Currency Adjustments and “Contagion”

Today I want to talk about debt. Not the kind you think about when you see headlines about student loans, credit cards, or the federal budget. No, this is a very special kind of debt, a kind you likely will hear nothing about, but a kind of debt that has a tremendous amount of influence around the world.

Let’s start in broad strokes. If you’ve read my previous blogs, or any article about floating currencies (fiat money, for the gold bugs out there), then you will know my thoughts on the state of the U.S. Dollar. The USD is the most stable currency in the world today, and it gets that ranking from both its Liquidity (the frequency that it is used) and its Notoriety (the amount of people and institutions that recognize its stability, and thus use it). Most
global energy transactions are made in USD, most financial clearinghouse activity is done in USD, and almost every country in Earth recognizes it as, for better or worse, a stable currency.

This blog post is not about America, however. It is about the rest of the world. How do other countries’ currencies compete with the Dollar in a floating currency system? Do other countries attempt the same industrial booms that America had? What about the same debt issuances, fiscal policy, or foreign direct investment?

The answer, as with most things financial, eventually comes back to the U.S. Federal Reserve. The Fed sets monetary policy for the U.S., which either makes the USD stronger or weaker relative to other currencies. When the USD gains strength, more people will want to hold USD, and when the USD weakens, people will want to sell. Recall that a stronger USD means imports to the U.S. will cost less, as a stronger dollar will be able to purchase more of a foreign currency for each dollar spent. However, a stronger USD also makes exports more expensive, as the stronger USD will push up dollar-denominated prices of goods, and other countries will want to buy less. It’s important, though, to think of currency strength not on a numeric scale. One Dollar will only ever be worth one
Dollar. Its strength or weakness is a result of how much in goods, services, or other currency it can purchase. By that metric, currencies can strengthen or weaken as needed to respond to a growing global marketplace and changing resources.

                                                               Monetary Policy Overview
For a more in-depth explanation of how all this works, the Federal Reserve sets U.S. interest rates, through the Federal Funds Rate (FFR). The FFR is the overnight interest rate on loans from Bank to Bank, set to an annualized percentage. If JPMorgan Chase, for example, needs to borrow money in anticipation of a large cash withdrawal in a few days, they will want to borrow from the Wells Fargo down the street, but Wells Fargo will not want to lend that money if they do not receive interest in return. That is the FFR in a nutshell, and the Fed raises and lowers it in response to economic strength and weakness, but based on consumer trends.

In a strong economy, theoretically, consumers will have more disposable income and will be spending a healthy amount. The Fed wants to protect against the economy getting too hot (and runaway inflation caused by overspending), so they will raise the FFR, thus pushing up the borrowing costs of banks and businesses, and also pushing up the effective interest rates paid on bonds. Consumers will then, theoretically, want to save more of their money by buying those bonds, and economic activity slows.

Conversely, in a weak economy, consumer spending will be weak, and saving will theoretically be strong. The Fed will lower the FFR in this situation, in order to entice people to save less money, and spend more. Lowering the FFR will lower the borrowing and lending costs to banks and businesses, letting them respond more effectively to consumer trends and letting the economy pick up steam.

The Fed has announced in recent years that their “normal” desired FFR is around 1% higher than the inflation rate, which as of August 2018, has come in at 2.2%.

                                                                 The Central Issue
The world is an ever more connected place these days, and that includes the financial world. Recall that investors, businesses, and governments from all over the world acknowledge the stability of the USD. Other countries (with the USD as not their local currency) can, for purposes of this blog, be lumped into three groups; Developed Markets, those that have strong currencies of their own and compete with the USD, Emerging Markets, those that have less pronounced, often pegged currencies to the USD, and Tertiary Markets, those with the weakest economies and most volatile currencies. For this blog post, we will focus on Emerging Markets.

Emerging Markets have seen an explosion of economic growth over the past 20+ years, due to a multitude of factors. These include, but are not limited to, easier access for developed-market investors to invest more directly in them, increased media coverage and grouping of certain countries (The African Union, BRICS, ASEAN, etc.) and overall liberalization of eastern markets. But no factor has had as much impact, nor been as lasting to long-term economic success of developing nations, than cheap debt. Loose monetary policy and cheap debt has been a tailwind to global growth for decades, and has allowed otherwise struggling countries, rife with political and economic turmoil, to reap the benefits of virtually unlimited investment, near-free money, and confidence that the good times would keep on rolling.

I often talk about secular trends in western civilization being responsible for lower interest rates, those trends being an aging population and falling birth rate, stagnant or decreasing real wages, and asset prices (stocks, homes, etc.) rising faster than the rate of GDP or wage growth. Think about this in tangible terms. You work as long as you need to, but your income doesn’t seem to rise much year to year. You look around, and everything is financed nowadays. Average home values have climbed in the last 30 years from under $200,000 to over $300,000, college tuition has more than tripled, even your phone costs more than $1,000. Rising costs for such common expenses pushes them to be paid in installments, and those have interest rates attached. As debt levels rise among
citizens of the West, the interest rates necessarily have to decrease in order to keep affordability. Since western economies make up such a large portion of the global economy, this dictates a lower overall world interest rate, and makes debt cheaper.

Emerging markets will want to take full advantage of this situation, because to them, it could not be better. Countries that can experience massive growth rates do so with mass influx of construction and industrial activity (the American way!) and that takes a lot of capital. Some of the most popular emerging markets are Turkey, Argentina, South Korea, and Indonesia, and I’m sure you’ve heard at least a little about the growth they have
experienced in the past few decades. How do you think they achieved it? Massive capital inflows, often, to their long-term detriment, denominated in USD.

Remember when I said the USD was the most reliable, stable, liquid currency in circulation? It holds true even in those emerging markets. Debt can be issued, bought, sold, and paid easiest when it is denominated in USD. It’s how investors in New York can lend money to Turkish construction companies, or South Korean software companies, or even Chinese bank notes. It’s how financial institutions can transact with each other without foreign currency adjustments getting in the way of quarterly earnings. But at its core, it’s most definitely how countries with no vibrant economy or stable currency of their own, can “borrow” one, to prop themselves up and propel massive growth.

Here’s how this works for governments. Say Turkey wants to undergo a massive infrastructure plan involving a lot of companies building new buildings. The project will cost, say, 5 billion Turkish Lira. Turkey does not have the money to cover this cost, and they have a choice to make. They could issue Lira-denominated debt to cover the cost, but that comes with a 24% interest rate paid every year. They could alternatively use their Lira to buy Dollars, and issue Dollar-denominated debt at a 5% interest rate. U.S. monetary policy is loose, and interest rates are still at historic lows, remember? Naturally, Turkey would choose the latter option. The effect is twofold. Dollars exit the U.S. and enter Turkey as a Foreign Exchange Reserve, which buoys the value of the Lira (because, theoretically, Turkey could sell its Dollars to keep its liquidity of Lira) and also allows Turkey to take advantage of the far lower U.S. interest rate. If the debt is rolled over every expiry, then demand for that debt will be high, and Turkey will experience a lot of growth as a result.

It works in a similar way for businesses. Say Turkey wants to infuse its private sector with a ton of cash in order to juice its economy. Countries do this all the time, in the form of tax cuts, tax rebates, sovereign wealth funds, or even helicopter money. Turkey wants to lend its businesses 50 billion Lira. Turkey only has 5 billion Lira, and has a choice to make. It could lend the 5 billion Lira now and accept a lesser result, it could invest the Lira in the hopes of having a larger amount in the future (but not lending it now), or it could buy Dollars with that Lira, issue Dollar-denominated debt to lever themselves and receive many more Dollars, and sell those Dollars to buy the 50 billion Lira it wants to lend. Businesses within Turkey’s domestic economy can only transact in Lira, so they cannot use Dollars. The effect of this is once again beneficial to Turkey. 5 billion Lira used to purchase Dollars results in leverage that allows Turkey to “borrow” the ability to access much more of its currency, as a much lesser cost. Once again, Turkey is taking advantage of lower interest rates and cheaper U.S. debt to grow its own economy.

Sounds like a win for Turkey, right?  Seems like a true “miracle” situation, one with no downside, right?

