Global Economic Crisis: Who are the Winners?

I don’t know about you but I’m feeling quite depressed nowadays. When one hears about people being retrenched and the spike in the unemployment rates, the blood pressure usually goes up and moodiness sets in. There’s something wrong with this picture somehow and this post is an attempt to answer a puzzling question I have about what’s happening right now.

Physical Wealth
From a global perspective, nothing major has happened in the physical realm that we live in. There were no major wars, earthquakes, tsunamis or any form of massive destruction of our assets, people or resources. I feel that I’m correct to say that if the entire planet’s resources were valued monetarily, there would be no significant changes from 2007 vis-à-vis 2008.

Financial Wealth
From a financial perspective, there has been a major seismic shift originating from the US. Major financial institutions have either collapsed or required government bailouts. These include branded names such as Citibank, AIG and Lehman Brothers. Additional bailout packages are being debated and approved as we speak, to help jumpstart the US economy. The effects of this seismic shift in the US have begun to reach the shores of other countries causing contraction in the major economies of other countries including Europe, Asia, China and Japan.

The Zero Sum Game
One of the reasons why I have always abstained from gambling is because it is purely a zero sum game. If you win, someone else loses. There’s just a transfer of wealth since nothing of value is being created. Let’s compare this with the current crisis. Is there something not quite right here?

The Cake Analogy?

A simple analogy should suffice here. Assume that the global resources of the earth are represented by a cake. Now instead of cutting this cake and handing a slice of this to everybody equally, everybody is given coupons as a claim over the cake. Assume the global population of the world consists of 100 people.

Ever person has a 1/100 coupon. Let’s denominate these 1/100 cake coupons as 1 cake dollar. So, the entire global resources are worth 100 Cake Dollars. Every person has a Cake Dollar and his happy with this arrangement. All these Cake Dollars are being held with ABC Bank Inc. One fine day, ABC Bank Inc says that 60 Cake Dollars have gone missing. Where has it gone? ABC Bank Inc says that’s not important, what’s more important is that it needs all the existing citizens to subsidize the losses. So, it asks the government to print an additional 60 Cake Dollars to make up for the shortfall. Each Cake Dollar is worth 60% less due to inflation. In other words, each Cake Dollar allows the citizens to claim 0.4/100 of the world resources.

Wait a minute here! Let’s see… So 100 persons now have 100 Cake Dollars. The total of these 100 Cake Dollars has a stake of 40% over the world resources due to inflation. Heck, who’s swindled off the remaining 60% of the global resources of the world?

Well, perhaps if you look hard enough, it’s likely that the original 60 Cake Dollars couldn’t just have disappeared, could it? Money just doesn’t disappear into thin air. Most likely, the missing 60 Cake Dollars were cashed out by the winner and he’s just taken the 60% slice of the entire cake from the table. And his gain is at whose expense? It’s the people still holding the Cake Dollars being asked to subsidize for the losses of ABC Bank Inc that’s left picking up the pieces.

How Could the Bank Lose?
As an analogy, assume ABC Bank Inc betted 60 Cake Dollars against *someone* that Roger Federer would win the Australian Open in 2009. ABC Bank Inc lost.

Normally, we would just let this bank fail. You made a bad call, you pay the price. Unfortunately, all the Cake Dollars are held with this bank. If it fails, there would be a run on the bank and everyone would start realizing their Cake Dollars are worthless. So, the 99 persons in the world have to absorb the 60% losses by ABC Bank Inc to avoid starting a world wide panic and riots.

In Real Life
The 2009 Australian Open bet is akin to the gambles taken by the financial institutions in CDOs, CMOs, CDS and the like. How could the derivatives arm of these major investment banks and financial institutions earn returns in excess of 20 or 30% per annum? Only if you play the zero sum game! And when you win big, you can also expect to lose big sometimes. And the banks have lost BIG against someone. The fact they need so much money is that they’ve used the depositor’s money to pay of their bad bets. Now, they don’t have any money left to pay the depositors money they were supposed to hold on trust for us.

