China's Warren Buffet, Guo Guangchang

Guo Guangchang elaborated his investment strategy during an interview with the Financial Times, which was published in the November 8/9, 2014 edition of the daily newspaper.

"The aim of tai chi is not to strike first to gain dominance over an opponent but to wait and hit at the right moment. That is, to be the first one to take action after feeling the change in momentum. Investing is similar to doing tai chi. No one holds a permanent speed advantage in the market due to the limits of human intelligence and vision. Your advantage comes from your ability to feel the change faster and take decisive action faster."

Buddhism teaches you that "everything starts from your heart, and feeling the heart of others is the most important doctrine in Buddhism. In doing business that means seeing things through other people's eyes. I feel that doing business is just like practicing Buddhism. Money is not your only purpose. Your purpose is to make things better for other people, and in the end, money will come as a result."

"Business is also the best form of charity. By making a company successful, you can provide more employment, and, if you treat your staff well, then your business itself becomes a charity."

Guo Guangchang, age 47, is the co-founder of Fosun, an $8bn conglomerate in China, which he co-founded with three university friends in 1992, using Rmb38,000 as the company's founding capital. (Today, Rmb6 = 1 US dollar.) Fosun is the largest private conglomerate in China. It has investments ranging from steel to mining, tourism to pharmaceuticals.

The name Fosun means "star of Fudan University", Guo's alma matter and Shanghai's most prestigious academic institution. At Fudan, Guo got a degree in philosophy.  He also honed his business skills by selling bread to hungry classmates when they finished studying at 11 each night. He earned Rmb5 a night, which seems a paltry sum until he points out that his monthly expenses were only Rmb30 at that time.

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Quiz. Calculate Guo's monthly profits from selling bread while in college. Next, express the founding capital for Fosun in terms of number of months of profits. Next, compare the result to the number of years required to complete a college degree. Did the founding capital for Fosun come entirely from Guo's selling bread?

If we assume that Guo sold bread for all 12 months of the year and that his college term lasted 4 years, then his profits from selling bread amount to only 15% of Fosun's founding capital! Derivation: [(Rmb5 earnings/day x 365 days/year x 4 years) - (Rmb 30 expenses/month  x  12 months/year x 4 years)] / (Rmb 38,000 Fosun founding capital) = 15%.

So, Guo must have had other sources of capital.

Author is also on Twitter.

New Analysis of the Financial Crisis

Nobel laureate Joseph Stiglitz reviewed and applauded the latest book by Martin Wolf, chief economics commentator at the Financial Times.  Inside finance ministries, few are cited as often as Wolf, according to the Economist.   

The book is entitled The Shifts and the Shocks. The review appeared on Aug. 29-30, 2014 in the weekend edition of the Financial Times. 

See Stiglitz' review.

Quoting Stiglitz, "The dismal picture painted by The Shifts and the Shocks is a forceful warning against the unfounded optimism that has episodically struck each of the countries in the north Atlantic as they grasp at any wisp of positive news: we are mired in a malaise, from which we are not likely to emerge any time soon."

(Also, see the Economist's review, which I discovered after the fact.)

(Also, see the book's other editorial reviews, which were also discovered after the fact. For example, George Soros writes, "The crisis is not yet over.")

The Cause: Excessive & Rapidly Growing Private Debt

Reading Stiglitz' review led me to the subsequent discovery -- don't ask me how! -- of Richard Vague, former banker and credit card expert, and co-founder and CEO of three companies. He has authored a book entitled The Next Economic Disaster.

Vague has done his own analysis regarding the primary cause of the financial crisis of 2008/2009.

He says the primary cause was rapidly growing private debt which reached excessive levels.  This has always been (and will always be) the primary cause of major financial crises, he says. 

Today, U.S. private debt stands at $26 trillion compared to public debt of $16 trillion, according to Vague -- see reference below. Today, U.S. private debt-to-GDP ratio stands at 156%, down from 170% at its peak before the financial crisis. In 1950, it stood at 56%.

