Odds Favor Shorting Paper Gold

The advent of paper gold in the forms of funds/ETFs/ETNs is a godsend for those who want to play gold on the short side. I don’t claim I can predict the movement of gold accurately, but all else being equal, the odds are stacked against paper gold. If you must own gold, try to own physical gold bullions and bars. If you want to short gold, paper gold is the perfect instrument - it is like being the house at a casino. Here’s why (I will use SPDR Gold Trust (GLD) for some of the examples but this is directed at paper gold in general):

(1) GLD has an expense ratio of about 0.40% per annum. Which means GLD will lose value at 0.40% per annum even if the value of gold stays the same; And if you are on the short side, it is functionally the same as receiving 0.40% per year. Unlike stocks and mutual funds, gold is a non-cashflow producing asset – it will never pay a positive dividend, which means there will never be anything that offsets the 0.40% in fees you’ll have to pay if you’re long or you’ll “earn” if you’re short. Granted, 0.40% is nothing to write home about even in the current near-zero interest rate environment, and it will easily get swamped by any capital gain on gold, but it does move the needle slightly in the short’s favor.

(2) In a doomsday scenario, you have a much better chance of keeping your physical gold than your paper gold. One of the reasons for investing in gold is that it is viewed as the money of last resort when the existing governments/financial institutions/fiat currencies fail. Although most paper gold instruments are backed by actual gold stored in a warehouse somewhere, you will experience counterparty risk on doomsday if you own them. A look at the prospectus of SPDR GLD, we see that it has World Gold Trust Services as its sponsor, BNY Mellen Asset Servicing as its trustee, and HSBC as its custodian. When disaster strikes and one of these institutions fail, it’s unclear how much gold you will be able to claim for your GLD shares.

In another scenario where US Government bans the ownership of gold to save its currency (as they did indeed in the Great Depression), you will have a much better chance of running to another country with your private, physical, stash than to try to claim your gold from a trust. But riddle me this – if you are short the GLD ETF, what happens when the government confiscates all their gold?

(3) Paper gold is exposed to fraud and accounting risks. There could be inaccurate accounting or out-right fraud at the trust/trustee level. Or some dishonest employees at the custodian could have stole some gold for themselves. Or, the custodian may have tight controls, but one of the sub-custodians that the custodian subcontracted to may not. It will be a stretch to say that all of the many precious metal ETFs and funds out there have perfect accounting and controls. If there is anything Bernie Madoff taught us, it’s that there is risk of fraud in the most established of institutions – and this is magnified with paper gold because there can be so many intermediaries between you and your physical gold.

I cannot predict the precise movement of gold the same way I cannot predict the next pai-gow hand at a casino. But what we do know beyond a doubt, is that the odds are stacked, and the house always wins in the long run.

Disclosure: short GLD

Beat the Market with 5 Basic Tenets of Long-term Investing

So you want to beat the market. Despite the fact that you can effortlessly earn market return by investing in index funds, despite the constant discouragement from the financial academia telling you that it’s impossible to beat the market, and despite research showing that most professionals really do fail to beat the market, you think you can do it.

The good news is it is possible. Warren Buffett once said, “Observing correctly that the market was frequently efficient, they went on to conclude incorrectly that it was always efficient. The difference between these propositions is night and day.” And I tend to agree that, if one is willing to bring intensity to the game, it is possible to earn excess return, or alpha.

But in the end the quest for alpha is a zero-sum game. By definition, the average investor cannot earn more than the average. Each dollar you make in excess to the market is taken from other investors who are earning below average return, and how much you make is depended on the edge you have over the other investors.

I believe that regardless of what your investment strategy is, incorporating these 5 basic tenets below will give you an edge over an investor who is not, all else being equal. They should form the foundation of any winning active strategy with a long-term horizon. Without further ado…

Read Wide

Have a wide variety of interests, and get into habit of reading anything that’s remotely relevant. I am not referring to simply browsing financial websites. Of course, “reading deep” in terms of doing rigorous research on the companies/sectors/asset classes you are investing in should go without saying. But if you are only reading the same things as the rest of the investing community is reading, you are more likely to think the same things as well. “Reading wide”, or seeking information beyond the normal realm of investing, increases the opportunity for synergizing outside information into an investment thesis, and you can never tell beforehand where you will come across relevant information. Also, having interests outside of investing gives you a better chance at noticing major trends ahead of the curve. For example, if you were a computer geek back in the 80s or early 90s, you might have bought the Microsoft stock ahead of the rest of the community.

Laziness is a Virtue

I could have said “Patience is a Virtue”, but this one is a little less cliché. I want to emphasize that it is good to be lazy when it comes to actual trading (but not when it comes to doing the prep work, which you definitely should not be lazy on). One of the longest running conundrum is that the average investor does significantly worse than the market average. On the surface, this statement sounds ridiculous – it is like saying the average NBA player shoots worse than the NBA average. But the former statement is, in fact, true, and the single biggest reason is that the average investor loses out by paying too much commissions and short-term taxes from over-trading. Avoid over-trading, and not only will you beat the average investor, you will probably beat the majority of the professionally run active mutual funds.

Once again quoting Warren Buffett: “Lethargy, bordering on sloth, should remain the cornerstone of an investment style.” So go ahead, procrastinate, and refrain from trading until the real opportunities arise, which leads to…

Expect Ridiculousness

The securities marketplace is part of Extremistan, the home of Black Swans.

