Tue, 21 Feb 2012 18:50:22 -0800WeeblyThu, 16 Feb 2012 19:37:02 -0800http://www.scalavolpe.com/1/post/2012/02/more-rationale-to-never-buy-a-house.htmlBack in September 2010, I wrote the following article on the four reasons why I'd never buy a house.  Today, CNBC published the following article detailing why renting is a better investment than owning 100% of the time.  I think it's safe to say that after the housing crash of 2007-09, the notion that owning a home is the embodiment of the American Dream is beginning to ebb.  Interested to see your thoughts in the comments section. ]]>Sat, 28 Jan 2012 11:55:35 -0800http://www.scalavolpe.com/1/post/2012/01/in-defense-of-the-entrepreneur.htmlThe entrepreneur is under fire in America today.  Amidst a severely weakened economy, high jobless rate, and declining standard of living for most Americans, it's no wonder that successful entrepreneurs, particularly those that have amassed significant wealth, are not looked upon favorably these days.

I'm here to do the unpopular and defend them.

A successful free market, free enterprise system that yields the kind of prosperity this country once knew requires that all of the parts of the whole be allowed to exist in equilibrium with each other, such that they can interact naturally.  The entrepreneur is as important a cog in this mechanism as any other, and the importance of his role is being overlooked at best, marginalized and vilified at worst.

"Entrepreneurs create jobs."  I'm sure you've heard this cliché by now.  It's true, but it's a bit oversimplified.  Look at it this way: entrepreneurs take ideas into the marketplace and risk their capital (and sometimes other people's capital too) to make that idea come to fruition.  When they risk capital, that capital is injected into the marketplace, where it stirs the engine of commerce.  By this I mean that the entrepreneur’s application of capital creates demand where there was none (or less) to begin with.  Let's look at an example of what I mean by this:

Let’s say an entrepreneur decides she wants to start a website that promotes her freelance writing skills.  She has amassed a small amount of capital through her earnings in her previous job.  She then applies this capital to various vendors who she relies upon to get her business up and running: the company that sells her the domain name for her website; the company that hosts her domain on a secure server; the web design consultant who gains her as a client and helps her create a suitable web page.  Through the pursuit of her idea to create this freelance business, she has in turn created demand for other companies' services and products, thus raising their bottom line, and in an aggregate sense, potentially impacting their decision to eventually hire more people.

Now let's say she grows her business over the course of a couple of years, and adds two writers to her staff.  This constitutes the job creation aspect of her entrepreneurial effort.  Two jobs exist now that would not have existed had she kept the freelance idea to herself.

Let's say ten years later, she operates a multi-million dollar writing service firm, and takes home over a $1 million a year in pay.  Through extremely hard work, quite a bit of lost sleep, her own personal funds, and the intangible cost of bearing the weight of risking everything she previously knew (her job) to pursue an unknown (her business), she has managed to create a comfortable lifestyle for herself.

While much of her incentive to do all of this was derived from her desire for autonomy and freedom from an employer, the financial rewards played a part in her decision as well.  She knew that as she amassed wealth, there would be mechanisms in place to protect that wealth and help her to grow it and allow her to use it as she sees fit: to pass on to future generations in her family, expand the writing business, or perhaps start new and different kinds of businesses.  In many respects, the growth and protection of her wealth could potentially translate into even greater benefits for society as a whole.

Unfortunately, in today's society, there is a sense that individuals like those in the example above simply "owe more" than they currently pay.  Since their lifestyle is perceived as "comfortable" or even “luxurious,” it's become a given that they can afford to pay more than they already do.  The individual's fundamental right to his or her property -- a core tenet in a free society -- is overlooked and never even introduced into the debate these days.

If you've been following the Republican Presidential primary race, you've probably heard by now that Mitt Romney has released his tax returns, revealing income of over $20 million per year the last couple of years, and an effective tax rate of 14%.  Many are outraged that he pays such a low tax rate.

I'm thrilled, because it means if he can reach that point, then the same reward awaits me if I can duplicate a measure of his success.

Here's another way to look at it: for every Mitt Romney who creates wealth through hard work and dedication, there are numerous others who have tried and failed.  They risked everything, and lost everything.  But they did so because a significant reward lay ahead for them if they succeeded.  Yes, there were lots of incentives that drove them to try, but certainly we cannot discount the financial reward as one of those driving forces.

Here some will argue that these individuals would still take these risks even if they didn’t pay the 14% tax rate, but instead paid some higher amount, such as the current top tax rate (35%).  I counter that by saying, how do we know that for certain?  How do we know some of the individuals, who may have possessed great ideas for a business or product, didn't like the fact that their hard work and risk-taking would be met by higher taxes, and passed at the idea of starting that business?  How many disliked the notion that if they amassed an especially large fortune, their ability to pass it on to their family or into new businesses would be significantly impacted?  How many were discouraged by the general sentiment surrounding successful entrepreneurs, who are often made to be the scapegoat or villain, especially in hard economic times like today?