Vague claims that the following rule may be used to predict future financial crises, a claim which is based on having studied 22 major financial crises.

When private debt relative to GDP grows more than 20% over 5 years and when private debt relative to GDP exceeds 150%.

Today in the US, the second criterion has been met but not the first one. However, in China, both criteria have been met and make the situation alarming: private debt relative to GDP has grown by at least 40-50% over the past 5 years and the private debt-to-GDP ratio stands in excess of 180%. 

The basic message is the following: Excess private debt creates too heavy of a burden for servicing that debt. This then puts a dampener on economic growth.  

For example, today in the US and Europe, the consumer is overburdened with underwater mortgages, which means that he cannot spend as much on goods and services. (In Japan in the late 80's, the problem was excess debt on commercial property, and Japan's economy is still suffering after 25 years.)

What has been missing from public policy since the financial crisis is a comprehensive plan for restructuring private debt (i.e. reducing the debt burden).

To prevent future financial crises, one would have to curb the rapid growth of excess private debt.

To further explore Richard Vague's thinking, please visit:

• Home page for Richard Vague's analysis.
• A good starting point is his interview: sections of it (3 minutes); full version (26 minutes). 
• The article from the Atlantic is noteworthy as well as the one from the Financial Times. 
• There's also a report and a book. 
• There's also lots of historical data and charts.

An article on Yahoo's finance web-site dated Sept. 18, 2014 quoted an article just published in Foreign Affairs which argues that the Fed could have given money directly to the people instead of following QE (quantitative easing). This seems consistent with what Vague is advocating. (1) Link to summary article on Yahoo. (2) Link to original article in Foreign Affairs, which is authored by a Brown University political economist and a hedge fund manager.

Private debt is to be distinguished from public debt. Private debt consists of debt held by individuals and businesses. Examples of debt held by individuals are: home mortgages, consumer loans, car loans, credit card debt, and student loans.  Examples of debt held by businesses are: business loans and corporate bonds.  Public debt consists of government issued bonds (e.g. what are known as Treasuries in the U.S.)

Elements of the Malaise

Perhaps the malaise described by Martin Wolf and confirmed by Joseph Stiglitz could be shortened if Richard Vague's policy recommendation was enacted. 

Stiglitz points out some of the elements of the malaise as being:

• high income inequality 
• high unemployment rates
• dysfunctional banking sector
• investor focus on speculation instead of investments in infrastructure and global warming solutions
• insufficient progress on health and education

The Wall Street Journal had an article detailing the weakness in median household income growth as a long-term historical phenomenon in the US. See article here, as published by Yahoo on Sept. 24, 2014. The same topic was picked up by the Financial Times on Sept. 16, 2014 in this article. 

The Other Cause: Psychopaths in Wrong Playground

On Sept. 2, 2014, the Financial Times published a letter from an 80 year old retired physician formerly from Las Vegas who now lives in Switzerland. The letter was a response to Joseph Stiglitz' review. 

The physician argues that the financial crisis was caused by psychopathy. See the letter here.

The Solution (Part I)

If we could agree that the true cause of the financial crisis has been precisely that which was identified above, then the solution would lie in removing these causes.  In doing so, we'd be relying on nothing more than the relationship between cause and effect, which means that if we know that the thing called "cause" produces the thing called "effect", then in order not to have "effect", we would need to eliminate "cause". 

(Of course, there may be another cause, albeit unknown, which we'll name by "cause 2", which could also produce the same effect called "effect". To the extent that such "cause 2" may exist, the proposed solution -- which consists of eliminating the thing called "cause" -- would be incomplete. Added later: Please see below for Part II of the solution.)

The causes that were identified above were twofold:

1. Rapidly growing private debt which reaches excessive levels 
2. Prevalence of psychopaths within the financial industry, and who aren't required legally to take personal responsibility for their actions, unlike in the medical field

Afterthought: The Geneva Report

The 16th annual Geneva Report was just published, as of Sept. 29, 2014.  One of the report's authors is Luigi Buttiglione, head of global strategy at hedge fund Brevan Howard.