“Black Swans” are very extreme events that have huge consequences, and Extremistan is a place where these types of events happen a lot more often than predicted by statistical normality (the Bell Curve).

What this means is don’t buy something merely because it is attractive. History has proven over and over that Black Swans live in the financial markets, thus it pays to keep your ammo dry to prepare for them. If you ever hear yourself saying, “holy s#!+, I can’t believe this market/commodity/condo/stock just dropped so much,” first, review the fundamentals. If they are still sound, you are probably witnessing a great buying opportunity. But if an investment merely seems interesting, add it to your watchlist, and then wait for that “holy s#!+” moment. You might miss a few opportunities this way, but the excess return you earn more than compensates, and more importantly, if you wait for Black Swans, you are less likely to get hit by the wrong side of one.

The flip side is also true: if it feels about right to sell a stock at $7, wait for it to go to $10! Markets often overshoot. This also works very well with the “lazy” tenet. Time and time again events have occurred in the markets that are beyond our normal range of expectations, so err on the side of inaction until the ridiculous happens – it probably will eventually.

Keep Your Options Open

It is usually not wise to have 0% exposure or fully leveraged exposure. You should always have a handful of positions ready to be sold if the market surges, and a handful of positions in your watchlist ready to be bought (and unused capital to buy them with) if the market moves against you. But, wait for the extreme moves.

Don’t be married to a particular idea. By necessity, you should have more investments that you want to buy than investments you actually end up buying. This is because, if you are following the previous tenet properly, you are not just going to invest in something merely because it is attractive; you are sitting there waiting for an extreme event to happen so you can get in at fire sale price. It is wise to monitor a large variety of choices because you never know where a Black Swan will land. “Luck favours the prepared” – position yourself such that you can take advantage of opportunities that come up.

If a particular investment runs away from you, don’t chase it; instead, make all the potential investments on your watchlist “compete” for your limited capital. This is similar to how one can do well in the dating scene – always keep a lot of options open so that your prospects are the ones doing the chasing and proving themselves to you.

Put Your Eggs in a Basket and Watch It

Diversification is a double-edge sword. The more diversified you are, the closer you are to earning the average market return, which is a terrific way for an amateur to invest and forget, and I recommend to anybody who do not wish to spend a lot of time managing money to not put all your eggs in one basket. But diversification won’t help you win the alpha-generation game you signed up for. Again by mathematical definition, you cannot beat the market by buying the market. To add value for your portfolio or your clients’, you will need to concentrate your eggs in some kind of basket (or a small set of baskets), and watch that basket. This is the mirror image of the previous tenets: read wide and keep a lot of options open, but invest rarely, make big concentrated bets, and get to know your holdings very, very well.

Islam

Comments welcome from both sides of the issue… As well as any factual correction.

 

Adapted from Dr. Peter Hammond’s book:
Slavery, Terrorism and Islam: The Historical Roots and Contemporary Threat

Islam is not a religion, nor is it a cult. In its fullest form, it is a  complete, total, 100% system of life.

Islam has religious, legal, political, economic, social, and military components. The religious component is a beard for all of the other components.

Islamization begins when there are sufficient Muslims in a country to agitate for their religious privileges.

When politically correct, tolerant, and culturally diverse societies agree to Muslim demands for their religious privileges, some of the other components tend to creep in as well.

Here’s how it works:

As long as the Muslim population remains around or under 2% in any given country, they will be, for the most part, be regarded as a peace-loving minority, and not as a threat to other citizens. This is the case in:

United States — Muslim 0.6%
Australia — Muslim 1.5%
Canada — Muslim 1.9%
China — Muslim 1.8%
Italy — Muslim 1.5%
Norway — Muslim 1.8%

At 2% to 5%, they begin to proselytize from other ethnic minorities and disaffected groups, often with major recruiting from the jails and among street gangs. This is happening in:

Denmark — Muslim 2%
Germany — Muslim 3.7%
United Kingdom — Muslim 2.7%
Spain — Muslim 4%
Thailand — Muslim 4..6%

From 5% on, they exercise an inordinate influence in proportion to their percentage of the population. For example, they will push for the introduction of halal (clean by Islamic standards) food, thereby securing food preparation jobs for Muslims. They will increase pressure on supermarket chains to feature halal on their shelves — along with threats for failure to comply.. This is occurring in:

France — Muslim 8%
Philippines — Muslim 5%
Sweden — Muslim 5%
Switzerland — Muslim 4.3%
The Netherlands — Muslim 5.5%
Trinidad & Tobago — Muslim 5.8%

At this point, they will work to get the ruling government to allow them to rule themselves (within their ghettos) under Sharia, the Islamic Law.  The ultimate goal of Islamists is to establish Sharia law over the entire world.

