Jamie Dimon Steps Back from Harsh Crypto Comments - Another Indication that the Traditional Financial World's Hatred of Cryptoassets is Slowly Beginning to Thaw
.Jamie Dimon, CEO of JP Morgan Chase, stepped down from his comments he made in late 2017. In September of 2017, Dimon said that Bitcoin is a "fraud" and that he would fire people who worked for him if they traded in the cryptocurrency.
bitcoin is a fraud
Many in the cryptoasset and cryptocurrency community were unhappy about such remarks coming form a very senior person in the financial and banking world. Many in the financial world, including Goldman Sachs CEO Lloyd Blankfein, hesitated even during that time in 2017 to make extremely harsh criticism of Bitcoin and cryptocurrency. They didn't make extremely harsh criticisms, but they still criticized it.
Blankfein said in November of 2017 that "maybe Bitcoin is kind of a bubble" but he also said that "the list of things that are conventional today that I use every day that I thought would never make it is a very long list."
the list of things that are conventional today that I use every day that I thought would never make it is a very long list
On Tuesday, January 9, however, Jamie Dimon said that he regretted calling Bitcoin a fraud - he added that he feels the "blockchain is real." These statements were likely prompted by various things, including the rise in cryptocurrency and cryptoasset prices since Dimon made that original statement. However, it's likely that pressure on Wall St. to not be the pariah of the crypto world also had something to do with it. Finally, it's possible that Dimon simply took some time to learn more about cryptocurrency and cryptoassets - after that learning he might have a better opinion of the overall technology behind it.
the blockchain is real
While many want to look down upon Dimon for going back on his remarks or for not being on the mark back in 2017, this isn't a smart way to think about things. Incentives matter a lot - this is basic economics. Jamie Dimon is the CEO of one of the world's largest financial institutions - he is the epitome of the entrenched establishment in the global financial world. No one who is not naive should be surprised that such a person would make negative comments about something that could potentially disrupt his entire industry - an industry he devoted his life to. Instead, it's promising that he took a step toward setting things right.
There have been 22 recessions since the turn of the 20th century -- see the table below for a list of all of them (sourced from here) -- and we have currently experienced one of the longest expansion in US history as of early 2017 - by June 2017 we will have experienced an 8-year expansion (almost 96 months) - this is the third longest bull market in over 100 years. Clearly at some point within the next 2 to 5 years, we're going to experience a recession.
This article isn't about 2017 or this latest bull market, however - it's about the economy in general and the fact that things so far have been cyclical. Given the last century of markets, we can safely assume things will continue more or less the same way unless deep structural changes cause some sort of change. These types of changes might be:
Until those things happen, a prudent person would assume a recession will occur when a bull market has been going on for a long time.
Can you predict when a recession will happen? NO.
Can you predict how bad the recession will be? NO.
BUT, can you reasonably assume there will be one? YES.
Now, why are we writing this piece? Doesn't it seem obvious? Well, in fact, there are generally two schools of thought in personal finance and investing when it comes to recessions - neither of which are healthy for most people to adopt:
What's a better option? The better way is to simply observe things in light of historical data and without trying to quantify things. In this observation, you need to be incredibly humble of your lack of ability to really predict much but you still need to be mindful of the length of bull market runs. As the run gets longer - as Year 1 turns into Year 5 and then turns into Year 8 of a bull market you will want to
Most people will sell during a recession - usually after having purchased at the previous highs in a euphoric frenzy. You, however, should be sitting calmly with a pile of cash ready to buy excellent stocks at very low prices. In the meantime, you'll still want to be investing - you don't want to stop investing and wait for a recession because you can't rally predict when it will come and you don't want to spend years sitting around waiting without getting any market returns.
Be wary of those individuals who try to predict things too much, in fact, add a lot of risk to the equality. The risk comes from the false assurance they provide themselves or others - it is better to wisely understand your total lack of knowledge about something than to confidently go forward when ou really don't understand something. As Mark Twain so eloquently stated: "It ain't what you don't know that kills you, it's what you know for sure that just ain't so."
You can't predict when a recession will hit, but you can be sure that a recession will come at some point. Speculation on the exact timing is a fool's proposition, but indicators exist to indicate when the overall market is overvalued and when a recession is more likely. Preparation for a recession is wise and simply ignoring overall market valuations will cause you to (1) not be ready to take advantage of investing opportunities a recession presents and (2) be potentially exposed in troubling ways due to improper diversification. The below 3 strategies are excellent ways to prepare for a recession.
1. Start Piling Away Cash for Cheap Stock Purchases When the Recession Hits
Cash is dry powder to investors and without some set aside you simply won't be able to take advantage of a recession. Cash will allow you to buy good stocks at deep discounts when the market falls during a recession.
Do you notice how the first thing we're advocating in terms of recession preparation is something that will allow you to buy more stocks instead of something that is meant to protect you? Obviously, you want to be protected in severely adverse market circumstances as an investor, but the most important thing about a recession isn't what it does to your portfolio in the short term, but the potential it has to boost your portfolio in the long term. A recession allows you to buy a lot of good quality companies at deep discounts - sometimes you see a price to earnings (P/E) ratios of indices such as the S&P 500 can drop below 10, indicating an extremely undervalued market overall.
Without having cash piled up ready to toss into good companies -- it's key that you only buy good companies -- you will miss out on potentially outsized gains due to inevitable market recoveries. The great thing about recessions is that you don't even have to pick individual stocks - something that is not recommended for novice investors or those with low-risk tolerances. Purchasing indexes (eg. S&P 500 or the Dow Jones) via broad mutual funds or ETFs will allow you to at once diversify and benefit from future recoveries. Purchasing the Dow Jones at the bottom of the 2007/2008 Great Recession would have created a 300% + return over the course of a decade without having to take on the risks of owning single stocks or having to put in the effort to pick them.
When the market seems overvalued in terms of market P/E ratios, in terms of timeframe since the last recession, or in terms of high-quality research/opinions, it might be a good idea to slightly pull back on some of the more speculative investing you're doing to put aside cash. You'll want enough cash so that you can comfortably enter positions at lows and then continue buying more and more if markets continue to drop. This abundance of cash will allow you not to think about timing the market -- something that you will not be able to do -- but will instead allow for an aggressive dollar cost averaging strategy once things start to decline until things start to turn up again.