Surely you can see a glaring flaw in all this. The system only works when dollar-denominated debt has a lower interest rate, or put simpler, when the USD is cheaper. For the last 30 or so years, this has been the case, with the massive interest rates of the 1980’s giving way to the Greenspan-led mass lowerings of the 1990’s, the teaser rates of the 2000’s, culminating in the all-time-low interest rates in the 2010’s of 0% – 0.25%. As you can imagine, zero is the “effective lower bound” here, as money cannot get any more free than “free”. But what happens when U.S. interest rates, finally start to rise?

Recall that the Fed raises interest rates to combat inflation and strengthen the Dollar. When the Dollar strengthens, it can buy more foreign currency, and foreign currency can buy less of it. This is where we begin to see the concept of Contagion. In our Turkey examples, for both government and business, growth in Lira terms is being fueled by Dollars, and in both instances, Turkey needs those Dollars to be as cheap as possible so they can keep buying them and issuing debt. If their liquidity dries up, and they can no longer buy as many Dollars with their Lira, then investors quickly lose confidence in the ability of the Turkish government to satisfy its debt obligations, and those investors will not buy Turkish debt. That forces Turkish debt to become more desirable to compensate, and it does this by pushing their interest rate higher. If it gets high enough, then Turkey will not be able to pay its debts, it will lose the ability to attract foreign capital, and its economic growth will flatline.

You’re probably thinking to yourself, surely this isn’t as big a problem as you’re making it out to be? A percent or two of interest won’t make or break an entire country’s economic performance, right? I say to that, look to history as the judge, specifically the events of 2007-2009. The Fed’s Quantitative Easing to combat the Recession had the double impact of shoring up debt markets (by buying distressed mortgages and bonds, eliminating much of the bad apples from the tree) and flooding the U.S. financial system with trillions of new, cheap, accessible Dollars, in the hopes that banks would lend them out and get the economy moving again. The net effect was an all-time-low interest rate (mentioned above), and emerging markets took full advantage of this. Liquidity was so high, and they could afford to borrow so much, that the situation had the look of a Liquidity Trap, when debt costs are so low, and so much is borrowed essentially for free, that when rates finally go up, borrowers have no way of paying it back.

This is what I believe has happened, and what is beginning to finally show, in emerging market economies. U.S. interest rates are about to pass the 2% minimum threshold, and the Fed is continuing to signal that the rate hike cycle is nowhere near over. As the Dollar continues to strengthen compared to more volatile, weaker emerging counterparts, borrowers of Dollars will not have a way to repay their debts. This will lead to massive capital flights from those economies, economic contraction, and continued divergence of the West, and the U.S. in particular, as the sole economic choice of the world’s money. So the next time you turn on the financial news and see the word Contagion, remember what it means, and keep your money close.


Fiscal Policy Part 2 – A Primer on Tariffs

If you haven’t been living under a rock for the past half year or so, you likely saw some variation of this headline on the news:

“Trade war heating up with China and/or the EU and/or Canada and/or Mexico!”

“Trump administration pressures Beijing to make trade fair”

“Business owners uncertain about their future after most recent tariffs”

“Business owners optimism showing after most recent tariffs”

If you noticed that these headlines seem to contradict each other, you would be correct! Tariffs are trade actions are all over the news, and don’t seem to be showing any signs of slowing down. What exactly this means for U.S. and Global commerce, like all specific things in economics, is evidence-based and remains to be seen. However, in this post, I will discuss the basics of tariffs; why they exist as a tool of fiscal policy, some applications of tariffs and quotas in the past (both good and bad), and some general economic application of this kind of policy in today’s context. And, as a bonus, I’ll also talk a little about a political theory that has application with this topic, Dependency Theory, and why it matters in the environment that is most suited for tariffs to take place.

Let’s start with the basics. What are tariffs?

Tariffs are essentially a way for a domestic government to make the prices of foreign goods more expensive, to achieve the goal of protecting domestic industry from foreign competition. When you hear the word “Protectionism”, tariffs should immediately come to mind. Tariffs are most often used to prop up domestic industry that cannot yet support itself financially when faced with much larger global competitors. Think of a nascent company in a mature industry, such as Tesla competing with Toyota or GM, or Venezuela’s oil company competing with Saudi Arabia’s. These are perfect examples of companies that are tapping into a big, rich marketplace, but are new and lack the capital or reach to compete effectively.

The way tariffs work is relatively straightforward. The domestic government will see that domestic industry needs to charge higher prices than foreign competitors, and will tack on an additional tax (the actual tariff) to those foreign companies when they want to sell their goods to the domestic economy. In theory, this raises the price of foreign goods up to or just below the price of the domestic goods. Since prices are now equal in the domestic market, consumers have less incentive to not buy domestic, and producers and governments can appeal to consumers’ patriotism to make them buy more out of the domestic market. In theory, this props up domestic employment and reduces exports.

Sounds good, right? Don’t get set on the idea just yet. For all the upside, there’s a whole lot more downside. The following series of paragraphs will address some of the problems with tariffs, from multiple points of view, followed by criticism of each paragraph. I apologize for the dryness in advance, but it’s interesting stuff, and if you understand both the good and bad sides, you will know more than many in government today.

First, there exists in macroeconomics a concept called “Crowding Out”. This is most commonly used to chastise government spending as a way of stimulating demand. Raising government spending levels necessitates more government borrowing, which raises interest rates as more bonds are issued. Since big governments like the U.S. can essentially spend as much money as they want, and their bonds are seen as ‘safer’ investments, huge demand for government bonds is created when interest rates rise. Money that would otherwise go toward more productive assets, such as corporate bonds or common stocks, instead goes toward government bonds, where it is theoretically safer, but does not contribute as much to private sector activity. In other words, private sector investment is “Crowded Out” by government investment. Many people think this is a leading contributor to the slowdown of western economies’ GDP in recent decades.

Now, let’s apply the concept of Crowding Out to tariffs, in the context of the modern United States. Ours is an economy with an enormous amount of Demand, coming from a multi-million-person population with a high amount of disposable income relative to other countries. But as wages stagnate, the demand of the U.S. will shrink as fewer and fewer people have access to more disposable income. Considering this macro issue, let’s assume that Demand in the U.S. is flat, and while it is high, will not rise unless acted on by a massive force. Consumers naturally try to access the highest quality product for the lowest cost, so they will buy more foreign goods while they are cheaper, and more domestic goods from companies that can compete on price. If prices of goods rise enough, then consumers will have to adapt while their income is stagnant. I would think this adaptation means simply buying less stuff, both foreign and domestic. In this way, even though tariffs are meant to stimulate demand for domestic products, that demand is Crowded Out by consumers’ need to save their money.

Second, tariffs fly in the face of fundamental concepts of free trade, such as Competitive Advantage. Competitive Advantage is the flip side to the consumer demand trend shown above, where economies will specialize in industry where they have an advantage relative to their peers. We see examples of this everywhere, all the time, from Software Technology hubs in the U.S. (due to our world-class university system and earning power) to Oil Drilling in the Middle East (due to their overabundance of natural resources) to Call Centers and Textile Manufacturing in India and Bangladesh (due to their dual characteristics of a massive population that is relatively poor and can perform cheap labor), all the way to exports of Chocolate from Ghana (actually, cocoa from Ghana is a primary source of world famous Swiss chocolate). When Opportunity Cost is lower for an area of industry, economies will naturally take advantage and specialize. Because of this, goods and services will increasingly come from places where cost is lowest, and as long as a country has an advantage in one measure of industry, they will gain market share against their peers. This is Competitive Advantage in a nutshell.

What does this have to do with tariffs? Remember the definition I gave to tariffs, and how they are mostly used to protect nascent industry from bigger foreign competitors. This reason can be perverted easily, and stretched to mean the protection of any industry the domestic government sees fit to protect, even at the long term expense of its economy. The context of the 2018 world economy is a perfect example of where tariffs are neither necessary nor appropriate. The Trump administration levied a 25% tariff on foreign steel because it sees the preservation of U.S. steel manufacturing as a national security priority. It even went as far as to call steel imports from our strongest allies (Canada, the EU) a national security risk. Tariffs are unnecessary here because they drive up costs wastefully and without reason. Canada and the U.S. enjoy the largest peaceful border in world history, and have not been at war since the War of 1812. You would be hard pressed to find a more allied set of two individual nations, as evidenced by our cultural and athletic rivalries that could not be friendlier. If the U.S. can secure reliable steel imports from Canada at cheaper prices than in the U.S., then why would we want to raise those prices and increase expenses of every U.S. company that uses steel as a raw material? Would it not make more sense, from both a consumer standpoint and a long-term producer standpoint, to keep the inputs of manufactured goods as cheap as we can reasonably make them, and foster better relations with Canada so they keep reliably exporting to us? I digress. The point of this example is to illustrate that Canada is able to produce steel at less cost, so they have a Competitive Advantage in steel production. Instead of propping up our own steel industry, and possibly sacrificing a portion of our workforce that can be more productive elsewhere, we should instead rely on the cheaper good from a close and loyal ally, and use that savings to advance industries where we have advantage of our own (notable examples are Tech, Movies & Entertainment, and Military/Defense).

