Friday, July 26, 2019

Sophistry of Suckers: The Sillyness of Self Insurance

"Become Debt Free! Pay off your home, then you don't need the insurance! Once your home is paid off and kids are grown, you don't need more life insurance! Stop paying all that additional insurance, its a rip off! You can save on the cost of insurance and invest in the Stock Market. You will grow your paper assets to the point where you are self insured at my good growth mutual funds that have averaged 12%." ~ The TV Financial Expert

All of these concepts mentioned, in this quote, are given out by many mainstream Finance Gurus. They may not express these concepts verbatim, but these concepts are the underlying theme of this philosophy. In my opinion, this type of thinking is like betting on horse racing without understanding the details of equines in the race. And, it can be risky. Let us look into this in more detail.

Self Insurance in Action with a major Catastrophe

Let us suppose you have a home that is worth $300,000. The mortgage is paid off, and you are debt free. You have accumulated in your 401(k) type plan $1,000,000. You take off your homeowner's insurance since you have been enough assets to be "self-insured". A violent tornado hits your local town, destroys your home, many local homes, buildings, and etc. Your home and all of its contents are totally destroyed. Nothing is left. What happens?

For starters, you are out of a home. Your home needs to be rebuilt. How much will it cost to rebuild? The preliminary estimate to rebuild your home may cost $300,000. In this scenario, it may cost more than that. Why? If the tornado hits the local town, chances are that other homes are impacted. Since there will be a higher demand for labor and materials, the replacement cost of the home just went up. Just think how that will impact your $1,000,000 if you are "self insured".

The contractors’ prices have risen, and same with the cost of materials. Materials that were destroyed from the Tornado, now must be transported into your town from another town. Prices of materials are now scarce, causing an increase in prices.

Let us not forget the home had other items, food, appliances, personal belongings, etc. All these items need to be replaced. Since there are not an unlimited supply of refrigerators, TVs etc, that either requires a wait for your type of appliance, or deal with a sharp an increase in the price of the appliances.

While your home is being rebuilt, you need a place to stay. If there are hotel rooms available, they also are scarce, causing the room rates for the local hotels to increase in price. Please do not forget, other people are seeking shelter while their home is being rebuilt; just like your family. This factor must be deducted from the $1,000,000 cash balance.

This may be a worst case example, but ask the folks during major storms if these things did not happen. Most homeowner policy holders quibble about the replacement cost, but never stop and analyze the complete economics of the situation in a major catastrophe.

This is why a comprehensive homeowner's policy is very important. Insurance provides the leverage to protect a valuable asset for little cost relative to the value of the investment or asset. In this horrible case, the most of the retirement cash monies would have been protected from the tornado. The majority the risk was transferred to the insurance company for a fraction of the net worth of the insured. The insured would keep the $1,000,000 cash in the 401(k), plus the insurance company would cover the expenses related to the replacement cost of the home. The insured would also receive $300,000 from the insurance company to replace the home. The only cost incurred by the insured in this scenario if he had Homeowner's Insurance, would be payment for the deductible.

Your 401(k)/IRA/Qualified Retirement plan being "Self Insured at Retirement"

Our previous example shows how having a proper Risk Management strategy can protect several assets in one catastrophic event, how about your hard earned cash retirement savings? Is it protected if you are "Self insured"? Let's take a scenario to show how being "self insured" at retirement is equally insane as the prior example.

You are 65, and your 20-30 year low cost, cheap term insurance policy has expired. You could choose to keep it in force, but the premiums are now annually approximately in the four figures, as the premiums are increasing exponentially per annum. They also are projected to renew annually, so you opt out of the renewal. You have $1,000,000 saved in your 401(k) plan, no need for insurance, right? Your home is paid off, and according to your experts you are "self insured".

Here are some things to consider that are potential catastrophic "Risks":

1. Taxes- As the $1,000,000 is withdrawn, from the 401(k), it will be taxed as earned income. Depending on how much is withdrawn annually, this money will be taxed on the current Earned income tax schedule. Of course, the home is paid off, so no interest deduction is used. In case of an early death by the 401(k) account owner, the IRS will want this money to counted towards the Estate Tax. If the money is still inside a 401(k) plan, the beneficiaries will need to ensure that that money is rolled into a qualified plan. If it is not, it will be taxed again. These funds must be withdrawn, from Qualified plans, before 70 1/2, otherwise more tax penalties shall take place against those funds.

