Tuesday, May 6, 2008

The Baker, Carpenter, Farmer and the washed-up Manufacturer of Money

Quote of the day:
"We think some of the real estate companies being adversely affected are being penalised by the mortgage market" - David Jackson, the chief executive of the Dubai-government-owned investment agency, Istithmar.

You think ... ?
(It is possible that he was misquoted, but if this is the kind of rigorous, inspired thinking in place at the top of ME Sovereign Funds ... then Oil money is not in good hands. I thought the quote was important because ME companies have begun to buy many Real Estate assets in the US. Not a completely foolish move in my book, but fairly close - neither mortgage assets nor the US$ have been fully re-priced yet, so they are investing too early. But then again, what do I know ... )
[Quote from http://economictimes.indiatimes.com/News/International__Business/Dubais_Istithmar_eyes_subprime_hit_US_firms/articleshow/2613602.cms ]

Commentary for the Week:

The letters edition is coming up soon and I have not received too many that I would like to print. Thus, I am going to write something that should elicit some response. This story is actually nearing classic status, and I have just adapted it for our use (I will try and find the exact reference over the holidays so email me if you would like me to share it with you). I will also leave you with a couple of questions that you can think about over the holidays. The Newsletter will return early in the New Year ...

The Baker, Carpenter, Farmer and the washed-up Manufacturer of Money.

John, Jacob and Jaffer are three energetic friends who frequently decide to take upon challenging adventures. They have bungi-jumped from the Peace Bridge, been hot-air ballooning in Kenya and even been canoeing in the Arctic. In short, they are an excitable, enthusiastic bunch that tend to think better in isolation, but accomplish more together. For their latest escapade, they decide to take a trip around the Bermuda triangle on a sailboat.

I think you can all guess what happens next. Disaster strikes at a particularly inopportune moment, and the sailboat catches fire, burning the sail, transponder, the GPS, Radio, Cell-phones, their wallets and leaving the backup engine inoperable. They begin to drift with the ocean currents and Hurricane Bills deposits them on an unnamed, uninhibited island on a broken un-repairable sailboat. The good news is that they find enough fresh water, abundant fruits, vegetables and various animals that are easily domesticated. The uninhabited island, in other words, is a veritable paradise - at least it was until they arrive. Being energetic people, and having need of things such as shelter, sustenance and occupation, they gravitate towards tasks that suit each of them well. Thus, John becomes a carpenter, using various bits of the sailboat to fashion for himself the tools that he needs to cut trees and shape wood. Jacob becomes a cook, excelling at baking cheesecake using all-natural ingredients. Jaffer becomes a farmer, tilling the soil and domesticating animals for transportation, milk production and as beasts of burden.

As the island economy grows to beyond subsistence levels, a barter system develops whereby Jacob makes food for others while they provide him with shelter and produce. John makes buildings for them and provides them with wood while Junaid provides them with animals for transportation and produce. As their welfare increases however, they have more and more trouble keeping track of what they each owe the other. They seem to have everything they need, but no system by which they can keep account. Also, hauling wood everywhere in order to pay for his food is getting on John's usually serene nerves, creating issues for the boys. At one of their meetings over dinner, they discuss inventing money for exchange purposes. There is only one problem though - John being an engineer in his previous life, Jacob being a doctor and Jaffer being a teacher, none of them are quite sure of how to set it up. In the best tradition of democratic governance however, they decide to delay any resolution and settle for the status quo.

A few weeks after that, as John is taking apart the badly beaten sailboat on the beach even more, he notices a small craft being pushed towards the island by the waves. As the craft gets closer, he sees that there is another survivor about to land on their shores. As the craft finally lands, an immaculately dressed, professional-looking man carrying a hefty briefcase alights.

I introduce myself as 'Jawad the Money-Maker' and proceed to ask John about all the possible real estate sites on the island where I can buy a house. John looks at me a bit strangely, perhaps thinking of overcharging me for the property, but being the honest soul that he is, proceeds to explain that there are no prior owners of the land. As he introduces me to the others and I begin to understand their roles in the island economy, I realize that although they are each master of their smaller domains, they all share the resources of island. This is an unfamiliar economic system to me, and I ask them more about how they transact their business. As they explain more about bartering wood for cows and bread for wood and cows for cooked lentils, I realize that they may be meeting their personal needs in a socially optimal way (they hardly fight), but they have their economic system all wrong. I know this because being from Absurdistan, the leading economy of the day, (while they are mere Canadians) I have worked in finance long enough to know what works. I accurately describe the problems they are having lugging around cows and wood and bread in order to get cows, wood and bread from their neighbours and they recognize my genius immediately. I propose that they hire me as consultant in order to design a solution for their problems. In return, I ask that they build me a house, provide me with a horse and feed me. Not being totally clueless, they agree to the house and some food up front, with a cow to be delivered only if my solution works. Being a practical and thoughtful man, I retire to a secluded space while they build me shelter.

