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Tuesday, February 22, 2011

Tensions in the Middle East Spill-over to U.S. markets

The Dow lost 178 points today as oil spiked on Libyan tensions escalating.  Oil is up to about $95 a barrel and we are seeing unrest in Bahrain and many other Middle Eastern countries.  Egypt is certainly still a big problem as well.  Libya has the largest proven reserves of oil on the African continent, so it is hugely important with regard to oil supply and prices.

The reality is that, even though we tend to think of the Middle East as being relatively stable most of the time, it's not.  They have been fighting with each other for millennia and that will not change.  The only difference today is that they control a large amount of the world supply of oil, so when unrest rises, we feel it more.

The other problem, in terms of our financial markets, is that valuations are so extended right now, that it doesn't take much to knock stocks, bonds, and even commodities down.  Today was a good reminder of the fact that a little uncertainty can rip a few percentage points off of the markets when valuations get this rich.

Stay tuned for more volatility as tensions rise and as unrest spreads across the Arabian world.

Monday, February 14, 2011

The future of the auto industry may lie with the after-market

Many have speculated on the future direction of the auto industry.  Auto executives have been under the gun to find ways of rejuvenating the big 3, or at least keeping them afloat long enough for the economy, and the car buying public to rebound.

However, the future of the auto industry just might depend more on the after-market, than on the auto manufacturers.  It is clear that energy prices and especially gasoline prices, have become expensive and will remain expensive for the foreseeable future, and possibly forever.  Short of a major drop in oil prices for a sustained period of time, we will likely not see a change in consumer attitudes towards purchasing fuel-efficient vehicles.  Even if prices fall and remain low, consumers do care about the environment, so it is likely that demand for vehicles that gt good gas mileage will remain high, regardless of where prices may go.

Here is the rub - and what the automakers seem to have completely failed to see: consumers want fuel-efficient vehicles, and are willing to pay extra to get them, but they also need and want large SUVs so they can take the kids camping, pull a boat to the lake, and go to Home Depot on the weekend and buy supplies for their home improvement projects.  A Prius just isn't going to cut it.  What is needed is an affordable conversion kit that can make any vehicle a fuel-efficient electric hybrid.

There are some companies already providing a conversion for some vehicles, although most are focused on converting already efficient vehicles, like the Prius into full electrics.  These companies appear to be operated by people motivated more by their environmental beliefs than by their desire to build a profitable business.  Further, the conversion kits I have seen are costs - running about $5,000.  These kits also include a large number of very bulky, heavy lead-acid batteries, which won't always fit in every car.

Sooner of later, a company will come along that develops an affordable, compact conversion kit that works in virtually any vehicle, that can make even the biggest gas guzzlers relatively fuel-efficient.  The person who finds the right solution to this problem will not only make a lot of money, but they will lead the entire auto industry in an entirely new direction.

There is no reason why fuel efficiency and having a roomy, capable vehicle must be mutually exclusive.  Once a conversion is made widely available int eh after-market, the automakers will adopt the new technology, and only then will we make a real positive impact on our fuel consumption and dependence on foreign sources of crude oil.

Thursday, February 10, 2011

Markets rebound on weekly jobless claims

Hosni Mubarak is likely to step down as early as tonight and pass power off to his vice president, according to reports.  Unrest in Egypt continues to plague the region, and to roil financial markets and oil prices.  Stocks here at home opened down, especially the NASDAQ, after Cisco Systems reported decent numbers but weaker than expected margins, especially in their switching products.  John Chambers, Cisco's CEO explained that sales are growing by 100% to 500%, depending on which segment of the their switching products you are following, but that pricing is in flux as the market adjusts to new releases, requirements, etc.

The 30-year fixed-rate mortgage hit its highest level since April of last year at 5.05% this week.  Watch the long end of the yield curve for signs of steepening, as long rates begin to adjust up in anticipation of inflation pressures.  The Fed will be forced to adjust short rates eventually, to combat inflation, and also because pricing of short instruments will dictate higher yields.

Kevin Warsh, one of the Fed governors, announced today that he is stepping down.  I didn't catch his reason for this action, and I have not seen who his likely replacement will be as of yet.  The change could signal a change in tone of the board, although it is unlikely that their overall strategy will change.

Wednesday, February 9, 2011

Quiet Wednesday

Stocks opened mildly lower with Coca Cola posting strong numbers, sending that stock higher by 3%.  Bernanke speaks today, but I don't expect anything material to come from his comments.  The European Central Bank - the equivalent of the Fed for the EU, is looking for a successor to Jean-Claude Trichet.  I have not been impressed at all with his leadership - he has been behind the ball every step of the way, throughout the global recession.

Locally, Pacific Capital reported a $20 million profit for the fourth quarter.  They used "push down accounting" for the purchase transaction, when Ford Financial bought the bank holding company, which has significantly altered their costs bases for the loans they hold.  It appears that it will take several quarters for a true picture of their balance sheet to emerge.

Tuesday, February 8, 2011

China Raises Rates

The People's Bank of China, after Asian markets closed, said it would raise key lending and deposit interest rates to combat rising inflation pressures.  China's GDP growth is about 3 times that of most western countries, including the U.S.  Keep an eye on our rates as well - the 10-year treasury is slowly (once again) creeping up towards 4%, and is now at a nine-month high of 3.65%.   I believe, once it breaks-through that 4% level, that rates will push significantly higher. 

Home prices were down significantly in December and Beazer Homes showed a 24% drop in profits for the quarter (reported this morning).  Rising rates will not be kind to real estate prices - it will be the other shoe to drop.  We have already experienced more than a 40% decline in local Santa Barbara prices, even with rates remaining at historical lows.  

Many stocks are hitting all-time highs, or multi-year highs, with 19 of the 30 Dow stocks at (at least) multi-year highs, as of this morning.  One could view this as a positive sign that the economy is improving and that stocks will push higher, or one could see this as a very risky investing environment.  I lean towards caution. 

Monday, February 7, 2011

Stock push up through technical resistance to trade higher

On the heels of several buyouts and takeovers, stocks have pushed up through some key resistance levels to trade higher this morning.  The Dow is up about 80 points so far, trading around 12,175, while the S&P 500 is up 10 points at 1,320.  The NASDAQ is also performing well, adding 20 points at 2,790.

Companies are sitting on about $2 trillion in cash, and many are looking for other companies to buy to put that cash to work.  Companies cannot afford to sit on cash for too long because shareholders will begin to question management's efficiency.  Large cash balances also make companies ripe for takeover, since the cash on their balance sheet can be used in the transaction.

