2011 Personal Finance Review

There used to be a graying tower alone on the sea
You became the light on the dark side of me
--Seal

Some reflection on progress toward personal finance goals set early in 2011.

My number one goal in 2011 was to build current assets. I regard current assets as financial securities and physical assets that can readily be converted into cash. In my case, this rules out the house and various tax deferred (i.e., IRA, 401k) accounts. For me, current assets include immediate sources of cash (checking, money market accts) as well as 'close' sources of cash (securities held in taxable brokerage accounts, plus precious metals).

Fortunately, current assets increased substantially in 2011. The primary driver behind this was being debt free, a condition in place since paying my house off in late 2010. The influence of being debt free in standard of living and building wealth cannot be overstated. Cash that was previously siphoned off to pay down debt is instead allocated toward consumption, saving, and investment needs in the here and now. From where I sit, one of our Creator's greatest gifts to us was the capacity to be free. Extinguishing debt, for me, was like throwing off chains of bondage. I hope to God that I never carry debt again.

In building current assets in 2011, my original focus was on increasing cash. Cash is the most liquid of all financial assets and promotes maximum flexibility to cope with life's challenges and opportunities. About halfway thru the year, however, it became more obvious to me that central banks around the world are increasingly likely to debase currency in attempt to stave off systemic collapse (with the EU at ground zero). In such a situation, risk associated with holding cash goes up because the purchasing power of cash goes down.

This found me swapping cash for stocks and metal. My general foray into stocks didn't last long, however. After catching some nice moves in stalwarts like JNJ, INTC, MSFT, and CSCO, it became increasingly difficult for me to hold stocks given general valuations and the macro state of the world. By late in the year I had drained most of my brokerage holdings of stock in favor of a blend of precious metals and cash.

I also set a goal to 'trade opportunitistically' in 2011. This was also done with some measure of success. The first half of the year found me long various stocks and commodities to express what initially seemed heightened chances for significant inflation. I also thought that a number of blue chip stocks were showing decent value.

Minds can change with the winds, however, and they did in my case by mid year. My constructive view on valuations turned pessimistic, and I unloaded most of my equity risk over the course of the next few months. The bigger issue were macro ones. Summer found Congress unable to cut spending and debt (both were raised), and the EU coming apart at the seams.

By late July I had a pretty big short side book that worked well when prices started cascading lower. I built and pared this 'hedged' position several times over the next few months as markets heaved to and fro. What I learned is that I could be much more patient with significant long and short exposure when these positions were more or less equally paired. Lower prices were times to lighten up the shorts and take on some longs, while higher prices allowed for the opposite.

The effectiveness of this approach waned some late in the year as my long exposure in commodities underperformed the SPX substantially, causing performance to bleed a bit into the final bell. All in all, though, I liked how this approach performed in the volatile environment that we have been facing, and I plan to carry over this approach into 2012.

Finally, my other 2011 goal was to increase precious metal holdings. Most of my activity here came in the second half of the year in conjunction with my increasingly bearish outlook for fiat currency and financial system stability.

In a future missive, we'll sketch some objectives for 2012.

position in CSCO, SPX

Origin of Society and Government

If I'm losing control, will you turn me away?
Or touch me deep inside?
And before this gets old, will it still feel the same?
There's no way this will die
--Pat Benatar

Excerpt from Frank Chodorov's (1959) The Rise and Fall of Society, which remains one of the best books on liberty and society that I have read. The basic question on the table in this excerpt is why humans socialize and form government.

There is a preposterous train of thought that society and goverment precede the individual. Lincoln, in fact, used such a rationale in his defense of authoritarian federal rule during the Civil War. Indeed, this twisted thought process forms the basis for socialism in all of its flavors--communism, facism, et al.

In reality, societies precede governments. And individuals precede societies. The question then becomes what motivates individuals to socialize and to form governments?

Chodorov reasons that there is one constant in human behavior that can be observed wherever we encounter people: they are always and everywhere concerned with making a living. 'Making a living' is broadly construed to mean the process of satisfying needs, be those needs physical or psychological.

