finance blog, Index Investing, Investing, Low-Cost Funds

Modern Marvels of Finance

Much rhetoric today is focused against “Wall Street”, bankers, hedge funds, and speculators.  People are upset about the effects of the Great Recession, but are often misguided about the causes.  I submit the idea that the foremost cause of the Great Recession was the business cycle (or economic cycle).    If we are to blame the people and institutions behind the business cycle for the Great Recession we must also applaud them for the periods of growth between recessions.  To one degree or another we are all participants in the business cycle.

Of course, there have been behaviors ranging from ethical violations to fraud, particularly in the arena of mortgages and mortgage-backed securities, and (MBS) credit default swaps.

While there are flaws and imperfections in the US financial system, the accomplishments of the system deserve some attention.  The United States represents an economic marvel of the 20th century and 21st century financial achievements of the American financial system.  Like Rome, the United States incorporates the best of other systems.  The stock exchange did not originate in the United States, but the US and Europe improved upon it.  To the best of my knowledge, the index fund and the ETF both originated in the US.

Right now, today, US investors have access to:

  1. Low cost online brokerage accounts.   It is easy to find brokerage accounts that charge less than $8 per trade and have a list of commission-free ETF trades.  With effort, it is possible to find accounts with trades costing less than $5, or even lower.
  2. Free stock and ETF market data. (For example Yahoo! Finance and Google Finance).
  3. Superb ETF offerings. (SPY, VTI, SCHB, BND, VEA, VEU…)
  4. Excellent order fulfillment and pricing (with most brokers).

Just imagine a world without stock exchanges.  Could you imagine placing a classified ad or holding a garage sale to trade stock certificates?  Ludicrous, right?

The current US financial system is indeed a modern marvel.   English, Canadian, and  European exchanges have been similarly efficient and successful.  Other exchanges around the world are playing catch up, and doing so quickly.

The global world of finance is constantly evolving, but as of today the options available to US investors are quite spectacular.  We are wise to take advantage.

bond funds, bonds, finance blog, funds, money

US Debt Ceiling… Sky’s the Limit?

The current debt ceiling is set at $14.294 trillion, and according to CNN Money we are days away from reaching it.  Treasury Secretary Tim Geithner estimates he and his team can keep the US out of default until early August.

I appreciate the increased attention on the US nation debt.  My concern is the the US is beginning to flirt with danger:  increasing risk of a debt crisis.   US debt is a fair ways removed from the debt crises of the PIIGS (Portugal, Italy, Ireland, Greece, and Spain).  However, the current trend of debt as a percentage of GDP is ominous.

A US debt crisis would look a bit different from that of the PIIGS because the US is not bound to a multi-country currency like the Euro.  Devaluation of the USD is likely to be a component of (or reaction to) a US debt crisis.  So are austerity and tax increases.

The danger is that buyers of US debt will demand higher and higher interests rates to compensate them for taking on three key risks,  inflation, devaluation, and default.   As debt increases so do these risks.  As the US refinances debt for expiring Treasurys it does do at greater and greater costs.  As the government raises taxes to combat debt (and pay higher borrowing costs) the US economy is increasingly depressed and tax raises do not result in nearly as much federal revenue as hoped.  Eventually only austerity and devaluation (via the printing press and increases in money supply).

The way I see it, playing brinksmanship now with the debt ceiling in an effort to but the brakes on the US deficit is a reasonable risk.  The current trajectory of the US debt is unsustainable and reckless.  With US debt 90% of GDP and closing in fast on 100%, we are in jeopardy.  This number puts the US next to the troubled Ireland and not far from Italy as shown in this table.

It is time for Congress to get its fiscal act together.  Time is rather short.  I hope we can start making some sort of progress.

finance blog

U.S. Armed Forces kill Osama Bin Laden

President Obama and other sources confirm that Osama Bin Laden is dead.  Reports say he was killed by Navy SEALs working closely with CIA agents, and DNA tests confirm that the body is indeed OBL.

The impact of this news on U.S. and global markets is yet to be seen, but the Nikkei’s performance is positive — up about 1.5%.

The impact of the 9/11 attacks had a traumatic multi-year impact on the U.S. economy, and a proportionally lesser, but nonetheless dramatic, impact on the world economy.

What can I add, but that this is very good news, both financially and in general.

bonds, finance blog

US Treasury Debt and other obvious warnings

It doesn’t take a rocket scientist to warn about the US’s debt woes.  For example this finance blog warned about it April of 2010.  And Bill Gross and PIMCO quit holding US Government bonds recently.  Now S&P joins the bandwagon with a warning that US Treasury debt’s AAA rating is at risk.  This in effect would mean lowering the government’s credit score.

Predicting particularly congressional outcomes is not my strong suit.  But I have been predicting growing US debt online since 1998.  Then the debt was a mere $5.3 trillion.  And I’ve been right that not only nominal debt, but debt as a percentage of GDP would rise.

To so many investors like myself the unsustainability of our current fiscal course is blatantly obvious.  During the day I work for a successful tech company, and I get a significant portion of my pay that varies based on the companies performance.  If profits increase my coworkers and I get more cash; if the profits dwindle so does my pay.  If the company stock rises, so does my compensation.  And if it falls, my compensation falls with it.  It is a smart system, commonly called profit sharing.

Might I suggest a similar compensation plan for federal government workers.  I’d call it deficit sharing.  (I’d prefer to call it surplus sharing, but get real.)  Beyond a certain point (say the average US annual wage) base pay is fixed and all future raises are in terms of variable pay increases.  And variable pay is awarded at the end of each fiscal year.  The proportion of the federal deficit to federal spending prorates this variable pay.  If someday there is a balanced budget there is a 1.0X multiplier to variable pay.  If there is a deficit then variable pay is reduced.  Should there be a surplus a multiplier of greater than 1 would apply.  Share and share alike.  The private sector employees do… and right now we are sharing the sacrifices.  So should Federal employees.

What to do you think America?