Taylor’s An Introduction to Austrian Economics (Selections)

~200 words, ~1 min reading time

The full text is available from the Mises Institute or from Amazon.

Introduction – What distinguishes the Austrian school: (1) devotion to a deductive method aimed at conceptual understanding, (2) methodological individualism – seeing economic phenomena as the result of individual actions.

The Subjective Theory of Value – Value is fundamentally subjective. Even prices are the result of subjective valuations of amounts of money (and their expected eventual use) and the goods that are being traded for that money. Producing for exchange means that we need to consider not only our own preferences, but also the preferences of our buyers. The fact of subjective preference suggests that there is no “economic man” who is bound purely by monetary calculations. Rather, monetary concerns are balanced against other concerns as well. For example, anticipating modern behavioral economics and the idea of “bounded rationality”, Bohm-Bawerk points out that the process of economic calculation is, in itself, costly in terms of time and effort. So, for trivial matters, it is probably best to follow general heuristics, saving the effort of monetary calculation for larger matters where precision is more important.

Mises’s Economic Freedom and Interventionism (Selections)

~200 words, ~1 min reading time

Full text available from the Mises Institute or Amazon.

The Individual in Society – This chapter is about the meaning of “freedom”. Mises suggests that there is no such thing as “freedom” from nature. All people are bound by scientific laws. To be meaningful, “freedom” then is freedom from the arbitrarily imposed will of others. At the same time, complete freedom from the influence of others would come at the price of abandoning all social relations. A market economy based on private property allows for interactions that enhance our productivity, while still allowing people to be free from compulsion and coercion. Historically, those who want to subvert freedom have tended to shift the definitions of terms – suggesting that employees are “wage slaves” rather than being really free, for example.

The Elite Under Capitalism – People are born unequal in certain respects – leading to “superior” and “inferior” people. In precapitalist societies, the superior used violence to take advantage of the inferior. In the market economy, the superior can only benefit by serving the inferior – producing products that the inferior are willing to pay enough for. So, in a market economy, the consumers – most of whom belong to the “inferior” group – end up “ruling” the superior – in that it is the masses of consumers that determine how profitable a business will be.

An Analysis of Infinite Banking / Bank on Yourself

~2800 words, ~15 min reading time

In my previous post, I explained a bit about how whole life insurance works – in particular trying to explain the idea of “cash value” and where it actually comes from. (Something that both the industry and critics get wrong, with just one exception that I’ve found.) This explanation was sought out and brought on by interest in the Infinite Banking Concept (IBC) or Bank on Yourself (BOY).

The basic idea: when structured carefully, a whole life insurance policy can be used as a savings instrument that can replace your need to take loans from banks. It’s really that simple. Now, let’s get into the “how” and “should I”?

How Does It Work?

As I previously explained, whole life insurance policies build up a cash value – which is basically a buyout offer from the insurance company to get you to cancel your policy so they can avoid paying the large death benefit. In order to maximize that buyout offer, you need to carefully structure your life insurance policy so that it’s worthwhile to buy you out quickly. How you do that: structure things so that you pay the premiums early in the policy.

At the extreme end, you would buy a “paid up” policy where you only pay once. And, this policy DOES build up cash value fastest. If you wanted to invest, say, $1000 per year, buying a paid up policy each year would build up cash value MUCH faster than getting a basic whole life insurance policy with a $1000/yr annual premium. But, there’s a catch: taxes.

For whatever reason, the government has decided that earnings in life insurance policies shouldn’t be taxed as long as you don’t access them until late in life (or after death…). This is a handy benefit. HOWEVER, the government has also decided that paid-up insurance isn’t REALLY insurance. It’s just an investment – called a “modified endowment contract” or MEC.  So, using the “buy a paid-up policy each year” plan would result in negative tax consequences.

So,  Infinite Banking/Bank on Yourself set out to maximize your cash value while, at the same time, avoiding the negative tax consequences. So, here’s what they do (this is from Bank on Yourself):

(1) Start with a standard whole life insurance policy with a smallish death benefit.

