stealing land.  Never the Mexicans or the Spanish.  And, of course, that America grew rich and powerful thanks to free slave labor.  Despite that very same economic system causing the South to lose the American Civil War.

The American Educational System failed to make Dzhokhar Tsarnaev NOT burn with a Seething Hatred of America

Then the attacks on capitalism came.  The system that made America great.  All of a sudden it was unfair.  It was unjust.  And it exploited the poor to help the rich get richer.  A better system was socialism.  For it was fair.  It was just.  Because it put people before profits.  (Just ask those who lived in the Soviet Union, the People’s Republic of China under Mao, North Korea, Cuba and the people who lived behind the Iron Curtain in Eastern Europe how wonderful it was to live where they put people before profits.  Here’s a hint.  A lot of these people were shot while trying to escape their social utopia).  Unlike the most evil thing in the world.  The corporation.  Who underpaid their workers.  Raped the land of its natural resources.  And polluted the environment.  So not only were they evil for pursuing profits they were evil for exploiting both people and the planet.  So we needed more government to regulate capitalism.  And those evil corporations.  So our children learned the evils of capitalism and the goodness of government in our public schools and universities.  Where their teachers and professors taught them all of the badness of the United States.  While glossing over all of its goodness.  Imbuing some shame into our students for being American.  Even making some burn with a seething hatred of the United States.

And so began the diversity movement.  And multiculturalism.  If America was so shameful we should not celebrate what unified us as Americans.  But we should celebrate our differences.  We no longer celebrated the things people immigrated to the United States for.  But the things they fled in the countries they emigrated from.  We are no longer Americans.  We are now hyphenated Americans.  And it was the thing preceding the hyphen that made us great now.  Not being American.  Because America had a shameful past.  And had a long way to go to atone for her sins.  Making a lot of hatred of America now home-grown.  Especially in the American universities.  Where radicals from the Sixties who wanted to overthrow capitalism and replace it with socialism now write the curriculum.  And these radical professors disparaged judgmental Christianity every chance they could.  For they liked the sex and drugs of their Me generation.  Mocking the Judeo-Christian values that made America great.  Something those who were not Christians ate up.

So the American university system is a hotbed of anti-American sentiment.  Perhaps explaining why some of the greatest terrorist attacks on American soil were perpetrated by people educated in the United States.  Such as Khalid Sheikh Mohammed.  Architect and mastermind of a series of terrorist attacks.  Including the attacks on 9/11.  Who attended college in North Carolina.  Earning a degree in mechanical engineering.  And Anwar al-Awlaki.  Who earned a degree in civil engineering from Colorado State University.  He also studied education leadership at San Diego State University.  And worked on a doctorate at George Washington University.  Then moved to Yemen and became the Osama bin Laden of the Internet.  And then we have the Boston Marathon bombers.  Dzhokhar and Tamerlan Tsarnaev.  Who immigrated to the United States about a decade ago.  With Dzhokhar being so young he probably has no memories of his native Chechnya.  A hotbed of radical Islamist terrorism.  Locked in a bitter war with Christian Russia.  Where barbarous acts in that conflict have rivaled the atrocities of the Eastern Front in World War II.  Yet he burned with such a seething hatred of an America founded on Judeo-Christian values that he could place a bomb next to an 8 year old child.  A seething hatred he learned from someone while living in America.  Either directly from the American educational system.  Or indirectly as that educational system failed to make him NOT burn with a seething hatred of America.

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Trend Analysis – Liquidity

Posted by PITHOCRATES - January 7th, 2013

Economics 101

Liquidity can be More Important than Profitability to a Small Business Owner

Small business owners lose a lot of sleep worrying if they will have enough cash for tomorrow.  For next week.  For next month.  You can increase sales and add new customers but unless this creates cash those new sales and new customers may cause more problems than they help.  For a lot of businesses fail because they run out of cash.  Often times learning they have a cash problem only when they don’t have the cash to pay their bills.  So savvy business owners study their financial statements each quarter.  Even each month.  Looking for signs of trouble BEFORE they don’t have the cash to pay their bills.

Investors poor over corporations’ financial statements to make wise investment decisions.  Crunching a lot of numbers.  Analyzing a myriad of financial ratios.  Gleaning a lot of useful information buried in the raw numbers on the financial statements.  Small business owners analyze their financial statements, too.  But not quite to the extent of these investors.  They may look at some key numbers.  Focusing more on liquidity than profitability.  For profits are nice.  But profits aren’t cash.  As a lot of things have to happen before those profits turn into cash.  If they turn into cash.  The following are some balance sheet and income statement accounts.  Following these accounts are some calculations based on the values of these accounts.  With four quarters of data shown.

