Economic Battleground A Fish Story

Part 1

By John P. Bott, II

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•Full service Houston-based brokerage firm founded in 1986

•Fixed income specialists•Success is built upon long-standing

client relationships based on trust, honesty, and quality service

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John P. Bott, II

•Chairman of Tri-Star Financial

•GP of Parallax Investments,

•GP& CIO of Parallax Capital Partners, LP Hedge fund and Portfolio Manager of Parallax Investments

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The talking points, ideas and images

for this presentation come

from the book “How An Economy Grows And Why It Crashes” by Peter

Schiff.

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Keynesian Economics vs. Austrian EconomicsKeynesian Austrian

John Maynard Keynes Carl Menger and Ludwig von Mises

Government Intervention Free Markets

Fiat Currency Gold Standard

Debt Savings

Consumption Investment

Bailouts Let Inefficient Companies Fail

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Keynesian Economics is generally the more popular

school of thought. Why?

An Idea Is Born7

• Able, Baker and Charlie lived alone on a desolate island with only fish to eat. One fish would feed one man for a day, however because they had no nets it took all day to catch that one fish by hand. Their entire island economy amounted to wake, fish, eat, sleep. Every fish that was caught was eaten. Nothing was saved, exchanged or leant.

• Able wonders, what if more fish could be caught in less time? Such a device could give him more time to make a home, make clothing and begin growing crops. But he would have to go a day without eating in order to make a net because there were no loans or savings he could rely on. At the end of the day Able had no fish to eat but he had his net. Through self-sacrifice if the net is successful he created capital.

•Underconsumption

•Risk taking

•Capital

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Economic Principles

An Idea Is Born9

• The next day Able caught two fish instead of the one Baker and Charlie each caught. By making the net Able has increased his productivity and can produce more goods than he needs to consume. Being able to catch a fish for tomorrow has creating savings on the island. Spare production is the life blood of a healthy economy. In most species economics really only boils down to day-to-day survival. They are constantly in search of food, water and shelter, which leaves little to no room for innovation and increases in capital.

Simplest definition of economics – the effort to maximize the availability of limited resources to

meet as many human demands as possible. Tools, capital and innovation are the keys to this equation.

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Economic Principles

Sharing The Wealth11

• Now Able only has to fish every other day in order to feed himself. Baker and Charlie ask to borrow the net on the days Able was not fishing. But Able has many concerns about loaning out his net. What if they break it? What if they don’t give it back? Why should I take the risk of losing my capital for no return?

• When Able shot down that idea Baker proposed another. Ok how about you loan us the extra fish you catch so that we can make our own nets and not starve? Then we will pay you back with the extra fish we catch from our nets?

• Able again had concerns. He was still putting up a lot of risk for no return. He was giving them his newly found savings and not getting anything back for it. Their nets might not even work and he would have given up his savings for nothing. He also risked that they would just sit on the beach all day rather than make their nets in order to pay him back. Again he said, it is not worth the risk for the return.

Fig

Sharing The Wealth12

• Finally Baker approached Able with a financial idea. For every fish you lend us we will pay you back two fish. Able liked that idea because he could easily double his fish and not do any additional work. But Able was also weighing his other options.▫ He could hold onto his fish for future use, which is the

most secure option. He would not have any losses but his savings also would not grow.

▫ He could eat his fish and consume his savings.▫ He could build a net rental company. He could use his

surplus fish to make 2 extra nets and charge ½ a fish a day rental.

• Able only has 5 options of what he can do with his surplus:▫ Save▫ Consume▫ Lend▫ Invest▫ Combination

• Able decides to loan the fish to Baker and Charlie. Now Baker and Charlie each have nets they did not have before.

Fig

•Demand is needed in order to spur economic growth, but is not what achieves it

•Only by increasing supply can people actually get more of what they demand

•Lenders benefits only if the borrower benefits

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Economic Principles

• Why not give the fish to Baker and Charlie?

• Evil Capitalist?

• Type of loans

▫Business

▫Consumption Loans

▫Emergency

• Can you really expand credit?

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Economic Principles

Economic Expansion15

• With Baker and Charlie’s successful net making complete they have now drastically increased the islands production. With each catching 2 fish per day they have more time for leisure and to make other innovations. Able made clothing, Baker collected coconuts and Charlie made the islands first hut. Baker devised another fish catching device which if successful could catch fish 24 hours a day and almost eliminate the need for fishing. In order for this project to succeed he would need help from Able and Charlie for an entire week. This would greatly reduce their savings and was a very large risk if it didn’t work.

• They decided the benefit was worth the risk and consumed their savings to work on the contraption. Success! The fish trapped caught 30 fish a week with only some small maintenance. With all of their extra time they built a second fish catcher and now had more fish than they had ever imagined.

• They began spending their time doing many things, Able was able to make enough clothing for himself and other islanders, Charlie created a surf board to make a fun leisure activity and Baker started working on a canoe to improve the islands transportation issues.

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Economic Principles

• Savings do not just allow for increased spending of time or money

• The Keynesian theory views savings as detrimental to an economy because it removes money from circulation and decreases spending.

• Why does government use spending to track the health of the economy?

Prosperity Loves Company17

• Word of all of the surfing, mass fishing and luxury clothes spread to other islands. Soon they were migrating to the island to live this luxurious life style. Some immigrants took over tending the mega fish catchers, others borrowed the extra fish to clear the land for farming and others took out loans for other trades. Society has become so good at producing food and tools that some people didn’t need to produce anything physical to survive. Thus the service sector was born.