2. Properly Diversify Your Portfolio so it Can Withstand a Recession
To make your portfolio more resilient to recession declines you'll want to diversify across:
You don't want to hold just US firm and you don't want to hold firms only in a single industry (eg. tech). Instead, you want to hold a broad portfolio of high-quality firms from around the world and from different industries. Some regions and industries will be more resilient than others and this will affect your portfolio. additionally, some firms will go bankrupt in recessions - hopefully, you don't own any such firms because you've done proper due diligence but some things are very hard to predict. You'll want to not be tied to a single industry, a single location, or a single firm when the market turns downward so that a single disastrous event will not affect more than a small portion of your portfolio and so that you can survive as an investor into the recovery.
A great way to diversify is through the use of mutual funds and ETFs, but diversification is also achievable through simply building your own high-quality stock for experienced investors - moderately experienced investors should not try this (novice investors shouldn't even think about this).
3. Buy Protective Puts on the Market (ONLY FOR ADVANCED INVESTORS)
If you don't know what a protective put is, this section is not for you at all and you should skip tot he end of the article.
If you do know what a protective put is but wouldn't be properly considered an advanced or experienced investor, you can read this section but you should not engage in this activity because it could cause a needless drain on your portfolio and a false sense of security.
If you're an advanced investor, you probably already know this strategy, but we'll remind you again. Protective puts are simply put options - they are called protective because of the context they are being used in. You can buy such protective puts on the overall market via market proxy (eg. S&P 500) in order to profit from market declines.
One way to execute such as strategy is to buy monthly out-of-the-money puts on the market proxy via a mutual fund or more likely an ETF. These should be out-of-the-money because what you're buying here is a form of insurance in case the market drops significantly - you're not trying to speculate. Out-of-the-money puts will be worthless if the market goes up or doesn't move much but will increase in value in a significant market decline. You can buy them for a reasonable term - monthly, quarterly, yearly but shorter repetitive purchases might be better because you're less exposed to the option's time decay.
If you're invested in the stock market -- be it with an individual portfolio, through an IRA, through a robot-advisor, or through a 401k -- you should know that markets will decline, economies will suffer, and your portfolio value will decrease. You can try to create a situation for yourself where you won't be exposed to the volatility of the markets, but the only real way to do this is to not be invested in equities at all - by entering the markets you're implicitly accepting a certain amount of short-term volatility that could cause you to see your portfolio drop by quite a bit. It's how you handle this drop that determines your resiliency as an investor and, in the long-run, that determines whether or not you're a successful investor.
Recessions Will Occur and Markets Will Decline
First, it's key that you understand that market will decline - you can't hide from this unless you're not invested in equities. If you only hold cash or fixed income securities (eg. bonds), you can safely ignore market prices on equities. In the case of cash, you don't care about the market either way. In the case of bonds -- although bonds can of course rise and fall in value based on credit worthiness and interest rates -you generally are more concerned with the ability of the borrower (eg. sovereign government, municipality, or firm) to pay as the agreed-upon schedule. If you hold stocks, however, you are exposed to two key factors:
Exiting the Stock Market at a Macroeconomic Downturn is One of the Greatest Mistakes an Investor Can Make
Imagine you own your house outright in 2007 and then in 2008 through 2010 the housing market starts to decline as it did in the US. Would you sell your paid-for house after seeing a drop in real estate prices of 30% or more? Clearly, that would be idiotic if you didn't need the money for something specific. Why, then, do so many investors feel so inclined to sell their stocks after a market drop? Just as with a paid-for house, you own your stocks outright unless you bought them on margin (highly unlikely for most retail investors).
Adding a mortgage on the house makes the situation riskier and it is, therefore, more understandable that you might need to sell your house in an economic downturn (eg. income loss). However, people are still far more inclined to sell losing stock positions in a macroeconomic downturn than they are to sell their mortgaged house. This doesn't make any rational sense and it represents a fundamental flaw in the way most people approach their portfolios.
Now, if something fundamental changes - meaning one of the following:
THEN you can be justified in existing a position. In this case, you'll be exiting, not because of a macroeconomic decline, but because of a macroeconomic change to your world of the stock you're holding.
In other circumstances, however, existing a previously good position is just foolish and will lead you to underperform the market over the long term. Additionally, you'll be effectively shooting yourself in the foot - you will be purposely selling off at the worst possible time instead of holding out a bit for a far better market scenario where a more fair value can be obtained for your investing.
Play Mind Games With Yourself to Prepare for the Inevitable Market Decline
One of the greatest ways to prepare for the inevitable market collapse (if you still think that this won't happen you need to go back and diligently study investing history before you proceed any further into the markets) is not use the same tactic elite athletes use to prepare themselves for competition - mental visualizations of game day with a focus on the desired outcome and the challenges that will likely be faced.
Elite athletes focus on the win, but they also visualize and understand the pain and the suffering that game day will likely entail. Instead of being optimistically naive, they in advance fully understand how difficult game day will be, they accept that difficulty fully, and they commit to persevering in spite of it.
Applying that same theory to your investing life you might want to visualise the goals you want to achieve (eg. the return you want to obtain over time or the number you want to hit in your portfolio) but you also will want to sit down and imagine how a 10% market drop will feel, how a 25% market drop will feel, and how a 50% market drop will feel.
Typically a 10% market decline will occur once every couple of years, a 25% market decline will occur once every decade or two, and a 50% market decline will occur up to a few times in your investing life. Failing to prepare for this almost inevitable circumstance could cause you to sell at a 50% market drop - clearly a very unpleasant outcome if waiting just a few years would allow you to recover all of your gains as has been shown via a study of US stock market history.
When you're playing these mind games with yourself it's key to really visualize the scenario and get that negative feeling in your gut you would get on the morning fo the crash. You will likely not have as intense emotions as you would actually staring at your dropped portfolio, but you should definitely feel that nasty feeling in your stomach. If no feeling accompanies this exercise you're doing it wrong and you should continue doing it over time until you really get that unpleasant gut feeling.