Various truths accompany the process of making a living. Human needs are never fully satisfied. People always reach for more. Moreover, the basic condition of our planet is one of scarcity. In order to satisfy needs, resources in non-consumable form must be converted into consumable form through productive effort. However, people have a general preference for less effort rather than more, and to satisfy their needs sooner rather than later.

Thus people constantly search for ways to economize effort. Economy may be obtained thru various approaches. People can set aside some resources today to develop tools that increase productivity tomorrow. Higher output per hour relieves conditions of scarcity and improves standard of living. This approach is central to capitalism--the development of labor saving devices thru capital investments that increase abundance.

Economy may also be gained by division of labor. Specialization in a particular line of work improves productivity through repetition. Learning by doing increases efficiency. Because there is less changing between tasks, switching costs are also reduced.

To realize the fruits of specialization, however, people must engage in trade. Trade permits people to broadly satisfy their needs with more economy. More can be obtained per unit of effort when people specialize in their production and then trade.

Here we have the basic answer to why individuals socialize. Societies are a natural expression of the human desire to satisfy needs. These needs can be better satisfied through voluntary exchange with others than by people working in isolation. The key word here is voluntary, for if an individual does not like the terms offered in societal exchange then that individual can choose a more self-sufficient condition, albiet at a lower living standard perhaps.

Because man has an aversion to labor, and prefers satisfying needs using the least amount of effort possible, there will be those in society who covet the output produced by others. As such, individuals engaged in societal cooperation institute government to help protect property from expropriation by others. As long as the scope of government is limited to the protection of individual property rights, then individuals and society prosper.

Unfortunately man's aversion to effort in the pursuit of ever more satisfaction finds him seeking a broader scope for government. "Because government is an instrument of force," he reasons, "perhaps it can be employed to deliver into my possession economic resources that I won't have to work for." Government thus becomes a strong armed agent for a thieving principal.

When the scope of government moves beyond the protection of property to the expropriation of property, then prosperity is lost in societal arrangements.

It should be evident, therefore, that society and government are constructs--institutions that individuals create in their lifelong pursuits of making a living. The institutions assist in man's endeavor to get more for less.

The problem, of course, arises when these institutions reduce the voluntary cooperation necessary for increasing prosperity, and instead fester forceful invasion of one individual on another.

Time Tunnel

There's a crazy mirror showing us both in 5-D
I'm laughing at you, you're laughing at me
There's a room of shadows that gets so dark brother
It's easy for two people to lose each other in this tunnel of love
--Bruce Springsteen

Decent demo of the slippage or tracking error that occurs when holding leveraged ETFs over time. While these vehicles may be useful for trading, the tracking error erodes long term returns, making them undesirable for investors with long time horizons.

no positions

Ownership and Socialism

You don't know how desperate I've become
And it looks like I'm losing this fight
In your world, I have no meaning
Though I'm trying hard to understand
--John Waite

Am starting once again Mises' (1951) Socialism. An important point made early relates to ownership. There is economic ownership and legal ownership. They are not necessarily equivalent.

In economic terms, ownership is the power of disposal. In the case of first order, or consumer, goods, the individual who can direct consumption of the good owns it. Thus, a thief who steals bread from a supermarket owns the bread from an economic standpoint because the thief is in control of its disposal. This state of ownership is true despite the fact that the thief does not have legal title to the bread.

Under the auspices of Natural Law, rightful ownership equates to individual property rights. Broadly construed, property includes an individual's life, his/her wherewithal to produce, and the fruits obtained from production. Natural Law declares that property is the dominion of the individual who can dispose of it as desired as long as the individuals does not forcefully interfere with the pursuits of others while doing so.

Socialism endeavors to expropriate property from the individual to the collective. It seeks to do this by empowering an institution, government, as a 'legal' agent for expropriation. Direct and forceful transfer of property from individual to states, as well as forceful limitations placed on the rights of individual property owners, are means of socialization.

From Mises:

"If the State takes the power of disposal from the owner piecemeal, by extending its influence over production; if its power to determine what direction production should take and what kind of production there should be, is increased, then the owner is left at last with nothing except the empty name of ownership, and property has passed into the hands of the State." (p. 56)

Reference

Mises, L. 1951. Socialism: An economic and sociological analysis. New Haven: Yale University Press.