• Chefs, hut builders, surf instructors, etc created a need for a currency system to pay these service providing people. Previously bartering was used but this is inefficient because a chef may want surfing lessons but a surf teacher may not want a professionally cooked fish meal. And how many meals are equal to a surf lesson anyway?

• Since everyone ate 1 fish a day the value of a fish was universal across the island and could serve as money. All wages and prices were based on fish and therefore was related to the real (or intrinsic) value of fish.

Prosperity Loves Company18

• Specialization increases production, which in turn raises living standards. Making a canoe takes most islanders 5 days; therefore we could consider it would cost them 10 fish if they were fishing with a net. One islander, Duffy, is better at carving canoes and can do it in 4 days. So he can split the difference and charge 9 fish then Duffy makes a profit of 1 fish and the buyer of the canoe saves 1 fish. Now suppose because he specializes in making canoes he comes up with an innovation allowing him to create a canoe in 2 days. This allows him to sell his canoe for $6 which give him a profit of $2 and a whopping $3 savings for the buyers. Win Win! A product which was once a luxury item is now available to more islanders.

Prosperity Loves Company19

• As the island society became more complex islanders began working for other people by trading their labor for wages. Each worker is free to choose from three options ▫ Underconsume to build a net ▫ Take out a business loan to buy a net ▫ Work for someone who already has a net

• Most workers choose the third option and specialize in something. Finnigan, a big burly man makes his fish by transporting fish from the fisherman to their market and he charges 2 fish a day for 100 fish moved. Murry took a business loan to build a fish cart where he can move 300 fish and charge 3 fish a day. Murray’s cheaper price and higher profit margin allow him to hire Finnigan who because of his strength can move 400 fish a day netting 4 fish a day. He pays Finnigan 3 fish (1 extra) and keeps one as profit towards making another cart and hiring more workers. Reduced freight costs will also bring down costs of fish for all islanders.

At aid and band

At aid and band last fast

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Economic Principles

•The vilification of deflation has led to governments enacting policies to push prices back up when deflation hits. But why?

• It’s not the spending but the production that counts!

•People do not need to be persuaded to spend. If society doesn’t want to buy something its either no good or too expensive.

Put It In The Vault21

• As the island became more prosperous peoples savings of fish increased. They had to keep their fish in their huts and robbers began stealing their hard earned savings. Many would like to invest in businesses but did not have the time or knowledge to pick a good business for investment.

• Max Goodbank, after years of protecting his own fish and seeing many neighbors’ fish stolen and burned by slick fish borrowers knew there had to be a better way to store savings. So he built a super strong building with the toughest guys on the island to guard his ‘bank’. But he didn’t want to just charge a storage fee, he could use the savings to loan out with interest returned going to pay his investors, his employees and keep the profits for himself. He started the bank for his own personal gain, but he also helped solve the islands problem of savings, credit and theft.

• Requirements▫ Keep his loan business profitable by carefully screening borrowers, collect interest and foreclose on

collateral when loans fail▫ Keep investors happy through regular interest payments▫ Attract more borrowers to keep they cycle going▫ Make decisions based on dollars and cents not on personal history, family relationship and emotions

Put It In The Vault22

• Lending Rate - lower for most secure borrowers and higher for those more questionable to repay the loan.

• Interest paid – the lending rate determines the interest paid; also longer term lessened the risk of a fish so the longer the term the higher the interest rate

• Large gains in productivity can result in large deposits of fish in the vault and not enough loans made to balance.▫ Lower the lending rates on loans in order to attract more borrowers. ▫ The bank is counting on the healthy economy to provide a fertile environment

for the new businesses they are loaning to (encourages borrowing)▫ Decrease the interest rate they will pay depositors (discourages savings)

Put It In The Vault23

• When savings dip (dangerous for an economy) things that encourage savings come into play▫ Goodbank is extra careful with loans because a default loan could be critical▫ Charges a higher rate to borrowers (discourages borrowing)▫ Offers higher interest rate to depositors (encourages savings)

• Interest rates that stabilize the market are created by▫ Banks desire for maximum returns on bank deposits▫ Banks fear of losing capital on risky investments▫ Individuals time preferences for consumption

• Some investors want higher returns than Max Goodbank was willing to offer. To make higher returns Manny Fund, a flamboyant fish tycoon, used his depositors funds to invest in more risky businesses which were more likely to fail but also had a higher return when they succeeded.

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Economic Principles

• When the Federal Reserve sets the federal funds rate the banks use this rate to determine the rate loans are made to individuals.

• Flaws with the Fed’s logic

• We have created a nation of spenders instead of a nation of savers and the Fed has a tendency to hold the rates too low for too long and not raise them high enough.

DisclaimerThe preceding presentation has been prepared for

informational purposes only. It does not constitute an offer, recommendation, or solicitation to buy or sell, nor is it an

official confirmation of terms. The above is based on information generally available to the public from sources

reasonably believed to be reliable. Note that for any collateralized mortgage product, (CMO), the yield and

average life will fluctuate depending on the actual rate at which mortgage holders prepay the mortgages underlying the CMO and changes in the current interest rates. Past performance is not indicative of future returns. Tri-Star

Financial makes no representations or warranties, express or implied as to the accuracy or completeness of the above information or that any returns indicated will be achieved.

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