Tuesday, May 6, 2008

Island Paradise II

Quote of the day:
'Inflation will reduce Americans' purchasing power. Deflation will collapse the value of their assets. Between the anvil of falling prices ... and the hammer of rising ones - the American middle class is going to get smashed.' - Bill Bonner from The Daily Reckoning

Bonner makes the case that what is happening South of the border today, is very similar to what happened in Japan during the 1990's. What this would mean for Canada is the big question. We have Oil of course, but that seems like a bit of a shallow defence if our only customer for our exports no longer has money to buy our stuff. Remember all the times we took sides against China? India? Brazil?

Commentary for the Week:

Island Paradise - Part II

This week we go back to the island paradise of last year (IWB Issue 8) to resolve some outstanding questions. On a loan to each of John, Jacob and Jaffer of $1000 Absurdodollars at 5% simple annual interest, the outstanding questions were:

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?

Since not many of our dear readers were perhaps quite busy over the holiday season, many did not attempt these brain-teasers. As such, I will try my best, but please correct me if you think I am wrong.

1. John, Jacob and Jaffer will actually never be able to pay me back. Between the three of them, they have $3000 only. On top of this, they must pay me pack $450 ($150 each). As I am the only one with an extra supply of Absurdodollars, one or more of them will have to declare his inability to pay me back.
2. Even though I have done very little productive work such as farming, carpentry or baking, in theory I am guaranteed a return of $450. The J-boys are not even guaranteed $1 in theory. In fact, they are guaranteed to lose money because they have to compete amongst themselves for the extra $150 that each needs. They cannot get that extra $150 they have to pay me back with except from each other's original $3000. Instead of a collegial atmosphere of working together, you can rest assured that in some ways, they are now working against each other. The island paradise, with the introduction of debt-based money, soon becomes quite stressful. Each day they wake, they know that they have to make around $0.41 AbsurdoCents ($150/365 days) to meet their year-end obligations.
3. They own or control real assets such as an oven, land and tools, whereas I own some printed paper on a deserted island. At the end of the year however, once I know which one or two of them will be short of $150, I can easily ask one of them to give me his tools/assets instead of the $150. In this way, I become not only the arbiter of financial services but also the mechanism through which real assets in the economy are traded or controlled.
4. At least one of them is guaranteed to be short the $150 that he needs to pay me back by next year. Let us however, make this question more interesting. Let us assume that I tell them that they can pay me only interest if they wish. That means that they can pay me $150/yr each and I will let them keep the capital of $1000 as long as they wish. Even in this apparently liberal debt regime, it will take less than 7 years for me to claim everything on the island ($3000/$450) because that is when the J-boys will simply run out of AbsurdoDollars.

As you can see, this is a pretty extreme result of what started off as a service to the community. Simply by the virtue of having some printed paper, in 7 slothful years, I can own all productive assets. While this is a grossly oversimplified model of an economy, this model does have some lessons for us. First and foremost, we have to realize that indebtedness is not necessarily a natural state of being - we got here because of our choices, not evolution. The second is that speculative sectors of the economy do not add value in the same way that real skills do. There is big difference between sectors that create value, and those that shift it around. The final lesson of course, is inescapable - I must move to Paradise Island.

(I apologize for the typos in Issue 8, I failed to recheck the commentary before I emailed it.)

Finance News:

1. Looking behind the $100/barrel price of Oil ... only a 1000 barrels were traded at $100 ... but it made news ... http://www.theglobeandmail.com/blogs/wenergyblog0613

2. Merrill Lynch is going to post a $15B loss from subprime ... but guess who they are going after to make up the capital? ... http://www.reuters.com/article/fundsFundsNews/idUST29249020080111

3. Some of the politics behind Carbon offsets ... http://www.nytimes.com/2008/01/09/business/09offsets.html?_r=1&oref=slogin

4. Guess where else Tony Blair is working in addition to 'solving' the Middle East Crisis ... http://www.reportonbusiness.com/servlet/story/RTGAM.20080110.wblairbank0110/BNStory/Business/?cid=al_gam_nletter_maropen and guess what his first deal is ... http://www.nytimes.com/reuters/business/reuters-northernrock.html?ex=1357707600&en=5576193f0e6b35ff&ei=5088&partner=rssnyt&emc=rss

Economic News:

1. Many people think that economic growth in China is dependent on exports. This means that if the US economy tanks, China's economy will not be far behind. This article argues something different - that China's economy has actually reached a point such that an export slowdown will not slow economic growth appreciably. Very interesting analysis with all sorts of political implications if it is true ... http://www.economist.com/finance/displaystory.cfm?story_id=10429271

2. Good News from Merrill Lynch about your mortgage, but not so good for your income ... Recessionary fears are made public ... http://www.reportonbusiness.com/servlet/story/RTGAM.20080109.wecooutlook0109/BNStory/robNews/home

3. CIBC says gas will be $1.50 soon ... This is funny, I've never really thought that CIBC can be right on anything but there you have it. You heard it from CIBC first ... http://www.financialpost.com/story.html?id=228661

4. News about the Loonie ... this speaks to the theory that regardless of our Oil and resources, the Loonie will be dragged down by the US relative to Asian / European currencies ... Perhaps this explains a little bit about how dependence on one customer for exports generates all kinds of vulnerabilities ... http://www.blackswantrading.com/files/3d9b61b67aa06a6/bsccc011108.pdf

Islamic / Middle East Finance:

1. Thinking of investing in solar energy? ... Some factors and companies to consider ... http://www.reportonbusiness.com/servlet/story/RTGAM.20080110.wrchinasun10/BNStory/SpecialEvents2/home


1. Tata's $2500 car is unveiled ... a good discussion of how it may affect climate change but I didn't expect the Globe to be so negative. I think they would have been full of praise if this car was American instead of Indian ... then it would have been Progress ... http://www.reportonbusiness.com/servlet/story/RTGAM.20080110.wtatacar0110/BNStory/Business/home

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