The Amateur Financier

One of the things that I enjoyed about getting a psychology minor at college was seeing just how psychologists attempt to examine and classify people.  Since it’s illegal to subject people to degrading and bizarre tests just to see how they will react (unless you are running a reality show), psychologists have come up with a variety of indirect tests to ascertain a person’s basic characteristics.  These can include every from Rorschach (ink blot) tests and dream analysis to more mundane methods like personality tests.

With the widespread nature of the internet, it should come as no surprise that there are even online personality tests.  Recent, My Life ROI pointed out the results he got from 41 Questions.  And, being the curious type that I am, I decided to give it a spin myself.  Here are my results:

My Take on the Results:

The test seems to be pretty spot on in my case.  I do tend to be rather introverted in nature, and focus more on rational thought as opposed to feelings.  I’ve actually held a few jobs in the fields they recommend as careers that could fit me, as a QC chemist and as an organic chemistry tutor, both of which I enjoyed quite well.

That said, their comments are a bit off; I’m not much of a leader, and have trouble turning plans into action.  And furthermore, the fact that there are no negative comments listed makes me suspiscious about the overall results; surely, someone who is as introverted as me should have some negative qualities as a result.

Ultimately, though, the real value of quizzes like this are that they get you thinking about your personality.  And that sort of deep thinking can lead you to make appropriate changes in your life.

Previously, on When Economists Agree: We saw startling evidence that occasionally, you can put ten economists into a room, give them an issue, and come up with less than twelve opinions.  In fact, we saw five issues where the great bulk of economists had a consensus on the best course of action.  But we’re not done yet; here are five more issues on which most economists maintain the same point of view (and the percentages that agree):

6) Cash payments are better than equivalent transfers-in-kind at increasing the welfare of recipients (84%) -For those who are not already aware, transfers-in-kind are things like food stamps, where the actual items being distributed are not directly salable.  Giving the recipients cash directly and allowing them to spend it as they wish expands the economic choices they can make and (in theory, at least) allow them to maximize the use of the welfare money that is provided to them.

7) A large federal budget deficit has an adverse effect on the economy (83%) – I’m kind of surprised that this one is so low on the list.  A short list of negative effects of a high federal budget deficit: more borrowing to pay for the spending, more interest payments on the borrowed money, and the increased anxiety in the broader economy from fear of higher taxes or decreased government spending if the deficit remains high.

8 ) A minimum wage increases unemployment among young and unskilled workers (79%) – Let’s assume you are running, say, a fast food restaurant.  You’d like to have ten people on each shift, and have $50 per hour to spend on salaries.  If you can pay each of your workers $5 an hour, there’s no problem; you can hire ten people per shift, and each person will make $5 an hour.  If you have to pay out $7 an hour, though, you will cut down the number of workers, to seven employees per hour that your restaurant operates.  As a result there are now three fewer people working for each shift your restaurant is open.  Since young and unskilled workers tend to be on the bottom of the wage scale, they are the ones who lose opportunities when the minimum wage increases.

(This is a bit of an oversimplification, of course.  If you require eight workers for each shift, for example, you’ll have to find some way of putting an extra $6 each hour into your salary budget to hire the needed workers at $7 per hour.  The less flexible the manpower requirements for a particular business, the less effect a change in the minimum wage will have on the number of workers who are employed by that business.)

9) Government welfare should be structured as a ‘negative income tax’ (79%) – This is along the lines of what we just mentioned up in number 6.  The essential idea is that the government sets a minimum income level, below which any person will receive money from the government, rather than paying taxes into the system.  In this way, one welfare system could replace things like unemployment, food stamps, and housing allowances from the government.  This should end up cutting down on administrative expenses and making the government efficient.

10) Effluent taxes and marketable pollution permits represent a better approach to pollution control than pollution ceilings (78%) – Heh, I find this one amusing, as there is currently a sometimes spirited debate over whether we should go for a cap and trade system (essentially marketable pollution permits) or a carbon tax system to control carbon dioxide emissions.  Almost nobody is discussing pollution ceilings for controlling greenhouse gases.

One reason for this, of course, is that taxes or cap and trade both give companies, agencies and individuals an incentive to cut pollution as much as possible, as opposed to reducing emissions to an arbitrary limit.  Companies that exceed the desired emission cuts can either save money on taxes or sell the permits they don’t need for their own use.

