Economic Battleground A Fish Story Part 1

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Economic Battleground A Fish StoryPart 1

• By John P. Bott, II

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• Full service Houston-based brokerage firm founded
  in 1986
• Fixed income specialists
• Success is built upon long-standing client
  relationships based on trust, honesty, and
  quality service

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John P. Bott, II

• Chairman of Tri-Star Financial
• GP of Parallax Investments,
• GP CIO of Parallax Capital Partners, LP Hedge
  fund and Portfolio Manager of Parallax Investments

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• The talking points, ideas and images for this
  presentation come from the book How An Economy
  Grows And Why It Crashes by Peter Schiff.

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Keynesian Economics vs. Austrian Economics
Keynesian Austrian
John Maynard Keynes Carl Menger and Ludwig von Mises
Government Intervention Free Markets
Fiat Currency Gold Standard
Debt Savings
Consumption Investment
Bailouts Let Inefficient Companies Fail
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• Keynesian Economics is generally the more popular
  school of thought. Why?

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An Idea Is Born

• Able, Baker and Charlie lived alone on a desolate
  island with only fish to eat. One fish would feed
  one man for a day, however because they had no
  nets it took all day to catch that one fish by
  hand. Their entire island economy amounted to
  wake, fish, eat, sleep. Every fish that was
  caught was eaten. Nothing was saved, exchanged or
  leant.

• Able wonders, what if more fish could be caught
  in less time? Such a device could give him more
  time to make a home, make clothing and begin
  growing crops. But he would have to go a day
  without eating in order to make a net because
  there were no loans or savings he could rely on.
  At the end of the day Able had no fish to eat but
  he had his net. Through self-sacrifice if the net
  is successful he created capital.

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Economic Principles

• Underconsumption
• Risk taking
• Capital

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An Idea Is Born

• The next day Able caught two fish instead of the
  one Baker and Charlie each caught. By making the
  net Able has increased his productivity and can
  produce more goods than he needs to consume.
  Being able to catch a fish for tomorrow has
  creating savings on the island. Spare production
  is the life blood of a healthy economy. In most
  species economics really only boils down to
  day-to-day survival. They are constantly in
  search of food, water and shelter, which leaves
  little to no room for innovation and increases in
  capital.

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Economic Principles

• Simplest definition of economics the effort to
  maximize the availability of limited resources to
  meet as many human demands as possible. Tools,
  capital and innovation are the keys to this
  equation.

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Sharing The Wealth

• Now Able only has to fish every other day in
  order to feed himself. Baker and Charlie ask to
  borrow the net on the days Able was not fishing.
  But Able has many concerns about loaning out his
  net. What if they break it? What if they dont
  give it back? Why should I take the risk of
  losing my capital for no return?
• When Able shot down that idea Baker proposed
  another. Ok how about you loan us the extra fish
  you catch so that we can make our own nets and
  not starve? Then we will pay you back with the
  extra fish we catch from our nets?
• Able again had concerns. He was still putting up
  a lot of risk for no return. He was giving them
  his newly found savings and not getting anything
  back for it. Their nets might not even work and
  he would have given up his savings for nothing.
  He also risked that they would just sit on the
  beach all day rather than make their nets in
  order to pay him back. Again he said, it is not
  worth the risk for the return.

Fig
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Sharing The Wealth

• Finally Baker approached Able with a financial
  idea. For every fish you lend us we will pay you
  back two fish. Able liked that idea because he
  could easily double his fish and not do any
  additional work. But Able was also weighing his
  other options.
• He could hold onto his fish for future use, which
  is the most secure option. He would not have any
  losses but his savings also would not grow.
• He could eat his fish and consume his savings.
• He could build a net rental company. He could use
  his surplus fish to make 2 extra nets and charge
  ½ a fish a day rental.
• Able only has 5 options of what he can do with
  his surplus
• Save
• Consume
• Lend
• Invest
• Combination
• Able decides to loan the fish to Baker and
  Charlie. Now Baker and Charlie each have nets
  they did not have before.

