Rebane's Ruminations

The Off and On of the Inevitable (Addended)

George Rebane

The Greeks are rioting in the streets again.  They don’t like the new tranche of austerity measures that their parliament was forced to levy on the country.  This was in response to the northern eurozone countries imposing more conditions before giving Greece its next bailout check of approximately $170B in March.  The north, led by Germany, is keeping a wary eye on Greece to see if these austerity measures will be made to stick.

Greece’s big unfunded liability is of the same stripe as ours – entitlements that range from public employee pensions to healthcare.  We recall that in Greece one out of four workers is unproductively employed by the government.  And up until now, the parliament doesn’t even want to put public sector pension cuts on the table.

The markets in Europe and America are acting insanely as they digest the daily dribble of news from Brussels and Athens.  ‘Are the Greeks going to make it?  Well maybe, and then again, today it doesn’t look like it.’  My long held view that Greece will tank is getting more certain by the day.  There is no hint that with the March check, the Greeks will be any closer to financial stability than they are today.  They’ll use that cash to service their national debt, make government payroll and pension payments,  and buy time in dickering with their bond holders to take a 50% haircut.  But none of this will put the country on to a path of fiscal recovery.  After the March check, they’ll start rioting for the August or September check.

As a political and finance junkie, I keep asking myself as to who benefits from this silly dance with the foregone ending.  The only answer I have been able to cobble together is the ruling elites and the rich guys.  They are buying time to get their finances rearranged, relocated, and redoubted (hidden in places their governments can’t get it, see nearby chart).  So when it finally hits the fan, and spreads from Greece around the European shore of the Mediterranean to the northern countries, the remaining visible wealth of the smart people will be small enough to surrender without really affecting the quality of their lives.  The delay also gives the clever people time enough to get out of Dodge, whether that be a political office or country of residence.

Countries like Switzerland have been the monetary redoubt for the smart and wealthy for generations.  But now that security is being breached by developed nations led by the US.  The Swiss are now the prime target of big countries who want to know who of their citizens have how much squirreled away where.  While the Swiss and others are putting up a fuss to the likes of America, they have no intention in getting out of the numbered bank account business for the rich of the less developed and muscular countries.  From these countries it is still easy to pull profits from your nation’s natural resource sales, or even foreign aid from idiots in America, and get it into your secret accounts on some ‘El Dorado shore’.

Employment 2022 (Addended)

George Rebane

Here's a quick back of the envelope look at the employment situation over the next decade when we take into account accelerating technology that increases worker productivity.  GDP growth is taken at the indicated 2.5%/year.  This post is really as a 'memo to file' since people have asked me how I come up with the 70 million un/underemployed in the next decade with unemployment at 35%.  Even with GDP growth at 5%/year, the 2022 unemployment does not come down below 17%.  The blue numbers are inputs.  I have posted the actual Excel spreadsheet here so that readers may play with it and insert their own numbers - Download Employment2022.

 

Pay Gaps and System D

George Rebane

Frankly, it’s a bit eerie how the events long predicted on RR are ticking off as recently having happened, or about to happen.  Here I want to focus on the infamous pay gap of the American worker, and an economic activity that is hard to track, but globally significant.

Income comes in two forms – wages and profits/interest.  As has long been argued here, the pre-Singularity years are illuminated by worker productivity abetted by screaming technology advances.  Using new gizmos and software, today a worker can make more and/or service more per unit time than yesterday, and even more tomorrow.  Given that the size of the markets requiring new stuff and services is not growing as fast as productivity, the result should be predictable for people who think.

A New Corporate Vision – The Constitutional Partnership Corporation

[In the 'Hiroshima+66, Detroit+Welfare' comment stream RR reader Michael Rogers introduced us to the John Lewis Partnership, a unique type of worker owned/controlled corporation that has a ‘constitution’ as its organizing and operating policy document – let’s call it a Constitutional Partnership Corporation (CPC).  MichaelR launched a comment thread that expanded its examination.  RR readers are familiar with my concern about the growth of US un(der)employment which I project to be over 70 million by the end of this decade.  This will call for massive wealth redistribution which I have discussed extensively in these pages and in my Union column (here).  I introduced the Non-Profit Service Corporation (NPSC) as a stake in the ground for starting a discussion about how to accomplish such wealth redistribution.  I have elevated MichaelR’s thoughtful and extended comment into a post of its own to invite development (integration?) of his expanded CPC and the NPSC ideas.  For continuity, please see the 'Hiroshima' comment thread. gjr]

Michael Rogers

Since when has complex design ever stopped us? We flew to the moon, built the Panama Canal, the Transcontinental Railroad, and the modern economy that has brought security to billions worldwide for gosh sakes.

I am not happy with (the John Lewis Partnership) constitution either -- not a tight feedback system as I see it. I also am not sure I see robust checks and balances or separation of powers in their design. However, they do seem to have created a stable management system that has a good deal of accountability built in, and appears to have legitimacy in the eyes of at least the long-term partners.

