You Want Me to Pay You … Why?

Fed Funds Rate goes negative
Negative rates burn wealth! ramcreations/Shutterstock

14 August 2019 – There’s been some hand wringing in the mass media recently about negative interest rates and what they mean. Before you can think about that, however, you have to know what negative rates are and how they actually work. Journalists Sam Goldfarb and Daniel Kruger pointed out in a Wall Street Journal article on Monday (8/12) that not so long ago negative interest rates were thought impossible.

Of course, negative interest rates were never really “impossible.” They used to be considered highly unlikely, however, because nobody in their right mind would be willing to pay someone else for taking money off their hands. I mean, would you do it?

But, the world has changed drastically over the past, say, quarter century. Today, so-called “investors” think nothing of buying stock in giant technology companies, such as Tesla, Inc. that have never made a dime of profit and have no prospects of doing so in the near future. Such “investors” are effectively giving away their money at negative interest rates.

Buying stock in an unprofitable enterprise makes sense if you believe that the enterprise will eventually become profitable. Or, and this is a commonly applied strategy, you believe the market value of the stock will rise in the future, when you can sell it to somebody else at a profit. This latter strategy is known as the “bigger fool theory.” This theory holds that doing something that stupid is a good idea as long as you believe you’ll be able to find a “bigger fool” to take your stock in the deadbeat enterprise off your hands before it collapses into bankruptcy.

That all works quite nicely for stocks, but makes less sense for bonds, which is what folks are talking about when they wring their hands over negative-interest-rate policy by central banks. The difference is that in the bond market, there really is no underlying enterprise ownership that might turn a profit in the future. A bond is just an agreement between a lender and a debtor.

This is where the two-fluid model of money I trotted out in this column on 19 June helps paint an understandable picture. Recall from that column that money appears from nowhere when two parties, a lender and a debtor, execute a loan contract. The cash (known as “credit” in the model) goes to the debtor while an equal amount of debt goes to the lender. Those are the two paired “fluids” that make up what we call “money,” as I explain in that column.

Fed Funds Rate

The Federal Reserve Bank is a system of banks run by the U.S. Treasury Department. One of the system’s functions is to ensure the U.S. money supply by holding excess money for other banks who have more than they need at the moment, and loaning it out to banks in need of cash. By setting the interest rate (the so-called Fed Funds Rate) at which these transactions occur, the Fed controls how much money flows through the economy. Lowering the rate allows money to flow faster. Raising it slows things down.

Actual paper money represents only a tiny fraction of U.S. currency. In actual fact, money is created whenever anybody borrows anything from anybody, even your average loan shark. The Federal Reserve System is how the U.S. Federal Government attempts to keep the whole mess under control.

By the way, the problem with cryptocurrencies is that they attempt to usurp that control, but that’s a rant for another day.

Think of money as blood coursing through the country’s economic body, carrying oxygen to the cells (you and me and General Motors) that they use to create wealth. That’s when the problem with negative interest rates shows up. When interest rates are positive, it means wealth is being created. When they’re negative, well you can imagine what that means!

Negative interest rates mean folks are burning up wealth to keep the economic ship sailing along. If you keep burning up wealth instead of creating it, eventually you go broke. Think Venezuela, or, on a smaller scale, Puerto Rico.

Negative Interest

Okay, so how do negative interest rates actually work?

A loan contract, or bond, is an agreement between a lender and a debtor to create some money (the two fluids, again). The idea behind any contract is that everybody gets something out of it that they want. In a conventional positive-interest-rate bond, the debtor gets credit that they can use to create wealth, like, maybe building a house. The lender gets a share in that wealth in the form of interest payments over and above the cash needed to retire the loan (as in pay back the principal).

Bonds are sold in an auction process. That is, the issuer offers to sell the bond for a face value (the principal) and pay it back plus interest at a certain rate in the future. In the real world, however, folks buy such bonds at a market price, which may or may not be equal to the principal.

If the market price is lower than the principal, then the effective rate of interest will be higher than the offered rate because what the actual market value is doesn’t affect the pay-back terms written on the loan agreement. If the market price is higher than the principal, the effective rate will be lower than the offered rate. If the market price is too much higher than the principal, the repayment won’t be enough to cover it, and the effective rate will be negative.

Everyone who’s ever participated in an auction knows that there are always amateurs around (or supposed professionals whose glands get the better of their brains so they act like amateurs) who get caught up in the auction dynamics and agree to pay more than they should for what’s offered. When it’s a bond auction, that’s how you get a negative interest rate by accident. Folks agree to pay up front more than they get back as principal plus interest for the loan.

Negative Interest Rate Policy (NIRP) is when a central bank (such as the U.S. Federal Reserve) runs out of options to control economic activity, and publicly says it’s going to borrow money from its customers at negative rates. The Fed’s customers (the large banks that deposit their excess cash with the Fed) have to put their excess cash somewhere, so they get stuck making the negative-interest-rate loans. That means they’re burning up the wealth their customers share with them when they pay their loans back.

If you’re the richest country in the world, you can get away with burning up wealth faster than you create it for a very long time. If, on the other hand, you’re, say, Puerto Rico, you can’t.

Do the Math

Applied Math teacher
Throughout history, applied mathematics has been the key to human development. By Elnur/Shutterstock

31 July 2019 – Over the millennia that philosophers have been doing their philosophizing, a recurring theme has been the quest to come up with some simple definition of what sets humans apart from so-called “lower” animals. This is not just idle curiosity. From Aristotle on, folks have realized that understanding what makes us human is key to making the most of our humanity. If we don’t know who we are, how can we figure out how to be better?

In recent decades, however, it’s become clear that this is a fool’s errand. Such a definition of humanity doesn’t exist. Instead, what sets humans apart is a suite of characteristics, such as two eyes in the front of a head that’s set up on a stalk over a main torso, with two legs down below and a couple of arms on each side ending with wiggly fingers and opposable thumbs; a brain able to use sophisticated language; and so forth. Not every human has all of them (for example, I had a friend in Arizona who’d managed to lose his right arm and shoulder without losing his humanity) and a lot of non-humans have some of them (for example, chimpanzees use tools a lot). What marks humans as humans is having most of these characteristics, and what marks non-humans as not human is lacking a lot of them.

On the other hand, there is one thing that most humans are capable of that most non-humans aren’t: humans are capable of doing the math.

Yeah, crows can count past two. I hear that pigeons are good at pattern recognition. But, I’m talking about mathematical reasoning more sophisticated than counting past seven. That’s something most humans can do, and most other animals can’t.

Everybody has their mathematical limitations.Experience indicates that one’s mathematical limitations are mostly an issue of motivation. At some point, just about everybody decides that it’s just not worth putting in the effort needed to learn any more math than they already know.

That’s because learning math is hard. It’s the biggest learning challenge most of us ever face. Most of us give up long before reaching the limits of our innate ability to puzzle it out.

Luckily, there are some who are willing to push the limits, and master mathematical puzzles that no human has solved before. That’s lucky because without people like them, human progress would quickly stop.

Even better, those people are often willing – even anxious – to explain what they’ve puzzled out to the rest of us. For example, we have geometry because a bunch of Egyptians puzzled out how to design pyramids, stone temples and other stuff they wanted to build, then proudly explained to their peers exactly how to do it. We have double-entry accounting because folks in the Near East wanted to keep track of what they had, figured out how to do it, and taught others to help. We’ve got calculus because Sir Isaac Newton and a bunch of his buddies figured out how to predict what the visible planets would do next, then taught it to a bunch of physics students.

It’s what we like to call “Applied Mathematics,” and it’s responsible for most of the progress people have made since the days of stone knives and bear skins. Throughout history, we’ve all stood around scratching our heads about things we couldn’t make sense of until some bright guy (or gal) worked out the right mathematics and applied it to the problem. Then, suddenly what had been unintelligible became understandable.

These days, what I think is the bleeding edge of applied mathematics is nonlinear dynamics and chaos. Maybe there’s some fuzzy logic thrown into the mix, too. Most of the math tools needed to understand (as in “make mathematical models using”) these things is pretty well in hand. What we need to do is apply such tools to the problems that today vex us.

A case in point is the Gini-Simpson Diversity Index I described in this blog two weeks ago. That is a small brick in the wall of a structure that I hope will someday help us avoid making so many dumb choices. Last week I ran across another brick in a paper written by a couple of computer science professors at my old alma mater Rensselaer Polytechnic Institute (aka RPI, or as we used to call it when I was there as a graduate student, “the Tute”). This bit of intellectual flotsam describes a mathematical model the authors use to predict how political polarization evolves in the U.S. Congress.

Polarization is one of four (at my last count) toxic group-dynamics phenomena that make collaborative decision making fail. Basically, the best decisions are made by groups that work together to reach a consensus. We get crappy decisions when the group’s dynamics break down.