Or look at it pragmatically.  If I’m taxed at a much higher rate, that leaves less capital with which I can risk for more business development and job creation. I’d simply have less resources on hand to try and grow my wealth any further than I already had.  Why would we want to hamstring business development and initiative?  Don’t we want to encourage it as much as possible?

Ayn Rand wrote brilliantly about these questions in her book "Atlas Shrugged," which depicts a society where, after made the scapegoat for America’s economic distress, all of the competent businesspeople and entrepreneurs simply disappeared in protest, leaving the society's economy to stagnate and collapse.  Fed up with being seen as the cause of the problem rather than the remedy, they simply dropped out of society.  While it's an extreme rendering of what's possible, the general theme is what's important, and we can see the same conditions for this developing here in America today.

There is one caveat that's worth mentioning.  What I've written above does not apply when the access a given individual has to the basic requirements for starting a business is prohibitive, or does not equally apply to all people.  In other words, the barrier to entry for starting a business should be as nonexistent as possible to encourage as many people as we can to try it.  Thus, things like the administrative filings required for a business should be streamlined and inexpensive, widening the access to as many people as possible.  (With the advent of the Internet and a slew of low-cost and even free resources, starting a business has probably never been easier, from a pragmatic standpoint.  Unfortunately, from a regulatory standpoint, the opposite is probably true, but that's a discussion for another blog post.)

I submit that if we truly desire a return to prosperity, a return to better economic times and viability within the world, we must once again embrace the entrepreneur as an equally important role within the free market system.  Encouraging such individuals to pursue their ideas and grow those ideas here within our borders would be the best stimulus we could generate for the economy.  Let's hope we give this a try as soon as possible, before it's too late.
]]>Thu, 05 Jan 2012 18:37:56 -0800http://www.scalavolpe.com/1/post/2012/01/a-stark-outlook-for-2012.htmlWondering what might lie ahead in 2012?  Check out this article, which details why the coming financial meltdown will be worse than 2008.  The author does a great job analyzing the European Union debt crisis, in particular.
]]>Fri, 30 Dec 2011 17:10:07 -0800http://www.scalavolpe.com/1/post/2011/12/a-closing-message-for-2011.htmlAs the year 2011 draws to a close, I wanted to briefly reflect on the past year and share some thoughts going into 2012.

Twenty-eleven was an eventful year for investors, as we witnessed everything from the Arab Spring uprisings, to a tumultuous summer of debt ceiling debates and credit downgrades, to the continuation of the euro crisis and deterioration of several European countries' finances.  All of these significant, large-scale crises/events should serve to remind us that black swan-style events are more common, and even less predictable, than we may allow ourselves to think, as we seek and crave stability for our financial portfolios.  At the risk of sounding clichéd, we must expect the unexpected.

Twenty-twelve will be no less eventful, considering that the following lies ahead:

1) Presidential election (remember what happened in the 2 months prior to the last one?)

2) Increasing waves of foreclosures in the housing market as Option ARM and Alt-A mortgage rates reset to higher levels

3) Unsettled financial outlook for more European countries that have yet to come into the spotlight (i.e., Spain, France)

4) Congress' continued ineffectiveness at reducing the national debt, cutting spending, or even just passing a budget

5) Possibility of further downgrades to the US credit rating (largely due to item #4 above)

I hesitated to even list these things, as it may come across as forecasting, and we know that doing so is too often a fool's errand -- but I put the list there to simply remind you of the very tip of the iceberg that we can even BEGIN to try to anticipate, all the while knowing that none of these things is guaranteed to come to pass (except #1 and probably #4) and could easily be replaced by other bad news.

While I don't tend to make New Year's resolutions, I do have every intention of maturing and refining my black swan protection protocols for 2012.  I think the stakes for having them in place will be higher than ever, and I'd like to create opportunities to generate some profits as market turbulence occurs.  (Notably, 2011 was the fourth-highest year for 100-point swings [plus or minus] in the market, behind 2000, 2002, and 2008.  I see no reason why 2012 won't compete with these other years.)  I'll be focusing a bit more here on the blog on options strategies and combinations that I plan to experiment with or at least consider in 2012.