Fig
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Economic Principles

• Demand is needed in order to spur economic
  growth, but is not what achieves it
• Only by increasing supply can people actually get
  more of what they demand
• Lenders benefits only if the borrower benefits

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Economic Principles

• Why not give the fish to Baker and Charlie?
• Evil Capitalist?
• Type of loans
• Business
• Consumption Loans
• Emergency
• Can you really expand credit?

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Economic Expansion

• With Baker and Charlies successful net making
  complete they have now drastically increased the
  islands production. With each catching 2 fish per
  day they have more time for leisure and to make
  other innovations. Able made clothing, Baker
  collected coconuts and Charlie made the islands
  first hut. Baker devised another fish catching
  device which if successful could catch fish 24
  hours a day and almost eliminate the need for
  fishing. In order for this project to succeed he
  would need help from Able and Charlie for an
  entire week. This would greatly reduce their
  savings and was a very large risk if it didnt
  work.
• They decided the benefit was worth the risk and
  consumed their savings to work on the
  contraption. Success! The fish trapped caught 30
  fish a week with only some small maintenance.
  With all of their extra time they built a second
  fish catcher and now had more fish than they had
  ever imagined.
• They began spending their time doing many things,
  Able was able to make enough clothing for himself
  and other islanders, Charlie created a surf board
  to make a fun leisure activity and Baker started
  working on a canoe to improve the islands
  transportation issues.

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Economic Principles

• Savings do not just allow for increased spending
  of time or money
• The Keynesian theory views savings as detrimental
  to an economy because it removes money from
  circulation and decreases spending.
• Why does government use spending to track the
  health of the economy?

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Prosperity Loves Company

• Word of all of the surfing, mass fishing and
  luxury clothes spread to other islands. Soon they
  were migrating to the island to live this
  luxurious life style. Some immigrants took over
  tending the mega fish catchers, others borrowed
  the extra fish to clear the land for farming and
  others took out loans for other trades. Society
  has become so good at producing food and tools
  that some people didnt need to produce anything
  physical to survive. Thus the service sector was
  born.
• Chefs, hut builders, surf instructors, etc
  created a need for a currency system to pay these
  service providing people. Previously bartering
  was used but this is inefficient because a chef
  may want surfing lessons but a surf teacher may
  not want a professionally cooked fish meal. And
  how many meals are equal to a surf lesson anyway?
  
• Since everyone ate 1 fish a day the value of a
  fish was universal across the island and could
  serve as money. All wages and prices were based
  on fish and therefore was related to the real (or
  intrinsic) value of fish.

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Prosperity Loves Company

• Specialization increases production, which in
  turn raises living standards. Making a canoe
  takes most islanders 5 days therefore we could
  consider it would cost them 10 fish if they were
  fishing with a net. One islander, Duffy, is
  better at carving canoes and can do it in 4 days.
  So he can split the difference and charge 9 fish
  then Duffy makes a profit of 1 fish and the buyer
  of the canoe saves 1 fish. Now suppose because he
  specializes in making canoes he comes up with an
  innovation allowing him to create a canoe in 2
  days. This allows him to sell his canoe for 6
  which give him a profit of 2 and a whopping 3
  savings for the buyers. Win Win! A product which
  was once a luxury item is now available to more
  islanders.

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Prosperity Loves Company

• As the island society became more complex
  islanders began working for other people by
  trading their labor for wages. Each worker is
  free to choose from three options
• Underconsume to build a net
• Take out a business loan to buy a net
• Work for someone who already has a net
• Most workers choose the third option and
  specialize in something. Finnigan, a big burly
  man makes his fish by transporting fish from the
  fisherman to their market and he charges 2 fish a
  day for 100 fish moved. Murry took a business
  loan to build a fish cart where he can move 300
  fish and charge 3 fish a day. Murrays cheaper
  price and higher profit margin allow him to hire
  Finnigan who because of his strength can move 400
  fish a day netting 4 fish a day. He pays Finnigan
  3 fish (1 extra) and keeps one as profit towards
  making another cart and hiring more workers.
  Reduced freight costs will also bring down costs
  of fish for all islanders.

