Blog My Brain

I’ve been following Peter Schiff, Jim Rogers, George Soros, Warren Buffett and Marc Faber lately.  I’ve also been watching Obama and Bernanke’s speeches.   And here are some thoughts about current state of the economy and where it is going:

The recession is deflationary because the current price levels are the results of the excesses of the consumption and credit bubble.   After the bubble busted, there are an over-supply and over-capacity of everything:  oil, houses, cars, cloths, over-paid employees.  Deflation is market’s way of getting rid of the excesses, punishing the debtors, rewarding the savers, making resources affordable for entrepreneurs who would re-allocate resources more efficiently.

Unfortunately, the government is the biggest debtor of us all.  Therefore, deflation would mean the debts the government owe would become more valuable in the future.   Considering that a large portion of the debt are owned by foreign countries and investors, it is in the best interest of the U.S. government to engineer inflation rather than deflation into the economy.   That’s why Bernanke and Obama keep telling us deflation is evil.

I can understand the government’s rationale that a deflationary spiral would be awful.  But if the government acts as the lender of last resort, new entrepreneurs would jump into the scene and snatch up these resources when they are cheap enough to justify a profible business.   I think here is where the government got it wrong.  Instead of allowing the market to spur new businesses, the government is trying to do it artificially by spending on energy reform, health care reform, education reform, etc, etc.  What the government fails to understand is that these investments would not be profitable because:

1.  If they would be profitable, the entrepreneurs would see the opportunities way before the government sees them.

2. The government has not run anything efficiently in the history of mankind.  It’s not the government’s job to run profitable businesses, and it does not know how to do it.  Government spending is more likely to be wasteful at best.

3. The government does not know where to invest and how to invest.  Central planning has never worked and never will.  Capital allocation are best done at the private sector.  One reason for this is that the government employee that makes decisions bears no personal financial risk should the investment go wrong.  On the other hand, an

entrepreneur risks financial losses should he makes a bad decision.

It is true that this country needs to produce more scientists and engineers.  Under market economy the shortage of scientists and engineers would reflect on their higher salaries, and therefore attract more students into these fields.   Obama’s education reform totally ignores this fact.  Students do not want to become scientists and engineers because the benefit does not justify the hard work one needs to put in.  In the past two decades the brightest minds have gone into the finance industry because that’s where the money is.  Since Obama is not letting the banks fail and bankers are still getting crazy salaries and bonuses, more bright students will get into the field and make crazy financial engineering feats that provides no value to society.  The whole financial industry is over-bloated and must be allowed to shrink.  The re-structure of the economy would depend on bright students going into industries that provide exportable goods and services.

From Obama and Bernanke’s speech it seems that their intention for the bank bail-outs are to prevent a financial meltdown.   The financial system is saved at the cost of tax payers absorbing the losses from bank’s bad bets.   Eventually these losses would have to materialize.  Obama’s only hope is that the economy would turn healthy enough (produce more) to pay off these losses over time.  It might work out if his plan actually will do what he promised.  But I am skeptical on that because government and bureaucrats are never good at allocating resources efficiently.  And Obama’s reforms and stimulus would not turn a profit, and would need subsidies by taxing profitable businesses in the economy, or borrowing more from other countries.

Many people are talking about a currency crisis for the dollar.  The dollar has not devalued in the past decades because foreign countries are buying U.S. treasuries.   Since the government would not allow deflation and encourages inflation, foreign countries are more worried about the value of these debts and the dollar reserves.  That would pressure the dollar to devaluate.   As a result, imported goods becomes more expensive and causes more inflation.  At this point the Fed would have to raise interest rate to slow down inflation, which will hurt the recovery, and drive the economy into stagflation.

So there are three scenarios:

1. Government allows deflation, which would make our exports more appealing and make our currency stable.  But deflation is devastating to all debtors, which includes most U.S. tax payers and the government.  So this happening is unlikely as it might result in revolts and social unrest.

2. Government does not allow deflation, hoping foreign countries will keep lending us money.  If this happens the economy will start to recover due to the injections of liquidity.   But the recovery would be a very slow process as the Fed will pull out money supply at any sign of increasing inflation.

3. Government does not allow deflation, and foreign countries stops lending to us.  The government then would have to increase tax, or print more money to fund its projects.   At the same time the dollar devalues and consumer prices rise.   The government might be force to choose war against other countries, social revolt, or hyper-inflation.

admin :: Apr.15.2009 :: The World, Business/Management, Finance/Investment :: No Comments »

During economic recessions, employment data has become a very important economic indicator.

Increasing unemployment is a sign of decreasing consumer spending and economic slow down.

Here are some employment related indicators that are useful in assessing economic conditions:

1. Unemployment Rate (See Graph of Unemployment Rate)

Unemployment Rate leads economic downturn and lags economic recovery.