Once my gorgeous house overlooking the beach is complete, they ask for my solution to their barter problem. I describe it as follows: As their island economy has grown and each produces more output than he can consume himself, they must trade with each other. In order for trading to fulfill its potential, we must be efficient. As their economy is poised for further growth now that they are experts in their chosen fields, the bottleneck was no longer output, but the method by which their output was exchanged. They had now grown enough to be able to move to more efficient system than barter - into a system based on money and credit. Also, it was quite lucky for them that I was from Absurdistan and that I had some of the premier currency of the day - the AbsurdoDollar - in my possession. As the Absurdistan monetary authorities were saints in human skin, we could all be assured that the AbsurdoDollar was sound and would remain strong. Furthermore, since the boys had all been exceedingly kind, I would let them use my AbsurdoDollars for a nominal interest rate. I would loan each of them $500 in return for a lien on their productive collateral (the carpenter's tools, the baker's oven, and the farmer's land) and charge them only 10% for their use of my funds. To ensure that I was a productive member, I would also agree to keep track of prices and payments as long as they fed me.

Again, not being totally clueless, the boys negotiate me down to 5% simple interest on a loan of $1000 AbsurdoDollars for each. This way, each of them has to repay me $1050 in one year. With my ingenious solution, production of bread, wood and grain increases tremendously. John, Jacob and Jaffer are no longer carrying their production around but are able to move easily with their hands free and their wealth in their pockets. This leaves them with more time to work or research more efficient production methods. The island economy begins to hum - when they want to buy food, they pay Jacob. When they want to buy wood, they pay John. When they want to ride around on cows or eat fruits and veggies, they pay Jaffer. But there may be some trouble in paradise ...

Even though we are all agreed that this is an excellent solution, my questions for you now are as follows:

1. How many years will it take for John, Jacob and Jaffer to pay me back?
2. How much am I guaranteed to make in a year? How much are the boys guaranteed to make?
3. If the boys just have to pay interest at the end of every year and there are no bankruptcy courts, what will happen to all productive assets on the island?
4. How many years before one of them runs out of money? How many years before all of them run out?

A Happy Eid, Hannukah and Merry Christmas to all ... the newsletter will return early next year with some of your responses ...

Finance News:
1. Interesting stats and views on whether women control the Financial Planning process in families ... Why is it that while women control the majority of purchase decisions, they are not as motivated to take control of their overall financial well-being? ... This article is somewhat of a call to action ... http://www.advisor.ca/practice/growing_your_business/article.jsp?content=20071211_154533_316

2. For those that wish to follow-up and read up on the subject of last week's commentary (Tax Efficient Charitable Giving) ... http://www.advisor.ca/news/article.jsp?content=20071212_150006_7468

3. Tax-Tips - Straight from the source ... http://www.cra-arc.gc.ca/newsroom/taxtips/menu-e.html

4. Carbon-Trading comes to Wall Street ... http://www.investmentexecutive.com/client/en/News/DetailNews.asp?id=42328&IdSection=148&cat=148&BImageCI=1

Economic News:
1. Must read story of the week - The title says it all ... 'The End of Cheap Food' ... http://www.economist.com/displayStory.cfm?story_id=10250420&fsrc=nwlgafree

2. Observing the 10th Anniversary of the Asian Financial Crisis, perhaps the single most devastating financial crisis of the last century if you measure according to sheer number of people that were deeply affected (and don't include wars) ... Imagine waking up in the morning and finding out that not only is the interest rate you have to pay on your loans now over 100%, but that your local currency is also worth 1/10th or 1/100th of its value in us$ from yesterday ... (I was working in Singapore in 1997 where the currency depreciated by 20-30% in a matter of days - the change was not as 'mild' in Indonesia, Thailand and Malaysia however) ... http://www.mckinseyquarterly.com/Economic_Studies/Productivity_Performance/Taking_stock_Ten_years_after_the_Asian_financial_crisis_2085

3. Greenspan speaks about the subprime crisis ... amazing how he absolves the Fed and thereby himself of all responsibility ... the column is admirable for the sheer hubris on display ... a bit like a policeman letting a drunk driver go when he could have arrested the fellow and then saying that the subsequent mayhem was an 'accident' waiting to happen ... No negligence, just an accident - something like being struck by lightning ... http://www.reuters.com/article/businessNews/idUSN1258328720071212?feedType=nl&feedName=usmorningdigest&sp=true

4. Central Banks around the world rally to keep the US $ from plummeting by lowering rates ... If the US were a developing country, there would be no easing of credit. The World Bank and IMF would have been sent in for 'Structural Adjustment' ... You and I will have to pay for this latest bailout through higher food and gas prices (see 1 above) ... http://www.reuters.com/article/businessNews/idUSN1262150920071212?feedType=nl&feedName=usdai&sp=true

Islamic and ME Finance:
1. The UK government is thinking very carefully about raising money through a sovereign sukuk - (More commonly known as an 'Islamic' Bond) ... I wonder how Islamic it will be if the funds raised go towards the financing of their various well-known military actions ... http://www.zawya.com/story.cfm/sidZAWYA20071210043618

2. An inspired investment or more Oil money on the way down? ... Dubai entity buys 8.1% of chip-maker AMD, even though AMD has been posting losses for a while ... this buy-in may have merit though ... maybe there is a chip-fabrication plant on the table for Dubai in the near future ... http://www.economist.com/business/displaystory.cfm?story_id=10180738

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