I think that a system like this applied to Detroit would necessitate the elimination of unions and the imposition of personal responsibility on the individual worker level so that working partners would need to focus on the efficiency of their unit in particular, and the coordination of the entire company in general, in order to get their wage or benefit desires fulfilled. Also, the more self-managing a unit was, the fewer managers are needed and thus more resources are available for higher wages/benefits or shorter work weeks.

There might also be the possibility of passing legislation where Industrial Democratic Incorporations are giving special tax-exempt (or at least tax reduced) status and long-desired deregulation could be achieved with bi-partisan support based on the premise that an Industrial Democratic Corporation would have a self-regulating, tight feedback design and does not need the regulatory oversight that an open loop control, traditional corporate management system does.

This could be extended to a drastic reduction in OSHA and Labor Law interference which were all predicated on an adversarial worker/management dynamic. When workers have the right to redress their grievances within an internal structure then the need of a nanny state to meddle is reduced if not eliminated.

It might also be possible to achieve a privatization of Social Security as the accountable and elected corporate officials in the pension division of the company would act as professional managers of the retirement portfolio of the partners thus reducing the likelihood of waste, graft, or stupidity diminishing the value of the portfolio -- and the portfolio manager who achieved a 55 year retirement age would be carried around the company on gilded litters as if he were a conquering Roman general.

The financing to build these companies could come from tax free government bonds which would create a tax advantages investment vehicle for the "1%" so that, rather than worrying about taxing the rich, the left could be focused on convincing them to invest.

You spoke of the ephemeral nature of our monetary system and the disconnect from anything of tangible value. I have even imagined the possibility of the growth of a stock standard, where the bonds of self-regulating companies become a currency of value. Where the stock of smart, well-run companies with solid markets, low levels of debt, and abundant tangible assets are traded at a premium and the bonds of poorly run companies with speculative markets and highly leveraged are discounted to their true market value -- these bonds would become the currency of trade and the ability of government to reduce or manipulate their value is eliminated.

Investors Playing the Odds

George Rebane

At the risk of boring the bejeezus out of RR’s readership, here’s a bit of quantitative follow-up for all you investors playing the odds on the approaching collapse of socialist Europe.  Well, maybe that’s putting it on a little too strong, but looking at the way sovereign debt is being priced by the bond markets today, you gotta do more than wonder.

My last yawner on this (it got all of 4 reader comments) was ‘Greece and the 100% haircut’ where I showed how to calculate the probability that a borrower (here Greece) would default within a future interval of time, say, in the next year or two years.  The probability would be assessed by the world bond markets.  I gave the formula for computing that probability on your calculator using your own input values.

The piece also had another formula for computing what minimum interest you should demand from a borrower if you thought he’d go belly up with a certain probability within a given time.  Fun stuff if you are an investor playing that great American favorite ‘You Bet Your Ass'.

Anyway, for those who don’t want to mess with their calculator, and still want to keep track of the real shenanigans in Europe (the rest is just BS), I made a plot of default probability as a function of time and the rate difference.  The numerate reader will notice that the probability of default (Q) depends on the interest rate spread (r_B – r_RF) between the current bond rate and the so-called available ‘risk free’ rate – for the faithful, that’s what a 10-year US Treasury pays.  The formula for Q is shown in the figure below, and when you use it remember to convert percents into decimals.


Suppose you hear in the news one morning that some teetering country’s bonds are going for 23% per annum, and US Treasuries are paying 3% - that gives you r_B – r_RF = 23%  - 3% = 20%.  And you want to find out what is the probability that said country will default before two years from now (T = 2).  Then enter the horizontal T-axis at two, go straight up to the 20% curve, and then left to the vertical Q axis to read off about 33%.  The market is saying that there’s a one out of three chance that you’re going to get a haircut if you buy and plan to hold those bonds for two years - that's the real news.  Now is 23% enough of a return for you to take that risk?  If your numbers fall between the values given in the figure, you'll have to remember how to interpolate.  See, you’re having fun already.

Greece and the 100% haircut (updated 5oct2011)

George Rebane

We hear that Greece’s financial situation is so dicey that they now have to pay over 270% yearly interest on their bonds.  The ten-year US Treasury today closed at 4.88% per annum.  Everyone who reads RR knows that Greece is teetering on the edge of default and pulling out of the eurozone.  Being prone to financial engineering, this set me thinking about the chance (probability) that Greece will go belly up during a certain future time interval, say, in the next 12 months.  The interest yields on the two bonds should contain enough information to tease out this number given that the US Treasury is still considered a safe haven or risk-free investment.