Third, in a world of ever-increasing globalization and competing world economies, tariffs do more harm than good. In the era of tariffs’ heyday, when the world was comprised of many individual countries that dealt with each other one on one, as opposed to in a group, hostile fiscal policy made more sense because it was used as a cudgel for a stronger economy to make a weaker economy do what it wanted. In case you didn’t know which era I’m talking about, it is the 1600’s – 1800’s. The great economies at that time, England, France, Holland, and Spain, all used economic hostility just as frequently as they used military hostility, to further their mercantilist goals of colonization and resource extraction. You may be aware that this era was comprised of many, many wars, and very few alliances or friendly relations. This was due in no small part to all the hostility between nations, in its various forms. Nowadays, the world is decidedly not that. The past 70+ years have seen rise to international and multilateral institutions previously unseen and unimagined, facilitating international development, financing, cooperation, and security. The effectiveness of these organizations is up to your personal interpretation, of course, but the world in general has taken great pains to make a world order than is without a doubt, one hundred percent not bilateral.

Why am I explaining all this? To drive the point home that bilateral economic relations is mostly a thing of the past, and attempts to further one nation’s agenda at the expense of a second nation will assuredly spill over and have negative effects with a third nation. To put it in a middle school context, other nations will talk behind our backs! If we slap a bunch of tariffs on China, for example, that drives the Chinese economy further from us. But if we also push away the Canadian economy, there is no rule saying Canada will be forced to deal with us and no other nation, regardless of how we treat them. Quite the contrary! China suddenly has more incentive to do business with Canada, since their economies are both further away from ours, and thus closer to each other. Who’s to say they won’t both levy tariffs of their own on U.S. exports, pushing up the world price of goods even further?

There have been a few notable examples of tariffs throughout American history, and the vast majority have been met with negative results on net. The most popular example is the Smoot-Hawley Tariff Act of 1930, meant to protect the profits of farmers suffering from the Dust Bowl. The Act set tariffs on foreign imports of agricultural products as high as 19%, pushing up domestic production and employment of agriculture in the short term. But US tariffs were already high at this time, and the additional tariff contributed to other countries’ rapid and substantial declines in global commerce. Obviously due to the Great Depression, the exact effects of the tariff were unclear, but the consensus is that Smoot-Hawley exacerbated its effects. Some notable statistics having to do with tariffs are, however, well documented. U.S. exports decreased 61% from 1929 to 1933 and Gross National Product fell 27% from 1929 to 1931. You don’t need me to tell you that the Great Depression was the worst economic event in modern history, but the tariffs certainly did not help, as foreign imports were discouraged in the U.S., which led to U.S. exports being discouraged in foreign countries.

Another example of tariffs in history is the Tariff of Abominations, enacted by Andrew Jackson in 1828. This tariff was a fixed 38% rate set on almost all foreign imports of products produced by the Northern states, so that they could compete with their British competitors. Again, this tariff produced more net negative than positive. By raising the prices of foreign goods to match domestic goods, the Northern states could compete on a level playing field in the domestic economy. However, the Southern states, which were not manufacturing states and relied on agrarian exports with cheaper foreign tools, suffered immensely due to a two-pronged effect. Their costs rose dramatically, while foreign countries they normally exported to would not accept as much of their exports due to perceived isolationism and unfair treatment. South Carolina in particular was hit so badly by this tariff, that in 1832, the state assembly approved a nullification measure, essentially saying that the states could choose to nullify any federal law they did not agree with. The ensuing clash over states’ rights and North vs South economies contributed in no small part to tension between the two sides of America, eventually leading to the civil war.

Finally, what about Dependency Theory? I’m no political scientist, but as I understand it, Dependency Theory is the emerging theory of international development that essentially splits the world into two types of nations. There are strong, sustainable nations, typically in the West and Europe, and smaller, weaker nations, typically found in Africa and East Asia. The growing inequality present in today’s rendition of capitalism causes the rich nations to grow richer on their own, and the poor nations to need the rich nations in order to get richer as well. So, the richer nations will turn this need into a predatory relationship, buying up natural resources and raw materials found in poorer nations for far cheaper than they would have had to pay to other richer nations. Since they pay the poorer nations far less than the resources are ‘worth’, poor nations only gain a small amount of wealth while rich nations keep the vast majority of their wealth. Tell me if this sounds familiar to you, because it should. This theory basically describes a modern version of Mercantilism, with poorer nations subject to ‘colonization’ by companies of richer nations, not unlike the East India Trading Company or the Hudson Bay Company belonging to England in the 1600’s.

The reason this theory comes to mind when talking about tariffs is because it gives a very good reason for tariffs to exist. If developing countries cannot sustain their own necessary industry, why would they allow themselves to be taken over by foreign developers and companies? Sure sounds good in theory, but again, it suffers the same fundamental negatives that we discussed already. Competitive Advantage is the cure for this. When I talked about Competitive Advantage above, I briefly brought up cocoa exports from Ghana, a small, developing African country. Despite having little in the way of manufacturing, a pegged currency, and a small population, cocoa exports from Ghana are the second largest exports of chocolate products in the world! Ghana happens to have several regions where rainfall is very heavy, and conducive to increased farming and production of cocoa and other chocolate products. As I mentioned, they export to famous chocolate producers like Switzerland, but they also export to and have beneficial trading relationships with the U.K. and Singapore. More facts about the cocoa exports of Ghana can be found here:

I’m not saying that Ghana’s cocoa exports are a perfect example of a country using competitive advantage to gain an edge in industry, but it is an example of how developing countries can effectively use this concept to compete with their foreign peers without limiting other industry. Countries like Ghana would do well to become friendlier with their neighbors, to pool resources for the common defense, and to promote commerce that is mutually beneficial and plays to all countries’ forms of advantage. In Ghana’s case, the African Union is a rapidly growing player in global trading blocs, and in a few decades, could become as important as the Association of South East Asian Nations (ASEAN) or even the European Union.

In summary, though I have not expressed my own opinion on whether tariffs are good or bad, I hope I have shown you that on the whole, tariffs are more negative than positive in a globalized, integrated economy like that of today. As with all things in economics, circumstances are never the same and everything should be taken with evidence. What’s important is that you make up your own mind using information readily available, and use your influence to make policy that better suits not only the U.S. population, but the population of the entire world. As always, thank you for reading, feel free to leave a comment or message me with any questions or concerns you have, and be sure to look out for more!

To Insure Promptitude, Not Wages

My name is Ian, and I hate tipping at restaurants.

Did that get your attention? Ready to call me rude? Callous? Unwilling to accept the struggle that service industry workers go through every shift? Before you jump to any conclusions, just hear me out.

The service industry in the United States, in my opinion, has become a charade, a parody of work. Hundreds of thousands of people willingly go to work every day, knowing that their employer pays them far less than the federal minimum wage, and accepts this as the norm, with the hope that some generous customers will tip them enough to make up the difference. It’s seen in many different lights. Either this version of work is societally acceptable, with the mandate of the customer tipping their server 15%-20% of their check is seen as an act of good faith, or it’s seen as wage theft, where the ingrained responsibility of the consumer to tip their server has replaced the employer’s obligation to pay a federally mandated wage.

This post will explore the history of tipping in the US, and what would happen if service employees in restaurants were paid the same standard of wage as anyone else.

Why do we tip?

We all know to tip, but why do we physically do it? Apart from the societal need for our servers to actually live… is there something from history? As it turns out, the reason we tip comes directly from our past.

The American version of tipping wasn’t popular in the States until the late 1800’s. Before that, it was a way for Western Europeans in various aristocracies to show off to their peers. A T.I.P. (literally meaning To Insure Promptitude) was left before a meal or drink, so servers would be faster in bringing items out to customers. Wealthy Americans didn’t start using this payment method until just after the Civil War, in the late 1860’s, when they began making trips to Europe and seeing it for themselves.