Along those lines, I encourage you as the individual investor to commit to a regular schedule or routine of reviewing and closely scrutinizing your portfolios amidst the uncertainty that we're facing.  Set aside some time as frequently as monthly, for example, to check the kinds of holdings you have and what their exposures are to which kinds of risks.  Compare this to what you see and hear in the news regarding government inaction and recklessness, global/market instability, geopolitical pressures, and so forth, and make the best attempt to align yourself defensively towards these risks, while looking for opportunities to benefit where possible and generate profits.  Of course, if you utilize a financial advisor, communicate these objectives and concerns to him or her and ensure they are being addressed.  (While none of what I write is intended as investment advice, I consider the above a common sense approach to investing that any of us could stand to employ.)

Lastly, I want to issue a simple "thank you" to all of the readers and contributors to this site, as I greatly appreciate your interest and passion for this subject.  I wish all of you a safe and prosperous 2012.
]]>Wed, 07 Dec 2011 19:22:18 -0800http://www.scalavolpe.com/1/post/2011/12/next-pearl-harbor-type-event-will-be-financial-in-nature.htmlSeventy years ago on this day, Japanese armed forces attacked the US naval base at Pearl Harbor, effectively marking the beginning of the United States' direct involvement in World War II.  While we take today to remember this historic and tragic event, I would now submit to you that our country will soon face another Pearl harbor-style event, but this time of the financial sort.

Put another way, we are up against the ever-increasing possibility that our country will suffer a crippling blow financially, with an impact not unlike the Pearl Harbor events of 1941.  The biggest difference may lie in the fact that our country recovered from the Pearl Harbor attack and emerged stronger, something I do not expect will happen now given the dire state of our nation's finances.

A quick summary/reminder of what we're up against:

1) A national debt that now exceeds $15 trillion.  We are paying approximately 3-4% interest on this every year, equating to interest payments of no less than $450 billion.  Servicing this debt will increasingly weigh upon our economy, and force future generations to work harder for less as we struggle to pay the interest alone, nevermind the actual principal.

2) Routine budget deficits totaling over $1 trillion a year, adding to the aforementioned debt.  Our government has promised us way more than they can deliver, and this is evidenced by the fact that every year our budget contains more spending than what we are taking in as a nation.  This is called "living beyond our means."  It's destructive, adds to the national debt, and must stop immediately.  Cessation of deficit spending means we will get less from our government for the same price for a while, but we need to accept that privation and stop selfishly pushing it onto our children and grandchildren.

3) Potential for further credit downgrades, increasing the cost of our borrowing needs.  S&P recently knocked the US credit rating down a notch, resulting in market turmoil, but curiously had no effect on our cost of borrowing.  That won't last forever -- as future downgrades are made, which we know they will be given our government's inaction on this crisis, it will eventually catch up to us and the interest we pay on our debt will go up. This means more of our country's wealth will be needed to make those interest payments, rather than being used for more productive means.

4) Economic productivity that hinges on consumer spending, to the tune of over 70%.  This is unsustainable, simply put.  When almost three-quarters of a nations' economic production is tied to consumers spending their income or going deeper into debt, a day of reckoning lies ahead.  We need to get back to producing exportable goods (read: manufacturing) and making the country more business-friendly, as opposed to forcing those businesses to move their operations overseas.  The obvious question here is, what happens when Americans are so strapped they can't spend anymore?  You guessed it -- the economy goes in the tank.

5) Dwindling job market that practically guarantees lower productivity from a GDP standpoint, declining tax receipts, and a lower standard of living for the American people.  The persistent 8-9% unemployment (and 16+% underemployment) rate says it all -- jobs have left the country and they aren't coming back anytime soon.  This reality has a severe ripple effect, since unemployed people pay less (or no) taxes, spend less money, add less (or nothing) to the nation's economic productivity, which leads to economic slowdown, which leads to more job losses, and so on...you get the picture.

If you listened to my November 27 podcast, you'll recall me saying that our political leadership will not address this financial crisis until it becomes a full-blown catastrophe, as they will then have the political cover to get away with any law or policy they wish to see instituted.  The September 11, 2001 attacks provide the best evidence of this impotent style of leadership, as Congress only passed the PATRIOT Act (albeit a draconian, liberty-killing law in and of itself) AFTER the Twin Towers and Pentagon had been struck, and Flight 93 had been downed -- not before.

Thus, you as an individual investor have to factor into your financial planning the fact that the government will allow this situation to reach catastrophic proportions before acting.  Creating some degree of defensiveness against everything from high inflation, dollar weakness/collapse, and a plummeting stock market would be a minimum level of prudence for today's investor.
]]>Tue, 15 Nov 2011 18:57:10 -0800http://www.scalavolpe.com/1/post/2011/11/piigs-crisis-worsens-italy-next-to-fail.htmlAnother month, another one of the PIIGS makes headlines for its impending financial meltdown.  (PIIGS stands for: Portugal, Italy, Ireland, Greece, Spain.)  This time it’s Italy, bumping Greece out of the news for the meantime.  The problem is, Italy’s situation is far more dire when viewed through the lens of the global economy.  The fact that Italy is Europe’s third largest economy alone would account for that fact, without even factoring in the growing strain all of these recent bailouts have placed on the EU.