When Muslims approach 10% of the population, they tend to increase lawlessness as a means of complaint about their conditions.   In Paris , we are already seeing car-burnings. Any non-Muslim action offends Islam, and results in uprisings and threats, such as in Amsterdam , with opposition to Mohammed cartoons and films about Islam. Such tensions are seen daily, particularly in Muslim sections, in:

Guyana — Muslim 10%
India — Muslim 13.4%
Israel — Muslim 16%
Kenya — Muslim 10%
Russia — Muslim 15%

After reaching 20% , nations can expect hair-trigger rioting, jihad militia formations, sporadic killings, and the burnings of Christian churches and Jewish synagogues, such as in:

Ethiopia — Muslim 32.8%

At 40% , nations experience widespread massacres, chronic terror attacks, and ongoing militia warfare, such as in:

Bosnia — Muslim 40%
Chad — Muslim 53.1%
Lebanon — Muslim 59.7%

From 60% , nations experience unfettered persecution of non-believers of all other religions (including non-conforming Muslims), sporadic ethnic cleansing (genocide), use of Sharia Law as a weapon, and Jizya, the tax placed on infidels, such as in:

Albania — Muslim 70%
Malaysia — Muslim 60.4%
Qatar — Muslim 77.5%
Sudan — Muslim 70%

After 80% , expect daily intimidation and violent jihad, some State-run ethnic cleansing, and even some genocide, as these nations drive out the infidels, and move toward 100% Muslim, such as has been experienced and in some ways is on-going in:

Bangladesh — Muslim 83%
Egypt — Muslim 90%
Gaza — Muslim 98.7%
Indonesia — Muslim 86.1%
Iran — Muslim 98%
Iraq — Muslim 97%
Jordan — Muslim 92%
Morocco — Muslim 98.7%
Pakistan — Muslim 97%
Palestine — Muslim 99%
Syria — Muslim 90%
Tajikistan — Muslim 90%
Turkey — Muslim 99.8%
United Arab Emirates — Muslim 96%

100% will usher in the peace of ‘Dar-es-Salaam’ — the Islamic House of Peace. Here there’s supposed to be peace, because everybody is a Muslim, the Madrasses are the only schools, and the Koran is the only word, such as in:

Afghanistan — Muslim 100 %
Saudi Arabia — Muslim 100%
Somalia — Muslim 100%
Yemen — Muslim 100%

Unfortunately, peace is never achieved, as in these 100% states the most radical Muslims intimidate and spew hatred, and satisfy their blood lust by killing less radical Muslims, for a variety of reasons.

‘Before I was nine I had learned the basic canon of Arab life. It was me against my brother; me and my brother against our father; my family against my cousins and the clan; the clan against the tribe; the tribe against the world, and all of us against the infidel. — Leon Uris, ‘The Haj’

It is important to understand that in some countries, with well under 100% Muslim populations, such as France, the minority Muslim populations live in ghettos, within which they are 100% Muslim, and within which they live by Sharia Law. The national police do not even enter these ghettos. There are no national courts, nor schools, nor non-Muslim religious facilities.   In such situations, Muslims do not integrate into the community at large. The children attend madrasses. They learn only the Koran. To even associate with an infidel is a crime punishable with death. Therefore, in some areas of certain nations, Muslim Imams and extremists exercise more power than the national average would indicate.

Today’s 1.5 billion Muslims make up 22% of the world’s population. But their birth rates dwarf the birth rates of Christians, Hindus, Buddhists, Jews, and all other believers. Muslims will exceed 50% of the world’s population by the end of this century at their current rate of reproduction.

 

A Capitalist’s Letter to Obama

Dear President Obama,

I had always been a supporter of you, precisely because you are not married to any particular ideology, and you have an ability to listen to varying opinions, weigh their merits, and ground them on reality.

I am writing to you because your heavy-handed economic policies are too interventionistic for their own good. I previously wrote about Capitalism in Jeopardy (http://seekingalpha.com/article/102629-capitalism-in-jeopardy), where I feared that governments all over the world will use the recent credit crisis as an excuse to enact various protectionistic and socialistic economic policies, undoing human progress over many decades past. My worst fears are beginning to take hold.

I will not go as far as naming you a socialist, as I remain convinced that your decision-making process is not overly hindered by any ideology. Which is why I even attempt to make a free-market capitalist’s case to you at all.

First off, I want to debunk a common misconception that the mortgage crisis was a failure of the markets. On the contrary, the private sector did their ordinary profit-seeking thing, but it was the government’s policies that were the prime drivers of the mortgage bubble:

(1) The Federal Reserve maintained an artificially low interest rate for over a decade, enabling cheap credit that caused a cascading effect down to the regular consumers who maxed out their credit cards and took out mortgages they couldn’t afford;

(2) Fannie Mae and Freddie Mac were created as government sponsored entities, with the mandate of increasing home ownership, again with the overall effect of encouraging low quality loans made to borrowers living beyond their means;

(3) The government sanctioned status of the rating agencies (S&P and Moody’s) were given too much influence, enough to convince investment funds to treat AAA-rated mortgage-backed securities as golden, when in fact they were junk.

It is not hard to imagaine that without the low interest rate, the credit bubble would not materialize. Without Fannie and Freddie, the supply of loans made to credit-unworthy borrowers would be significantly limited. Without the rating agencies, investment funds would rely more on their own research when purchasing these structured products.

The cure for misguided regulations is, of course, not more regulations, but smarter regulations. Now, it is very difficult to pass smart regulations on economic matters, mainly because the free market, when left alone, is a well-oiled machine that functions efficiently the vast majority of time. However, I am not implying that the government should never intervene in the economy. Contemporary economics identified some cases of true market failures, for example: instances of externality, monopolies, the free-rider problem of public goods etc. The trick is to identify if a particular fall-out was caused by a true market failure, or if it is the remnants of some previous misguided policies.

I agree with Keynes that “in the long run, we are all dead.” There are merits to his supply-side economics – the government has a role in resuscitating an injured economic by spending stimulus money. But let’s not weaken your stimulus package with any ulterior agenda. I don’t have to remind you of the global backlash you received upon inserting protectionist language like “Buy American” into the stimulus bill.