Once you have that gut feeling, let it wash over you and don't try to make it go away as humans tend to do with all emotions. Let the feelings stay with you and explore it a bit. See what that feeling is telling you to do. Realize how your emotions are ruling over you instead of anything rational - this is dangerous because investing is very unnatural to human beings and only rationality will help you do well. Tell yourself
It's important to not underestimate the power of such mental exercises. It's easy to dismiss this and argues that imagining things during a bull market won't help you when things really go bad and you actually are sitting in front of your broker's website looking at a number that is 50% less than it was yesterday. Of course, the two things aren't the same, but the power of visualizing is far greater than meets the eye at first. A lot of mental resilience to making foolish moves can be built up using the exercise above and be doing it once a quarter will over time create a healthy mental discipline against acting like a crazy person when things really go bad int he stock market.
Dow Jones Industrial Average Components Over the Decades: A view of the changing face of enterprise in the United States
The Dow Jones Industrial Average is one of the longest-running stock market indexes in the world. Its components have changed since inception - they've changed 51 times since the inception of the index by Charles Dow.
Looking at the Dow Jones Industrial Average's (or simply the Dow's) components over time allows us to see how American business (and the world in general) has changed over the last century and a half.
We won't go into all 51 component changes here -- you can find them here if you'd like -- but we will focus on the most interest and relevant ones and discuss them in a bit more depth than you can find elsewhere on the internet. Instead of giving a cursory overview, we'll dig a bit deeper to see what underlying changes were the root causes of the changes and in the process, we'll gain the following benefits:
The Dow on July 3, 1884 (precursor)
The initial Dow (which wasn't properly the Dow Jones Industrial Average but was instead a creation of Dow called the Dow Transportation Average) consisted of the following:
As the original "Transportation Average" name should indicate, the original Dow components were heavily focused on transportation. We can clearly see that there are a lot of railroad companies represented in the initial Dow mix. In the 1880s, railroads had been around for a few decades, but they still represented the new and happening industry - similar to how technology is today fast growing and focused on thing in business even though computers have been around for a few decades already. Railroads represented Manifest Destiny and a new industrial era where lots of money was being made in the business of moving things from one place to another.
We see that 9 out of the initial 11 firms represented in the 1884 Dow were railroad companies - that's a very large representation and should clearly indicate the importance of transportation generally (and railroads specifically) in the pre-20th Century US economy. As the country moved westward and as more and more goods were in need of rapid transportation in the post-Industrial Revolution era, railroads were able to extract very healthy nominal and real profits.
Basically, a discussion of the early years of the Dow inherently is a discussion of railroads. The first public railways opened up in the US in 1830 using steam engine - by the 1880s, technology had improved as did ridership and a need for transporting goods in a new type of economy where self-reliance was beginning to give way to mass consumption and production.
The equivalent today in terms of industry would be seeing all tech firms dominating the Dow Jones Industrial Average - imagine seeing the Dow today composed of the likes of Google, Facebook, Microsoft, Oracle, Salesforce, Twitter, Apple, HP, Dell, Cisco, etc. An observer would think that the US economy was heavily dominated by tech. Luckily for us, today's economy is far more diverse than the industrial and transportation economy of the late 19th century - we have large industrial firms, firms involved in chemicals, firms involved in telecommunications, firms producing basic products, firms that primarily provide services (eg. consulting firms), etc. Today's economy is as diverse as any has been in human history.
May 26, 1896 (the first proper Dow Jones Industrial Average)
The first proper (non-transportation only) Dow Jones Industrial included the following firms:
This was the first real Dow Jones Industrial Average. Here we see many of the railroad companies replaced - only two of the firms (the Northern American Company and the Tennessee Coal, Iron and Railroad Company) are firms heavily involved in transportation.
We can see that the list has now moved away from transportation and is focused important necessities for late 19th Century America. Things like cotton, oil, tobacco, cattle feed, coal, iron, leather and rubber are all represented - these basic necessities were key to a life that was moving away from self-reliance on farms and into a mass-produce economy that required energy (in the form of gas, oil, and coal), straps, linens and other fabrics, heavy metal, electricity, etc.
If the Dow had existed 500 years prior in the Middle Ages, things like electricity, leather, cotton, coal, and rubber would not be there - most of life would consist of cattle feed and other types of feed.
Another interesting thing to note is that the names of these firms are quite basic - they are literally are names of what the company produces. Can there be any doubt that the Tennessee Coal, Iron, and Railroad Company is involved in the production of coal, iron, and railroads? Would you be surprised to find out that the United States Rubber Company produces rubber? These firms were the first of their kind - they are representations of commerce and big business in an era that had only recently exited the darkness of the Middle Ages via the Renaissance. The unique names we see that not only don't represent the firm's products or services but sometimes are not even traditional words that humans have used are only possible in a world that understands what firms are - world filled with people used to branding, buying things from companies instead of from friends or family, and have a lot of trust in business and capitalism in general. The ability of firms to market and brand themselves in order to educate the public about their products and services allows firms today to eschew the basic naming conventions of the past and to use innovative and obscure names such as Twitter or Exxon. A Twitter or an Exxon would be strange in the early years of the Dow - no one would have any idea what these firms produced. Without the ability to create an image of the firm through the use of advertising (which requires a lot - print ads, TV, radio, the internet, etc.), firms would who used strange names would find themselves at a deep disadvantage in the past. It was a far smarter idea to make sure people knew what your business did just by reading the name.
October 1, 1928 (Dow expanded to 30 firms)
As the index expanded to contain 30 firms (the size it's been ever since), the Dow was comprised of the following firms:
Here, the index was expanded to the 30 firms we have today. This was an interesting time in the history of the United States and especially its economic history. The Roaring Twenties were coming to a close and little did anyone knows that the Great Depression was right around the corner.
Here we can see the that we have a few automotive firms represented - we've got General Motors, American Car, Mack Trucks, and Nash Motors. Car companies have come on the market and are now some of the largest firms in the country. A car firm at this time would be similar to seeing the edition of technology and internet firms in the 2010s and 2020s - the firms came up over a few decades and finally took their place among the largest in the US by playing in a new and important industry.
We see that the names here are still those basic names that hearken back to an era before sophisticated marketing and advertising and before readily available means of communicated such as radio, TV, and mass color print.