And there you have it; ten public policy decisions where most economists agree on the best course of action.  Hopefully, you have a better idea of how economists view the world now.

Recently, I’ve been doing a bit of spring cleaning, and I came across my old microeconomics book.  (In case you are curious, it’s Principles of Microeconomics by Mankiw.)  Being the packrat that I am, I ended up keeping more than a few of my textbooks from college, rather than selling them back.  I’ve been re-reading the book since I found it, and I’m being reminded of all the interesting economic information contained therein.

One thing I am particularly struck by is a list, early on in the book, that covers ten propositions where the majority of economists agree.  I find it fascinating as to just how few things there are that the bulk of economists can agree on.  Part of it is because, as a biochemist, I’m used to most issues in my professional life being well settled and seldom debated.  Another reason is that I’m attempting to become a professional PF blogger, and it’s interesting to see just what professional economists think.

Therefore, I’m going to be sharing these points of agreement (and the percentage of economists who agree) today and on Wednesday.  Here are the first five:

1) Rent control reduces the quality and quantity of available housing (93% agree) – I can understand this principle pretty well.  Rent control decreases the amount of profit a landlord or other building owner can make, thus providing a disincentive for them to put as much money and effort into maintain the building or apartments.  At the same time, the chance to obtain housing at less than fair market prices increases demand, which further decreases the incentive to make improvements to the building.  (Why invest in upgrades to a building if there’s already a line of people clambering to get an apartment?)  It’s a vicious cycle, too many people fighting over too few properties, most of which probably are declining in quality.

2) Tariffs and import quotas usually reduce general economic welfare (93% agree) – This is also a pretty easy one to follow.  If there is a disincentive to buy foreign cars, in the form of a tariff or other increased charge, the domestic auto industry would benefit, but the buying public would suffer from less selection and potentially higher prices.  Furthermore, the industries that supply the foreign auto companies with raw materials or other items needed to make cars would take a hit.  And all this is before there’s any response from the foreign country in question in the form of counter tariffs or quotas.  While barriers to trade may help some people (those in the protected industries), it’s far from advantageous for the country (and world) as a whole.

3) Flexible and floating exchange rates offer an effective international monetary arrangement (90% agree) – In a perfect world, all exchange rates would be completely free to adjust to the movement of money around the world; so if money flows into a country like China and out of the US, then China’s money will become more expensive and the United States’ currency will become cheaper (that is, a Chinese yuan will buy more more dollars when exchanged).  This would have the effect of making imported goods more expensive, leading to either a decrease in imports or an increase in exports (either of which would help to correct the trade deficit).  One of the reasons for the vast trade deficit between the US and China is that until recently, the yuan was fixed to an artificially low value against the dollar, making Chinese imports comparatively inexpensive.

4) Government policy (tax cuts and/or spending increases) has a significant effect on a less than fully employed economy (90% agree) – The caveat about a ‘less than fully employed economy’ might seem a bit odd, so here’s the short version: if there’s zero unemployment, it’s harder for companies to hire or fire people.  If a company is the recipient of a federal grant and wants to expand its work force, it will have to work much harder (and offer higher salaries) to pull employees away from its competitors.  Similarly, if taxes are raised and the company is feeling an economic pinch, they will think twice about downsizing, as there is not a pool of unemployed workers to draw from when they try to expand again.  In a less than fully employed economy, of course, there is more slack in the system, in the form of us unemployed folks, and the company can add or remove workers from its payroll with some confidence that it can hire replacements for essentially the same cost.

5) If the federal budget is to be balanced, it should be done over the business cycle, not yearly (85% agree) – Essentially, this means that, rather than ensuring that each yearly budget spends only the income from that year, we instead allow defecit spending when the economy is poor, to be recuperated when the economy picks up again.  The goal, of course, is to not hit the economy with a double whammy: lowered government spending (as a result of less tax revenue) and business decline, occurring at the same time.  Similarly, such a policy would lead to higher tax rates and/or lowered government spending in boom times, to recover the excess spent during the bad years.  The end result would hopefully be a smoother economic cycle, with the booms being tamped down a bit and the busts being countered.