(2) Tack on a Paid-up Additions Rider – in effect, this rider lets you ADD paid-up insurance to your standard policy. As long as the proportions are right, since the tax man analyzes the policy AS A WHOLE (basic policy PLUS the riders), this can allow you to build up cash value more quickly than the basic policy would while still avoiding the negative tax consequences of an MEC.

(3) Tack on a Term Insurance Rider – this increases your death benefit for fairly cheap. Since the MEC determination is based on a comparison of your premiums vs. the death benefit, this rider allows you to put MORE into paid-up additions. Eventually, you can let this rider expire if you follow the Bank on Yourself method. The dividends you get from the whole life insurance policy will build up your death benefit to the point where you don’t need the term rider to allow the larger paid-up additions.

Sound complicated? That’s okay. This is why Infinite Banking and Bank on Yourself recommend that you NOT try to cobble this thing together on your own. Instead, both are assembling teams of agents who are trained in their techniques – which are pretty similar to each other, as far as that goes. And, unfortunately, life insurance is so highly individualized that you kind of HAVE to talk to an agent about your case. (Or is it just me that hates to talk to people trying to sell me things?) I’m just laying out the basics so you have some clue what’s going on.

Once you’ve built up a cash value, you can then access it in one of two ways:

(1) you can withdraw as much as you have put in – this involves a partial buyout, so you sacrifice some death benefit. (Withdrawing more than this sparks tax problems.)

(2) you can borrow from the insurance company, using the cash value as collateral – this allows the cash value to continue accumulating and does not sacrifice death benefit. If you happen to die before you pay the loan off, then the insurance company will subtract the amount of the loan from the death benefit. This option allows you to use the FULL cash value now (at least as I understand it…) – not just the premiums that you put in. Of course you have to pay it back, or the interest (interest rate 8% from what I’ve seen) may accumulate to the point where the insurance company cashes in your policy for you to make sure the loan gets paid. Basically, like with a bank, you can withdraw money from your account without putting it back in – it just means it’s not there in the future. And, like with a bank, if you don’t pay the loan you might lose the collateral. Policy loans are just a LOT more flexible than bank loans.

The Problem with Analyzing IBC/BOY

The problem I ran into: I like to analyze things myself without a sales person looking over my shoulder. So, I didn’t want to contact a trained agent to ask about the details for one of these policies. I would probably end up feeling guilty enough to buy one if I did that, just because they invested their time in talking to me. But, life insurance companies seem to keep information about their policies under lock and key. It’s VERY hard to get the detail I wanted without giving them my phone number so an agent could call me. (Something, by the way, that is RIGHT THERE in the fine print on the website – that I’m agreeing to have agents call me when I ask for information.) Since the structure of these policies is a bit complex, I couldn’t analyze them exactly.

But, I found something that could get me close. State Farm has decided that it might actually be worthwhile to provide some detailed information to people WITHOUT forcing them to give their contact information. So, I could run some scenarios through them. Awesome.

EXCEPT that they don’t let me tailor things in the IBC/BOY way. To be fair: IBC is less restrictive than BOY in terms of the policy structure, based on my limited understanding. It’s more a philosophy of how to structure these things. Some IBC advocates point out that a 10 pay policy (in which you pay premiums for just 10 years to get the death benefit for life) does a reasonably good job for IBC purposes. It satisfies the tax man’s definition of insurance, AND it builds cash value reasonably quickly. Best of all – I could actually get information about it from State Farm.

Analytical Method

From State Farm, I could use 2 values: the “Guaranteed Cash Value” (which assumed zero dividends) and an “Illustrated Cash Value” (which assumes reasonable, but certainly not extravagant, dividends).

The next choice I had to make: what should I compare this TO? I mean, it’s fairly obvious that, as long as the cash value eventually exceeds the total premiums I paid, it’s going to beat my savings account at my bank – which literally pays 0.1% right now – over the long run. That’s hardly a necessary comparison.

So, I took a page from Pamela Yellen of BOY. She seems to advocate (I’ve not finished the book, so I might be wrong here) replacing a 401(k) with a BOY policy. So, the obvious point of comparison would be stocks – or, more properly, a stock/bond mix like you might use in a 401(k).

