American capitalism

Reinventing the deal

America’s startups are changing what it means to own a company


ATTENDING a baby-shower is not an obvious means of contributing to the vigour of American capitalism. But when thrown for one of 24 investors in Julia Jacobson’s small startup, NMRKT, which enables boutiques and small manufacturers to create appealing electronic marketplaces for their products in half an hour, it is vital. Since 2013 the company has amassed 150 clients and is now considering its fourth round of financing. Attending social events helps Ms Jacobson and her equivalent at other startups to take stock of what investors want. This enables them to confront an enduring inefficiency of the market: aligning the interests of investors and owners.

Investors’ opinions matter hugely to young firms like Ms Jacobson’s. Judgments abound and diverge on the value of a startup without the ability to test it in an open market. One investor pushed Ms Jacobson to think about a dreaded “down-round”, basing new fund-raising on a reduced valuation of the company. Others were eager to invest at a higher valuation or buy the company outright. By controlling the purse strings, investors have a great deal to say about the future growth of tiny endeavours like hers.

The personal touch may be useful but it is not the main way that startups stand apart from traditional firms. The most distinctive aspect of America’s vibrant startup sector is the way the ownership of companies is structured. A new breed of firms such as Uber, a taxi-hailing app, or Airbnb, a website that lists properties for short-term rental, is establishing a novel type of corporate arrangement. Investors, founders, managers and, often, employees have stakes that are delineated by carefully drawn contracts, rather than shares of the sort that trade on exchanges.

For people like Ms Jacobson these contractual arrangements provide an experience of ownership that sidesteps the concerns of public companies, by avoiding the contentious regulations and politics that surround big businesses. That should make for better-run firms if managers are fully focused on transforming a concept into a successful company.

Working this way is not easy. Conflicts between the parties arise all the time, over valuations and much else. But it allows such firms to reach pools of capital that an old-fashioned family business would not have got its hands on. Startups typically begin with savings, or money from family and friends, but then tap outside investors for seed funding through a variety of channels, including lawyers, accelerators (in essence, schools for startups) and other “angel” investors with cash to back founders with ideas. These increasingly include entrepreneurs who made money from their own startups and now invest in others. Indeed, the number of small deals has increased substantially in recent years (see chart 1).

Jerry Schlichter’s day-to-day experience untangling questions of ownership is less uplifting. Mr Schlichter is a lawyer who works not on heading off conflicts in small firms but on attempting to get better deals for investors in larger ones. He specialises in suing firms and financial institutions over their management of 401K pension accounts, through which a large number of Americans save for retirement. The money invested is automatically removed from pay cheques by employers, making workers, in the words of Leo Strine, chief justice of the Delaware Supreme Court, “forced capitalists”.

Contract and expand
As in Ms Jacobson’s world, there is a distinction between what it is to be an owner and an investor.

But unlike the contract-heavy world of the startup, that distinction is not well defined and indeed in many ways it is denied. The language used, and the law applied, seems to treat such forced capitalists as owners. But they lack almost all the rights and freedoms that privilege might normally afford.

Interests are misaligned along the entire chain. An employer running a 401K selects a committee which selects an investment provider which in turn selects fund managers who select companies whose—selected—board members appoint managers. Each step is swathed in regulation that, even if well-intentioned, is shaped by lobbyists to benefit one or other of the parties rather than the system as a whole.

This layer-cake provides ample scope for mischief, as Mr Schlichter’s business attests. But even if it were to operate without added complications, the different interests of the different layers would impose large and inescapable costs. Fees, such as those charged by mutual funds, are unavoidable at every level. More insidious is the “agency problem” that arises from conflicts of interest between people who provide money and all the parties through which it travels to and from investments.

Agency problems make the idea that a company is actually owned feel almost illusory. The link between the interests of the forced capitalists in 401Ks (and federal-government pension schemes that are broadly similar) and the management of the assets they purportedly own is, at best, compromised. The experience of owning a company no longer accords with what is normally meant by ownership.

The new model of capitalism practised by Ms Jacobson and thousands of other startups is an attempt to get around the inefficiencies and costs imposed by the agency problem. The allocation of rights in a public company is unarticulated and ambiguous. Attempts to fix this through demands for more transparency and regulatory changes, such as the Sarbanes-Oxley reforms introduced in the wake of the Enron scandal, may have helped in some ways but have added to the costs and complications by adding another level of bureaucracy and more red tape.