Shortly after the end of the Civil War, when the South was going through Reconstruction, there was a quandary regarding how recently freed slaves should be treated in society. Legally they were freed, and therefore deserved to be paid for their work, but white owners of businesses did not want to pay them. Bring in the tip! By compensating low-skilled work (most often in the service industry) through customer gratuity, rather than through the fixed shackles of a wage (hope you get the sarcasm), workers have the potential to increase their earning power many times over by simply providing great service. This concept weaved its way through history, but likely not even the creators of the idea would realize what a national trend it would become.

Eventually, amended into the Fair Labor Standards Act in the 1990’s was the penultimate warping of this concept, into the two-tiered minimum wage system. Whereas the regular federal minimum wage currently sits at $7.25 an hour, the FLSA established provisions for a wage far below that level. Workers that receive more than $30 a month in tips qualify for a reduced minimum wage, of just $2.13 an hour, with the idea being they could make up their other income with their primary business activity, literally Insuring Promptitude. But making what was once simply a mindset into federal law had a two-pronged effect. It provided service employees with the opportunity to boost their earnings, sure, but it also allowed the people of America to steadily forget why they tip, and simply feel that they must tip.

My position on this issue is very simple. I, as a customer, do not want to directly pay the salary of the employees of the restaurant I eat at. My position is not against all of tipping, if my server does an excellent job then they deserve a tip. But forced tipping of 20% or more simply because the restaurant does not pay its workers a minimum wage, that I do have a problem with.

What if restaurants paid the real minimum wage?

Take an example, Restaurant X. X makes $25,000 a month in revenue, and let’s say after its food, drink, and management salary costs it has $3,000 to spare. X employs 8 servers for the month and pays those servers the tipped minimum wage of $2.13 an hour. For those 8 employees working 40 hours a week for 4 weeks, total wage expense to the restaurant is $2,726.40, and they have $273.60 left over in Net Income. If they were to pay the regular minimum wage of $7.25 an hour, wage expense for the month would be $9,280, resulting in a net loss of $6,280 for the month. From a flat comparison standpoint, as you can see, bringing wages up to the real minimum would not work.

Let’s imagine that our Restaurant X sells chicken and steak dinners and charges from $12-$24 for its entrees. The restaurant makes $25,000 a month, let’s say 30% of that is in appetizers, sides, and drinks. So 70%, or $17,500, is made with the entrees. Restaurant X would have to seat 973 different customers in a month to arrive at this number, with an average entrée value of $18. If the restaurant were to raise their food prices $3, making the new range of prices $15-$27, and they seat the same number of customers, they would make an additional $2,919 a month, not including any changes to their other food or drink items.

I will not continue going down the line until our hypothetical restaurant breaks even, but you can see how by raising their prices a marginal amount, or by making manageable investments into their ambiance and experience (for example, dim outside lighting and some foliage to stimulate a more formal evening crowd), our restaurant can make up the expense for paying their workers fairly. Yes, it can be done.

Is there any real-world evidence?

As recently as 2009, some big-name restaurant chains have experimented with raising their food prices and ending the practice of forcing their employees to rely on tips. Joe’s Crab Shack attempted this for three months before ending it, presumably because they could not continue the changes in many areas in which they operate. And largely, it does depend on the area. But restaurants all over the country are starting to buck the trend.

Take Packhouse Meats, in Newport, Kentucky. Packhouse decided to cut out tipping and instead, pay its servers a minimum wage of $10 an hour. This is high for industry standards, but Packhouse realized that several problems with the tipping system were resulting in a high turnover rate for its employees, and that cost a lot of money. They raised their food prices almost 20%, but on the flip side, encourages its customers not to tip. Ultimately the resulting money paid by the customer is the same, whether it be the old food price plus a 20% tip, or the new 20% higher food price with no added tip. In my opinion, this is a far fairer way to treat every stakeholder who participates in the restaurant system. The customer knows what they are buying and how much they are paying, the employee knows how much they are making and can still collect a tip if their service is truly exceptional, and the restaurant suffers little to no net change in margins. It should be noted for the critics of my position that Packhouse has since converted itself into a food truck, but it is unclear whether this was due to their wage policy or something else.

What can we do?

Demand side economists believe that wages are sticky. This means that they are affected by two factors, how much employers are willing to pay, and how much employees are willing to bargain. Once those two factors reach a median, the wage is set, and typically does not fluctuate much. Tipped wages are so low because tipped workers have let themselves believe that they do not deserve the same wages as everyone else, and feeds into the narrative of customers paying their wages for them. If you want this to change, then there’s a few things you can do.

If you work for a restaurant, start voicing your concerns to your employer. One voice is nearly powerless in the modern day right-to-work economy, but here’s a motto I often repeat to people in the industry: If every server in America got up and walked out the door because they were not being paid fairly, employers would have to pay them fairly or they would close their doors. Unions may be dying in this country, but that does not mean workers have no rights and need to accept what their boss gives them. If you eat at restaurants frequently, talk to your server about the idea of tips being built into food prices instead of a post-meal term of endearment.

In summary, tipping has undergone a transformation in America, from a ritual that rewarded service employees for exceptional job performance, to an excuse for restaurant employees to legally underpay their workers and leave customers societally forced to foot the bill. I believe that paying restaurant workers more fairly, by increasing the prices of menu items by a commensurate amount, provides greater transparency in the dining experience, leaves customers with the ability to still leave a tip for great service (its original purpose, after all) and most importantly, takes the pressure off the customer to subsidize the restaurant’s failure to pay its employees fairly.

Do you have any thoughts on this topic? Think I’m wrong and want to tell me off? Feel free to leave a comment on this post or shoot me a message with your thoughts! Thank you for reading, and stay tuned for much more!


Packhouse Meats:

Tipped Minimum Wage:

Fair Labor Standards Act:

Volatility, Fundamental Analysis, and the Bear Market of 2018

The week of March 20 – 24 2018 was the worst week for the American stock market in over two years. Both the Dow and the S&P declined over 5% in a week, entering correction territory, and concerns are mounting over the viability of Big Tech being weighted so heavily in various market indexes. Stocks are now slated to end the quarter in negative territory, and bond yields continue to steadily rise. With corporate tax cuts largely priced in, prospects for US-based companies to remain profitable and organically growing seem to be diminishing in the face of an ever more protectionist world. How, then, are retail investors like you and me supposed to make any money?

In this blog post, I will endeavor to explain the investing climate of 2017 and 2018 so far, with emphasis on events that have caused the recent spikes of volatility, as well as talk about my own investment strategy. I will mention various macroeconomic factors leading to the current climate, but as this is a financial markets oriented post, I will focus on how the markets look.

After the 2016 election, capital markets around the world became obsessed with the concept of Reflation, the idea that animal spirits would lead inflation to soaring new heights and the US and world economies would suddenly and magically revitalize and boom. During the ensuing months, both stock prices and bond yields rose rapidly, while the US Dollar strengthened against other major currencies. The British Pound slumped due to Brexit, the Euro took a hit when other elections were held, and the Yen continued to be a global safe haven but was weighted down by fears of a nuclear North Korea. But perhaps the most telling of this trend was in the VIX.

The VIX, or Volatility Index, is a measurement of how much implied risk there is in the stock market. It is comprised of a series of call- and put-options of varying lengths bought and sold on the S&P 500, and the actual VIX number is a measurement of the spread between those option prices. Traders will buy and sell call options if they believe the underlying security will go up, and will buy put options if they believe the underlying will go down. A higher number for the VIX means the price of a call and a put is wider apart, making there more ‘implied risk’ in the market, while a lower number means those options spreads are tighter, and less risky. For context, the VIX typically spikes during times of volatility and settles for longer periods of time when there is not as much.

What is telling about the 2017 stock market rally is that the VIX hit levels not seen since before the turn of the millennium. Not on the high side, which would indicate higher volatility, but on the lower side. Throughout almost all of 2017, the VIX declined from 14.04 to 9.22. For historical context, in 2008, the VIX peaked at 41. Volatility levels this low suggest that not only were spreads between buys and sells in the market extremely tight, but also explained why there were so few days of 2017 with more than a 1% move up or down. Investors seemed so sure that tax cuts and deregulation would spur the market to go even higher that they were actively making it play out that way. And it certainly showed; The S&P 500 index, as measured by the security ticker SPY, rose from $223.53 on 12/29/2016 to $266.86 on 12/29/2017, a 19.4% upward move. By many metrics, 2017 was a seller’s market.

