AUTHOR’S NOTE:

I hate to be the bearer of this news, but the plan for the federal government to spend more trillions is current and a big deal. Because economics is a primary topic of this blog, I believe that I owe it to my readers to address the issue. The last thing we all need right now is something else to worry about, but the issue is too huge to be ignored. On the other hand, if you cannot handle more bad news right now, my advice is to find something else to read for the time being.

🙛

For many years (1) Republicans have donned somber faces and spoken in ominous tones about the national debt—as they did essentially nothing about it and have routinely voted for things that have exacerbated the problem, and (2) Democrats have scoffed at the national debt as unimportant except when it can be used to justly bash Republicans as hypocrites—as they have continuously proposed and voted on new spending, tax, and other proposals that increase debt and diminish the economy’s ability to produce enough wealth to service the debt.

Prior to the pandemic, the levels of national debt and unfunded liabilities were untenably high,^[i] ineluctably growing, and the political will to slow the growth was nonexistent. Given the mal-informed public’s indifference to debt and pleas for more spending, for a politician to actually do anything to slow the growth of spending, much less reduce the country’s spending would have been an act of political suicide.

Worse, even if there had been such a political will, no plausible theory to reduce the debt to a tenable level exists (with the possible exception of a pandemic or other disaster that would wipe out a high percentage of people drawing social security and welfare benefits—which, of course, would be beyond terrible). There are plenty of reasons to believe that moves to reduce the debt would result in destructive civil unrest. Yet, Congress is in the process of passing a spending plan that will vastly increase the debt and the Federal Reserve is printing money with unbridled abandon. Here are a few images from Venezuela showing what the end of the above process looks like.

In this Sept 1, 2016 photo, demonstrators take part in the “taking of Caracas” march in Caracas. Venezuela’s opposition is vowing to keep up pressure on President Nicolas Maduro after flooding the streets of Caracas with demonstrators Thursday in its biggest show of force in years. Protesters filled dozens of city blocks in what was dubbed the “taking of Caracas” to pressure electoral authorities to allow a recall referendum against Maduro this year. (AP Photo/Ariana Cubillos)

As a result of the history described above, the country may have already created such a powerful black hole of debt that being sucked into its vortex (i.e., suffering a financial collapse) is unavoidable. The closer mounting debt pushes the country toward the black hole, the more powerful its pull.

In light of the above, one might conclude that bailing out companies, sending checks to individuals, and “printing” money to deal with the current crisis is a mistake. After all, there is no question that each move will take the country closer to the black hole and will fortify the populous’ errant belief that government spending is excellent, unlimited, and harmless—thereby making it even harder to turn back from the brink.

Nevertheless, one would be wrong to conclude that spending and “printing” should not be done.

The country’s chances of avoiding a financial collapse in the (hopefully distant) future were low before the impending spending splurge. However, unless the country’s economy can be revived, its chances of avoiding an economic collapse in the near term are almost certainly zero. The economy weakens with every hour that it remains mostly shut down. The business interruptions have placed many large and most small businesses at or beyond the point of no recovery. Without a significant recovery by most businesses, the economy will surely collapse soon. If desperate people have no hope of receiving cash for an extended period, civil unrest could bring the whole thing to a stop. Keeping enough companies and desperate people afloat will not be possible without federal government action. The planned measures are desperate and unwise in non-desperate situations. Sadly, we are in a desperate situation.

Let’s hope and pray the bitter pill of more spending will allow us to have a chance gain a footing that will enable the country to push the economic collapse well into the future and that the country finds a way to convince a solid majority of voting Americans that socialism is both unsustainable and a huge step in the wrong direction. The alternative is too bleak to discuss.

UPDATE: Following the publication of this post, Peter Robinson of the Hoover Institution conducted this excellent and pertinent interview of John Taylor: “The Corona Economy with John B. Taylor”

^[i] As I write, the reported national debt is almost $24 Trillion, is growing, and the clamor for more spending may be at an all-time high, not counting the $2 – 3 Trillion additional spending Congress is trying to get passed right now. The government’s commitments to pay money in the future are over five times larger than the reported debt.