The report warns of high world debt - private and public combined. World debt stood at 215% of GDP in 2013, up from 200% after the 2009 crisis, up from 160% in 2001. The message is that the world hasn't deleveraged since the financial crisis!

The report predicts that interest rates worldwide will have to stay low for a "very, very long" time to enable households, companies, and governments to service their debts, according to an article in Financial Times.

It warns that record debt and lower growth form a "poisonous combination".

See news coverage of the Geneva Report here. See the report's overview here with interesting charts, and the report itself here.

The Solution (Part II)

Who is the Economy Working For?

Amir Sufi, who holds a PhD in economics from MIT and is a professor of finance at the University of Chicago School of Business, prepared a statement for a hearing of the US Senate Committee on Banking, Housing, and Urban Affairs, dated Sept. 17, 2014.  

A summary of Sufi's statement is as follows:

1. The economic recovery since 20090 has been "dismal".
2. The reason is due in part to the lack of any rebound in wealth among middle and lower income households. This matter is related to real income shrinkage among all but the top 10% of households.
3. What triggered the Great Recession was the massive pullback in spending by indebted households.
4. Two important lessons from their research are:
1. Encouraging borrowing by lower and middle income Americans -- as has been the case since the crisis, and as witnessed by growing auto loans and credit card lending -- may temporarily boost spending, but is not a path to sustainable economic growth. Instead, stronger income growth is necessary among this group, and the best way to achieve it is to improve the productivity of workers.
2. The financial system in its present form concentrates risk on lower wealth households who are least able to bear it.
5. It is a matter of certainty that stagnating income growth for the majority of American households is a "serious economic threat".
6. Financial reform ought to entail introducing so-called "flexible debt contracts" which would allocate risk between debtor and creditor in proportion to the ability to bear risk.

To further explore Amir Sufi's thinking, please visit:

• Full statement for the US Senate hearing
• Bio
• Media coverage of his book, House of Debt (published in May 2014 with Atif Mian of Princeton University)
• Blog, in conjunction with Atif Mian
• Home-page at University of Chicago

Author is also on Twitter.

Menu of Fees

 charged by Fund Managers

 "The only thing an investor knows for certain when they buy into a fund is how much they are going to be charged."

Sarasin & Partners, a London-based asset management group, recently listed eight different ways that fund managers charge their investor clients. The list was printed in the Fund Management insert section of the Financial Times on July 21, 2014. It appears below.

1. Investment management fee
2. Performance fee
3. Charge for value added tax
4. Commission
5. In-house fee
6. Charge for investing in funds managed by third parties
7. Brokerage fee
8. Proportion of interest rate earned by cash on deposit

Sarasin commented that there may well be a degree of double charging among these fees.

What's the baseline? Vanguard, the pioneer in low cost, passive index funds, charges a fee of 0.19% on average across all its funds. This compares to an industry average of 1.08% across active fund managers.

Author is also on Twitter

Is the US Stock market too high?

 No, This Time is Different!

On October 14, 2013, two days before US Congress agreed to raise the debt ceiling, John Hussman wrote the following in his weekly newsletter, 


"[E]very market collapse ultimately comes as a surprise to investors, because something always convinces them that this time should have been different." 


For full article, please visit: http://www.hussman.net/wmc/wmc131014.htm

Author is also on Twitter

How Wealthy are Politicians?

 USA v.s. China

The 50 richest members of America's Congress are worth $1.6 Bn. In China, the wealthiest 50 delegates to the National People's Congress control $94.7 Bn.

The richest person in America's Congress is worth $355 Mn. The richest in China's Congress, $18.7 Bn.

The 5th richest person in America's Congress is worth $84 Mn. The 5th richest in China's Congress, $2.9 Bn.

