The US Federal Budget (and my 10th Grade teacher)

No, John Maynard Keynes was not my 10th Grade teacher. But it was in Grade 10, from my history teacher, that I learned about famous economist John Maynard Keynes.

It was Keynes who first proposed that markets move in cycles - in repeating booms and busts - and that the best way to lessen the impact of these booms and busts is to implement countermeasures.

Prior to Keynes, governments taxed less and spent more during good times (when they could afford to do so), and taxed more and spent less during bad times (when they couldn't). It all seemed very straightforward. After the Great Crash of 1929, for example, the US government cut back on myriads of projects and social services in order to save money.

Keynes argued that such seemingly sensible measures only worsen recessions. Instead, he argued that in bad economic times we need to cut taxes, cut interest rates, and increase government spending in order to “stimulate” the economy back to life. Then, in boom times, we need to increase taxes and curtail spending (since the economy is sustaining itself), and pay back that debt.

My 10th grade teacher pointed out that Keynes was foolish and that his ideas would never, ever work. The problem was not with Keynes' theory, but rather that his plan ignored human psychology and the reality of politics.

In bad economic times, people enjoy having their taxes reduced and interest rates cut, even though this leads to the large government deficits that these same people become angry about (rather like being pleased to receive expensive presents from your wife, then complaining that she spends too much).

As the economy improves, it gets even harder for the government to implement Keynes’ ideas. Despite being angry about large government deficits (“debt for our children!”) people are nonetheless unwilling to pay more in taxes to reduce it.

In the United States, any proposed tax changes are complicated by the remarkable fact that low-income earners have been led to believe that rich people need lower taxes, but that they personally don’t need them! Yes, only in America, prefabricated home owners and squirrel hunters can actually be seen protesting against higher taxes for the rich, even if that results in higher taxes for themselves.

The US budget promises to be a Frankenstein-like creation. The US Democratic Party hits walls of opposition because they propose ideas that only economists can appreciate. The US Republican Party is politically successful because they propose simple and intuitive economic ideas, no matter how unworkable those ideas may be.

Like John Maynard Keynes, Barack Obama expects people to be as logical and practical as he is – except that they aren’t. Even my tenth grade teacher knew that.

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"The avoidance of taxes is the only intellectual pursuit that still carries any reward."

John Maynard Keynes

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For an example of the class divide in America see:


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Stocks I Like - Nevsun Resources

Hitting new highs, gold is once again making headlines.

Hedge fund managers love gold, since it the easiest thing in the world to sell – gold is shiny, pretty, used to make expensive jewelry, and is great during currency devaluations and other disasters. Gold is easy to sell because it appeals to both greed and fear at the same time.

The problem with gold is that it’s impossible to determine its intrinsic value. Like tulip bulbs, gold has practical purposes but is primarily worth whatever someone is willing to pay for it. Gold doesn’t pay dividends. Gold doesn’t increase revenues. I would never recommend buying physical gold when it is trendy to do so.

Having said all that, I’m not at all against buying companies whose product is gold. One such company is Canadian-based Nevsun Resources.

Among other things, Nevsun Resources (stock symbol: NSU) owns a copper-gold-silver-zinc mine in Eritrea, East Africa. The Eritrean government owns 40% of the mine’s shares, 10% of which was mandated and 30% of which was purchased by the government in the market. In other words, the government has full reason to protect and encourage its investment.

Nevsun’s flagship Bisha mine just began production in January of this year, and is expected to have a thirteen-year mine life. Over those thirteen years it is expected to produce more than 800 million pounds of copper, 1 billion pounds of zinc, 1 million ounces of gold, and 11 million ounces of silver. Promising additional sources of these metals are also being explored in the region.

Despite a newly-completed, fully-functioning mine with enormous reserves, Nevsun shares are trading at only $6.05 CDN per share, giving it a low forward P/E of 7.4 and a great Current Ratio (debt safety measure) of 3.8. Surely there must be a downside, right? Of course there is!

Like many countries in Africa, Eritreans and their neighbors despise each other. The Canadian government’s official warning: "The political situation is highly instable, due to ongoing tension between Eritrea and neighbouring countries, and could become violent at any time.” This is in addition to the street crime, lack of reliable communications, and border area landmines common to this part of Africa. As a poignant example of the dangers, it is fitting to remember that during a geological mapping expedition in 2003, one of Nevsun’s geologists had his throat cut and his four-wheel drive vehicle set on fire.

Those who have studied economics will recall reading about “political risk” - the possibility of losing your investment due to negative political events. Eritrea is an example of political risk at its harshest.

For any investment in Nevsun Resources, the political and also ethical risks must be weighed against the ridiculously wonderful economic potential. Having considered all, I believe an investment in Nevsun Resources is indeed worth it. Supporting this idea is the fact that construction of the Bisha mine (which began in 2008) was completed on time, under budget, and without incident. The locals are apparently completely onside with the positive attributes (ex. non-military jobs, electricity and health care) that have resulted from Nevsun's presence.

As with all stocks I recommend on this site, I own Nevsun shares.

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"If you want to make peace with your enemy, you have to work with your enemy. Then he becomes your partner."

Nelson Mandela

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For more information, see:

Nevsun Resources Main Page

Nevsun Resources - Social Responsibility Page

US Gov't Eritrea Travel Warning

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Disclosure

Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

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China's Housing Bomb

keeps burning, though the fuse is getting shorter.



In an recent article (Year of the Hot Rabbit) I related the news that property purchase restrictions have been introduced in more than 40 of China’s major cities, in an effort to deflate their massive property bubbles.

In Beijing, for example, a property purchaser must prove residency status to purchase in that city, and is restricted to owning one primary residence and one additional property. The days where a non-resident investor could buy 20 or 30 properties is - at least according to the rules - over. For the moment, these rules seem to be working. In fact, they are working too well, and could potentially obliterate the bubble rather than deflate it slowly.

According to China Real Estate Index System (CREIS) statistics, home prices sank in most of China’s largest cities in March. For instance, prices in Shanghai dropped 7.6% in that month alone: an annualized rate of 91.2%! Most of this titanic drop occurred in the final week of March, where prices sank 5% (260% annualized). These large nationwide drops occurred despite very high volumes in “home trading” (their words, not mine).

Following the lead of real estate spokespersons throughout history, Zhu Zhongyi, Vice Secretary-General of the China Real Estate Association, said he predicts a “modest decline” in prices, adding that a large decline in real estate prices is “not quite possible.” He said this quite seriously, as if saying it seriously makes it true.

Nonetheless, not everyone has given up hope on one of the greatest booms in real estate history. Lin Lei, in charge of marketing for 21 Century Real Estate (not to be confused with Century 21, despite the libelously similar name), said that the market would drop only “if restriction policies were carried out strictly.” In other words, he hopes that if real estate prices continue to drop, government officials will simply ignore the new rules. Red "gift" envelopes are likely to fly off store shelves.

And the bubble continues...

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“Having a third party sign a mortgage loan contract on behalf of another person is a serious offense, and banks and financial institutions have to examine their own operations and investigate to find out who is responsible for such offenses.”

The China Banking Regulatory Commission, March 2011
(Showing that already, Chinese citizens are trying to get around new regulations that home buyers in a city must be residents of that city).
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For further information, see:
China's housing prices expected to drop, but not sharply, in second quarter