In yesterday’s daily press briefing, Trump said his administration would figure out how to prevent any corporate bailout money being used to buy back stock. The country is facing many problems right now. Spending time and effort in these times on a non-problem is a bad idea.

Companies buy back their stock when they have more cash on hand than they have ideas, skills, or capacities to produce things people need or want. If those companies keep such excess money, the money won’t be used to provide goods or services people want or need. Idle cash helps no one. Money put to productive use helps everyone.

If a company buys back its stock, the stockholders who receive the money will use most or all of the part of the money (leftover after capital gains taxes are paid) to invest in companies that have good ideas as to how to make stuff people need or want.

Consequently, whether or not the bailout money is used to buy stock, that money will be invested in making new or more stuff people want or need. Workers and consumers win no matter which company profitably invests the money. Idle cash in companies with insufficient ideas as to how to deploy it effectively prevents the money from being put to better uses.

The bailouts of corporations will be either a good idea or a bad idea independent of what any individual corporation does with the money.

Another relevant observation is that few companies reject the corporate finance theory of an “optimal debt/equity ratio.” A rule of thumb is: “The optimal D/T ratio varies by industry, but it should not be above a level of 2.0” (i.e., company debt should not exceed twice the value of its stock).

So, almost all companies have debt. Given how much the value of corporate stocks have fallen recently, most companies have an unusually, probably dangerously, high debt ratio (the higher the debt/equity ratio is, the greater the risk of going out of business. Given how much riskier doing business is now than it was two months ago, the best use of some or all of any bailout money could be paying off debt to stay in business (rather than buying back stock or being thrown into bankruptcy).

Concerning companies that do not have too much debt right now, if Trump precludes companies from buying back stock with bailout money, nothing would prevent them from paying off debt.

The worst alternative would be for Trump to disallow the use of bailout money either to buy back stock or to pay off debt. In that case, the funds would be far less likely to be put to productive use.

The idea that the government dictating how companies use their resources will either work or is a good idea is a bad idea.

The fact that leftists are in constant fear that someone somewhere might be making a profit is making the adoption of sound economic policies harder. That the general public thinks it knows more than it does about corporate finance or how a company can increase its chances of continuing to provide jobs and to serve the wants and needs of the people isn’t helping either.

Italy’s universal healthcare system is experiencing the harsh reality of living in a world with scarce resources, as all real worlds are. Italy, like every other country, has a limited number of doctors, nurses, hospital beds, medical devices, medicines, test kits, etc. When the demand for those “scarce resources” exceeds their supply, the resources must be rationed. No matter what rationing scheme is used, some people will get some or all the care they need as others get little or none at all.

As the Boston Globe reported^[i] about a Bergamo, Italy hospital’s response to the COVID-19 outbreak, “the intensive care unit was already at capacity, and doctors were being forced to start making difficult triage decisions, admitting people who desperately need mechanical ventilation… making clear that the “first come, first served” criterion that had been used among patients with the same illnesses and level of risk in ordinary times was not appropriate in dealing with the current emergency… How do we decide who gets an ICU bed and who doesn’t? Age? Life expectancy? How many kids they have? Their special abilities? Is the patient’s profession a relevant factor? Is it right to save a middle-aged doctor who will save more lives if he survives as opposed to a younger person who’s been unemployed for the last 12 months?”

When faced with an overabundance of patients and scarce medical resources, no rationing scheme is a solution, i.e., all the available options involve agonizingly terrible tradeoffs. If the severity of America’s (or anywhere else’s) COVID-19 outbreak approaches that of Italy’s, some people will get medical aid while others do not. Equality is not a solution. If available medical care were divided equally among all patients, a higher number of patients would die.