2.Health Concerns-One of the fast growing segments of our population are people living to be age 100. But, there are obvious health concerns that are more common with the elderly population than the younger population. Let's hope that $1,000,000 can fill in the gap for those needs. If those needs are not met, then the need for Long Term Care, Pharmacy visits, Occupational Therapy, Physical Therapy, or other rising health care needs can not easily ignored if you are "self insured".

3.Day-to-Day Expenses-People worked their entire lives to enjoy retirement. What will be the quality of life? How long will that money last? Will you outlive your retirement savings? Cost of food, gas, other goods and services change with are Fed monetary policy and Government Spending. What will be the cost of gas? These things impact your wallet.

4.Safety of Principle-Based on the external factors of inflation, interest rates changes, stock market, bond market, and other external financial vicissitudes, will your hard earned retirement savings be surreptitiously eroded do to these factors? If so, how can you mitigate these risk?

5-Baby Boomers-This age segment of the represents approximately 28% of the total population. This age segment will make all the resources needed for this age segment more scarce, the net effect will be an increase on the price of services and goods specific to the needs of retirees and other age groups.

Based on these factors, having just cash in the bank at 65 may not be enough. All these concerns must be considered.

What needs to be done?

Taking control of your financial future is the first step. Becoming more familiar with the world of investing, insurance, etc is a way of mitigating these risks. Another way is transferring this possible risks to an insurance company, advisory firm, etc. These entities are experts in management of risks and assets.

The current popular belief that one product or one plan is the silver bullet for every situation. Unfortunately, this is not the case. The other myth, is that one product is cheaper or better than other products. This is also not the case. Each product exists to serve a purpose. If no one needed that product, it would not exits. It is your job to fit the correct product into your goals and plans.

In closing, simply being "Self-Insured" for retirement is equally as foolish as the person that removes his hazard insurance policy from his home. It eliminates the use of leverage, which is a vital tool in developing, maintaining, and protecting wealth.  Having a proper risk management strategy is equally important for your cash savings as well as for your other fixed assets.

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Saturday, July 13, 2019

Taxation: Do Costs determine Prices?

In the advent of intense competition, due to rise of  innovation and technology, domestic consumers are benefiting from higher standard of living, at lower costs. Due to this exponential expansion of growth, contemporary economists are analyzing in great detail utilizing a menagerie of statistical models to provide civic leaders the most precise information—these leaders feel compelled to make an informed decision while making public policy.

While these publicly elected officials engage in that decision making process, the subject of taxes always seems to rear its ugly head. For some, they see taxes as a necessary function to fund the operations of government. While others may quibble regarding the role of Government in today's society; the notion of excess taxation always strikes as a rapier into the hearts and minds of the general public, nonetheless, it still something of worthwhile analysis.

While the political experts engage in verbal combat over the notion of taxation, two questions always rise during these debates is about this notion: Who pays the tax? Is the tax passed down to the consumer?

Before these questions are analyzed, let us recall the supply and demand model. With this supply and demand model, there comprises two intersecting curves. The first curve, rising from left to right, is the supply curve. This represents the supply of a certain "good" provided to the market. The demand curve, sloping downward left to right, represents the consumers desire for that particular good. Both curves are analyzed graphically as follows: The horizontal axis(x-Axis) shows the quantity of the good, and the vertical axis(y-axis) shows the price of the good. As the two curves intersect, they reveal the Equilibrium point. This is the market price for that good, assuming all things are  constant(ceteris paribus).

Back to our two questions: Who Pays the Tax? Is the tax passed down to the consumer? Before we answer these questions, more analysis must be completed, so patience is required. With regards to taxation, it must be conceded that the notion of taxation is a trade off. A trade off: In a republic, in order to have various Government "positive liberties", namely, public goods, to be provided to its citizens, taxation is required to underwrite this political model. Since it is a trade off, that means there is an economic cost related to having Government provide these "positive liberties". We shall keep our analysis of the costs restricted to taxation, as the costs are many. Oh, and speaking of cost, in an economic sense, taxation is a cost.

Economic costs play a role in the bringing of goods to the marketplace. Each firm must gather up all the factors of production in order to bring their goods to consumers to purchase. Those individual firms must pay some sort of tax on those goods. Now is the time we must address the first question: Is the tax passed down to the consumer?

