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If you know any good Robinson R44 pilots… we have a helicopter instructor job open at East Coast Aero Club here in Bedford (KBED; close to Boston).

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I’m throwing a little wine and cheese party tomorrow night so I stopped by Formaggio in West Cambridge for the first time in a couple of months. Prices had gone up 25 percent on almost everything. Imported cheeses are now $25-35/lb. Domestic cheese is $20-25/lb. A tuna sandwich has gone up 25 percent as well. Perhaps this is the solution to the obesity problem.

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A good New Yorker magazine story about the Beijing airport, from the April 21, 2008 issue.

“The Beijing terminal cost $3.65 billion to build, which in China bought a structure bigger than all five terminals at Heathrow put together, for less than half the cost of the new Terminal 5. The project was conceived, designed, constructed, and opened in four years, whereas the Heathrow terminal, from conception to completion, took twenty years. … the public hearings over the Heathrow terminal took the same amount of time as the entire construction of the Beijing one.”

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A few months ago, I wrote a posting about the insanity of anyone paying billions of dollars for Yahoo. The insanity seems to be spreading. Microsoft walked away finally. Yahoo shares are trading at $24.50. Journalists are talking seriously about how the company is somehow worth $37 per share. If they wanted to buy Yahoo shares at $37 today, it seems that they would have no shortage of sellers.

Thanks to the miracle of inflation, I think it is possible that a share of Yahoo will be worth $37 one day. And when you sell that share, you can buy yourself a 40 oz. Diet Coke (the obesity epidemic will render 20 oz. soda bottles obsolete).

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Newspapers haven’t reported any new Wall Street crisis for at least a couple of weeks. Does that mean that financial markets are likely to be stable for a while? Let’s look at how we compensate money managers (old news) and how managers of blown up funds and companies are regarded (new news).

Most of the investment dollars in this world are managed by professionals. If you look at the way leverage is typically used in hedge funds, you could even argue that professionals manage more than 100 percent of our savings.

Most professional money managers are compensated with a percentage of the return on investment that they achieve, e.g., the famous “2 and 20” of hedge funds (2 percent of the total just for showing up to work; 20 percent of any advance; 0 percent of any decline).

Let’s suppose that every 10 years the markets suffer a big stress, e.g., the Russian default of 1998, the dotcom implosion of 2000, or the subprime collapse of 2007. Let’s also suppose that every 50-100 years the markets suffer a catastrophic stress, e.g., the 1929 stock market crash and subsequent depression. An investment strategy that ignores these risks can yield a very high return for 5-15 years. Would you want to pursue such a strategy as an individual? Probably not. A high return for the next 5 years isn’t so great if you might be wiped out in the next crisis.

Consider the professional money manager. If a fund generates high returns for 5-10 years, he benefits handsomely. Then one day the fund blows up and the investors are wiped out. The old theory was that the fund manager would be sad and ashamed. Sure he had the beach house in the Hamptons, the coop in Manhattan, and gold bars under every mattress. But he would never work again and he would be forced to spend his remaining 50 years Gulfstreaming from golf course to golf course.

The entirely predictable subprime “crisis” and the way that it has been treated in the industry and in the media should embolden professional money managers to take even more risk in the future. The guys who blew up are mostly excused. They didn’t act irresponsibly with their customers money for personal gain. They were caught up in an industry-wide and worldwide “crisis” that was practically unavoidable. It seems that the very same folks who wiped out a lot of American dreams will be back on the job in a few months, collecting their 2 and 20 from the next round of investors. And what strategy will they pursue in their new job? The same one that you or I would if given the same incentives: maximize personal income by taking some risks that are unlikely to blow up the fund before the new jet is paid for.

[Exceptions to this rule are money managers like Warren Buffett who keep most of their own wealth in the fund that they manage.]

What do we get when we have tens of thousands of professional money managers worldwide operating with these same incentives? Unstable markets.

That leaves the question of what the next meltdown will be. We have had the dotcom meltdown. We have had meltdowns of debt from various countries that were obvious houses of cards, e.g., Argentina. We have had the U.S. “sold by criminals to deadbeats, rated by idiots, bought by fools” mortgage meltdown. We have had a substantial meltdown in the value of the dollar. My prediction is that the next collapse will be caused by a collapse in the prices of oil and gold, items that people currently believe can only go up and are making big bets based on those beliefs.