Those who have insufficient knowledge or understanding of economics will fault politicians, hospitals, drug companies, or [you name it] for having failed to ensure that the country was fully prepared for the pandemic. Some of the chronic critics will cluelessly theorize that vastly more resources could and should have been poured into training doctors, inventing and stocking tests kits and antidotes, building enough hospital rooms and medical equipment, etc. to handle the worst-case scenario of any conceivable emergency. In theory, that could have been done. In reality, however, preparing for the worst-case scenario of every possible emergency would be terrible public policy.

First, realize that only a fraction of the foreseeable potential emergencies will strike, and few that do will be as severe as the worst-case scenario. As a result:

• The amount of money necessary to achieve such preparedness would be colossal;
• A high percentage of that stuff acquired by the enormous sum will never be used (i.e., a high portion of the investment will have been wasted), e.g., statistically, if the country pays for preparedness for adverse effects that, on average, have a 50/50 chance of happening, half of the money spent on preparedness will have been wasted; [An example.]
• The money spent on the underutilized or unused preparedness stuff could have been invested in projects that could have done a lot of good, i.e., the opportunity cost of wasting money is large;
• Having wasted money on unneeded preparedness would leave the country with far less wealth and fewer resources to other pressing human needs and wants that exist or could arise, e.g., every dollar spent on healthcare is a dollar not available to spend on the environment; and
• Perhaps most importantly, given that not all future emergencies are foreseeable, the country would have wasted wealth that could have otherwise been used for unforeseen emergencies.

Consequently, draining the country of some of its capacity to address specific problems as they arise by paying for tens of thousands of unused hospital rooms and supplies for disasters that may not come for decades, if ever, is a profoundly unwise use of resources.

It is also self-defeating. During the time between a preparedness investment is made and the time that a worst-case emergency happens, only so many doctors are required to cover the normal state of affairs.  With the hyper-preparedness demanded by chronic critics, many more doctors would be trained and added to the system. Those newly trained doctors would vie for the available doctor jobs, i.e., the doctor jobs required to serve non-emergency demand for medical services. As in all supply and demand situations, that excess supply of doctors would drive down doctors’ compensation.^[ii] If, due to the overabundance of doctors, doctors pay is less than it currently is, fewer people to be willing to go to the trouble and expense of becoming a doctor. In the long run, training doctors who must sit on their hands until a catastrophe strikes would result in fewer doctors, not more doctors. That’s no solution.

The colossal amount of money necessary to chase the phantom of ultimate preparedness would require much higher taxes. Every tax dollar collected suppresses wealth creation.^[iii] Worse, a noticeable fraction of the tax money the government receives is spent on running the government and placating or lining the pockets of politicians, rather than on things people need or want. [Does anyone believe that we are getting our money’s worth out of the dollars paid to or for Congresspeople and their staff?] Running money through the government to address a problem destroys wealth. Less wealth creation means that there will be less wealth to address problems than would otherwise be the case.

The complaints and demands of the clueless chronic critics are unfounded and misguided.

^[i] “A coronavirus cautionary tale from Italy: Don’t do what we did.”

^[ii] “Investment Income and Universal Basic Income Are Not ‘Basically The Same’”

^[iii]/sup> “Tax Cuts and Employee Compensation.”

AUTHOR’S NOTE: This post about investing is out of the ordinary for this blog. It is prompted by the recent stock market “crash,” and the subsequent volatility. Over many years of observing coworkers and friends in the midst of stock market “crashes,” like the one underway now I’ve witnessed people doing very unwise things. Hopefully, this post will reduce the likelihood that my readers will make those mistakes in the future.

Rely on the following observations and comments at your own risk. I have no formal training in stock trading and have never been a stock analyst. I have, however, read and thought about the buying and selling of publicly traded stocks a great deal over the 50 years since I graduated high school. More important, during my long career and since, I’ve observed co-workers and friends reacting to “crashes” in ways I believe were monumental missteps—with no apparent ability to learn from their prior experiences. I have done reasonably well with my own investments using a different strategy, but that is largely because I have studiously paid little attention to my stock, bond, or money market holdings and have not paid people to guess what securities or when I should buy or sell. [Past performance is not necessarily indicative of future results.] Let’s sort out why paying little attention and not paying people to guess which or when you should buy or sell stocks or bonds can make sense.