Here is the answer: Yes and all depends. Yes: If the good's costs are increased due to taxation, and the consumer sees the good as inelastic, meaning they are less concerned with the price of the good relative speaking, the consumer will simply buy that product. When this happens, the consumer simply absorbs "some" of the costs of the good. No: If the price of the good pushes the price elasticity to the point, for the consumer, where the good goes from "inelastic" to "elastic", the firm selling the good begins to lose gross revenue. This is due to the fact that consumers have found alternative uses for that product, due the price increase. Based upon these answers, it all depends...depends on the price elasticity of the consumer purchasing the good. In both cases, the consumer pays the cost; this is due to the fact that owners of firms are also consumers. So, firms and consumers pay the tax.

In the latter case, once revenues decline, firms are unable to purchase more of the inputs for that good, subsequently increasing the scarcity factor, which leads to a higher economic cost of that good. This cost is absorbed by firm, due to the fact it has declining revenues and increasing input costs for the good; the consumer also is impact, as the good’s economic cost increases due to scarcity.

Now it is time for the supply and demand model to be revisited. As previously stated: The equilibrium point is the market price. Stated differently, this is the optimal price firms can sell the good. If they sell the good at a higher price, based upon elasticity of the good, they will sell fewer  units. This is an instance where the economic cost of the good is paid for by the firm.

Since the equilibrium price is the optimal price, as previously stated, the cost is passed to the consumer; the final price is not determined by cost. If the good’s price was determined by the cost, the firm could simply raise the price to meet the costs of the good, but the business runs the risk of having declined sales. The equilibrium price demonstrates the power the consumer has with the sale of the good.

The discussion of taxes is never a pleasant one. It always lends itself to cantankerous banter, and distribution of mis information...bordering on prevarication. When individuals state that the cost of taxation, of a good, can be simply passed onto the consumer, this is a misspeak of the facts.

Tuesday, May 21, 2019

Trade War: Who is Vulnerable?

Trade Wars. Easy to initiate, but challenging to terminate. As the trade war escalates between China and the United States, many economists have provided their insight to this international trade war. Of course, the overall analysis would not be complete unless I provide more insight into this situation. Please note: My perspective has nothing to do with my personal political views for any politician, as I am analyzing this from an economics framework.

This article, Who is Most Vulnerable In A Trade War?, analyzes which side, China or the US, is the most vulnerable in this conflict. I have a perspective, and I will use economic logic to support it. I will also look at the position of the allegations of China’s intellectual property theft of US firms and if that is a proper reason to raise tariffs on US Imports.

Who is Really Vulnerable?

First of all: The question is built upon a faulty presupposition: “Who is the most vulnerable in a trade war?” The question is framed from a collective: China or The United States. This needs to be made clear: Trade does not happen between two countries, but individuals. Individual firms, in China and the United States, engage in voluntary trade with each other. It is not about which country will be hurt the most with this “trade war”; rather it is about the individuals who will be impacted from the increased economic cost forced upon their distribution process.

For example, if a Chinese steel manufacturer sells his steel to a United States supplier, and tariffs are raised in the United States, the supplier, in the US, is impacted. Depending on the price elasticity, namely, how sensitive the consumer is to price increases, the supplier will stop purchasing Chinese steel. Or the firm may continue to purchase the steel, and absorb the price increase, or raise his prices. There are many variables here to consider. In the case of the US Supplier is unable to purchase Chinese steel, the domestic firm may go out of business if he can not absorb the cost, or if he can not sell his product at a higher price. In this scenario, the smaller US Suppliers are vulnerable, along with the Chinese steel maker.

As an aside: With any tax increase, it is always subject to elasticity. With regards to tariffs, this is no exception. For example, if tariffs are raised to 100% on all imports, the possibility of the tax revenues generated, from the tariffs, will be close to zero. If the tariffs are set at 0%, it is obvious that the revenue generated from tariffs will also be zero. In between the minimum and maximum, the Federal Government will set the tariff rate. This is done to optimize all factors: elasticity, tax revenues, and etc.

Secondly, simply stating, “Oh well, the Chinese will lose here, and the US will be able to absorb the tariffs”, is specious statement. This is framed in a means that the “wins and losses” can be accurately quantified, in order to “keep score”. Economics is not a quantitative science, but it is a qualitative one. It is built upon the fact that human beings act, and their actions are driven to obtain “happiness”, as these economic actors utilize subjective means. It is possible to attempt quantify some things within economics, but that explicit analysis will never capture all the economic costs, as that feat is impossible.

Back to the specious statement...if we could actually keep score, how is it done? Can the United States’ economists analyze the potential economic impact of billions of people (China), as compared to the hundreds of millions (United States). This means, to capture this data, the economists would need to determine the needs of all the citizens in both nations, and figure out all the preferences of the individuals involved in the entire supply chain process. This too is impossible.