The fragmentation of ownership is an unintended consequence of the rise and development of the public company. In the 19th century, American limits on banks’ ability to lend restricted credit, but a strong legal system supported contractual agreements, notes Robert Wright of Augustana University in South Dakota. That enabled capital to be raised through direct public offerings, which were instrumental in the early development of American industry.

Over time, mechanisms emerged to trade these direct offerings in regional and national financial markets. Stockmarkets were not the only source of finance and the joint-stock company not the only model of ownership. But big public companies became the capitalist norm.

A result of this democratisation of ownership was its dilution and the loss of one of its components—control. Shareholders lost their grip on ownership and the collective strength to manage their agents, who ran companies. In 1932 Gardiner Means and Adolf Berle argued in “The Modern Corporation and Private Property” that the outcome was that companies became akin to sovereign entities, divorced from the influence of their “owners” by retained earnings that allowed managers to invest as they chose. As companies became ever larger and more powerful, government felt the need to constrain them.

Laws and regulations have increasingly limited what companies can do, including, most recently, the amount of profits they can return to shareholders. To help owners evaluate whether to buy or sell shares, companies are forced to disclose ever more of what they are up to, but the usefulness of this information is undermined by the layer-cake of agency issues.

Individuals have been net sellers of shares for decades; in their place institutions have expanded relentlessly. Financial institutions now hold in excess of 70% of the value of shares on America’s stock exchanges (see chart 2). The leaders include such familiar names as BlackRock, Vanguard and JPMorgan Chase.

Their size gives the biggest financial firms a great deal of influence. But just as managers of a company may not find their interests aligned with those of shareholders, so the managers of these investment firms may not share the interests of their investors. This creates what John Bogle, founder of Vanguard, calls a “double-agency” society in which the assets nominally owned by millions of individuals are in the hands of a small group of corporate and investment managers whose concerns may differ from those of the masses.

Surprisingly, given America’s litigious nature, few, if any, legal actions emerged in this area until 2006 when Mr Schlichter initiated a string of cases that accuse American companies of not acting in the best interest of their employees who participate in 401K plans. His first court victory came in 2012. This year he has won settlements from Boeing and Lockheed Martin. His extensive briefs provide a window into a complex world with layer upon layer of hidden costs and conflicting interests.

The disparity between the fees some institutions charge and their performance has recently received much attention, in part because, as an issue, it is both understandable and relatively transparent. Less easily quantified bones of contention may matter as much or more. For instance, a disparity between the pressure investment firms place on companies to perform in the short term and the time-horizon of investors, which may be much longer, has given rise to complaints voiced by Mr Bogle and others about a destructive “quarterly capitalism”. And Jamie Dimon, head of JPMorgan Chase, has criticised investment managers as “lazy capitalists” for farming out decision on crucial shareholder votes to consultancies. Those consultancies, working as they do for many investors, are open to conflicts of interest themselves.

No fund to be with
Agency issues are particularly acute in the fastest growing part of the money-management business: the index funds which now represent a third of all the money in mutual funds. They are popular because in an efficiently priced market they are hard to outperform and can be managed at almost no cost. But they do not make their own decisions about when to buy and sell but simply seek to match the holdings of the index, such as the S&P 500, that they track. This low-maintenance approach does not generally include employing stakes to intervene in company decision-making.

Large index managers such as Vanguard, BlackRock and State Street, along with Legal & General in Britain, are acutely aware of this issue. They are responding by trying, in the words of Vanguard’s Glenn Booraem, to be “passive investors but active owners”. Each firm has created a department to consider shareholder motions and management issues, and to interact with activist investors. It is unclear how this will work or what will be considered. As their power grows, so will controversy.

As huge funds ponder the agency problem, New York’s startups are trying to do away with it. In years gone by, entrepreneurs in small businesses would have existed in an informal state. Now the terms of ownership for investors, founders and employees are being defined ever more tightly almost at the time of the creation of new businesses. Clarifying issues of ownership along with innovations in finance is encouraging the availability of capital and expertise, once harder to come by for the small business.

Visit 85 Broad Street in downtown Manhattan to see this in action. Until 2009 it was the headquarters of Goldman Sachs and at the beating heart of American finance. WeWork, a firm that houses young companies, has now taken over six of its 30 floors to house 2,000 of what the firm likes to call its members. The stream of limousines with blacked-out windows that surrounded the building during Goldman’s tenure has thinned, replaced by swarms of people in an array of startup-wear, from tartan shirts to hoodies.