The bigger issue is that these companies do not seem to be using their cash to hire workers, which is really what we need to see before the unemployment picture will improve significantly.  Unemployment is a lagging indicator, meaning that we won't see unemployment improve until fairly deep into an economic recovery.  We did just see the rate decline from 9.4% to 9% last week, but I feel that the calculation of the rate has been skewed a bit, due to poor weather and holiday temporary hiring, etc.

We are certainly at risk of seeing a meaningful correction for stocks, since many companies are trading at multi-year or all-time highs.  Also, commodities are extremely extended, with copper making yet another all-time high, at more than a 30-year high trading level.  Those high commodity prices will eventually work their way into all other prices for the things you and I buy on a regular basis, which means that real inflation will begin to accelerate on the upside.  Higher inflation pressure means higher rates, as the Fed will be forced to combat inflation.  Higher rates will mean lower real estate prices, curtailed economic activity, and higher costs for companies that need to borrow to expand operations, etc.

Things are going right in a lot of ways, but I would feel much more comfortable putting new money to work in stocks if we were to see a sizable correction, to bring prices down to more reasonable levels.

Thursday, February 3, 2011

Reinventing the Wheel: Green Innovation and Profitability Working Hand-in-Hand (published in CSQ Magazine, Winter of 2010/11)

Much has been written about the perceived and real benefits of green innovation and invention.  Ideally, to be both environmentally and financially successful, products need to offer a triple benefit—to the environment, the consumer, and the producer.  There has been an interesting and instructive evolution of the marketing of green products over the past two decades, during which time consumer attitudes and behavior have shifted from purchase decisions based on packaging claiming environmental benefits, to a focus on real benefits, including positive environmental benefits, and direct consumer benefits.  The direct consumer benefits include greater quality and durability, ease of repair, upgradability, and reduced costs of use, such as lower energy consumption (where applicable). 

Porter and van der Linde outlined the win-win proposition in the mid-1990s, stating that environmental regulation could drive innovation by making industry aware of and willing to exploit otherwise missed opportunities. They claimed that increased environmental regulation would result in environmental benefits and increased competitiveness.  But is regulation enough to drive the necessary level of green innovation, not only to sustain the movement towards more environmentally friendly products, but also to support the many companies that have entered the green space, and that have been responsible for the successes to-date? 

It is unlikely that a large enough percentage of the U.S. (or world) population will be willing to pay a premium price for a product that offers no direct consumer benefits and instead, only claims to be green—good for the environment in some way that does not directly benefit the consumer and likely is not visible to the consumer.  In other words, simply putting a green label on a product and charging a premium price, even if the claims are legitimate, is simply not enough. 

Today, businesses must do more—they must offer products that are truly green and that provide measurable, direct benefits to the consumer.  Further, while producing the “win-win” for the consumer, they must also produce a win-win for themselves—produce green products and be competitive, including being financially competitive with companies that do not offer green products, and therefore do not incur the added costs associated with green products.

New terms like “upcycle” reflect converting recycled, reusable items and waste to higher value products and often saving energy and resources compared to using virgin or dwindling, costly, or politically risky materials.  Recycling facilities generate $4.3 billion each year in revenues, while waste collection businesses generate $43.4 billion—ten times as much.  Green innovators that can find ways to use waste materials to create economically viable products that meet the above-mentioned criteria of generating a triple benefit—environment, consumer, and producer, and possibly using partnering with larger companies, can bridge the historical gap between green products and competitiveness.

According to Acs and Audretsch, large firms are more innovative in capital-intensive markets because they have the financial resources to pursue product innovation in these markets, while smaller firms tend to benefit from markets that are more competitive. Smaller firms can react faster to change because they have less bureaucracy, a higher commitment from management, more exposure to competition, higher R&D efficiency, and niche strategies.  Combining these finding to the need to offer direct benefits to consumers and be competitive mentioned above, those operating smaller firms should recognize the need to focus on markets where they have the greatest chances for success.  In the strictest sense, this would seem to indicate that smaller firms should only play in their own sand boxes, rather than going to the beach. 

An interesting trend that has developed due to the severity of the economic troubles we have been experiencing is the willingness of U.S. companies to not only partner, but to actively seek opportunities to find innovative solutions to drive new revenues from new sources.  The result has been that smaller companies now have access to many of the same resources that the larger companies have exclusively enjoyed in the past.  For example, many manufacturing companies with significant investments in capital equipment are looking for partnering opportunities with very small, innovative, green product companies to use their excess capacity at very affordable, and therefore competitive rates.  This means that, for the first time, the smallest companies can enter markets previously requiring heavy upfront capital investments, avoiding not only the financial requirements of this equipment, but also the time to locate and build facilities, train employees, inventory raw materials, etc.

Green2Gold has its non profit intl HQ in Santa Barbara ,and for 40 years has been catalytic to  sustainable,green inventors rapidly commercialising  eureka moments ideas. Encouraging "Eco Enterprises" such as CWP,EcoLight,Life Cube and hundreds of others,etc.,and also establishing Licensing opportunities worldwide.Tens of thousand of members strong, worldwide,G2G encourages conventional companies to co venture,invest,license opportunities for more profit,great PR,and competitive stance across an entire spectrum of consumer ,industrial-- even military tech sectors.

Tax Tips for the Procrastinator (published in December of 2010 in the SB News Press)

We are all very busy these days, with many of us working twice as hard for half the money (at least it seems that way to me).  However, this is an important and opportune time to review some of our tax planning strategies.  In this week’s column I will highlight a few of the most useful tips to help you take advantage of opportunities, or possibly avoid some pitfalls.

First, with the stock market gains that we have experienced this year, many have paper profits—gains in their investments that have not been realized as of yet by selling the position.  It is quite common for the stock market to sell-off in January, especially after a positive year.  Many investors would prefer to sell their stocks in December to lock-in their profits, but do not want to assume the tax liability on their capital gains for the current tax year.  If only there was a way to sell in December, but put-off the tax recognition for the capital gain until the following tax year.

Prior to 1997, we could “selling short against the box.”  In essence, we would do would be to sell the stock short in our account, even though we actually own the stock (shorting stock normally involves borrowing shares we do not own from someone else, depositing these borrowed shares into our account, and then selling them).  What results when we sell short against the box is that we still own the original shares in our account, but we also have a short position in our account for the same number of shares that we actually own.  Both positions—the long position we already owned, and the short position—are in the account at the same time.  We hold both positions until after the first of the year, at which time the transactions are closed out—the long position is crossed with the short position, and the investor gets to defer the tax liability on the capital gains until the following tax year.