The RPI model is a nonlinear differential equation describing an aspect of the dynamics of decision-making teams. Specifically, it quantifies conditions that determine whether decision teams evolve toward consensus or polarization. We see today what happens when Congress evolves toward polarization. The authors’ research shows that prior to about 1980 Congress evolved toward consensus. Seeing this dynamic at work mathematically gives us a leg up on figuring out why, and maybe doing something about it.

I’m not going to go into the mathematical model the RPI paper presents. The study of nonlinear dynamical systems is far outside the editorial focus of this column. At this point, I’m not going to talk about solutions the paper might suggest for toxic U.S. Government polarization, either. The theory is not well enough developed yet to provide meaningful suggestions.

The purpose of this posting is to point out that application of sophisticated mathematics is necessary for solving society’s most intractable problems. As I said above, not everybody is ready and willing to become expert in using such tools. That’s not necessary. What I hope you’ll walk away with today is an appreciation of applied mathematics’ importance for societal development, and a willingness to support STEM (science, technology, engineering and mathematics) education throughout our school system. Finally, I hope you’ll encourage students who show an interest to learn the techniques and follow STEM careers.

Misconceptions About Maslow’s Hierarchy of Needs

Maslow's Pyramid
Maslow’s pyramid of needs analyzes human needs and arranges them in a hierarchy. By Shutter_M/Shutterstock

24 July 2019 – Abraham Harold Maslow (1908-1970) was a 20th century psychologist famous for describing human motivation as an hierarchy of needs in a 1943 paper entitled “A Theory of Human Motivation” published in Psychological Review. He was a central figure in the founding of Humanistic Psychology, which concentrates on studying mentally healthy humans.

You have to remember that Maslow did his most important work in the middle of the 20th century. At that time there was great popular interest in the works of Sigmund Freud, who worked with the mentally ill, and B.F. Skinner who mainly studied lower animals. Indeed, the entire arts-and-letters school of Surrealism explicitly drew inspiration from Andre Breton’s interpretation of Freud’s work. Despite (or perhaps because of) this interest in Freud and Skinner’s work, there had been little, if any, study of mentally healthy people.

Humanistic Psychologists felt these earlier studies were of limited value to understanding the healthy human mind. Maslow chose to study the workings of healthy human minds from all social strata, but he was especially interested in studying high achievers. For this reason those of us interested in organizational behavior find his humanists of particular interest. We kinda hope our organizations are populated with, and run by, mentally healthy humans, rather than Freud’s neurotics or Skinner’s lab rats!

Maslow’s emphasis on studying high achievers likely gave rise to the first misconception I want to talk about today: the idea that his work gives cover to elitist views. This elitist theory assumes that everyone strives to reach the self-actualization level at the top of the so-called “Pyramid of Needs” used to illustrate Maslow’s hierarchy, but that only an elite fraction of individuals reach it. Lesser individuals are doomed to wallowing in more squalid existences at lower levels.

The second misconception I want to treat today is a similar notion that people start out at the lower levels and climb slowly up to the top as their incomes rise. This theory substitutes a ladder for the pyramid image to visualize Maslow’s hierarchy. People are imagined to climb slowly up this ladder as both their income and social status increase. This, again, gives cover for elitist views as well as laissez-faire economics.

Maslow’s Conception

What Maslow’s Hierarchy really describes is a priority system that determines what people are motivated to do next. It has little to do with their talents, income or social status. To illustrate what I mean, I like to use the following thought experiment. This thought experiment involves Albert Einstein and it’s particularly appropriate because the Grizzled Genius loved thought experiments.

Albert Einstein’s greatest joy was becoming immersed in translating his imaginings about the physical universe into mathematical equations. This is an example of what Maslow called “peak experiences.” Maslow believed these were periods when self-actualized people (those engaged in satisfying their self-actualization need) are happiest and most productive.

Once in a while, however, Einstein would become hungry. Hunger is, however, one of those pesky physiological needs down at the bottom of Maslow’s Hierarchy. There’s nothing aspirational about hunger. It’s what Fredrick Herzberg called a “hygiene factor” or “demotivator.” Such needs are the opposite of aspirational.

If you’ve got an unsatisfied demotivator need, you become unhappy until you can satisfy it. If, for example, you’re hungry, or have a toothache, or need to pee, it becomes hard to concentrate on anything else. Your only thought is (depending on the nature of the unmet physiological need) to go to the bathroom, or the dentist, or, as in Einstein’s case, go find lunch.

The moral of this story is that people don’t sit somewhere for extended periods of time on a shelf labeled with one of Maslow’s categories. Rich people don’t float in a blissful self-actualizing state. Poor people don’t wallow in a miasma of permanently unmet physiological needs. People constantly move up and down the pyramid depending on what the most pressing unmet need of the moment is.

The hierarchy is therefore actually an inverted priority list. Physiological needs are more important than safety needs. When something frightens you – a safety need – the first thing that happens is you feel an urge to pee to take care of a physiological need to prepare your body for running like a scared rabbit. When you see a fast-moving Chevy bearing down on you, you immediately forget pride in that (esteem level) achievement award you just got.

Elitist Fallacy

A combination of confusion about how Maslow’s heirarchy works and his preference for studying high achievers has led many people to imagine his work gives cover for elitist views. If you’re predisposed to imagine that rich people, smart people, or those of high social status are somehow innately “better” than denizens of what 19th century novelist Edward Bulwer-Lytton called “the great unwashed,” then you’re an elitist. An elitist can derive great comfort by misinterpreting Maslow’s work. You can imagine there being a cadre of elite people destined to spend their lives in some ethereal existence where all lower needs are completely satisfied and life’s only pursuit is self actualization.

The poster child for elitism is 16th century theologian John Calvin. In Calvin’s version of Protestant theology everyone was tainted with original sin and doomed to an eternity in Hell. That was a pretty common view at the time of the Protestant Reformation. Calvin added an elitist element by hypothesizing that there was a limited number of individuals (the elect) whom God had chosen for salvation.

It’s called predestination and those folks got tickets into the elite ranks through no merit of their own. There was nothing anybody could do to beg, borrow, or steal their way in. God decided, while making the Universe in the first place, who was in and who was out based on nothing but His whimsey. (Sexist pronoun used specifically to make a point about Calvinism.)

Of course, the requirements of natural selection logically lead to everyone having a desire to be part of an elite. We all want to be different, like the Dada-esque avant garde group King Missile. That’s how DNA measures its success. Only elite DNA gets to have long-term survival.

So, elitism has a lot of natural appeal. This natural appeal accounts for all kinds of rampant racism and xenophobia. Misunderstanding Maslow’s heirarchy provides a pseudoscientific rationale for elitism. To the elitist, the fact that this view is completely mistaken makes no nevermind.

I hope that by now I have disposed of the elitist fallacy.

Economic Ladder Fallacy

Hoping that I’ve disposed of the idea that Maslow’s work gives cover to elitism, I’ll turn to the fallacy of imagining his hierarchy as an economic ladder. This puppy is a natural outgrowth of the Pyramid of Needs image. The top (self actualization) level of the pyramid is imagined as “higher” than the bottom (physiological) level.

This image actually works from the viewpoint that “lower” needs take precedence over “higher” needs in the same way that a building’s supporting foundation takes precedence over the walls and roof. Without a foundation, there’s nothing to support walls or a roof in the same way that without fulfilling physiological needs, there’s no motivation for, say, self actualization.

Think of it this way: dead people, whose physiological needs are all unmet, hardly ever want to run for President.

So, how do you reach something high? You use a ladder!

That’s the thinking that transforms the Pyramid of Needs into some kind of ladder.

If you’re a strict materialist (and way too many Americans are strict materialists) the “high” you care about reaching is wealth. Folks who haven’t understood last month’s posting entitled “The Fluidity of Money” often confuse income with wealth, so there’s some appeal to thinking about Maslow’s Hierarchy of Needs as a metaphor for income levels. That completes the economic-ladder fallacy.

With this fallacy, folks imagine that everyone starts out at the bottom of the ladder and, with time, hard work and luck, climbs their way to the top. There are obvious problems matching income levels with needs levels, but if you’re sufficiently intellectually lazy, you can unfocus your mind’s eye enough to render these problems invisible.

I especially get a kick out of efforts to use the idea of Engel curves (from economics) to make this ladder fallacy work. Engel curves map the desireability (measured as the demand side of the economics law of supply and demand) of a given good or product against a given consumer’s income level. If the good in question is, for example, a used Mazda Miata, the desirability may be high when the consumer has a low-to-moderate income, but low if that particular consumer has enough income to pay for a new Ferrari SF90 Stradale. If you want to, it is obvious you can somehow conflate Engel curves with the ladder idea of Maslow’s Heirarchy of Needs.

The problem with this thinking is, first, that the Ladder doesn’t make a lot of sense as a visualization for Maslow’s Heirarchy, since the latter is formost a priority-setting scheme; second, that Maslow’s Hierarchy has little connection to income; and, third, that Engel curves present an incomplete view of what makes a product desirable.