July 3, 1956
This is the first Dow changes after the US entered WWII - the previous Dow adjustment occurred on March 4, 1939. Since we last saw the Dow above (1928), the US had plunged into a decade-long economic downturn called the Great Depression, entered WWII (which helped it recover), and saw droves of new babies being born in post-war America (the Baby Boom). Let's see how the Dow has been affected:
Here in 1956, we can say that we are in a totally different America. The last time we checked in was in 1928 - almost 30 years later the Depression-era youths fought a war abroad and came back home to have a ton of babies. Although key staples remain in the Dow, we can see the addition of many new firms.
We can see a big variety of firms represented here - car companies, companies producing basic materials, food-related companies, retailers, energy firms, and even a photography company in the form of Kodak. In 1950s America, technology has advanced far enough to make consumer products (photography, cars, retailing, toiletries, etc.) major parts of the economy. A Procter & Gamble wouldn't exist just 50 years prior - people didn't have the disposable incomes to shower often and use toiletries nor did they have a desire to in their mostly self-reliant forms of living. In 1950s America, a firm producing household necessities would make a lot of sense. In the same light, in 1950s America, big retailers, big tobacco, and big car companies all make sense - our conception of that era is of one that has now moved way past the agrarian roots of the United States and now is in the realm of post-WWII technology and sophistication. If you had told the people living through the Great Depression that a photography firm (Kodak) would be one of the biggest in the country, they would have scoffed and not understood why - photography was a luxury and the technology was not all there yet. The same can be said about many things represented above.
August 9, 1976
Jumping forward another twenty years, let's see where this journey has brought us:
In these 20 years, surprisingly little has changed. Only a 5 firms were replaced since the last time we checked in in 1956. By comparison, there over 30 changes from 1928 to 1956 (some back and forth). What you have in this period is a stable period of growth, some merging of firms, and a movement away from those classic self-descriptive names to the more unusual firm names we know of today.
Look above to see the firms that remained in the Dow but changed their names - International Nickel became Inco, Texas Incorporated became Texaco, Swift became Esemar, and Standard Oil of NJ became Exxon. These movements are away from names that clearly state what the firm produces to more esoteric and strange names that don't provide any indication whatsoever about the firm - clearly a reliance on marketing, adverting, and branding is required in order to educate the public and create a mental picture of the firm when such strange names are used. This is possible because we are no in a world of color television, radio, print magazines, and other forms of advertising.
This trend has continued today where almost all new and interesting firms have absolutely strange names that give zero indication of what the firm actually does - names such as Twitter, Facebook, Yelp, Apple, etc. If you took a person from 1850 and asked him to whet he or she tough a firm named Standard Oil or a firm named American Can do, he or she would very likely guess correctly. If you asked the same person to describe what he or she thought a firm like Exxon does (bear in mind this is Standard Oil with a name change), they would have no clue and rightly so because Exxon is a totally made up term. As stated above, such strange names can only work in a modern world filled with modern telecommunication systems and a general populace that is receptive to advertising and marketing.
March 17, 1997
About two more decades after our last stop, a lot has happened - the Cold War is over and we're at the apex of the 1990s economic boom. Here are the Dow components now:
Here we can see more name changes (eg. Chevron and AT&T), continuing the overall movement away from the simple names to the more strange and esoteric ones that require branding.
We can also see that some of the old components (eg. AT&T, Chevron, Exxon, Union Carbide, General Electric, General Motors, Minnesota Mining, Sears, and Union Carbide) still here - times have changed but these good firms have endured for a variety of reasons. Some endured because of good management (eg. General Electric), some because of early entry and the existence of various barriers to entry (eg. General Motors), and many because of luck.
It's interesting that even though we're in the heart of the proliferation of personal computing and the internet, there are few technology firms. This makes quite a bit of sense - it takes time for these new firms to grow to a size large enough that would put them in the Dow (the top 30 firms in the US). Firms like Apple, Cisco, Microsoft, and others might have been making big moves during this era, but they were still growing. IBM and HP are present because they were around longer - IBM was around for almost a century at this time.
November 1, 1999
About two more decades after our last stop, a lot has happened - the Cold War is over and we're at the apex of the 1990s economic boom. Here are the Dow components now:
With the addition of Intel, Microsoft, and SBC, we can see that in just about 2 years, the Dow has taken on some of the tech firms. These firms have grown in market cap by now (due in part to what would later be called the Tech Bubble) and had market caps large enough to allow placement within the Dow. The Dow here contains many old stalwarts but is filled with new firms that were either started within the last few decades or came to major prominence recently.
March 19, 2015
The last Dow Jones Industrial Average change happened in early 2015 - here is the current makeup of the Dow:
In today's Dow, we see the familiar firms that make up the market share and the mind share of the US economy today. We see an almost complete transition away from the simple self-descriptive business names to esoteric and strange names that require branding - compare this final list with the first list. Firms like National Lead, Tennessee Coal, United States Leather, and others are so clear in their descriptions while firms like Visa, Pfizer, Nike, and Apple would be totally obscure if not for branding and advertising.
Another interesting thing is the rise of big pharmaceutical and healthcare firms - firms such as Merck, Pfizer, and UnitedHealth have come to major prominence due to various large-scale factors. These factors include an aging population (Baby Boomers), a more wealthy economy that can spend more on healthcare, and the success of pharmaceutical research in producing new, innovative, and expensive drugs.
We also see the tech firms playing a bigger role - Cisco, Apple, Microsoft, and Verizon are all part of the overall technology economy, helping to provide hardware, software, and telecommunication services.
The fallacy of composition is a fundamental fallacy of reasoning or thinking and it arises when we infer that just because something is true of some part of a whole (or every part of a whole), it is also true of the whole.
Put another way, the fallacy of composition arises when we infer that something is true of the whole just because it is true of some part (or every part) of the whole.
If the above semi-formal definition(s) are confusing, let us try to put it into even simpler terms. The fallacy of composition tells us that just because something is true of some part of something (or even every part of something), we cannot then automatically infer that the same thing is true of the entire thing.
The fallacy of composition is a common fallacy in various spheres including relatively primitive scientific endeavors, political and voting theory, and economics. In fact, there are many interesting examples of the fallacy of composition in economics.