Congress’s fiasco over the banks’ executive compensation did more harm than good. If the terms of compensation were not stipulated originally when the TARP money was handed out, we should not dictate them retroactively. However, if we do dictate, it makes the banks reluctant to take the money, which reduces the effectiveness of TARP in resuscitating the credit market. There is no free lunch – tinkering with the market in one place causes unintended side effects in another.

Recently you ridiculed the bond-holders of Chrysler for not compromising their loans in order to save the company. You said “I stand with Chrysler’s employees and their families and communities, not those who held out when everybody else is making sacrifices.”

You neglected that the lenders like hedge funds and investment firms have a fudiciary duty to their own investors to maximize return, and in this particular case they actually have a duty to bring matters to a bankcrupcy court because that is where they can recoup most of their investments. The investors trusted the fund managers to look out for their interests. These fund managers bought into what they thought was the most senior of Chrysler’s debt, but your proposal would effectively make them subordinate to the UAW union.

Imagine the consequences if this took hold. The hedge funds buying into senior debt can no longer be sure of their senior status. Going forward, this will make them less willing to lend, or they will demand a higher interest rate from the companies that need the capital. The investors will no longer trust the hedge funds in watching over their money, so they would either withdraw their capital, sue them, or both. End result is there will be less capital available to lend. And did you say you need the private investors’ help in providing capital for your PPIP initiative? There is no free lunch.

The government should intervene to negate true market failures. But the bankruptcies of Chrysler and GM are not failure of the market; they are failure of Chrysler and GM themselves for producing crap that nobody wants. These companies should be allowed to fail such that they either restructure to become competitive, or, over time, have their labor and assets reallocated to other more productive enterprises.

An author of The National Review recently claimed that you declared a War on Capital. I think that is still an unfair statement at this point. Once again I trust that you will judge these arguments on their merits alone, without ideological bias. Please carefully consider each economic policy you enact and err towards the side of non-intervention; we do not need another war.

 
Sincerely,

Gene Chan

The Final Bubble

For the last two decades, we lived in a speculative economy where one bubble appeared after another in rapid succession. We had the hot money bubble in Asia that ended in 1997, then the dot-com bubble in the late 90’s, followed by the housing bubble, and then finally the commodities bubble in energy and metals. As each one ended, the financial system was not allowed to wring out its excess because central banks and governments around the world churned their printing presses, and pumped incalculable amounts of money into the economy in order to it from the short-term aftermath of each bubble. The result was that when each bubble burst, a new one began almost immediately, fueled by the flood of excess liquidity. It is not over just yet – I believe we have one final bubble to work out.

The final bubble is the US dollar itself, whose current strength is fueled by a flight to safety of investors away from all risky asset classes. The flock of investors buying US Government debt has allowed a gargantuan amount to be issued without the repercussion of sky-high interest rates, which enabled the Federal Reserve to massively expand its balance sheet, and congress to take on an astronomical amount of debt without a significant increase in borrowing cost. It was made possible by the reserve currency status of the greenback, and its perceived safety relative to all other asset classes.

This too, will end. In our epic game of musical chair, we are now fighting for the last chair. This is how I think it will play out. For the time being, the bubble will continue in the short term. We will continue to see strength in the US dollar insofar as it is still perceived as the safest asset class. At the same time, even though the Fed is pumping liquidity into the system, the economy is still in the process of LOSING liquidity due to credit contraction. The funds that are pumped into the financial system are getting sucked into a black hole, because the credit market is frozen and the funds going in are not coming back out as loans. As long as banks refuse to lend, we are going to see destruction of liquidity, which is deflationary in nature. And the best asset class to hold during a deflation cycle is cash – which means as long as the financial system is in trouble, the bubble in the US dollar and its equivalent (e.g. treasury bills) will likely to continue.

Ironically, the eventual recovery of our economy will set the stage for its ultimate collapse. Firstly, the up-tick in the general economy will eventually cause institutions to start lending again, which will reverse the conditions from credit contraction to credit expansion, and turn deflation into inflation. Secondly, investors will have less need for safety, thus selling off safe-haven asset classes such as US treasuries and gold, putting pressure on the debt that US Government owes. Both of these are pillars that are currently supporting the US dollar, and as they disappear, we will suddenly realize that the US owes tens of trillions and it has no way of repaying. The US government will not default on its debt, but it will try to print its way out of trouble, which will likely burst the USD bubble, drive the dollar towards zero, and trigger hyperinflation.

Nobody is sure exactly what will happen when the US dollar collapses, except that it will be bad. There will probably be chaos in international trade, as a large portion of goods are priced in USD. There will be chaos in the derivative markets, as majority of the derivative models are driven by the US treasury yield with the assumption that it is “risk-free”. The currency reserve of most of the world’s central banks will become virtually worthless. The world’s largest importer, the United States, will suddenly lose its purchasing power. There will be riots on the street similar to those that happened after the collapse of Iceland, except it will be worse by orders of magnitude.

Where will be good places to park our funds in this scenario? To be honest, there aren’t very many. A lot of countries are in a similar predicament as the US. The UK banking system and fiscal situation is just as bad, if not worse, so the British pound will collapse along with USD. There are already secession talks from some of the fringe EU countries, who are soon to be facing the stark choice of either bankruptcy or abandon the Euro because the countries have no control over their own money supply, so the Euro may not survive this crisis. The Japanese has a public debt that is a larger percentage of their GDP than the United States, and it is to be serviced by a population that is aging quicker than the United States.

