Archive for March, 2011

Viva Lost Wages!

Wait I think we got that wrong.  Elvis is surely spinning in his grave right now.  What was that song….that’s right its:

VIVA LAS VEGAS!!

Yes my friends, we just got back from one of the biggest audit and risk conferences in the world.   While there, we unveiled our new risk assessment software:

www.logicbringslight.com

Of course I urge you to click on the link to find out more.  

Now that you know the reason for my infrequent posting as of late, onto Las Vegas! 

Ah yes, Las Vegas…where middle aged suburban housewives walk around showing complete strangers what they refuse to show their husbands at home.  Where men dressed as Rhett Butler or Elvis don’t get a second look, and most critically, where people take great joy in giving their money away…for nothing.  

Now I am sure some people will jump up and shout, “They’re not giving away their money for nothing!  They are deriving enjoyment from gambling!” 

It doesn’t add up to me.  Most vices involve the exchange of money for something tangible.  The alcoholic trades his money for whiskey, the glutton orders another steak and the womanizer trades diamonds and furs for…..well anyway.  

Nonetheless I am willing to concede that some people enjoy gambling very much and I accept the right of people to indulge in gambling away to their hearts desire.  

But what if the gamblers are in charge of a national currency? 

Uh oh……this becomes a little different.  

Like a washed up father forced to come home and explain to his children why he lost his entire paycheck at the casino, the Federal Reserve Bank of New York recently went to the New York City borough of Queens to explain their monetary policy to the average American.   

The results have to be filed under, “you just can’t make this stuff up.”  Let’s go to the Wall Street Journal for the details.  

Warning:  The following story is funny….but only if you’re into gallows humor.  Our emphasis added: 

The former Goldman Sachs chief economist gave a speech explaining the economy’s progress and the Fed’s successes, but come question time the main thing the crowd wanted to know was why they’re paying so much more for food and gas. Keep in mind the Fed doesn’t think food and gas prices matter to its policy calculations because they aren’t part of “core” inflation. 

So Mr. Dudley tried to explain that other prices are falling. “Today you can buy an iPad 2 that costs the same as an iPad 1 that is twice as powerful,” he said. “You have to look at the prices of all things.” 

Reuters reports that this “prompted guffaws and widespread murmuring from the audience,” with someone quipping, “I can’t eat an iPad.” Another attendee asked, “When was the last time, sir, that you went grocery shopping?” 

Mr. Dudley has been one of the leading proponents of negative real interest rates and quantitative easing, so this common-man razzing is a case of rough justice. If Mr. Dudley were wise, he’d take it to heart and understand that Americans aren’t buying the Fed’s line that rising commodity prices are no big deal. Unlike banks and hedge funds, they can’t borrow at near-zero interest rates, and most of them don’t have big stock portfolios. Wall Street and Congress may love the Fed’s free-money policy, but Mr. Dudley and Chairman Ben Bernanke ought to worry about losing the confidence of the middle class. 

Full story here:  http://online.wsj.com/article/SB10001424052748704893604576199113452719274.html 

Just a few weeks ago we wrote about the rising commodity prices mentioned in the story above.  We included commodity price charts for some of the basic necessities, wheat, oil, cotton, beef, etc.  For those that forget quickly, the price increases on the charts looked like the Himalayas rising from the Indo-Gangetic plain.     

I am often asked what “we” (companies, individuals, etc) should do to insulate ourselves from the seemingly endless stream of financial and economic risk that is being thrown at us.  

There is no “one size fits all” answer of course.  The answer depends of what you are trying to achieve.  Are you trying to increase your wealth, protect your possessions, maintain a basic level of happiness….or something else? 

I must warn you; however, the answer to this question will reveal as much about who you are as what you should be worried about.  

But back to our little vignette in the borough of Queens, I often wonder what the Fed learned from their brave excursion to meet the common man.  Perhaps they now understand that food and fuel are “kinda important” things to worry about.  Maybe they will try to put some ketchup on an iPad and see if it tastes like chicken?

Maybe…… 

But perhaps the more likely scenario is those guys dressed as Elvis and Rhett Butler wandering around the Fed entrance on Maiden Lane while those inside…hope for more luck.   

