The official "blog of bonanza" for Alfidi Capital. The CEO, Anthony J. Alfidi, publishes periodic commentary on anything and everything related to finance. This blog does NOT give personal financial advice or offer any capital market services. This blog DOES tell the truth about business.
I met with an entrepreneurial colleague earlier this week to brainstorm some concepts for helping veterans start businesses that leverage their backgrounds. I mentioned NaVOBA and its franchisee population but we were looking for venues specifically focused on veteran-owned high-tech startups. Fortunately, we don't have to reinvent the wheel.
Vet-Tech is a Silicon Valley startup accelerator specifically for veterans. I should probably contact them to see what's up because my connections and insights may be useful. I totally respect their partnerships with the Angel Capital Association and Plug and Play.
Vetransfer is a Wisconsin-based accelerator doing something that more organizations should do. They want their participants to use the free tools available from MOOCs and venture investing best practices. Military veterans are quite familiar with doctrinal templates refined in military branch schoolhouses that dictate baseline references for unit operations. The emergence of Lean Startup, CustDev, and the business model canvas serve the same doctrinal role among entrepreneurs.
Techstars' Patriot Boot Camp is a three-day immersion program in Washington, DC. I think it would be most useful for vetrepreneurs who have a serious business concept but need preparation before entering an accelerator.
CADRE is an accelerator focused on veteran-owned businesses that specialize in cybersecurity solutions for the federal government. Cyberwar is a growth industry in the federal government. Even if the NSA changes its monitoring programs, big private corporations will still need computer network defense and intrusion forensics. Vetrepreneurs trained to chase Uncle Sam's cyber contracts can easily pivot to private sector clients.
I do not have any relationships with any of these programs at this time. Business leaders with strong relationships are welcome to graft onto these organizations. They need corporate sponsorship. I think big companies seeking government contracts would obtain a competitive advantage by hiring veterans, buying from veteran-owned small businesses in their supply chains, and sponsoring veterans' accelerators.
Oh, BTW, none of these programs will tolerate Stolen Valor frauds who wore falsified decorations and want to rip off procurement programs with contract fraud. Yes, "Mickey Ronin," that means you and anyone associated with you. Don't even think about contacting any of these organizations, Michael. It will be enough to finally put you in prison where you belong.
I finally attended a conference that was completely incomprehensible to me. I dropped in on DesignCon 2014 primarily to check out the keynote address from the XPRIZE Foundation. I like that XPRIZE is reaching out beyond their space interests to incentivize exponential changes in the environment and transportation. Go for it, folks.
The XPRIZE talk definitely addressed the proper crowd. These electrical engineers and computer programmers held very technical seminars, all of which were over my head. I try to attend geek conferences to find topics the finance sector will find attractive but I just could not fathom anything discussed here.
I did accomplish one thing while I was here yesterday. The conference people gave out these adhesive photo mosaic pieces we were supposed to stick to a wall by the numbers. I stuck mine in place and I could already see the finished photo taking shape . . . a large image of Darth Vader constructed from computer board pieces. Brilliant. The ultimate nerd images dominate these shows.
The last time I saw the XPRIZE people was at the Maker Faire Bay Area 2013, and that was the first time I noticed the emerging strength of art and design thinking as a force in STEM education. I was skeptical at first about diluting STEM into STEAM but it's probably a worthwhile addition if it teaches engineers to think outside the box.
I won't return for future design events because they're intended for technical specialists. Generalists can enjoy the Maker Faire and experiment with technology building blocks the technicians assemble. I wish I had majored in engineering as an undergrad instead of business. I probably would have invented faster-than-light speed engines by now because I'm such a genius.
The US government-sponsored "MyRA" is the newest kid on the block in the universe of retirement savings accounts. It doesn't appear to be all that impressive at first glance, but it might make a difference for people who otherwise would have nothing. We only have media coverage of the basics at the moment, so the government should explain its full details on an official website.
The MyRA is certainly not some kind of attempt at confiscation. Sovereign Man's "Simon Black" and other fringe finance sources pushing this line need to calm down. It does not direct existing IRAs of 401(k)s to reinvest assets exclusively in government bonds. It does not even appear to be mandatory. The MyRA is a new mechanism independent of those accounts.
Account minimums tell us everything about the target market. A MyRA account minimum of $25 and monthly paycheck contributions of $5 are barely condiments on a nothing-burger. Putting five bucks a month into an account seeded with $25 gives an investor $85 at the end of the year. Setting the maximum size for the MyRA at $15,000 is hilarious. Someone saving $60 per year is not going to accumulate $15K over a lifetime with interest rates on new Treasury bond issues in the low single digits. The power of compounding that Warren Buffet likes works best when you have significant amounts to compound. If you don't believe me, do the math yourself. I used the SEC's compound interest calculator at Investor.gov to figure this out. I typed in $25 for the current principal, $5 for the monthly addition, 30 years to grow, and assumed a more normal interest rate of 5% compounding at one time per year. I got an ending value of $4,094.38. That's what I think a MyRA investor can reasonably expect from no-fee government bonds. It's not much to those of us who won the intellect lottery at birth but to your average burger-flipper it must look like a king's ransom. Try living off a four-figure sum in retirement. The MyRA won't be enough to bring retirement security on its own, even for investors putting in enough to get the compounded amount to $15K in their lifetimes.
The product available to MyRA investors is likely to be the G-Fund from the Thrift Savings Plan. The amounts investors may contribute are too small to buy a whole bond outright, even if the bonds are packaged as "R-bonds" designed specifically for retirement accounts. There's nothing wrong with using an existing product as an expedient way to get Americans to plan for retirement. It is consistent with the adoption of low-cost superannuation-type funds as the preferred approach for retirement reform in America. The biggest risk for investors in a concentrated government bond position is of course inflation but the MyRA target audience won't understand this risk. Americans who bought war bonds during World War II experienced sustained postwar inflation that severely harmed the value of those investments. That worked out fine for the Federal Reserve as it helped the US government reduce its debt repayment burden by sustaining inflation. MyRA's G-Fund investors will not be sufficiently diversified to endure future inflation unless they also have conventional IRAs invested in equities or hard assets. Good luck getting that message out, Uncle Sam.
Any education effort aimed at MyRA's target audience of investors will probably be a waste. People will forget they have these accounts because the amounts are so small. The concept of retirement savings is an abstraction for people living paycheck to paycheck. It's the same problem I identified when I recently discussed the unbanked population. I would prefer to see the MyRA somehow joined to a public option bank in each state. I suspect that the target demographic of MyRA investors is the same audience heavily dependent on unemployment benefits and other forms of public assistance. Collecting all of these transactions under one roof in a public option bank provides a platform for the delivery of financial literacy training. Low-income, low-information people won't pay attention to education without incentives. "Come get your EBT card recharged at the public bank, and don't forget to start your MyRA payroll deduction."