Personally, I think a Roth IRA is a reasonable comparison. It has a lot in common with these policies. Earnings are tax-free, as long as they’re invested until you’re old enough (59 1/2). AND you can withdraw anything you put in without sparking tax consequences. The Roth has 2 restrictions these policies don’t: (1) You can only put in a set amount each year (for me, $5,500 for me and $5,500 for my wife). (2) You can’t borrow against the earnings. So, keep that in mind.

Here’s my method to do the Roth comparison:

(1) I looked up a 10 pay policy from State Farm for $100,000 (the smallest they offer of that policy type). Premium for me: $2784/yr.

(2) I looked up how much a 3o year $100,000 term life policy would cost. (answer: $216 per year)

(3) I subtracted $2784-$216 (the premium for the term policy) – $20 (likely annual commissions in a Roth account that is rebalanced once a year using TDAmeritrade).

Putting together 1-3, I’m assuming “buy term and invest the difference”. So, $2784 is going into the 10 pay policy in the one case, and $2784 is going into buying a term life policy ($216) + commissions ($20) + Roth contributions ($2548) in the other. This is for the first 10 years. After that, I’m assuming that the Roth IRA cashes out $216 per year to pay the term life premium.

I assume that the investments in the Roth will be a bit aggressive. 80% small-cap stocks (using the IJR ETF), and 20% in a boring bond fund that just pays 3% per year with no price volatility. (3% is the dividend yield on BND right now. BND isn’t old enough to fit my whole time frame, so I just assumed that bonds were held until maturity and earned 3% per year.) The Roth is rebalanced each year to ensure an 80/20 allocation. Also, because I assumed ETFs were used I don’t have to worry about any hidden expenses.

For time frame, I went back as far as I could. Turns out IJR has existed since 2001. This is GREAT – because it means we’ll capture BOTH the tail end of the dot-com burst (which was not good for small caps) AND the subprime crisis. So, we’ll see both a fairly “standard” stock market crash associated with a mild recession, AND a major “worst since 1929” crash followed by a prolonged, deeper recession.

80/20 Roth v. 10 Pay Life Insurance

So… what happens? Well, here you go:

Roth ends much higher than either insurance policy

In the early years the Roth outpaces the insurance policies – even through the tail end of the dot-com burst. The Roth keeps going up because of the contributions being made in this time, which are large enough relative to the existing balance to offset the losses.

At the end, the high average returns of stocks (especially small cap stocks) lead the Roth to outpace the insurance policies by quite a bit – so you end up with about 2x as much money at the end of this time as in either of the life insurance scenarios.

The only time frame where you should say “Oh, I’m so glad that I followed the insurance plan rather than the Roth plan.” is in 2009 – which reflects that the market collapsed amidst the financial crisis in 2008. But, the recovery was so fast that by as early as 2010, the Roth was ahead again.

[Note: one might think that the end result is affected by the fact that the Roth was still in the contributions phase during the crash. And that is true. However, I performed another analysis using SPY – which is an older ETF – over a longer time frame – so that contributions had stopped before 2009. The end result was still similar to above.]

In terms of total value, it’s pretty clear that the Roth wins in the long run. However, in terms of ACCESSIBLE value, it loses (as long as you’re not 59 1/2 yet!). The Roth had $25,480 go into it that can be withdrawn without tax consequences. Of that, $1,888 HAS been withdrawn to pay for the term life insurance – so only about $23,500 can be accessed without sparking tax consequences.

Meanwhile, of the $39,130 in the Guaranteed Cash Value in the life insurance, fully $27,840 can be withdrawn without having to repay AND without sparking tax consequences. OR the entire amount can be borrowed.

In addition, the Roth plan’s $100,000 insurance policy is going to run out in about 12 years (and will need about $2500 more in premiums). The $100,000 whole life insurance policy won’t, doesn’t need any more premiums, and the death benefit might grow. (In the illustrated version, the death benefit has grown to $103,602 by the last year analyzed, thanks to dividends.)

100% Bonds v 10 Pay Insurance

“BUT WAIT!” an IBC/BOY advocate may say. “Look at the roller coaster that is the Roth! If things had ended in early 2009, then IBC/BOY would have won.” I absolutely do not deny that. The issue is that, over the long term, 2008-2009 happens, but doesn’t stay around forever. Stocks do recover. So, their average return is what matters. And that beats what State Farm is telling me about their policy.