To state following: "Who is the most vulnerable" simply is a derivative of the "us vs them" dynamic, which is a common theme in sports. Voluntary exchange is not a "football game" where there are winners and losers, yet it is about both sides benefiting from the mutual exchange. Once intervention by fiat takes place, e.g. from the Government, the economic costs are raised. In this event, all sides are "vulnerable"; mainly the smaller firms in China and the United States.

“But, China is stealing from the US Firms!”

There is always a risk of asset theft in any market. Theft happens in the American market. To propose it never happens is quixotic, and to propose it happens 100% of the time, is equally nonsensical.

However, let us suppose this is true. Let us suppose that it is true 100% of the time. Questions would need to be raised to address this claim. For starters, why would any firm do business in a market that has an absolute risk of Intellectual Property theft? If the risk is that high, no firm would do business in China. Not one. Yet, it is evident US firms still do business in China, despite the risk of IP theft. The risk of that IP theft is built into the marginal cost of every product sold on the retail market. If the firms' marginal cost exceeded the marginal benefit, based upon this risk, they would seek alternatives. The fact that some US Firms still engage in the Chinese market means this allegation is not an absolute, but a percentage...which is all about a probability of risk. Due to the fact is about a probability of risk, US firms conducting business in China must determine the means to manage this specific risk.

If every single firm is a victim to the nefarious Chinese US IP theft cabal, and tariffs are the solution to mitigate the IP theft, the American people are paying the insurance for the US firms doing business in China. As previously mentioned, since it is not an absolute risk, this means there is a probability of risk. Since the rationale of the use of tariffs acts as a response to Chinese IP theft, this means the tariffs revenues collected act as “insurance”, to indemnify the US firms’ stolen IP assets (allegedly). If this is true: How are the premiums calculated? This process would require an evaluation of the IP assets of every single US firm, doing business in China. Also: The Government would need to factor in all the risk factors calculating the premiums. This assumes those tariff revenues actually go to the firms that file claims for IP theft. In the event this happens, this creates a moral hazard involving the US Firms. Those firms would have little to no incentive to internalize the risk (cost) of doing business in China. They will simply conduct business as usual, seeking Government funded protection from the risk of IP theft in China.


Firms must absorb all risk associated with their projects and endeavors. The costs, related to the risk, along with other costs, are factored into the development of the product as it is brought to the marketplace for sale. If that risk, is mitigated with the use of Tariffs, then that risk is passed on to the American consumers via higher taxes or tariffs.

Back to the earlier portion of this analysis, smaller firms would not be able to compete properly, due to the increased economic cost of the tariffs. The larger firms would be able to absorb the costs, yet would they actually be indemnified due to a loss? Furthermore, will the revenues from the tariffs be held in some sort of “reserve” account for these firms who need to file a claim from stolen IP assets from the Chinese?

Saturday, May 18, 2019

How Central-Bank Interest-Rate Policy Is Destabilizing Banks | Justin Murray

A brief conceptual overview of how Federal Reserve established interest rates impact banks.

How Central-Bank Interest-Rate Policy Is Destabilizing Banks | Justin Murray: Broadly speaking, banks operate under the concept of maturity transformation. Banks take short-term – less than one year – financing vehicles, such as customer deposits, and use that to finance long-term – more than one year – returns.

Wednesday, May 15, 2019

More Thoughts on Trade

Free Trade. Voluntary exchange..something all human being engage. This is no exception. The biggest misconceptions is that trade is a zero sum game. This is false. Trade is simply an exchange, as both parties are seeking to obtain “happiness”. Both parties benefit from engaging in voluntary exchange.

Trade is not equal

When two parties engage in a transaction, the respective parties have different valuations on the goods exchanged. Suppose I am seeking a case for my iPad Pro: What happens? For starters, I review the various items, in the Apple store, and compare prices. Why am I comparing prices? Perhaps I have a budget, and I must consider the other items. I have scarcity: I must purchase the iPad Pro with my limited stack of cash. As I review the inventory of iPad accessories, I locate the case: $49.99 plus tax.
I go to check out register, I provide the cash for the iPad case. The cashier rings up the order, bags up my item, and I walk out of the store. The store values the cash, $49.99 plus tax, more than they value the iPad Pro case. They need my money in order to purchase more inventory, cover its fixed and variable cost associated with the business operation. On the other hand, I value the iPad case over the $49.99 plus tax I paid for the accessory. Both parties value the items, in the trade, differently.

