Trickle Up

The Benefit of Investing in America’s Poor

By: Sergio Robles Jr.

President Ronald Reagan was a vocal advocate for free market policies that included financial deregulation, which would cut taxes on America’s wealthiest citizens. The logic is simple and integral to job creation according to laissez-faire supporters. If the rich are allowed to further invest their capital in the market, the market will respond to the increase by creating jobs and the process trickles-down from there.

The one problem with this practice is that it assumes that the market and corporations have the ability to grow. In the situation where a company has saturated the market, money saved from tax cuts cannot go into reinvestment because there is no room to grow. Excess capital is therefore put into savings, where they can presumably earn more capital from the market interest rate. Under this model, companies such as AT&T, Lockheed Martin, and Dell would be considered to be at capacity (Zajac).

The opposing side to this argument is ‘trickle-up economics,’ which is most often associated with microfinance. Microfinance is the disbursement of small loans for an individual to start a business, and is most common in the developing world. A more domestic example of trickle up economics would be investing in skills and training programs for America’s lower quartile population (The Economist).

Investing in America’s poor and uneducated is an investment on the country as a whole. This population is often surviving on a minimum wage, subsidized by government assistance programs. In figure 1.1 we see the difference in salary between various levels of occupations in the same field, the field in particular being nursing. I used a standard minimum wage occupation as a baseline because most of these jobs are interchangeable and require the least amount of specialized skills.

From there I added the three most common types of nursing credentials according the Bureau of Labor Statistics. The facts and figures presented are based on median salaries nationwide, it is important to note that there will be discrepancies regionally and when an individual starts out in the industry.  The first type of training available is a certification as a Certified Nurse’s Assistant (CNA) which is available as a onetime class and offers a modest increase in hourly wages The second type of training is as a Licensed Practitioner Nurse (LPN), which is available as a year-long diploma program at most city colleges. Lastly, we have a Registered Nurse (RN/ADN), who has earned their Associate’s Degree in Nursing, and earns the highest salary of the group, as a result of the largest investment (U.S. Bureau of Labor Statistics).

Figure 1.1: Nursing Occupations (Based on 2012 BLS Facts and Figures)

Occupation	Amount by hour ($)	Amount Annually ($)	Cost Associated with Degree	Time Cost
Minimum Wage Occupation	$8.00	$16,640	N/A	N/A
CNA (Certified Nurse’s Assistant)	$11.73	$24,400	$1,500	5 Weeks
LPN  (Licensed Practitioner Nurse)	$19.97	$41,540	$2,000	1 Year
RN/ADN (Registered Nurse/Associate’s Degree in Nursing)	$31.48	$65,470	$4,500	2/3+Years

NPR recently published that on average, it costs $11.20 an hour or $23,300 annually to live in the state of California. Using the occupations and salaries listed in Figure 1.1, I constructed a graph that shows their earning potential over a period of 5 years, using both the costs associated with that option as well as the salary/benefits (Green).

The graph displays all four occupations as having negative returns in the first year, with the most costly options of LPN and RN causing the individual to incur serious debts. This is known as barriers to entry due to opportunity costs. The price of the training programs themselves are relatively low, but when an individual has to forgo earning a wage in favor of education they find themselves in deeper debt than they would have been otherwise. Under this criteria, the most costly option is the one that also has the greatest earning potential at the end of the five year period.

It is no surprise that individuals with limited resources find themselves with very little options as giving up a steady wage in favor an opportunity a year from now is an unfavorable decision when rent and utilities are due every month. In this situation, it becomes imperative that government agencies and other public works programs help individuals in this predicament. If and when governments create incentives for individuals to further pursue education and training programs to earn a higher salary, the return on investment is higher as they can tax a higher salary more. This type of investment is not singular or exclusive to the individual, but all-encompassing. When multiple individuals in the community earn more, property values increase, there is job creation and the community at large is lifted into economic self-sufficiency.

In closing, I leave you with these words by Hubert Humphrey: “a country is only as rich as its poorest citizens”.

Works Cited:

Green, Matthew. "How Much Does It Really Cost to Live in California?" The Lowdown RSS. NPR, 23 July 2013. Web. 29 July 2014.