The elitist fallacy and the economic-ladder fallacy are not the only fallacies people, with their infinite capacity to generate cockamamie theories, can concoct in connection to Maslow’s work. They are just two that have come up recently in articles I’ve had occasion to read. I think analyzing them can also help clarify how the Hierarchy of Needs applies to understanding human behavior.

Besides, I’ve had a bit of fun knocking them around, and I hope you have, too.

Computing Diversity

Decision Team
Diversity of membership in decision-making teams leads to better outcomes. By Rawpixel.com/Shutterstock

17 July 2019 – It’s come to my attention that a whole lot of people don’t know how to calculate a diversity score, or even that such a thing exists! How can there be so much discussion of diversity and so little understanding of what the word means? In this post I hope to give you a peek behind the curtain, and maybe shed some light on what diversity actually is and how it is measured.

This topic is of particular interest to me at present because momentum is building to make a study of diversity in business-decision making the subject of my doctoral dissertation in Business Administration. Specifically, I’m looking at how decision-making teams (such as boards of directors) can benefit from membership diversity, and what can go wrong.

Estimating Diversity

The dictionary definition of diversity is: “the condition of having or being composed of differing elements.”

So, before we can quantify the diversity of any group, we’ve got to identify what makes different elements different. This, by the way, is all basic set theory. In different contexts what we mean by “different” may vary. When we’re talking about group decision making in a business context, it gets pretty complicated.

A group may be subdivided, or “stratified” along various dimensions. For example, a team of ten people sitting around a table trying to figure out what to do next about, say, a new product could be subdivided in various ways. One way to stratify such a group is by age. You’d have so many individuals in their 20’s, so many might be in their 30’s, and so forth up to the oldest group being aged 50 or more. Another (perhaps more useful) way to subdivide them is by specialty. There may be so many software engineers, so many hardware engineers, so many marketers, and so forth. These days stratifying teams by gender, ethnicity, educational level or political persuasion could be important. What counts as diversity depends on what the team is trying to decide.

The moral of this story is that a team might score high in diversity along one dimension and very poorly along another. I’m not going to say any more about diversity’s multidimensional nature in this essay, however. We have other fish to fry today.

For now, let’s assume a one-dimensional diversity index. What we pick for a dimension makes little difference to the mathematics we use. Let’s just imagine a medium-sized group of, say, ten individuals and stratify them according to the color of tee-shirts they happen to be wearing at the moment.

What the color of their tee-shirts could possibly mean for the group’s decisions about new-product development I can’t imagine, and probably wouldn’t care anyway. It does, however, give us a way to stratify the sample. Let’s say their shirt colors fall out as in Table 1. So, we’ve got five categories of team members stratified by tee-shirt color.Table 1: Tee-Shirt Colors

NOTE: The next bit is mathematically rigorous enough to give most people nosebleeds. You can skip over it if you want to, as I’m going to follow it with a more useful quick-and-dirty estimation method.

The Gini–Simpson diversity index, which I consider to be the most appropriate for evaluating diversity of decision-making teams, has a range of zero to one, with zero being “everybody’s the same” and one being “everybody’s different.” We start by asking: “What is the probability that two members picked at random have the same color tee shirt?”

If you’ve taken my statistical analysis course, you’ll likely loathe remembering that the probability of picking two things from a stratified data set, and having them both fall into the same category is:

Equation 1

Where λ is the probability we want, N is the number of categories (in this case 5), and P is the probability that, given the first pick falling into a certain category (i) the second pick will be in the same category. The superscript 2 just indicates that we’re taking members two at a time. Basically P is the number of members in category i divided by the total number of members in all categories. Thus, if the first pick has a blue tee-shirt, then P is 3/10 = 0.3.

This probability is high when diversity is low, and low when diversity is high. The Gini-Simpson index makes more intuitive sense by simply subtracting that probability from unity (1.0) to get something that is low when diversity is low, and high when diversity is high.

NOTE: Here’s where we stop with the fancy math.

Guesstimating Diversity

Veteran business managers (at least those not suffering from pathological levels of OCD) realize that the vast majority of business decisions – in fact most decisions in general – are not made after extensive detailed mathematical analysis like what I presented in the previous section. In fact, humans have an amazing capacity for making rapid decisions based on what’s called “fuzzy logic.”

Fuzzy logic recognizes that in many situations, precise details may be difficult or impossible to obtain, and may not make a significant difference to the decision outcome, anyway. For example, deciding whether to step out to cross a street could be based on calculations using precise measurements of an oncoming car’s speed, distance, braking capacity, and the probability that the driver will detect your presence in time to apply the brakes to avoid hitting you.

But, it’s usually not.

If we had to make the decision by the detailed mathematical analysis of physical measurements, we’d hardly ever get across the street. We can’t judge speed or distance accurately enough, and have no idea whether the driver is paying attention. We don’t, in general, make these measurements, then apply detailed calculations using Gallilean Transformations to decide if now is a safe time to cross.

No, we have, with experience over time, developed a “gut feel” for whether it’s safe. We use fuzzy categories of “far” and “near,” and “slow” or “fast.” Even the terms “safe” and “unsafe” have imprecise meanings, gradually shifting from one to the other as conditions change. For example “safe to cross” means something quite different on a dry, sunny day in summertime, than when the pavement has a slippery sheen of ice.

Group decision making has a similar fuzzy component. We know that the decision team we’ve got is the decision team we’re going to use. It makes no difference whether it’s diversity score is 4.9 or 5.2, what we’ve got is what we’re going to use. Maybe we could make a half-percent improvement in the odds of making the optimal decision by spending six months recruiting and training a blind Hispanic woman with an MBA to join the team, but are we going to do it? Nope!

We’ll take our chances with the possibly sub-optimal decision made by the team we already have in place.

Hopefully we’re not trying to work out laws affecting 175 million American women with a team consisting of 500 old white guys, but, historically, that’s the team we’ve had. No wonder we’ve got so many sub-optimal laws!

Anyway, we don’t usually need to do the detailed Gini-Simpson Diversity Index calculation to guesstimate how diverse our decision committee is. Let’s look at some examples whose diversity indexes are easy to calculate. That will help us develop a “gut feel” for diversity that’ll be useful in most situations.

So, let’s assume we look around our conference room and see six identical white guys and six identical white women. It’s pretty easy to work out that the team’s diversity index is 0.5. The only way to stratify that group is by gender, and the two strata are the same size. If our first pick happens to be a woman, then there’s a 50:50 chance that the second pick will be a woman, too. One minus that probability (0.5) equals 0.5.

Now, let’s assume we still have twelve team members, but eleven of them are men and there’s only one token woman. If your first pick is the woman, the probability of picking a woman again is 1/12 = 0.8. (The Gini-Simpson formula lets you pick the same member twice.) If, on the other hand, your first pick is a man, the probability that the second pick will also be a man is 11/12 = 0.92. I plugged all this into an online Gini-Simpson-Index calculator (‘cause I’m lazy) and it returned a value of 26%. That’s a whole lot worse.

Let’s see what happens when we maximize diversity by making everyone different. That means we end up stratifying the members into twelve segments. After picking one member, the odds of the second pick being identical are 1/12 = 0.8 for every segment. The online calculator now gives us a diversity index of 91.7%. That’s a whole lot better!

What Could Possibly Go Wrong?

There are two main ways to screw up group diversity: group-think and group-toxicity. These are actually closely related group-dynamic phenomena. Both lower the effective diversity.

Group-think occurs when members are too accommodating. That is, when members strive too hard to reach consensus. They look around to see what other members want to do, and agree to it without trying to come up with their own alternatives. This produces sub-optimal decisions because the group fails to consider all possible alternatives.

Toxic group dynamics occurs when one or more members dominate the conversation either by being more vocal or more numerous. Members with more reticent personalities fail to speak up, thus denying the group their input. Whenever a member fails to speak up, they lower the group’s effective diversity.

A third phenomenon that messes up decision making for  high-diversity teams is that when individual members are too insistent that their ideas are the best, groups often fail to reach consensus at all. At that point more diversity makes reaching consensus harder. That’s the problem facing both houses of the U.S. Congress at the time of this writing.

These phenomena are present to some extent in every group discussion. It’s up to group leadership to suppress them. In the end, creating an effective decision-making team requires two elements: diversity in team membership, and effective team leadership. Membership diversity provides the raw material for effective team decision making. Effective leadership mediates group dynamics to make it possible to maximize the team’s effective diversity.

The Free Press, and How You Get It

Free Press Image
The right to sit in a cafe, drinking coffee and reading newspapers is wasted unless that press is free! By Impact Photography/Shutterstock

10 July 2019 – ‘Way back in the late 1960s I spent an entire day as a news hawker. That is, I stood on street corners shouting things at passersby intended to induce them to by copies of a newspaper I was selling. The newspaper was something called The L.A. Free Press. It was produced and sold in Los Angeles, and the street corners I stood on had names like “West Hollywood Boulevard and Sunset.”

