Pool and Flow

October 2, 2016

A few weeks ago, I introduced two concepts: stock and flow. I’ll develop that a bit to help the reader analyze their portfolio with a bit more clarity.  To avoid confusion between stocks, as a type of investment, and the concept of a stock as in a reservoir or pool of something, I’ll refer to the concept as a pool and stocks as a type of investment.


Each month we might check our investment and bank statements to find that the value has gone up or down.  In any one day only a tiny portion of stocks and bonds trade, yet these transactions determine the value of all the unsold assets, including the ones on our statement.  As I mentioned a few weeks ago, the flow from a reservoir of water determines the value of all the water in the reservoir.  It is like the butterfly effect, the idea that the fluttering of a butterfly’s wings in Mexico can cause a typhoon in southeast Asia.  In financial terms, when a small event has a large influence it is called leverage. A flow, a transaction, is the  catalyst for a transfer of value from one asset to another.

Let’s look at an example.  We buy a 1000 shares of the XYZ biotech firm for $10 a share, for a total investment of $10,000.  The next day the FDA announces that, contrary to expectations, they will allow a drug trial to proceed to Phase 3.  XYZ’s stock price rises 10% in response to the news.  The market price of our investment is now worth $11,000.  Where did the other $1000 come from?

Transfer of Value 

An asset value rose, so the value of another asset pool fell as the value is transferred from one asset to pool to another. Yesterday $10,000 of cash was worth 1000 shares of XYZ.  Today, that $10,000 of cash is worth only 909 shares of XYZ.  This is a different way of looking at cash – not as a liquid medium with  a stable value – but as an asset with an erratic value.

Cash = Investment 

What is cash?  It is an investment of faith in the United States.  We might give it a stock symbol like CASH and I’ll use that stock symbol to distinguish cash when it acts as an asset.  Stockcharts.com allows users to track the relationship between two stocks, or to price one stock in terms of another. We do by typing in the a stock symbol ‘A’ followed by a colon and a second stock symbol ‘B’.  Stockcharts will then show us the value of A priced in B units.  Below is the chart of Google (GOOG) priced in Apple (AAPL) units, or GOOG:AAPL.

On the left side of the chart in early 2014, Google’s stock was worth about 6.25 “Apples.”  By mid-2015, Google’s stock had fallen to 4.25 Apples.  Did Google’s value fall or Apple’s value rise?  Let’s imagine that we live in a world without money, as though we had taken the red pill as in the movie “The Matrix.”  Without a fairly constant measure like cash, we simply don’t know the answer to that question.  Imagine that each investor gets to choose which asset they want their monthly statement priced in and that our choice is Apple.  Over a year and a half, we see that we have lost about a third of the value of our portfolio of Google (6.25 / 4.25 = about 2/3).  We can’t stand the continuing losses anymore and sell our Google stock and get 4.25 units of Apple. It is now September 2016 and we still have 4.25 units of Apple because Apple is our measure of value.  Had we continued to hold the Google stock, we would have 7.29 Apple units.

What is CASH worth?

Now let’s turn to a slightly different example.  We are going to price CASH in Apple units, the inverse or reciprocal of how we normally do things.  When we say that Apple’s stock is $100, for example, we are pricing Apple stock in CASH units, or AAPL:CASH.  Instead we are going to look at the inverse of that relationship: pricing CASH in Apple units.  Remember, we are no longer in the matrix.

We begin with the same portfolio, 6.25 Apple units in early 2014.  We think that this CASH asset is going to do better than Apple, so we sell our Apple units for CASH and get 68 cash units for each Apple unit, a total of 425 cash units.  In mid-2015, we find that our CASH units are now worth only 3.5 Apple units.  We have lost about 45% in a year and a half!  We sell our CASH units and get 3.5 Apple units which is what we still have in this latest statement 15 months later.

Our losses are even worse than that.  Each year, Apple gives the owners of its shares another 2/100ths of a share as a dividend.  The owners of CASH get only 1/100th of a cash share each year.  Apple pays those dividends from its profits.  For owners of CASH, a financial institution pays the dividends from its profits. While the Federal Reserve, a creation of the Federal Government, doesn’t directly “set” interest rates it effectively does so through the purchase of bank securities.  Each dollar bill is equivalent to a share in an entity called the United States and it is ultimately the U.S. government that largely determines the dividend rate that is paid on safe investments like savings accounts.