Unfortunately, the Tax Relief Act of 1997 removed the tax benefit of selling short against the box, so we can’t do that anymore.  (There does appear to be a small loophole in the 1997 revisions that permit shorting against the box to delay a taxable event. If you have a short against the box position and then buy-in the short within 30 days of the start of the tax year, and then leave the long position at risk for at least 60 days before offsetting it again, the constructive sales rules do not apply. So it appears that you can continue shorting against the box to defer gains, but you have to temporarily cover the short and be exposed for at least 60 days at the beginning of each and every year.  Investors should consult their tax advisor before employing this strategy.)

One thing we can do to protect our profits is to purchase put options on our long positions.  For example, if we own 1,000 shares of IBM, which currently trades around $145 per share, we could buy 10 IBM put options with a $145 strike price.  If the option expires in March, we would be protected from $145 down, meaning that regardless of where IBM traded, even if it went to $0, we could still sell it at $145 per share, at any time up through the March expiration of the option contracts.  There is, of course, a cost to buying the put options, much like buying an insurance policy.  Options are a good tool that can be used, not just at the end of the year, but anytime the investor has a gain, and/or is concerned about the stock declining significantly in price.  (Options can be tricky, so those investors inexperienced in options should consult an expert.)

Another consideration with stocks is to match capital gains with capital losses.  If you are concerned about the stock market correction, or about an individual stock that you own, which has done well, falling in price, and if you have another stock that has done poorly, you can offset the gain on the good position with the loss on the bad position, assuming that the loss is at least as much as the gain.  If the loss is less, you will still incur some capital gains on the profit, but it will be less than it would be without the offsetting loss. 

Another reason to wait until the following tax year to realize a capital gain (on stock or anything else) would be if you are expecting your income in the following year to be substantially lower than in the current year, which would put you in a lower tax bracket.  If this is the case, deferring the capital gain may save you significantly on your taxes, so the put option may make more sense.

Keep in mind also that, if you have owned a stock for less than one year, the capital gain will be considered ordinary income, and therefore will increase your overall income, possibly pushing you up into a higher bracket.

Another tip to consider at the end of the year is funding an IRA.  Luckily, we actually can fund an IRA for 2010 all the way up until April 15th of 2011, but it is a good idea to at least plan for the investment, especially if we need time to save-up the contribution. 

Another good tip is to defer income.  If a bonus or additional income will push you into a higher tax bracket, if received before the end of the year, try to defer receiving it until 2011, especially if you think you will earn less next year.  Some companies want to pay bonuses and additional compensation in the current tax year for their own benefit, but to the extent that you have a choice, it may make sense to push the income into 2011.

You can also write your checks for property taxes and for your mortgage payment by December 31st, to receive the tax benefits for the 2010 tax year.  This can be particularly beneficial if your 2010 income is higher than you expect your 2011 income to be.

You can also charge business and personal expenses that are tax-deductible on a credit card prior to the end of the year, and then actually pay for them later (when the bill comes, or over time if you prefer), receiving the tax deduction for these expenses for the 2010 tax year.

One final tip has more to do with planning ahead for the 2011 tax year—this is the perfect time to review your tax withholding options, your 401(k) or 403(b) contribution levels, and your investment portfolio.  We already spoke about some possible tax strategies for an individual stock or other investment that has performed well.  You should also review your entire portfolio, so that you can not only identify any gains or losses that you might want to take or defer, but also compare your current asset allocation—the division of your assets among stocks, bonds, cash, real estate, commodities, art, etc.—to your long-term asset allocation target.  You should further review each position and evaluate it as it relates to the other positions in your portfolio to make sure you are comfortable with the risk in the position, and believe that it belongs in the portfolio.

With tax withholdings and 401(k) and 403(b) contributions, you should review what occurred over the course of 2010 and make any adjustments that are necessary, so that your 2011 withholdings and contributions are in line with your long-term financial goals.

By spending a little time on some end-of-year tax planning, you can minimize your tax liability and prepare for the new tax year with a game plan in place, and the confidence of knowing that you actually have a plan and you are proactively pursuing it.  Hopefully these tips will help get you started, but you have to make the effort, so don’t put it off any longer!

There is still time to convert your traditional IRA to a Roth IRA (published in December of 2010 in the SB News Press)

In the final installment of my three-part series on end of the year planning, I will discuss the very important and attractive opportunity to convert a traditional IRA to a Roth IRA.  While this opportunity may not necessarily apply to everyone, a conversion is certainly worth considering before the end of 2010.

One of the most attractive tax planning options that is only available for the 2010 tax year (unless extended) is converting a traditional IRA to a Roth IRA, and spreading the tax liability over the 2011 and 2012 tax years.  For example, if the traditional IRA account owner converts their IRA to a Roth before year-end 2010, they can spread the tax liability over the 2011 and 2012 tax years, meaning you can pay half on April 15th, 2012, and the other half on April 15th 2013 (you can pay the taxes in 2010, or all of more than half in 2011, etc, if you wish).  You will still have to pay ordinary income tax on the value of the proceeds you take out of your traditional IRA, except for any contributions you have made with after-tax money. This tax deferral option makes the conversion much less painful.  In years past, there was a $100,000 adjusted Gross Income limit on conversion, but there is no limit for conversions in 2010.

One thing to keep in mind is that, if you convert, you will not want to use proceeds from the traditional IRA to pay the taxes, if you are younger than age 59 ½, because you will incur a 10% penalty for early withdrawal.  You don’t have to convert the entire amount in the traditional IRA to the Roth, (although you can).  You can choose to convert any portion of a traditional IRA to a Roth IRA, and can maintain the traditional IRA with whatever balance you choose to leave in the account.  You can also convert more than one traditional IRA (or all of them) into a Roth.

You will want to review your 2010 tax liability and understand if converting will push you up into a higher bracket.  In this case, you may want to convert only that portion of the traditional IRA that will allow you to take advantage of this opportunity without increasing your tax bracket.  Also keep in mind that you cannot avoid the conversion tax by just rolling over an amount equal to your after-tax (nondeductible) contributions. Each dollar you roll over from a regular IRA is considered a "blended" dollar. Therefore, a percentage of the amount rolled over into the Roth account will be taxed unless your IRAs are worth less than the amount of your after-tax contributions). 

Keep in mind that, if you have multiple IRAs, you will be required to pull equally from all IRA accounts, so that the tax liability on each dollar converted is the same.  In other words, you can’t pick and choose which assets within the traditional IRA you want to convert, and only choose those, for example, that are down in value to reduce your tax liability.