WeWork has 30,000 members in over 8,000 companies in 56 locations in 17 cities. A number of other co-working spaces exist, such as the Projective, which housed early incarnations of Stripe, an online-payment system, and Uber. Demand is booming for the desks that served as launching pads for firms that now flourish. Apartments in Williamsburg, Greenpoint, Bushwick and other newly fashionable neighbourhoods are filled with startups.

In at the startup
Startups with appealing ideas and driven employees but with no contacts, business expertise or capital can receive all those through institutions such as Techstars and Dreamit Ventures, which receive thousands of applications every year. The handful that are selected get money, advice on strategy, marketing, leadership, legal help and access to investors—all functions large firms either provide internally or through pricey consultancies. In return, the nurturers receive small equity stakes and, if they have chosen the right startups and given them the right boost, a reputation that will attract further promising corporate youngsters into their orbit.

New companies have always suffered because commercial banks cannot lend to firms lacking assets and revenues, nor can the firms pay the high fees and retainers demanded by traditional investment banks and law firms. But an elaborate system has begun to emerge for both. Some will be able to get initial capital at effectively no cost from crowdfunding sites like Kickstarter and Indiegogo. An enthusiastic reception can attract bigger investors. This was the route taken by Oculus VR, a virtual-reality startup acquired in 2014 by Facebook for $2 billion.

More common is the creation from the outset of a company that can receive more usual forms of investment, albeit in a novel way. Law firms with experience in the older startup culture of the west coast, such as Cooley and Gunderson Dettmer, do a lot of business setting up such things in New York; so, perhaps unsurprisingly, do a number of law firms that are startups themselves. Spencer Yee left a career at Simpson, Thacher & Bartlett, an established law firm, to work from home on Manhattan’s Lower East Side but has since moved to a co-working space.

Lawyers in the startup world play a vastly different role from those who advise—or sue—large companies. This is in part because of the nature of their clients; often tottering between failure and success they rely more heavily on outside advice. But it is also because lawyers, in the early stages, have replaced banks as the key intermediary for financing. But most importantly they negotiate directly with investors and physically maintain the “cap structure”—the all-important legal contract noting who owns what.

The ambiguities and obfuscation of public companies contrast sharply with the new corporate structures set out by legal contracts that make the rights of both investors and owners more explicit. These legal agreements tackle two fundamental difficulties. The first is the need to mitigate agency problems. This is handled by detailed agreements that include control issues, such as the allocation of board seats. Investors usually insist that management, and often employees, own large stakes to ensure their interests are aligned to the success of the venture.

The second difficulty concerns enabling investment in the absence of an important detail: a plausible valuation. Startups are pioneering a novel answer: an agreement at the early investment stages that enables an investor to buy a proportion of the venture, but at a price determined at a subsequent round of fund-raising, typically a year or two in the future.

The website of Wilson Sonsini, a California-based law firm, offers a 47-step process for generating such contracts; it is free to use as long as you tick a box promising not to claim Wilson Sonsini is your lawyer. The growth of Mr Yee’s tiny firm—he has closed six rounds of financing and two company sales—depends on the need to negotiate each term carefully.

Typically, after initial funding, a founder will retain as much as 60% of the company, with 10-20% reserved for employees and the rest for outside investors. But terms are fluid. Each subsequent round of financing usually dilutes the original stakes by a fifth. That may sound harsh but if the firm’s value is growing fast it can transform a large stake worth nothing into a small one worth a fortune.

The more appealing the idea and the more plausible their record as mangers, the better the terms founders can demand. Annie Lamont, a venture capitalist, points to a management team which, for its first startup, raised an initial $25m and held 10% of the equity by the time the venture was sold. Its most recent startup raised $160m and the team held 18.5% of the company when it was sold. Success lets you raise more money and negotiate a better deal in subsequent rounds of financing. There is no shortage of individuals and institutions straining for a chance to invest in some of the more successful but yet-to-go-public startups like Uber and Airbnb, which have done a series of fund-raising rounds on increasingly attractive terms.

This new way of doing business does not mean there is no role for conventional finance. For all the startups that promise they will never go public—Kickstarter is one—others are keen to do so at some point. Some hope to follow the trajectory of Facebook and Google—vast enterprises, led for a time by their founders, whose shares trade on public markets.

At the moment, however, successful businesses find raising money quick and easy through private means, which gives them no incentive to rush. Using technology to create a secondary market for shares might also means that the biggest no longer need to go public because the ability to extract liquidity from private firms is becoming much simpler. For now, at least, public markets are seen less as a place to raise money and create enterprises than as a mechanism to cash out if and when the time is right.