This new approach is aimed at low-information voters who are probably incapable of understanding the concepts of dollar-cost averaging, portfolio diversification, and full contributions that trigger employer matching in 401(k)s. Any American worker who isn't covered by an employer's 401(k) at work has always been free to set up an IRA at any brokerage or bank. That lesson is lost on Americans who earn little and don't understand finance. The government should play a role in helping that population become self-sufficient and MyRA is a good try at a solution. It's like an IRA with training wheels for beginning investors who need habituation to deferred gratification before they can graduate to more complex IRAs. Uncle Sam needs to put me in charge of this thing so I can graft it onto public banks.
The Affordable Care Act's supporters praise it for adding mandatory coverage to participating plans. They allege that men who buy plans covering birth control, pregnancy, and endometriosis redress historic price discrimination against women who have bought insurance. This flawed logic is easy to debunk. This law enshrines a new form of price discrimination against men by replacing actuarial results with a contrived political argument.
Price differences in the insurance sector are not the result of discrimination against gender, race, or other protected categories. Pricing for policies of any type is always the result of carefully calculated actuarial solutions that distribute the costs of rare but discrete events across a large pool of the insured. If a policy covering pregnancy is more expensive than one that does not, its because that service has a cost that must be distributed among a pool of people likely to experience that condition. Men do not experience pregnancy. Forcing them to participate in a risk pool for pregnancy is like mandating that someone who does not own a car must purchase automobile collision insurance.
Arguing that men should share the cost of birth control and pregnancy policy coverage because they potentially share in procreation ignores participants' risk profiles. A sixty-year old man is at far less risk of impregnating a woman than a twenty-year old man. Women also have the option of pursuing pregnancy trough artificial insemination, and anonymous male donors typically do not incur paternal obligations in the eyes of the law. Some emerging case law has begun to establish such paternal obligations for male donors who did not fulfill legal requirements that would have shielded them from parental liability for child support, but that is a minor issue with little relationship to insurance risk pools.
Requiring men to pay for coverage of endometriosis is even more ludicrous; that is a medical condition specific to women. Taking this logic further would require women plan subscribers to pay for erectile dysfunction and prostate cancer treatments, which of course disproportionately affect men. I have yet to see those arguments appear in public media. Perhaps I haven't looked hard enough for those arguments or for plans' coverage requirements. Requiring men to join a risk pool that covers women's specific conditions, without requiring the reverse commitment from women to cover male risks, is exactly the kind of gender discrimination the ACA's defenders should oppose if they are intellectually honest.
The ACA's authors in the health care sector knew that the appeal of cheaper coverage for female-specific conditions would help sell the law to women voters. The price that health care providers can extract on the back end - higher deductibles, suppression of innovation through a device tax, and no real cost controls - was easy to hide with rhetoric. The bait and switch worked and the health care sector maintains its ability to extract surplus rents in the manner of a rentier regime. ACA plan pricing sets a precedent for politically determined investment outcomes. This precedent suborns fiduciary duties and actuarial results to the will of a political majority. This revelation is lost on many Americans.
The US Supreme Court upheld the legality of the ACA mandate as a tax, establishing a firm legal precedent for politics to determine investment outcomes with little regard for links between cost and consequences. I expect further legal developments under the cover of fairness to redistribute wealth according to the wishes of a donor base. The challenge for economic actors who want to safeguard wealth in this environment is to become an effective donor constituency.
I listened to tonight's State of the Union address on NPR. I shall repost the comments I made in real time on my Facebook wall. I made minor edits for typos and clarity. My stream-of-consciousness musings follow. I speak solely in my capacity as a private citizen, and my comments do not reflect in any way upon my affiliation with any organization or entity. This is how I roll.
State of the Union on NPR . . . let's listen in . . .
"Rebounding housing market . . ." due to Fed ZIRP . . . but redirected FDI from China to US is correct.
"Let's Move (obesity) and Joining Forces (veterans) . . ." for once, I agree.
"Trade promotion . . ." historically has always been bipartisan. NAFTA was a success story.
"Basic research . . ." lots of IP already on shelves at federal lab consortium. Why not put the six new tech hubs next to the biggest labs?
"Energy independence / natural gas . . . " true for now but shale wells have steep decline rates. I see these all the time in investment presentations. US has maybe 20-30 year window to use NG as bridge fuel.
"Immigration . . ." plays to high-tech business lobby eager to train HB-1 engineers cheaply and import lower-cost labor, keeping wages under pressure. Contentious only in border states.
Biden in charge of training? Uh-oh. Not my call.
"Unemployment / education . . ." nature of work is changing to piecemeal, education transforming to MOOCs. Hard to design top-down solutions to either from policymakers accustomed to government employment. I can't see a federal solution to this obsolescence.
"Race to top (education) . . ." still a traditional K-12 state-owned solution. Just like No Child Left Behind, ignores MOOC revolution driven by entrepreneurial disruption.
Repeat meme "let's come together . . ." but where was White House leadership in multiple budget / cliff negotiations?
Note to self: I need a raise.
Hard to raise wages when labor market is still slack. Will federal contractors in Afghanistan have to pay locals equivalent in US wages?
"My RA (retirement account) . . ." need more details.
"Health care . . ." ACA still seems like a very complicated way of expanding insurance pools with no reference to underlying actuarial calculations. Cost controls still not adequate and health care sector likes it that way, which is why surgery and pharma are still hugely expensive in US.
"Afghanistan . . ." I assure you US is not leaving in 2014.
"Fighting Al-Qaeda . . ." not the whole reason for continued operations. Watch China's moves in Africa. Sleight-of-hand stalking horse, sort of.
"Iran's program . . ." Tehran has stated a different interpretation. Expect a repeat confrontation.
"New sanctions bill veto . . ." veiled message to AIPAC saying "trust me."
"Asia-Pacific . . ." far longer verbiage than messages about Europe and Ukraine. Veiled message to Beijing: US will not leave Asia.
"Veterans . . ." start by digitizing VA records management to speed up case processing!
Hooah. When in doubt, thank a veteran.
Closing rhetoric was Reaganesque, hitting all the right notes much like his convention renomination speech.
GOP up next . . . now hear this . . .
For crying out loud, this woman's rhetoric is flat and uninspiring. No wonder the GOP isn't connecting with the middle.
Enough with the personal stories. This isn't even as good as Nixon's "Checkers" speech.
"We have plans to . . ." do what exactly? Zero specifics. No wonder Dems have such an easy time painting GOP as obstructionist.
Good Lord, that response was a nothing-burger! Embarrassing. Not even a soundbite for a future campaign. Did GOP pick her because they thought a woman would connect? This is why national GOP is rudderless.
That's the end of my impressionistic commentary. Now I shall be more deliberative. I tried to be as fair as possible in my stream-of-consciousness deconstruction of the speech and its response. The President does in fact speak well from prepared text - diction, intonation, themes, images are all excellent. My disagreements with the substance of Administration policy - and I have many points of disagreement - are not based on the President's public persona or personal history. We should remember that modern Presidents excel in part because of their role as public performers. President Reagan understood this and remained personally popular and effective even after the tax increases of his first term and Iran-Contra in his second. President Obama exhibits the same qualities. I admit this even though I would have preferred Mitt Romney on that podium.