The reason a Roth makes so much sense, particularly for younger investors, is that all growth and future disbursements will be tax-free.  In other words, once you have paid the taxes on the conversion, you will not have to pay any taxes on any profits you make in the Roth account, or on any money you withdraw from the Roth (after age 59 ½ and as long as you have had the money in the Roth for at least 5 years).  So, the younger you are, in general, the more sense converting makes.

Another reason to consider converting is that, if you feel you will be in a higher tax bracket in the future, either because you think tax rates will rise (they probably will after 2012), or because your income will be higher, converting now may allow you to pay a lower tax rate on the money that is currently in your traditional IRA.

Another benefit of converting now is that, if you believe the stock market still has room to rise in value over time from where it is now (and assuming you are holding stock investments in the IRA), converting now will mean paying less in taxes because the market is lower today and therefore your account value is lower than it will be in the future.

Even if you are older, a Roth still may make sense. Normally with an IRA, at age 70 ½ you are required to withdraw from your IRA through mandatory required distributions. However, with a Roth, there is no mandatory withdrawal rule allowing you more time for the account value to grow tax-free. Also, under the present tax laws, converting a traditional IRA to a Roth can lower the size of your taxable estate. Also, if you name your spouse as the beneficiary of your Roth IRA, your spouse can treat the inherited IRA as his or her own after you die and forego withdrawals. This allows those Roth IRA assets to keep compounding untaxed across the rest of your spouse’s lifetime.  Your spouse could then name a son or daughter as a beneficiary. This would allow your children the choice to make minimum withdrawals according to his or her life expectancy. All the while these assets continue growing completely tax-free.

Keep in mind that you will owe federal and state taxes on any converted amount less any after-tax contributions you made to the traditional IRA.  If you decide to convert, you will need to fill-out conversion paperwork, which you can get from the custodian—mutual fund, banker, stockbroker, etc.—of your traditional IRA account(s).  The conversion paperwork isn't that complicated. If you have made nondeductible contributions to your IRA, you will need to know how much you contributed in nondeductible contributions, which you can find in your income tax forms on Form 8606, Nondeductible IRAs.  You'll need to let the custodian know certain information, including:

  • How you want your converted assets invested
  • Whether you will pay the taxes due yourself or want the custodian to withhold the amount from the IRA's assets to pay them (remember the 10% penalty in you are under age 59 ½)
  • Who you want to name as a beneficiary to receive the money upon your death

There isn’t much time remaining, and it may be difficult to get in touch with your tax or investment advisor to get the information you need to make this important decision.  However, the potential benefits are material, especially for those with many years remaining before they plan to withdraw funds from their IRAs.  Consider your options and seek expert advice, but a Roth conversion is certainly worth a look.

Inflation: Does the CPI Capture Reality? (published in December of 2010 in the SB News Press)

Yesterday, I dropped my truck off at Richard’s Accurate for some repairs.  While speaking with Oren, he mentioned that Interstate Battery has raised their core battery price from $5 to $25, because the price of lead has increased so much.  This made me think about inflation in general, and more specifically, about how the official calculation for the CPI (Consumer Price Index) doesn’t really capture the realities the average person faces with regard to price inflation.

The Consumer Price Index is the government's key inflation indicator, and The Bureau of Labor Statistics calculates the CPI each month. This index is based on data related to consumer spending habits and the prices paid for a variety of goods. 

The CPI reflects spending patterns for each of two population groups: all urban consumers and urban wage earners and clerical workers. The all urban consumer group represents about 87 percent of the total U.S. population, and is based on the expenditures of almost all residents of urban or metropolitan areas, including professionals, the self-employed, the poor, the unemployed, and retired people, as well as urban wage earners and clerical workers. Not included in the CPI are the spending patterns of people living in rural nonmetropolitan areas, farm families, people in the Armed Forces, and those in institutions, such as prisons and mental hospitals.

The CPI market basket is developed from detailed expenditure information provided by families and individuals on what they actually bought. For the current CPI, this information was collected from the Consumer Expenditure Surveys for 2007 and 2008. In each of those years, about 7,000 families from around the country provided information each quarter on their spending habits in the interview survey. To collect information on frequently purchased items, such as food and personal care products, another 7,000 families in each of these years kept diaries listing everything they bought during a 2-week period.  Over the 2 year period, then, expenditure information came from approximately 28,000 weekly diaries and 60,000 quarterly interviews used to determine the importance, or weight, of the more than 200 item categories in the CPI index structure.

The CPI represents all goods and services purchased for consumption by the reference population BLS has classified all expenditure items into more than 200 categories, arranged into eight major groups. Major groups and examples of categories in each are as follows:

Food and Beverages
Medical Care
Education And Communication
Other Goods and Services

Also included within these major groups are various government-charged user fees, such as water and sewerage charges, auto registration fees, and vehicle tolls. In addition, the CPI includes taxes (such as sales and excise taxes) that are directly associated with the prices of specific goods and services. However, the CPI excludes taxes (such as income and Social Security taxes) not directly associated with the purchase of consumer goods and services.  The CPI does not include investment items, such as stocks, bonds, real estate, and life insurance. (These items relate to savings and not to day-to-day consumption expenses.)

For each of the more than 200 item categories, using scientific statistical procedures, the Bureau uses samples of several hundred specific items within selected business establishments frequented by consumers to represent the thousands of varieties available in the marketplace. For example, in a given supermarket, the Bureau may choose a plastic bag of golden delicious apples, U.S. extra fancy grade, weighing 4.4 pounds to represent the Apples category. (Bureau of Labor Statistics website)

Although the BLS method is highly complex and thorough, it is also a very generalized approach, intended to represent the big picture for inflation.  While debate rages on about the effectiveness and accuracy of the calculation of the CPI, the reality is that each individual’s experience rarely relates closely to CPI. 

When working with my students at the University of Phoenix, I always state that today, for most of us, it feels like we are working twice as hard for half the money.  While this statement is intended to elicit a response from students, it may not be that far from reality.  Even at an inflation rate of just 3 percent, it would take only 24 years to double prices.  Unfortunately, given the enormous level of our national debt and budget deficits, it is highly likely that inflation will rise well above 3% in the near future.  (With an inflation rate of 6 percent, it would only take 12 years to double prices.)

The problem with inflation is that incomes rarely increase at the same pace, which means that, as prices rise, the average person’s purchasing power is eroded more and more (assuming their income does not increase). 