The Roosevelt Myth

"Unfortunately, no one can be told what the Matrix is. You have to see it for yourself."
--Morpheus (The Matrix)

Finally completed Flynn's (1954) The Roosevelt Myth. Flynn believed that mainstream history was giving FDR a free pass and he wanted to set the record straight. As such, Flynn's work parallels that of Garrett, Lane, Hazlitt, et al who sought to record and analyze what others were ignoring during the 1920s-1940s.

Flynn was a well known journalist who wrote for Harper's, Collier's, and others. By the 1930s he became one of the best known political commentators in the United States.

His perspective is particularly interesting because he was a Democrat with populist inclinations who voted for FDR in 1932. However, it did not take Flynn long to realize that FDR was veering far away from his original campaign promises (which amazingly enough centered on reducing government, balancing the budget, and keeping the US out of war!).

The book, which is well cited, is divided into sections that chronologically follow FDR's three and a fraction terms (FDR died in April 1945 shortly after his inauguration for a fourth term).

An overarching question that Flynn considers is what motivated FDR to do the things he did during his presidency? The evidence suggests that Roosevelt was not motivated by strong ideology. By his second term beginning in 1936, opponents were accusing him of being a Marxist or at least someone of Communist persuasion.

While it is true that FDR had begun populating his administration with people of those colors from the outset, it appears that FDR was no more loyal to collectivist ideals than to any other idea that could earn him votes. Indeed, it was during the FDR administration that the market for political favor exploded in size. Prior to FDR, special interest groups were largely limited to big business. FDR made markets for political favor across the spectrum, picking up the poor, labor, old people, and any other category that sensed that they could get something from government in exchange for their vote.

The Roosevelt family itself was not immune to graft. For example, Roosevelt's wife and two sons made fortunes by exploiting White House ties during this period.

FDR displayed little discipline toward self-study and self-expertise. Instead, he surrounded himself with 'The Braintrust,' i.e., so called experts on economics, sociology et al who had opinions that FDR could use. And use them he did, flittering about like a moth in a light bulb factory from one government program to the next. During his first two terms, more than 100 government agencies reporting to the executive branch were created.

Flynn astutely observes that it was the practice of Congress writing blank checks to FDR for his spending whims, and the practice of FDR then using those funds to enact policy thru his vast agency reach, that elevated presidential power far beyond the intent of the Framers. The result is the Statist model that continues to escalate today.

Although FDR's behavior can be seen as politically rather than ideologically motivated, there is little doubt that many in his administration were sympathetic to socialist causes. And those administrators knew how to manipulate FDR in manners that advanced their agendas. It is unlikely that FDR would have been re-elected in 1940 or 1944 without the support of union and other special interest groups with Communist ties. One of Flynn's contributions is to elaborate those linkages and their impact on FDR's behavior.

When he began his second term in 1936, FDR was engaged in some end zone dancing about the economy, patting himself on the back that his New Deal programs had slain the Depression monster. Within a year, however, deflation returned and unemployment quickly recaptured Depression era highs above 20%.

Desperate to kick-start the economy, FDR eyed military spending and, gradually, military involvement as a means for breaking the back of the Depression. Flynn makes it clear that Russian interests played in role in US military policy decisions before, during, and after WWII. Stalin was clearly the dominant figure in policy decisions during the war, walking right over FDR in nearly every way possible.

It is quite likely that FDR's policy decisions, which can be seen as increasingly inept by late 1939, were partly due to his deteriorating health. Flynn makes a strong case that there was broad concerted effort to deceive the American people as to FDR's true state of health, and that this deception was successful enough to push Roosevelt over the top in the 1944 election. All the while, politically motivated interests were using FDR as a puppet to express their desires.

Flynn's portrayal of FDR as a purely political animal with modest intellectual capacity who oversaw a morally bankrupt regime is the antithesis of popular accounts. It demonstrates the power of the Matrix to slant, and the capacity for truth if the Matrix is cast aside.

Reference

Flynn, J.T. 1948. The Roosevelt myth. New York: The Devin-Adair Company.