Stock dividends compete with cash dividends

To remain competitive with safe investments, Apple only has to pay a little more than the very low dividend rate that savings accounts are currently paying.  If interest rates were 5% instead of the current 1%, Apple would have to devote more of its profits to dividends to appeal to income oriented investors.  By keeping interest rates low, the Federal government effectively allows Apple to retain more of its profits.  Where does Apple keep that extra money?  Overseas and out of the reach of the IRS.  That’s only part of the irony.  If Apple had to pay more of its dividends to the share owners, the share owners would pay taxes on the income. So the U.S. government loses twice by keeping rates low (See footnote at end of blog).

So CASH is effectively owning the stock of an entity called the United States, which doesn’t make a profit.  In the long run, owning the stocks of companies that do make a profit generates much more return to the owner.  Let’s look again at the leverage aspect of stocks and cash.  Earlier I noted the huge leverage involved in stock and other non-CASH asset transactions.  A tiny number of transactions affects the value of a large pool of assets.  On the other hand, millions of CASH transactions take place each day and have little effect on the nominal value of CASH.  So we price highly leveraged assets – stocks, bonds, etc. – in terms of an unleveraged asset – cash.

The functions of cash  

Cash plays several roles. First, as a medium of exchange, it acts as a measuring stick of economic flow in a society. This first role has a symbol – $.  Secondly, as an asset pool, CASH acts as a holding pond, a reserve in the waiting, the first in the asset reservoir to be tapped. Lastly, it acts as an insurance on the principal of other assets, like stocks and bonds.  Let’s call that INS.


As an insurance, let’s consider a portfolio of $900 in stocks, $100 INS.  A 10% fall in stocks is reduced to a 9% fall because of the INS position.  Let’s consider the exact same portfolio, except that the investor’s intention is that the $100 is a CASH investment, a reservoir of asset buying power.  The same 10% fall in stocks is now a trigger for additional purchases.  In the first case the $100 is an anxiety reduction fee; in the second, a prediction of a market correction.

An investor might blur the distinction between the functions. Retired people who want to preserve the nominal value of their savings may tend to keep the majority of their nest egg in cash without distinguishing the different functions.  Cash = safety and liquidity. Because cash is used as a yardstick, its nominal value is kept constant.  But what that cash can buy, its purchasing power, changes.  When they need some of that CASH ten years from now, the purchasing power of that asset may have fallen by 30% but the nominal value is the same as it was ten years earlier.

Cash Analysis

As noted before, companies must make a profit or go out of business. Not so the U.S. government. Over time, the rate of a company’s profit growth must exceed the inflation rate, so that stocks give the best investment return in the long run.  Investors would benefit by separating their cash position into its functions, $ and CASH and INS, to understand more clearly what their intentions and needs are for the coming year.  This can be as simple as a piece of paper that we review each year.

Analysis Example 

An example – Cash needs:
1) income for the next year including emergency fund – $50K – $ function.
2) stock market seems awfully high and it has been a while since there has been a 10% correction – $100K CASH function.
3) $30K INS function to help me sleep at night in case there is more than a 10% correction.
Total: $180K.

Why write it down?  Believe it or not, we forget things.


As a footnote:

Offsetting the tax losses to the government is the fact that some of Apple’s cash consists of cash-like equivalents like Treasury bonds which pay a very low dividend.  Apple loses income because of the low dividend and the U.S. government gains by being able to borrow money from Apple at low rates.

Adults Wanted

The end of another month ending involving billing customers, paying taxes, balancing the bank accounts and closing the books.  Each month it becomes apparent that one of the reasons why there is not more robust job creation is the “invisible” employee costs, both in dollars and in the business owner’s liability.  By invisible, I mean that these costs are typically out of sight and out of mind to most employees.  These costs are quite visible to the owner who, failing to account for them in their business pricing, soon goes out of business.