🙛

First, the obvious: Saving and investing what the guessers would have charged for making guesses for me, rather than wasting the money on investment analysts, adds up to real money over time. Now let’s move on to sort out the less obvious, but very valuable other reasons not to pay for those “services.”

Consider these headlines about the “crash” that started on February 21, 2020:

“The S&P 500 is now 12% below the all-time high it set just a week ago. This is now the stock market’s worst week since October 2008…,” intoned the AP on February 27, 2020. [Yet, the recent low (3167) was 4.7 times higher than the low in 2009 (677), which was 6.3 times higher than the S&P 500 in 1980 (106). See charts below.]

“Long-term stock investors still shouldn’t buy the dip, says El-Erian…” That’s economist and investor Mohamed El-Erian updating his previous blanket call to refrain from the previously tried-and-true strategy of reflexively buying stock-market dips.” [Note: The “tried-and-true strategy” is often tried, but not always true. Such is the hallmark of every investing strategy. One should be wary of people who say that their previous “tried-and-true” strategy should not be followed.]

“Coronavirus stock market crash may have created a once in a lifetime buying opportunity: strategist.” [“May”? Why can’t they say, “did” or “didn’t”? Note: Using the word “may” is an admission that the author doesn’t know whether the crash created a “lifetime buying opportunity.” The reality is that the author does not know whether or not it even is a buying opportunity, much less a once-in-a-lifetime opportunity.]

The U.S. financial industry employs about 8.5 million people. A goodly percentage of those employees hold themselves out to be (and appear to believe they are) people who can reliably predict whether a publicly traded stock or bond will be worth more or less tomorrow (or next week, quarter, year, or decade) than it is now. The number of analysts that actually have that skill is zero. The fundamental reasons for this fact are (1) not all of the facts that need to be known to accurately predict the future value of any security are knowable, (2) the impact of the unknowable facts can overwhelm the impact of the known facts, and (3) excrement happens.

Evidence of the unpredictability of individual stock and bond prices over time is abundant. In a Forbes-conducted 14 year, 100 round contest between stock “experts” and dart-throwing monkeys, the stock “experts” eked out a statistically insignificant win (51% to 49%) concerning Dow Jones Industrial Averages (“DJIA”) predictions, before brokerage fees and expenses were applied (on average, people lost money paying analysts). On average, stock “experts” won 61% to 49% concerning predictions of individual stocks (before fees, etc.), but from one round to the next, individual “experts” sometimes won and sometimes lost,^[i] i.e., their clients got wins and losses over time, which brought their average return closer to 50/50 (which was what the monkeys were achieving). That result is also skewed because some of the “winners” obtained advanced notice of soon to be published articles that artificially and temporarily boosted individual stock results (which cannot be consistently obtained by individual “experts”).^[ii] Another indicator is that Morningstar, a “highly respected” mutual fund performance predictor” regularly publishes ratings of mutual funds that, it is reported, that do not correlate with how the rated funds perform.^[iii] (My, perhaps faulty, recollection is that, during at least for some periods of time, Schwab’s rating system produced palpably poor results for investors who relied on it.) [I don’t know if Schwab paid Google to bury those stories or my memory is faulty, but I’d bet on my memory on this one because I was delighted at the time to see my theory validated.]

More fundamentally, however, if your stock analyst could predict rises and falls in stocks, your analyst would always advise you to withdraw your investments in stocks and bonds before they fall. Do you know anyone whose stock analyst consistently prevents their clients from ever losing money? I don’t. After crashes, analysts usually say something like, “No one saw that coming!”—as if that is an acceptable excuse for being not giving you the advice you needed, i.e., predicting future stock prices so that you can make money.