As we are talking about huge losses of trillions of USD, *someone* must have made a hefty gain at the expense of the banks and tax payers. In addition, since everyone is feeling depressed, prices of commodities (i.e. real resources) are under priced. This *someone* is going to have a bonanza time taking over commodities and companies at fire sale prices.

Anyone has any idea, who this *someone* is?

Financial Bailouts

The Rise of Illusions: A New Economy

The wane of the power of Truth as discussed earlier corresponds with the rise to power of Illusions. To first understand the meaning of Illusions, let’s see how it is defined in the Dictionary.com:

Illusion is defined, inter-alia as ‘something that deceives by producing a false or misleading impression of reality’.

Reality is defined, inter-alia as ‘something that exists independently of all other things and from which all other things derive’.

So, looking at these two definitions, one could argue that anything that is not reality is an illusion. Something which is real, is something of intrinsic value that is not dependent on the subjective opinions or perceptions of people around them. In this epoch, the rise of the power of Illusions has consumed our time and robbed us of the meaning of life. Perhaps the most depressing part of it all, is that we are all too willing to participate in it.

Money!
I am sure MONEY is a topic that is close to everyone’s heart. Upon reaching adulthood, most of us spend our entire life pursuing it. Yet, what is money really? In the simplest sense, it is a SYMBOL that we use to allow us exchange goods and services with other people and replace the barter system.

Bartering with people is a difficult process, as there are two primary difficulties:

1. Valuation issue: Without a common agreed standard to value all goods and services, the exchange of goods and services may face delays. E.g. how many apples in exchange for a loaf of bread?
2. Transaction issue: A barter system would also require someone in possession of bread looking for apples and vice versa. This causes difficulties in real life.

MONEY as a symbol allows this process to be carried out easily. A loaf of bread could be worth RM2 whereas an apple is worth RM0.40. So, 5 apples are worth a loaf of bread. Further, someone that needs a loaf of bread doesn’t need apples to buy it. He could exchange the loaf of bread for MONEY worth RM2. The bread seller can then use this RM2 to purchase the apples from someone else. Simple isn’t it?

An Illusion?
Now let’s step back for a minute and ask ourselves: Is there anything wrong with this picture?

1. What should be symbolic representation of MONEY? [Illusion]
2. How does the IDEA of money be used to value ALL goods and services? [Coercion & Manipulation]
3. Does the producer of the bread ever meet the producer of the apples? [Disembodiment]
4. Can money by itself distort reality? [Debt]
5. Can money by itself acquire a sense of identity and become a common reality? [Interest]

Illusion
As we have seen earlier, the power of money lies not within the form but as an IDEA. Money as an IDEA, is something outside the realm of reality altogether. Money whether be it Treasury Bills, Paper Money or even gold coins is that can exists outside of humanity. If you were Will Smith in ‘I am Legend’, would money have any meaning? Can money conjure up food on the table, furnish you a house to live in, provide entertainment etc.? No! Anything could be used to represent money, so long as portable, scarce and difficult to counterfeit.

Coercion and Manipulation
The phrase ‘No man is an island’ is apt here. For truly, all human beings need a community to survive. We are so specialized now that we would not survive if we had to live alone in a jungle for a month, even if we were given all necessary tools. If you knew how to cook, do you know how to catch food in the wild? If you could take care of your food problems, would you know how to build a shelter for yourself? And so on…

From time immemorial, society values the goods and services a person produces via coercion. Depending on the age we live in, certain skills are valued more highly than others. A barbaric society may value fighting skills more than scholarly ventures whereas the opposite may be true in a civilized society. Although monetary value is an ILLUSION, it works because society COERCES each and every individual to accept it as an infallible truth. If you produced a great science fiction novel worth millions such as Philip K. Dick, it would still be deemed worthless [then] because of the coercive nature of society.

The problem with the coercive powers of society lies in the ease in which it can be manipulated in present times. The vast majority of humanity is now fed on a steady stream of marketing and advertisements. Propaganda fills the airwaves attempting to manipulate and shift public opinions to suit the machinations of the elite class. What could be more laughable than to see advertisements succeeding in encouraging people to smoke?