I’d recently transplanted from Boston, Massachusetts to the Los Angeles, California area and had never heard of The L.A. Free Press before. A small gang I’d been hanging out with that morning heard that I had a driver’s license on me, and knew that we could use it as collateral to get a great whacking stack of those newspapers to sell at a profit.

Seemed like a good idea at the time.

I initially thought the newspaper copies were somehow free for the taking (as so many local papers are today). I was quickly disabused of that idea because I got pretty decent money for buying copies of it at a low price, then selling them on street corners for a higher price. It clearly wasn’t that kind of free!

Then, I imagined that was (like so many thin publications of the time) some hippy-dippy propaganda rag full of free-love manifestos and ads for beatnik-poetry venues. Being a veteran hippy-beatnik-biker, that was okay with me. I didn’t care as long as there was coin to be had. I wasn’t one of Donovan Leitch’s “beatniks out to make it rich,” but I was interested in coming up with lunch money!

The main headline on the first page of the copies we got in exchange for a mortgage on my driver’s license sounded like a local-interest story that I was not embarrased to wave at potential newsprint buyers, so it didn’t seem to be some hippy-dippy propaganda rag, either. The papers actually sold pretty well!

I needed the money (being dead broke at the time), so I swallowed my pride and did the job. I kept the last copy from my stack, however, to read when I got back to wherever I was sleeping that night.

By the time I’d finished reading the thing I’d realized why the publication was called The L.A. Free Press. It was an independent newspaper founded by a small group dedicated to investigative journalism with nobody to answer to but their readers. I became proud to be working with them.

If I’d been smart and ambitious I would have tried to get a job with them writing copy. After all, part of my reason for relocating was to find some kind of writing gig. But, as is typical with homeless eighteen-year-olds living on the streets, I was more frightened and depressed than smart and ambitious. The next day I moved on to doing something that turned out to be another stupid career move.

Sometimes depression is not a sign of mental illness, but a rational response to the way your life is going.

What I learned from that episode of my misspent youth (What’s the point of misspending your youth if you’re not going to learn something from it?) was what intellectuals mean when they talk about “the Free Press.” It’s not just some empty slogan you hear once in a while on CNN. It’s how we, as citizens of a free country, keep track of what’s going on outside of our individual hovels.

The difference between we citizens of a free country and downtrodden medieval serfs slaving to feed their “betters,” is that we have some say in what goes on outside our hovels. We can’t affect things in a way that’s good for us and the people we care about unless we find out what’s actually going on out there. For that we hire independent journalists who have at least half a brain and make it their business to find out for us.

We pay them a living wage and (if we’ve got at least half a brain ourselves) listen to what they tell us is happening. The Free Press is not, as some dishonest demagogues try to tell us, “the enemy of the people,” but a necessary part of a free democratic society.

For this reason, the journalistic profession has been called “The Fourth Estate” since the Enlightenment. Originally, the term was meant to indicate that a Free Press was available – in addition to the three original estates of clergy, aristocracy and commoners – whose writ was to frame the debate upon which society made common decisions. Later political systems still had (usually) three competing authorities explicitly charged with governing, along with a Free Press implicitly charged with framing the debate about what to do next.

In the United States, our Constitution explicitly delineates a government made up of three co-equal branches: Legislature, Court System, and Executive. The Founding Fathers (If that’s not a sexist term, I don’t know what is!) realized they’d forgotten the Free Press in the original document when they couldn’t get anybody to ratify (agree to) the thing without immediately amending it to include a Free Press (as well as the rest of the Bill of Rights).

The Free Press was considered so important that it was included in the first amendment.

Before anybody gets the idea that I’m criticizing the Founding Fathers as incompetent, I want to point out that this error just goes to prove that those guys were human, and humans make mistakes. Specifically, they were exceedingly bright guys to whom the need for a vibrant Free Press was so obvious that they forgot to mention it. The first ten Amendments – the Bill of Rights – should be seen as an “Oh, Shit!” moment.

“How could we have left that out?”

Having a Free Press, and making good use of it, is the first thing you have to have to set up a democracy. In a sense, it’s not the “fourth” estate, but the first. All the rest is afterthought. It’s bells and whistles designed to be the mechanical parts of a democracy. They’re of no value whatsoever without a Free Press.

On the other hand, once you have a functioning Free Press and a society that makes good use of it, the rest of the bells and whistles will inevitably follow. In that sense, the Free Press is not an afterthought or a result of democracy. Instead, it’s the essence of democracy. That’s why the first thing would-be authoritarians seek to eliminate is the Free Press.

Constructing Ideas

Constructivist pix
Constructivist illustration with rooster’s head. By Leonid Zarubin/Shutterstock

3 July 2019 – Long time readers of my columns will know that one of my favorite philosophical questions is: “How do we know what we think we know?” Along the way, my thoughts have gravitated toward constructivism, which is a theory in the epistemology branch of philosophy.

Jean Piaget has been credited with initiating the constructivist theory of learning through his studies of childhood development. His methods were to ask probing questions of his children and others, in an attempt to understand how they viewed the world. He also devised and administered reading tests to schoolchildren and became interested in the types of errors they made, leading him to explore the reasoning process in these young children.

From his studies, he worked out a model of childhood development that mapped several stages of world-view paradigms they seemed to use as they matured. This forced him to postulate that children actively participate in constructing their own ideas – their knowledge base – based on experience and prior knowledge. Hence, the term “constructivism.”

Imagine a house that represents everything the child “knows.” Mentally, they live in that house all the time, view the world in relation to it, and make decisions based on what’s there.

As they experience everything, including the experience of having someone tell them something verbally or through written words, they actively remodel the place. The operant concept here is that they constantly do the remodeling themselves by trying to fit new information into the structure that’s already there.

My own journey toward constructivism was based on introspective phenomenological studies. That is, I paid attention to how I gained new knowledge and compared my experiences with experiences reported by others studying the same material.

A paradigm example is the study of quantum mechanics. This subject is difficult for students familiar with classical physics because the principles and the phenomena on which they are based seem counterintuitive. Especially, the range of time and distance scales on which quantum principles act is not directly accessible to humans. Quantum mechanics works at submicroscopic distances and on nanosecond time scales.

Successful students of quantum mechanics start by studying human-scale phenomena that betray the presence of quantum principles. For example, the old “planetary model” of atoms as miniature solar systems in which electrons revolve in stable orbits around the atomic nucleus like planets around the Sun is a physical impossibility. Students realize this after studying Maxwellian Electrodynamics.

In 1864, James Clerk Maxwell succeeded in summarizing everything physicists of the time knew about electricity and magnetism in four concise (though definitely not simple) equations. Taken together, they implied the feasibility of radio and not only how light traveled, but even predicted its precise speed. Maxwell’s Equations were enormously successful in guiding the development of electrical technology in the late nineteenth century.

The problem for physicists studying atomic-scale phenomena, however, was that Maxwell’s Equations implied that electrons whizzing around nuclei would rapidly convert all their energy of motion into light, which would radiate away. With no energy of motion left to keep electrons orbiting, the atoms would quickly collapse – then, no more atoms! The Universe as we know it would rapidly cease to exist.

When I say rapidly, I mean on the time scale of trillionths of a second!

Not good for the Universe! Luckily for the Universe, what this really means that there’s something wrong with classical-electrodynamic theory (i.e., Maxwell’s Equations).

The student finds out about dozens of such paradoxes that show that classical physics is just flat out wrong! The student is then ready to entertain some outlandish ideas that form the core of quantum theory. The student proceeds to piece these ideas together into their own mental version of quantum mechanics.

Every physics student I’ve discussed this with has had the same experience learning this quantum-electrodynamical theory (QED). Even more telling, they all report initially learning the ideas by rote without really understanding them, then applying them for considerable time (months or years) before piecing them together into a mental pattern that eventually feels intuitive. At that point, when presented with some phenomenon (such as the sky being blue) they immediately seize on a QED-based explanation as the most obvious. Even doubting QED has become absurd for them!

To a constructivist, this process for learning quantum mechanics makes perfect sense. The student is presented with numerous paradoxes, which causes cognitive dissonance. This state motivates the student to seek alternative concepts and fit them into his or her world view. In a sense, they construct an extension onto the framework of their world view. This will likely require them to make some modifications to the original structure to accommodate the new knowledge.

This method of developing new knowledge dovetails quite nicely with the scientific method that’s been under development since Aristotle and Plato started toying around with it in the fourth century BCE. The new development is that Piaget showed that it is the normal way humans develop new knowledge. Even children can’t fully comprehend a new idea until they fit it into a modified version of their knowledge base.