Let’s back up for a second and see how we got here.

In general, the entire PIIGS crisis can be summed up with the following statement: the countries in question borrowed more money than they were making.  In slightly more technical terms, they borrowed too much relative to their Gross Domestic Product (GDP), to the extent that they are now unable (or having serious difficulty) meeting their fiscal obligations.

How did Italy get into this mess, specifically?  This article, titled “Italy’s Debt Crisis: Doomed by Corruption, Bloated Bureaucracy and Poor Productivity,” is a good primer on the basic reasons, and I’ll attempt to sum them up here:

1) First and foremost, perhaps as the general and foundational reason behind Italy’s woes, is the fact that it’s overspent by 1.9 trillion euro, or 120% of GDP.  

2) Corruption is widespread, with Italy’s Mafia accounting for nearly 16% of GDP.  (Obviously, this economic output isn’t necessarily optimized to aid the country’s growth.)  Tax evasion isn’t just limited to the criminals, as ordinary citizens have seemingly embraced it as a national pastime.

3) Bloated bureaucracy is an enormous cost unto itself.  Italy’s politicians earn 140,000 euro a year on average, and are driven around in executive cars (Audis, Maseratis, etc.) that cost the country 2 billion euro a year.

4) Italy’s education system is extremely poor, with only one of the world’s top 200 universities located in Italy (University of Bologna).  To underscore this, Italy’s unemployment rate for youth between the ages of 15 and 24 is a staggering 30%.

As you can see, many of Italy’s problems are systemic, and have gradually led the country into a worsening position financially.  The irresponsible government spending is really only the tip of the iceberg.

So where do things stand as of today?  Italy’s borrowing costs have rapidly increased over the last several weeks, hovering around 7% as of the writing of this article.  These government bond yields are a good yardstick for determining how unstable things have become, and it’s interesting to note that the other three EU nations that required bailouts (Greece, Portugal, Ireland) had also reached the pivotal 7% mark when they received emergency assistance.  These higher yields reflect investors' declining confidence that Italy can and will repay the debt.  Thus, they are seeking a higher premium for taking the risk of buying these bonds.

The outlook for Italian citizens is grim.  This past weekend, austerity measures were proposed that would result in a familiar combination of remedies -- spending cuts and tax increases – with the goal of balancing the budget by 2014.  Expect Italians to vehemently protest these measures.

External to Italy, I expect things to worsen significantly as we head into 2012.  The previous bailouts of EU nations have cost billions, and ultimately have done little to stem this contagion.  How much more money will the EU have to conjure up (read: print) in order to save Italy?  Not to mention the possibility of Spain and other countries requiring similar assistance in the near term.  

I cannot understate the severity of the aftershocks the collapse of Italy would cause for both the global economy and the US in particular.

Let’s walk through a possible vignette on how things could get ugly quickly if Italy goes down (keep in mind, this is a highly simplified example, and only one of many possibilities that could arise):  Italian bonds are bought and held by a wide variety of institutions around the world.  Let’s assume a host of Italian banks hold these bonds, and are informed by the Italian government that many of them will either only be paid back to a partial extent, or perhaps not paid back at all.  Several of these Italian banks would then presumably go insolvent, especially if they have high exposure to the bonds.  The same goes for other EU banks holding those bonds, as well as EU banks that had other types of holdings with the Italian banks that are suddenly failing.  Several of these EU banks would then go under, as well.  Here in the US, banks holding Italian debt, and/or invested in any way in the Italian and/or EU banks that are going insolvent, would also be subjected to potential insolvency.  As the EU collectively attempted to inject monetary assistance into the system, the very stress that cost would create would likely exacerbate the matter and trigger even more bank failures, insolvencies, and related bankruptcies. 

In other words, an enormous chain reaction would be set off.  If you think of the global economy as a massive series of interconnected/interdependent nodes, then you can begin to envision how the failure of several of those nodes begins to propagate negative consequences across the entire network.

This scenario would not be pretty for your investment portfolio.  Recent market perturbations and EU/PIIGS anxiety have already spooked the average investor, and this is just a taste of what’s to come.  Now is the time to review your portfolio and determine how much exposure you have to the kinds of systemic risks I’ve discussed here.  Gauge how high your risk tolerance is and then make defensive adjustments as necessary.  If you have extra cash, you might also consider betting that a collapse will occur, and invest in options or other high leverage instruments.  
]]>Sat, 29 Oct 2011 13:51:44 -0800http://www.scalavolpe.com/1/post/2011/10/our-monetary-system-enslaves-you-with-debt-and-creates-poverty-on-purpose.htmlWe’ve all heard the countless cries by our leaders and government officials about “ending poverty,” “waging the war on poverty,” and “eliminating poverty for future generations.”  They claim that if we just give them more of our wealth, more of our earnings, then we can finally, once and for all, put an end to poverty.

