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    A Warren Buffett Story

    Feb 27 • Economic History, Financial Markets, Thinking Economically • 616 Views

    If you had purchased Berkshire Hathaway stock on December 6, 1976, you paid approximately $77. At yesterday’s closing price, one share of the same firm (BRK/A) was $127,550. (Looking at the BLS CPI inflation calculator, $77 in 1976 is equal to the buying power of $298.02 today.)

    Annually, Warren Buffett, the person responsible for the astronomical increase in Berkshire Hathaway’s share price, sends his letter to shareholders. 26 pages long, it is statistical, it is folksy, it expresses general investing acumen, specific performance information, and even a letter to his uncle from his grandfather about always having a financial reserve. I recommend reading it all. For now, though, I wanted to share one story from the letter. It reveals the secret to success.

    The story involves Mr. Buffett’s first contact with GEICO, a firm that Berkshire Hathaway owns. As a business student at Columbia, 60 years ago, Mr. Buffett’s idol was Ben Graham, the co-author of a classic investing “primer.” When Buffett discovered that Graham was the chairman of the Government Employees Insurance Co (now GEICO), he decided, one Saturday, to visit the company’s headquarters in Washington, D.C. When he arrived, the door was locked because the offices were closed on Saturday. Buffett’s response? To knock and shout until a janitor appeared. Asked if anyone was there, the janitor took him to the office of Lorimer Davidson, an executive who later became GEICO’s CEO. Davidson spoke with his young visitor for 4 hours.

    Fast forward to 1996 when Mr. Davidson made a video expressing his pleasure that his firm, GEICO, would “permanently reside” with Berkshire Hathaway. He also “playfully concluded” by saying, “Next time, Warren, please make an appointment.”

    The Economic Lesson

    Both Adam Smith and John Maynard Keynes wrote about the spirit exhibited by Warren Buffet as a student. Smith might have referred simply to the business activity generated by self-interest while Keynes could have taken us to the motivational role of “animal spirits.”

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    Ivy League Games

    Feb 26 • Businesses, Demand, Supply, and Markets • 815 Views

    Joining Harvard and the multitudes they hoped would follow, in 2006, Princeton eliminated its early admissions option. Now, with Harvard and the University of Virginia, Princeton has said it will return to early admissions because few followed.

    The Economic Lesson

    I wonder whether we can explain both decisions through game theory. First, let’s call the market structure within which Ivy League schools compete, an oligopoly. With few market participants on the supply side, a “price making” capability (admissions standards), and difficult entry and exit (colleges neither leave nor enter the Ivy League), schools typically wield considerable power.

    Also, as oligopolies, they engage in game theory. Here is how it works. The two firms (or schools) know that, to some extent, they are interdependent; one school’s decisions affect the other school. Consequently, each one tries to predict what the other will do.

    The result is a behavioral matrix called the prisoners’ dilemma. Imagine a square divided into quarters. For example, above the left quarter is Princeton/no early admission. Above the right quarter is Princeton/early admission. To the left of the upper quarter is Penn/no early admission. To the left of the lower quarter is Penn/early admission.

    You can fill in the matrix. Where Princeton/no early admission and Penn/no early admission converge, we could say that equal numbers of students apply. However, what happens when they converge with one school not doing it and the other proceeding? What if neither proceeds?

    As you can see here, the prisoners’ dilemma conveys the pros and cons of unilateral behavior and of collusion. The problem, as Princeton discovered, is that market participants cannot guarantee competitors’ behavior.

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    Innovative Challenges

    Feb 25 • Businesses, Economic Debates, Government, Innovation, Labor, Macroeconomic Measurement, Regulation, Thinking Economically • 544 Views

    Is it likely that, with each new discovery, innovation gets tougher?

    It might have been easier to identify an asteroid a century ago because the undiscovered ones were very big. It might have been simpler to find a new human organ; the last one, the parathyroid gland, was discovered in 1880. Similarly, developing plants with larger fruit gets to a point where incremental progress is smaller and smaller.  

    So, where does this take us?

    1. To teams. With discoveries becoming more complex, the “renaissance man” like Thomas Edison or Albert Einstein, no longer can know it all. Instead, scientists need to pool their expertise.