NPR's commentators correctly identified the President's goals as modest. What they missed is linguistic analysis that goes deeper and broader than mention of specific programs. Intelligence analysts are trained to deconstruct major policy speeches by heads of state to identify shifts in national priorities and strategy. The US commitment to Afghanistan and pivot to Asia are obvious. Both of those themes are clear messages to China that the US will block Chinese encroachment upon its Asian neighbors. The mention of the pursuit of Al-Qaeda's remnant throughout the world is likely another veiled message to China that the US will maintain a flexible presence in many areas where China seeks influence. Chanting "Al-Qaeda" is a way to keep the American people motivated and tolerant of foreign interventions. The discussion of Iran's diplomatic status was a message to Israel that it should take its cues from US leadership and not overreact; this is designed to prevent a unilateral Israeli strike on Iran's nuclear program.
The discussions of domestic priorities were focused on favors to strong constituencies in the President's base. The health care sector and teachers' unions will continue to benefit from subsidies that insulate their business models from disruption. This will of course make them even more fragile and prone to disruption, and their long-term collapse will be all the more sudden once disruptive alternatives find viable mass markets.
The official response from the loyal opposition reveals the intellectual bankruptcy of one party in America's two-party political system. The GOP articulated precisely zero positive policy prescriptions and rendered zero effective criticisms of the President's agenda. This leaves the President and his party with a relatively free hand for the remainder of 2014, until the Congressional mid-term elections reveal their results. Speaker Boehner's dislike of the Tea Party caucus is well-known in DC and among national pundits. The Tea Party represents the inarticulate, disaffected middle of America that is rapidly becoming the GOP's sole remaining constituency outside of the evangelical South.
Neither the President nor the opposition addressed income inequality in detail. Raising the minimum wage is not a middle class solution and merely strengthens one potential transmission channel for a wage-price spiral in hyperinflation. Tax reform received a passing mention, with few specifics. I predict that "income inequality" will be a useful campaign theme in 2014 with no real policy outcomes after the election.
The 2014 State of the Union does not change the basic investment thesis of Alfidi Capital. The Federal Reserve continues a ZIRP policy and the federal government continues deficit spending. Those two policies will eventually trigger some combination of a deflationary asset market collapse and a hyperinflationary policy response. The address is worth noting for the tone it sets and the coded messages it sends to foreign capitals.
The sample question about energy shares, oil, and Middle East instability strikes me as a no-brainer. Energy stocks benefit from oil price shocks of any kind. Deep data mining of the history of energy prices and share price movements is within the reach of existing data subscription services, so I don't see how this "Warren" AI would add value. I don't buy the argument that highly specialized quants need hours of coding to find a satisfactory solution. That's a crutch hedge funds use to justify their enormous fees. A good analyst can use data to make an intuitive leap from experience. I do that all the time. The quality of that experience matters because it processes judgments about human nature. Natural language queries in finance must incorporate real-time effects of other humans acting on events.
The qualitative differences between the financial body of knowledge and the medical body of knowledge are extremely relevant to the utility of financial AIs. IBM's Watson can give consistent answers to medical queries because it can reference a body of knowledge validated by centuries of scientific experimentation. The available data points don't change after interacting with observers. Financial data behaves differently. Markets change because human decisions move them, and published interpretations of those changes move them further. This complex feedback system is similar to Heisenberg's uncertainty principle, and George Soros' The Alchemy of Finance discusses it in detail. My point is that a finance AI confined to interpreting historical data misses the real-time changes wrought by human interaction.
Mastering the effects of uncertainty, observer interactions, and black swans implies finance AIs need a different computational approach. Quantum processing may be the correct solution. If human observation of random events has quantum effects, a quantum computer driving an AI can deliver a more robust interpretation. This is all pretty far-out stuff. I look forward to seeing what the next generation of finance AIs can deliver.
I would be intrigued to see how municipal bond underwriters use collaborative tools to estimate the viability of infrastructure bond issues. That may be asking too much of finance types. My experience with a few investment bankers is that they are too intellectually lazy to do their own project work but will quickly steal someone else's analysis if they think it will enhance their sales pitch. I prefer to do my own homework, and that's why I prowl the Web for tools like TCAPP.
The next obstacle I've observed is more nebulous. The snobbery of students raised in elite households is real and very prevalent at top American universities. I encountered this firsthand in the early 1990s and it has worsened along with income inequality. The low-income students who are lucky enough to attend top-ranked universities will never truly find social acceptance from the vast majority of very privileged students they meet. Class distinctions are hardening in America and having a brand-name degree is no longer a path to upward mobility. I noted that SRA played two video studies of their best clients. I found it telling that one became a teacher and the other became a non-profit worker after graduation. Those are low-income, low-prestige occupations with zero upward mobility. That's what the ruling class wants now for its non-pedigreed graduates. We should do better.
The final obstacle I've noticed in society lies in the financial condition of the entities sponsoring financial aid. The federal government cannot run persistent budget deficits forever and it will eventually try to destroy its unfunded liabilities with hyperinflation. This will in turn destroy its ability to fund Pell grants and underwrite student loans. Private sources of aid will fare no better. The 2008 financial crisis devastated the endowment portfolios of Harvard, Yale, and other schools that had just made strong commitments to merit-based financial aid for low-income students. I fully expect a repeat of that episode, with no recovery. Private aid will have to fill the gap if private sources can survive hyperinflation.
Clark Kerr's California Master Plan for Higher Education defined clear roles for each tier of the state's post-secondary education system. Changes in our society's structure are destroying this plan's ability to deliver value. The junior colleges were intended to provide instruction in skilled trades for less intellectual students. They have become feeder schools pushing academically unprepared students into four-year universities. It should come as no surprise that college dropout rates are higher than ever. A feeder system that encourages academically unskilled students to take on debt for degrees they cannot complete is a broken system. Low interest rates have fed the student loan bubble but that will pop once the Federal Reserve loses control of the yield curve. The crash in funding sources - any way it happens - will further destroy the sustainability of California's publicly funded university system.
I was pleased to hear SRA discuss the potential of MOOCs as course offerings for students who can't join their mentoring program. MOOCs have the potential to completely blow away traditional resident universities in all academic subjects. I believe we won't even recognize the educational landscape a generation from now once a critical mass of middle class and poor parents figure out that their kids can train themselves for any career online at their own pace for free. No snobby brat can tell a poor kid they don't deserve a university education if the equivalent of that education is available on the Internet at no charge. The rise of MOOCs is a free-market update to the Clark Kerr plan's noble goal of providing affordable education appropriate to all skill levels.
I will suggest one way forward. I have written before on the potential for public option banks to address the financial needs of low-income citizens. I think they can also address the needs of disadvantaged students. If every state had a public bank, low-income students receiving financial aid through any government channels would be required to hold their money in this bank's no-fee checking accounts. The banks could also be conduits for financial literacy education. This ties together the delivery of aid and the maturation of the recipient.