"Trickle-up Economics." The Economist. The Economist Newspaper, 16 Feb. 2013. Web. 28 July 2014.

"U.S. Bureau of Labor Statistics." U.S. Bureau of Labor Statistics. U.S. Bureau of Labor Statistics, 01 Jan. 2012.Web. 27 July 2014.

Zajac, Brian. "Nine Famous Companies That Can’t Get Bigger." 247wallst.com. 247wallst, 05 Apr. 2013. Web. 

29 July 2014.

Four Financial Crises in a Large Nutshell

Please forgive me for my disappearance, but I currently lack the discipline to post regularly. I’m working on it. I previously announced a post regarding financial crises in emerging markets but I would like to postpone that topic so that I might learn how to explain the regression analyses more thoroughly. I will instead offer you a summary of five four financial crises that have shaped the financial system. I originally intended to include The Great Depression of 1928, but decided to save that for a different discussion post entirely.

In the wake of the 2008 recession, many people were left wondering how it all happened and where we went wrong. Since then there has been a plethora of works on the topic from documentary movies a la Inside Job to feature films like Margin Call. Currently in print there are dozens of books on the topic and six years later, as the business cycle begins to pick up again, the world is still hungry for more answers. In the most recent issue of The Economist, the authors offer not an answer a single reference to the crisis of 2008 but offer a look at five crises that date back to 1786. Upon examination of the crises, we start to notice certain patterns such as systemic failure and moral hazard, and the roles they play in perpetuating financial risk. Though the last crisis they cover is dated 1928, because of its nature, we will not be covering it in overview but instead save it and the plethora of information for a later date.

1786: Alexander Hamilton’s Pet Project

A student of finance, Alexander Hamilton had been interested in the financial institutions of Great Britain and Northern Europe for some time. Once the United States had established its independence from the Royal Crown, Hamilton reasoned that it was time for the United States to grow… monetarily speaking. Hamilton sought to expand the financial system of the newly sovereign country in the form of the Bank of the United States (BUS). The primary goal of the BUS was to establish credit and to create a uniform standard by which to judge federal debt. The bank would also work to form a more cohesive federation. The status quo at the time had been to have several separate banks for each State, the BUS would serve to purify the convoluted waters of interstate finance with ‘One nation, and one bank’. In short, the bank would supplement the growth of the US.

From the start there were problems with the new financial institution, the main one being the open market sale of its bonds. Bonds are a promise of a future sum of money, paid with interest. In order to own a portion of the BUS, a purchase of bonds was required and seedy investors sought out to exploit this niche market. One such investor was William Duer, who would purchase bonds on credit and sell them only to reinvest in more bonds. The issue with Duer’s policy was that there was no cash investment and when investors became speculative, they began to withdraw in droves. It became apparent that Duer was embezzling and he was eventually sentenced to federal prison for his crimes, but not before stressing the need for reform in the newly developed BUS.

Hamilton wanted to protect his lasting legacy to the United States and in doing so provided the first (United States) public bailout. He quickly bought up bonds in order to raise their price in the market. He provided large amounts of liquidity to banks in the form of federal debt, with only a small amount of collateral required and refused to let firms fail for their foibles. His plan worked and the blunders of the bank were overlooked as it managed to weather the crisis. The BUS managed to stay open up until 1812, when its charter expired and congress refused to renew it.

For his financial contributions, a bronze statue was sculpted in the likeness of Alexander Hamilton on May 17, 1923 and currently sits in front of the US Treasury Building.

1825: The Latin American Crisis: Before There Were Asian Tigers.

As the Spanish empire broke apart, it left new burgeoning markets in its place. Investing in these newly sovereign countries became the trend and financiers were flocking to them like flies to honey. The rationale behind it was that since Great Britain (the safest investment in the world at the time) supported their independence, then they would logically support their financial obligations. Bonds from Peru, Colombia, Mexico, Chile, and Guatemala were selling fast as they were seen as risk free. The intuition behind it was fallibly logical, who would purchase a British bond that earned less return than a Chilean bond if both were equally rated, and seen as equally safe investments?