Meanwhile, the very system we live under, and which our government preserves and protects at every turn, continues to create poverty for millions of Americans – a system which in turn, supports and funds those leaders telling us to sacrifice more for the good of all.  That system is called the “monetary system.”  

You’re probably not familiar with this term, not only because it’s never mentioned in the mainstream media or in your school textbooks, but also because when you think of our economy you think of capitalism.  This is not surprising since we’ve been conditioned to think we live in a capitalist society.  And to some extent, we do.  But the problem is, by thinking of it that way and describing it by that one word alone, we omit an important aspect of the overall system that governs our economic livelihood.

Now, the term monetary system is quite broad, and so we need to look closer at what that really entails.  In general, a monetary system is any economic system that assigns goods and services a value that is exchangeable through a medium such as paper (fiat) money, gold/silver, or other means.  Capitalism per se does not imply the use of money – rather, it traditionally refers to things like the free market exchange of goods and services and private property rights.  Thus, it is important that we separate capitalism and the monetary system in our minds in order to understand the true nature of the overall system we live under.

The use of money to govern transactions within a capitalist system is not a bad thing in and of itself.  In fact, if the money has intrinsic value (such as gold or silver), this can improve the integrity of the overall economy by ensuring that the monetary value remains stable and intact, versus fluctuating significantly over time.  An example of such fluctuation would be the US dollar (a fiat currency not backed by anything of value), which has lost over 90% of its purchasing power in the last century.  (Indeed, most of this erosion in value occurred after 1971, when the dollar was unhinged from the gold standard.)

The US monetary system, of course, is based on the use of fiat money, which can be created arbitrarily through policy decisions originating from the Federal Reserve System.  In conjunction with this capability, the employment of “fractional reserve banking” provides further flexibility to the monetary system, and encourages the creation of money from, essentially, nothing.  Simply put, fractional reserve banking is when banks only maintain a portion or fraction of customer deposits in reserve, while using the remainder to originate loans and thus create higher amounts of interest income.  The amount of money the bank must retain in reserve is called the “reserve ratio.”  Traditionally, US banks have maintained a reserve ratio of 9 to 1, meaning for every dollar kept on deposit, $9 can be lent out.

The practice of fractional reserve banking is actually detailed in a booklet issued by the Chicago Federal Reserve Bank (one of the 12 regional banks under the purview of the Fed), called Modern Money Mechanics.  While I think it’s worth reading the entire 40 pages of this document, this quote should suffice as a summary:

“The purpose of this booklet is to describe the basic process of money creation in a ‘fractional reserve’ banking system. The approach taken illustrates the changes in bank balance sheets that occur when deposits in banks change as a result of monetary action by the Federal Reserve System - the central bank of the United States….The illustrations in the following two sections describe two processes: first, how bank deposits expand or contract in response to changes in the amount of reserves supplied by the central bank; and second, how those reserves are affected by both Federal Reserve actions and  other factors.”

We can translate this summary to mean one thing: banks create money out of nothing.  By illustration, we can see how fractional reserve banking accomplishes this:

Bank A receives a deposit of $10 million from a customer.  It places $1M in reserve (according to its 10% reserve ratio requirement), and then lends out the other $9M to Bank B, collecting interest payments from Bank B.

Bank B puts $900,000 in reserve (again, 10%), and lends out the other $8.1M to Bank C, collecting interest from Bank C in the process.

Bank C puts $810,000 in reserve, and lends out the remaining $7.2M to Bank D, while collecting interest from Bank D.

…And so on, until approximately $90M (nine times the original $10M) has been created, loaned, and monetized into interest payments for all banks involved in the transaction.  Thus, you can see how $1 of actual “wealth” (I use quotes because even the original fiat money deposit has no intrinsic value) becomes $9 of artificial money.

There are two things that are very pernicious about this.  First is the simple fact that money that never existed in the first place is used to make even more money, through the payment of interest.  Second, and more insidious since it is unseen and intangible, is what I would call the “debt-to-wealth gap” that is created by the monetary system and fractional reserve banking.  Here’s what I mean by this:

There are only so many goods and services that can be produced or performed, and subsequently sold in the marketplace.  In other words, there is a physical, tangible limit to it (however large and unquantifiable it may be to us).  At the same time, the creation of money from nothing is dislocated from this reality, since the money is created artificially and arbitrarily, when compared to the actual value of all the goods and services available in the marketplace.