This model also explains why humans’ normal initial reaction to novel ideas is to forcefully reject them. Accepting new ideas requires them to do a lot of work on their mental scaffolding. It takes a powerful mental event causing severe cognitive dissonance to motivate them to remodel a mental construction they’ve been piecing together for years.

It also explains why younger humans are so much quicker to take up new ideas. Their mental frameworks are still small, and rebuilding them to fit in new concepts is relatively easy. The reward for building out their mental framework is great. They are also more used to tinkering with their mental models than older humans, who have mental frameworks that have served them well for decades without modification.

Of course, once they reach the point of intolerable cognitive dissonance, older humans have more experience to draw on to do the remodeling job. They will be even quicker than youngsters to make whatever adjustments are necessary.

Older humans who have a lifelong habit of challenging themselves with new ideas have the easiest time adapting to change. They are more used to realigning their thinking to incorporate new concepts and have more practice in constructing knowledge frameworks.

The ASEAN Community

ASEAN Summer 2019 Logo
The 34th Asean Summit Bangkok: Advancing Partnership For Sustainability, 23 June 2019

Apologies to all the folks whose words I’ve expropriated for this piece with insufficient attribution – mostly from Wikipedia and ASEAN sources. It’s already taken three days to piece this essay together and I’m trying to get it published while the dateline is still good! Just ONE more editing pass.

26 June 2019 – This is an appropriate time to visit a little-known and -acknowledged regional international community being developed in Southeast Asia: ASEAN. Last Sunday (23 June 2019) marked the 34th meeting of the ASEAN Summit in Bangkok, Thailand

ASEAN was established on 8 August 1967 with the signing of the ASEAN Declaration (Bangkok Declaration) by the five founding member states, namely Indonesia, Malaysia, Philippines, Singapore and Thailand. Five additional member states – Brunei Darussalam (1984), Viet Nam (1995), Lao PDR and Myanmar (1997), and Cambodia (1999) – joined later to complete the ten member states of ASEAN today. An eleventh nation, Timor-Leste (in English: East Timor) has applied for membership.

The creation of ASEAN was originally motivated by a common fear of communism among the original five founding member states. ASEAN achieved greater cohesion in the mid-1970s following a change in the international balance of power after the end of the Vietnam War in 1975. The region’s dynamic economic growth during the 1970s strengthened the organization, enabling ASEAN to adopt a unified response to Vietnam’s invasion of Cambodia in 1979.

ASEAN’s first summit meeting, held in Bali, Indonesia in 1976, resulted in an agreement on several industrial projects and the signing of a Treaty of Amity and Cooperation, and a Declaration of Concord.

The end of the Cold War between the West and the Soviet Union at the end of the 1980s allowed ASEAN countries to exercise greater political independence in the region, and in the 1990s ASEAN emerged as a leading voice on regional trade and security issues.

ASEAN has a total population of 642 million people, which is nearly double that of the United States (327 million), and twenty-five percent larger than that of the European Union (513 million). Its average annual income per person, however, is only $4,308.00, putting it between the Israeli-occupied West Bank and Mauritania in the Western Sahara as far as average wealth per person is concerned. That means its people still have a long way to go! Its GDP growth rate, however, is 5.3% per annum, which is comparable to that of Egypt or Pakistan and ahead of the average for even emerging and developing countries.

Why Do We Care?

Why should Americans care about ASEAN?

First, it has aspirations to be a regional intergovernmental organization similar to the European Union in an region where the United States has economic and political interests. Their charter specifically calls for adherence to basic principles in line with those of the United States and other Western democracies. Notably the ASEAN charter specifically calls for adherence to democratic principles and maintaining the region as a nuclear-free zone.

Second, as a large and (aspirationally) politically and economically cohesive regional intergovernmental organization, ASEAN can provide a large and (again aspirationally) economically powerful ally in Southeast Asia to counterbalance Chinese efforts to extend its hegemony in the region. Especially, their actions reveal a desire to cooperate with the United States and its allies. For example, the charter refers in numerous places to working with United Nations principles and protocols, and establishes English as the ASEAN working language.

Organization

The ASEAN Community is comprised of three “pillars:” the ASEAN Political-Security Community, the ASEAN Economic Community and the ASEAN Socio-Cultural Community. Each pillar has its own Blueprint, and, together with the Initiative for ASEAN Integration (IAI) Strategic Framework and IAI Work Plan Phase II (2009-2015), they form the Roadmap for an ASEAN Community.

The figure below shows ASEAN’s top organization levels. At the top is the ASEAN Summit, comprised of the heads of state or government of the member states. By charter, they meet together twice a year, hosted by the member state holding the ASEAN Chairmanship, which cycles through the member states. At present, that is Thailand (Prime Minister General Prayut Chan-o-cha), so the latest meeting was held on 23 June 2019 in the Thai capital, Bangkok.

ASEAN Org Chart
ASEAN Organizational Structure.

At the next level, ASEAN is divided into three Community Councils that represent the three pillars of ASEAN activity:

  1. The ASEAN Political-Security Community Council

  2. The ASEAN Economic Community Council

  3. The ASEAN Socio-Cultural Community Council

Each of the three Community Councils has their own makeup and sphere of activity. The ASEAN Coordinating Council, for example, comprises the Foreign Ministers of the ASEAN member states and meets at least twice a year, not only to prepare the meetings of the ASEAN Summit, but to undertake other tasks provided for in the Charter, or for such other functions as may be assigned by the ASEAN Summit. For example, the Coordinating Council coordinates implementation of agreements and decisions of the ASEAN Summit.

In order to realize the objectives of each of the three pillars of the ASEAN Community, each ASEAN Community Council ensures the implementation of the relevant decisions of the ASEAN Summit; coordinates the work of the different sectors under its purview; ensures implementation of Summit decisions on issues that cut across the other Community Councils; and submits reports and recommendations to the ASEAN Summit on matters under its purview.

Each member state designates its own national representatives for each ASEAN Community Council. In addition, each ASEAN member state establishes an ASEAN National Secretariat that serves as a national focal point, the repository of information on all ASEAN matters at the national level, coordinates the implementation of ASEAN decisions at the national level, coordinates and supports the national preparations of ASEAN meetings, promotes ASEAN identity and awareness at the national level, and contributes to ASEAN community building.

Political-Security Community

ASEAN member states pledge to rely exclusively on peaceful processes in the settlement of intra-regional differences and with regard to their security. They are fundamentally linked to one another and bound by geographic location, as well as by a common vision and objectives.

The ASEAN Political-Security Community (APSC) aims to ensure that countries in the region live at peace with one another and with the world in a just, democratic and harmonious environment. The APSC Blueprint envisages ASEAN to be a rules-based community of shared values and norms; a cohesive, peaceful, stable and resilient region with shared responsibility for comprehensive security; and a dynamic and outward-looking region in an increasingly integrated and interdependent world. The APSC’s normative activities include: political development; shaping and sharing of norms; conflict prevention; conflict resolution; post-conflict peace building; and implementing mechanisms.

Economic Community

The ASEAN Economic Community (AEC) has a Consolidated Strategic Action Plan (CSAP) that includes strategic measures in the AEC Blueprint 2025 that takes into account the relevant sector work plans, and is reviewed periodically to account for developments in each sector.

The inaugural issue of the ASEAN Economic Integration Brief (AEIB) was released on 30 June 2017. The AEIB provides regular updates on ASEAN economic integration progress and outcomes, and is a demonstration of ASEAN’s commitment to strengthen communication and outreach to raise stakeholder awareness of the AEC.

The ASEAN Good Regulatory Practice (GRP) Core Principles was adopted at the 50th AEM Meeting in 29 August 2018 and subsequently endorsed by the AEC Council. It provides a practical, non-binding set of principles to assist ASEAN member states to improve their regulatory practice and foster ASEAN-wide regulatory cooperation.

Socio-Cultural Community

At the heart of the ASEAN Socio-Cultural Community (ASCC) is the commitment to lift the quality of life of ASEAN peoples through cooperative activities that are people-oriented, people-centered, environmentally friendly, and geared toward the promotion of sustainable development through member states’ cooperation on a wide range of areas including: culture and information, education, youth and sports, health, social welfare and development, women and gender, rights of the women and children, labor, civil service, rural development and poverty eradication, environment, transboundary haze-pollution, disaster management and humanitarian assistance.

Free-Trade Zone

The AEC aims to “implement economic integration initiatives” to create a single market across ASEAN member states. Its blueprint, adopted during the 13th ASEAN Summit (2007) in Singapore, serves as a master plan guiding the establishment of the community. Its characteristics include a single market and production base, a highly competitive economic region, a region of fair economic development, and a region fully integrated into the global economy.

The areas of co-operation include human resources development; recognition of professional qualifications; closer consultation on macroeconomic and financial policies; trade financing measures; enhanced infrastructure and communications connectivity; development of electronic transactions through e-ASEAN; integrating industries across the region to promote regional sourcing; and enhancing private sector involvement.