Here are a few examples of the fallacy of composition economics:
The fallacy of composition is more than just something that is interesting to think about - the fallacy of composition is a real error in thinking that has caused mistakes and misunderstandings throughout history. By understanding the nature of the fallacy and giving it a name, we might be able to be on guard against future fallacious and illogical thinking and be able to lead smarter lives both as individuals and as a society. For example, if we don't understand as a society that extreme saving might not do for society as a whole what it does for an individual super-saver's pocketbook, we might be able to create better policies and incentives - the kind of policies and incentives that benefit the whole society.
Scarcity is a fundmental principle in economics that lies at the bedrock of the elegant social science. Scarcity in economics refers to the limitations inherent in our world and universe. We live in a scarce world. There are finite amounts of all of the resources humans find useful. There's a finite amount of timber, coal, oil, land, cattle, chickens, iron ore, land, etc. Additionally, humans have a finite amount of time in the day, in the year, and in their lives.
Because of scarcity, choices must always be made regarding what to produce, what to spend our time on, what to spend our energy on, and what to spend our money on. There are alternative uses to land, resources, capital, and time. All of the possible uses cannot come to fruition because there is not enough land, resources, capital, and time for them. It is the role of economics and economists to assist with finding the best uses for the scarce resources, the best uses generally meaning those uses which create the most utility.
Economics, at its core, is about answering three elegant but important questions. They lie at the foundation of the subject and must be answered by every nation on Earth. Read the lengthy article to find out what the three questions are and to get a good perspective on what the core of economics is about.
Do you really know what economics is about?
Unless you've taken an economics course (and maybe even if you have), you probably have the wrong idea of what economics is. Economics is obviously a very complicated and broad field of study, but what is at the most primal core of economics? Throughout my conversations with people unfamiliar with the subject, I have realized that people generally have a misconception of what economics really is at its most fundamental core. Some people seem to think of it as something close to accounting. Other people seem to think of it as close to business or entrepreneurship. Others still think of economics as having something to do with the political realm. Although they are all moving in the right direction with these definitions, they are pretty much all wrong.
Economics might touch on accounting, business, entrepreneurship, politics, and many other human endeavors, but it does so only incidentally. It touches accounting because accounting is the language of finance and economic sometimes deals with things related to finance. It touches business and entrepreneurship because firms and individuals act in rational ways that economists attempt to describe. It touches political science because economists attempt to answer important questions about how societies organize themselves to produce things. It touches other things also, but only incidentally. Economics, narrowly defined, is actually something quite different than what most people believe it to be - something very different than accounting, business, or politics. Economics, at its most basic core, is the pursuit of something much simpler - it is an attempt to answer just three basic questions
Question 1: What to produce?
Question 2: For whom to produce it?
Question 3: How to produce it?
These three questions are more macro-oriented (economics can be divided into macroeconomics and microeconomics). All societies and all nations must answer these three questions.
Why do they have to be answered?
Why do all nations have to answer these questions? Because we live in a world of scarcity and we want to efficiently allocate the scarce resources that exist. In a world of unlimited resources without any scarcity of any kind, these three questions wouldn't make sense because no choice would need to be made - everything could be produced for everyone. In a world of scarcity, however, a choice must be made, either implicitly or explicitly. By its very nature, the scarcity in our world imposes constraints upon our actions and forces an answer to those three questions. But that might be a bit too philosophical for our purposes here, so we'll continue.
Are you surprised?
Looking at those questions, you might be puzzled. If this isn't what you thought economics was about that's ok. Economics is obviously a very broad field of study and goes way beyond those three questions, but pretty much everything that economics is and does emanates from an attempt to answer those three questions. That is why I love economics so much and that is why I am so intrigued by it.
Now, Let's Dig Deeper Into the Questions
1. What is to be produced
Every society must answer this question and has answered this question since antiquity. To sustain life, water and food are required. Some for of shelter is also a primary necessity for life and safety. Society has managed to move beyond the basic necessities of life and much of the world (specifically the Western world) lives in a state of such affluence that past generations would not even be able to comprehend our lifestyles.
A society, whether that society is a small tribe in our distant past or a modern nation, must decide what is to be produced. Economics looks at this question at both a macro and a micro level, but we'll focus on the macro level here for the purposes of explanation.
Asking, "What to produce?" might sound a bit confusing, but it shouldn't be. The question is simple and straightforward. Economics literally is concerned with the final mix of goods and services produced by a society during a certain time interval (usually a year). The question's answer is also easy to see or observe. You just have to look at the final mix of goods and services produced by a society. For example, we can observe the final mix of goods and services produced in the United States in a given year. Obviously there are a lot of things produced and it would be extremely difficult (if not impossible) to count or list them all, but that isn't a problem and that isn't a concern. The point isn't to count or list the goods or services produced. We can understand in our mind that every year a certain mix of goods and services is produced in the United States and we can understand that this mix of goods and services is society's answer to the question of "What to produce?"
Here are a few examples that might help illustrate the meaning of the question:
2. For whom to produce it?
The next logical question after it is determined (somehow) what is to be produced, is "for who?" This makes a lot of sense. After all, everything produced is for the benefit of the society. Whenever anyone makes something, it is either to benefit himself or herself directly, or it is to obtain income by selling that product or service to another. The only way to do that is to provide some sort of value to the other. Obviously, this is a bit idealistic, because sometimes useless things cloaked in a lot of marketing are sold to unsuspecting buyers, but we won't go down that path in this piece.
Here are a few examples that might better illustrate the question:
3. How to produce it?
Finally, once we decide what to produce and for whom, we should think about how to produce it. This question might not seem as important as the other two at first glance, but it is actually very important. How we produce something reflects our beliefs and values. It also downstaters our society's technological abilities.
Here are a few examples to better illustrate what this question is getting at:
But wait! - There's a fourth question!
The above 3 questions really are the main questions that economics attempts to answer, but in answering those 3 questions, a fourth question organically arises:
Question 4: Who decides?
This question is a very interesting one to answer. It makes sense to ask it, doesn't it? We're answering three questions. So WHO should answer them? Who should decide what to produce, for whom to produce it, and how to produce it? Question 4 has been answered in man different ways throughout history. Let's examine two of the main ways we can answer this question:
Capitalism - We all Decide (Sort of)
In capitalism, the entire society decides how to answer the three economic questions using a magical mechanism called prices operating in what should be a free or laissez-faire market. Prices cause the invisible hand (an important economic concept first articulated by economist Adam Smith in the Wealth of Nations) to direct the flow of resources and energy towards certain things and away from others. In a properly working society or nation, the invisible hand guides the economy toward the optimal mix of goods and services and allocates those goods and services in an optimal way among the members of the society or nation. Now, what does optimal really mean? That's beyond the scope of this piece of writing, but it is safe to say that, generally, capitalism does work in making things pretty good for most people.