2018, however, has not panned out the same way, and what was sunshine and roses last year may have started to show its vicious underbelly this year. NAFTA renegotiation talks have gone nowhere, China has created a new TPP alliance with the other 11 Pacific Rim nations without the US, and recent tariff actions have given rise to retaliatory measures and worries about a global trade war. The willingness of politicians and nationalist economists to rely on the strength of the US economy will likely be pushed to new extremes this year, as it is looking more likely that US consumers will be shut out, on at least some level, from the broader global growth we are already seeing. The Eurozone has had their strongest year of growth ever in 2017, at 2.5%, and China’s lofty ambitions to connect the world in trade has profound implications for global supply chains and international relations.

China, the E.U., and Tariffs all should have their own blog posts and thus do not belong in this one. Suffice it to say, however, that recent events have made it more challenging for companies to grow while being based in the US, and is starting to reflect in their stock prices.

Given all this, how should retail investors proceed with investing? Enter Fundamental Analysis.

My investing strategy is simple, at least compared to other strategies. I look at stocks based on company performance and fundamentals, with some attention paid to their industry and outlook. This is a strategy first coined by Benjamin Graham in the early 1900’s, called Value Investing, which stresses focus on company financials and performance, without much mind to what other investors are thinking or doing. This strategy is the opposite of Technical Analysis, which stresses analysis of stock price charts, discerning what is overbought or oversold, finding levels of ‘support’ or ‘resistance’ in a stock price (a range in which it stays based on buying and selling), and other terms reflective of what the masses think of a stock.

I prefer Fundamental Analysis to Technical Analysis because, though it may not be as glamorous or fun, it plays better to my Accounting background, and it holds up far better in financial down markets. The market outlook I explained earlier in this post leads me to believe that 2018 will be a buyer’s market, or a market in which the stock picker will have his choice of companies in which to put his money, and in which the seller of said company sees the down times coming and will want to get out while he is ahead.

Above all else, Fundamental Analysis is synonymous with a Buy-and-Hold approach, finding a good time to invest in a company for the long term, and reaping the rewards of the cash flows that come from it.

What is the point of this investing philosophy? I believe that to truly have a portfolio of companies that withstands the test of time, one needs to put in some due diligence and research those companies, understand their cash flow and how they operate, and not be distracted by what is going on around them.

My first step in researching a company I want to invest in is the most important step. I go to the SEC database and look at the company’s Financial Statements. There are a few Statements that show the company’s financial health. First, the Balance Sheet shows the value of its Assets (profit making items), its Liabilities (profit taking items), and its Equity (what’s left over). Recall from a previous blog post the accounting equation:

Assets = Liabilities + Equity

Meaning, if a company wants to make money, they need to have less Liabilities than Assets.

The second Financial Statement worth looking at is the company’s Income Statement, or Statement of Operations. This is the statement that tells you how well the company did at making money for that period of time. It starts at the top, with Revenue (gross sales), and subtracts expenses until it arrives at Net Income at the bottom. It is not uncommon for new, smaller companies to have negative Net Income but positive Revenue, as some higher expenses (such as marketing and interest) mean they are trying to grow into profitability more aggressively. However, I tend to like bigger, historically profitable companies better. At the end of each period of time, Net Income gets ‘closed’ from the Income Statement and rolled into the Equity section of the Balance Sheet.

The third Financial Statement to look at is the Statement of Cash Flows. This is the statement that shows the breakout of how the company moves cash around, and separates the non-cash items in other statements, such as depreciation and stock-based compensation. At the bottom of this statement, there will be a line showing the cash balance at the beginning of the period, a line for the cash balance at the end of the period, and a line showing how much cash was made or lost. At the end of each period, the cash balance will be rolled into the Assets section of the Balance Sheet.

Financial Statements for all public companies are posted for public inspection every quarter and can be found here: All you have to do is type in the company’s name or ticker symbol and their filings will automatically populate, for your viewing pleasure.

See also:

My second step in analyzing a company consists of running a few general ratios to determine how cheap or expensive the company’s stock is. Most important here is the Price to Earnings ratio, which shows how many times a stock is trading above its bottom line. This is where I determine which companies stand to lose the most in a downturn, and which are more defensive buys. Traditional Value Investing says to keep this ratio between 5 and 25, with companies below 5 being too cheap, and likely without the prospect to advance in future years, and companies above 25 too expensive, likely trading on irrational behavior and thus more susceptible to rapid price decrease on bad news. The ratio is derived from dividing a company’s Stock Price by its Earnings per Share (Net Income divided by amount of shares). For instance, in 2017, AT&T had a stock price of about $37 and per-share Net Income of $4.77, making a P/E ratio of $37/$4.76, or 7.77. This is on the lower end, which is good news, given the size and impact of AT&T as a company. However, it likely reflects the poor likelihood of their merger with Time Warner passing US regulatory overview and the impending lawsuit.

On the flip side, a tech company like Take-Two Interactive (the company behind the 2K and Grand Theft Auto video games) had a stock price of about $110 with per-share income of ~$0.98, making a P/E ratio of $110/$0.98, or 112.24! This company is a lead player in an industry with tremendous growth, as the rapidly changing world of video games gives opportunity to make some serious money, as long as they can continue pumping out fun, playable games. But a ratio that high? I’m not interested in that big of a gamble.

Another ratio to consider is the price to Book ratio. This one is not as important, but it compares the company’s stock price to the value of its Balance Sheet, or Book Value, to determine if the stock is trading lower than the company is physically worth. Recall that the Accounting Equation has Assets on one side, an Liabilities + Equity on the other side, meaning either side will constitute Book Value. I try to keep this ratio around 2. Much higher than 2 would mean the company does not have the capacity to make enough money to support their stock price, and much lower than 2 means the company is worth significantly less in the market than on paper, and may either be a fantastic steal or a money-losing proposition.

For an example of this ratio, we can again look at AT&T, who’s share price of $37 divided by its per-share book value of $13.97 (Assets divided by Shares Outstanding) gives a P/B ratio of 2.64. Our other company, Take-Two, has a stock price of $110 and a book value of $32, giving it a P/B ratio of 3.44. While both companies are trading above our median 2, This tells us that AT&T may not have much more room to grow in price without growing their company’s fundamentals, while Take-Two is priced entirely too expensively relative to their capacity to make money, and thus is far more likely to respond negatively to news rather than positively.

The Third step in my Fundamental Analysis is deceptively simple; I look for stocks that pay dividends. Dividends are part of a company’s profits that are distributed directly to their shareholders after the closing of every period. Companies pay dividends for a variety of different reasons. It could be that the company wants to reward its shareholders for being faithful to it and holding the stock, or it could be that the company has gotten so big and successful that it no longer has use for all its cash. A company that pays a dividend is generally seen as a ‘safer’ play, or a company that has more value to it. Newer or smaller companies, on the other hand, will reinvest all of their profits, or pay no dividend, in order to grow faster, at least theoretically. AT&T, being a historically large and profitable company, pays an annual dividend of $2 on its stock worth $37 per share, which means it has a yield of just about 5.5%. Take-Two, being the opposite kind of company, a fast-growing tech company in a highly growing industry, pays no dividend and retains all its earnings.

Other steps in my version of Fundamental Analysis, such as looking at industry growth rates and the price of competitors’ shares, are optional and not necessary. These metrics are generally all I use in order to determine which stocks are buys and which are not.

So, now that you’ve read how I choose my stocks, are you wondering how this strategy works in action? My last big stock purchase was with Cisco Systems (CSCO) and I employed this strategy to find an attractive buy point. Cisco is a giant tech conglomerate, with over 200 independent businesses under its corporate umbrella. They produce switches, keyboards, and other tech hardware you commonly see in offices and computer labs around the world. I had wanted to own this company for a while because of their size and yield, but thought they were always a little too expensive. Then, on August 17, 2017, it dropped to a share price of $31.33. On that day, its dividend was a very attractive 3.71%, its earnings per share was $1.92, giving it a P/E of 16.32, and its book value was $25.71 per share, giving it a P/B ratio of 1.22. With ratios like these, and such a high yield, I felt compelled to buy at that price. Maybe the company was getting some bad press due to the tax reform? Or maybe the company wasn’t responding well to the growth prospects of Tech as a sector due to their business lines being focused on hardware, and not software? Either way, I did not think the company was justifiably valued at such a low price, yet the market was telling me that they were. So, I simply had to buy it. Sure enough, just a few short months later, in March 2018, Cisco’s share price rose to a whopping $45! This translates into a 44% gain in a few months.