The mistake I’ve seen coworkers and friends make is this: They become frightened by sudden drops in the stock market and pull their 401K or other investments out of the market after the drop. Even when the market starts to rise, they remain too scared to put their money back in—lest they are burnt again. Only after an extended period of the market going up, they regain the confidence to put their money back into the market. Of course, at that point, the market has not only recovered all the previous losses it is on its well on its way to the next crash. Worse, when they muster the courage to get back in, they dump all their money back in all at once or over a short period of time. Sadly, that usually coincides with other people gaining similar confidence, i.e., the herd is arbitrarily increasing demand and pushing stock prices higher than is warranted. One would be hard-pressed to identify a worse strategy, but it is as common as it is bad.

Consequently, there is no “right time” to put all your money in the market. Even if there were a right time, there is no way to confidently know when the right time is. That, however, does not mean that people should not put money in the stock market. Quite the contrary. Let’s sort out that apparent contradiction.

The following charts reveal what is as knowable as anything can be known about stock prices.

The charts reveal that, at least in the past, stock prices go up over the long haul. There is no guarantee that the broad markets (e.g., DJIA, S&P 500, and NASDAQ) will continue to go up over the long haul, but the history of the U.S. markets provides reasons to believe they likely will. [With the looming risk Americans might elect more socialistic governments across the country, the likelihood is significantly less than it would otherwise be.

Sidebar: If the trend toward socialism is not turned back, no investment strategy will work and much of your gains, if you get any, will be confiscated anyway. Not investing and making less money between now and then will not save you. They will take from you whatever they determine you don’t need as much as others (especially the politicians and bureaucrats) need it—no matter how much you have.]

The huge short-term swings in the markets shown in the above charts also reveal that there is no way to predict when to invest or when to sell. Nevertheless, they do suggest a strategy (described below) that can work.

Investing in individual stocks is vastly riskier than investing in funds that track broad markets. Individual stock prices are much more volatile than averages of many stocks and the value of market indices going to zero is practically impossible. Which companies might go bankrupt is not easily predicted. Consider these companies that went bankrupt: General Motors, Chrysler, Braniff Airways, Enron, WorldCom, Conseco, Sears, ToysRUs, Kmart, CIT Group, Washington Mutual, Lehman Brothers, Circuit City, Sports Authority, and Kodak. Some of those companies are still in business but, upon bankruptcy, their stock and bondholders were wiped out or nearly so (sometimes unfairly so^[iv]). In short, unless you have inside information, are into rolling the dice, or want to support a company for non-financial reasons, investing in individual stocks should be kept to a minimum.

The supposedly “sage” advice is to “diversify your investments.” A truly diversified portfolio of investments is impossible for at least two reason: (1) Many investment opportunities are “private” investments, i.e., not available to the ordinary investors (and even if they were, it is impossible to know enough to invest wisely in a wide array of ventures—so people tend to have too many eggs in any private investment basket, which is the opposite of diversity), and (2) The best mix of each kind of available investments is unknowable and unpredictable as well. For example, how much of your portfolio should be invested in South African Krugerrand coins, Russian icons, or the thousands of other esoteric possibilities? Absent some of each, you are not diversified. Nevertheless, more diversification is better than less. Shooting for (much less paying for) a perfect allocation is a waste of time (or money).

On the other hand, the charts above show that the DJIA, S&P 500, and NASDAQ have had a very good track record of increasing in value over the long haul. That streak might come to an end but predicting what might have a better chance of rising over time is unlikely to succeed and is almost certainly a riskier strategy. To reduce risk more, one would buy shares in multiple EFTs or mutual funds (carefully consider the charges of each to find ones with low fees and charges) for each of the broad market indexes. One would also not put all of her eggs in stock index funds. One would buy some bond indexes as well. (That is currently hard to do given the low yields they now create, but you will be glad you did when the stock market crashes from time to time.) I go even further and keep a very noticeable percentage of money in the even lower-yielding money markets.