The AEC is the embodiment of the ASEAN’s vision of “a stable, prosperous and highly competitive ASEAN economic region in which there is a free flow of goods, services, investment and a freer flow of capital, equitable economic development and reduced poverty and socio-economic disparities.”

The average economic growth of member states from 1989 to 2009 was between 3.8% and 7%. This was greater than the average growth of APEC, which was 2.8%. The ASEAN Free Trade Area (AFTA), established on 28 January 1992, includes a Common Effective Preferential Tariff (CEPT) to promote the free flow of goods between member states.

ASEAN member states have made significant progress in the lowering of intra-regional tariffs through the CEPT. More than 99 percent of the products in Brunei Darussalam, Indonesia, Malaysia, the Philippines, Singapore and Thailand, have been brought down to the 0-5 percent tariff range. ASEAN’s newer members, namely Cambodia, Laos, Myanmar and Viet Nam, are not far behind.

ASEAN member states have also resolved to work on the elimination of non-tariff barriers, which includes, among others, the process of verification and cross-notification; updating the working definition of Non-Tariff Measures (NTMs)/Non-Tariff Barriers (NTBs); the setting-up of a database on all NTMs maintained by member states; and the eventual elimination of unnecessary and unjustifiable non-tariff measures.

I led this essay off with the comment that ASEAN does not seem to get the attention it deserves, at least in U.S. national media. Certainly, U.S. President Donald Trump seems to feel it’s not worth a tweet. The closest I was able to find with a quick Internet search was a report that he insulted Philippines President Rodrigo Duterte before meeting him on the sidelines of the Winter 2017 ASEAN Summit meeting!

That said, I must report that I became interested in ASEAN through a segment in Fareed Zacharia’s GPS show on CNN. So, not everybody is completely ignoring what I’ve come to realize is potentially an important regional intergovernmental organization.

I encourage you to learn more about ASEAN by visiting the various links peppering this column. Maybe together we can generate more interest in what could be a powerful U.S. ally in the Eastern Pacific.

The Fluidity of Money

Money exchange
Money is created in the exchange of credit for debt. Image by bluedog studio/shutterstock

19 June 2016 – I’m supposed to have some passing understanding of economics and accounting. I have, after all, a Master’s degree in Business Administration, for which I had to study Macroeconomics and Microeconomics, as well as Cost and Financial Accounting.

Howsomever, while trying to make sense of what folks call “Modern Monetary Theory” it dawned on me that, not only didn’t I have a clear concept of what money actually is, but the people babbling on about money and monetary policy aren’t any clearer on the concept than I am. A review of the differences between neoclassical economics based on Keynsian ideas and so-called Modern Monetary Theory reveals an incomplete understanding of money.

We all think we know what money is, and spout long winded and erudite-sounding loads of gobbledygook that only serve to prove, beyond a shadow of a doubt, that none of us have a clue what the stuff actually is!

I find that situation intolerable, and have set out to change it by trying real hard to come up with a theory that makes sense of all the stupid things we do with and say about money.

Now, I’m not a financial wizard, or a prize-winning economist, or even a whiz-bang developer of computer models of the global economy. I’m just some schmuck with some basic math ability, a little time on my hands, and the desire to make sense of something that it seems the “experts” haven’t wrapped their brains around, yet. So, I’ve thought about this problem a bit, and have a hint of an answer that I want to run up the flagpole to see if anyone salutes.

If this essay triggers something in the brain of somebody smart that sets him, her or it thinking in a new direction about money, I’ll count it time well spent.

So, here goes … .

In science, we try to make sense of anything we don’t fully comprehend by developing some kind of conceptual model that helps us predict what will happen in any given situation. The fact that we currently haven’t a clue what will actually happen when, for example, the Federal Government runs up huge deficits for a very long time, indicates that we’re very far from knowing what we’re talking about with regard to money.

I generally try to model things poorly understood through analogy with things that are well understood. I’ve developed a two-fluid model of money by analogy to certain ideas in classical physics. It seems to work decently for the situations I’ve applied it to.

Analogy with Momentum

Specifically, the model draws an analogy with Newtonian momentum, which is a conserved vector quantity – meaning that the total momentum in a closed system cannot be changed, and that the quantity involves both a magnitude and a spatial direction.

For our analogy to be useful, we need to also use the idea of generalized coordinates, which allow the idea of “direction” to extend beyond strictly cartesian spatial coordinates (motion in straight lines). For example, a bicycle drive chain wraps around two sprockets and has flexible spans linking them, so its motion certainly does not follow along a single cartesian coordinate, yet there is a well-defined path along which any two points on the chain follow each other, maintaining their separation (measured along the path). That allows us to measure motion along the path by a generalized coordinate.

In Newtonian mechanics, momentum is exchanged between objects, which are thought of as components of a system, through the action of forces. Mathematically, the magnitude and direction of the force equals the rate of flow of momentum between the objects.

Newton’s third law, which states that every force is paired with an equal and opposite reaction force, is just an expression of conservation of momentum in that every force (representing a transfer of momentum from one object to another) is paired with an equal and opposite transfer of momentum from the second object to the first. This takes care of maintaining conservation of momentum.

Take, for example, a person stepping off a boat onto a dock. At first, everything is (as seen from the perspective of the dock) stationary. The momentum of an object is defined as the object’s mass (amount of material) times its velocity (a vector combining speed and direction). Since both the person and the boat are stationary (meaning they both have a velocity of zero), the total momentum of the system of person + boat is zero.

Then, the person applies a force to the boat in a direction away from the dock. The Newton’s-third-law reaction force is a push by the boat on the person toward the dock. That’s how the person actually gets to the dock. The boat pushes him/her toward it!

The boat moves away from the dock. The person moves toward the dock. So, the directions of the two momenta are opposite. The speeds of the person and boat automatically (or maybe you’d like to say “magically”) adjust to keep the total momentum of the system equal to zero at all times. That is, at every instant the momentum of the person is equal and opposite to the momentum of the boat.

Money

In the theory of money that I’m proposing, money itself is analogous to momentum. Altogether, it’s conserved. That is, it cannot be created or destroyed. There’s always the same amount of “money” – zero!

What we’re used to thinking of as “money” is only half the story, which is why there’s so much confusion over it. Borrowing from double-entry bookkeeping, we’ll call what we usually think of as money as credit. Everyone who understands double-entry bookkeeping knows that for every credit, there is an equal (and opposite) entry called a debit. For our purposes, we’ll shorten that word to something we’re all familiar with: debt.

Debt is the other side of the analogy, which we tend to ignore and that accounts for all the confusion.

We’re going to visualize credit and debt as fluids because they’re measured as continuous, as opposed to quantized, variables. That means that they’re representable by real numbers as opposed to integers. So, nobody has a problem with dividing seven dollars ($7) into two portions each containing three and a half dollars ($3.50). Current usage is to round everything to the nearest cent, or hundredth of a dollar, but that’s for convenience and not wanting to be bothered with truly small change.

At one time, we had half-penny ($0.005) coins, but we don’t do that anymore.

Okay, so “money” actually represents credit and debt in equal amounts, which consequently always add up to zero. Whenever money is created, it’s created as equal amounts of credit and debt.

Money creation always requires activity by two cooperating entities: a creditor and a debtor. Credit is created and transferred from the creditor to the debtor. An equal quantity of debt is created and flows from the debtor to the creditor. “Money” consists of these paired fluids, which flow through the economy via paired interactions between creditors and debtors. Money is created by an interaction that creates equal amounts of credit and debt, and the words “creditor” and “debtor” simply indicate the direction of flow.

Once created, the money flows around in the economy through paired transactions in which credit flows one way and debt the other.

Wealth

This visualization allows us to separate the concepts of “money” and “wealth.” Wealth refers to tangible and intangible assets, such as commodities and intellectual property. Wealth is very definitely not conserved. When a contractor builds a house, he or she creates wealth from, essentially, nothing. The contractor then sells the house to the new owner in a binary transaction that transfers credit to the contractor and debt to the owner.

We’ll leave out discussion of what happens to the wealth represented by the house, since this essay is about money, and money is not wealth.

The owner previously got the credit through a transaction with a lender in which money was created as a transfer of credit to the owner and debt to the lender. The lender can then, for example, package the debt up into something called a “collateralized debt obligation,” and exchange it with somebody else for an equivalent amount of credit. The lender then transfers that credit to another prospective home owner in exchange for an equivalent amount of debt, and the merry-go-round keeps turning.

Unlike wealth, which was created from nothing, the total of credit minus debt in the system remains zero at all times.

It is interesting to note that wealth appears through the creation of a pattern in the physical universe. For example, bricks used by a contractor to build a house start out as a less-organized pile. The contractor creates wealth by arranging those bricks in a house-like pattern. The owner has no use for the disorganized pile of bricks, but has a use for them when arranged as a house. Similarly, the contractor had no use for the raw clay that went into the bricks until the brick manufacturer rearranged it into the pattern we call “bricks.”