Melted Butter

Dream of better lives the kind that never hate
Wrapped in a state of imaginary grace
I made a pilgrimage to save this human's race
Never comprehending the race had long gone by
--Modern English

Action in precious metals continues ugly. New lows for the move today. Peering thru a longer time horizon lens, however, finds the yellow metal just now touching its multi-year uptrend line--a defined risk set-up for bullish traders.

One apparent takeaway from a macro perspective is that gold is not buying the thesis that the financial system is reliquifying--particularly w.r.t. the EU. Instead it is behaving like a wave of deleveraging, deflation in in the cards.

position in GLD

Under the Euro Surface

We mention the time we were together
So long ago, well I don't remember
All I know is that it makes me feel good now
--The Motels

Am continuing to pick up chatter like this that the situation in Europe is worse than appears. The EU version of TARP, the Long Term Refinancing Operations (LTRO), has seen a commensurate jump in bank funds with the ECB Deposit Facility to a record high half trillion euros.

The implication is that interbank lending in Euro is largely frozen. Banks are instead choosing to keep funds w/ the central bank.

Deja vu pangs here, as this is very reminiscent of the risk averse behavior we saw stateside in 2008.

Which probably shouldn't be surprising. After all, the situations are largely the same. Risk seeking behavior and easy credit ran up massive debt and leverage. Now risk appetites are waning. And price declines threaten leverage systems with insolvency.

position in SPX

Rogers Outlook

"My prediction? Pain."
--Clubber Lang (Rocky III)

Jim Rogers checks in w/ his thoughts on 2012. He is not optimistic, but does note that markets could be propped up as gov'ts print and spend ahead of big elections in order to buy votes.

Also thought this extended interview w/ Glenn Beck was interesting. It is easy to see why Beck left the mainstream media system. He can now ask questions that he could not have when under the control of someone else.

JR does not mince words. But what is interesting here is that Beck's format made JR perhaps let is guard down even more and let it fly. He obviously foresees a rough road ahead.

He pulled a couple of 1 oz gold coins out of his pocket that he picked up on his way to the interview. He shows a Canadian Maple and a Chinese Panda.

His favorite commodity sector continues to be ags, and he says that he buys the Rogers ag index.

position in RJA, gold

Media Bias and Distortion Effects

Message just keeps getting clearer
Radio's on and I'm moving 'round the place
I check my look in the mirror
I wanna change my clothes, my hair, my face
--Bruce Springsteen

One implication of of Crawford and Sobel's (1982) model of strategic information transmission is that politically motivated information sources are likely to exaggerate their messages in order to influence less biased consumers of information.

Cai and Wang (2006) subsequently conducted experiments to estimate the amount of information and the degree of bias.

In an average state of the world that was 5.0, senders sent a message of 5.894. On average, then, senders sent a message that was biased by 0.894 units from the truth.

The receivers, even though they know that the average state of the world would be 5.0, chose an average policy of 5.282. Thus, receivers were 'fooled' into choosing a policy that was 0.282 units higher than the truth.

The results demonstrate that the typical person underestimates the degree to which other prople are strategic. In the context of media bias, consumers of information are more 'trusting' of news sources than they should be.

Such findings do not support a rational choice theory basis for media consumption. Instead, the results argue for a 'media effects' explanation.

Even when consumers are on guard for bias in the information that they receive, bias emanating from media sources is still prone to distort the beliefs of information consumers.

References

Cai, H. and Wang, J.T. 2006. Overcommunication in strategic information transmission games. Games and Economic Behavior, 56: 7-36.

Loan Ranger

Step right up, and don't be shy
'Cause you will not believe your eyes
--The Tubes

After more than a year in court, the Fed has finally released data on its bank lending programs during the credit market meltdown in 2008/2009. Some mind numbing numbers. $1.2 trillion in loans plus a pledge to backstop about $7 trillion on bank liabilities. Bloomberg estimates that nearly 200 banks participating in the Fed's programs could have made nearly $13 trillion by investing the Fed's loans that they took.

Many people continue to pat themselves on the back that these measures averted a system meltdown. The numbers above should tell you that we printed our way out of this episode. Those hurt go beyond taxpayers, as anyone holding dollars now has less wealth in hand. Not to mention the elevated moral hazard...

It continues to amaze me how people keep pointing to the banks and the rich as the 'cause' of widening income differentials in this country...