The flow of money into the startup world is, to some extent, for want of a better alternative. Low interest rates have undermined returns from “safe” investments and encouraged speculation. It would not be surprising if the current upheaval in equity markets curtailed this flow. A similar dampening will be felt if lots of the new firms fail, or if down-rounds become common. Even so, the new structure pioneered by startups is likely to endure as long as it serves as an effective response to the flaws of the public markets. Ms Jacobson is unlikely to have visited the last baby-shower in honour of an investor.

Up and Down Wall Street

50 Years Isn’t Too Long—To Borrow Cheaply

If the Brits see record demand for their 50-year bonds, why shouldn’t Uncle Sam go ultra-long?

By Randall W. Forsyth      

“Time passes and love fades.” So sums up IBM’s Watson supercomputer the themes of Bob Dylan’s lyrics in a current ad for Big Blue. “Sounds about right,” the 74-year-old Dylan responds with a wry smile.

It certainly strikes a chord with Baby Boomers, who also swore by Pete Townshend’s declaration that they hoped they’d die before they get old. Well, for those of us still around, too late for that. Especially since the song whence those lyrics come, “My Generation,” was actually released as a single 50 years ago next week.

Also in 1965, Frank Sinatra released the September of My Years album on the occasion of his 50th birthday. Most poignant was the single “It Was a Very Good Year,” a look back over Old Blue Eyes’ life up until then, which he compared to a vintage wine. And 50 years on, 2015 is the centenary of Sinatra’s birth.

Time indeed passes. Still, a half century seems an almost incomprehensibly long span, especially in terms of investments where long term is considered in terms of weeks or months and not years.

But the British government defied the prevailing short-term mindset by selling 50-year bonds Tuesday. For the offering of some 4.75 billion pounds ($7.35 billion) of the ultra-long gilts, the U.K. Debt Management Office received a record £21.9 billion in orders. The bonds with a 2.5% coupon were sold at a price of 98.403 to yield 2.557% at maturity in 2065.

For those with a truly long-term perspective, that compares with a low yield of 2.25% paid on U.K. perpetual consols in 1894. That was when sterling was backed by gold and Queen Victoria ruled the Empire on which the sun never set.

Great Britain’s example should be obvious. There is strong demand for ultra-long, high-quality assets from institutional investors that need to match very long-term liabilities. But, unlike the U.K. government, the U.S. Treasury has chosen not to take advantage of historically low interest rates to lock in borrowing costs for decades to come—as have corporations and American homeowners.

The U.S. Treasury has mulled issuance of 50-year bonds—as opposed to 30 years, its lengthiest maturity—but has resisted that option. In mid-2014, the Treasury was reported to have polled the so-called primary dealers—those with which the Federal Reserve conducts open-market operations and also are expected to bid at Treasury securities auctions—but wasn’t ready to pull the trigger. Which raises the question, if not now, when?

Speaking at the Barron’s Art of Successful Investing conference Monday, Jeffrey Gundlach, DoubleLine chief executive and chief investment officer, opined that bond yields “broadly bottomed” when the benchmark 10-year Treasury hit 1.38% in July 2012. Since that time, the 30-year bond also hit a record-low yield of 2.25% early this year and remains below 3%.

Not that Gundlach sees the sharp rise in yields predicted seemingly forever by bond bears. But several years down the line, some of the salubrious factors that have kept interest rates low will be reversing.

While every corporate treasurer has taken advantage of subdued borrowing costs to extend maturities, Gundlach said “hundreds of billions” of dollars of high-yield bonds, leveraged loans and investment-grade corporate bonds will be coming due around 2019. At the same time, the Fed’s holdings of Treasuries will begin to mature as well. That adds up to a massive supply of bonds for the market to absorb.

Starting around the same time, the federal deficit—which has shrunk substantially, to only about 2.5% of gross domestic product—will be become problematic again. As the retirement of those Baby Boomers accelerates, the Congressional Budget Office forecasts entitlement spending will shoot up in “hockey stick” fashion, he added. Indeed, entitlement spending and the budget could be the big issues of the 2020 election, Gundlach further opined.

Given that borrowing costs now hover near historic lows, investor demand for long-dated fixed-income assets is robust and borrowers are tapping the market to exploit attractive financing options rather than out of necessity, shouldn’t the U.S. Treasury do the same?