    2. To a knowledge plateau. According to economist Tyler Cowen, because the “low hanging” fruit has been picked, it is ever more difficult to make the scientific breakthroughs that spearhead growth.

    3. To a very busy patents office. With scientific teams submitting ever more complex research, it takes the patent office more expertise, more people, and more money to issue the patents that new firms frequently require.

    4. To a President with a challenge. Saying in his State of the Union address that innovation is the key to future economic growth, President Obama now needs to determine the governmental incentives that will accelerate innovation. Economist Mike Mandel has several policy suggestions

    The Economic Lesson

    With Article 1, Section 8, Clause 8 saying, “To promote the Progress of Science and useful Arts, by securing for limit Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries,” the US Constitution established the right to protect innovation.

    Interestingly, although Hamilton and Jefferson did not entirely agree, both were involved with the first Patent Act in 1790.

     

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    An Oil Surprise

    Feb 24 • Demand, Supply, and Markets, Developing Economies, Environment, Government, Households, International Trade and Finance • 587 Views

    As the turmoil in the Middle East unfolds, if you want to sound knowledgeable about oil, you could just say $147, contango and floating storage.

    As you can see on this graph, it was mid-July, 2008, when the price of oil peaked at slightly more than $147 a barrel. A plunging line that went below $40 during 2009 followed the 2008 peak. Most people were surprised by the plunge and also by the peak. 

    Meanwhile, only last July, the supertankers that were carrying “floating storage,” started to download their cargo because oil prices appeared to be declining. The reason they had initially loaded the oil could have been “contango.” Very simply defined, contango just means that traders expect a higher price in the future.

    Now, floating storage could come in handy. As the oil that is stored oil tankers around the world, floating storage could be used to compensate for any Libyan oil shortfalls. In addition, extra Saudi Arabian production could equal 4 times a day what the world gets from Libya. So, if we need it, the oil is right there.

    Conclusion? The future price of oil will be a surprise.

    The Economic Lesson

    When you hear a price for oil, it probably refers to Brent or West Texas Intermediate. The origin of Brent is the North Sea while West Texas is the U.S. This explanation explains oil prices further and names other types including Nigerian Bonny Light and Algerian Saharan Blend.

    The $147 was for Brent.

     

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    Cotton Markets

    Feb 23 • Businesses, Demand, Supply, and Markets, Developing Economies, Financial Markets, Macroeconomic Measurement, Money and Monetary Policy, Regulation, Thinking Economically • 629 Views

    On November 10, 2009, the price of 1 pound of cotton was 59.2 cents. A year later it was $1.02 and now, it is close to $1.90.

    For many of us, the result will be more expensive jeans, more polyester, and smaller buttons. 7 For all Mankind and North Face said prices would probably be higher next year. The Jones Group CEO, owner of Anne Klein and Nine West, said that an $80 jacket could experience a $15 price increase.

    We also might see more organic cotton products. In the Alabama town that used to be called “The Official Sock Capital of the World,” one factory switched to organic cotton. Make a more upscale product and people might accept the price increase. Others just had to close because they could not compete.

    You can see how the impact of more expensive cotton will ripple from cotton fields to fabric factories, to designers, to synthetics, to retailers and to Congress because opposition to cotton subsidies has intensified. Even Ben Bernanke might have something to say.

    The Economic Lesson

    The cotton story is classic Econ 101 1/2.

    On the supply side, events have shifted the supply curve to the left. We started with less supply because of depleted inventories during the recession. Then, bad weather in cotton producing nations like Pakistan, hoarding in China, and export restrictions in India have further diminished supply. In addition, when biofuel commodities started to rise in price, some farmers shifted acreage away from cotton.

    The result? Because the upward sloping supply curve shifts to the left, price rises.

    But then, suppliers try to cut costs and high prices attract more cotton growers. Lululemon Athletica, for example, has moved factories from China to Vietnam and Cambodia because of cheaper labor. Demand for cotton diminishes as suppliers try new fabric combinations. Quantity demanded for cotton will rise when supply increases. Ultimately, the market could take care of the problem.

     

     

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