In other words, there is simply more available debt than available wealth.  The ease with which new and virtually endless amounts of debt/fiat money are created is the reason why there is so much more available debt than wealth.

Again, the catalyst for this is relatively simple to understand -- through our monetary system and the use of fractional reserve banking, debt is generated rapidly and artificially.  Conversely, wealth (for the vast majority of us) can only be generated through the exertion of labor over time.

Think of it this way: in one day’s time, assuming I placed no limits on you from a credit perspective, how much debt could you get into in that one day?  Probably a whole lot.  A house purchase, a trip to the Ferrari dealership, maybe a new yacht – you could easily be millions of dollars in debt in the span of 24 hours.  Now in that same one day’s time, how much wealth could you create?  If I gave you one whole 24 hour span to generate wealth from scratch, how far do you think you’d get?  Probably nowhere, and it would have nothing to do with your aptitude.  Simply put, the creation of wealth would take time, energy, and effort that would far exceed one day’s time.

This surplus of debt compared to available wealth comprises the debt-to-wealth gap.  So what, you might be thinking…what does this have to do with you, or the poverty problem I referred to in the beginning of this article?

Here’s why it is directly relevant to you: you cannot function in our economic system without getting into debt.  It’s virtually impossible.  If you are able to pull it off, it probably means you’re living something unlike the “American dream.”  You certainly don’t have a house, and you probably don’t have a car.  You most likely never went to college.  In other words, all of the trappings of the American lifestyle are unavailable to you – until you take on that debt load.

Once you’ve taken it on, you must generate enough cash flow to service that debt.  In other words, you need a job.  Now of course, we all need cash flow for the necessities of life, but the kind of job, frequency of how often we must perform that job, and length of time we must keep that job changes considerably when we have a mortgage, car loan, student loan and other debt payments to service.  It’s one thing to truly work to pay for the basics (food, rent for shelter, medical care when needed), but another thing entirely to work to cover the trappings of the American lifestyle we’ve been conditioned to believe are “necessary” (nice house, two cars, vacations, yearly wardrobe changes, sundry electronic gadgets, other luxury items, etc.).

In other words, the availability – and more accurately, the necessity – of debt, turns us into indentured servants, who must hold jobs whether we like them or not in order to function economically.  Furthermore, when that imperative is combined with the illusion that we must continue to spend/consume in order to achieve the “American dream,” the average person’s debt load rises considerably.

And what about the poverty issue I mentioned at the beginning of this post?  How does the system create poverty purposefully?  Now that you understand the monetary system and fractional reserve banking, it’s easy to see how.  Let’s look at it through a rudimentary example:  

Say a bank has a home loan portfolio totaling $100 million.  It created these loans off of just 10% of that figure, or $10 million (so there is only $10 million of actual deposits at stake here).  The other $90 million is artificial debt created through fractional reserve banking.  Now let’s say of the $100 million, $15 million worth of loans is spoiled by foreclosures and bankruptcies.  Let’s see where that leaves the bank:

$10 million of initial capital, turns into…
$100 million of loans, with an average of 7% interest a year yielding…
$7 million a year in interest income…
With only $15 million of the total loan portfolio gone bad.

Since the $15 million of bad loans is fake money anyway, the bank doesn’t care, since it never had that money to begin with.  Its loan portfolio is generating $7 million a year, which across a 30 year standard mortgage period yields the bank revenues of over $200 million.  Ultimately, the bank turned $10 million of seed capital into over $200 million…do you think it cares one bit about the $15 million in bad loans (which really translates to foreclosed homeowners, homeless people, etc.) it perpetrated along the way?  Of course not – it’s just the cost of doing business.

The bottom line is, the bank doesn’t care who goes bankrupt or forecloses – the bank simply cares that enough debt is created to generate enough interest income for it to be profitable.  If it overshoots the mark on debt creation, and individuals go bankrupt/lose their home, it matters not – it simply performs a write-down of the loan on its books and moves on.  It was fake money anyway – it never existed in the first place.

The key for the banking/monetary system is to continue creating enough debt to generate enough interest to continue to be profitable and aggregate more wealth.  The collateral damage along the way, in the form of impoverished/bankrupt/homeless individuals, is simply the byproduct – the remainder off of the proverbial mathematical equation – that is tolerated in the overall process.

Using this premise as a backdrop, I would go on to assert that the entire 2007-09 housing collapse was nothing more than the rabid creation of debt in order to fuel more interest payments into the system, with zero regard for how many loans went bad or homeowners were devastated along the way.  Why would this matter, when the banking system knew the government would step in, bail them out and cover the losses?