Argentina is liberalizing its restrictions on foreign currency. IMHO that signals the beginning of that country's hyperinflation end game but we're nowhere near the denouement. Argentina would have to reduce the currency transaction tax to zero and allow other currencies as legal tender to truly end its crisis. The Fernandez administration isn't ready to throw in the towel on its failed micromanagement of Argentinians' economic choices. Argentina could have been a contender for world domination a century ago with its rich agricultural resources but its potential has been comatose since after World War II. Maybe it's all the fault of the bizarre Peronist combination of incompatible ideologies.
The global elite confab is studying more than just rate benchmarks. The Davos crowd sees broader risks in the emerging market sell-off. They give themselves too much credit. The crowd in the eye of the pyramid may be blind. The biggest risk right now is the lack of confidence investors have in the transparency of markets and the trustworthiness of institutions. The inability of elites to prosecute their own kind for financial malfeasance is the source of market distrust. Solve that with prosecutions and trust will gradually reappear.
I have a couple of meetings this week in the San Francisco Bay Area with some business folks and an event to attend. I'll let you all know what happens. Alternatively, maybe I won't let you know what happens.
Corporate IT departments must be at some new level of stupid if they can't encrypt laptops or secure transaction streams. I spent the better part of last year hearing the superstars of enterprise computing tell thousands of aspiring CIOs how cloud security is totally awesome. It would help if they addressed device encryption too.
Do you trust your bank to secure your credit payment history? Do you trust your email service provider to secure your messages and contacts? Do you trust your web host service to secure your digital storefront? These are all becoming very relevant questions. The enterprise computing sector needs to come up with the IT security equivalent of a Good Housekeeping seal of approval that retail users will trust. That probably won't happen as long as NSA backdoor agreements leave open gaping vulnerabilities that disgruntled insiders can exploit. The corporate IT sector needs help tying its own shoes; it still has some growing up to do.
Full disclosure: No positions in the securities of any companies mentioned at this time.
It's obvious that China's miracle economic growth is slowing down. The authors cited urbanization and an aging workforce as structural problems but glossed over the enormous cost of environmental devastation. Replacing coal in energy use will drive investment, but China is already running into opposition from its neighbors as hydroelectric projects on the Mekong River threaten water supplies to Southeast Asian nations. China's rush into sustainability is thus becoming a force for destabilizing regional relations. The panel did mention how Bay Area companies with expertise in sustainability are in demand in China but I suspect playing environmental catch-up will be more expensive than anyone thinks. Contrast this with the US's experience with environmental regulation starting in the 1960s. Environmentalism coincided with US urbanization and one force did not hinder the other's contribution to economic growth. China's central planners have a bad habit of tackling one economic theme in full force and leaving others to languish. The environmental sustainability push now may leave little planning flexibility for addressing the country's aging work force or inadequate health care system. This is the fundamental flaw in centrally planned economies that even bullish Wall Street cheerleaders ignore when they sell more Western investors on Chinese joint ventures.
Speaking of joint ventures, Silicon Valley Bank has one in China. SVB lends to most of the VC-backed startups in the US, so it must think it can replicate this success with Chinese small and medium size enterprises (SMEs). They see opportunity in the Chinese bank sector's focus on SOEs, real estate, and municipal governments at the expense of SMEs that want to expand. I see risk in SVB's approach. Asians traditionally present a different face to Westerners than they do to their own familiars. It's a cultural trait that is still particularly pronounced in China. I am not the only financial analyst who has noted that China's economic statistics are largely fabrications intended for a foreign audience. The Heritage Foundation deconstructed China's imprecise financial picture in 2013. Western banks penetrating China's interior in search of growth will learn hard cultural lessons for the next few decades as Chinese partners present them with deceptive results. American bankers need to read the history of foreign hongs that penetrated China's interior during the colonial Hong Kong era for a glimpse of what they can expect.
One of the panelists noted that foreign banks still can't use renminbi within China. No kidding. China invented that currency as the foreign version of the yuan because it did not want its domestic currency to be fully convertible. Check out the Shanghai Free Trade Zone, where the Chinese government is specifically chartering branches of non-Chinese banks that can freely exchange currency. The CFR gave a good run-down of the Shanghai FTZ last year. The opening of FTZ footholds for foreign merchants and bankers to penetrate the interior follows the precedents set through centuries of trade concessions. Like I said above, Western businesses need to read up on the histories of hongs and national trade legations before they start smacking their foreheads in frustration. Closed Asian societies open on their own timetables, in their own ways.
China has allowed a huge banking sector to grow in record time. Much like the ghost cities and empty malls that litter China's interior, these banks are impressive but dysfunctional so long as they serve state planners' interests in presenting an image of success to the outside world. The "shadow banking system" of weakly collateralized securities sold to the emerging middle class as wealth management products (WMPs) is a disaster waiting to happen. Next week will reveal whether a default on a half-billion dollar WMP will affect ICBC. The inevitable detonation of a significant portion of WMPs tied to non-performing real estate may trigger a collapse in confidence in the Chinese banking system that forces the PBOC to intervene. I have no idea where the PBOC will obtain the liquid resources it can use to backstop WMPs. It has been injecting enormous amounts of liquidity into China's overnight lending markets to stabilize repo rates, and another huge bailout will stress it in unforseeable ways. Imagine the black swan implications of PBOC selling off some its US dollar reserves to raise yuan it can use to backstop a run on its own banks by Chinese middle class savers. Even if China can contain a WMP implosion, the evaporation of middle class savings intended for health care expenses and childrens' education will dash whatever hopes the country had for adding a strong consumer spending component to its GDP.
The panel's speculation that Chinese SMEs are capable of untold innovation strikes me as a cultural mirroring effect. We see what we want to see in Chinese entrepreneurs while we are ignorant of Chinese culture. Innovators think differently partly because they're genetically hard-wired to break molds. Western cultures that elevate individualism over tribal identification attract misfit immigrants and celebrate idiosyncratic underdogs. Where is the cultural evidence that this is tolerated in China? Confucian societies value filial piety, ancestor worship, and hierarchy for the sake of hierarchy. Those are not cultural conditions conducive to innovation. I would like to see evidence that major Chinese technology companies are capable of incentivizing the three types of innovation I heard US tech executives talk about earlier this week at the Commonwealth Club. I will give the panel and their report credit for mentioning the Chinese Enterprise Association and the China Energy Group at LBNL. Innovation and technology transfer are things the West does very well. China does not yet do them well. I expect many Chinese engineers and middle managers will experience cognitive dissonance when their corporate mandarins hand them "innovation goals" they must meet. We will see the results of this cultural trait grafting experiment in China's GDP, assuming state economists don't falsify the figures.
I read broadly to avoid confirmation bias. I like opinions that are different from the norm, in all directions from my own. This leads to the discovery of some pretty radical assertions that beg fact-checking. The lesson for would-be fact-checkers follows later, so I ask your patience.