However, there are some really risk averse people out there. They just can’t stomach the idea that 2009 happens. Okay. Let’s compare a Roth portfolio (keeping the tax benefits) 100% in perfectly stable bonds paying 3% per year to the 10 Pay Insurance plan. Here, I’ll decrease commissions to $10 per year (since I’m just buying the bonds once a year, instead of having to rebalance between two investments), but continue the $216 term life insurance premium.

The results:

In the first few years the bonds win, since it takes time for significant cash value to build up in the insurance policies, but you have 100% access to all your contributions immediately with the bonds – but that reverses by year 8 (for the illustrated case) or 9 (for the guaranteed case).

Add to that, again, that in terms of immediately ACCESSIBLE value, the insurance policies obviously win around year 7 or so, as their cash value has grown past what has been contributed to the bonds in the Roth IRA at that point. AND that the term policy paired with the Roth is going to run out in 12 years (and require continuing premium payments in that time) while the whole life policies’ death benefit will never go away and might grow.

Conclusions

Weirdly, writing this blog entry led me in a direction I didn’t expect. I expected to conclude with something like “An 80% stock/20% bond Roth provides a better long run return and better short-run (less than 6 yr) access to contributions. Whole life policies really shine if you’re very risk averse – otherwise, go with a stock-heavy Roth.” Since I’m not particularly risk-averse, I figured I’d conclude that IBC/BOY was good for some people, but not for me.

But, I think that conclusion isn’t *quite* right. Now, don’t get me wrong. The 80/20 Roth DOES provide a better long-run return. And it DOES provide better short-run access to contributions for the first 6 years.

But, there’s another possibility I hadn’t considered.

The analysis shows that, over the long run (8-9+ years), a 10 pay policy IS an attractive alternative to super-safe investments in things like bonds, Certificates of Deposit, or savings accounts.

The fact is that EVERYONE should have SOME safe investments. Why not (gradually) REPLACE your bonds and savings accounts with whole life policies’ cash value?

I mean, bonds in a 401(k) or Roth IRA are long-term investments ANYWAY. And you can keep your cash emergency funds while you build up your cash value.

In the grand scheme: what about combining a smaller IBC/BOY policy with a Roth that gradually turns to 100% in stocks as the policy’s cash value grows? Basically, do the 80/2o thing, but, instead of it all being in the Roth, have the 20% in “bonds” be replaced with an IBC/BOY policy.

Some thoughts on this:

(1) Using this as a replacement for a larger life insurance policy probably wouldn’t be a great idea – so you’d still need to carry a term policy, at least until the stock portion of the Roth IRA grew enough to self-insure.

(2) Early on (years 1-7 or so), you’d still want to have some bonds in the Roth, as the cash value hasn’t caught up yet.

(3) You might be able to eliminate your need for a cash emergency fund. Since the purpose of a cash emergency fund is to have liquid savings available that will not lose value, the fact is that whole life insurance cash value FITS that. It just takes some time to build up. So, keep the cash emergency fund until the life insurance cash value catches up, then you can use the cash emergency fund to either buy more life insurance or to go into a Roth, 401(k), or some other riskier investment.

(4) This would be most effectively done with a flexible paid-up additions rider. This allows you to buy extra paid-up life insurance on your own schedule. The insurance company will be careful to make sure that you don’t accidentally convert your life insurance into an MEC by buying too much paid-up insurance.

In Brief

Based on my analysis, 10 pay life insurance is best seen as a replacement for long-term (7+ year) SAFE investments.

Now, I’m seriously considering taking part of my raise from next year and talking with someone about how I can get started in a whole life insurance policy…

Lucas Explains Whole Life Insurance

~ 2300 words, ~ 12 min reading time

About 15 years ago, I was introduced to the Infinite Banking Concept when I met Nelson Nash and his wife at the Mises Institute. He was giving out free copies of his book Becoming Your Own Banker. When I read it, I decided (1) it sounded very interesting and (2) I didn’t understand the thing at all, because I was unfamiliar with whole life insurance. So, all the examples just felt totally made up. And that was where I was for a long time. Then, just recently, I ran across this article by Robert P Murphy. He provided a key insight that let me understand how whole life insurance works. Here, I will share that with you in my own way – though reading Murphy’s article is also certainly worthwhile.