In conclusion, no matter what the challenges the stock market brings in the coming months, there are ways to make your picks wisely and profit. Fundamental Analysis is my investing philosophy of choice, focused on specific company performance and determining if the stock price is justified in comparison to the company’s financial fundamentals. As we move into more volatile, turbulent times, a level head and a clear investing strategy will see you through with a solid portfolio of companies.

Gun Violence: An Economic Problem with an Economic Solution

Guns in America are a uniquely polarizing issue. Some people are repulsed at the very sight of a gun, while others are in love with them and the culture they represent. Surely they have important importance throughout our history, but gun violence simply cannot be ignored. Almost all Americans agree that gun violence is a scourge on the country. You have probably heard these countless times, but some facts to consider:

  • The US accounts for 82% of the world’s gun homicide deaths
  • There have been over 12,000 gun homicides in the US annually since 2012
  • Americans own about 48% of all civilian-owned guns on Earth

(statistics taken from

I am not writing simply to regurgitate depressing gun statistics. Instead, I argue that gun violence in America is an economic problem as much as it is a societal one. After I make my case, I will propose an economic solution to the growing problem, that does not infringe on any constitutional right, but targets specific economic factors related to America’s unique obsession with guns.


It is not my intention to belittle or otherwise misuse any gun-related tragedy in order to make this case. However, I will be examining the most recent shooting and analyzing its economic impact to determine the ‘cost’ of such an event. The shooting occurred in Parkland, Florida (coincidentally, about 15 minutes from where I work). Often times we do not even think about the cost of things like human life, but I will endeavor to go over a few of those costs.

Parkland is an affluent suburb outside of Fort Lauderdale, Florida, so I will make a few assumptions (constraints). First, I will assume that the victims’ parents would be putting money away for their college years, rather than having to take out large amounts of loans. Second, the cost of living is somewhat above average. Third, the State of Florida has offered to pay for all final expenses as well as medical care, so I will assume that those pledges have been honored.

Now that we have our picture somewhat refined, let’s apply some reference data to outline our case:

Great, we have reference numbers to apply to this shooting. Now let’s run through the situation to apply the numbers.

  • 17 students were killed. Final expenses for these victims are $7,509 per victim, or $127,563 in total. In addition, 529 savings will have to be withdrawn by the parents on account of no longer being qualified (their purpose for being tax-deferred is no longer valid), subject to a 10% early withdrawal penalty. The total 529 money saved up is $476,425, so a 10% penalty would be $47,642.50. The economic impact of these two costs alone nets over $175,000.
  • 14 students were wounded and are still in the hospital recovering. Time spent in the ICU alone is $2,068 per day, for 5 days now, and we can assume they will have to stay in recovery for at least one more day ( This comes out to $173,712 in hospital costs. In addition, the initial operation itself, as well as additional tests (CT scans, X-rays, etc.) total over $10,000 (anecdotal evidence at Using $10,000, we arrive at a net of $140,000 for these victims. In total, these two costs for the wounded come out to just over $313,000.

There are obviously many more variables to consider, but add up the total cost for both wounded and dead victims and you will arrive at around $488,000, in just these specific categories of costs, for just this one isolated mass shooting. Would you be surprised to know that the Parkland shooting was Florida’s third mass shooting in three years? Fort Lauderdale International Airport suffered a shooting with five casualties on January 6, 2017, and the prior June, the Pulse Nightclub shooting in Orlando claimed 49 lives and wounded 58 others. Clearly, this is a far bigger economic problem than we thought.


How does any of this get paid for? Parkland is a unique example, with the State of Florida offering to pay for all final expenses and the socioeconomic status of the area suggesting most families carry health insurance. But what about all the other school shootings happening across the country? It would be foolish to assume the same applies to them. And there have been so many over the past few years, so many that I will not list them here.

Should the victims’ families be fully liable for all costs incurred because of a shooting? Why are the gun manufacturers totally removed from shootings, with nothing to lose when tragedies like these happen?

Today I propose a way to even the financial playing field, in a way that both forces manufacturers of guns to be (at least marginally) responsible for the atrocities people commit with their products, and that incentivizes good, responsible gun owners to be more proactive in demanding constructive change from their respective Congressmen and lobbyists. What I propose today, is Gun Insurance.


Gun insurance would work in the same functional capacity as car insurance or health insurance; it would shield the payer from far-reaching financial exposure to a catastrophic event, in exchange for a small monthly premium. Gun insurance would emulate various factors from both other types of insurance. Whereas car insurance is mandatory upon purchase of a car, being necessary to protect the driver from any large cost associated with adverse outcomes of operating a dangerous instrument, I would like gun insurance to function the same way. Whereas health insurance has variable premiums for different demographics of buyer, gun insurance can apply different premiums to different age ranges, prior criminal history or health issues (a ‘preexisting condition’), etc. Ultimately, I believe this is what is needed.

Roughly one quarter of Americans own at least one gun, that’s 81.5 million people. Nearly all, if not all of them, are responsible, take care of their weapons, and would never think of committing a mass shooting or other atrocity. But whether you believe the gun laws in this country have to change, or whether you think the mental health issues have to change, there is only one way any of them can really change. For the last decade plus, organizations like the NRA have successfully lobbied the Congress to not pass any significant gun reform legislation. Whether or not you think that is a problem, the fact remains that lobbyists against gun reform are extremely effective at influencing Congress to not take action in the face of increasingly overwhelming calls to action. Therefore, I submit to you that the onus of change in legislation, be it gun reform or mental health reform, is on their shoulders.

Gun Insurance would force these organizations and lobbies into action through financial incentive. Currently, if there was an automobile accident, the victim’s family is able to sue the auto manufacturer. If there is medical malpractice, the victim’s family can sue the hospital. But if there is a shooting, the victim’s family cannot sue the gun manufacturer. Insurance would change that twofold. Gun manufacturers would be subject to the same scrutiny over misuse of their products as automakers or drug companies, and would have to dole out cash settlements over cases in the same manner. All legal gun owners would be charged a premium, the same way all car owners are charged for insurance. In a year with no mass shootings or extraneous gun deaths, the manufacturer would not have to make any payments, so the premium would surely be infinitesimally small, say, $5 for the entire year. 81.5 million gun owners each paying only $5 a year yields $407 million in premiums to the gun manufacturers. But in today’s environment, where the quantity and severity of mass shootings seems to increase every year, gun owners would feel the pinch.

To be clear, my intention with this idea is absolutely not to penalize responsible gun owners for the acts of a few deranged monsters. I am predicating this solution on two factors. One, that nearly all Americans agree that something has to be done legally to solve the growing problem of gun violence, and that the gun lobby is the most effective agent to create that action. Two, that the surest way to make a presence felt is through someone’s wallet. Currently, the gun manufacturers and gun activist groups are shielded from negative effects of these events because they are not hurt financially. Gun insurance would allow them to bleed, the same as us normal citizens, whenever an atrocity like this occurs, and it would incentivize change to happen in the most organic way, from the bottom up.

Gun lobbyists would likely not seek to change gun laws, even if they were being financially squeezed. That would drive down availability of their products for demand-rich consumers. Instead, they would likely seek to change the country’s mental health laws. Are you upset that certain politicians blame mass shootings on mental health, but seem to not do anything to actually address mental health problems? This would be a way to change that. Again, regardless of what legislation you would like to see passed, influencing the people that control legislation is the best way to achieve something. Maybe not the optimal change, or the change any of us personally desire, but something. Something would be a significant improvement from what we have now.


If you’ve read this far, congratulations, you’re finally finished! I know this was on the depressing side of economics, but it’s important to know that everything in life has a cost, and a way to address that cost, if we think hard enough. As always, if you have any questions or comments, please leave a comment on this post or send me an email!