How could gold not go to $2000/ounce and oil to $200/barrel? The Earth contains an unlimited supply of gold if you’re willing to spend enough to extract it. That’s also what we were always told about energy, i.e., that if oil went to the seemingly ridiculous price of $50-80 per barrel, all kinds of alternatives would become viable. We would have geothermal systems pumping cold water down into hot dry rock. We would have all kinds of solar. We would be melting down shale into oil. Maybe folks in the U.S. won’t do any of these things since our government is investing all of its money in trying to make Iraqis love each other and our companies are investing all of their money in China and Mexico. But nothing stops the Canadians, Chinese, Indians, Europeans, et al., from pursuing technological innovation in energy and gold mining.

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Here’s a video taken from a helicopter showing dogs and some of the colorful characters that make Florida such a great place to live.

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The U.S. may be slipping in education, manufacturing, IQ (especially at credit rating agencies and among investors who bought mortgages), and economic growth. According to USA Today, however, we are doing great at creating jobs in local, state, and federal government: “Hiring leaps in public sector.”

“Governments added 76,800 jobs in the first three months of 2008, reports the Bureau of Labor Statistics.

“That’s the biggest jump in first-quarter hiring since a boom in 2002 that followed the terrorist attacks of Sept. 11, 2001. By contrast, private companies collectively shed 286,000 workers in the first three months of 2008.”

Let’s hope that the tax fairy doesn’t come around asking those handful of us who are still working to pay these folks’ salaries…

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As noted in “Young, Gifted, and Black In Massachusetts”, our governor has finally accomplished something. It seems that the sales tax on aircraft, aircraft rental, and aircraft parts is returning. Massachusetts prior to 2002 experimented with trying to collect a fat sales tax on $50 million Gulfstreams and $3 million Pilatus PC-12s. What happened? Planesense set up shop in Manchester, New Hampshire (tax-free) and NetJets based all of their Gulfstreams in Hartford, Connecticut (tax-free). The state lost thousands of jobs in hangar construction, flight dispatch, maintenance, pilots, sales, etc.

A Republican initiative in 2002 resulted in a repeal of the sales tax and encouraged growth in communities such as Worcester and Springfield where a big seldom-used airport was their only asset aside from widespread availability of crack cocaine. During a period when general aviation activity declined nationwide and population growth lagged sunbelt states, Massachusetts enjoyed a 40-percent rise in the number of based aircraft. Governor Deval Patrick has been working for months to reverse this trend.

According to the Worcester Telegram, the governor’s plan to export jobs to New Hampshire and Connecticut has succeeded. Massachusetts will attempt to collect tax on new aircraft and aircraft maintenance. People will set up their new aviation businesses in Connecticut and New Hampshire (only a 5- or 10-minute flight away in most cases). Airplane owners in Massachusetts will take their planes to these other states for service (we already take our Cirrus to Groton, CT for most of its service).

Flight schools in Massachusetts are going to suffer an additional crippling blow. Their competitors in sunbelt states pay $1-2 gallon less for fuel and can defray fixed costs much more easily due to the perfect weather.

Perhaps the lesson here is to beware of politicians whose campaign slogan boils down to “I’m black and make people feel good, so elect me.” Being inspired is nice, but it is also nice to have a job.

[Update: I ran the numbers and figured out that the 5% Massachusetts sales tax would be enough, for most jets, to pay an entire year of operating costs. You could base the plane in New Hampshire, hire a crew to fly it down to meet you anywhere in Massachusetts whenever you needed it, and the 5% tax would just about pay for the salary of the crew, fuel, hangar, insurance, etc. Subsequent years wouldn’t be quite as advantageous, but you’d be able to get employees in New Hampshire at a lower cost because (a) they wouldn’t have to pay income tax, (b) they wouldn’t have to pay sales tax, and (c) housing is much cheaper in New Hampshire.]

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I ran into a girl from Bangladesh who is here in Cincinnati for one year at one of America’s Top 100 high schools (Walnut Hills). I asked her how the courses compared to what she was accustomed to in Bangladesh. “School here is much easier than in Bangladesh.”

Note that Bangladesh has a per-capita income of approximately $500 per year. The government spends between $25 and $50 per year per student in primary and secondary schools, many of which are madrassas that spend a good portion of the curriculum on the Arabic language and Islamic topics.

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May 2008 Harpers’s Magazine carries an article, sadly not online, titled “Why the Economy is Worse Than You Know” by Kevin Phillips.