Disembodiment
Whilst the concept of money solved the Transaction Issue, i.e. obviating the need for the actual producers to meet each other to exchange their products, it gives rise to Disembodiment. This Disembodiment permeates extensively throughout our economy today. What do I mean by this? Simply put, Disembodiment creates an illusion that the consequences of your action do not have an impact on society or yourself.

Let’s go back to our example of the bread maker and apple farmer. Since the bread maker never meets his customers, he feels that so long as the bread looks the same or even better, it doesn’t really matter whether he skimps on certain ingredients. Who cares whether the bread is as nutritious as before? Whereas it used to cost him RM1.50 to make a loaf of bread, it now costs him a mere RM1. Why should he care? He will probably never meet his customers. So long as he can get away with it, he’ll do so.

Of course, others in the society will start getting the same ideas. The apple farmer will start using pesticides instead of natural fertilizers to grow his apples. He doesn’t care whether the apples aren’t as nutritious as before. He has another batch of crops of premium apples that he grows for his own use.

So, this vicious cycle permeates the entire society. Every person begins to lie to one another to gain an unfair advantage. Since almost everyone does so, no one gains an advantage over the other. Instead they all poison each other. The lawyer cheats on his client and is cheated by the mechanic at the car workshop. The Corporations cheats on its’ consumers by producing sub-standard products whilst the Board of Directors cheats on the shareholders (owners) by paying themselves exorbitant salaries and bonuses.

Debt
Ah… my favorite subject! How can something be created out of nothing? Let’s look at the simple example of a loaf of bread. Now, to actually produce a loaf of bread to eat, one has to put in the effort to procure flour from the granary, mix the flour with yeast and water into dough and bake it in the oven before it is ready for consumption. Assume that you do not have the money to buy a loaf of bread. You borrow RM2 from a friend to buy the bread and consume it. Do you realize what you have just done?

This is difficult to envisage but in reality, you have obtained the loaf of bread by promising to do something for your friend in the FUTURE. And is this promise a REALITY or an ILLUSION? In the present, it is an ILLUSION since it exists outside the realm of reality. What has really happened is that your friend is the one that has invested his time and effort to produce the bread [via the monetary system] which you now enjoy. You, on the other hand, have done nothing to earn that loaf of bread.

Now, if we put this into a present day situations, most debts are on big-ticket items such as houses and cars. What has occurred is that these debtors have promised to do something in the FUTURE to obtain something NOW which they have not earned. The great irony here is that such a phenomenon cannot exist in reality. How can something in the future be converted into reality here and now?

Interest
Now, this brings us to another fascinating concept, Interest! From the lenders’ point of view, the promise by the debtor to do something for me in the future is not a reality. Yet, it is a probability. If I had 1 million people borrowing from me, a certain percentage may decide to breach their promise; others may die early or face some mishaps in life. Yet, a large percentage, say 90% would make good on their promise. That’s where the concept of interest appears. I would need to charge an additional amount on the debt that I lent out to cover for such risks. So, if I charged a 10% interest, I would be able to cover for the risk of default by some debtors. So far, everything seems to make sense as these pool of borrowers have to pay extra to cover for the risk of their brethren not paying up.

Now, what if I, as a financial institution were to take this concept further?

Raise the interest rates in excess of the default rates. I would begin to make more money from these debtors. In essence, I would have the ability to coerce them to act in the manner I desire. They assumed the debt in exchange for promising to do something for me. Depending on their earning ability, this could take several years of their life. For instance, they may spend 15 years of their life to build their own house. However, in exchange for obtaining a house immediately, they need to spend 20 years of their life to repay the loan. They will spend those 5 years serving me instead.

Most modern monetary systems (including Malaysia, I believe) operate a system known as a Fractional Reserve System. Simply put, financial institutions need only to set aside a certain % as reserve requirements. This is usually 10%. What does this mean? This means that if you placed a deposit of RM100,000 with a bank, it can lend out RM1,000,000 out to customers as loans and charge interest on them. The RM1,000,000 created out of thin air, when re-deposited with the banks are considered deposits which can then be used to create more money.