Pulling Money Out of Thin Air? Some Due Diligence on AMD

I was getting bored in class the other day, so I did what I usually do when I start to research a stock; I went to the SEC company database and looked up their financial statements. I then proceeded to fall down a sort of rabbit hole of accounting, to do with the ability of a company to issue more Equity (stock) and suddenly be worth more money. This post will be my endeavor to explain my thoughts, and to put them in context with some Due Diligence of the terrible excuse of a company I researched.


First, let’s go over the basics of accounting. Accounting is the universal language of business, and though the dialect of that language may change in different parts of the world, the fundamentals are simple. There is one equation that builds a business, and it is the same for every business:

Assets = Liabilities + Equity

Defining the terms…

Assets are the parts of a company that generate money. This ranges from Cash and Investments, to Land and Buildings, to Patents and Copyrights.

Liabilities are the parts of a company that lose money. Debt goes in this category, as well as any income taken in advance.

Equity, in simple terms, is what’s left. This is where the company stores its money. The Initial Value of issued Stock goes in this category, and any profit/loss from the year’s operations go in the Retained Earnings account in this category as well. The third most important account here is Additional Paid In Capital, the account that grows when the company issues more shares of stock.


Accounting uses the Double-Entry system, meaning an addition or subtraction from one half of the above equation must be matched with an equal change from the other half. For example, say my company bought a new car worth $20,000 with a $4,000 down payment and a $16,000 auto loan:

Assets          = Liabilities               + Equity

+$20,000        + $16,000                  +$4,000

Assets goes up by the value of the car, while Liabilities and Equity go up by the same amount, broken up by the value of the loan and down payment, respectively.

The two sides to this equation must balance at all times. Failure to balance isn’t necessarily breaking any rule or regulation, but it means the financial statements don’t accurately reflect the standing of the company it describes.


The company I was looking at, the company I love to chastise, is Advanced Micro Devices, or AMD. You may recognize the name, they are a chipmaker and a competitor of Intel and Nvidia. I should say for emphasis that both Intel and Nvidia are profitable. AMD posted a profit of 7 cents per share on just over 1 billion shares of their stock, or $70 million this past quarter. Let’s see if that number is really accurate.

AMD is, to quote a friend, the textbook definition of a memestock. They make chips that are used to mine cryptocurrency, and they’ve had a few other big headlines, and as a result, millions more shares of AMD get traded each day relative to other stocks in its industry. But this stock, as I will hopefully explain to you in clear enough terms, is a dumpster fire. To quote Gordon Gekko from the classic movie Wall Street, it’s dogshit.

Below is a snapshot of AMD’s Balance Sheet from the most recent quarter. Notice that the accounting equation shown above holds up.

A few observations to glean from this statement. Total Liabilities are about the same amount as Total Assets, which is very unusual for a tech company. But at the bottom, where the Equity section would go, their Accumulated Deficit account is tremendously negative, to the tune of $7.8 billion. This is the account that contains the sum of all their profits or losses, and from the look of their balance sheet, they have a lot of losses. This is directly offset by their Additional Paid In Capital account, valued at $8.4 billion, and providing almost the entirety of their Total Equity of $520 million.

Why is their APIC so high? That account can only be so high if AMD issues a lot more equity, no? Let’s dig a little deeper. Keep in mind that the accounting equation must balance, so if AMD issues $1 million worth of equity, they can report $1 million of cash to balance it out.


Below is AMD’s most recent Statement of Cash Flows. This statement takes their bottom line (net income) and breaks out the noncash factors to see how money really moves. Money, or lack thereof.

Let’s work our way down this statement to see the important things. First, AMD posted a net loss of $18 million this quarter, but issued $76 million of stock-based compensation. Warren Buffett would call this a red flag of financial disclosure. Normally, you would think, compensation is shown as a cash expense, meaning employees get paid with money. That would be recorded as a subtraction of Cash (on the Asset side of the accounting equation) and an increased wage expense, shown as a lowering of Retained Earnings (on the Liabilities + Equity side). Paying your employees in stock is not a huge deal, as long as it is recorded as an expense. When it is not an expense, then it is used to prop up earnings as equity accounts are increased, but not decreased.

Now that we understand that issuing equity to pay for things without including it in expenses is bad, look at the bottom of the sheet. You will see that AMD issued $38 million worth of stock to pay for their debt. This is not recorded as an expense, rather it is effectively canceling debt by issuing equity. If I understand this transaction correctly, they settle debt in stock, that is worth cash, meaning their Assets go up by the amount of money raised by issuing stock, and their Liabilities + Equity side remains the same by substituting debt for stock. This overstates their assets and lies to shareholders. If we subtract the $38 million in issued stock from the reported income of $70 million, we are left with $32 million. If we further subtract out the proceeds from issuance of stock from stock-based compensation as a financing activity, we are left with $23 million. Lastly, look at the Accounts Receivable line. This is where money that is acknowledged as revenue, but hasn’t come in yet (possibly due to terms on a contract or an accounting method) is recorded. If we take that into account, cash net income is profoundly negative, but we’ll leave that be.


Let’s move on.

Below is a snapshot of AMD’s note to its stock-based compensation plans for the recent quarter and nine month fiscal year so far.

You can see that AMD issued another 8.3 million shares of stock as part of compensation, at a value of $13.24. This comes out to $109 million in cash raised for this quarter in just this area of equity issuance. While this makes accounting sense, as I said earlier, from a point of view of a potential investor, this should raise a huge alarm! AMD only made $23 million in the current quarter, yet they issued nearly 4 times that amount in just stock-based compensation! That should immediately tell you that AMD cares about paying its management more than it cares about turning a decent profit, or returning capital to its shareholders.


The last item I want to look at comes from their financial statement note regarding their ability to pay income taxes.

Specifically in the second to last paragraph, AMD mentions that it has substantial deferred tax assets that have arisen from its losses in prior years. These deferred tax assets are Net Operating Losses that are accrued to the company when it doesn’t turn a profit. Instead of a direct payment from the government, this NOL can carry forward indefinitely to offset future gain. However, AMD states that “The realization of these assets is dependent on substantial future taxable income which, as of September 30, 2017, is management’s estimate, is not more likely than not to be achieved.” In lighter terms, AMD can offset those NOL’s with future gain, but management does not anticipate enough gain to materially make use of the NOL’s.

If that isn’t management saying they don’t expect to make any money, I don’t know what is. They say that, while they take home $109 million in company stock in just this last quarter. Insanity.


So, after all this, we know that AMD is barely profitable, if at all, and that they are only able to stay afloat by issuing massive amounts of Equity (to pay their officers and to pay their debt). Does that seem sustainable to you? It certainly does not seem that way to me. AMD is the recipient of a few headlines that play into all the market’s volatility (which as of writing this blog is in cryptocurrency) and the fanboys in that space trade this stock like it’s the next Microsoft. As a result, AMD is able to hold a price level of around $12-$13, despite having a Price/Earnings ratio of about 180. At that price point, with enough people still willing to buy this stock, management likely still feels that they can milk the company of its profitability while directly benefiting from Equity issuance to stay afloat. In this way, the company is essentially generating money out of thin air. At some point, there will either be too many shares outstanding to support the share price in the eyes of enough shareholders, or the company will run out of ways to pump out Equity, and the company will collapse unless it starts turning bigger profits. But who knows when that day will come.


If you read this far, I hope you were able to follow my thought process regarding AMD and some rigmarole of accounting! I will write in the future about how I screen a stock before buying it, and this is certainly part of that process. As always, if you have any questions, feel free to comment or send me an email, and as always, keep learning!



Pictures Taken From Source:

Balance SheetCash Flows pt 1Cash Flows pt 2Income TaxesStock Based Compensation

Personal Finance; Start 2018 Off Right!

For the first post of 2018, I thought we could switch things up a bit. Chances are, if you read this blog on a regular basis, you are already financially oriented and likely have a solid hold on your personal finances. This post is not for you. Instead, I will be sharing some helpful tips for getting your financial house in order, as well as what I personally do to make sure I’m not underwater.

Let’s start with some facts. Financial literacy is unfortunately not taught in public grade school, and as a result, few Americans come out knowing a whole lot about money. This shows in some data.