The United States, Wester Europe, and many other modern countries are capitalist or quasi-capitalist societies where prices guide the flow of resources and a free-market system prevails. Prices are a pretty magical thing when you think about it. Prices are sort of like a voting machine, expect you to get more votes if you have more money. Though the price function in a free market, resources are somehow magically allocated to their most efficient use without the participants of the economy having to do much more than observe what is happening in front of them and making rational decisions based on those observations. If a certain product or service has a very high price and profit margin, you might be induced to produce some of that product or service yourself. It's as if the economy magically communicates to producers what the society wants (Of course a society can't "want" anything in the proper sense of the word because a society isn't a sentient being, but I hope you understand what I mean). No planning or discussion or analysis is required in such a free-market laissez-faire society, only observing things and acting in a rationally self-interested way. It's pretty cool in my opinion, although drawbacks, inefficiencies, and inequities do exist in a free-market capitalist society.
A command economy is where a central governmental body answers the three basic economic questions. The former Soviet Union is an excellent example of a command economy. In the Soviet Union, private ownership of businesses didn't exist and economic participants could not decide for themselves what goods or services to produce. Everyone was a government worker and a private sector didn't really exist. You couldn't observe extremely high prices for a certain type of product or service, for example, and then decide to open up shop and produce that product or service yourself. Instead of the messy capitalist system where prices give us information about what to do, the government body decides most things in a much more formalized approach in a command economy. The government body decides how much bread to produce, how many cars to produce, and how to produce them all. It also decides who gets them. In reality, a command economy is extremely difficult to implement well because of the nature of knowledge and, specifically, of the knowledge that is required to answer the three economic questions in the most efficient and optimal ways. The knowledge needed to answer the three questions is generally time-specific and localized. Those who have the most knowledge of what needs to happen at a particular moment (the participants of the economy) are not the ones making the decisions in a command econnomy. Instead, a government body that is far-remvoed makes the decisions, but it is almost impossible for that government body to have as much knowledge as the colelctive "mind" of the paritcipatns fo the economy. Look for articles on this later, as this is a very interesting but somewhat esoteric and difficult concept.
A Word of Caution About Capitalism vs. Command Economy
It's importnat to understnad that what we presented above was a very basic description of capitalism and command systems. Additionally, it's importnat to realize that no nation fits a mold perfectly. Most nations that are capitalist, for example, have asepcts of a comand system (eg. some socialism with a generally capitalist framework). Sometimes command economies have capitalist pockets in place (eg. relatively sophisticated black markets where a more capitalist structure prevails).
Other Ways to Answer Question 4?
Those are the two main ways the questions can be answered, but let's examine a few other possibilities for answering Question 4 (Who decides?):
Answer Question 1 (What to produce?) via voting?
It's possible to imagine everyone voting on how to answer the three economic questions, but that would obviously be unfeasible in a complex economy such as that of the United States.
Answer Question 2 (For whom to produce it?) with an essay-writing contest?
Doesn't that sound like a good and fair way to decide who gets what? Everyone writes and essay arguing why they need and deserve something. It might work in a utopia, but that's obviously not feasible in the world we live for many reasons, the main one being that it would take an enormous amount of time to process and read the essays. That's the beautify of prices and a open and free economy - no essay contest is needed! With the price function, there doesn't have to be anything centralized deciding who gets what. Instead, things somehow work themselves out based on the forces of supply and demand. It's a pretty incredible and elegant thing in my opinion, but it's not very easy to deeply understand how profound the price function in a free-market economy really is without studying it and thinking about it for a long time.
Answer all three economic questions yourself?
What does that even mean? How can only YOU decide the answers to those questions? Well, if we lived in a world where each person produced every single thing for themselves, you would decide what to produce in your own little world (Question 1) and how to produce it (Question 3). Question 2 (For whom...) wouldn't need to be answered in this self-sufficient world because everything would be for you. The problem with this is that if you had to produce everything for yourself (total self-sufficiency), you would be in poverty along with everyone else in the world. There would be no specialization, trade, or economies of scale and everyone would live as humans lived many thousands of years ago - in destitute poverty. Humanity used to live in a much more self-sufficient way, but it was never totally self-sufficient in my opinion. Some trade and some cooperation did occur even in the distant past.
This was a long piece on what started out as three simple questions. The thing is, they are not that simple. They might sound simple, but they are incredibly deep and it takes years of study and thinking to truly understand how profound the questions are and how beautifully economics attempts to answer them. That's one of the many reasons I love economics.
Further Reading: The Greatest Infographic Ever Created
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The most basic question that one can probably ask regarding all things finance, economics, and money is “What is money?” We all know that a US Dollar Bill or a Euro is considered money, but most people have never really given thought to what the properties of money are and what makes something actually money.
We can begin by going back in history before there was anything that could be considered money as we know it today. Let’s go back 10,000 and look around at what we see. In that distant and difficult world, most individuals provided everything for themselves with almost no specialization as we know it today. However, there was some trade occurring – maybe one farmer or a group of farmers would trade some cattle with another group of farmers. They would give cattle and receive some sort of fruit in return. This could have occurred for a number of reasons (eg. maybe that fruit didn’t exist readily where the farmers with the cattle lived), but that’s beyond the scope of this discussion.
Now, we just witnessed an exchange (cattle for fruit), but would we call either cattle or fruit money? No, we wouldn’t. We may not be sure why, but we intuitively understand that neither cattle nor fruit nor any animal can properly be considered money as we know it today. To be properly classified as money, an item (or set of items) must possess the following properties:
Unit of Account: We should be able to keep count with money. This is possible with things such as grain or salt because we can weigh them. It is surely possible with US Dollars or other paper or metal currency because they are inherently designed to be a unit of account. US Dollars exist in three forms, either in paper, in metal coins (fraction of US Dollars), or in digital form, all of which lend to easy counting. Counting might be possible with animals, but it’s much more difficult to do it accurately and in a sophisticated fashion (eg. large cow vs. small cow – are they the same?).