Unless the real economy (production of goods and services) matches the increase in the money supply, inflation will occur. To put in simply, when the giant pool of money increases and yet, the supply of goods and services remains the same, the value of money will lessen. This is inflation.

Conclusion:
It is my hope that this little article has made you stop for a moment and think about the nature of those pieces of paper that you use to trade for goods and services everyday. Feel free to share your opinion.

This series of posts labeled the ‘Age of Illusions’ are subjective, introspective in nature and based on my observations in life. My aim is merely to put to words the niggling sense of unease that all is not right with this world. It is an attempt to make sense of the NONsense that is this world.

The Demise of Truth: A Worthless Commodity?

Truth! There are times when it frightens me that just how rare this commodity truly is in this world. Even though the concept of Ethics, Integrity and Morality are lauded, praised and adorn the mission statements of corporations and governments alike, are they truly being practiced? In a world driven by money, greed and profits, do you think that Truth even permeates the world of corporations and governments?

Instead of analyzing this at a global level, let’s bring this concept down to the ground level. Let’s assume that I run a financial advisory firm. What would be the ideal approach to convince them to invest with me?

1. Liar’s Approach (Skim Cepat Kaya)
2. The Machiavellian Approach (Lies Intertwined with Truth)
3. The Truth (Are you Crazy???)

1. A Liar’s Approach
The Liar’s Approach is the simplest way to make money. Come in a flashy car all dressed up in designer clothes adorned with jewelry and accessories. Speak in pseudo mumble jumble and sell… ‘50% returns in two months. No risk, profits guaranteed. Don’t miss this once in a lifetime opportunity’. Of course, as more and more of your customers make handsome profits; more and more investors decide to invest without reading the fine print. Come to think about it, could this be what happened with the US Sub-prime Crisis?

2. The Machiavellian Approach
These days, people are becoming savvier. The majority of people can smell the liar’s approach a mile off. Some of them still get burned because they are blinded by greed. Most of them would walk away. Well, if that’s the case, the second approach would be to ‘massage’ the truth. Instead of a hard sell, you now have Chartered Financial Planners (CFPs) asking you for your hard earned money. They then start flashing you fancy charts, graphs and analyst reports. Since some of the investment vehicles they are asking you to invest is being offered by regulated financial institutions, the information presented is mostly true. However, I am sure it has been massaged to show fantastic returns, of course. Now, let me ask you: Does your CFP tell you how much commissions they are earning by selling you these products? Do they tell you the potential risk to your capital during times of recession? Do they tell you the fees charged by the financial institutions in managing the unit trusts?

3. The Truth
The Truth is plain and simple. No matter who runs the financial advisory firm, you can be ABSOLUTELY CERTAIN that no one can make profits all the time. Heck, if I were that good, why would I want you to invest with me? I’d borrow from the banks at a fixed interest rate of, say 10% per annum. Using that money, if I were able to generate returns in excess of 10% per annum, I would be filthy rich. Investing in stock markets these days are risky. Why? It’s because it’s a Big Boy’s game. They are privy to information that you and I do not have. They have the resources to move markets and share prices with a snap of a finger. So, if you invest with me, there are no guarantees of making a profit at all. There’s a very real risk of losing your capital. There’s a very real risk that I’m investing based on imperfect or false information. There’s a very real risk that the impending recession will wipe out the stock market and take decades to recover. I’m telling you now that the mantra of investing today is ‘High Risk, Low Gain’.

So, assuming that my competence and knowledge level remains the same, as a potential investor, which approach would you prefer to hear? Errr… do I hear a B? Truth be told, most Corporations don’t tell the Truth because it makes good business sense. Most consumers don’t want to be told the Truth because they just can’t be bothered with it. Telling the Truth will just drive your customers to your competitors.

What’s the morale of the story?
If something is too good to be true, it usually is. Educate yourself and remember ‘Trust but Verify’.

This series of posts labeled the ‘Age of Illusions’ are subjective, introspective in nature and based on my observations in life. My aim is merely to put to words the niggling sense of unease that all is not right with this world. It is an attempt to make sense of the NONsense that is this world.