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Milton Friedman had pointed out that socialism and dictatorship is the natural tendency of human societies.  He had also observed that free market capitalism and the subsequent prosperity is the exception rather than the norm in human history.

In fact, we can generalize the above conclusions to all human organization.   And such tendency is what drives big companies to failure.  These companies once had all the resources to maintain their market dominance.  Unfortunately, sooner or later the succumb to the “law of socialistic tendency” and gradually loses to more efficient competitors.

At the core of the “law of socialistic tendency” is the sense of entitlement based of seniority.  People who served the company well ages ago but failed to keep up with technological innovations are kept and often promoted to high posts, crowding out opportunities for smart, motivated, and more efficient new-comers.   Therefore gradually the company would be full of inefficient, inflexible, and over-paid employees or bureaucrats, whose skills and knowledge are outdated, while expert in playing politics.

In a slowly changing technological landscape, the company might survive longer as the inefficiency gradually grows in comparison to young competition.  However, as technological innovations grow at rapid pace, the company would find its workforce grossly inefficient.  Failure to re-structure and fire the dead-weights in the workforce due to the culture of entitlement would result in a slow death for the company and all its stakeholders.

I often wonder, “how can big companies with vast resources and an absolutely advantageous market position slowly let itself overtaken by small competitors?”  Today I found the answer from Milton Friedman.

admin :: Mar.04.2010 :: Business/Management, Finance/Investment :: No Comments »

Someone in linkedin asked how human behavior contribute to financial bubbles and how to manage such risk.  Here is my answer:

If you think of a bubble being the consequence of inefficiencies in the market, then we can examine how the two premise of efficient market theory can be broken:

1. Misinformation. Academics assumes perfect information to make their models work. In reality, misinformation is everywhere. To be more precise, misinformation is greatest when something is new. That’s why bubbles are always associated with innovation or “new concept”. The fact that no one can accurately value “new paradigms” (ie. dot-com technologies, sub-prime derivatives, etc) leads to bad investment decisions.

2. Irrationality. Academics assume people to make rational decisions based on perfect information. The perfect information part is addressed above. Rationality is also challenged when misinformation is rampant, because now people have to rely more on “gut feelings”. When emotion becomes the vehicle for decision making due to the lack of predictability of “new paradigms”, greed and fear lose balance. The imbalances are small at the beginning, and often go away as more accurate information unravels. In rare cases, the misinformation persists because innovations become more complicated, and rising asset prices reinforce the greed, then people start attributing their success on their own intellect … and a real bubble is born. Self-proclaimed “Experts” would start to write books and show on TV to “teach” others how to get rich, effectively worsening the misinformation. Then you have the academic bunch who believe that “the market is always right” writes papers about “how this time is different”. The politicians cheer at their success of creating “prosperity”.

It’s about time when envy kicks in and everyone becomes invested.

When everyone wants to invest becomes invested, the prices start to go down ….. and BOOM !

admin :: Oct.29.2009 :: Finance/Investment :: No Comments »

Recently I had a conversation with a friend, who asks me, “why is gold valuable?  It is just a metal that people dig it up and bury it again underground.  It is not income-generating.  You can’t eat it or use it in any productive purpose.  Then why do people buy it and invest in it?”

I think he is right in that gold does not have much value as a productive asset.  The value of gold, however, comes from it being a globally recognized hard money.   Money is what makes trade and division of labor possible.  Without money, trade breaks down and society would go back to bartering.  That means, if you want food, you have to produce some type of goods or services and trade them with the farmers directly.  Therefore, money comes to existence to support indirect exchange.

Being a medium of exchange, there are some attributes that any form of money should have:

1.  Durable.  Meaning it should last a long time without changing or corroding.  Therefore metals like iron would not work because it rusts.

2.  Portable.  Meaning people can easily carry it.  Therefore assets like real estate would not work because one cannot carry land with them to trade.  And oil would not work because to carry $700 dollar worth of money in oil means carrying 10 barrels of it.

3.  Divisible.  Meaning it must be easily divided into small pieces.  Therefore valuable stones like diamond would not work because it takes a lot of technology to cut a diamond into smaller pieces, and the value of a diamond decreases exponentially when it is divided.

4.  Has limited supply.  Meaning that it must be rare and difficult to be brought into existence.   Therefore sand would not work because there are abundant amount of it easily accessible to the public.

Throughout human history, gold has been the ideal form of money because it satisfies the above requirements.  In modern society, paper money has replaced gold as the medium of exchange.  Paper money is fairly durable; it is certainly portable; it is divisible into paper money of smaller face value or coins.  The only problem with paper money is that its supply is artificially controlled.

Central banks controls the monetary supply in modern economies and they have the rights to print money.  Therefore with undisciplined central banks, the supply of paper money can easily get out of control.  When the supply of paper money in an economy increases, the value that existing paper money holds are diluted.   This means inflation:  prices go up and the same amount of paper money cannot buy as much stuff as before the dilution.  When inflation gets out of control, as inflation usually breeds more money printing and more inflation, trading with paper money breaks down.  Who would want to offer their products or services for pieces of paper that lose value the next day?  But then, how can anyone survive in today’s society if trading reverts to bartering?  And thus, people would start to use gold and would only accept gold as payments.

That’s the value of gold.  Even though it is not used as money today, it reflects the risks of a complete break down of the paper money currently in circulation.

admin :: Oct.14.2009 :: The World, Finance/Investment :: No Comments »

Here is a comparison of the amount of searches in google for “economic recession” and “economic recovery” with the stock market (QQQQ is the nasdaq index fund).   A peak in interest about economic recession along with a peak in interest about economic recovery calls for the March bottom in stock prices.  This makes sense in that the crash stops when lots of people is worrying about a recession and more people start to see recovery.

You can access the most updated comparison Here.

admin :: Sep.10.2009 :: Market Analysis, Finance/Investment :: No Comments »

Recently there are a lot of debates between the Keynesian and Austrian economists on the skyrocketing government deficit.

My opinion is this:

In general, government spending is wasteful.  To expect governments to efficiently allocate capital is a larger mistake than to believe in Bernie Madoff.

Keynesian policies only makes sense if consistently followed.  The true Keynesian policy maker would save money during good times and spend money during bad times.  The intention of such policy is to smooth out the business cycles.  Unfortunately, our government hasn’t been saving money during good times, therefore to spend now requires the nation to elevate its debt level.  And high government debt would easily lead to money printing & hyper-inflation.  The solution to too much debt is not be accumulating more debt.  If there is no saving, there should be no spending, especially when the spender has a tendency to be very wasteful.  In the U.S. case I would side with the Austrians.

The Chinese government, on the other hand, is also spending a lot of money to stimulate the economy.  Fortunately for the Chinese, they were saving a lot of money during their economic boom.  And now in a global recession, they can snatch up assets and resources for cheap.  This investment mentality is what drives the “easy-money” policy in China right now.   Therefore, in China’s case I would side with the Keynesians.

admin :: Aug.20.2009 :: Market Analysis, The World, Business/Management, Finance/Investment :: 2 Comments »