Have a great weekend, 

Michael Bechara

Managing Director

Granite Consulting Group Inc.

mbechara@consultgranite.com

www.consultgranite.com

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An Alternate View

Still buried at the moment, but Dan Helming was kind enough to offer his thoughts for us this week.  Its not your usual Weekly Recon fare, but hey read, evaluate and ponder…..

What Exactly are we, and Is it all Business? By Dan Helming 

We tend to follow our trendsetters in America, and the trendsetters seem to be leading us in all different directions.  We have an historic recession, and unemployment that has knocked 1 in 7 people out onto the street.  At the same time, we have half the country calling for the curtailment of government spending.  Not inconsequentially, government spending is stimulative to the economy. 

It seems if we are going to be all business, we can cut spending, but we need to restore or direct some spending to stimulate the economy.  Since we lack the productivity of 1 in 7 workers and are also providing benefits to many of those workers, we are curtailing real growth and health in our economy as long as those assets are not productive.  Note that the problem is understated in that another of those employed workers is underemployed as well.  

And let’s not be fooled into giving tax cuts as a stimulative benefit.  In the minds of some people, there is a field of dreams with, instead of baseball players, workers sitting on the bench.  And in the minds of people who believe in the field of dreams, the manager reads the Wall Street Journal in the morning before a game, sees news of a a tax cut, and says, OK, Ned, you’re going in to work, there’s been a tax cut.  Ha. In the real landscape of business, the majority of people are employed in small businesses.  And maybe 30% more are consultants.  If any of the small businesses can sell products that day, they do to the best of their ability without regard to taxes.  And when business picks up so well that they don’t have enough workers to sell or produce a product or service, they hire more workers.  Taxes are a fraction of the bottom line, if there is one, and are an afterthought.  

I had a client who used the remainder of his bottom line each year to buy supply inventory, he was being “smart” to “use up the money and avoid taxes”.  So he should have been stockpiling these savings he made each year, right?  If that was the case, he would have had a burgeoning supply inventory and maybe an obsolescence problem.  Well, he didn’t and hadn’t.  He had in reality had a marginally profitable business and was buying supplies that were being used up in the business the next year.  No savings, no profits…no clue until we explained the basic accounting to him and the employees he had transferred the business to.  He had sold the business as a function of the pre-buy net income to the detriment of the buyers. 

Don’t be fooled into thinking that the extension of or the Bush tax cuts themselves were stimulative to business.  First, the cuts weren’t made to businesses, but individuals:  a larger childcare credit, a reduction of the marriage tax, a lowering of the top tax rate, and a phase-out of estate tax.  Second, among the wealthier individuals who were the primary ones affected by the rate and estate tax cut (over $250,000 in income), only 1.7% owned small businesses reported through a K-1 or Schedule C, according to spinsanity.com.  The median effect to an American was $600, from the childcare credit and the marriage tax only.  The thousands and tens of thousands given to other individuals were givebacks with little stimulative effect.  And not a single family farm was lost, from the reporting done in the last year before the estate tax cuts.  Though it was a powerful image.  So if we’re going to be all business, we’ve already made a misstep in re-establishing the cuts, and as an economic conservative, I am none too happy with the presidents that did this.  Let it be known that neither Bush nor Obama are economic conservatives. 

And if we are going to be all-business, where is the competition and choice in healthcare?  Medicare operates with about 2% administrative cost and no frills.  Why not increase competition if we are all business and let the no-frills option compete?  If people want choice, they can choose the more expensive private companies and the value they offer.  And let the Veterans Administration compete against both Medicare and privates too!  Then we’ll have a competitor that runs its own medical facilities, and we in America will have a choice between the three great models of healthcare, private, single payer and government facilities.  Rather than healthcare that is equivalent in the Western world to only Turkey and Cyprus, and when you get really ill, stops working or makes you broke. 

In the Middle East revolutions, we see the requirements of being all business means that we sometimes have to swallow our pride.  China and Russia do a good job of being all business and seem to have a better footing in making business with what we call rogue states.  In Libya, we came as close as we ever have come to the all-business model.  We held our nose with relation to Pan Am 847, allowed Libya to rejoin the international community, and through international contact, wealth creation and the sophistication of the military and middle class, a revolution had arisen. 

People don’t need to waste their breath on some sort of Middle East peace agenda taking hold.  The parties to these conflicts have almost universally said that we in the US need to keep out.  This is unfortunate, because the real revolution will be into the creation and popularity of political parties in the free elections that will occur afterwards, and the Muslim political parties tend to be the most established.  If anything, the action we took in Iraq will work in this way against the election of representative democracies.  Beware of a government friendly to Iran and Russia, allowing them to locate their navies there, with control over the mouth of the Meditteranean.  