In 2008, when oil prices rose to nearly $150 per barrel, we saw an immediate and dramatic impact on consumers.  The freeways of America were littered with cars that had run out of gasoline, since their owners, living paycheck to paycheck could not afford to buy gas.  So many of us are living on the edge, so that only a relatively small increase in prices can have a very material, negative impact on our standard of living.

Gold and many other commodities have risen dramatically in price recently precisely because of the national debt, budget deficits, and the potential for inflation.  Despite what the official CPI calculation might show, when we go to buy food, gasoline, or just about anything else that is produced with raw materials, we are seeing sizable price increases that have a direct impact on our monthly living expenses.  This, of course, translates to our ability to save and invest—two things that our economy desperately needs. 

Obama, just this week, agreed to a compromise on extending the Bush tax cuts for two more years.  While I agree that this was necessary, it will mean that government revenues will be lower than they would have been, if tax rates had risen back to previous levels.  Lower government revenues mean a higher budget deficit and a higher national debt; a debt that someday we are going to have to pay back.

There isn’t much we can do about inflation, other than plan for it, save our money, reduce our expenses, and possibly buy gold or other inflation hedges (gold is very expensive already, so it may not be such a great inflation hedge at present).  We can also prepare for the likelihood that real estate prices will decline further, as mortgage rates increase.  Additionally, we can expect that the Fed will be forced to raise short-term interest rates—the Fed Funds rate and Discount Rate—which will pressure rates across all maturities, and will increase borrowing costs. 

More importantly, higher rates will have a significant cooling effect on the economy, and potentially could push us into another recession, if the Fed is forced to raise rates rapidly to combat inflation.  Historically, the Fed has been more concerned with fighting inflation than will supporting economic growth, so it is likely that they will push rates higher to slow inflation, even if it means crushing the economy in the process.

The latest round of quantitative easing (QE) flooded the market with $600 billion in new dollars, although one could argue that the majority of those dollars went to foreign investors who sold their treasuries back to the government.  Many have suggested that we will need as much as $2 trillion in QE to prevent another recession.  If this is the case, the potential for inflation will increase even more, and the possible consequences of inflation on the economy, and on you and I, will increase sizably as well.

One thing is certain though—prices will continue to rise relative to our incomes, at least for the foreseeable future, so it is best to expect this outcome and to prepare for it, even if it’s painful to contemplate.  

Final Tech Brew of 2010 Looks to Impress (published in December of 2010 in the SB News Press)

The final Tech Brew Mega Mixer of 2010, which will be held Wednesday, December 7th, at the Fess Parker Double Tree, will combine the traditional Tech Brew format, providing a powerful forum for entrepreneurs, investors, consultants, and those interested in all things technology to mix and mingle, with the Maverick Angels Open Evening for Entrepreneurs for the Central Coast and Southern California regions.

The Tech Brew is the “Region's Premier Networking Event for High Technology Professionals, Cutting Edge Entrepreneurs and Innovators, Business and Community Leaders, and related Non Profits dedicated to Sustainable Economic Development.”  These events are held throughout the year, to provide opportunities for the movers and shakers in the area to make key contacts, to facilitate venture funding, the exchange of ideas, and general information about what is driving the economy of the Central Coast.

Maverick Angels is an angel investment group that takes an entrepreneurial approach to investing to create win-win results for both investors and portfolio companies.  Some of the top angel investors from around the Central and Southern Coastal regions are members of Maverick Angels, and will be attending this event.  It is a fantastic opportunity, especially for first-time entrepreneurs looking for advice, information, guidance, and possibly funding, to meet the right people who can make things happen for their businesses. 

Maverick Angels will present multiple expert speakers in the form of mini-seminars with topics including: Intellectual Property, Valuations and Term Sheets, Outsourced CFO Solutions, and Human Resource Traps.  All seminars will focus on both start-ups and growing enterprises, so this event is not just for the first time business owner who needs the basics, but is also for those who may be experienced entrepreneurs or serial entrepreneurs looking to take their businesses and their knowledge-base to the next level.

After the mini-semiars, which begin at 4 P.M., a special "Open Evening for Entrepreneurs" presentation by Maverick Angels' President Bill Barber on Understanding Angel Investing will be offered at 5 P.M.  To follow will be a presentation by the featured sponsor—Convergent Informatics—on IT solutions for emerging growth companies, and then an Entrepreneur presentation by Davis Brimer of ActiveLife Scientific will follow.  These presentations will all be followed by an exciting 30-second Entrepreneur Pitch Contest with a prize going to the winner worth more than $500—a full day Maverick Angels boot camp for entrepreneurs, and 6 months of business Incubation by SBEC/Green2Gold.
From 6:30 P.M. to 8:30 P.M., the Tech Brew networking session and mixer will be in full swing with exhibits, resources, and complimentary snacks; all free to attendees.  There will also be a cash bar.

During the Tech Brew, an update on the progress of the Green Coast Alliance and Innovation Zone, a regional economic development plan to encourage the development of clean technology companies in the region, will be presented.

One of the greatest benefits of the Tech Brews is to meet the people who are making business happen in our area—people like Alan Tratner of Green2Gold and Jerry Knotts of Maverick Angels.  These are individuals dedicated to helping entrepreneurs build successful businesses, not simply to make a profit, but because they truly care about our economy, and about helping people. 

Most economists that follow our local economy will agree that the movement toward green, sustainable technologies, products, and the businesses that provide these technologies and products will be a primary driver for our future growth and for jobs in the area.  Our community needs new businesses to create jobs and to drive commerce.  We also need to diversify away from our reliance on education and tourism alone.  I am not saying that there are no other businesses; there are.  But we have heavily focused (and therefore heavily dependent) upon a small number of industries to make our economy work.  Just as with a company’s product or service offering, or our investment portfolios, we need diversification.

The all-day Maverick Angels boot camp mentioned above is a wonderful program, and a must for any business owner who plans to make a presentation to an angel group for funding purposes.  In fact, it is a requirement to present to Maverick.  Entrepreneurs will dig deeply during this boot camp, into many of the topics that will be discussed at the Tech Brew this coming week, in addition to subjects like how to write a good business plan,  Make a Successful Investor Pitch, Create an Effective Executive Summary, Develop a High-Impact Slide Presentation, Personally Align with Your Company Vision, Understand the Playing Field with the Circle of Success™, Leverage Resources for Growth with the Collaboration Spiral™, and Pressure-Testing Your Plan.  Fully understanding and mastering these topics will be critical to the entrepreneur’s success as they navigate the funding process. 

