Why do wages rise?

I was reading the Wall Street Journal and I read an extremely interesting explanation about wages from Henry Hazlit's book, "Economics in one lesson". Greed, i.e. competition, is what makes wages rise. Generally speaking compensation is based on productivity, the more some one produces the more they get paid. The counter intuitive aspect of this is: why would you pay someone who is more productive not because they are any smarter or work any harder but press a button on some piece of machinery? It almost seems unfair that a guy who works for someone else should take advantage of the capital investment of their employer. That person didn't invest in any capital, they just sit there and utilize the machinery and tools given to them. Yet, these people make more money then those that don't have the capital to improve their productivity.

What is the most you are willing to pay someone? The right answer is that you are willing to pay them anything less than the revenue they generate. You won't pay them anymore money than they generate because you will go out of business, but anything less is acceptable. So the question is, in a competitive market what will that salary be? Well, it will tend to be just underneath the value added by that employee. Let's say you pay someone 1 dollar an hour and that person is generating 10 dollars an hour what will happen? A greedy entrepreneur will see the 9 dollars an hour in profit and say, hey I'll take 5 dollars a hour in profit. This will continue until the wages can't go any higher. The important thing to note is that the amount someone would be willing to pay is independent of how that revenue is generated. Some greedy guy is always out there willing to pay a button pusher if it makes him an acceptable profit.

How far have we come?

In 1964, the civil rights act was enacted equalizing the rights of blacks in the eyes of the law. I believe that government, and consequently the law, is only a reflection of society and it's values. At the time of the civil rights act, the mores of society were changing and those changing norms preceded, did not follow, the eventual change in the law.

We have witnessed a very sad event in our country. The punitive tax on AIG employees is a travesty. It is blatantly unconstitutional and reflects new dangerous mores developing in our country.

First let's look at government. Every single one of them swears an oath to DEFEND the Constitution. What does that oath mean? Nothing, and neither does the constitution. Before this we pretended like the constitution mattered, now we know it does not. Maybe this will be vetoed by Obama or ruled unconstitutional by the supreme court. Regardless, we have definitive proof that your representatives don't give two cents about the constitution. Remember that. Also remember who did care and give them your money because they are your true advocates and leaders.

We forget so soon the evils of which we are capable. In my life I can't conceive of a world where blacks are openly discriminated against. This is beyond my comprehension because where I grew up this was unthinkable. Just as we are probably not evolved enough for our technology, we haven't evolved that much in 200, no 30 years. This episode demonstrates just how little it takes to bring society down to a base level.

What we need to learn from this is that the danger from us to us is very great. In this case we may feel justified in our anger and retribution (I don't), but should that be the basis for our action? The basis for our society? One of the reasons this country is great is because of equality under the law. Now, as we and our "leaders" foam at the mouth, the law is used for punitive inequality. Shame on us.

The outrage over bonuses

I think the outrage over bonuses is ridiculous. I was watching the senate hearings and it came to light that there are multiple types of bonuses: retention and performance. Apparently, no performance bonuses were paid which makes sense. The bonuses everyone is upset over are the retention bonuses. The purpose of these "bonuses" was to keep people familiar with entangled financial products around so that they could unwind them and close them out. It seems that there are few people knowledgeable enough to deal with these things. So the company did something that made sense. They kept valuable assets.

The problem that everyone is having is one with semantics. These are really not bonuses. Bonus implies something extra and undeserved but who determines that? In the case of performance we naturally assume that as the driving factor in the bonus. The purpose of a retention bonus is to keep people that the company needs. This is analogous to paying a signing bonus for a new employee. The signing bonus is used to incentivize someone to join the company or a sports team. The subsequent performance is ancillary. The company has an obligation to get the people they need at the lowest cost. If they could have gotten those people from outside and fired everyone who worked there, then they should have done that. They chose to do what they felt was the lowest cost alternative. This is rational and good for the owners of the company, i.e. investors and government.