My interest in mining and energy investments has sometimes led me to Peak Oil websites. The resident doomsayers claim the nearsightedness of the world's scientific establishment blinds us to the pending end of advanced civilization. One radical cites a common quote wherein Aristotle supposedly observed that a fly had only four legs and naturalists repeated his observation for centuries without any independent verification. That is just total baloney. No such thing happened. This science blog article "Aristotle On The Mayfly" deconstructs in detail how this false canard was born. It just goes to show that plenty of scientifically-minded people have been sufficiently curious for thousands of years to fact-check simple observations. Dogmatism among lazy "thinkers" with angry agendas inhibits quality research.
I want to contrast this empirically based behavior with the attitudes of other less inquisitive humans I have experienced in modern America. I have contacted a large number of people in my local area who have had contact with one very glib and crafty Stolen Valor fraud. His lies are easily disproven with a Google search of his name, but the people who continue to support him show absolutely no interest in checking facts for themselves. They instead recoil in anger when presented with facts and continue to enable this person's lies.
I marvel at the stupidity of my contemporaries. I have tried to understand this behavior from many angles. Perhaps accepting comforting falsehoods provides humans with emotional satisfaction. That would certainly explain the persistence of the world's monotheistic mystery religions well past the birth of scientific rationalism. It may be that the people I've tried to warn are just lazy or stupid. That puts them in good company with the majority of the human race.
If my focus on facts is insufficiently impressive, then karma will have to suffice. The universe does not tolerate injustice indefinitely in human affairs because even extreme behavior reverts to some mean. I do not tolerate injustice at all if I have the power to fight it. The vile Stolen Valor criminal who hides among The City's steel canyons will eventually meet justice in our nation's court system and his supporters will be powerless to help him. I do not expect them to understand what will happen or why, any more than I expect dogmatic radicals to perform deep background research on how ancient philosophers addressed scientific knowledge. That is simply too much to ask of most humans.
I still remember the awesome movie Crouching Tiger, Hidden Dragon that took America by storm at the tail end of the dot-com era. Americans were fascinated to see acrobatic Chinese martial arts and swordplay. Well, there's none of that on display at my blog but I think it's a cute segue from this article's title into a couple of news items I noticed today about financial corruption. I'm all about cheap thrills.
The second item is the continuing capital flight from China's ruling elite. China's military and political leaders continue to move their families' wealth into offshore accounts. Western financial institutions have played key roles in setting up the trusts and other legal mechanisms enabling this capital flight. This isn't just about avoiding taxes in their home country. The remaining China bull shills like Jim Rogers need to read this news and take a hard look at their own bets on China's future. I have every right to question Western investors who tout China's prospects while China's own leaders move their wealth out of the country.
These two news items aren't directly related, but they do indicate the lengths to which financial and political elites will go to maintain untenable fictions. The US sovereign credit rating should be an honest barometer of fiscal sanity. China's elites should not fear transparency for their financial interests if they are truly optimistic about investing in their own country. These are ideal conditions that unfortunately do not hold in the real world. That's just too bad.
I've heard a few things over the years about innovation. I heard a few more tonight at the Commonwealth Club event "R&D, Innovation Labs and Channeling Your Inner Startup." Large enterprises that have their own internal innovation efforts don't like discussing the secret sauce behind their creative process. I suspect a common approach has something to do with mixing specialists and generalists on cross-functional teams. Maybe they pick people who are naturally creative and driven, or who are misfits and need an unstructured outlet for their frustrated ambitions. I'm less interested in the interpersonal dynamics of enterprise innovation and more interested in the institutional processes that link innovation to strategy.
Prevailing wisdom holds that there are three critical paths to innovation, all of which tonight's CW Club experts understood. The first path is top-down, driven by product managers. The second path is from a distinct internal lab, like the classic case studies of Bell Labs or Skunk Works. The final path is from bottom-up intrapreneurship. I think these paths all have peculiarities that demand some kind of governance to ensure they stay on track and accomplish bottom-line results. The top-down path can be subject to internal political fights for resources and may ignore innovation that can move business units into more desirable quadrants on the BCG growth-share matrix. The internal lab can waste resources on ineffectual projects, like government scientists in the Federal Lab Consortium who sometimes churn out busy work to justify budgets. The bottom-up path intrigues me most because it can be an outlet for the pent-up creativity of unheralded performers, but it can go nowhere without incentives. I think gamification can incentivize plenty of little ideas that can later be subject to Technology Readiness Level (TRL) scrutiny.
I like arguing from first principles because it provides an epistemological foundation for whatever comes next. It's also a great way for me to show off my stellar intellect. My principles are quite bold, in bold type.
Link innovation to strategy. The top leaders of a small startup or large enterprise determine overall strategy. I mentioned the growth-share matrix above because it used to be a popular tool but its critics prefer to include more measures of profitability. That's why nature and Providence gave us key performance indicators (KPIs) and SWOT analysis. The strategy derived from these concepts should drive innovation goals that bolster strengths and mitigate weaknesses. This philosophy can prevent innovation from falling into a "paralysis of analysis" that destroys focus.
Measure innovation the way VCs measure startups. Success metrics for enterprise innovation have readily available comparables from the way VCs evaluate, fund, and manage their startup portfolios. One truism is that a stereotypical VC will look at 1000 business plans, listen to 100 live pitches, fund ten startups, and harvest one success. Let's copy that funnel and graft it onto enterprise innovation. Start with random generation of 1000 off-the-wall ideas, write the best 100 into basic proposals that are testable against the firm's KPIs, launch the best ten as live projects after assessing their net present value (NPV), and harvest one big success.
Use multiple testing methods, rapidly and repeatedly. This VC-style 1000:1 funnel helps innovators "fail quickly" by rapidly testing ideas and dropping the ones that are unlikely to succeed. Enterprises with a separate internal lab may have an advantage in testing if they can run projects that "decouple from a brand" in Lean Startup terms. Crowdsourcing and Twitter A/B testing are methods to covertly launch trial products to see if they gain CustDev traction.
Define success as meeting specific KPIs. A startup's KPIs are more growth-oriented and time-constrained than those of a large enterprise. Their definitions are different. The "success" of an externally oriented project is defined by its ROI compared to the capex spent on generating the 1000 ideas that led to its creation. The "success" of an internally oriented project can be defined as improvements in quality control or business processes that reduce cost or avoid liability.
Design a KM process to document innovation. The knowledge management role is to archive the 1000:1 process, locate the most successful iterative path from idea generation to ultimate success, and replicate that path in future iterations. KM should also track active projects the way VCs track their funded startups. The final documentation of an innovation series won't bear much resemblance to a typical BPM improvement effort. It will look more like case management with an artisan approach to photographing prototypes and archiving program code. KMWorld has an excellent white paper on BPM and case management.
Senior management's ultimate role is to link the innovation strategy that strengthens the enterprise's SWOT position with whichever of the three innovation paths resides within the firm's structure. The cultural incentives will be different for each path and the KM case documentation will be different for each result. That's the cool thing about innovation. It's always about something different. Vive la difference.
Alrighty, then. My regular monthly portfolio review and alteration timeline was delayed by one day because yesterday was a federal holiday. I believe the Reverend Dr. Martin Luther King would be proud of my financial self-reliance. Whatever. Today is the first trading day after an options expiration weekend, so I had to look at my money.