The 50th richest person in America's Congress is worth $7 Mn. In China's Congress, $600 Mn.

The average wealth of the 50 richest American Congressmen is $31 Mn. In China's Congress, $1.9 Bn.

In America's Congress, the average age is 60, with the youngest and oldest being 32 and 80 years old. In China's Congress, the average age is 56, with the youngest and oldest being 40 and 71, respectively.

Reference: The Economist, September 28- October 4th, 2013, p.40.

Sources: Hurun Report, CQ Roll Call, The Economist

Baseline. Per capita income in the US was $52,000 in 2012, versus $6,000 in China, according to the International Monetary Fund, as reported in Wikipedia. 

Author is also on Twitter

2013 US Federal Budget

 Interesting Facts & Implications

Wikipedia has an article on the 2013 US federal budget. Of particular interest are the last sections covering (a) 10-year projections and (b) total revenues and sending.

I will make some observations, ask some simple questions, and then proceed to answer them. The answers will be based on simple quantitative analysis. The observations and questions were originally posted in my previous blog.


Observations

Growth rates. The highest annual rate of increase among major tax revenue categories belongs to individual income taxes, at 8.4%. The highest annual rate of increase among major spending categories belongs to interest payments on Public Debt, at 14.2%.

Revenue composition. Corporations pay 12% of tax revenue while individuals pay 47%.

Expenditure composition. The top 5 spending categories in the federal budget account for 76% of spending and are, in descending order:

1. Medicare, Medicaid
2. Social Security
3. Defense
4. Interest payments on Public Debt
5. Agriculture

Questions

1. If interest payments on Public Debt are growing so fast, what does this mean in the long run? 
2. If corporations pay a smaller percentage of tax revenue than individuals, does this mean that individuals are disadvantaged?
3. How fast is the US federal budget growing relative to the general economy?

Answers

1. If interest payments on Public Debt are growing so fast, what does this mean in the long run? 

The intent of this question is to find out (a) what portion of the total federal budget is currently going toward interest payments and (b) how that portion is expected to change. If interest payments represent a large portion currently, then it means that less funds are available for other uses. If this portion is expected to increase, then it means that the squeeze on funds availability for other uses will only increase.

Answer: For 2013, interest payments on Public Debt represent 6.5% of the federal budget. By 2023, they are expected to represent 15% of the US federal budget. In relative terms, the interest payment burden is expected to more than double in 10 years.

Supporting calculations: (a) 2013 interest payments = $246 bn. 2013 federal budget = $3.803 tn. Ratio = $246 bn / 3.8 tn = 6.5%. (b) Interest payments' annual growth rate = 14.2%. Federal budget's annual growth rate = 5.0%. All figures from Wikipedia article cited at the top. Implied interest payments after 10 years = $246 x (1 + 14.2%)^10 = $928 bn. Implied federal budget after 10 years = $3.803 tn x (1 + 5%)^10 = $6.195 tn. Ratio = $928 bn / $6.195 tn = 15%.

Acronyms:
mn = million
bn = billion
tn = trillion

2. If corporations pay a smaller percentage of tax revenue than individuals, does this mean that individuals are disadvantaged?

This question is intended to provide insight into whether one category in society receives preferential treatment relative to another category.

Answer. It depends on one's perspective, and there are three perspectives.

1. From the tax recipient's perspective (i.e. the federal government), individuals represent a more significant contributor than corporations, and by a factor of 4 times: 47% of tax revenue comes from individuals vs. 12% from corporations.
2. From income earners' perspective, corporations pay a larger fraction of their income than individuals, and by a factor close to 2 times: 17% of corporate profits goes toward tax payments vs. 10% of individual income. 
3. From the perspective of foregone wealth in absolute terms, corporations pay less tax than individuals, and by a factor of more than 2 times: A shareholder (indirectly) pays $2,000 in corporate taxes vs. $5,000 paid in income taxes by an individual taxpayer, on average.