The Infinite Banking Concept

The basic idea behind infinite banking is that you can use whole life insurance as a saving instrument from which you can make withdrawals and take loans. Nash’s book shows that this is typically superior to simply saving using Certificates of Deposit (and certainly beats borrowing from a bank!) or something like that as long as you’re dealing in a reasonably long time frame.

Unlike term life insurance, whole life insurance builds up a “cash value”, which you’re allowed to access – in part or in whole – permanently or temporarily – before you die. And that’s really the key to the whole thing.

Nash’s book includes lots of tables showing the amount of cash value that builds up over time in different types of policies, and shows how you could access that cash to do things like give yourself a car loan, pay for retirement, pay for your kids’ college, etc. (Note: a lot of Infinite Banking is about carefully designing a whole life policy so that it builds cash value quickly while keeping the tax benefits that life insurance provides.)

The natural question I had: how does this cash value thing really work? I’m familiar with term life insurance – where you pay a (at my age, small) premium and if you happen to die in the agreed upon term, the life insurance company will give your beneficiaries a bunch of money. To understand whole life, then, it seemed I really just needed to get my mind around the “cash value”.

Cash Value Explained Badly

The typical explanation for cash value goes something like this… “Each year, we put part of your premium into accumulating cash value while the rest pays for the death benefit.” (from insurance companies) Or “Whole life insurance is a combination of an expensive insurance policy with a mediocre savings plan.” (from critics like Dave Ramsey)

This leads to a natural question: HOW MUCH of my premium is going into cash value each year? If you look for this answer, you can’t really find it. But, hey, I have Excel. I can make some assumptions and figure it out, right?

Wrong. All my attempts to do this ended up making no sense. Cash value doesn’t accumulate the way that you’d expect, say, money in a savings account to. It grows – but the rate of increase in the growth isn’t consistent. True, that’s probably because the % of your premium that goes into the cash value changes over time.

So, I recently used information I got from statefarm.com (which is the ONE insurer I could find that would give me a detailed statement of cash value over time without me having to give them my contact information – I am very averse to receiving sales calls…) to try to tease things out. With the premiums and cash value structure I got from State Farm, I could assume a rate of return on cash value, and then find out what the implied death benefit premiums were. Unsurprisingly, I found that the death benefit premium went up over time. This is what I’d expect. Since you get the death benefit when you die, you’re going to pay more for it if you’re closer to death. But, there were a couple surprising things: (1) The premium for the first couple years was ENORMOUS. Is it really that common for people to take out life insurance policies just before they commit suicide, so that your odds of death in year 1 are so big that a basic whole life policy should accumulate $0 of cash value for a couple years? (2) the premium rose at an increasing rate (not surprising) until you hit age 85, at which point the premium rises at a DECREASING rate. Okay, so I’m a LOT more likely to die at 85 than at 84 (I’ll grant that), but only a LITTLE more likely to die at 95 than 94? That feels a bit… wrong. But, I suppose I’ve not seen the mortality tables…

Another problem with this explanation: it opens whole life insurance up to the worst criticism against it. If you die, your estate does NOT get BOTH the cash value AND the death benefit. It just gets the death benefit. Now, defenders of Whole Life will say things like “if you sell your house, do you expect to get BOTH the equity you built up AND the whole sale price?” (from The Bank on Yourself Revolution by Pamela Yellen) But, this analogy is a bit goofy if we accept the “part goes to death benefit, part goes to cash value” explanation of whole life. When I use a mortgage to buy a house, the part of the home payment that doesn’t go to escrow is ENTIRELY used to pay down the home loan and its interest. I build up equity not because the bank is investing part of the money that I pay them into the house, but because the loan is getting smaller. So, are you saying that when I take out a whole life policy that the insurance company LENT me the policy, and I’m paying it off, so that I build up “equity”? If that’s the case, then why do I get the whole death benefit if I die early?