Unemployment statistics were redefined starting in the early 1960s by the Kennedy Administration. First they took out the “discouraged”, people who wanted a job, but had stopped looking. Under the Reagan Administration, the workforce was expanded by adding in members of the U.S. military, who were by definition “employed”, thus shrinking the percentage of “unemployed”. The Clinton Administration reduced the number of households sampled from 60,000 to 50,000 and “a disproportionate number of the dropped households were in the inner cities.” Phillips doesn’t talk about prisoners, but we have greatly increased our prison population, most of those incarcerated are working-age men, and none are counted in the workforce. Phillips claims that “Based on the criteria in place a quarter century ago, today’s U.S. unemployment rate is somewhere between 9 percent and 12 percent.” [Poking around at http://www.bls.gov/cps/ reveals that, in 2007, 146 million of us were working, 7 million were unemployment, and 4.7 million were classified as not in the workforce but “wanted a job”; an additional 2.3 million Americans were in prison, presumably due to their energetic work habits in illegal trades. The “U-6” series, published by the BLS but almost never reported by newspapers, shows an unemployment rate right now of 9.1 percent.]

Calculations behind the inflation numbers cited in newspapers are beyond the grasp of any layperson. One of the most obvious distortions in the inflation index is that it is adjusted for “hedonic value”, on the theory that new widgets, made with Chinese slave labor, are better than old widgets, made by the lunchpail Americans for whom Barack Obama feels pity. The $500 Whirlpool dishwasher from the 1996 is replaced by a $1200 Bosch in 2007. Inflation? Not for the civil servants who construct the index; they assume that the Bosch is superior somehow (and it would be for them, having so far generated at least 8 days when they could have taken off work to wait for the repairman). A non-obvious distortion is created by ignoring what homeowners actually pay for mortgage, maintenance, real estate taxes, etc. Starting in the 1980s, the BLS began to use “owner equivalent rents”, i.e., asking homeowners “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?” (source). Under the Nixon Administration, food and energy were going up in price, so these items were removed from the published “core inflation” number, which happens also to be the basis of cost-of-living adjustments that the government must pay for pensions and Social Security. Phillips claims that the true rate of inflation is between 7 and 10 percent, not the 2-3 percent published by the government. [Support for this theory might be seen in the reluctance of foreigners now to trade their euro for dollars except at historically extreme exchange rates.]

Aside from reducing government pension costs, how do politicians and their cronies benefit from a lower published inflation number? Phillips claims that a low inflation rate makes investors comfortable with accepting a lower interest rate, which makes it much cheaper for the government to borrow money and also helps those who benefit from real estate bubbles. Phillips cites a 2007 article by Robert Hardaway saying that the subprime circus (which made a lot of people very rich before it made the Greater Fools rather poor) “can be directly traced back to the [1983] BLS decision to exclude the price of housing from the CPI”.

What about GDP, the source of all wealth? Phillips says that “federal economists used the Gross National Product until 1991, when rising U.S. international debt made the narrower GDP assessment more palatable.” He notes that a full 15 percent of GDP is “imputed”. This includes the fees that banks don’t charge you if you have a “free” checking account and rent that you didn’t have to pay because you owned a house. The CIA factbook says that our population is growing at 0.9% (mostly immigration and the children of recent immigrants) and GDP is growing at 2.2%, but if it doesn’t feel like the average person is getting richer that might be partially because much of the GDP growth is fake (in addition to the hedge fund managers and CEOs taking most of the new money (and much of the old) for themselves). Phillips does not estimate our true economic growth, but claims that much has been illusory, without even resorting to pointing out that much GDP comes from things that add no net value when you compare American lives in 1998 to American lives in 2008, e.g., rebuilding from Katrina and Florida hurricanes, replacing things that are broken or stolen, hiring hundreds of thousands of security guards to deal with risks of terrorism perceived only after September 11, making Iraq safe for Iraqis, reinforcing cockpit doors on airliners, buying guns and running training courses for airline pilots, paying mechanics to patch holes in airliners created when some of those guns accidentally discharge, etc.

The article ends with a whimper. Phillips doesn’t make a convincing argument for how accurate data would help us. By pointing out the collapsed and further collapsing value of the dollar, he implies that foreigners have already figured out the real numbers. So if it makes us feel good to think that very few Americans are unemployed, why shouldn’t we think it? If the thought of 2 percent inflation takes some of the sting out of paying $1000 for dinner and a show in New York City, why shouldn’t we take comfort in our low core inflation rate? If we record a massive improvement in GDP every time New Orleans gets submerged or we equip more troops to go to Iraq, aren’t we entitled to some good news?

[Critics of the Internet Age often complain that Web articles aren’t sufficiently authoritative, yet this Harper’s article is worse. The author is not identified except as the author of a new book entitled Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism. There is no way to gauge his credibility by reading other things that he has written or even a biography. The article itself contains no references to fundamental data and only a handful to some newspaper articles (citations incomplete). The average Weblog posting would have hyperlinks to at least some sources.]

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