To be sure, Uncle Sam has been able to borrow recently for absolute zero by issuing short-term Treasury bills. Indeed, notes due in three years or less cost the government less than 1%. So why borrow 50 years if it will surely cost well north of 3%?

If Gundlach is right, locking in a sub-4% borrowing cost into the second half of the 21st century will look like a good deal for taxpayers, or more particularly, their children.

The Treasury, however, has been reluctant to innovate. During the 1980s, with long-term interest rates at historic highs, the department emphasized long-term, fixed-rate, non-callable debt. As a result, U.S. taxpayers locked in high borrowing costs. It’s not so long ago that the last 30-year bond with a double-digit coupon finally matured. Meanwhile, innovations such inflation-indexed and floating-rate notes weren’t introduced until much later.

By contrast, the U.K. Treasury embraced alternatives such as inflation-indexed bonds long before. It even issued floating-rate, U.S.-dollar-denominated securities—not long before the 1985 Plaza Accord paved the way for a lower greenback and interest rates.

Mexico also issued 100-year bonds—denominated in euros—earlier this year. That is indeed a vote of confidence that the Mexican government will be there to honor that obligation. As for the euro still being in existence in 2115, who knows? For that uncertainty, investors were rewarded with a 4.2% yield when the bonds were sold in April.

As IBM’s Watson observed of Dylan’s lyrics, time definitely passes. As it does, opportunities can slip away.
Rather than fighting over things such as the debt ceiling, Washington would do better to deal with its financing options now—while interest rates are at historic lows and before the real fiscal crunch begins later this decade.

Economic data

Funny numbers

America’s GDP statistics are becoming less reliable

IN THE coming week government statisticians in America and Britain will release their initial estimates of economic growth for the third quarter of the year. Markets will leap or sag, depending on the news. But investors are wrong to see the releases as a moment of statistical insight; they are merely the first round in a high-stakes game of “pin the tail on the donkey”.

Take January-March last year in America, when an icy winter kept shoppers at home. The intial estimate of GDP growth from the Bureau of Economic Analysis (BEA)—an annualised gain of 0.1%—was disappointing but not disastrous. The second estimate—a decline of 1%—made things looks bleaker. By the time the third and final estimate came in, at -2.9%, it was clear the quarter had been the worst since the depths of the financial crisis (see chart).

Statistics are revised for years, but their relevance soon fades. The BEA recently reviewed its data for 2012-14 and discovered that the American economy had grown more slowly than it had previously thought. At a stroke it removed $70 billion, equivalent to Sri Lanka’s entire output, from its figures. No one noticed. It is changes in the early estimates that move markets and influence policy.

Balancing reliability and timeliness is hard, however. The BEA releases its advance estimate about a month after the quarter has ended. By its own admission, it relies on incomplete data and projections of trends to meet this deadline. The second and third estimates follow at monthly intervals. Other offices operate more slowly: the Australian Bureau of Statistics waits three months before issuing its first numbers and does not release regular revisions.

A recent study by Jorrit Zwijnenburg of the OECD compares the size of GDP revisions for 18 rich countries between 1994 and 2013. It shows that whereas other agencies’ initial estimates were typically too low, the BEA’s tended to be too high. However, the average size of the BEA’s revisions was comfortably mid-table, larger than those in Canada and Spain, but smaller than in Finland, Japan and Norway.

Alarmingly, though, the BEA appears to have become less accurate of late. The average revision from the first to the third estimate was 0.6 percentage points in 1993-2013, but has risen to 1.3 points since the beginning of 2014. That may reflect greater volatility in the economy itself. In the past six quarters growth has bounced around, rising to 3.9% or more three times and falling below zero twice.

There may be other problems too. Between 2010 and 2014, first-quarter GDP averaged just 0.6%, a full two percentage points below the other quarters. The BEA has admitted that it may not have fully allowed for the seasonal effects of holidays and the weather. It has promised a “multi-pronged action plan” to fix the issue.

The BEA is not the only statistical agency mulling changes. In Britain, an independent review of the country’s economic statistics is under way, encompassing both the methodology behind data releases and their scheduling. Delaying releases to improve accuracy would almost certainly result in complaints from businesses and policymakers, however.

An alternative would be to release more data in the hope that the overall picture this provides will be more accurate, if fuzzier. In addition to GDP, for instance, the BEA also publishes figures on gross domestic income. GDI, like GDP, is a broad measure of economic activity, but it tracks income instead of expenditure. GDP and GDI rarely match exactly, as in theory they should: in January-March of this year, America’s GDP fell by 0.2% but GDI rose by 1.9%. The BEA’s solution is to publish an average of GDP and GDI along with the quarterly GDP data.