The better analogy based on the “part death benefit, part cash value” explanation is “buy term and invest the difference”. If I buy a term life insurance policy and also invest in something – stock, bonds, llama farms, whatever. When I die, my heirs get BOTH the life insurance death benefit AND my investments. So, using the “divided premium” explanation DOES make it look like whole life insurance is a big old scam to seize people’s investments when they die.

Good news! As Murphy explains: this explanation is just wrong.

Cash Value Explained Reasonably

Let’s take another stab at explaining cash value.

We’ve already mentioned one key difference between term and whole – the accumulation of cash value. But, there’s another, and it’s absolutely essential in understanding why cash value exists. If you pay your premiums on a term p0licy, you very well may still walk away with exactly $0. How? You don’t die during the agreed term. That is, in fact, what the life insurance company is hoping for.

If you pay your premiums on a whole life policy, you WILL walk away with the death benefit. Guaranteed. Either you’ll get it because you die (and since there is no expiration, you’re pretty well guaranteed to do that at some point), OR you’ll get it because the policy matures (which typically happens when you turn 121, now a days).

What that means, then, is that, from the life insurance company’s perspective, when you buy that $100,000 policy, they are going to be paying you $100,000 unless they can convince you to cancel it. The cash value, then, is really a BUYOUT. It’s an offer from the life insurance company to try to convince you to cancel the policy early so they DON’T have to pay the entire $100,000.

So, why does cash value grow over time? Two reasons: (1) early in the policy, you are least likely to die. Later you’re more likely. This increasing odds of a payout soon makes the life insurance more eager to get you to cancel. (2) early in the policy, you have lots of premiums to pay throughout the remainder of the policy. Later, you don’t. So, early on, if you cancel the policy, the insurance company loses decades of premiums they would receive. They don’t want to do that. But, later, when you’re closer to “death or 121”, you have fewer payments left to make. So, it doesn’t cost them much to have you cancel.

It’s the combination of (1) and (2) that lead the insurance company to want to make you a buyout offer that increases over time.

This ALSO explains why different variations with the same annual premium can provide very different cash values. Consider just 3 options: standard whole life, 10 pay, and paid-up. With the standard policy you pay the premium forever. With 10 pay, you pay premiums for just the first 10 years. with paid-up insurance, you just pay once. Naturally, for a given death benefit, you’ll pay MORE each year if you use 10 pay than a standard policy, and you’ll pay even more for the paid-up policy than you would for a single year’s premium on a 10 pay policy. In effect you’re “paying in advance” for these two structures. It turns out that if you shorten the pay period, you get cash value faster. Why? Because you’ve accelerated reason #2. With a standard policy, I would have possibly 80 years of additional payments coming – this dampens the insurance company’s enthusiasm when it offers me a buyout. But, with a 10 pay policy, I only have 9 additional payments after the first. They’re not losing much if they make a reasonable buyout – and are possibly saving themselves a big death benefit expense. With a paid-up policy, they ALREADY HAVE all the money they’re going to get – so there is no “expected future premiums” to offset their desire to make a buyout offer.

When you die, why don’t you get the cash value AND the death benefit? Because the cash value was a buyout offer to convince you to give up the death benefit. You didn’t take the buyout offer and got the death benefit instead.

So, why can you access this cash value through loans? The reason is fairly simple: the cash value is an asset with a guaranteed value. If I have an asset with a fairly clear value, I can take out a loan using that asset as collateral. Most obviously the case with mortgages and home equity loans, but, with pawn shops, you can do this with literally anything that has a reasonably clear resale value. In this case, it’s the insurance company which provides the asset (the buyout offer), so they’re certainly willing to lend you the money now – and don’t particularly care when you pay it back. At worst, they cancel your policy if the interest on the loan accumulates to more than the cash value is worth. So, no credit check is needed.

What about withdrawals? That’s easy to explain, too. What you’re doing with a withdrawal is taking a PARTIAL buyout. So, you can, for example, sacrifice half the death benefit by taking out half the cash value.

Explaining Dividends

Okay, the last odd thing about whole life insurance (which, weirdly, I never found particularly confusing) is the payment of dividends. When you sign up for a dividend-paying whole life policy, you’ll have the policy itself which offers you a guaranteed cash value over its life. In effect: things are predictable enough on average that the insurance company knows the buyout offers it is willing to make over time. But, you’ll also have claim to dividends which ARE NOT guaranteed. Where do these come from?