Long answer:

(Part 1) For the fraction of tax revenues paid by individuals vs. corporations, please see the Wikipedia article cited at the very top.

(Part 2) US individual income tax payments in aggregate represent 10% of aggregate individual income, as of 2012. On the other hand, US corporate income tax payments in aggregate represent 17% of aggregate corporate profits. From this viewpoint, the corporate income tax burden on beneficiaries is heavier than the individual income tax burden.

(Part 3) However, if a different metric is used and which is based on the number of individuals making tax payments, the picture flips. For those individuals who make an individual income tax payment, the average amount paid per individual is about $5,000. Similarly, for those individuals who benefit from corporate profits (by being shareholders), the average amount paid per shareholder is $,2000.

Supporting calculations: (Part 2) US aggregate individual income tax payments in 2012 = $1.359 tn (source: Wikipedia article cited at the very top), vs. US aggregate personal income in same year = $13.402 tn (source: BBER) Ratio = $1.359 tn / $13.402 tn = 10%. Aggregate corporate tax in 2012 = $348 bn (source: Wikipedia article cited at the very top, vs. US aggregate corporate profits in same year = $1.755 tn (source: St. Louis Fed). Ratio = $348 bn / ($348 bn + $1.755 tn) = 17%.

(Part 3) Regarding individual income tax, not all individuals make such payments. A good guess is that those below the poverty line don't make any individual income tax payments. If we adjust for this, out of a US population of 314 mn (as of 2012, source: US census), 14.3% are below the poverty level (same source, US census), leaving 269 mn as the number of individuals who pay individual income tax. Average individual income tax payment per person = $1.359 tn / 269 mn = $5,052, after rounding = $5,000.

Regarding corporate income tax, not all individuals are shareholders in corporations (and in businesses in general). The percentage of Americans who are corporate shareholders reached a 15-year low of 52% in May 2013 versus a peak of 65% in 2007 (source: Christian Science Monitor). Number of Us individuals who are corporate shareholders is therefore between 52% x 314 mn and 65% x 314 mn, or between 163 mn and 204 mn. Average corporate income tax payment per shareholder, higher value = $348 bn / 163 mn = $2,135. Lower value = $348 bn / 204 mn = $1,706. Average = $1,920. After rounding = $2,000.

Before moving on, I do acknowledge that the above analysis is simplistic. The next step would be to perform an analysis which first divides individuals by income level ...

3. How fast is the US federal budget growing relative to the general economy?

The intent here is to find out (a) the level of federal government activity relative to the entire economy and (b) how this relative level is expected to change.

Answer. The US federal budget in 2013 represents an amount equal to 23% of 2012 US nominal GDP. By 2023, this budget is expected to represent 26% - 32% of US nominal GDP.  If the US economy grows slowly, the actual figure will be closer to 32%, but if it grows quickly, the actual figure will be closer to 26%. It follows that the relative size of the federal budget is expected to increase by somewhere between 10% - 40% in 10 years, when measured relative to GDP.

Some takeaway nominal growth rates over the next 10 years:

• 7.6% p.a. tax revenues    -- p.a. = per annum
• 5.0% p.a. federal spending
• < 3.5% p.a. economic growth    -- my educated guess

Supporting calculations: (a) 2013 federal budget = $3.803 tn.2012 US GDP = $16.62 tn in nominal terms, i.e. in current dollars and without any adjustments for inflation (source: Wikipedia). $3.803 tn / $16.62 tn = 23%. (b) Implied federal budget after 10 years = $6.195 tn, as calculated for answer 1. We need to estimate nominal GDP growth rate for the next 10 years. Looking at various historical time horizons all ending with 2012, we see the following annualized growth rates for US nominal GDP: 10-years: 4.0%, 20-years: 4.6%, 30-years: 5.4%, 40-years: 6.5%, 50-years: 6.9% (source: multpl.com). For example, for the 10 year period ending with 2012, the 10-year historical growth rate of nominal GDP has been 4.0%. We observe that US GDP growth has been slowing down over the past 50 years, in nominal terms. (The real question is whether it has slowed down in real terms, but that's a suitable subject for a future blog.) 