  • The nationwide average savings rate as of 12/22/2017 is only 2.9% (taken from FRED) meaning on average, people are only saving 2.9% of their income.
  • Fourth Quarter 2017 total outstanding Consumer Credit (credit card debt) is $3.802 Trillion! Divide this by the total US population (323.1 million) and you get $11,767, of this type of debt alone, for each American citizen.
  • Average deferral rate to an employer-sponsored 401(k) retirement plan for 2015 was only 6.8%, meaning employees on average only contributed 6.8% of their paycheck to this type of plan. Source:

We’ll stop with the data there, but this paints a stark picture. Income inequality aside, Americans on average are saving very little, have an enormous amount of debt, and are not planning for their financial future (retirement).

I’ll stop to clarify something here. In economics and finance, Credit is the same thing as Debt. Both are simply the lending of money at interest, and by itself, it is not a bad thing. A moderate amount of student debt ($40,000), at a reasonable interest rate (4%), in exchange for potentially doubling your earning power ($8.50/hour working retail or $20/hour working a professional service job) is well worth the manageable loan payment ($296 monthly at 15 years). Another example is the US Government. The government maintains a deficit of around $600 billion every year, meaning there is not enough tax revenue coming in to support its operations. However, if it borrows money to fund those operations, and those operations boost economic output, then the interest payments would be more manageable and the government could continue to function as normal (this is basic Keynesianism). I’ll explain this in more detail further down the post.

In short, Americans on average do not have a hold over their finances. There is too much money going out, not enough coming in, and we all pay the price in the form of low inflation and a weakening middle class. So, I have some advice on how to make sure your 2018 goes the right way.

  1. Understand Different Types of Credit – For most Americans, this is the biggest one, so it goes first on the list. Though we all borrow money for various things (mortgages, auto loans, financing appliances, credit cards), the rate of interest we pay on these varies a lot. For example, Student Loans are 95% backed by the Federal Government, so there is not much risk to a bank in lending them. As a result, the interest rate is mostly around 4-5%.


There are two main types of credit. The first is Revolving Credit, which includes the credit I referenced above (credit card debt) as well as Home Equity Loans and Home Equity Lines of Credit (HELOC). This credit type is generally classified as a certain amount of credit every period (monthly credit limit on a credit card) that should be paid in full every month, and any outstanding credit carried over to the next month will begin to accrue interest. For example, say I have a $500 credit limit and spend $400 of it, but can only pay $300 of that $400 back to the bank at the end of the month. The remaining $100 sits on my statement and I will have to pay interest on it until I can repay the original amount (the principal)

The second type of credit is Installment Payment based, which means any amount you borrow at a certain interest rate for only a certain amount of time. Common examples of these are mortgages, car loans, and payday loans. Unlike revolving credit, this structure is intended to be a one-time loan and fully paid back at the end of the term period. For example, if I take out a $400,000 mortgage for 30 years at 3.5% interest, my monthly payment will be $1,796. Note that for this type of credit, interest is calculated at origination, so total interest on my mortgage example would be $246,624, and this is built into my monthly payment.

What determines the interest rate on credit? The benchmark for determining an interest rate is the corresponding Treasury Rate. A mortgage typically runs for 30 years, so the rate would correspond to the 30-year US Treasury Bond, plus a little extra for the bank to make money. 4-5 year car loans also run closely with the 5-year Treasury. Revolving credit, carrying no term limit, is most affected by the Federal Funds Rate. But another big factor in determining this rate is your individual Credit Score. This is a number calculated based on your history with credit (past cards owned, payments made, etc.). The credit score range is from 200 to 900, with higher credit scores showing a higher ability to repay borrowed money based on previous history. The more able you are to repay debt, the less risk a bank would have to take by lending you money, so your interest rate would be lower to compensate. Try to get this number as high as possible.

Let’s come back to the US Government, from above in the post. How are they able to borrow such outrageous amounts year after year? Credit rating agencies give Governments scores based on their economic strength and their ability to levy taxes to pay their debts. Even though the US Government has not ran a surplus in over a decade, the size of the economy, coupled with the ability of the government to raise taxes if it needs to, means that creditors to the US have reasonable assurance of its ability to repay. This is, in essence, all a credit score is.


  1. Pay Down Outstanding Debts – I mentioned earlier that debt by itself is not necessarily a bad thing, but if you let it sit for too long, it can turn into a real problem. This is especially true for revolving credit. Since the bank doesn’t make money on credit cards if people pay their statement on time, the interest charged on outstanding balances is high to compensate. Credit card interest is typically as high as 25% on this money! To put this into a scenario, my $100 missed credit card payment above would be charged $25 in interest the next month. If I was unable to pay any of that back, interest would be charged on the $125, making me owe an additional $31.25 the month after. Because interest compounds, this has the potential to get out of control very quickly.


As for the other type of credit, loans are usually backed by some collateral that the bank can reclaim if you are unable to make the payments. This means the bank comes and repossesses your house. In the case of student loans, you are the collateral, so there is no way to default. Make sure you make those payments!


  1. Start an Emergency Fund – After you’ve paid down your high interest debts, it’s time to start putting money away. The best place to start is an emergency fund. Literally, this is an account for emergencies, if you suddenly get laid off at work, if you get into a car accident, money in this account should be able to cover these sudden expenses. It can even be used to save up for a down payment on a house, or tuition expenses. The typical rule of thumb is to put 3 to 6 months’ worth of pay in this account, but the amount varies with your personal situation.


An emergency fund should absolutely NOT be mingled with a checking account. This is reserved for money you will eventually need, but will not frivolously spend. My favorite place to have my emergency fund is an online savings account from a non-brick & mortar bank. There are several options one quick google search away, but I personally use a Goldman Sachs account that pays 1.4% interest. To contrast, the average big commercial bank savings interest rate is 0.05%, that’s quite a difference.

  1. Contribute to a Retirement Plan – Once you’ve erased your debt and secured a big enough cushion, you’ll want to start letting your money grow for you. The easiest way to do this is through a designated retirement plan. The two main types are Employer-Sponsored and Individual.


Employer Sponsored plans come in a few shapes and sizes, either 401(k), 403(b), or 457 (corresponding to the IRS code). If you work for an employer who offers these plans, you can elect to defer a percentage of your income to the plan. Each plan offers a set of mutual funds, selected by the employer, that you can choose to invest in. Your employer may also match your contributions up to a certain amount, as an incentive for contributing. The contribution limit to this plan for 2018 is $18,000.


Individual Retirement Accounts (IRA) are the second type of retirement plan. These do not require an employer to use, but they do require earned income to contribute (meaning wage or salary). I prefer this type of account because the individual has full control over which investments he/she can buy and sell. The contribution limit to this account for 2018 is $5,500.

Why pick these types of accounts over a normal brokerage account? These two accounts are Tax Advantaged. Under a Traditional 401(k) and IRA, you can exclude the full amount of your contributions from that year’s income taxes, meaning up to $23,500 of your income would not be taxable if it goes into these accounts. However, tax would have to be paid on any gains made on your money, and when you distribute on retirement. There is a second option, called a Roth, that lets you contribute post-tax dollars now, and lets the gains and distributions from these accounts be tax free later. Whether or not you should pick either one depends on your current tax rate and financial situation.

  1. Start Investing – If you’ve made it this far, congratulations! Your financial house is in order and you’re saving the right way for your future. The last thing to do is to start saving up in a taxable brokerage account. You can open one of these the same way you opened your IRA, and you can invest in whatever financial instruments your broker allows (stocks, bonds, mutual funds, currencies, derivatives, etc.). This is the most personal step on this list because at this point, how you continue to save and invest your money is entirely up to you.



Additional Info

If you are reading this for the first time, I can understand that it’s a lot of information to take in at once. So how do you keep track of it all? It helps to keep track of your income and your expenses all in one place, so you can look at your spending and see how you can be impacted by various changes. Microsoft Excel and Google Sheets are my personal favorite places. To track all of this. I have attached links to two types of Google Sheets I have used for tracking my financial situation. The first is a small summary that tracks expected income and has a simple expense budget. The second is far more detailed, and has separate sheets for every month as well as sheets for tracking your net worth.

Short: Edit only the cells shaded in green, and the rest will populate.

Long: Instructions are on the first sheet, follow them closely.

I currently use the second sheet, because it breaks out each month separately. The most important number to see is the Savings Rate, on the top of each month’s sheet. This is your revenue minus your expenses. Get this number as high as possible and you will be in sound financial position in no time.

I hope this helped you get your financial house in order. If you follow these instructions, you’ll be building wealth and starting off 2018 right! As always, if you have any questions or comments, please feel free to send me a message.