This average should reduce the influence of errors. It also gives investors another number to pore over.

The Latest Margin Debt Figures Send An Ominous Signal For Stocks

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What's more, the level of margin debt relative to the economy is now contracting from an all-time high. In other words, financial speculation as a percent of overall economic activity looks to have possibly peaked from one of the most extended levels we have ever witnessed.

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I like to look at this measure because it's been highly (negatively) correlated with forward 3-year returns in the stock market for at least the past 20 years or so. Right now, this measure forecasts a 45% decline over the coming three years.

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Based solely on these measures, stocks have already likely entered a major bear market that will not end before significant wealth destruction is accomplished. Obviously, this is only one measure, however, so it can't be relied upon on its own. Still, I believe investors would do well to respect the elevated risk in U.S. stocks right now and position themselves accordingly.

The Inevitable Intifada

Dominique Moisi

Yitzhak rabin images at ceremony in his honor.

PARIS – After the stones of the first Palestinian intifada, or uprising, came the human bombs of the second one. Now Palestinians have turned to knives. On the eve of the 20th anniversary of the assassination of Israeli Prime Minister Yitzhak Rabin, the last man to have embodied a real hope for peace, is a third intifada erupting?
To be sure, the recent knife attacks that have taken place across Israel and the West Bank, have apparently been carried out by “lone wolves.” But they echo a new wave of resistance by Palestinians that goes beyond physical assaults – reflected, for example, in the recent arson attack on a Jewish shrine in Nablus. With Hamas now calling explicitly for a third intifada, there is no denying the seriousness of the situation.
In fact, a new Palestinian uprising should come as no surprise. It is not as if anything has happened to break the Israeli-Palestinian cycle of fragile truces and violent explosions. The situation is not even frozen; it is deteriorating, owing to increasing political and religious radicalization on both sides. And yet, judging by the attitude of the international community, no one would know it.
A few days ago, I attended a small conference in Paris focused on the new challenges and changing balance of power in the Middle East. None of the main speakers made even a passing reference to the rising wave of violence in Israel. They were too busy discussing the crisis in Syria – which now poses a real threat of international escalation – as well as the diplomatic, strategic, and economic consequences of the nuclear agreement with Iran.
The reality is that world leaders have little energy left to dedicate to the seemingly interminable conflict between Israel and Palestine – a conflict that they have tried and failed to resolve innumerable times. And, indeed, there are serious doubts as to whether there is a viable alternative to today’s frail and sometimes violent status quo.
If Israel refused to leave the occupied territories in the past, how can it be expected to do so now, when the Islamic State is creeping toward the border? Doing so would raise massive new risks, in stark contrast to the brief spasms of violence that now punctuate Israel’s otherwise stable security situation.
And who on the Palestinian side would be willing, much less able, to engage in serious negotiations with Israel’s increasingly right-wing government? There are too many rifts and weaknesses on one side, and too powerful an illusion of strength on the other, for talks to yield anything of value.
In any case, even if they did resume talks, Israeli and Palestinian negotiators would not come to an agreement by themselves; and the international community is too divided, fatigued, and indifferent to impose a deal on them. If a consensus exists today, it is a negative one. With all parties resigned to the current situation, the dream of a “two-state solution” – based on the sound idea of exchanging territory for peace – is effectively dead.
Of course, the status quo is far less desirable for the Palestinians than for the Israelis. But they may have to do no more than bide their time, as their demographic advantage grows. Without a viable state of their own, Palestinians will progressively become the majority in the current “Jewish state.” The political, social, and religious implications of such a transformation would be far-reaching – and unacceptable to the Israelis.
The Israel-Palestine conflict has been so intractable because it is a clash between nationalisms.
If it becomes a clash between religions as well, compromise will become nearly impossible, even without further radicalization.
With the two-state solution off the table, and the establishment of a peaceful binational state unviable, some voices, mostly coming from the Israeli left, are now toying with a third idea: a confederation of Israelis, Palestinians, and Jordanians. Palestinians share a strong kinship with Jordanians, more than half of whom are of Palestinian origin. At the same time, Jordan is Israel’s closest partner in the region. These factors make Jordan seem to many like an ideal bridge between Israel and Palestine.
Of course, there remains serious mistrust among the parties. Nonetheless, advocates argue that the clear economic advantages of such a confederation – which would include a free-trade zone and joint economic ventures – could prove tempting enough to all sides to put the idea on more solid footing.
But the proposal, though certainly appealing, is not consistent with the realities of the Middle East today. Unlike European countries, which emerged from World War II so exhausted by conflict that they agreed to pool their sovereignty for the sake of peace, the countries of the Middle East are experiencing an ever-intensifying climate of nationalism, intolerance, and hatred.
By causing a continuous shift to the political right, Israel’s occupation policy has undermined the state’s political and ethical foundations, while turning Prime Minister Binyamin Netanyahu into a hostage of forces even more extreme than he is. Small minorities of Israeli extremists no longer hesitate to use violence to defend, if not impose, their views on others. And the radicalization that the occupation has helped to fuel on the Palestinian side is well documented.
But amid the rise of the Islamic State and the end of Iran’s international isolation, not to mention the Palestinian knife attacks, who can convince the Israelis that the biggest long-term threat they face is their own policy?
One cannot say with certainty that if Rabin had lived, peace between Israelis and Palestinians would have become a reality. But, as the region increasingly becomes trapped in a race to the abyss, the rare combination of courage, modesty, and lucidity that he embodied is badly needed.