For the next 10 years, I will assume that GDP growth rate will be between 1.5% and 3.5% per annum. We can now calculate US GDP after 10 years: $16.62 x (1 + 1.5%)^10 = $19.29 tn, lower bound. $16.62 x (1 + 3.5%)^10 = $23.44 tn, upper bound. We can now proceed to calculate the size of the US federal budget 10 years into the future relative to the general economy. Lower bound: $6.195 tn / $19.29 tn = 32%. Upper bound = $6.195 tn / $23.44 tn = 26%. Final comment. The federal budget is expected to grow at 5% p.a. (as per answer 1), whereas it is almost impossible for US nominal GDP to grow by as much as the same rate. The Wikipedia article cited at the very top also indicates that that tax revenues will grow at 7.6% p.a. over 2012-2022.


Final remarks. This kind of analysis -- all 3 questions -- can very well be performed for other countries and then be used to perform a cross-country comparison ....

haditaheri is also on twitter

Is the US Tax System Efficient?

 (Including side comments about the US Federal Budget)

The following facts were excerpted from the July 13-19th, 2013 edition of The Economist.

1. The US tax code isn't simple. 90% of US taxpayers use an accountant or commercial software to file their returns.
2. Americans spend at least 6.1 billion hours each year complying with tax rules. This time could have been spent more productively. (See below for an interpretation.)
3. Interestingly, tax revenues would remain unchanged by getting rid of all loopholes and by allowing individual income-tax rates to fall a whopping 44%. (See below for an interpretation.)
4. Each year $1.1 trillion in tax revenues is foregone through countless deductions, exemptions, and credits. To put this in perspective, total federal tax revenues are only $2.8 trillion each year.
5. Corporate tax rates are the highest in the rich world: add state and local taxes to the 35% federal rate and they reach 39.2%.
6. The top individual tax rate is 39.6%.

Commentary on Fact #1

The US federal tax code is 73,954 regular 8-1/2" x 11" sheets of paper long. (source: Google search). This would be a stack of paper that's about 30 feet tall or as tall as a 3-story building.

Commentary on Facts #3 & 6

If the 39.6% top individual tax rate were to fall by 44%, it would become 21.4%.

Commentary on Fact #2

Assuming 115 million households in the US, the time spent on tax filing translates to 53 hours per household or 6.6 eight-hour work days per household. (Source: http://quickfacts.census.gov/qfd/states/00000.html)

If the time spent on tax filing were valued at $20 per hour, it would be worth $122 billion. Valued at $100 per hour, it would be $610 billion. To put this in perspective, the US defense budget for 2013 is $672 billion and is the largest discretionary line item in the federal budget. (Source: http://en.wikipedia.org/wiki/2013_United_States_federal_budget.)

Interesting facts about the 2013 US federal budget are (a) the annual rate of tax increases budgeted for the 2012-2022 period, (b) sources of US tax revenue, and (c) composition of US federal budget. Here are some excerpts.

Growth rates. The highest annual rate of increase among major tax revenue categories belongs to individual income taxes, at 8.4%. The highest annual rate of increase among major spending categories belongs to interest payments on Public Debt, at 14.2%.

Revenue composition. Corporations pay 12% of tax revenue while individuals pay 47%.

Expenditure composition. The top 5 spending categories in the federal budget account for 76% of spending and are, in descending order:

1. Medicare, Medicaid
2. Social Security
3. Defense
4. Interest payments on Public Debt
5. Agriculture

Some questions to think about: 

• If interest payments on Public Debt are growing so fast, what does this mean in the long run? 
• If corporations pay a smaller percentage of tax revenue than individuals, does this mean that individuals are disadvantaged?
• How fast is the US federal budget growing relative to the general economy?

For answers, please visit my next blog entry.

haditaheri is also on twitter