If we’re all business, we’ll follow the agenda of those who want to roll back social security.  It isn’t so long ago, just the 40’s, when we had poorhouses run by religious bodies… when we didn’t have care for orphans, the old, the infirm.  The streets will look a lot more like our southern neighbor.  News item: under the last president, the number of children who lived under poverty increased from 16% to 18%, nearly 1 in 5.  I am all for public work programs, and with a philosophy of putting everyone to work, I fail to see how sending kids to school hungry is optimal even if we are all business.  A lot of these kids will end up in crime, pregnant and impoverished themselves.   

If any of these conclusions shocked you or don’t agree with your sensibilities, then question whether you want this world and this country to be all business all the time.  Or go to Mars… maybe that will benefit someone’s Mars agenda…

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The Pressure on the Dam Increases

 Everyone loves a good economic boom.  

Ah yes, the always loved and ecstasy filled economic boom.  A euphoric period of economic prosperity when everyone is feeling good and enjoying the ride.  

Thinking back to the real estate and dot com booms, I certainly can remember the smiles and tall tales exchanged at cocktail parties about flipping condos, stratospheric PE ratios and the toys acquired with the proceeds.  

It was a time when the men were displaying the false bravado that comes with telling stories of trading paper rather than say…hunting, fishing, old cars or other manly pursuits.  And the women…they attempted to incinerate each other with jealously by describing and displaying the most outrageous wastes of money possible.  

But hey don’t get us wrong, we like booms just as much as the next guy.  In fact we are positioning ourselves for the coming boom in risk management! 

Unfortunately for us, and for many people, we may be experiencing a different kind of boom…a very dangerous and deadly boom.  

An economist of yore, Ludwig von Mises, described a phenomenon that he called “the crack up boom.” 

Even the name sounds ominous, doesn’t it? 

A crack up boom occurs when a government expands the supply of money and credit to the point where inflation takes hold.  Once inflation takes hold, there is a “plateau” type period where people see the higher prices, but still retain faith in the long term purchasing power of the paper money in their wallet.  

The “crack up boom” is a kind of tipping point when investors and consumers see more money and more credit being created and they suddenly lose faith in the future value of the currency.  Once this Rubicon has been crossed, people are desperate to exchange their paper money for hard assets and goods, whether they need them or not, to avoid paying even higher prices for them in the future.  

The “crack up boom” is a boom in hard assets typically those needed to sustain life…like commodities.  

“Why doesn’t this Bechara talk about something that’s relevant for us Americans!  I think it’s disgusting how he spins these irrelevant tales”, jeer our friends in the peanut gallery.  

For those who haven’t caught on by now, a “crack up boom” is a very destructive, and sometimes life threatening kind of boom, because it raises the costs of staying alive.  Some can afford the increases in commodities, while others….can’t.  

Over the past years we have witnessed a vast expansion of money and credit, known as the Fed’s, QE1 and now QE2 programs.  We won’t even mention all of the other backstops and bailouts for now.  

Over the past months, we have all seen prices rise from gasoline to food to clothing without major disruptions but……has anyone taken a look at commodity prices lately? 

I must warn you, the following charts are very unsettling.  Doth the tipping point approach perhaps?  Let’s take a look: 

For those that like to eat:

 

For those that like to have heat:

For those that like to wear clothes:

And finally for those that like stable money:

The only thing that has kept these skyrocketing commodity prices from fully manifesting themselves to consumers is the concept of “margin collapse.”  This simply means that the full amount of the cost increases have not been passed on to consumers by producers of goods.  They have decided to absorb the costs and reduce their margins, to avoid scaring off consumers with higher prices. 

This only can go on for so long; however, for if prices continue to rise, producers will either go out of business or pass on the massive cost increases to consumers.  What do we think will happen then?

In any case, it is clear that massive amounts of money are flowing into commodities and driving up the prices.  For sure, there will be some people who will benefit from this boom, but for the vast majority this crack up boom may be the final blowout. 

Regards,

Michael Bechara, CPA

Managing Director

Granite Consulting Group Inc.

mbechara@consultgranite.com

www.consultgranite.com

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