The Tech Brew will provide the first-time entrepreneur with an introduction to some of these valuable topics, and will offer opportunities to meet with some of the angel investors and professionals that teach the various components of the Maverick Angels boot camp, such as Bill Barber. 

Intellectual Property, or IP, is another interesting and highly complicated subject that many technology entrepreneurs must understand well, in order to protect their business concepts.  While it is certainly true that experts in this area can be hired, the reality is that most entrepreneurs simply cannot afford to have a top IP attorney on staff or on retainer.  In this case, the burden falls squarely on the shoulders of the entrepreneur to do their homework in this area.  The Tech Brew will provide a great introduction to this topic, and Alan Tratner is also a great resource to contact for more in-depth questions and needs. 

Search Engine Optimization, or SEO, is another complex topic that affects any Internet-based business.  One of my business partners who own SMG Business Plans is an expert at SEO, and he has to be to support the marketing needs of the business.  The tricky part to SEO is that the playing field is constantly changing, so that those techniques that produce meaningful results one week, will not work at all the next.  Effective SEO requires constant tweaking, and an expert that know how to undertake that tweaking, in an effective manner that consistently produces real, measurable results—meaning consistent and meaningful revenues and profits.  There will be experts in SEO and also individuals like Alan Tratner, Bill Barber, and Jerry Knotts who can put entrepreneurs in touch with qualified experts that can help.

Whether you are a first-time business owner, or a seasoned veteran looking for your next success, the Tech Brew Mega Mixer and Maverick Angels Open Evening for Entrepreneurs for the Central Coast and Southern California regions offers plenty of compelling reason to attend.  It’s free for one thing, and the contacts and information available in one location, on one night, is simply priceless.  I will be there as well, so if you attend, be sure to stop by and say hello!

TARP: A good deal for the taxpayer (published in November of 2010 in the SB News Press)

Much was written about how terrible it was for the government (we, the taxpayers), to “bail-out” the big banks, automakers, insurance companies, etc.  While it is true that some of these businesses have yet to repay their TARP money, (some will never pay it back), the vast majority, and particularly the ones that took the lion’s share of the money, have already repaid it, (with interest).

With GM’s return to the public markets this week, and with the success of their IPO, I thought it would be interesting to review the TARP program, the investments that were made, and the returns we have received to-date.

First, a quick review of the TARP program - The Troubled Asset Relief Program, commonly referred to as TARP, was established to purchase assets and equity from financial institutions to strengthen the financial sector.  It was signed into law by President Bush on October 3, 2008, and was the largest component of the government's efforts to address the subprime mortgage crisis.  It officially expired on October 3, 2010.

TARP allowed the Treasury to purchase or insure up to $700 Billion of "troubled assets," defined as "(A) residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008, the purchase of which the Secretary determined promotes financial market stability; and (B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determined the purchase of which would be necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress." (CBO report; dated 12/1/2008)

The TARP money was intended to improve the liquidity of these assets by purchasing them using secondary market mechanisms, thus allowing participating institutions to stabilize their balance sheets and avoid further losses.  The Act required financial institutions selling assets to TARP to issue equity warrants—a type of security that entitles its holder to purchase shares in the company issuing the security for a specific price, or equity or senior debt securities, (for non-publicly listed companies) to the Treasury. In the case of warrants, the Treasury only received warrants for non-voting shares, or agreed not to vote the stock. This measure was designed to protect taxpayers by giving the Treasury the possibility of profiting through its ownership stakes in these institutions. Ideally, if the financial institutions benefited from government assistance and recovered their former strength, the government would also be able to profit from their recovery.

Originally expected to cost the U.S. Government $356 billion, the most recent final net estimate of the cost, (as of October 5, 2010), will be close to $30 billion, including expected returns from the interest in AIG. (This is significantly less than the taxpayers' cost of the savings and loan crisis of the late 1980s.  The cost of that crisis amounted to 3.2% of GDP during the Reagan/Bush era, while the GDP percentage of the current crisis' cost is estimated at less than 1%.)  

Of the $245 billion invested in U.S. banks, $192 billion, or 78% has been paid back, including $26.8 billion in income, and $4 billion in warrant proceeds, as of September 30, 2010.  Although the TARP program was officially $700 billion, a maximum of $475 billion was available to Treasury to use, and of that, only $388 billion was spent.  Of that $388 billion, $204 billion has been repaid to-date (as of September 30th), or 53%, including $30 billion in income (profit).   (Treasury, Office of Financial Stability; TARP: Two Year Retrospective) 

Many of the larger banks, such as Wells Fargo and JP Morgan, did not want any money through TARP, but were forced (by Henry Paulson) to take it.  He reasoned that if only some banks took the money, they would be seen as weak, and the others strong, and this could cause runs on the weak banks.  He may very well have been right, but now the banks that didn’t need, nor want, the money, are tarred with the same brush as those that did need it. 

AIG is considered “on track” to pay back $51 billion from divestitures of two units and another $32 billion in securities. In March 2010, GM repaid more than $2 billion to the U.S. and Canadian governments and on April 21st GM announced the entire loan portion of the U.S. and Canadian governments’ investments had been paid back in full, with interest, for a total of $8.1 billion. This was, however, subject to contention because it was argued that the automaker simply shuffled federal bailout funds to pay back taxpayers.

“. . . if there’s one thing that has unified Democrats and Republicans, and everybody in between, it’s that we all hated the bank bailout. I hated it. You hated it. It was about as popular as a root canal. But when I ran for President, I promised I wouldn’t just do what was popular – I would do what was necessary. And if we had allowed the meltdown of the financial system, unemployment might be double what it is today. More businesses would certainly have closed. More homes would have surely been lost.  So I supported the last administration’s efforts to create the financial rescue program. And when we took that program over, we made it more transparent and more accountable. And as a result, the markets are now stabilized, and we’ve recovered most of the money we spent on the banks.”
~President Obama, January 27, 2010

The GM IPO, which priced Thursday, was the second largest IPO in history, behind Visa, which came public in 2008 with a $19.7 billion raise, before the financial crisis broke.  The government, which owned 61% of GM prior to the offering, was hoping to cut their stake to 33% (or less) through the deal.  With the successful sale of 478 million shares at $33 per share, and the likelihood of raising even more money (reducing their stake further) through overallotments—extra shares that the bankers sponsoring the deal can sell if demand is there (which it certainly is), the government will recoup a sizable amount of their investment in GM.  However, even with the overallotments, which will mean that GM could raise as much as $21.6 billion, making their IPO the largest in history, the government will have to sell their remaining shares in GM at an average price of $53 per share to break-even on their investment.  The government is expected to sell their remaining shares over the next two to three years, and this gives them a reasonable chance of getting their money back (which is really our money).