What percentage of each kind of investment should you buy? It depends on your appetite for risk. The more money you put in stocks over bonds or bonds over money markets, the more money you will likely make over the long haul (if you live long enough), and the more likely you will have less investments to cash out if you happen to need to draw money out during a crash. Beyond that, there are nearly as many theories on what the mix should be as there are theorists. Rest assured, however, if you ask an investment adviser about investment allocation, she will likely give you the answer that creates the largest fees for her and/or her firm. [I’m not suggesting they are all unethical. Some surely are, but I believe most investment counselors who interface with the public do not know that the advice they have been taught to give is not worth the price charged for the advice or is unwise.]

Lastly, none of the above investing should be done all at once. Steady, consistent investing over time will result in you having bought stocks and bonds in up markets and down markets, i.e., you are likely to have a reasonably averaged purchase price, which, on average, will be lower than the price at which you will sell the investment (assuming the market continues to perform roughly as it has in the past).

The above advice may be worth exactly what you paid for it, i.e., nothing. If you look for them, you will find many articles that defend what stock analysts do. For the reasons above, I believe modern stock analysis for ordinary investors to be one of the biggest waste of human brainpower and talent (“human capital”) ever. Many will protest that some stock analysts have had long streaks of being at or near the top of stock analysts. That is true. It is also true that such streaks are a low probability occurrence. Here is a description of a similarly improbable event: “What is the probability of rolling a pair of dice 154 times continuously at a craps table, without throwing a seven? The answer is roughly 1 in 1.56 trillion, and on May 23, Patricia Demauro, a New Jersey grandmother, beat those odds at Atlantic City…”

In “Fooled by Randomness,” Nassim Taleb posed the following situation and question:

If one puts an infinite number of monkeys in front of (strongly built) typewriters, and lets them clap away, there is a certainty that one of them would come out with an exact version of the Iliad. Upon examination, this may be less interesting a concept than it appears at first: Such probability is ridiculously low. But let us carry the reasoning one step beyond. Now that we have found that hero among monkeys, would any reader invest his life’s savings on a bet that the monkey would write the Odyssey next?^[v]

In short, a normal “bell curve” of random events will include very unlikely events, and bell curves of streaks will produce very unlikely streaks. Those who happen onto a winning streak make the news and often truly believe and claim the random event was due to their diligence and brilliance. Only a fool would be fooled by such randomness.

On the other hand, please note that there is a big difference between stock analytics and investment services. Some people are unwilling or incapable of carrying out any investment strategy, including the one described above. For those people, the services of an investment firm can be very valuable. Those valuable services include:

• Construction of a financial plan;
• Basic investment advisory services [excluding picking investments], e.g., helping you identify which funds have the lowest fees;
• Tax-efficient investing consulting;
• Rebalancing portfolio investments to maintain the desired mix of stock, bond, and money market investments;
• Holding investments, which are in your name, in a secure and reasonably safe place; and
• Maintaining and providing access to good accounting and tax records concerning your investments.

As I said above, use these observations at your own risk. If nothing else, I hope they are food for thought.

^[i] See “The Truth About Top-Performing Mutual Fund Managers.”

^[ii] See “Can Monkeys Pick Stocks Better than Experts?” for the source of the cited numbers and, for greater wisdom on the general topic, see or listen to “Taleb on Black Swans,” or read the mother loads, “Fooled by Randomness” and “The Black Swan.” See also, “Analysts Do A Great Job Predicting The Past. The Future? Not So Much.”

^[iii] “A plethora of studies have examined Morningstar, such as Blake and Morey (2000) who study the rating system to determine if they predict future fund performance for U.S. equity funds. They find no compelling evidence of significant outperformance.”

^[iv] See “Auto Bailout or UAW Bailout? Taxpayer Losses Came from Subsidizing Union Compensation.”

^[v] See, Part II, “Monkey’s on Typewriters – Survivorship and other Biases” Location 2320 Taleb, Nassim Nicholas. Fooled by Randomness (Incerto). Random House Publishing Group. Kindle Edition.