But put the recent housing market crash aside for a moment.  The real problem is this: the monetary system is on its last legs.  Eventually, there is too much debt created, and no one left to service it.  And when not enough entities can afford to take on debt, then the debt creation begins to grind to a halt.  And when debt creation grinds to a halt, interest payments decrease and profits begin to shrink.  The outstanding debts remain, but there’s less profit to offset it and make the process worthwhile for lenders.

We are seeing this breakdown in the monetary system in the news every day, when we read about bank failures, rising foreclosures and shrinking home sales, states going under financially (i.e., California), entire countries going bankrupt in the EU due to systemic financial failure (i.e., Greece, Ireland, etc.), and the rising ranks of unemployed who’ve been victimized by the system and will never return to the same standard of living they once had.

Once you understand that the system you’re living within places you into servitude, creates poverty knowingly and purposefully, and is impossible to get ahead within, as an individual you begin to realize that your financial and investing priorities must adapt to such realities.  Ultimately, the monetary system needs to change, as it simply does not serve the interest of the vast majority of the people.  When we make such a claim, and it’s a significant one, we need to do so with the full and accurate knowledge of what the system actually is and how it operates, and only then can the proper reforms be put in place.
]]>Thu, 13 Oct 2011 18:52:57 -0800http://www.scalavolpe.com/1/post/2011/10/the-unemployment-rate-is-really-165.htmlLast week's jobs report, while not astoundingly good, was generally regarded as a good sign, as over 100,000 jobs were added in September.  The unemployment rate was listed as holding steady at 9.1%.  The purpose of this post is to clarify that unemployment figure.

The 9.1% refers to the number of people who actively sought/applied for a job in the given month, but did not secure one.  Thus, we can say that of every 10 Americans who can work, approximately one of them is looking for work and unable to find it.  That's bad enough, and one of the highest unemployment rates in recent memory.

But I don't think it's the most important figure being measured.  That one equates to 16.5% -- or the number of people out of work, including those who had sought work and/or have now given up, and are not counted as an "active" job seeker.  (This higher figure is also referred to as the "underemployment" rate.)  So with this number, we can say that if we brought 100 Americans into a room, about 16 of them would be out of the work force and/or not bothering any longer to get back into it.

That's a frighteningly high number.

Not surprisingly, the government doesn't advertise this number.  Obviously, they're incentivized to report the lower number, but it's done a disservice to the rest of us trying to grasp the scope of this problem and left most Americans unaware of how bad things have really gotten.

The next time the government releases these metrics (November 4), make sure to check the underemployment rate and not just the unemployment rate.
]]>Wed, 28 Sep 2011 18:13:49 -0800http://www.scalavolpe.com/1/post/2011/09/operation-twist-signals-increasing-desperation.htmlLast week, the Federal Reserve announced the next step it planned to take to intervene in the economy and attempt to aid in its recovery.  This step is called "Operation Twist."  I want to briefly discuss it here so you understand what's actually being referred to when you hear this term.

US Treasury bonds range from short term (such as 2 year notes, though there are even shorter terms than that) to long term (30 year Treasuries).  The bonds have price and yield characteristics that move opposite each other (picture a seesaw -- when a bond's price rises, its yield falls, and vice versa).  These characteristics can be plotted along what's called a "yield curve," which under normal circumstances, depicts low yield for short term bonds and high yield for longer term bonds.  The reason for this is, if you buy a short term bond, the duration of time over which you're risking your capital is brief, and therefore lower on the risk scale -- thus, you don't get much yield back for it.  On the other hand, if you risk your capital over a long period of time, say 30 years, you would normally be rewarded for it by receiving a higher yield.

That's under normal circumstances.  We are not operating under normal circumstances.

The Fed has already used various monetary policies to push down interest rates to the 0-0.25% range, which influences the rate at which banks lend to their customers (and which has resulted in historically low rates for borrowers today).  The problem is, there still isn't as much borrowing going on as the government/Fed would like.  The reasons for this are not the point of this article -- suffice it to say that borrowing remains below target.

Enter Operation Twist.  Picture that yield curve again, with the line sloping upward from the 2 year note to the 30 year bond.  If you could grab each end, like a dishrag, and twist it (like you were ringing it out), you'd flatten out that curve.  Yields on 2 year notes would rise; yields on 30 year bonds would fall.  That's the objective behind this policy move.

So how does the Fed accomplish this?  Simple.  The Fed has a certain number of 2 year notes on its balance sheet.  It sells them in the open market.  This increases the supply of 2 year notes, diluting demand and thus lowering the value/price of the notes.  As the price falls, yields rise.

With the money it receives from the sale of the 2 year notes, the Fed enters the 30 year bond market and buys those Treasuries.  As it buys them, supply drops, increasing demand and thus increasing the value/price of those bonds.  As the 30 year prices rise, their yields fall.

