Economics & Finance

Does the President Actually Understand the Concept of Insurance?

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As much as leftists like to call Sarah Palin stupid, I’m think I can confidently assert that she knows the difference between liability and comprehensive automotive insurance.

I have long assumed that the demagoguery by Obama and other leftists against the insurance companies was just cynical “eat the rich” politics. I assumed that behind closed doors, these Ivy League grads did actually understand that insurance provides protection against statistical risk only and not protection against absolute certainties. I assumed they understood that money being payed out in claims has to be balanced out by money paid in as premiums or the entire system will collapse very quickly.

However, hearing the President speak on the matter of insurance over the course of the past year, I’ve come to the conclusion that he, personally, simply does not understand how insurance works. I fear that no one else around him really understands either.

I say this because if he did understand how insurance worked, he would know that the story about his car insurance would make him look like an idiot.

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Munger on China

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Charlie Munger
Charlie Munger

From Charlie Munger in a speech at UC Santa Barbara:

Another example of not thinking through the consequences of the consequences is the standard reaction in economics to Ricardo’s law of comparative advantage giving benefit on both sides of trade. Ricardo came up with a wonderful, non-obvious explanation that was so powerful that people were charmed with it, and they still are, because it’s a very useful idea. Everybody in economics understands that comparative advantage is a big deal, when one considers first order advantages in trade from the Ricardo effect. But suppose you’ve got a very talented ethnic group, like the Chinese, and they’re very poor and backward, and you’re an advanced nation, and you create free trade with China, and it goes on for a long time.
 
Now let’s follow and second and third order consequences: You are more prosperous than you would have been if you hadn’t traded with China in terms of average well-being in the United States, right? Ricardo proved it. But which nation is going to be growing faster in economic terms? It’s obviously China. They’re absorbing all the modern technology of the world through this great facilitator in free trade, and, like the Asian Tigers have proved, they will get ahead fast. Look at Hong Kong. Look at Taiwan. Look at early Japan. So, you start in a place where you’ve got a weak nation of backward peasants, a billion and a quarter of them, and in the end they’re going to be a much bigger, stronger nation than you are, maybe even having more and better atomic bombs. Well, Ricardo did not prove that that’s a wonderful outcome for the former leading nation. He didn’t try to determine second order and higher order effects.
 
If you try and talk like this to an economics professor, and I’ve done this three times, they shrink in horror and offense because they don’t like this kind of talk. It really gums up this nice discipline of theirs, which is so much simpler when you ignore second and third order consequences. The best answer I ever got on that subject in three tries was from George Schultz. He said, “Charlie, the way I figure it is if we stop trading with China, the other advanced nations will do it anyway, and we wouldn’t stop the ascent of China compared to us, and we’d lose the Ricardo-diagnosed advantages of trade.” Which is obviously correct. And I said, “Well George, you’ve just invented a new form of the tragedy of the commons. You’re locked in this system and you can’t fix it. You’re going to go to a tragic hell in a handbasket, if going to hell involves being once the great leader of the world and finally going to the shallows in terms of leadership.” And he said, “Charlie, I do not want to think about this.” I think he’s wise. He’s even older than I am, and maybe I should learn from him.

Originally posted on the Committee of Public Safety.

Dividend Cuts and Interest Rates

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Recently I wrote about how Interactive Brokers was offering to lend money at 1.25% in order to purchase stocks yielding 5% or more in dividends. I was struck by the low rate that they were able to offer as interest and the fact that there was a large universe of large companies offering such high dividend payouts (and not just companies that had a stock price decline with a dividend cut yet to follow so it was unusually high relative to the stock value).

To give Interactive Brokers some credit, the ad was kind of “tongue in cheek” in that it was made to look like it was written on a napkin like the classic business plan but there were enough elements there to get me thinking about what an odd state of affairs this represented.

Just recently this model started coming under siege. The Fed recently began tightening interest rates, increasing the discount rate to 0.75% from 0.5%. While the Fed has been denying that this is part of a long term policy shift, the markets have started to feel otherwise, as markets went down and yields increased on government debt. This won’t directly impact the 1.25% that they are able to borrow for on the “napkin” today, but it seems to be trending that way, even if this is just a first step.

On the other side, 2 large European firms just cut their high dividends. Daimler Benz (DAI), manufacturer of Mercedes autos, suffered a loss and canceled their dividend, leading to a drop of 4.6% in their stock price in one day. Societe Generale, a large French investment bank, cut their dividend from $1.2 Euros to $0.25 Euros (a drop of 79%) and their stock also fell 7.2% in a day.

The question is – how can companies pay out such high dividends in a sustainable manner when there isn’t much growth in the world economy and many of them are in mature industries? While 2 stocks don’t constitute a balanced statistical survey, they show that dividends are a function of profits and long-term profit view and to talk about them in an “historical” view is backwards.

The other side of this is that investing for yield in such a volatile area as stock prices shows that not only did the long term value of the income stream from dividends drop significantly (in the case of Daimler it dropped to zero, and for Societe it dropped by 79%) but then you can also see the impact on the underlying value of the shares, which dropped 4.6% and 7.9% in ONE DAY.

Cross posted at LITGM and Trust Funds for Kids

The Makers vs the Talkers

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[Note :I wrote this as a comment to this Victor Davids Hanson post but it ran long enough that I think I will make it an actual post.]

Way back in the ’80s the columnist William Raspberry wrote about a conversation he had at a Washington party.

Looking around at the collection of lawyers, bureaucrats, journalists, academics, etc., he turned to a friend and asked:

“Do you know anybody who makes anything?”

It had suddenly occurred to Raspberry that his entire professional and social circle was comprised of people who more or less did nothing but talk for a living. He had no personal contact with anyone who participated in the creation of any material good. After asking around, he found that he didn’t know anyone who even made things as a hobby. He said, “I couldn’t even find anyone who had made so much as a bookcase.”

That little newspaper column opened my eyes up to the most profound division in modern society. It is not rich vs. poor or ethnic-group/race A vs. ethnic-group/race B or male vs. female etc. It is the division between those who create the real physical wealth of our civilization and those who merely manipulate others by persuasive communication.

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Closing Time?

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Here’s Citigroup, with 10 mega-themes that spell the end of Western dominance

On the other hand, here’s Joel Kotkin: Complaints of China’s ascent and the U.S.’ collapse are overly pessimistic

I’m reminded of a point that was made in a 1930s book on military strategy (edited by then-colonel George C Marshall: The enemy always has problems of his own of which you are unaware.

Not that China–still less India–is the enemy. Surely the economic development of the Far East is a good thing…indeed, it is wonderful that so many hundreds of millions of people have been rescued from desperate poverty, and surely it is good for us to have millions of more creative contributors to global economy. I’m more concerned with our own level of economic growth, and whether it can be sustained at a level necessary to deal with our problems without declining living standards and permanant long-term unemployment than I am with scorekeeping vis-a-vis China and India. Economically-dynamic countries should indeed be viewed as competitors, but also as customers, suppliers, and sources of knowledge and ideas. (For military as well as competitive reasons, relative position cannot be totally ignored, given the nature of the Chinese regime.)

So what say you? Who is more convincing, Citi or Kotkin?

(Kotkin link via Newmark’s Door)