Another Government Ponzi Scheme Starts to Crack - Do You Depend on It?

by Nick Giambruno

Government employees get to do a lot of things that would land an ordinary citizen in prison.

For example, it’s legal for them to threaten and commit offensive, rather than defensive, violence.

They can take property from others without their consent. They spy on anyone’s email and bank accounts whenever they please. They go into trillions of dollars in debt and then stick the unborn with the bill. They counterfeit the currency. They lie with misleading statistics and use accounting wizardry no business could get away. And this just scratches the surface…

The U.S. government also gets to run a special type of Ponzi scheme.

According to the Merriam-Webster dictionary a Ponzi scheme is:

[A]n investment swindle in which some early investors are paid off with money put up by later ones in order to encourage more and bigger risks.

In the private sector, people who run Ponzi schemes are rightly punished for their fraud. But when the government runs a Ponzi scheme, something very different happens.

It’s no secret that the Social Security system is effectively one giant Ponzi scheme.

Actually, I think it’s worse. That’s because the government uses force and the threat of force to coerce people into it. People don’t have the option to opt out. They either pay the tax for Social Security or someone with a gun will show up sooner or later. I imagine Bernie Madoff’s firm would have lasted a lot longer had he been able to operate this way.

This whole practice is particularly egregious for young people. They have no chance at collecting the future benefits the government has promised to them. But they’re hardly the only people that are going to be disappointed in the system, which will eventually break down.

There are simply too many people cashing out at the top and not enough people paying in… even with the government’s coercion. That’s a function of demographics, but also the economic reality in which there are fewer people with quality jobs for the government to sink its fangs into. I expect both of those trends to increase and strain the system.

Actually, it’s already starting to happen.

Recently, the government announced that there would be no Social Security benefit increase next year. That’s only happened twice before in the past 40 years.

You see, the government links Social Security benefit increases to their own measure of inflation. If the government says “no inflation” then there are no benefit increases. It’s like letting a student grade his own paper.

So it’s no surprise that the official definition of inflation is not reflective of the real increases in the costs of living most people feel.

Medical care costs are skyrocketing. Rent and food prices are reaching record highs in many areas. Electricity and utility costs are soaring. Taxes, of course, are going nowhere but up.

But the government says there’s no shred of inflation. In actuality, it amounts to a stealth decrease in benefits.

One reason for this is that they constantly change the way they calculate inflation so as to understate it. Free market analysts have long documented this sham. If you take a global view, it’s easy to see that fudging official inflation statistics is standard operating procedure for most governments.

Incidentally, governments and the financial media don’t even understand what inflation is in the first place.

To them, inflation means an increase in prices. But that is not at all how the word was originally used. Inflation initially meant an increase in the supply of money and nothing else. Rising prices were a consequent of inflation, not inflation itself.

It’s not being overly fussy to insist on the word’s proper usage. It’s actually an important distinction.

The perversion of its usage has only helped proponents of big government. To use “inflation” to mean a rise in prices confuses cause and effect. More importantly, it also deflects attention away from the real source of the problem…central bank money printing.

And that problem shows no signs of abating. In fact, I think the opposite is the case. The money printing is just getting started.

At least this is what we should prudently expect as long as the U.S. government needs to finance its astronomical spending, fueled by welfare and warfare policies.