At aid and band
At aid and band last fast
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Economic Principles

• The vilification of deflation has led to
  governments enacting policies to push prices back
  up when deflation hits. But why?
• Its not the spending but the production that
  counts!
• People do not need to be persuaded to spend. If
  society doesnt want to buy something its either
  no good or too expensive.

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Put It In The Vault

• As the island became more prosperous peoples
  savings of fish increased. They had to keep their
  fish in their huts and robbers began stealing
  their hard earned savings. Many would like to
  invest in businesses but did not have the time or
  knowledge to pick a good business for investment.
  
• Max Goodbank, after years of protecting his own
  fish and seeing many neighbors fish stolen and
  burned by slick fish borrowers knew there had to
  be a better way to store savings. So he built a
  super strong building with the toughest guys on
  the island to guard his bank. But he didnt
  want to just charge a storage fee, he could use
  the savings to loan out with interest returned
  going to pay his investors, his employees and
  keep the profits for himself. He started the bank
  for his own personal gain, but he also helped
  solve the islands problem of savings, credit and
  theft.
• Requirements
• Keep his loan business profitable by carefully
  screening borrowers, collect interest and
  foreclose on collateral when loans fail
• Keep investors happy through regular interest
  payments
• Attract more borrowers to keep they cycle going
• Make decisions based on dollars and cents not on
  personal history, family relationship and
  emotions

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Put It In The Vault

• Lending Rate - lower for most secure borrowers
  and higher for those more questionable to repay
  the loan.
• Interest paid the lending rate determines the
  interest paid also longer term lessened the risk
  of a fish so the longer the term the higher the
  interest rate
• Large gains in productivity can result in large
  deposits of fish in the vault and not enough
  loans made to balance.
• Lower the lending rates on loans in order to
  attract more borrowers.
• The bank is counting on the healthy economy to
  provide a fertile environment for the new
  businesses they are loaning to (encourages
  borrowing)
• Decrease the interest rate they will pay
  depositors (discourages savings)

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Put It In The Vault
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• When savings dip (dangerous for an economy)
  things that encourage savings come into play
• Goodbank is extra careful with loans because a
  default loan could be critical
• Charges a higher rate to borrowers (discourages
  borrowing)
• Offers higher interest rate to depositors
  (encourages savings)
• Interest rates that stabilize the market are
  created by
• Banks desire for maximum returns on bank deposits
• Banks fear of losing capital on risky investments
• Individuals time preferences for consumption
• Some investors want higher returns than Max
  Goodbank was willing to offer. To make higher
  returns Manny Fund, a flamboyant fish tycoon,
  used his depositors funds to invest in more risky
  businesses which were more likely to fail but
  also had a higher return when they succeeded.

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Economic Principles

• When the Federal Reserve sets the federal funds
  rate the banks use this rate to determine the
  rate loans are made to individuals.
• Flaws with the Feds logic
• We have created a nation of spenders instead of a
  nation of savers and the Fed has a tendency to
  hold the rates too low for too long and not raise
  them high enough.

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Disclaimer

• The preceding presentation has been prepared for
  informational purposes only. It does not
  constitute an offer, recommendation, or
  solicitation to buy or sell, nor is it an
  official confirmation of terms. The above is
  based on information generally available to the
  public from sources reasonably believed to be
  reliable. Note that for any collateralized
  mortgage product, (CMO), the yield and average
  life will fluctuate depending on the actual rate
  at which mortgage holders prepay the mortgages
  underlying the CMO and changes in the current
  interest rates. Past performance is not
  indicative of future returns. Tri-Star Financial
  makes no representations or warranties, express
  or implied as to the accuracy or completeness of
  the above information or that any returns
  indicated will be achieved.