There you have it; the first five principles with which most economists agree.  Turn in on Wednesday to discover what else meets the approval of most economists.

The recent economic turmoil has sent people scrambling for someone to blame.  One popular target is short sellers, those stock traders who sell borrowed shares and profit when the prices decrease.  Recently, there have been proposals to put limits on when people are allowed to short stocks, including reinstating the uptick rule.  Short sellers are taking exception to all the blame being directed toward them, pointing out that they are simply profiting from the downturn, not causing it.

With all of this discussion going on, you probably have numerous questions.  Why are short sellers so reviled?  Would the uptick rule really stop them?  And what is short selling, anyway?  Let’s use a simple example:

I’m an investor, and I feel that the Zipper, Yak, and Xylophone, Inc. (ZYX) company is going to decrease in price, due to a recent increase in yak feed prices.  If I want to profit from this price move, I could sell any shares of ZYX that I own and then repurchase them at a lower price, which would allow me to pocket the difference.  If I don’t own any shares, though, I have to look at alternate ways to make a profit.

Here’s where you enter.  You have an account at the same brokerage that I do, and you own one hundred shares of ZYX.  If I want to short sell ZYX, I can have the brokerage sell your shares, leave you with a virtual IOU, and give me the money; then, after the shares drop in price, I buy the stocks back, returning them to your account without you even noticing (the brokerage would not inform you that your shares were being used to short the stock).

If the share price is $50 when I short your stocks, I’ll receive $5000 for selling them.   When the price per share goes down to $30, I can buy them back for $3,000, making $2000 by shorting your shares of ZYX.  (In actuality, I won’t make that much; commission fees in buying and selling the stockes, margin fees on the money borrowed from the brokerage when shorting the stocks, and the cost of any dividends paid out while I’m shorting your stocks will lower my profits.  To make the math simplier, I’ve omitted such costs from all the math here, since the costs would vary with the brokerage and time the short was executed.)

Not all short selling results in profit, though.  If I’m wrong about ZYX and it goes up in value, I’ll spend more money to replace the borrowed shares than I got by selling them.  Should ZYX go up to $60 per share, I will spend $6000 to replace them, a loss of $1000 (on top of the aforementioned expenses).  Furthermore, the downside risk of shorting stocks is greater than owning them.  If ZYX goes bankrupt while you own your 100 shares, you will have lost $5000.  However, if the ZYX share price shoots up to $110 while I’m shorting them, I’ll have to spend $11,000 to buy them back, a loss of $6000, more than the total cost of the stocks initially.  The losses from shorting can theoretically be unlimited, as long the per share price keeps rising (although, that’s somewhat unrealistic).

Now that we have a better idea of what short selling is, you can probably see why it rankles so many investors.  If I’m making money when your investments are declining, chances are you aren’t going to be too happy with me.  I’m not really causing you to lose money if your stocks go from $50 a share to $30 a share, since I’m just a fellow investor and can’t influence stock prices, but if I’m cheering for your stocks to fall, it’s hard to avoid thinking of me as the enemy.

But would the uptick rule actually stop short selling?  The uptick rule says that, if I’m going to short a stock, I have to wait until there’s an uptick, that is, for the selling price of the stock to be higher than the last previous sale.  This rule had been in place until 2007, when it was repealed, but in light of the past year’s turmoil, there’s plenty of talk about bringing it back.  The goal is prevent short sellers from piling on when news gets bad, continually driving down the price and beating down the stocks.

My view: while a reestablished uptick rule may decrease short selling of beleaguered stocks, it won’t necessarily save them.  Stocks will still be able to fall, as the the owners sell their stocks and mutual funds need to gain cash for redemptions.  All that banning short sales may do is prevent those few people who are benefiting from the falling prices from, well, benefiting.

Furthermore, with the number of trades that are executed each day, especially for large cap stocks, the uptick rule may be little more than a formality.  Most popular stocks will be traded hundreds, if not thousands of times each day.  A dedicated short seller would simply need to wait for an opportune moment and leap in after a small uptick, and then be able to short sell to their heart’s content.

I personally am interested in just what the Securities and Exchange Commission will decide regarding this practice.  Hopefully, you now have a better understanding of short selling, and might just be more interested yourself.