The bigger picture from my perspective is that the GM IPO represents more than the repayment of some of our investment.  The success of the offering underscores the confidence the investment public has in GM, and more importantly in the U.S. economy.  After all, GM is as quintessentially American as you can get, and its success will depend on and represent a complete recovery for the U.S. economy.

As for the TARP program, I feel that most Americans will always consider it a bailout of the big banks that should never have happened.  I truly believe that the U.S. economy and world financial system would have completely collapsed if we had allowed some of our large banks to fail.  More importantly, it was highly likely that the collapse of some big banks would have had a domino effect, taking stronger banks down as well. 

We will never know for sure what would have happened.  The government took a stand, and if you review the hard facts, TARP was a success overall.  For a cost of about $30 billion to save the U.S. economy, which is less than 3% of one year’s GDP, I can’t imagine anyone thinking this was a bad deal for the taxpayer. 

History will surely look at the TARP program as a huge success, and as a turning point in an otherwise catastrophic downward spiral for the world economy.  It certainly wasn’t perfect, but it worked, and sometimes we have to accept, and move on. 

Currencies: How countries manipulate their value, and why (published in November of 2010 in the SB News Press)

I recently had a friend ask me to write about the value of the dollar and why and how the government manipulates its value.  Like most economic concepts, this is a complex topic.  The trick for me, as usual, is to find a way to explain something complex in an easy to understand way.  I’ll do my best!

In general, larger, industrialized countries do various things to change the value of their currencies to achieve certain economic goals.  Under most economic situations, having a relatively weak currency is preferred.  This is because these countries tend to export a lot of the products they produce and therefore, they want to keep the prices of these products relatively low in terms of other currencies (other than their own). 

A good way to think about this is to view countries like they are a business selling one product.  If Apple wants to sell more iPhones, they will lower the price.  If they lower the price, a buyer can get the same iPhone that was, let’s say, $300, for $250.  In other words, the buyer is getting the same product for $50 less.  By lowering the price, Apple would sell more iPhones, potentially increasing their profitability.

A country that lowers the value of their currency is no different than Apple—they are trying to make their products more affordable for buyers, only the buyers are from other countries.  If a buyer in the UK can get $1.40 for a euro today, and then the U.S. government lowers the value of the dollar so that the same person can get $1.50 for a euro tomorrow, that potential UK buyer can buy more ($0.10 more) stuff in dollars tomorrow than he or she could today.  If you multiply that by billions of euros and dollars, you can see why it can be very important to countries to keep their currency values low.

Here’s the rub – as with most things in economics, decisions are not made in a vacuum. As you can imagine, if both countries in our example—the U.S. and the U.K.—want to keep their currencies low, we have a serious problem.  Currencies, in general, are only weak or strong when compared to another country’s currency.  In fact, at any given time, the dollar could be weak and strong—weak against the euro and strong against the Chinese yuan, for example.  When we introduce multiple interrelationships among many currencies, one can see how the situation can get complicated very quickly.

As a direct consequence of all of these interrelationships, countries face significant challenges when trying to weaken their currency value.  China, for example, has been holding their currency, the yuan, weak against the dollar for years (since 1994 they have pegged the yuan to the dollar at an artificially low value).  They do this specifically because they want their goods to remain cheap for U.S. buyers, so we will buy more Chinese goods.  This strategy has worked well, and we can see the results clearly in their GDP growth, which is three to four times that of the U.S., and has been consistently stronger for years.  To put into monetary terms, the U.S. trade deficit with China was $30 billion in 1994 and it is about $300 billion now.

There are a variety of methods a country can use to weaken their currency, but in general they involve selling their home currency and buying the currency of the other country—the U.S. in this case, or just printing more currency (which is what we are doing now with Quantitative Easing (QE).  The Fed just announced this week that they would be taking printed dollars in the amount of $600 billion, and buying assets, such as treasuries and mortgaged-backed securities.  Their aim is to stimulate the economy, but in so doing, they will also weaken the dollar).  The buying of the dollar results in upward pressure on the value of the dollar, while the selling of the yuan in the example with China, has the effect of lowering the value of the yuan.

In practice, what happens with China is that they are exporting tons of stuff to the U.S.  They are paid in dollars for these goods, and therefore need to convert the dollars they receive back into yuan.  If they sold dollars andf bought yuan on the currency markets (like they are supposed to do), they would drive the value of the dollar down and the value of the yuan up (selling dollars and buying yuan).  Instead, they use the dollars to buy dollar-denominated assets—usually U.S. treasury bonds—thereby avoiding the impact on their currency that would otherwise take place.

There is, by the way, a law in place, called the Omnibus Trade & Competitiveness Act of 1988, which gives the president some tools to basically retaliate against a country that manipulates their currency to unfairly affect the balance of trade, etc.  However, in practice, the government never does much of anything except talk to the country—China in this case—and try to negotiate with them to stop the manipulation.  So far, although China has said they are trying to move the value of the yuan back up, they really are not doing much about it, and for good reason.  A rising value of the yuan will directly, negatively impact their economy, which is the last thing they want.

The only attempt to impose a cost on China’s distortion of global financial markets this year was congressional action on the Currency Reform for Fair Trade Act, known as the Ryan Bill, which would allow US companies to file complaints against China’s currency policies with the Commerce Department, and would empower the Department to levy tariffs and countervailing duties on imports from China.  The Ryan Bill passed in the House but stalled in the Senate.

The reality is that we need China to buy our treasuries, and to keep buying them, because we have a gargantuan national debt of about $13 trillion (and counting), and their money finances that debt to the tune of about $2 trillion.  For that reason, we don’t make too much noise about their currency manipulations.

A markedly tougher challenge for countries is trying to increase the value of their currency.  This would occur when inflation has become too high and the country is trying to lower inflation by strengthening their currency (we will very likely see this occur in the U.S. over the coming few years).  There are a few ways to strengthen a currency, but the two main ways countries use are raising interest rates and buying their currency.  Raising rates is definitely easier than buying the currency, but raising rates can have dire economic consequences.  Typically, when an economy starts to get overheated, raising rates is used as a tool to slow economic growth.  Increasing rates is an effective way to cool an economy, and is what the Fed typically does here int eh U.S. in those situations. 