So I pulled out my trusty pencil with the big eraser strapped to one end, and set myself down to push a few squigglies.  The question I sought to answer is ‘Given the market interest rate for a risky and a risk-free bond, what probability of default in a specified future interval does the market implicitly assess to a risky borrower?’  Well, it turns out that there is a very definite answer to that question, and the market’s probability of default is given by –

Where Q is the default probability, i_R and i_RF are risky and risk-free annual interest rates, and T is the interval from the present to some future time expressed in years.

Plugging in the above interest rate numbers and looking out one year, we get 0.93 or 93% as today’s market assessment of Greece defaulting some time during the next twelve months.  One can, of course, work the formula backward and answer the question ‘If I believe the probability is X% that Greece will default during the next year, what interest rate should I demand on their bonds?’  The answer to that is computed from –

Where the mathematically astute will recognize 1-Q as the probability that the risky borrower will NOT default.  ln is the natural logarithm (to the base e = 2.7182… ).

You can now put those formulas into a spreadsheet and have all kinds of fun figuring out how solid a certain corporation is, given the interest they have to pay on their bonds.  And you can plot Q, their probability of default, against T, which you would expect to increase over longer periods into the future.  Using the above numbers, I’ve done that for Greece.

Again, technically inclined investors will recognize that these formulas can now be used in allocating assets and designing a portfolio.  If there is qualified interest in their derivation, I’ll write up my scribbles into a readable pdf and attach it as a download to this post.  Enjoy.

[5oct2011 update]  A reader emailed me that the risk-free rate really closed at 2.04% instead of the 4.88% I used above.  My eyes must have been crossed when I looked at that rate to get the example for this post.  Nevertheless, I reran the calcs with the 2.04%, and as expected, the results were essentially the same as they were higher only in the third decimal place.  This is because the two interest rates enter the formula as a difference, which in this case did not change very much at all.  H/T to the attentive reader.

‘Investors sell …’ – What a crock!

George Rebane

Time to vent.  One of today’s financial reporters again comes out with – “U.S. stocks sank in afternoon trading as investors worried about policymakers' ability to contain Europe's debt crisis.” (28sep11 WSJ)  You read this kind of pabulum constantly in the financial press.  ‘Investors believe X, therefore they sell’, ‘Investors look forward to Y, therefore they buy.’

As a long time investor in the stock and bond markets, I and my friends of similar persuasion always smile at the naifs who write such drivel.  If the investors are selling or buying, who the hell are they selling to or buying from? The local public storage facility, United Van Lines, inmates of the nearby mental hospital, who?

No one has informed these ‘journalists’ that when investors sell, guess what?, other investors buy.  And it would probably surprise those same keen observers of the markets that it also works the other way around.

Such pieces point out the uselessness of 95% of financial reporting.  They spout the obvious (i.e. tautologies), or make up stuff when no one knows what’s happening.  When the market goes down and I buy, what am I then?  A potted plant?

Entrepreneurship 2011

George Rebane

[This is the submitted form of my July column that appears in the 11jun11 edition of The Union and in its online form here.  A related graphic on the impact of the stimulus is on NC Media Watch here.]

This administration has taken a bad economy and, by any measure, made it unimaginably worse.  We all know the litany of government stimulus packages, corporate bailouts and takeovers, new reams of regulations designed to drive business and finance off-shore, and, of course, Obamacare.  That nationalized healthcare monstrosity is proving to do exactly the opposite of every one of its touted benefits.  And parodying Nancy Pelosi, the more we find out about the Patient Protection and Affordable Care Act, the worse it gets.

Polls now show President Obama’s disapproval ratings well above 60% for his handling of the economy, yet enough people are being paid sufficiently that 44% of voters would still re-elect him.  With so many people ignorant about or out of today’s economy, it will take a miracle to replace him.

Meanwhile both Democrats and Republicans agree that small businesses are the nation’s job creators, and success there paves the road to recovery.  Yet the social engineers and vote buyers in Washington continue hindering the very economic activities they tout from the other side of their mouths.

Few people know what it takes to be an entrepreneur and start a job-creating business.  A successful entrepreneur comes with an over-arching dream, a practical approach, tolerance for considerable risk, and enough funds to last through the ‘cash minimum point’ when revenues start exceeding costs – whenever that may be.

You would? Really?

George Rebane

Would you lend money to someone who already owes you more than he can repay, wants you to loan him more so he can use some of it to pay you the interest on what he currently owes (a la Madoff), and owns a printing press that is already printing his debt to you into oblivion?

 

(If YES, then when would you stop?)

Bet You Didn’t Know About this Tax

George Rebane

This year I promised to write more stuff on technology and finances.  In the winter I also start writing the year’s TechTest2011 which will be taken in the spring by a select cadre of Nevada County’s high school seniors and juniors.  Reviewing some of the problems from previous TTs, I came upon one that involves taxes and should be of interest to all of us.

Not many people have a clue about how income and sales taxes combine to present us with the total tax burden we have to bear.  If we did, maybe more progressives would abandon their faith in ever higher taxes.  So let’s consider a simple example of dollars and cents or sense.