As long as the government spends money, it will find some way to make you pay for it - either through direct taxation, money printing, or debt (which represents deferred taxation/money printing).

It’s as simple as that.

Like most other governments that get into financial trouble, I think they’ll opt for the easy option…money printing.

This has tremendous implications for your financial security. Central banks are playing with fire and are risking a currency catastrophe.

Most people have no idea what really happens when a currency collapses, let alone how to prepare…

Socialist Finds 14 Flaws in Capitalism and Seeks Help to Fix Them; Mish 14 Point Rebuttal

By: Mike Shedlock

Those looking for a big laugh can find one in Philip Kotler's Huffington Post article entitled Fix Capitalism - Join Us!

Kotler says "The economic system is failing to deliver rising living standards for most Americans.
Most of the gains from higher productivity are going to the rich. The middle class is getting smaller, the wages of the working class are lower in real terms than in the 1980s, and the really poor continue to constitute 15% of our citizens."
On his website FixCaptalism.Com Kotler notes 14 shortcomings of capitalism but says "there may be more".

  14 Alleged Shortcomings
  1. Proposes little or no solution to persistent poverty
  2. Generates a growing level of income inequality
  3. Fails to pay a living wage to billions of workers
  4. Not enough human jobs in the face of growing automation
  5. Doesn't charge businesses with the full social costs of their activities
  6. Exploits the environment and natural resources in the absence of regulation
  7. Creates business cycles and economic instability
  8. Emphasizes individualism and self-interest at the expense of community and the commons
  9. Encourages high consumer debt and leads to a growing financially-driven rather than producer-driven economy
  10. Lets politicians and business interests collaborate to subvert the economic interests of the majority of citizens
  11. Favors short-run profit planning over long-run investment planning
  12. Should have regulations regarding product quality, safety, truth in advertising, and anti-competitive behavior
  13. Tends to focus narrowly on GDP growth
  14. Needs to bring social values, well being and happiness into the market equation.

Kotler's list is so preposterous, I hardly know where to start. So let's just go down the list one by one. 

Mish 14 Point Rebuttal
  1. It is capitalism that is responsible for improved standards of living over the decades.
  2. The Fed and government bureaucrats, not capitalism is behind growing income inequality. That said, some degree of inequality is not only a good thing but a very necessary thing. People need to be rewarded for bringing new ideas to the market. Successful new ideas raise the standards of living of everyone, and income inequality creates the very incentive to market new ideas.
  3. The inflationary policies of central bank planners is the primary reason people do not make a "living wage".
  4. Throughout history people feared automation. Yet every technological advance created new jobs. One reason for the acceleration of job losses now are the very "living wage" proposals espoused by those like Kotler that price humans out of jobs.
  5. It's not the role of businesses, nor should it be, to be concerned with undefinable "social costs".
  6. It's not capitalism that fails to charge businesses for pollution costs, but rather governments.
  7. It is beyond idiotic to propose capitalism causes economic instability. It is governments and central banks that cause economic instability.
  8. With his concern about "community commons", one can easily see Kotler is a dyed-in-the-wool socialist. The problem with socialism is, it does not work and never will.
  9. Capitalism does not encourage high consumer debt. The Fed and central banks do, in the inane belief debt drives the economy.
  10. Capitalism does not let "politicians and business interests collaborate to subvert the economic interests of the majority of citizens". Rather corrupt politicians willing to do anything to get reelected are the problem.
  11. Capitalism does not favor short-run profit planning, but tax laws might.
  12. In point 12, Kotler argues in favor of "anti-competition". Competition is the very essence of improved products and rising standards of living.
  13. Capitalism does not focus on GDP at all. Misguided economists, politicians, and central banks do.
  14. Pray tell, whose "social values" do we need to consider? Mine? Yours, ISIS? Kotler's? Personally, I do not want some jackass or set of government jackasses, deciding what is socially right or wrong.
Save Us from Socialists!

Philip Kotler is the S.C. Johnson & Son Distinguished Professor of International Marketing at the Northwestern University Kellogg School of Management in Chicago.

Having completed my 14 point rebuttal, it is pretty clear Kotler has no idea what capitalism really is or the advances it has created. He attributes problems to capitalism that are in reality caused by central banks and government bureaucrats.

Kotler wants to "save capitalism from itself."

The irony is capitalism does indeed need to be saved, not from itself, but from economically illiterate socialists like Kotler.

Rather than fixing capitalism, I suggest we actually try capitalism in lieu of Fed foolishness, government foolishness, and socialist foolishness.