So what do these numbers say about this year of business activity?  Well, the business was profitable in all four quarters.  And rather profitable at that.  Which is good.  But what about that all important cash?  With each successive quarter the business had a lower cash balance.  That’s not as good as those profitability numbers.  And what about accounts receivable and inventory?  There seems to be some large changes in these accounts.  Are these changes good or bad?  What about accounts payable?  Accrued expenses?  Current portion of long-term debt?  These all went up.  What does this mean in the grand scheme of things?  Looking at these numbers individually doesn’t provide much information.  But when you do a little math with them you can get a little more information out of them.

In Trend Analysis a Downward sloping Current Ratio indicates a Potential Liquidity Problem

Current assets are cash or things that a business can convert into cash within the next 12 months.  Current liabilities are things a business has to pay within the next 12 months.  Current assets, then, are the resources you have to pay your current liabilities.  The relationship between current assets and current liabilities is a very important one.  Dividing current assets by current liabilities gives you the current ratio.  If it’s greater than one you are solvent.  You can meet your current financial obligations.  If it’s less than one you will simply run out of current resources before you met all of your current liabilities.  In our example this business has been solvent for all 4 quarters of the year.

Days’ sales in receivables is one way to see how your customers are paying their credit purchases.  The smaller this number the faster they are paying their bills.  The larger the number the slower they are paying their bills.  And the slower they pay their bills the longer it takes to convert your sales into cash.  Days’ sales in inventory tells you how many days of inventory you have based on your inventory balance and the cost of that inventory.  The smaller this number the faster things are moving out of inventory in new sales.  The larger this number is the slower things are moving out of inventory to reflect a decline in sales.  These individual numbers by themselves don’t provide a lot of information for the small business owner.  Big corporations can compare these numbers with similar businesses to see how they stack up against the competition.  Something not really available to small businesses.  But they can look at the trend of these numbers in their own business and gain very valuable information.

The above chart shows the 4-quarter trend in three important liquidity numbers.  Days’ sales in receivables increased after the second quarter upward for two consecutive quarters.  Indicating customers have paid their bills slower in each of the last two quarters.  Days’ sales in inventory showed a similar uptick in the last two quarters.  Indicating a slowdown in sales.  Both of these trends are concerning.  For it means accounts receivable are bringing in less cash to the business.  And inventory is consuming more of what cash there is.  Which are both red flags that a business may soon run short of cash.  Something the three quarters of falling current ratio confirm.  This business is in trouble.  Despite the good profitability numbers.  The downward sloping current ratio indicates a potential liquidity problem.  If things continue as they are now in another 2 quarters or so the business will become insolvent.  So a business owner knows to start taking action now to conserve cash before he or she runs out of it in another 2 quarters.

Keynesian Stimulus Spending can give a Business a Current Ratio trending towards Insolvency

In fact, this business was already having cash problems.  The outstanding balance in accounts payable increased over 100% in these four quarters.  Not having the cash to pay the bills the business paid their bills slower and the balance in outstanding accounts payable rose.  Substantially.  As the cash balance fell the business owner began borrowing money.  As indicated by the increasing amounts under current portion of long-term debt and interest expense.  Which would suggest substantial borrowings.  Putting all of these things together and you can get a picture of what happened at this business over the past year.  Which started out well.  Then experienced a burst of growth.  But that growth disappeared by the 3rd quarter.  When sales revenue began a 2-quarter decline.

Something happened to cause a surge in sales in the second quarter.  Something the owner apparently thought would last and made investments to increase production to meet that increased demand.  Perhaps hiring new people.  And/or buying new production equipment.  Explaining all of that borrowing.  And that inventory buildup.  But whatever caused that surge in sales did not last.  Leaving this business owner with excess production filling his or her inventory with unsold goods.  And the rise in days’ sales in receivables indicates that this business is not the only business dealing with a decline in sales.  Suggesting an economic recession as everyone is paying their bills slower.

So what could explain this?  A Keynesian stimulus.  Such as those checks sent out by George W. Bush to stimulate economic activity.  Which they did.  Explaining this sales surge.  But a Keynesian stimulus is only temporary.  Once that money is spent things go right back to where they were before the stimulus.  Unfortunately, this business owner thought the stimulus resulted in real economic activity and invested to expand the business.  Leaving this owner with excess production, bulging inventories, aging accounts receivable and a disappearing cash balance.  And a current ratio trending towards insolvency.  Which is why Keynesian stimulus spending does not work.  Most businesses know it is temporary and don’t hire or expand during this economic ‘pump priming’.  While those that do risk insolvency.  And bankruptcy.

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FT149: “Poor people don’t hate rich people; they envy them and buy lotto tickets to become one of them.” —Old Pithy

Posted by PITHOCRATES - December 21st, 2012

Fundamental Truth

People don’t hate the Lifestyles of the Rich they just hate the Rich because they’re Living it Instead of Them

Overweight and less beautiful women hate beautiful women with toned, firm bodies.  Overweight and less handsome men hate more handsome and muscular men who get all the beautiful women with toned, firm bodies.  They may hate those who are more physically attractive than they are.  Until they start dieting and going to the gym to become one of them.  Once they are one of the beautiful people they no longer hate the people they once did.  In fact, they now enjoy being part of their world.  A world where their physical appearance gets them the attention they didn’t know when they were less attractive.  But for some dieting and working out is hard work.  Especially if they have to work harder than others who can eat and drink anything they want without putting on a pound.  So if they falter from their new healthy lifestyle and put that weight back on those old feelings of hatred will return.