My covered calls on GDX in my IRA were exercised when the market price of GDX rose through the strike price. This is good news, as I had been forced to buy a bunch of GDX late last year when I wrote some cash-covered puts under that security. I repurchased a much smaller amount of GDX to maintain a more normal allocation. The rest of what I didn't commit remained as a slightly higher pile of cash in my IRA. I still consider gold mining stocks to be a hard asset hedge but they are not my ideal preference. I may add other hard asset hedges as they become affordable.
My covered calls on FXF in my IRA expired unexercised. I renewed them for next month. I consider the Swiss franc to be a well-managed currency and I am impressed with the way that country's central bank has stabilized its value.
I remain long GDX, FXA, and FXC in my taxable account. I consider the Australian and Canadian currencies to be hedges against US dollar hyperinflation. I have noticed significant pressures on those currencies from the relative strength of the dollar and euro but I consider that condition to be temporary. I have also noticed inflationary concerns rising in Australia and Canada but I remain convinced that those nations will not do foolish things to devalue their currencies. They don't have any quantitative easers like Bernanke or Yellen running their central banks.
In a departure from my investing pattern through much of 2013, I have sold covered calls on my holdings of GDX, FXA, and FXC in my taxable account. My opportunity cost of not writing these calls last year was high. I do run the risk of seeing these holdings called away but that is a risk I can tolerate for the next month. I wanted to get back in the habit of generating cash from an options strategy, which has absolutely done very well for my net worth over the last decade. I actually enjoy seeking volatility and risk provided I have tools to manage my exposure.
I maintain a long put position against FXE. I still think that common currency is toast. I do not expect the euro to last forever, let alone become an alternative to the dollar as the world's reserve currency.
I'm still sitting on piles of uncommitted cash. I'm not buying into an overpriced US stock market. I await a deflationary asset market crash, followed by a hyperinflationary policy response. I am not in the top 1% but I have enough to live comfortably. I anticipate radical changes in economic conditions and asset prices that will transport me far ahead of many other people I know. I consider equities (and their ETF equivalents) in public storage, timber, mining, energy, and agriculture to be appropriate for my cash, along with equities in logistics sectors that service those sectors. I just want to see heavily discounted prices.
I'm going to say this one more time. What I do with my own money is not ever supposed to be some kind of advice or guidance for what other people do with their money. I do not give financial advice to investors and I do not care what anyone else does with their money. My decisions are in accord with my own goals and risk tolerance, which might as well be in another universe separate from the rest of humanity. The world may observe my genius and marvel at my magnanimity. That is all for now. Go back to work, people.
The state government has made the California Water Action Plan an interagency effort. The undated draft makes it clear that water supplies are stressed and California must manage demand more carefully. The plan states that over seven million Californians live in a floodplain, and later states that large amounts of floodplains and other natural habitats have been lost in modern history. The connection is obvious to me. Development in floodplains puts humans and habitats in danger. IMHO the state government is in dire need of a UN Agenda 21 smart development plan that will prohibit further residential development in floodplains and gradually unbuild legacy development.
The Bay Delta Conservation Plan is a comprehensive attempt to preserve an ecosystem that sustains California's agricultural might. Without this plan, I believe there will not be enough water available in Northern California to support both agriculture and the need for eventual oil and gas drilling in the Monterey Shale Formation. Southern California developers and residential property owners are probably going to be very disappointed that their fantasies of comfortable life in the desert can longer be sustained by intrastate water transfers. Metering and rationing mean the California golden age of lush front lawns and leisurely car washes is closing for good.
It's really funny to hear SoCal politicians talk up the fairness of charging ratepayers for new water development. Any further infrastructure development that diverts freshwater to SoCal will move the saltwater gradient so far inland as to make much of California's agribusiness nonviable. It makes zero economic sense to invest in infrastructure projects that benefit agriculturally poor land at the expense of agriculturally rich land. SoCal ratepayers would eventually face a death spiral of higher water rates to sustain more expensive crops, while those crops are gradually priced out of world markets. Adding water infrastructure in Kern County will be wasteful investment as more farms in that region become untenable and cease operations.
I see the following business opportunities based on this emerging regulatory framework.
Water utilities. I have never been impressed with the financial performance of US publicly traded water stocks. I may have to reconsider this stance, at least for companies that serve the California market.
Disruptive water technologies. Cleantech entrepreneurs can make a difference with new solutions in water delivery, recycling, and decontamination. SoCal's soil and climate may not be suited for water-intensive agriculture. This is one reason why drip irrigation will address a much larger market than flood systems. Oh BTW, water rationing implies that flooded crops like rice will play less of a role in California's economy. GMO crops may have a future if more independent research helps paranoid people get over their hysteria.
Smart metering. This one's a no-brainer. Any unmetered residential parts of California - aside from those suburbs that will eventually become uninhabitable and marked for deconstruction - will soon be metered. Any vendor of smart meters for water delivery can expect large orders from California utilities.
Desalination. Making fresh water from seawater along the California coast has long been a policy pipe dream. The state DWR has a desalination plan for grants and small experiments. Desalination plants on a scale to meet SoCal's needs will require a huge investment. The opportunity exists for visionaries with deep pockets and giant visions. The market for water in SoCal is huge and water from the Delta won't supply its needs forever. Use your imagination. If you build it, they will come.
I foresee more regulatory control and microeconomic changes in the future, regardless of whether the private sector steps up to the water opportunity. Here are my predictions for California. New residential developments will minimize or prohibit front lawns and private swimming pools. Existing homeowners will remove lawns and replace them with local native plants or drip irrigation gardens. Some suburbs will cease to exist and be unbuilt, either because their municipalities are bankrupt (Bell, Stockton, Vallejo) or because they are environmentally untenable. Many golf courses, especially in SoCal, will cease operations. Those courses occupy space that will be more valuable as farmland or watersheds. I don't like making bad investments. Much of suburban California is malinvestment that will come undone in prolonged periods of water austerity.
One thing will not change in California's future hydrology cycles. I will find a way to make money from the state economy's transition to more strictly controlled water use. That is why Alfidi Capital exists. Water and money both seek the path of least resistance.
Deconstructing decision trees. Human beings have a hard time thinking in probabilities. Weighing probabilities and using game theory don't come naturally to most of us but they are teachable subjects. Decision trees for project options are particularly valuable but discarded options may come into play later as "branch and sequel" plans if a selected option fails. This is why documenting rationales for decision tree options matter. The article "The Curious Case Of A Broken Crumb Trail" from KMWorld March 2013 describes the utility of creating an Option Outline documenting the reasons why various project options were considered and discarded. This allows project managers to revisit archived knowledge for tips on alternate ways forward if a main effort runs into trouble. I think this approach to documentation is especially valuable for documenting options in decision trees.
KM governance of DM rules. This is a discovery I stumbled onto last year after hearing experts describe the advantages of automated business rule management systems (BRMS) engines. Automating every routine thing is great, and AIs can help, but human decision makers must remain in the loop at the top. Regular manual updates to the KM collection guidance insure that managers capture results that inform strategic key performance indicators (KPIs). Top management must publish those KPIs in media where every subordinate manager can track them.