Historically, folks’ fascination with the credit side of money has led them to confuse “money” with “wealth.” They’re entirely different things. One is a medium of exchange related to entries in a bookkeeper’s ledger, the other is a real thing related to patterns in the physical world.

I hope this essay manages to help make sense of the money nonsense!

Stick to Your Knitting

Man knitting
Man in suit sticking to his knitting. Photo by fokusgood / Shutterstock

6 June 2019 – Once upon a time in an MBA school far, far away, I took a Marketing 101 class. The instructor, whose name I can no longer be sure of, had a number of sayings that proved insightful, bordering on the oracular. (That means they were generally really good advice.) One that he elevated to the level of a mantra was: “Stick to the knitting.”

Really successful companies of all sizes hew to this advice. There have been periods of history where fast-growing companies run by CEOs with spectacularly big egos have equally spectacularly honored this mantra in the breach. With more hubris than brains, they’ve managed to over-invest themselves out of business.

Today’s tech industry – especially the FAANG companies (Facebook, Amazon, Apple, Netflix and Google) – is particularly prone to this mistake. Here I hope to concentrate on what the mantra means, and what goes wrong when you ignore it.

Okay, “stick to your knitting” is based on the obvious assumption that every company has some core expertise. Amazon, for example, has expertise in building and operating an online catalog store. Facebook has expertise in running an online forum. Netflix operates a bang-up streaming service. Ford builds trucks. Lockheed Martin makes state-of-the-art military airplanes.

General Electric, which has core expertise in manufacturing industrial equipment, got into real trouble when it got the bright idea of starting a finance company to extend loans to its customers for purchases of its equipment.

Conglomeration

There is a business model, called the conglomerate that is based on explicitly ignoring the “knitting” mantra. It was especially popular in the 1960s. Corporate managers imagined that conglomerates could bring into play synergies that would make conglomerates more effective than single-business companies.

For a while there, this model seemed to be working. However, when business conditions began to change (specifically interest rates began to rise from an abnormally low level to more normal rates) their supposed advantages began melting like a birthday cake left outside in a rainstorm. These huge conglomerates began hemorrhaging money until vultures swooped in to pick them apart. Conglomerates are now a thing of the past.

There are companies, such as Berkshire Hathaway, whose core expertise is in evaluating and investing in other companies. Some of them are very successful, but that’s because they stick to their core expertise.

Berkshire Hathaway was originally a textile company that investor Warren Buffett took over when the textile industry was busy going overseas. As time went on, textiles became less important and, by 1985 this core part of the company was shut down. It had become a holding company for Buffett’s investments in other companies. It turns out that Buffett’s core competence is in handicapping companies for investment potential. That’s his knitting!

The difference between a holding company and a conglomerate is (and this is specifically my interpretation) a matter of integration. In a conglomerate, the different businesses are more-or-less integrated into the parent corporation. In a holding company, they are not.

Berkshire Hathaway is known for it’s insurance business, but if you want to buy, say, auto insurance from Berkshire Hathaway, you have to go to it’s Government Employees Insurance Company (GEICO) subsidiary. GEICO is a separate company that happens to be wholly owned by Berkshire Hathaway. That is, it has its own corporate headquarters and all the staff, fixtures and other resources needed to operate as an independent insurance company. It just happens to be owned, lock, stock and intellectual property by another corporate entity: Berkshire Hathaway.

GEICO’s core expertise is insurance. Berkshire Hathaway’s core expertise is finding good companies to invest in. Some are partially owned (e.g., 5.4% of Apple) some are wholly owned (e.g., Acme Brick).

Despite Berkshire Hathaway’s holding positions in both Apple and Acme Brick, if you ask Warren Buffet if Berkshire Hathaway is a computer company or a brick company, he’d undoubtedly say “no.” Berkshire Hathaway is a diversified holding company.

It’s business is owning other businesses.

To paraphrase James Coburn’s line from Stanley Donen’s 1963 film Charade: “[Mrs. Buffett] didn’t raise no stupid children!”

Why Giant Corporations?

All this giant corporation stuff stems from a dynamic I also learned about in MBA school: a company grows or it dies. I ran across this dynamic during a financial modeling class where we used computers to predict results of corporate decisions in lifelike conditions. Basically, what happens is that unless the company strives to its utmost to maintain growth, it starts to shrink and then all is lost. Feedback effects take over and it withers and dies.

Observations since then have convinced me this is some kind of natural law. It shows up in all kinds of natural systems. I used to think I understood why, but I’m not so sure anymore. It may have something to do with chaos, and we live in a chaotic universe. I resolve to study this in more detail – later.

But, anyway … .

Companies that embrace this mantra (You grow or you die.) grow until they reach some kind of external limit, then they stop growing and – in some fashion or other – die.

Sometimes (and paradigm examples abound) external limits don’t kick in before some company becomes very big, indeed. Standard Oil Company may be the poster child for this effect. Basically, the company grew to monopoly status and, in 1911 the U.S. Federal Government stepped in and, using the 1890 Sherman Anti-Trust Act, forced its breakup into 33 smaller oil companies, many of which still exist today as some of the world’s major oil companies (e.g., Mobil, Amoco, and Chevron). At the time of its breakup, Standard Oil had a market capitalization of just under $11B and was the third most valuable company in the U.S. Compare that to the U.S. GDP of roughly $34B at the time.

The problem with companies that big is that they generate tons of free cash. What to do with it?

There are three possibilities:

  1. You can reinvest it in your company;

  2. You can return it to your shareholders; or

  3. You can give it away.

Reinvesting free cash in your company is usually the first choice. I say it is the first choice because it is used at the earliest period of the company’s history – the period when growth is necessarily the only goal.

If done properly reinvestment can make your company grow bigger faster. You can reinvest by out-marketing your competition (by, say, making better advertisements) and gobbling up market share. You can also reinvest to make your company’s operations more effective or efficient. To grow, you also need to invest in adding production facilities.

At a later stage, your company is already growing fast and you’ve got state-of-the-art facilities, and you dominate your market. It’s time to do what your investors gave you their money for in the first place: return profits to them in the form of dividends. I kinda like that. It’s what the game’s all about, anyway.

Finally, most leaders of large companies recognize that having a lot of free cash laying around is an opportunity to do some good without (obviously) expecting a payback. I qualify this with the word “obviously” because on some level altruism does provide a return in some form.

Generally, companies engage in altruism (currently more often called “philanthropy”) to enhance their perception by the public. That’s useful when lawsuits rear their ugly heads or somebody in the organization screws up badly enough to invite public censure. Companies can enhance their reputations by supporting industry activities that do not directly enhance their profits.

So-called “growth companies,” however, get stuck in that early growth phase, and never transition to paying dividends. In the early days of the personal-computer revolution, tech companies prided themselves on being “growth stocks.” That is, investors gained vast wealth on paper as the companies’ stock prices went up, but couldn’t realized those gains (capital gains) unless they sold the stock. Or, as my father once did, by using the stock for collateral to borrow money.

In the end, wise investors eventually want their money back in the form of cash from dividends. For example, in the early 2000s, Microsoft and other technology companies were forced by their shareholders to start paying dividends for the first time.

What can go wrong

So, after all’s said and done, why’s my marketing professor’s mantra wise corporate governance?

To make money, especially the scads of money that corporations need to become really successful, you’ve gotta do something right. In fact, you gotta do something better than the other guys. When you know how to do something better than the other guys, that’s called expertise!

Companies, like people, have limitations. To imagine you don’t have limitations is hubris. To put hubris in perspective, recall that the ancients famously made it Lucifer’s cardinal sin. In fact, it was his only sin!

Folks who tell you that you can do anything are flat out conning your socks off.

If you’re lucky you can do one thing better than others. If you’re really lucky, you can do a few things better than others. If you try to do stuff outside your expertise, however, you’re gonna fail. A person can pick themselves up, dust themselves off, and try again – but don’t try to do the same thing again ‘cause you’ve already proved it’s outside your expertise. People can start over, but companies usually can’t.

One of my favorite sayings is:

Everything looks easy to someone who doesn’t know what they’re doing.

The rank amateur at some activity typically doesn’t know the complexities and pitfalls that an expert in the field has learned about through training and experience. That’s what we know as expertise. When anyone – or any company – wanders outside their field of expertise, they quickly fall foul of those complexities and pitfalls.

I don’t know how many times I’ve overheard some jamoke at an art opening say, “Oh, I could do that!”

Yeah? Then do it!

The artist has actually done it.

The same goes for some computer engineer who imagines that knowing how to program computers makes him (or her) smart, and because (s)he is so smart, (s)he could run, say, a magazine publishing house. How hard can it be?

Mark Zuckerberg is in the process of finding out.