People fear cancer.  They hate cancer.  And may adopt a healthier life style to avoid cancer.  By eating healthier.  And exercising.  They may quit smoking and cut buck on drinking.  And they may add certain foods to their diet they understand will help prevent cancer.  Even if some of these foods aren’t delicious.  After adopting a healthier lifestyle they don’t change their position on cancer.  They still hate it.  But staying on a healthy diet and making time to exercise is hard.  Because the delicious, less healthy foods are hard to give up.  And going to the movies is a lot more enjoyable than going to the gym.  Once their healthier lifestyle lapses their position on cancer does not change.  They still hate it.  As they always hated it.

There is a difference between hate and envy.  You may hate people you envy.  Because they are, or have, everything you want.  And you covet what they have.  But what you hate is that they are living the good life instead of you.  They don’t hate the good life.  Whereas you don’t envy what you truly hate.  No one has ever complained that someone else got cancer instead of them.  No one has ever complained about the unfairness of cancer that way.  Usually the complaint is more along the lines of ‘why me and not someone else’.  For the hate of cancer is a pure hate.  It is not relative.  It is absolute.  Whereas someone’s hate of the rich is relative.  It will disappear the moment a person comes into money.

People in the Public Sector exploit the Taxpayers to pay for their very Generous Pay and Benefit Packages

Kids may go on to college and take courses in the social sciences.  Where they learn about the unfairness of capitalism.  The evil of corporations.  How businesses exploit their employees.  How they put profits before people.  By the time they leave college the word ‘profit’ is a four-letter word to them.  And they believe we should shun anyone pursuing profits like those exploitive business owners.  Raising taxes on them is a good thing.  For by doing so we can help redistribute the wealth from those hoarding it to those who don’t have enough.  To produce a fair and egalitarian society.

They also learned how socialism is better.  That the Soviet Union only failed because of the Americans undermining a superior economic system.  They believe so strongly that they vote Democrat to try and do something about making America a fairer place to live.  They go on to get jobs in the public sector to do their part in making America fairer.  By redistributing wealth.  To help those who have little.  And they exploit the taxpayers.  Forcing them to pay for their very generous pay and benefit packages.  While those same taxpayers never live a life as fair or as equal as the public sector workers they support.

These public sector workers envy the life of the rich.  They don’t hate that life.  They just hate the people who are smarter and more talented than they are who were able to achieve that life.  It’s not fair that these people had talent.  And worked hard for success.  So it’s only fair to take their money away from them to make society fair.  And so they can enjoy a lifestyle that neither their talent nor their ability could ever provide.

Poor People voted overwhelmingly for President Obama to Punish the Rich for Winning Life’s Lottery

President Obama won reelection with a campaign of class war.  Getting the people to believe that the rich weren’t paying their fair share in federal income taxes.  Despite the top 10% of income earners paying 70% of all federal income taxes.  Early on Occupy Wall Street agitated the people against the 1%.  Which grew into a bitter character assassination of Mitt Romney.  Because he was rich.  People hated him for that.  Not for having money per se.  For the people wanted everything he had.  They just hated him because he had the talent to earn what they couldn’t.  For they lacked the talent to achieve the success of Mitt Romney.

President Obama enjoyed the support of rich Hollywood stars and musicians.  And the president enjoyed hobnobbing with them.  Even the suffering masses enjoyed seeing the president hobnob with their idols.  Even though they had wealth just like Mitt Romney.  But for some reason their inequality was okay.  And these superstars, incidentally, all went into their chosen field to become rich.  To live in mansions.  And to have more money than they could ever spend.  While the people castigated Mitt Romney for having money the people looked on in awe and reverence at the lifestyle of the rich and famous they so admired.  And all the rich and famous had to do to get this pass on having obscene wealth is to attack other people with wealth.  And publically support Democrats.  You do that and they will leave you alone.  No matter how much money you shelter in the Cayman Islands.

No one hates rich people.  They just envy their lifestyles.  And covet what they have.  They hate the fact that they weren’t born with the passion, drive, ability or talent to become rich.  And hate these people for being able to do what they cannot.  Become rich.  Though it doesn’t stop them from trying.  Especially poor people.  Who voted overwhelmingly for President Obama.  To punish the rich for winning life’s lottery.  While they themselves spend every last dollar they can buying lotto tickets.  For they may have voted for President Obama to punish the rich.   But that’s only because they envy the rich.  And want to become one of them.  Should they win the lotto their position on hating the rich will quickly change.  Perhaps going so far as to start voting Republican.  To save as much of their winnings from the taxman as possible.

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