Business continuity planning. This should be well-established by now in large organizations but small and medium enterprises (SMEs) should also do it. This is more than buying insurance. A business continuity plan should start from the SWOT matrix's identified environmental threats and continue with a risk assessment of hazards graphed in a 2x2 matrix. That's right, folks, I'm talking about severity versus probability once again.
A culture of honesty. I thought about putting this one up front but I decided it would be more effective as my last point. Human beings typically don't use Bayes' Theorem to update their assessments of conditional probabilities; they instead overweight the most recently acquired information. I may have misstated that explanation in the past. Whatever; I have to include this to salve my own conscience. Highly ethical organizations cultivate trust vertically and horizontally, which makes sharing information easier. It also accelerates actions during a crisis because teams that are honest and trusting won't hesitate to execute good decisions. This is my understanding from personal experience with both trustworthy and untrustworthy people.
These principles are worth incorporating into a continuous improvement model. Most people won't do it; they'd rather just wing it through life with no data supporting analysis. That's totally understandable in light of human nature. My thinking is for the handful of people on this planet who truly think for themselves and care about things that matter.
I first noticed Derma Sciences a few years ago when they garnered some notice for marketing a honey-based topical wound application. I'm checking up on their progress. I don't know why they put their management bios on the investors relations page but I have to deal with it. Their CEO has a background in managing life sciences companies with two acquisitions. That's good, and the rest of the management team has bench strength in life sciences.
Derma Sciences offers other products besides the honey wound treatment I first noticed. I'm not knowledgeable enough on the scientific qualities of their other products to evaluate their effectiveness. It's good to have patents, but I have questions. Do any of their anti-microbial applications cause allergic reactions? Is there enough supply of honey and other inputs to support projected sales growth? I admit that I don't have the answers at this time.
The share price has seen a dramatic run-up since the beginning of 2011. The high price is odd in light of their financial performance. They have experienced continuing annual net losses, although they announced record revenue for 2013. Their retained earnings likewise experience continued annual declines, indicating their bottom-line results are not adding value despite the rise in the share price since 2011. I like honey, especially the organic varieties found in San Francisco boutique markets, but I can't understand Derma Sciences' prospects well enough to include it in my portfolio.
Full disclosure: No position in Derma Sciences at this time.
I have analyzed tons of penny stocks on this blog. Quite a few of them are destined to go exactly nowhere. I continue to marvel at the gullibility of investors who think penny stocks are a secret source of bonanza. The only real source of bonanza for me is the genius research at Alfidi Capital but penny stock pumpers are too dumb to understand my thinking.
I read with dismay the unverifiable claims of one investor on a blog comment stream who says the "trick" to making money in biotech penny stocks is to somehow get in front of their momentum while they're burning cash and get out before the next private placement dilutes shareholders. I've got sad news for this idiot. No one can predict when a management team will launch its next private capital raise. Any current investor who knew in advance that one was coming and tried to get out could face SEC charges of trading on material nonpublic information, especially if said trade moves the price of a thinly traded stock. Lots of penny stocks are thinly traded.
Unexpected bad news can interrupt the short-term penny stock investor's thesis of trading for quick gains. A drug company that discovers bad side effects from a trial or a mining company that discovers poor grade ore can't keep that news a secret from the market. News events move the prices of penny stocks, and bad news moves against the penny gambler crowd.
There's no good analogy between penny stocks and poker. Every hand in poker is different and the ability to calculate conditional probabilities, apply game theory, and read an opponent's expression can help reduce risk. Those abilities are not as useful in penny stock investing as the ability to read balance sheets, estimate market size, or compare the price points of comparable products. I've done that on this blog for some biotech stocks.
I once knew a fellow military veteran who bragged about her recent investment in a penny stock. Her logic was hilarious. "It's only a few cents a share, so it's a bargain!" I did not laugh in her face but she was too dense to read my expression of dismay. Her due diligence consisted of looking at the share price. That is totally stupid but lots of penny stock investors think that way.
I haven't found much peer-reviewed academic research on penny stock investing. A few web queries didn't turn up much besides the usual pumping sites and message boards. There may be some room for original thinking in this area that I could publish myself, if only to debunk some of the folk wisdom that dummies use when they "invest." I like this FMA paper, "Too Good to Ignore? A Primer on Listed Penny Stocks" because they located good source data to determine whether a penny stock portfolio generates alpha.
I don't listen to penny stock investors, or the paid touters who pump them into stupid investments. I look at underpriced stocks from a private equity perspective to understand whether a ten cent gamble will ever become a ten dollar share. That transformation happens when talented executives meet their development milestones, launch viable projects, and grow market share. It happens in hard asset sectors when academically qualified geologists and engineers successfully pull ore and energy out of the ground at costs below the historical average price of their target commodity. I have not yet invested in a penny stock. I'm not saying I will never buy one, but I have to believe in its business model.
I first noticed Victoria Gold (VIT.V / VITFF) back in 2010 but I must have forgotten about them. I'll revisit them now to see if I missed anything in the intervening years. Their current CEO is different from the one they had when I first noticed the company. That's good because at least this guy is a mining engineer.
Their Eagle gold project up in the Yukon has 2P reserves. That's good; they've made progress on this project even though the 0.78 g/t Au grade isn't stellar. Their estimated operating cost is just below the long-term average historical price of gold, so the project should remain viable as long as the cost doesn't rise. They estimate an initial capital cost of C$382.8M. Remember that figure. I won't evaluate their other Yukon properties because they're still in the exploration stage with no 43-101 reports.
Their Nevada project is the only one remaining from several they were exploring in the state back in 2010. This site used to be a productive open pit mine for gold and silver but I need to see a 43-101 report that covers more than just a few initial drill holes.
Now, back to that initial capital cost I mentioned above. I looked at their financial statement for the quarter ending August 31, 2013, the most recent one available. They had over C$14M in cash on hand and their burn rate is over C$300K/month. They'll have to raise another C$368M to start operations at Eagle. Photos of the site show a road network and mining camp, so some of the infrastructure is in place.
It's too early for me to invest in Victoria Gold but I am pleased that they have made progress on their most promising project. I'll revisit this one later once they have secured sufficient financing.
Full disclosure: No position in Victoria Gold at this time.
Stellar Biotechnologies (KLH.V / SBOTF) makes targeted therapeutics from keyhole limpet hemocyanin (KLH). This protein is cultivated from mollusks called keyhole limpets in some kind of aquaculture. The CEO is a scientist who invented the extraction method this company uses, and he formerly ran an aquaculture company. I can't think of a more appropriate combination of scientific and business backgrounds.
I am impressed that a single source of protein enables multiple products in vaccine carriers and test kits. Vaccine carriers typically have cold change storage requirements, so it will be interesting to know the shelf life of a KLH-based product. I am further intrigued that this business model does not depend on the success of one specific vaccine because the basic protein can be adapted to the needs of multiple vaccines.