Investors were wrong, and these once safe investments fell victim to speculation and investors wanted out. By 1825 The Bank of England had to bail out lenders and firms at a cost to the English taxpayer. Though this crisis bailout did help soften the blow, it did not meet the demands of the entire financial system and by 1826 10% of Britain's firms and banks had gone bankrupt. Britain was in need of reform and sought to make their financial institutions large enough to not need public sector support. The end result was to allow banks that were burdened by their size (i.e. too small) to grow and expand their capital base so that in the event of another crisis they would be able to withstand the blow. English banks were now allowed to merge with one another and, in time, would become famous for being too big to fail.

1857: Discount Bonds: Discount for Who?

As investors looked elsewhere to invest their money, they found that this time around the most profitable venture was railroad stock. Railroads were seen as a safe investment because their value was not based on the present, but on the assumption that their future payoff would make up for their current deficit. Their stability was also based on lack of technological foresight.  Another major financial innovation was the creation of the discount houses in London which started out as middlemen (matching firms with lenders) but eventually grew to serve as banks themselves. The main difference between the two was that the discount houses did not have to maintain the strict 25% cash reserves that banks did. This left a lot of wiggle room for diversification on part of the discount houses, allowing them to re-invest the cash that would otherwise be sitting in a bank vault.

As railroad stock began to decline and depositors demanded their money in America, it led to a domino effect that reached the overseas markets. The illusion of safety vanished soon after and bank runs became common once more. As British banks came close to becoming completely illiquid, it was apparent that intervention was needed. Discount houses only served to make things worse as they provided credit but found that when depositors demanded their money back, their leverage ratio led to them failing along with several firms. Previously, the Bank of England had allowed discount houses the ability to borrow at will (the discount houses knew this and exploited it) but in 1858 the bank upped its borrowing policies, limiting the dollar amount that they could borrow. By tightening credit, Britain ensured that being prudent today led to a less risky tomorrow. As one can imagine, it was an unpopular decision on the financial market but this more frugal approach led to 50 years of financial calm that stripped the system of moral hazard.

At the start of the 20^th century railroad stock was seen not only as a safe investment but an investment that would last generations.

1907: Trust In No One

Prior to 1907 a new financial institution had come to prominence in the form of trust companies. Trust companies were allowed to own and manage property, distribute shares, and also take in deposits. They were the discount houses of tomorrow and the AIG of yesterday. Once again, they were banks without as stringent regulations. They only had to hold 5% of their assets in cash whereas banks had to hold a minimum of 25% and by 1907, trust companies had grown 250% to be as large as national banks. This proved problematic when of all things the penny caused a ripple effect in the American financial pond.

The crisis began when United Copper began to slow down production and the value of copper dropped domestically. The two primary investors, Augustus Heinze and Charles Morse, in order to manipulate the market and save their shares used funds from the banks they ran in order to bump up Copper stock prices. The attempt failed and it set off a chain reaction that led to several small bank runs. The market was shocked when it permeated the once reliable Trust market and led to the deposit run of the Knickerbocker Trust Company. This was followed by deposit runs of The Trust Company of America and then the Lincoln Trust. In order to prevent a systemic decline financier John Piermont Morgan realized that intervention was imminent and after much debate, provided a 25 million dollar bailout that was financed from the largest banks and businessmen of the time. The bailout worked brilliantly and proved that trickle-down economics works under ideal circumstances. Still, it had become evident that bank was needed to act as a lender of last resort and in 1913 the Federal Reserve Act did just that and set up the third central bank of America.

The Federal Reserve was established on December 23, 1913 and recently celebrated its centennial birthday.

 

Perhaps the most telling about the nature of the market, the United States has adopted the bull to represent the infamous Wall Street.

The United States financial system is a beautiful thing. It has grown and developed alongside the Unite States, and has allowed America to set the standard when it comes to financial regulation and fiscal responsibility. The only problem is that in the rush for growth and prosperity certain behaviors are glossed over, not matter how much moral hazard they present to the market. If the United States is to continue its reign as financial superpower, it is important to learn from the past and to question rapid growth and not assume that it is merely a positive market adjustment without consequence. 