This leaves a few places in the world. The Canadian banking system is currently the most stable in the world, and its fiscal and trade balances are in relatively good shape, so I am bullish on the Canadian dollar. Same goes with some of the major emerging markets: Brazil, China, and India (Not Russia, whose government seems set on reversing all the progress they have made in economic liberation since the collapse of USSR). Their currencies will do well versus the rest of the world, although their equity markets will not due to the export-focused nature of their economies, and their biggest trading partners will be the countries whose purchasing power disappeared. It is my view that Hong Kong will unpeg its currency from the United States when it becomes clear that the USD is on the path of disintegration, and China will also float its currency when the rest of the world goes to hell.

Gold, traditionally a good inflation hedge, will retain its value as the major fiat currencies collapse. However, I believe there will be a chance for us to go into gold at an entry point cheaper than now, during the early stage of the economic recovery, and before inflation truly appears. When that happens, I recommend moving a sizable portion of our networth into gold, but not so much that we would miss out on a benign recovery if the Armageddon thesis turns out to be false.

There will likely be a short-lived, but voracious, stock market rally when signs of economy recovery first appear, and we should use that opportunity to off-load certain names in our stock portfolio. Companies that sell to the United States or the other failing countries will not do well, which means BRIC and Canadian exporters, and companies that serve the US, UK, European domestic markets. The banking system will implode so financials is also a sector to avoid. To the extent that we must keep some equities in our portfolio, we should focus on the ones that may outperform, relatively speaking. Domestic-focused emerging market companies should do OK (like emerging market real estates and utilities), as well as US exporters (like General Electric (GE)), and companies in industries supported by major tailwind (health care, mining, alternative energy, and technology).

Instead of trying to get the timing exactly right, let there be humility as the aforementioned strategy is implemented, in that it should be implemented in a piece-meal fashion. I would sell a little bit of the positions that don’t fit the overall strategy at each major rally of equities, and I would add a little bit to gold at each correction of the metal.

Getting back to gold, the instrument a lot of retail investors will be using for their gold investment will be the SPDR Gold ETF (GLD), because that is the simplest way we can invest in gold through regular brokerage accounts. However, I recommend that we purchase some physical gold coins or bars as well when the prices go down a bit. Ultimately, the rationale for buying gold is the same as that of the people who are stocking up on guns, ammo, and water: “just-in-case”. In the “just-in-case” scenario, which is the complete annihilation of the existing financial system, the fund company that offered the Gold ETF may not survive, and the banks where we opened our brokerage accounts may cease to exist. To fully hedge against this possibility, we will all need a little bit of physical gold, stored in several different undisclosed locations that are known to be safe.

Good luck.

The Marriage Contract

Observe that:

 

(1) Fundamentally, marriage is a private contract entered into by two consenting adults for a life-long commitment, and a divorce is a voiding of that contract, with associated costs and penalties.

(2) A couple who love each other, and who are most happy together compared to any of their other alternatives, will prefer to stay together anyway, with or without official marriage. (In other words, marriage is irrelevant if two people stay in love with each other, because they would have been kept together regardless.)

(3) Because of (2), the only instance where marriage actually makes a functional difference is when a couple, who were initially in love when they entered into marriage, stopped loving each other at some point, but are forced to stay together due to the difficulties associated with a divorce.

 

Just from what I wrote above, you may come to the conclusion that I have quite a dismal opinion of marriage, and that I think marriage has no value at all. That is, however, not exactly true. I believe marriage adds value to the society in a very specific case, and the value added is positive enough to justify the existence of marriage, but not significant enough to warrant too much of our attention over other much greater issues. Marriage in general, and gay marriage in particular, do not deserve as much of our collective attention as it does now.

I am specifically talking about the legal institution of marriage, not the wedding celebration and other fluffiness surrounding it – anybody can throw a huge party without actually being legally married.

The specific case where marriage adds value is when a couple stopped loving each other AND they have had children together.  Note again that if a couple never stopped loving each other, they would have taken care of their children together regardless of marriage. Without children, the only thing that marriage accomplishes is to keep unhappy couples together, so there is no value added in that case. Let’s consider the specific case where the love stopped but they have had children together.

Without the stability of marriage, couples would break up more easily and children would be left more often with a single parent. Granted, even with marriage, couples can still divorce, but it is relatively more painful and costly, so it would at least give them some incentives to try to work things out. The difference from the children’s point of view is significant – having the time, attention, and resources of two parents is vastly better than one parent in terms of their development. In other words, in this specific case, there is a trade-off between the parents’ suffering (from having to stay together) and the children’s happiness (from having two parents), and as such, the ONLY time where value is added to the society is when children’s gain in happiness is greater than the parents’ loss.

I believe this specific case happens often enough to justify marriage, or something like it, but its exact definition is not important. We can call it whatever we want, but what people do is create institutions of two (or more!) people, formed consensually and held together by a private contract, to provide a stable backdrop for raising children. Gay or straight, two or many, they are agreements reached by consensual parties, therefore I do not have strong opinions on them, and I do not think they are something that the government should meddle in.

As a corollary, I do not have a strong opinion on gay marriage, other than the view that the entire marriage legal framework is unnecessary noise because existing laws surrounding private contracts would have sufficed.