Durability: Money must be sufficiently durable to act as (1) a store of value and (2) a means of exchange, two crucial sub-properties of money. Money must not perish quickly and must maintain its shape, structure, and form for sufficiently long periods of time. US Dollar Bills are pretty durable while a coin is obviously even more durable. A fruit, such as a head of cabbage or a banana is exceedingly fragile because each will perish quickly and cease to be recognizable or useful. People are willing to accept an item for payment because they are confident that they will be able to use that item at a later time for a purchase of their own. If an item is fragile, then it will be useless as a store of value or a means of exchange.
Divisibility: Money must be able to be divided. US Dollars, both in paper, coin, and digital form can be divided into increments as small as pennies. Salt piles and grain piles can be divided by weight. Gold, silver, and other precious metals can also be divided by weight as well. An animal is very hard if not impossible to divide. If you only have one cattle but want to purchase something that is only worth a quarter of a cattle, you’re in a bit of a dilemma.
Fungibility: To be fungible is to possess the property of mutual interchangeability. In simple terms, an item is fungible if you don’t care about the quality of the item. For example, whether you have a very used US Dollar Bill or a brand new one, you still have a US Dollar Bill and should be indifferent among the two (accept for aesthetic purposes). As long as the purity is the same, all gold or silver in the world is exactly the same. Things such as diamonds, however, are not fungible because diamonds come in different clarities. One diamond cannot perfectly replace another like one Silver Eagle can perfectly replace another Silver Eagle. Animals are also not fungible because each is unique in terms of gender, size, health, or even disposition.
Non-counterfeitability: Good money should possess properties so that you can easily tell whether it’s real or whether you have been presented with a fake or counterfeit. US Dollars are very difficult to counterfeit although it’s obviously possible to make fake dollars of sufficient quality to fool an unsuspecting individual. Gold and silver are difficult or impossible to counterfeit as long as proper tests are done by the recipient to make sure that the chemical makeup of the item is actually that of gold or silver. Art might be counterfeited moer easily and it is much costlier to check it to make sure it is original. Currency that is poorly designed or that doesn’t contain any anticounterfeit measures within it will be poor money because it will be very difficult to tell if it is real or fake.
These are the main properties of money, although some texts and economists might label them differently or add or remove a property. What we can take away here is a fundamental understanding of what money is and what it isn’t. This very basic understanding might not prove useful right away, but such an underlying knowledge will help to inform you as you learn more about money, finance, investing, wealth building, and other topics for your personal and financial development. The development of money is a crucial part of why humanity has progressed so far (without money modern trade would be nearly impossible) and this post has barely scratched the surface of what money is, its history, and it’s central role in humanity rise from darkness into prosperity.
This is an incredibly inspiring speech by Robert F. Kennedy on the use of the Gross Domestic Product (GDP) to measure economic well-being in the United States of America. Obviously, GDP isn't something we should abandon because it provides a very useful metric to see how we're doing relative to the past and to see how we're doing relative to other nations, but it doesn't come close to painting a complete picture for various reasons, one of them being described in a beautifully poetic way by Robert F. Kennedy in this video.
Note: No affiliation with the YouTube poster and no support or endorsement for other YouTube videos by the poster.
Have you heard the saying "More isn't always better" before? That's not true according to economists. An underlying assumption in economics is that, for goods (as opposed to bads), more is always better.
Why is this true? There are two things we can consider: (1) if something brings you utility, you want more of it and (2) once it stops bringing you utility (likely because of diminishing marginal utility) you can sell it.
Utility = Happiness/Satisfaction Derived from a Good or Service
If one item gives you utility, more will give you more utility. If one pen gives you a certain amount of utility, two pens will give you more (maybe double), and three pens will give you even more (maybe triple). You can use one pen and then use the others in order as each pen runs out.
Let's discuss another example: burgers. If one burger gives you utility, two will give you more (although probably not double like with the pens), and three will give you even more (but maybe not if you are already full). With burgers things are a little different aren't they? One burger may be amazing, two burgers may be great, but by the third or fourth burger, you might be full. That third burger may give you a lot less utility than the first because you are already full. The fourth burger might actually have negative utility as it causes a stomach ache. This is an example of a central principle in economics called diminishing marginal utility.
Diminishing marginal returns can occur with the pen example above also, but it would just occur much more slowly. If you have 10 pens, you are still doing fine. You can put them away for use later on. But what if someone gave you 10,000 pens? Then the 10,000th pen may actually have a negative utility because you no longer have any room to store it. At some point the pens become a burden.
So how can we say that more is always better if we have diminishing marginal utility, with some cases more extreme than others? We can say that because we can always sell the item should it no longer provide us with positive utility (or at least we assume we can sell it). For example, we can sell that fourth burger. We can also do something else with it (eg. give it to a friend or a homeless person) that gives us some kind of utility. The same is true with the pens. We can start to sell the pens at the point where utility is no longer possible.
So, the old saying that "More isn't always better" isn't really true in the world of economics. Assuming that more IS always better (non-satiation) is an underlying assumption of economics that allows for further theory creation and model development.
Soccer (or Football in most of the world) has become a great demonstration of perverse incentives. If you haven't watched the video above before reading this, take a moment to watch it now. When economists say that incentives are perverse they mean that they are "off" in some way, not that they are perverted in the sexual sense of the word.
Incentives matter a lot. You may want people to behave a certain way, but what really will affect behavior is incentives. Incentives are incredibly powerful and economists understand this fact much more than most other individuals. Misunderstanding the importance of incentives causes individuals and organizations a lot of headaches and confusion.
One example of perverse incentives is the diving that now occurs in soccer throughout the world. I'm fairly young and I've grown up in an increasingly diving-prone soccer environment, but I still understand that diving is absolutely ridiculous. Few soccer players don't dive today and I deeply respect them, but are the rest of the players who consistently dive just crazy for engaging in such a ridiculous and degrading act?
Obviously most soccer players don't engage in the absolute ridiculousness demonstrated in the above video, but in my opinion, diving is degrading and pathetic if you dive to get a penalty kick. Diving to prevent injury or to minimize the chances of being injured is a completely different story. Still, soccer players often dive at what appears to be a slight touch. Soccer players dive and send their bodies on trajectories that in no way match the ballistic trajectory that would be expected from the initial contact. Most soccer fans can tell that these players are diving and playacting. Then why do these professional athletes engage in such a ridiculous act? The answer is incentives. Incentives align in such a way to make such action profitable despite the costs (which I believe are not insignificant).