Ultimately, as the 30 year bond yield falls, the eventual interest rate you or I might receive on a 30 year loan (read: mortgage) should fall, as well.  At least that's the hypothesis.  Whether banks actually lower the rates any further than they already have (as opposed to just pocketing the wider margin), remains to be seen.

But in the abstract, what does all this really signify?

Desperation.

The government, using the instrument of the Fed, is desperate to juice the economy, by stimulating more borrowing and consumption on the part of the consumer.  Specifically, juicing the housing market has all kinds of (temporary) positive effects on the economy, since so many industries benefit from home construction/remodeling/etc.  Of course, I'd thought we'd already found out in 2007-09 what happens when a housing bubble bursts...but hey let's face it, we don't learn lessons too well around here.

The key point is to see past the fancy jargon and terms of reference that the government and the Fed will throw at you, which only serves to obscure the often negative reality involved, and to understand what is actually happening and how it affects you.
]]>Mon, 26 Sep 2011 19:59:41 -0800http://www.scalavolpe.com/1/post/2011/09/the-2012-election-will-be-as-irrelevant-as-2008.htmlAs our economy continues to struggle, with both parties in our political structure pointing the finger back and forth, I thought it might be helpful to dredge up an old article I wrote back during the 2008 Presidential campaign season (located on my previous blog, "Austrian School"), titled "Your Presidential Candidate Doesn't Matter (Subtitle: You'll Be Worse off Economically in 2016 No Matter Who Gets Elected)."

Now, I hate to jump the gun by five years, but I'm starting to feel like I was more right than I even imagined in the first place.  I suspect that if you had read this article of mine when it was first published, at the very least you were a bit skeptical...but now here we are, worse off than we were then, and all signs pointing downward.

While I encourage you to read the whole article, I did want to share and comment on a couple of excerpts here.  To begin:

To quickly summarize: when inflationary policies are instituted, and money is created out of nothing, that money flows to entities that can utilize it before its price-raising effects seep into the larger economy. These entities (investment banks, corporations, the wealthy) can invest it or capitalize it in a fashion that is advantageous to them, such as by investing in real estate, stocks, derivative investments (options, collateralized debt obligations), or anything else for that matter. Then when the added money trickles down to the consumer (read: you and I), we are left with one thing: higher prices. Less purchasing power. Smaller paychecks. Whatever you want to call it, it's not good.

I like this paragraph because it captures, in essence, this prescription we've received of more government borrowing/money printing/spending (through Quantitative Easing I [February 2009], Quantitative Easing II [November 2010], and Operation Twist [September 2011]), which so many of us take for the beginnings of an economic recovery.  Unfortunately, it is actually the poison that will eventually do us in.  It LOOKS good -- "Great! The government is actually doing something, they're helping us out."  It SOUNDS good -- "This government spending will create more construction/infrastructure/etc jobs."  It FEELS good -- "We've GOT to do something, we can't just do nothing."

But it is NOT good, and it will turn out very badly as time goes by.  Briefly said, it will ultimately achieve only the following:

1) Add to the national debt, burdening us with increasing interest payments over time in order to service that debt.
2) Contribute to devaluation of the currency, weakening the value of each dollar, lowering our purchasing power, and leading to a lower standard of living.
3) Crowd out more jobs than it creates; for every job created by the government, the fact that it had to borrow/spend to create it destroys 1+X jobs (we'll never know what the X is).

I also wanted to highlight this excerpt, the closing paragraph of the August 2008 article:

Allow me to proclaim with even more emphasis the following: no matter who becomes President - Barack Obama or John McCain - your economic situation will be worse after the presumptive two terms that individual will serve. By worse, I mean some combination of the following conditions: less home equity, devalued investments in stocks and bonds, lower purchasing power, less available savings, more reliance on credit to buy the essentials, you name it. It won't be pleasant.

Gloom and doom.  Yeah, I know everyone is tired of it, but it's way past the time to face facts.  The government does not have a shred of a clue how to fix the economy, aside from their misguided appropriation of our wealth and the subsequent redistribution of it.  And we see where that has gotten us today.

Actually, it's got to be somewhat unnerving for those who have put so much faith in the government's ability to aid an economic recovery, to see the ineffectiveness of these policies.  I honestly don't know how anyone could actually believe at this point that the government has a viable approach for fixing the problem.  Every policy has failed, and indeed has worsened the conditions under which we're subjected to economically (rising inflation, higher national debt, etc.).

I hate to say it, but at this point in looking ahead to the 2012 election, it really matters not who ends up President.  There is no political will nor ability to compromise on the big issues and problems to suggest that the economy will once again prosper and thrive.  The election season and campaigns will roll on with theatrical flourish, and you and I will continue to witness a declining standard of living.
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