The outrage over this would be laughable if it were not true. Another lesson to learn is that "rights" are always dependent on the public mood. Notice how the idea of taxing the people who received the compensation (I refuse to continue to call it a "bonus") has support and no one is hollering how this violates anyone's rights.

How Evil is Bernie Madoff?

I feel for my pal Bernie. He stole some money, OK, a lot of money, but basically he stole money from people who didn't do their homework and relied on faith and the "watchful" eye of the government. Well, once again our fearless feckless leaders blew it. Remember that. What isn't being said and what I find fascinating is the total irony of the situation.

Over and over again I see rich people talking about how Mr. Madoff stole their life savings and I can't help but notice that if Mr. Madoff were an agent of the government, we would be applauding him. His only real crime, because taking from the rich is not a crime, is not giving to the poor. Wait, he did give to the poor. Oh well, I guess no good deed goes unpunished. Our moral lesson in immorality is that all animals are equal but some are more equal than others.

Now is the time to buy

I have made many bad decisions when it comes to investing, but my logic has always been very sound. I want to put it on record that if you have access to any money that isn't invested you should be buying like crazy right now. Now don't do what I did and not hedge (i.e. buy some downside protection) but this is the time when fast millionaires are made. Buy foreclosed properties and get in the market!

Greed and Fear predominate in the marketplace. You can't beat people based on the information you have (although what my friend Geoff and legendary mutual fund manager Peter Lynch do is a very good idea - visiting the stores and seeing what their traffic is like, etc) but you can beat them based on resolve. You have to be greedy when others fear and fear when others are greedy. That's it. Put the odds in your favor and become the house at the casino!

Interesting Lesson Learned At School

In my finance class we are learning about efficient market theory. There are three versions of this theory:
Weak - All historical data is priced into the market
Semi-Strong - All historical and publicly available information is priced into the market
Strong - All information both public and private is priced into the market

The Weak theory implies that it is not possibly to beat the market by looking at past historical data (apparently there is some academic dispute regarding momentum but I digress)
The Semi-Strong implies that it is not possible to beat the market utilizing all past and present public information
The Strong means that you can't beat the market. Period.

Then we talked about Perfect markets. A perfect market is one that is efficient AND has no transaction costs. An efficient market is not necessarily perfect.

Anyway this is the less interesting part of my diatribe, the interesting part is the question the professor asked: If we are telling students that they should pursue positive NPV projects for their future companies but you can't beat the market then isn't this a contradiction? I admit to not knowing the answer (I hate when that happens) but the answer is that you are talking about two different markets. The financial market is what is generally referred to as the market. The real market is when you actually take resources, lumber and land, and turn them into more productive assets, a house. THAT market is not efficient (or not nearly as efficient as the financial market) and there are arbitrage opportunities.

To show the inefficiency of the real market he gave an example. Let's say the price of oil goes up, do the plastic spoons sold in the grocery rise immediately in price. No they don't. Eventually they will, but the lag between the rise in the factor of production, which should raise the price of the product immediately, is inefficiency in the real market.

Cool stuff!

Natural Selection Never Fails

Recently I commented on Deal or No Deal. Well, there is yet another example of natural selection in action: Charles Barkley. Now don't get me wrong, I really enjoy him as a commentator on TNT but, how do I say this tactfully...hmmm...oh yeah, what an idiot! I don't encourage drinking and driving (and nor does anyone else other than some hardcore libertarians) but possibly the only reason someone would contemplate breaking the law would be of utter necessity. Mr. Barkley, on the other hand, is a very wealthy man. Why, WHY, didn't he call a cab? It's not like he can't afford it. I predict that 20 years from now Mr. Barkley will be yet another formerly rich athlete. Our country likes to redistribute wealth from those that have it to those that don't under the pretense that the "have nots" were unlucky. I hope we can all agree that Mr. Barkley has been more than lucky and let's make a pact now that no matter what happens we will keep our money and let him live with the consequences. Maybe, if he has another hot date, I'll give him money for a cab ride!