Fed Reports on U.S. Economic Well-Being

Federal Reserve Building
The Federal Reserve released the results of its annual Survey of Household Economics and Decisionmaking for calendar year 2018 last week. Image by Thomas Barrat / Shutterstock

29 May 2019 – Last week (specifically 23 May 2019) the Federal Reserve Board released the results of its annual Survey of Household Economics and Decisionmaking for CY2018. I’ve done two things for readers of this blog. First, I downloaded a PDF copy of the report to make available free of charge on my website at cgmasi.com alongside last year’s report for comparison. Second, I’m publishing an edited extract of the report’s executive summary below.

The report describes the results of the sixth annual Survey of Household Economics and Decisionmaking (SHED). In October and November 2018, the latest SHED polled a self-selected sample of over 11,000 individuals via an online survey.

Along with the survey-results report, the Board published the complete anonymized data in CSV, SAS, STATA formats; as well as a supplement containing the complete SHED questionnaire and responses to all questions in the order asked. The survey continues to use subjective measures and self-assessments to supplement and enhance objective measures.

Overall Results

Survey respondents reported that most measures of economic well-being and financial resilience in 2018 are similar to or slightly better than in 2017. Many families have experienced substantial gains since the survey began in 2013, in line with the nation’s ongoing economic expansion during that period.

Even so, another year of economic expansion and the low national unemployment rates did little to narrow the persistent economic disparities by race, education, and geography. Many adults are financially vulnerable and would have difficulty handling an emergency expense as small as $400.

In addition to asking adults whether they are working, the survey asks if they want to work more and what impediments they see to them working.

Overall Economic Well-Being

A large majority of individuals report that, financially, they are doing okay or living comfortably, and overall economic well-being has improved substantially since the survey began in 2013

  • When asked about their finances, 75% of adults say they are either doing okay or living comfortably. This result in 2018 is similar to 2017 and is 12%age points higher than 2013.

  • Adults with a bachelor’s degree or higher are significantly more likely to be doing at least okay financially (87%) than those with a high school degree or less (64%).

  • Nearly 8 in 10 whites are at least doing okay financially in 2018 versus two-thirds of blacks and Hispanics. The gaps in economic well-being by race and ethnicity have persisted even as overall wellbeing has improved since 2013.

  • Fifty-six percent of adults say they are better off than their parents were at the same age and one fifth say they are worse off.

  • Nearly two-thirds of respondents rate their local economic conditions as “good” or “excellent,” with the rest rating conditions as “poor” or “only fair.” More than half of adults living in rural areas describe their local economy as good or excellent, compared to two-thirds of those living in urban areas.

Income

Changes in family income from month to month remain a source of financial strain for some individuals.

  • Three in 10 adults have family income that varies from month to month. One in 10 adults have struggled to pay their bills because of monthly changes in income. Those with less access to credit are much more likely to report financial hardship due to income volatility.

  • One in 10 adults, and over one-quarter of young adults under age 30, receive some form of financial support from someone living outside their home. This financial support is mainly between parents and adult children and is often to help with general expenses.

Employment

Most adults are working as much as they want to, an indicator of full employment; however, some remain unemployed or underemployed. Economic well-being is lower for those wanting to work more, those with unpredictable work schedules, and those who rely on gig activities as a main source of income.

  • One in 10 adults are not working and want to work, though many are not actively looking for work. Four percent of adults in the SHED are not working, want to work, and applied for a job in the prior 12 months. This is similar to the official unemployment rate of 3.8% in the fourth quarter of 2018.

  • Two in 10 adults are working but say they want to work more. Blacks, Hispanics, and those with less education are less likely to be satisfied with how much they are working.

  • Half of all employees received a raise or promotion in the prior year.

  • Unpredictable work schedules are associated with financial stress for some. One-quarter of employees have a varying work schedule, including 17% whose schedule varies based on their employer’s needs. One-third of workers who do not control their schedule are not doing okay financially, versus one-fifth of workers who set their schedule or have stable hours.

  • Three in 10 adults engaged in at least one gig activity in the prior month, with a median time spent on gig work of five hours. Perhaps surprisingly, little of this activity relies on technology: 3% of all adults say that they use a website or an app to arrange gig work.

  • Signs of financial fragility – such as difficulty handling an emergency expense – are slightly more common for those engaged in gig work, but markedly higher for those who do so as a main source of income.

Dealing with Unexpected Expenses

While self-reported ability to handle unexpected expenses has improved substantially since the survey began in 2013, a sizeable share of adults nonetheless say that they would have some difficulty with a modest unexpected expense.

  • If faced with an unexpected expense of $400, 61% of adults say they would cover it with cash, savings, or a credit card paid off at the next statement – a modest improvement from the prior year. Similar to the prior year, 27% would borrow or sell something to pay for the expense, and 12% would not be able to cover the expense at all.

  • Seventeen percent of adults are not able to pay all of their current month’s bills in full. Another 12% of adults would be unable to pay their current month’s bills if they also had an unexpected $400 expense that they had to pay.

  • One-fifth of adults had major, unexpected medical bills to pay in the prior year. One-fourth of adults skipped necessary medical care in 2018 because they were unable to afford the cost.

Banking and Credit

Most adults have a bank account and are able to obtain credit from mainstream sources. However, sub- stantial gaps in banking and credit services exist among minorities and those with low incomes.

  • Six percent of adults do not have a bank account. Fourteen percent of blacks and 11% of Hispanics are unbanked versus 4% of whites. Thirty-five percent of blacks and 23% of Hispanics have an account but also use alternative financial services, such as money orders and check cashing services, compared to 11% of whites.

  • More than one-fourth of blacks are not confident that a new credit card application would be approved if they applied—over twice the rate among whites.

  • Those who never carry a credit card balance are much more likely to say that they would pay an unexpected $400 expense with cash or its equivalent (88%) than those who carry a balance most or all of the time (40%) or who do not have a credit card (27%).

  • Thirteen percent of adults with a bank account had at least one problem accessing funds in their account in the prior year. Problems with a bank website or mobile app (7%) and delays in when funds were available to use (6%) are the most common problems. Those with volatile income and low savings are more likely to experience such problems.

Housing and Neighborhoods

Satisfaction with one’s housing and neighborhood is generally high, although notably less so in low-income communities. While 8 in 10 adults living in middle- and upper-income neighborhoods are satisfied with the overall quality of their community, 6 in 10 living in low- and moderate-income neighborhoods are satisfied.

  • People’s satisfaction with their housing does not vary much between more expensive and less expensive cities or between urban and rural areas.

  • Over half of renters needed a repair at some point in the prior year, and 15% of renters had moderate or substantial difficulty getting their landlord to complete the repair. Black and Hispanic renters are more likely than whites to have difficulties getting repairs done.

  • Three percent of non-homeowners were evicted, or moved because of the threat of eviction, in the prior two years. Evictions are slightly more common in urban areas than in rural areas.

Higher Education

Economic well-being rises with education, and most of those holding a post-secondary degree think that attending college paid off.

  • Two-thirds of graduates with a bachelor’s degree or more feel that their educational investment paid off financially, but 3 in 10 of those who started but did not complete a degree share this view.

  • Among young adults who attended college, more than twice as many Hispanics went to a for-profit institution as did whites. For young black attendees, this rate was five times the rate of whites.

  • Given what they know now, half of those who attended a private for-profit institution say that they would attend a different school if they had a chance to go back and make their college choices again. By comparison, about one-quarter of those who attended public or private not-for-profit institutions would want to attend a different school.

Student Loans and Other Education Debt

Over half of young adults who attended college took on some debt to pay for their education. Most borrowers are current on their payments or have successfully paid off their loans.

  • Among those making payments on their student loans, the typical monthly payment is between $200 and $299 per month.

  • Over one-fifth of borrowers who attended private for-profit institutions are behind on student loan payments, versus 8% who attended public institutions and 5% who attended private not-for-profit institutions.

Retirement

Many adults are struggling to save for retirement. Even among those who have some savings, people commonly lack financial knowledge and are uncomfortable making investment decisions.

  • Thirty-six percent of non-retired adults think that their retirement saving is on track, but one-quarter have no retirement savings or pension whatsoever. Among non-retired adults over the age of sixty, 45% believe that their retirement saving is on track.

  • Six in 10 non-retirees who hold self-directed retirement savings accounts, such as a 401(k) or IRA, have little or no comfort in managing their investments.

  • On average, people answer fewer than three out of five financial literacy questions correctly, with lower scores among those who are less comfortable managing their retirement savings.

The forgoing is an edited extract from the Report’s Executive Summary. A PDF version of the entire report is available on my website at cgmasi.com [ http://cgmasi.com ] along with a PDF version of the 2017 report, which was published in May of 2018 and based on a similar survey conducted in late 2017. Reports dating back to the first survey done in late 2013 are available from the Federal Reserve Board’s website linked to above.