The incentives for diving and playacting should be fairly obvious. Diving increases the chances that a foul will be called, benefiting the player’s team. Over time, as more people do this sort of thing, the pull to do it also increases because if everyone is doing it, you are penalized in a way if you don’t do it. It’s the same thing with steroids. If everyone in a sport takes steroids and you are the only one that doesn't do it, you are deeply penalized because you will likely always under-perform. That explains in part why athletes often take steroids despite the fact that taking them is a foolish and dangerous act.
The costs of diving are not insignificant in my opinion, however. Diving is a bit ridiculous and degrading when overdone. A soccer player should epitomize sportsmanship and strength, not be always on the lookout for an opportunity to fool the referee. This is degrading to the soccer player personally and degrading to the sport generally. Another cost is just looking foolish, but that cost has greatly decreased because more and more people are engaging in this behavior.
So, we have a situation in which the benefits of the action seem to outweigh the costs. Over the last few decades this difference has increased greatly due to the fact that more and more players engage in diving. The larger number of players engaged in diving lowers the costs because it seems less ridiculous and degrading. The benefits seem to have remained the same for the most part.
But what did I mean when I said there were perverse incentives? Why are the incentives to dive perverse? Let’s begin with a general definition of perverse incentives.
A perverse incentive is an incentive that has an unintended and undesirable result which is contrary to the interests of the incentive makers. Perverse incentives are a type of unintended consequences. (Wikipedia)
Can you think of other perverse incentives? How about the perverse incentives to lend too easily during the last decade. Those perverse incentives brought on the financial crisis and the Great Recession? Easier lending regulations and practices were created to promote a noble cause, increased home ownership. These easier regulations, combined with mortgage securitization (where originators of loans didn't really hold on to their loans but instead sold them off, often packaged with other loans), created a situation with perverse incentives, ultimately leading to a very unpleasant global financial crisis.
We can learn, from both diving in soccer and from other situations where perverse incentives exist, that incentives matter a lot. Noble causes may be espoused and rules may be created, but the wise economist knows that if you really want to predict how people are going to act, looking at the incentive structure that exists is one of the best ways to begin analysis. Perverse incentives and unintended consequences are real things that can lead to sub-optimal outcomes and everyone from parents to teachers to various rule-makers to policy-makers and to law-creators should take care to make sure that incentives line up in the right ways lest unintended consequences and perverse incentives bring on disaster.
Ever since I took my first economics course as a freshman in college, I fell in love with the field. As I continued my studies, both in the classroom and outside of it, my love for economics increased.
I am not sure why I am so fascinated by the subject, to be honest. It might be because I am reasonably good at it. It might be that after a mediocre high school career doing really well in the economics course I took in my first semester in college made me feel very good about myself. Maybe I attached those good feelings to the field of economics and I would feel the same way about another subject had I taken that subject instead.
The above is possible, but I think it's much more than that. Here are a few reasons why I love economics:
Studying economics has made me a more educated and intelligent person allows me to live a more informed life. I love this field of study and I believe anyone who takes the time and puts in the effort to study this social science which tries so hard to be a real science will fall in love with the subject as well.
I learned about this video while I was an undergraduate pursuing my degree in economics. Learning economics and being a genuine economics nerd, I fell in love with the video and the concept. I remember thinking that it was amazing that someone or some group would make a video like this. I thought that the ideas presented were important, but that the subject matter was fairly narrow and that only a small audience would really appreciate this video. I was surprised, therefore, that the production quality of this video was so high.
I later found out that the video was made by a group called ECONSTORIES and that the host of my favorite podcast, Russ Roberts, was a big part of the making of this video. Russ Roberts has a weekly podcast called EconTalk that I listen to every week and highly recommend. You can learn more about this great podcast here.
The Keynes vs. Hayek rap video is a short music video with characters playing the roles of economists John Maynard Keynes and Friedrich Hayek. John Maynard Keynes is portrayed as a confident, self-assured, slightly wild, and popular man while Friedrich Hayek is portrayed as more cautious, attempting to obtain recognition, and a lot less popular. This parallels the real world as a lot of a people know of British economist John Maynard Keynes, while in my experience it seems that only economists and policy makers have some knowledge of the Austrian economist Friedrich Hayek.
Each economist describes his world-view and economic philosophy in the music video in simple and easy to understand ways. Being an economist I understood everything, but I feel that the video will not have the same effect on a non-economist. It's easy to understand, but it seems to me that a non-economist might not understand certain concepts and terms (eg. Keynes’s “animal spirits”). Keynes describes his top-down stimulus spending approach and how that approach can help reenergize the economy when there is a general glut. Hayek argues that such a top-down approach only leads to perverse incentives and ignores the importance of savings to changes in the economy and increases in productivity, which Hayek believes is the true path to prosperity. Hayek believes that the government intervention that Keynes argues for creates boom and bust cycles.
The video was created by ECONSTORIES, a media channel dedicated to exploring the world of economics with visual storytelling and entertainment. You can learn more about them and watch other very interesting and informative videos here.
"The ideas of economists and political philosophers, both when they are right and when they are wrong are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist."
The Economics of Seinfeld
I was never a fan of the hit show Seinfeld, but after finding this interesting website I realize that it's a pretty funny and interesting show. I absolutley love this website and what it tries to accomplish. The website uses short clips from the famous "show about nothing" to demonstrate all sorts of economic principles from arbitrage to zero-sum games.
And now, given the rise of cyrptocurrencies and crypto assets to quasi-mainstream financial assets, we're dedicated to providing quality, relevant, and interesting material on cryptocurrencies and cryptoassets. Articles on Bitcoin, Ethereum, Ripple, Cardano, and many more cryptocurrencies and cryptoassets can be found on Pennies and Pounds - all that in addition to a plethora of information on what cryptoassets are, how the entire crypto industry came to be, blockchain/immutable ledge technology, mining, proof of work, proof of stake, and how to prudently invest in crypto if you are so inclined (based on your risk tolerance and ability to withstand the volatility that will come with a crypto portfolio).