My first post (we all have to start somewhere):

           

A brief summary and analysis of:

 "Conscious Uncoupling." The Economist. The Economist Newspaper, 05 Apr. 2014. Web. 19 Apr. 2014

        Russia’s recent foray into Ukrainian territory has left democratic Europe in a predicament. Europe, specifically the democratic European Union (EU), has increasingly felt the need to step in on the Russia-Ukrainian conflict regarding Crimea. Crimea was once part of the Ukraine until Russia intervened and effectively absorbed it following political unrest that left the Ukrainian president ousted. Fellow European countries have been at a loss for how to intervene, with most simply condemning the action but not taking any explicit action.

The problems of the Ukraine, however antidemocratic they may be, are not the main concern of the EU. The concerns of the world’s largest monetary union are those regarding Russian energy, specifically their supply of natural gas. Europe receives most of their natural gas supply from Russia via the South Stream pipeline that runs through the Ukraine. Potentially, European countries that are reliant on Russian energy (as many are) could face energy shortfalls in the scenario that Russia shuts down the South Stream Pipeline.  This is where the The Economist article titled ‘Conscience Uncoupling’ begins. It hypothesizes what the different scenarios would be should the rest of Europe decide to put up protectionist policies against Russia. The Economist goes on to highlight how nations are dependent in their current energy use status quo.

In an increasingly interconnected world, it is easy to see how energy security is an issue that affects every country.  In this real world scenario, several European countries are heavily reliant on Russian gas to maintain their day-to-day operations. This affords Russia a certain level of political power and they know it. This delicate balance of European demand for Russia’s gas supply is in fact, a Russian Achilles heel. Should the conflict between the Ukraine and Russia escalate even further with Europe deciding to rally behind the Ukraine, Russia will find themselves cut off from an important and large market, greatly reducing the demand for all Russian exports.

 A simple study of exchange rates (which can also be thought of as an extension of supply and demand) illuminates how problematic the situation can become for either party. For Russia, if things shift out of their favor and Europe decides to put up protectionist policies against them, it will greatly reduce the demand for Russian goods and negatively affect their currency. Currency is a derived demand, meaning that it is not the currency itself that investors seek but what goods it can be exchanged for. Supposing that European investors can no longer purchase Russian gas, they will seek alternative forms of energy elsewhere. All else constant, this will cause a decrease in demand for Russian Rubles. At this point speculators and foreign investors will logically seek to remove themselves from the situation and sell their holdings of Russian Rubles in favor of a more stable commodity. The foreign exchange market will be flooded with Rubles, which will lead to a depreciation of Rubles against the Euro and several other currencies.

The negative impact of a depreciated currency, as well as decreased demand, is that output is inevitably affected. With Europe no longer consuming the same level of Russian gas, this will leave Russia in a pinch as they will have to shrink production until a new equilibrium is met. It is possible that Russia will find a new buyer in the market (in the long run) but the odds are not in their favor that this buyer will be willing to purchase the same amount of gas as Europe nor at the same price.

Countries that are heavily reliant on Russian gas cannot simply stop their demand, however, at least not until alternative methods of energy eliminate the need for Russian gas. This is the dilemma that most European nations find themselves in. Investing in alternative avenues is expensive; building a new pipeline from northern Africa would cost an estimated twenty billion dollars. Then new problems would arise such as who would pay for the construction of the pipeline and which country was to receive primary reserves. Aside from the cost there is also the added pressure of a time constraint. The construction of alternative pipelines will take years, at which point they will be at the mercy of Russian retaliation (i.e. Russia cutting them off from gas reserves).

In truth, the only option is for the EU to begin construction of a new pipeline and to diversify their gas imports as Europe cannot be so reliant on one supplier. It leaves them with far too few options in the event that Russia invades a seemingly sovereign nation. The EU may not have that many options but it seems that they just received the proper shove for them to make the right decision.

To my brave following of no one, I must apologize for simply making this fantastic blog and not posting. I am my own worst critic and I often prevent myself from writing anything of merit for fear that it is not up to par. I am being forced to publish my first blog post within a weeks time, so, expect that soon. There will actually be two posts.

Shocking right?

The first has to do with the Ukraine/Russian argument and its effect on global markets, specifically the euro.

The second article will mostly be a summary about financial crises in recent years. The Economist recently published a special article on the topic and seeing as how I have to do a presentation on the matter, I figured 'why not'?

Keep your eyes open for any Economic thought and stay gold,

-Sergio