Stellar's success depends on executing licensing agreements rather than clinical trials. I searched SEDAR for their financial statements because I didn't see anything useful in EDGAR. Their annual statement for the year ending August 31, 2013 showed almost US$7.9M in cash on hand, and annual losses of almost -US14.9M. They still have to raise significant amounts of money because their increasingly negative retained earnings shows them going farther in the hole every year since 2011.
I think their technology holds promise, but they need to execute some licenses. Negligible revenue for a company that has been publicly traded for almost four years makes me wonder whether vaccine makers are getting Stellar's value proposition. BTW, other companies (such as biosyn) also market KLH products. Stellar must show the market some major clients to prove it has something worthwhile.
Full disclosure: No position in Stellar Biotechnologies at this time.
Mast Therapeutics (MSTX) has continued to make progress since the last time I checked them out in February 2013. I need to clarify one hurdle they must surpass to be competitive. I had mentioned the per-pill dosage cost in my last article as a comparable price point of a competing product. Their drug MST-188 is injectable as an acute treatment, so comparing it to pills would not be an apples-to-apples analogy.
It's good that they're trying to apply MST-188 to other ailments besides sickle cell anemia. This potentially gives them fallback options if the Phase 3 trials for sickle-cell patients are not productive. Oh BTW, they still have a page on ANX-514 but I don't see any recent developments with that drug.
Note their 10-Q for November 4, 2013. Their expenses for the MST-188 clinical studies are increasing. Their SGA expenses are increasing even though they're not selling anything. I did mention in my last blog post on this company that they would need a lot more cash to conduct their trials. They priced an SPO in June 2014 but I do not see a follow-up press release on when they closed the fundraising round. I will continue to check up on Mast Therapeutics as it moves forward.
Full disclosure: No position in MSTX at this time.
The Center for Financial Services Innovation (CFSI) does really good work on theoretical banking solutions for unbanked people. I call it theory because we won't know whether these ideas work until society tries them on a large scale. I suspect many of the market-based approaches to reaching the unbanked population will fail for reasons that have little to do with market size or product scalability. They may fail because of the quality of the people involved.
Smartphone adoption is very high among the same low-income demographic common to the unbanked population. The problem is that they are unable to harness the full effects of mobile technology because they can't afford or don't understand the monthly data plans they must also purchase to download apps and use them in commerce. This indicates to me that the unbanked are terminally parochial and even stupid. I can understand a reluctance to buy something unaffordable for lack of financial resources. Hey, I've been there myself and I still can't afford a yacht or private jet. I just cannot understand paying hundreds of dollars for a fancy smartphone knowing that the full data package needed to use its apps is unaffordable. I think many unbanked people just make impulse purchases for shiny things. The cargo cult mentality dictates that the outward trappings of technology are sufficient to generate a high-tech lifestyle. This translates to the unbanked crowd as "get smartphone, look like rich person." Marketing cheap banking solutions using mobile tech simply won't reach the unbanked who have to stop paying for cable TV and landlines just to afford food!
Startups who think they can change human nature while salivating over the size of the unbanked market must read a copy of The Unheavenly City Revisited several times. Most of the poor will stay poor because they are at the dumb end of the bell curve and lack impulse control. They are constitutionally incapable of using a high-tech solution. Banks learned hard lessons in the last decade by pushing stored value cards and other prepaid solutions to the unbanked. The poor forgot that they had dormant accounts, or never learned how to use them, or forgot how to use them once they learned the steps, or never accepted digital deposits as real money because they couldn't hold the digits in their hands like hard cash. That cargo cult never left the beach, if you know what I mean. Don't even get me started on Bitcoin as a solution; those transactions can't be reversed and the unbanked are too immature to safeguard their part of the encryption key. Pushing mobile apps and other tech solutions to the poor is like feeding sushi to a goat. They just can't acquire the taste.
The unbanked do use some rudimentary financial services, specifically those that use low-tech interfaces. Migrant labor from emerging economies to developed nations creates a huge market for money remittances. I've blogged before about how Google Wallet gives users the ability to literally email money as an attachment. Such a simple technology attains full value as more than a remittance mechanism. It may be a way to store multiple currencies in a single account as a hedge against hyperinflation in a single country. It may even be a way to avoid capital controls because it doesn't transmit via monitored wire transfer architectures. That's all too advanced for our unbanked friends, but I had to throw it out there.
I have a humane solution to the problem of the unbanked population lacking access to real banking solutions. I want every state in the United States to charter its own public option bank. The public banks would be much like the Bank of North Dakota. They would offer no-cost checking and savings accounts and low-interest loans. They will not offer advanced merchant services, commercial banking, capital markets trading, or wealth management because a public bank cannot replace the private sector. The public bank fills a gap in financial services that is mostly unreachable. It can even enable poor people to establish credit histories through microlending, along the lines of Grameen Bank. Once the banks are stable with a large client base, they represent a contract opportunity for cheap "white label" insurance plans.
A public bank account can also be a conduit for deposits from social service payments: unemployment payments, workers' compensation insurance, SNAP/EBT, and other such programs. Mandating these deposits for a public bank account helps monitor their use. Payments can be conditioned on completion of financial literacy classes, parole obligations, and other duties that public assistance recipients owe the taxpayer.
The private sector is well aware of the high cost of customer acquisition for unbanked customers, given their technological illiteracy and low profitability. A public option bank can reach its customers in channels where they spend much of their day. Street teams are a well-developed marketing tactic for generating word-of-mouth buzz among early adopters. Let's adapt this concept for the bottom quintile. I would have the public bank hire its best customers to run street team patrols at county welfare offices, unemployment offices, day labor pickup sites, courtrooms that try petty offenses, drug treatment centers, halfway houses, and DMV offices. The street teams can partner with social workers and parole officers to increase their chances of contacting the unbanked.
The parts of the unbanked population that hail from countries where the rule of law is weak are naturally reluctant to trust big, impersonal institutions like private banks. That makes personal contact through trusted channels all the more imperative for the public bank. I'm not being facetious at all. The next US financial crisis will once again weaken private banks and private payment mechanisms, and whatever outreach they made to the unbanked prior to that crisis will have been for naught.
I maintain that the public option bank is the best solution a capitalistic society can offer its least financially able participants. It is part deus-ex-machina governing humans too inept to govern their own affairs. It is part social control mechanism for a permanent underclass that is otherwise a source of pre-revolutionary instability. Forget about pushing high-tech unbanking solutions through hackathons and competitions like FinCapDev. Those won't work until the unbanked underclass is herded out of the underground economy and into a nanny state solution like a public bank. The poor must at least go through the motions of capitalism until they are habituated to responsible decision making, or at least a reasonable facsimile. I would not fund a startup pitching financial services to the unbanked unless it allows for adoption by a state's public bank. Entrepreneurs need to spend some time at inner-city convenience stores watching the unbanked "invest" in lottery tickets and malt liquor before they try a high-tech solution to poverty. People are hard to change, but give them a public bank as their new cargo cult and they'll at least adopt the proper rituals.