These costs were designed to be invisible to employees because if most employees knew all the costs, some politicians might lose their jobs.  A paycheck with a gross amount of $1000 might have $200 or more taken out for taxes and health care premiums.  The net amount of the paycheck is $800, which is what we get to spend on bills, rent/mortgage, food, transportation and a movie. We grouse about the $200 in taxes but that $200 pales in comparison to the invisible costs that don’t show on that paycheck stub.  Most of these costs are mandated by either Federal or State law and include Workmen’s Compensation insurance, Unemployment Insurance, Liability Insurance, and Social Security and Medicare taxes (employer’s half).  The cost of these mandates goes into neither your pocket or the employer’s pocket. Benefit costs include health insurance, retirement contributions, education reimbursements, vacation and sick pay.  Mandated costs and benefits can easily add $500 to $1000 in cost to that $1000 gross paycheck amount.  In addition, there are indirect costs which include office and production equipment, rent, utilities, and transportation, as well as the internal costs of accounting, supervision, and training.  After those costs, that $1000 gross paycheck can have a final cost of $2500 or more. 

The indirect costs are simply a part of any business; they are the costs of producing a dollar of revenue to the business.  My chief concern is the invisible insurance and tax mandates whose costs are hidden from employees.  By making the employer, not the employee, responsible for the payment of these costs, politicians could more easily sweep them under the rug.  Some people strongly object to the health insurance mandate but how many protest or are even aware of the Unemployment Insurance mandate or the Workmen’s Compensation Insurance mandate?  Many are not aware simply because the cost is paid by the employer.  While the employer may write the check, the employer “deducts” the cost from the employee by lowering the gross amount that they can pay to an employee.

I am not making a case against these insurances and taxes that add a safety net for workers.  What I do object to is the surreptitious way that lawmakers have enacted them in order to hide the magnitude of the costs of these safety programs.  Because these mandates are structured as a payment from the business and not the employee, Workmen’s Comp, Liability, and Unemployment Insurance are rated based on the company’s industry classification and claims history.  An employee who has worked twenty years without an accident is charged the same amount of money as his/her co-worker who does not pay attention to safety regulations and common sense.  The same holds true for liability insurance; a thoughtful employee and a careless employee pay the same amount.  In some construction industries, Workmen’s Comp and Liability insurance can be 20% or more of gross pay – not a trivial amount.  Should a careless driver and an accident-free driver pay the same amount in auto insurance?  Of course not.  Yet that is how Workmen’s Comp, Liability and Unemployment Insurance are rated.  Since there is no individual worker history, no individual experience rating, there is no direct cost tied to a worker’s actions.  An employee can become naturally divorced from the consequences of their actions.  Often an employer will not add another employee if they are not sure whether he/she will be able to keep them on six months from now.  The reason is that many, if not all, states will increase the unemployment insurance rate for that business when the employee is let go in six months and files for unemployment insurance.  It can be more cost efficient for an employer to pay some overtime to existing employees to make up the extra work till the employer is sure that business volume is on the increase. 

Unlike the other insurance mandates, the health care mandate at least makes individuals personally responsible for their own insurance.  With no direct responsibility for their own Workmen’s Comp, Liability and Unemployment insurance, employees are effectively treated, in the eyes of lawmakers, like teenage children.  A host of state and federal employment regulations only confirms that status.  In the eyes of our laws,  employees are not quite adults.  Employers are treated by state employment agencies as though they were the parents of not quite fully responsible teenagers and the burden of proof is on the employer to show that the employer complied fully with regulations.

How did we get here?  During the second World War, the Federal Government was running up extremely large war costs and experiencing severe cash flow problems.  One problem the government had was that tax payments were not due till March 15th of each year (in 1954 the date was changed to the current April 15th), which meant the government had to borrow a lot of money each month.  Many people were not paying all of their taxes, either income or the Social Security tax enacted several years prior.  The problem of collecting delinquent taxes presented yet another costly headache for the government.  A noted economist of the time, John Kenneth Galbraith, suggested a solution last used eighty years earlier during the Civil War:  make employers withdraw the taxes before they paid their employees.  This would both solve the problem of timely collection of taxes and curb much of the delinquency.  It would be much easier for the government to go after the far fewer businesses in the country than millions of individual taxpayers.  Thus the withholding system was born again. (A history of taxes)