But the reality is we have laws governing the marriage contract that we have to obey. However, within this framework, what I do have a problem with is how this gay marriage issue is framed. Gay marriage advocates often claim that gay people deserve the same rights as straight people, therefore they should be allowed to marry each other. The fact of the matter is, they already have the same rights as straight people, so this had nothing to do with inequality. What they are asking for is not equal rights, but additional privileges. Fairness under the law is objective fairness, not subjective. Let me explain.

The law does not adjust for personal preferences. The law prohibits drinking and driving, regardless of whether you like to drink or not. The law (here) says you must drive on the right side of the road, regardless of your preference. The law says an adult cannot have sex with underage children, regardless of whatever sick fetish one has. I am not suggesting any moral equivalence among these acts; I am merely illustrating that equality under the law means it is applied equally to everybody without regard to subjective preferences.

So, as it stands currently in most places, anybody, straight or gay or lesbian, is allowed to marry someone of the opposite sex – man with woman, woman with man. The law is applied equally to all regardless of each individual’s sexual preference of man over woman or vice versa. The law does not, and should not, apply differently to different kinds of people. Just like how all people, vegetarians or meat-eaters, are not allowed to eat endangered animals, we have equality because justice is blind to differences in individuals. The law is fair objectively in that same sex marriage is prohibited for people of all sexual preferences.

This fact in itself does not determine the merits of gay marriage either way. But as we debate, we should know that what we are asking for is not equality, but a special provision – a brand new privilege for a man to marry a man, and a woman to marry a woman. The issue of equality has no place in this discussion – don’t cry wolf or we are diluting the argument when REAL problems of equality arise.

***Update***
I have received some feedback since publishing the article above, illustrating certain misunderstanding that I would like to clarify.

What I wrote above is a cold rational dissection of the marriage contract. I wrote that on an intellectual level, the only benefit to society of marriage is for raising children. I may have inadequately explored the emotional side of the issue because I felt that the topic of marriage is already saturated with such literature on the emotional side, but not enough from a rational perspective.

However, I would personally be marrying on an emotional level, because I am a product of evolution and I experience the same emotions as everyone else. So despite what I wrote, I will be marrying for love.

(But what is love? That is whole another topic… Just like this one, love also has both an emotional side and a rational explanation based on evolutionary psychology.)

Please accept my apologies if the content of this essay was confused with what I feel on a personal level and reflected unfairly on my character.

I believe rational discourse and human’s innate desire to pursue happiness are both worthwhile activities; the differing perspectives that result are not in conflict – they are just two ways of looking at the same thing.

Henry Paulson Could Have Done Better

I expected US Treasury Secretary Henry Paulson, being the ex-head of Goldman Sachs (GS), to be more effective at deploying the $700 billion financial bail-out package handed to him by Congress. I expected him to manage what is essentially one of the world’s largest hedge fund with the acumen of a shrewd trader.

I did not expect him to openly declare his change in policy of using the funds to purchase shares in banks directly instead of buying up their toxic assets. He changed his mind too early, and tipped his hand too clearly, that not only does he appear he does not know what he is doing, he also exacerbated a crisis in confidence that has unintended cascading effect on the rest of the system. What he should have done instead was to keep his options opened.

His explicit switch of focus from the toxic ABS to bank shares removed the floor from ABS prices, which made the balance sheets of the major banks deteriorate further, pushing behemoths like Citigroup (C) to the brink of collapse.

He should have made the entire range of policy options available instead of tying one hand behind his back by explicitly limiting the type of assets he can buy. His policy should simply be this: starting with a profit motive from the tax payers’ perspective, he will buy any distressed financial assets that become cheap enough that we can reasonably expect to turn a profit in the long run.

In this confidence game, his mere mention of buying up cheap financial assets would prevent them from getting too cheap, thus preventing further deterioration of the balance sheets of the banks that hold these assets. A policy that keeps his options open would have been a force multiplier that puts a floor on the prices of assets all across the system instead of the distortion we have now.

Another side-effect of a profit motive would be that he would have to focus the funds on helping competent organizations or purchasing assets that can reasonably recover in the future and turn a profit, but are only hurt in the short term due to collateral damage from the crisis.

I had expected the best of Goldman Sachs to be better than this.

Capitalism in Jeopardy

While testifying before the House Oversight Committee last week, Alan Greenspan said,

“The economic crisis has revealed a flaw in the model that I perceived as the critical functioning structure that defines how the world works… Those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity, myself especially, are in a state of shock and disbelieve.”

The recent crisis did reveal very clearly about one aspect of how the world works. There are in essence two economies: the real economy, where real goods and services are produced and consumed, and the financial economy, where asset are swapped for investment or speculative purposes. These two economies interact and affect each other, but each requires a unique regulatory framework to support. While government intervention in the real economy is almost always bad, government intervention in the financial economy is almost always necessary. For this reason, I fully agree that we need more regulation in the financial economy, as long as we are careful not to let it spill over to the real economy.

I believe this dichotomy needs some explaining.

While the invisible hand of laissez-faire does a pretty good job at keeping things in check in the real economy, it fails when applied to the financial economy. The free market relies on the mechanism of orderly discovery of equilibrium prices. In the speculative financial markets, this mechanism, although still exists to a certain extent, fails too often and for too long.

When there are not enough shoes being produced in a real free market, for example, shoe prices go up, and the market adjusts by selling more shoes, causing shoe prices to come back down, and vice versa. Self-correcting forces keep the free market of goods from drifting too far away from the equilibrium (i.e. just enough shoemakers selling just enough shoes at just the right price). These forces of benign price discovery fail too often in the financial markets because there are other forces, self-feeding and much more powerful, that overwhelm them.