The problem with raising rates is that, if they are raised too rapidly or too high, they can stifle the economy or may even cause a recession.  Worse yet, if a country is already in a tough economic situation, and they are forced to raise rates to combat a weak currency and inflation, this can really destroy their economy.  We experienced exactly this situation in the early 1980s, when Paul Volker, the then Chairman of the Fed, had to raise interest rates dramatically to combat inflation.  He was successful in decreasing inflation, but also crushed the U.S. economy in the process, and put us through one of the worst recessions, including a double-dip, that the country has ever experienced.

Personally, I have never seen any country successfully manipulate their currency over the long-term.  Most of the failures have been in countries trying to peg their currency to the U.S. dollar, holding their home currency artificially high.  China, thus far, has been pretty successful at keeping the yuan low, and has benefitted from strong economic growth as a result.  However, there are cracks starting to appear, including rampant real estate speculation and many bubbles in prices.  Further, owning $2 trillion in U.S. treasuries may not turn out to be a great investment.  One thing is certain, however, and that is that countries will continue to manipulate their currencies, and these manipulations have economic consequences that we should understand so we can plan for their potential impacts on our lives.

China: Emergence or Twilight? (published in November of 2010 in the SB News press)

On Tuesday of this week, China and Russia, during their bilateral trade talks, agreed to drop the dollar as their medium of exchange in favor of their own currencies.  Is this simply a matter of two countries recognizing the importance of one another in their trade regimes, a matter of practicality with regard to settling transactions, or is there a deeper, more disturbing significance to this development?

The U.S. dollar has long been the reserve currency, meaning that countries around the globe have used the U.S. dollar as a store of value and a medium of exchange.  With the mind-numbing progression of measures undertaken by the Fed and Treasury to stimulate the economy and stop the financial crisis from become contagion—spreading all over the planet and destroying the global financial system, the dollar may have lost its luster.  The most recent round of quantitative easing, which is estimated (so far) to amount to $600 billion, underscores the continuing pressure that the dollar is suffering.  Quantitative easing, in simple terms, is printing money to buy securities, such as treasuries and mortgage-backed securities, to pump cash into the economy and thereby stimulate growth.  The downside is that when you print currency, you devalue it—more supply equals a lower price. 

While all I have written above is true in a theoretical sense (all other things being equal), in the real world, things are not so clear-cut.  For example, even though we are printing money and thereby pressuring the dollar’s value, other countries are doing the same or similar things that also put pressure on their currencies.  Then there is the all important perception factor, meaning that people’s perceptions of what is happening within a given country have a direct and significant impact on the value of that country’s currency.  For example, if people believe that a country is a bad place to keep their money, they will sell that country’s currency and buy the currency of another country—one that they feel is safer.  We are seeing this in Ireland today—people are afraid that their debt is going to overwhelm the government, and that they will be forced to restructure their sovereign debt.  Many investors are not comfortable with this risk, and so they are selling Irish debt and moving their money elsewhere.  Perception becomes reality and currency values adjust.

Keep in mind also that anytime we discuss the value of any currency and state that it is strong or weak, we are making a comparison to another currency.  In fact, a given currency can be at once strong and weak—the dollar may be strong against the yuan and weak against the pound sterling.  These interrelationships are critical because they are the foundation for international trade and for many of the decisions international investors make—an international investor may think investing in a country is attractive, but may refrain from making the investment if he or she feels that the currency will fall in value against their home currency. 

Recently, at the G20 meeting, China and Germany took the lead in criticizing the Fed’s current policies.  Just this week, the Fed announced a revision of their 2011 economic outlook, stating that they now believe that economic growth in the U.S. throughout 2011 will be slower than anticipated (readers may recall that I have been stating for many months that although we are in a recovery, I believe that the recovery will be very anemic.)  As a result, we can expect the Fed to not only keep short-term interest rates low, but to also support additional stimulus measures, including more quantitative easing.  Some economists have estimated that it will take as much as $2 trillion of additional quantitative easing to support a recovery in the U.S. (far more than the $600 billion currently on the table).

China made a number of significant economic and political announcements over the past few weeks. The People’s Bank of China hiked deposit and lending rates by a quarter of a percent on October 19, the first rate increase since December 2007. On October 20, third-quarter 2010 figures were released, which showed economic growth may be easing. The economy expanded at a 9.6 percent vs. 10.3 percent in the previous quarter. Their inflation rate is estimated to be 4.4%, and their target inflation rate is 5.56% (so they are willing to accept even more growth and inflation). 

The most frequently mentioned potential problem for the Chinese economy is the property bubble. Property prices have risen remarkably since 2008, primarily in residential real estate, in major Chinese cities. Ironically this is the time when our real estate market began its collapse.  Prices for new apartments in Beijing and Shanghai rose between 50 and 60 percent in 2009 alone.  The types of financing options, such as negative amortization products or no money down loans, that helped bring down the U.S. property market are not available in China. The degree to which you can get into trouble as a real estate investor when you pay cash is far different than when you put no cash down. Approximately 25 percent of home purchases in China are all-cash deals.  Furthermore, there is a requirement to put a minimum of 30 percent of the purchase price down in cash on a first home larger than 970 square feet and 20 percent down on smaller homes.  It would appear that, although their real estate market is expanding rapidly, they do not face the same threat of complete financial meltdown that we experienced in the West.

China’s long-term economic success will depend largely on their ability to transition from an export-driven economy to a more balanced economy with domestic consumption.  The Chinese central government has issued a series of five-year plans over the last several decades. The new five-year plan puts a high priority on increasing domestic consumption.  There is a large number of companies in China waiting for regulatory approval from the China Securities Regulatory Commission to launch an initial public offering (IPO), many of which are consumer products companies.  The government, following their five-year plan, may fast-track some of these businesses, supporting a more rapid development for the domestic consumer segment of the Chinese economy.  Additionally, the government may remove some regulatory barriers to allowing outside consumer-based companies, including those from the U.S. and Western Europe to operate more freely in the Chinese market, even in smaller cities.

The ongoing growth and prosperity of China could bode well for the U.S. dollar, in that, at least so far, the Chinese have been happy to own dollar-denominated assets, including about $2 trillion in U.S. treasuries.  We are certainly highly dependent on this funding source, to support our ongoing government spending needs, and to service our rapidly expanding debt ($13 trillion and counting).  It remains to be seen if the recent bilateral trade agreement between Russia and China, which includes dropping the dollar, will be a precursor to more significant global trade issues.  With all that is occurring in Europe, especially with the massive debt woes of Ireland, Greece, Portugal, Spain and others, the dollar will remain a relatively safe place to store value.  However, in the longer-term, we will face serious inflationary pressures which could significantly devalue the dollar, which could send the Chinese (and everyone else) scrambling to dump dollars in favor of other currencies.