Once the mechanism of withholding was in place, politicians realized what a boon this was.  Taxpayers dislike taxes and the politicians who enact them. Politicians could now increase existing insurance costs and mandate new ones without the taxpayers – the voters – constantly being reminded of these now invisible costs.  Politicians simply had to change the law, then notify a relatively small number of businesses to pay more.  That created a new problem for business owners.  Politicians had effectively deflected the disapproval of voters onto employers.  When an insurance cost goes up, it is difficult for an employer to say to an existing employee that the employer will have to reduce an employee’s hourly wage or salary to make up for this increased cost.  For subsequent hires, an employer can reduce the hourly wage or salary that they will offer to a new employee.  The employer has two alternatives:  raise the price it sells its product or service; or eat the increased cost.  Employers complain about this state of affairs long and loud. They form trade groups and lobby their state legislatures.  The politicians get the better of a bad situation:  listen to loud protests from a lot of voters and possibly get thrown out of office or have to listen to a relatively few employer lobbyists.

I am not advocating the abandonment of the withholding system, which does solve the problem of timely tax payments.  I am advocating for a system that directly charges those who are going to benefit from the safety net that exists – the employees.  This is no longer the paper and pencil age of World War 2.  Digitized records would enable most state and federal agencies to assign individual ratings to employees based on their history.  A new or existing employee presents their individual rating for various types of insurance to the employer and the employer deducts the amounts and sends to the appropriate agency, just as they do now.  The difference is that the employee gets to see what he/she is being charged for and might in some cases be able to control some of those costs.  Instead of being paid $20 an hour, an employee might be paid $34 an hour.  The cost to the employer is the same.  For many of these mandated costs, the tax write offs to the employer are the same; it is a cost of producing business income.

What can we do about it?  Press your elected representatives for individual ratings for these insurances.  An employee who has never filed for unemployment insurance pays the same as a person who has collected six months of unemployment insurance last year.  Does that seem fair?  Why have an employee half and an employer half of the Social Security and Medicare tax?  It all comes out of the employee’s pocket in the long run.  Why the game of hiding the costs?

Imagine a world where an employer can have a bit more sales volume, hire an employee and let them go if sales subsequently fall off.  An employee who is let go would then make the choice of whether to collect unemployment.  They might absolutely need the unemployment insurance and that would affect their individual unemployment rating the same as it does when we file an auto insurance claim.  They might try harder to get another job or switch to a different job in order to keep their individual unemployment rating pristine.  It would be the employee’s choice.

Imagine a world where the employee controls what they put away for retirement.  If you want to put away $6,000 a year tax free into a 401K retirement plan, why shouldn’t you?  Why have the charade of the employer matching your contribution by some percentage?  How did we get to the point where employee compensation is a haunted house of smoke and mirrors?  

Imagine a world where an employee is not bound to an employer for insurances and benefits and tax benefits.  Imagine a world where the employee has choices.  Imagine a world where the employer pays the total of the employee cost to the  employee and the employee then sees the true scope of deductions.  In fact, we do have that world now.  Employers are increasingly using subcontractors and temporary agencies as a way to sidestep the burdens of employment.  From the BLS July Labor Report: “Temporary help services has recovered 98 percent of the jobs lost during the most recent downturn.” (Source).  Tell your state and federal representatives that you would like a different world – one in which you are treated like an adult.

Health Care Right

For some Americans, there is a question fundamental to the debate on health care insurance reform: is health care insurance a right or a privilege? Taking apart the question, the central debate is whether health care itself is a right or privilege.

In 1986, Congress passed the Emergency Medical Treatment and Active Labor Act (EMTALA), requiring hospitals to treat those in need of emergency care. The law, and subsequent amendments, established some universal access for urgent health care. What the law left out was any provision for paying for the care received and about half of emergency room care goes unpaid. The debate over reform involves two issues.

The first is does a person have a right to health care? Legislation and both state and federal court cases ensure that prisoners have a right to adequate medical care. In 2002, a heart transplant for a California inmate prompted a contentious debate over the meaning of “adequate.” If you are a taxpayer who pays to maintain the prisoner, however, you may or may not have a right to health care. It depends on your condition, which has to be assessed by a doctor using a number of guidelines, both local and federal, to determine if you have an EMC, or Emergency Medical Condition. If you do have an EMC, you have a right to health care. That doesn’t mean you have a right to free health care. You’ll have to figure that one out on your own or with the help of a counselor at the hospital.