While the real economy anchors on physical goods and services, the financial economy anchors on confidence of its participants. In this confidence game, markets degenerate too easily into a self-perpetuating cycle, more so when they involve speculative assets, and especially when they are affected by the expansion/contraction of credit.

Examples of self-perpetuating cycles are everywhere in the financial world. Bubbles are caused by people buying assets that rose in prices, causing the asset prices to rise even further. The richer you are, the easier it is for you to borrow money, which you can invest with and make even more money. The reverse is also true: Lower asset prices begets more selling, contracting credit begets tightening of lending standards. The abundance of these runaway processes is the crucial difference between the financial and the real markets – lower shoe prices does not get more people into the shoe-selling business!

This is not a new idea. The lack of a stable equilibrium in the financial markets has previously been described in George Soros’s The Theory of Reflexivity. Even the late economist John Maynard Keynes knew that the “animal spirit” of market participants is unpredictable, and the government will often need to step in to prevent the economy from swinging, destructively, to the either extremes of boom and bust. The animal spirit is exceptionally acute in the financial world.

But let’s not give up on capitalism yet. Recent hiccup notwithstanding, the trend towards freer and more global markets has coincided with improvements in our overall standard of living, albeit in a choppy fashion, over the long period of history. Capitalism is not dead, it just needs some tweaking. Lending standards need to be regulated, bank deposits need to be fully insured, and money supply needs to be controlled with care. But the responsible regulators and policymakers must be astute in noticing the crucial distinction between these creatures of the financial markets and those of the real goods and services.

This credit crisis has emboldened certain observers into declaring “capitalism doesn’t work”. We already hear about politicians all over the world taking advantage of this opportunity to enact regulations over many areas of the economy. There is now significant risk that governments of many nations are on the trajectory towards a more socialistic/protectionistic stance, destroying the climate of globalization and capitalistic experimentation that has served us so well throughout history.

It is not my intention to trivialize the recent credit crisis – The crash in the Dow Jones Industrial Average, for example, has effectively erased 10 years of gains. But let’s not allow this stumble undo our centuries of progress. Yes, the pendulum swung too far to the side of deregulation, of unchecked capitalism, and we are suffering for it; but still, more important now than ever, we need to use all our power to prevent the pendulum from overshooting to the opposite side, because the consequences will be much direr.

The Utilitarian Manifesto

Utilitarianism is a system of morality, a code of conduct. But to me, it is my religion.

I have been exposed to various major sects of religions in my lifetime. I went to a Protestant primary school in Hong Kong. When I moved to Canada I switched to a secular public school, but near the same period my parents switched religion from Christianity to Buddhism – Mahayana Buddhism to be exact, and my mother is the most devout, who now does volunteer work for a Buddhist organization on a full-time basis. I have dated more than one girl who was Catholic. I have a friend who is a Satanist.

I was positively influenced by all the religions I was exposed to, but the deficiency of each is so severe that I could never find myself committed to any (Buddhism was very close), until I read about Utilitarianism.

Utilitarianism is hardly ever referred to as a religion by most people. It is usually described as a philosophy of ethics, a somewhat practical tool for deciding what is right and what is wrong. But I call it a religion for the way I believe in it and the intensity of how I live by it.

The utilitarian ideal is this: each act is judged by its contribution to the overall happiness of people. That’s it! Now, there are different branches of utilitarianism and different ways of interpreting what that ideal means, but this is the overarching gist of it. You are doing good when you create happiness, and you are doing evil when you destroy happiness (or create suffering). What better ends can there be? If you have to believe in something, why not this?

Utilitarianism appeals to me, especially to my pragmatic mind, because it removes all the unnecessary superstitious stuff from other religions and reduces them to their core, the essence of goodness. There are many people who would not call this a religion at all, but this is as religious as I get.

I used to call it my “worldview”, but other parts of my worldview are typically supported by testable facts and logical deductions. Classifying Utilitarianism as a “religion” actually makes it a second class citizen in my head. I do this because it has flaws, just like any system of morality, but I live by it because it is by far the least seriously flawed system.

One major flaw that disqualifies utilitarianism from the realm of, say, cold hard facts, is that by believing in it, I am elevating its status above all other ethical systems. I feel deep down in my gut that this is by far the best, but I cannot and will never be able to prove it empirically. Although I intuitively know that making people happy is less evil than ravenously murdering innocent babies, I can never prove this to you as a fact. One can never prove the superiority of a moral belief, so these beliefs will always stay in the realm of quasi-religion.

Another flaw is the problem of measurement. If the goal is to maximize happiness, it implies that there is a quantity of happiness we can measure. That is not always a major problem – economists have long measured utility within an individual via methods based on principles of substitution and order of preference. The real problem lies in comparing happiness between separate individuals. How do I “know” for sure that you derive the same amount of enjoyment from this apple as I do? I can ask you if you like the apple or not, but I can never subjectively feel your feelings and then compare it against mine, nor can I objectively measure it. You can tell me that you think the apple is only “OK”, but may be you actually liked it as much as I do. It’s just that you’ve had even better tasting fruits before so the apple is nothing special; whereas that apple is all I’ve ever had in my limited experience and it’s delicious.