Trade is balances(?)

Before going into a simple analysis on how trade is equal and it balances, another concept must be introduced: Money/Currency. Money is utilized as an intermediary in the voluntary exchange, since the process of barter, is quite clumsy and inefficient. Why would the Apple store take two cows for an iPad accessory? They are in the electronics business, not the farming business. Money simply holds value, acts as a financial intermediary, and it acts as a score keeper. Prices are typically expressed in terms of money.

Although the valuation of the respective “goods” differ (The need for the iPad by the buyer, the need for the money by the seller), the accounting is equal or it balances. On the Apple store’s books, they will realize an increase in cash, but a decrease in their inventory of iPad accessories. Those entries shall equal based upon the transaction price. Note: This analysis is not going to go through all the GAAP details needed to make proper bookkeeping of the transaction, just the cursory journal entries are covered here. The buyer has a decrease his cash balance, but he increases his goods inventory by one iPad accessory. The trade balances. Of course, we can account for this balance expressing the transactions in terms of the money used.

But is there a Trade Deficit?

Suppose I compare how many iPads I purchase from the Apple store versus how many iPads the Apple store purchases from me? Using this sort of analysis would yield a deficit. However, I am not in the business of selling iPads to the Apple store. The Apple store already sells iPads—why would they need to purchase iPads from me, yet they are attempting to sell them for cash? When Government economists are analyzing the “trade deficit”, this is the basis of their analysis. This sort of analysis does not include the subjective value of the parties involved in the trade, nor does it account for the varying goods, services, talents, and skills have—and the things that the other party desires or values. If a person is comparing the exact same items that both parties should purchase from each other, it will show a “trade deficit”, but this notion makes no economic sense.

Comparative Advantage

All of us are born with a certain set of skills, talents and abilities. As we mature, if we identify these talents, and develop them, we enter the marketplace to promote them. For example, if I am an aspiring musician, and I want to showcase my talent, I will sell my time to perform a concert for others. When I perform this concert, I would be compensated, with money, for my efforts. In this case, I value the money being paid, over the time spent perform the music. I am not seeking to trade music for music...again that is nonsensical, for the reasons previously mentioned. I am seeking to obtain the money to payback some of the expenses related to musical development, and to continue the promotion of my talent. Oh , yes, I would need to eat, sleep, bathe, and those sort of trivial matters.

Since the fundamental condition of human behavior is to “seek happiness”, I shall use my talents and gifts to engage in voluntary exchange to obtain happiness. The notion of comparative advantage is all about what skills I have compared to the other party in the trade; both parties can benefit via the trade with each other. Neither party will have the exact same skill, nor will either party value their skills equally, as they want what the other party is offering in the trade.

The Missing Part in Trade Analysis

While there are growing concerns regarding the trade deficit, people are pushing to “balance” the trade. Yet, trade is balanced. It is balanced for every single individual transaction, on the micro level, and it is balanced at the macro level. What is still causing the concern of a trade deficit? The analysis of comparing how many goods one party purchases from another party is the main issue in this analysis. Stated differently, using our example, the concern is that the Apple Store is not purchasing the same amount of goods from me, as compared the same amount of goods I purchase from the Apple Store. On the surface, this seems plausible, but it is not. There is another part missing in this analysis: The money.

If money is analyzed as a “good”, then it is simpler to understand that there is no trade deficit. For example, a firm in another country, produces the ZPad. I go online to purchase the ZPad. The exchange follows the pattern as previously mentioned, and to complete the transaction, I pay for the item with US Dollars. This firm, located in another country, is glad to receive my money. At the time of this writing, the US Dollar currently is the reserve currency, this foreign firm values my dollar over his currency and the product he is selling. The US Dollar allows him to pick up more items, in his native nation, more cheaply, which allows him to purchase more inventory to sell. At the macro level, this sort of activity increases the capital base, as the banks, and other financial institutions, and accumulate more US dollars to develop, loan out, and build the local economy in that nation.

Eventually, those US dollars make their way back “home” to the United States. Those foreign banks will invest into US assets, i.e. US Government Treasury Bills, Real Estate, and other assets located in the United States. As those assets are purchased, those US dollars are deposited into banks based in the United States. It all balances, and it actually comes “full circle”.


There is no such thing as a “trade deficit” in voluntary exchange. There is not a zero sum transaction when trade occurs. Both parties benefit from trade despite the fact that both parties value their respective goods differently. And, if there are concerns about if the trade “balances”, always follow the money.