Among Americans who are not lawyers, the debate often turns on this constitutional and philosophical debate: does a person have a right to health care? Some say that the Declaration of Independence clause citing a right to life and the 5th Amendment protection of life gives one a right to health care. Some argue that these constitutional provisions include only life or death care. People see it one way or another and there is a tall fence between the two camps.

The second debate is partially founded on the first. If someone has a right to health care, does that imply that the government then has an obligation to provide that care at no cost? Some argue yes, some argue no and there is a big wall between these opposing groups.

As a comparison, let’s review a few other rights. The citizens of this country have a right to the protection of life and liberty. Government, then, has an obligation to provide for armies, police and courts to sustain that right of its citizens. Likewise, if health care is a right, shouldn’t that also be provided by government? Some who argue that health care is a right, could also argue that there is a differentiation of rights. Defense is provided to all citizens whether they pay taxes or not. The 2nd amendment gives one the right to own a gun but the government has no obligation to buy any citizen a gun. If health care is a right, is it a right similar to that of owning a gun?

Some argue that there is no right to health care, be it life or death. For those people, the case is closed on both the health care and health care insurance debate. I heard one older man say that when he was growing up, if you didn’t have money for a doctor, you died and that was how it was and everyone got along the way it was.

For some pragmatic Americans, the debate over rights to health care is stupid. There are two camps here as well, some arguing that unhealthy people spread disease and inevitably are a burden to those around them so we, as a community, have to find a way to provide health care to everyone. Some object that simply paying the additional taxes required to provide that health care will make us all more unhealthy, thereby exacerbating the condition we hoped to cure.

In this debate, which camp are you in?

For a look at some of the gripes about the existing health care insurance situation, read a few
real life stories

United States of Insurance

The United States government has become the largest insurance company in the world.
Its citizens are among the most heavily insured people in the world. We are insured for many aspects of our lives, from our life itself to other people’s mistakes.

Some insurance fees we pay directly. These include insurance against getting old, Social Security and Disability Insurance, insurance on our health, home, car and mortgage. Some insurance fees are indirect in that the cost of that insurance is passed on to us in the price of a product we buy or income to us is reduced by these fees.

Examples of the first type of indirect insurance are “mistake” insurance, malpractice and liability. A business pays a fee to protect themselves in case they make a mistake. Those fees are passed on to us in higher prices.

Unemployment and FDIC insurance are examples of the second type of indirect insurance.
Unemployment insurance is a based on a percentage of the wages paid by an employer to an employee. An employer typically reduces the wages that it can pay an employee by that amount. FDIC insurance is a fee charged to banks to protect savings against bank failure. The bank reduces the interest it can pay on a savings account to offset the fee. Like individuals, businesses pay for many types of insurance, passing the cost on to their customers in the form of higher prices.

There is another indirect form of insurance in the form of taxes paid into a general fund.
We are insured against poverty in the form of SSI and food stamp programs, whose payments come out of general Federal and State tax revenues.

How have Federal and State governments become so heavily involved in the insurance business? With the passage of the Social Security Act during the 1930s Depression, the Federal government entered the annuity insurance business – sort of. Annuities are a type of insurance where a person pays premiums over a period of time and, at the end of that period, begins collecting payments from the insurance company. Insurance companies invest the premiums paid in order to make the payments at a later time. The Federal government, on the other hand, spends the premiums received each year, relying on future premiums to make payments. If our Federal government did not spend the premiums each year, Social Security would be more like an annuity program. Since the premiums are spent, it is a Ponzi scheme.

With the introduction of the Medicare and Medicaid programs in the 1960s, the Federal government stepped into the health insurance business. Unlike private health insurers who charge higher premiums for those with higher risks, the government charges higher premiums based on a person’s ability to pay higher premiums. This premium pricing system is most often used by those in the protection racket.

Ponzi schemes and protection rackets eventually collapse. What can we do? Elect representatives who are willing to make a transition to a valid business model. Elect representatives who will support a new law giving them a legal fiduciary duty to the voters and taxpayers. Without that duty, our elected reps have no responsibility to the public or liability for their actions other than the prospect of losing their jobs. They can enact laws and make promises with impunity. We, the voters and taxpayers, pay the price.