In order to properly apply utilitarianism to my everyday life, despite the difficulties of measurement, I use a little trick for estimation purpose. But it is a crude estimation at best, a heuristic.  We will never get more than utilitarian heuristics, and this limitation excludes Utilitarianism from the methods of facts and logic.

I use a concept I call “self-circle”, where you redefine your sense of “self” to include whoever’s impacted by your action. The goal is to trick your genetically predisposed selfishness to work in favour of more than just yourself. Let’s use this method to judge the action of a thief, who steals somebody’s wallet, takes the cash, and throws away the IDs.

Use the self-circle trick from the thief’s or the victim’s perspective and pretend they are one person. What is gain or lost in this transaction? The victim lost cash and IDs; the thief only gained cash. On net, we lost IDs and have the same amount of cash. If they were one person, they would prefer not to have the trouble of reapplying for all their IDs, therefore it was a decrease in net happiness. Therefore this was an evil act.

So what happens if the thief takes only the cash, but leaves the victim with her wallet and IDs? Naively speaking, this is a neutral act because nothing is lost between the thief and victim. However, look at the long term impact of allowing such an act. Let’s expand our self-circle to include all human beings. If we allow the stealing of cash, many people would choose to take this easy way out instead of working on something productive to earn their own cash. The net result will be a less productive economy, and we would have less goods and services to enjoy. So even though it is neutral at best in the short term, once we consider the long term impact, we can conclude that “stealing just the cash” is also unequivocally evil.

It is apparent that we can expand the concept of “self-circle” and eventually push it to the logical limit of universal utilitarianism. You can first define your self-circle as your family and close friends, pretending that all of them and you are one person. You can then expand the circle to include everyone in your company, or your country, and act in their interests. You can eventually push this to include all mankind, and then all things in the Universe. By then there will be no concept of “self”, because you are everything, and everything is you, and there are no “others” to contrast against your “self”. Any decision you make will be to maximize the sum of happiness of everything in the Universe. This concept is in fact eerily similar to the Buddhist philosophy of selflessness and “everything is nothing, nothing is everything”. This is why I mentioned Buddhism was the only religion I came close to believing in. But it comes with much additional baggage and I prefer a more concise, distilled version.

Utilitarianism is different from altruism in that it does not advocate ignoring one’s own happiness in order to increase other people’s happiness, because everybody’s happiness should be accounted for, we are all part of the system. In fact, in borderline cases, I have a tendency to be selfish. If I can reasonably estimate that you derive about the same amount of enjoyment from the apple as I do, then I prefer I get the apple rather than you. And I rather it is me who ends up with all the chips on the poker table.

That said, I admit that I am not perfectly ethical under the utilitarian system of ethics, just like even the best Christians are not perfectly ethical under the Christian system. But at least I judge my morality using a gauge that is better than any other.

When I don’t rape somebody, I don’t have to be told to think that because God said so; When I don’t steal an unattended purse , I don’t have to be told that it’s because I don’t want to go to Hell. Being good is an end in itself. Utilitarianism also automatically removes outdated clauses - No sex before marriage might have been a rule that became popular because it prevented the suffering caused by unwanted child-birth, but obviously it has no place in my rule book in this day and age of contraception.

I sincerely hope that by calling utilitarianism a religion, I did not lower your impression of it down to the level of the other pedestrian religions. If there exists any definition of goodness, then utilitarianism found it, like Occam’s razor, by cutting out all the excess from the major religions to reveal the nuggets of truth. There is no need to posit an external god.

Let’s keep the amount of untestable beliefs to a minimum. Celebrate no god other than Mankind itself, for all its strengths and flaws, all its achievements and failures, all its glory and embarrassment. We are not omnipotent, we are not omniscient, but we are us. Worship no tyrannical God who casts you to hell for your sins; obey no Allah who sends you to war against unbelievers; serve no karmic cycle where the only purpose to do good is to get repaid by good karma. Striving for the happiness of all mankind is an end in itself.

I am a utilitarian, and this is my manifesto. There will never be a temple built for the Utilitarian God. The only temple already exists in each of our minds.

 

Hello World

Hello World,

It has been a while since I last wrote to you. My, so much has happened since – you have changed so much I barely recognize you.

Between my last blog post from a couple years ago and now:

You had your little summer fling with Katrina. You made your precious black juice cost $120, but still kept most of it in the most unstable regions of the world. You put the first chinese guy in space. You implanted Mama Russia a new set of balls and gave her a remilitarized government.

You let the country of my ethnic origin host their first Olympics ever, and in its opening ceremony, you were gracious enough to involve a ”beauty-challenged” little girl in a scandal that made her more famous than she otherwise would’ve been. And then you gave some swimmer guy 8 new gold medals to add to his existing collection of 6 - just to guarantee that he has enough gold to melt to survive the upcoming collapse of the banking system.

You got your first ever black (or more accurately, half-black) candidate for The President of the USA, and the first ever woman (hopefully, not half-woman) Vice President nominee.

But all of the above pales, in terms of how you affected me, compared to the crisis you are in right now, where you saw the complete destruction of the investment banking business model.

Remember that one time, around 2001, when I was pursuing a degree and career in the software field just in time for the great burst of the tech bubble? Fast forward to today – now that I have firmly planted myself in the finance industry, the gift from you this time is none other than the unprecedented collapse of the global financial system. If I didn’t have a sense of humour, I would’ve thought you were serious.

Or may be you ARE serious. But it wouldn’t matter. Because we both know that in the end, I am going to win.

And trust me, you will be glad I won. It will be for your own good.