2. Weekly Earnings (See Graph of Weekly Earnings)

Higher Weekly Earnings bodes well for the economy.

3.  Total Layoffs (See Graph of Total Layoffs)

Layoffs shows how much financial stress the corporations are facing.  Increasing layoffs shows anticipation of decreasing profitability for businesses.

4. Total Quits (See Graph of Total Quits)

Total Quits are voluntary.  An increase in total quits indicates a positive outlook for the job market and economy, and vice versa.

5.  Total Job Openings (See Graph of Job Openings)

Total Job Openings is very sensitive to a corporation’s outlook for the future.  A sharp decrease in job openings usually precedes  a sharp increase in unemployment rate.

admin :: Jan.30.2009 :: The World, Business/Management, Finance/Investment :: No Comments »

What do Dinosaurs, Big Companies, Traditions, and Experienced People in common?  They are slow to change and adapt.  In a stable environment, they would thrive because they know how things would work based on the understanding of how things worked.  However if the environments they understood suddenly change the rules, they would be the slowest to adapt and would possibly go extinct.  In this stage, established structures and traditions become burdens, old knowledge and experiences become dead weights.
  
  
As humans, we are constantly trained by our experiences.    Based on what works and what doesn’t, we develope our way of thinking and acting.  Unfortunately, these habits would impose a limitation to our ability to adapt.  At turbulent times, big companies, like dinosaurs, would fail to adapt and get crushed by smaller and more efficient companies.   For the same reason, start-ups with old, traditional investors often fail as the investors interfere innovation with rules and traditions.  This is how the young outperform the old despite the difference of decades of experiences.  This is how small companies can take on multinational giants despite the huge difference in financial strength and business experience.

admin :: Aug.08.2008 :: Business/Management :: No Comments »

Just finished reading the book The Black Swan: The Impact of the Highly Improbable.   Several important points to take away:
  
  
1.  A black swan is a random and yet highly improbable, highly impactful event that exists in reality.
  
  
2.  Black swans are produced in the platonic fold, in which the gap between what you know and what you think you know becomes is dangerously wide.  This often happens in areas where the unknown unknowns plays a huge role in the generating process.  In such areas the predictive models we construct using known knowns and the margin of error we assume with known unknowns is far far away from reality.
  
  
3.  Assuming normal (Guassian) distribution in variables subject to black swan would makes predictions that work most of the time.  However when the black swan happens, the result is often devastating.  
  
  
4.  There is an information asymmetry between forward and reverse processes.  Put an ice cube on your desk, you can predict that in 2 hours you will see water.   However, seeing water on your desk, you cannot tell what caused it without other evidences.  This asymmetry exists where a cause can have an inevitable effect, but the effect can have many different causes. 
  
  
5.   There are two types of black swans:  a. Event that is not expected to happen happens.  b.  Event that is expected to happen does not happen.   Both situations would create huge opportunities or risks to those involved.
  

Managing the Black Swan
  
  
In a way, the value investing concept of Benjamin Graham and Warren Buffet is one way to profit from the postive black swan.   When a stock is beat down to very low prices, it basically means that the general expectation of future performances is low.  By buying such stock, if the public is right, the downside is little.  But if the public is wrong, the upside is huge (a black swan).   All the criteria that Graham and Buffet use are to maximize the chance of the black swan happening.
  
  
The Kelly Criterion is another way to manage black swans.  In fact, it is the optimal solution when dealing with the real world, in which black swans are abundant.   If we treat any investment as a rigged black jack game, in which you have X% chance of doubling your money and (1-X%) chance of loosing all your money, the Kelly Criterion would never tell you to commit 100% of your bankroll in the game, no matter how big X is.   You can play with the numbers at http://www.cisiova.com/betsizing.asp. 
  
  
Basically, when black swans happen often, we should exploit its occurances.  When black swans are rare, we should benefit from our models, but heed from the black swan with kelly criterion.
  
  

admin :: Mar.21.2008 :: Math/Statistics, Business/Management, Finance/Investment :: No Comments »

http://multimedia.mcb.harvard.edu/media.html

Very amazing video. In a way, a human being is just a compilation of individual automatons, with each automaton has its own biological function. Together, the automatons make up a complex system which we define as one human being.

If you think of a human being as a cell, with its designated functions, we can imagine any organizations to have its own consciousness and spirit, just like a biological being.

Therefore, it does not surprise me that an army, a company, a society, or any form of social organization can have its own self-awareness, memory, personality, desire, intelligence, emotion, aggressiveness & defensiveness, and a spirit.

admin :: Mar.10.2008 :: The World, Physical Science, Business/Management, Psychology :: No Comments »