Here, we need to get into the old-timey structure of mutual life insurance companies. The basic idea: a bunch of people get together and pay premiums. This money is then invested fairly conservatively so that it can pay any expected expenses (people dying, agents’ commissions, etc.), and probably earns a bit more than that. So, what to do with the “bit more”? As with any business, it should go to the owners. So, who owns the insurance company? In a mutual insurance company, the policyholders do. So, the dividend goes, as it always does, to the owner.

Now, one option that you have is that you can use this dividend to buy more insurance in a paid-up fashion. Since paid up insurance provides a large % of cash value immediately, this is often a reasonable option, and is generally advocated by Infinite Banking/Bank On Yourself.

So, How About Infinite Banking/Bank On Yourself?

I’m going to save my analysis for the next post, but I do want to mention some important points about Infinite Banking/Bank on Yourself.

(1) Infinite Banking and Bank on Yourself advocates typically do not advocate buying just a basic whole life policy. The cash value builds up too slowly to be used for banking purposes. At the same time, they don’t advocate a plain-vanilla paid up insurance policy EITHER. They end up somewhere between using a couple of “riders”. The purposes: build up cash value as fast as possible WITHOUT triggering negative tax consequences.

(2) Nothing in this should be read as me advocating for Infinite Banking or Bank on Yourself. I am not a financial planner or financial advisor. I don’t even have a whole life insurance policy myself, and I’m still not decided whether it makes sense for me to do it. More to come on that. Each of us must make up our own mind. My goal in this post was just to explain some of how cash value actually works. This does, somewhat accidentally, answer one of the big criticisms of whole life insurance (not getting the cash value when you die).

I hope this helped!

Hazlitt’s Economics in One Lesson (Selections)

~ 250 words, ~ 1  min reading time.

The full book is available from the Mises Institute or Amazon.

Chapter 1 – The Lesson – In very brief, what distinguishes good economists from bad is that good economists consider the impacts of a policy on ALL groups and both the immediate term AND in the long run. Bad economists tend to focus on either the impacts on just one group, or on just the short run effects of a policy. (It is also technically possible for bad economists to focus only on the long run effects of a policy – but this seems to be a rare error today.)

Chapter 2 – The Broken Window – A hoodlum threw a brick through a baker’s window. People began gathering outside, and realized that this is a good thing for the economy. After all, buying a new window will create income for the glazier, who, in turn can spend this money on something else. On the surface, this seems right. It’s certainly true that the glazier and those who produce things he buys will benefit from this event. However, this ignores two sets of losers. (1) The baker himself has to pay to replace the window – that means giving up something else – say, a new suit. So, without the broken window, the baker would have had a window + a suit. Now, after replacement he simply has a window. (2) Had the window not been broken, the tailor would have gotten an income – as would those who produce the things the tailor would buy.

Garrison’s The Austrian Theory of the Trade Cycle and other Essays (Selections)

~400 words, ~ 2 min reading time

These are the Mises U selections from Garrison’s collection The Austrian Theory of the Trade Cycle and other Essays. The book is available from both the Mises Institute and Amazon.

Garrison – The Austrian Theory in Perspective – the Austrian business cycle theory (ABCT) incorporates capital structure in a way that Keynesian and Monetarist theories don’t. While ABCT doesn’t explain everything, it does provide the core theory for why business cycles happen. Details, however, are dependent on history and institutions. Thus, expositions of the theory will vary over time – and should! – as each exposition should reflect the concerns and institutions of the time.

Rothbard “Economic Depressions: Their Cause and Cure” – Any cycle theory should explain (1) the recurrence of business cycles, (2) the cluster of errors that gets revealed in the crisis, (3) the relatively large impacts on capital goods industries. ABCT does this by combining Humean arguments to explain recurrence, Mises’s argument about the information content of interest rates sending a false signal to entrepreneurs, and the relatively larger impact of interest rates on capital goods industries predicted by Austrian capital theory. To cure depressions, the government should refrain from credit expansion (which causes the problem in the first place, and can only prolong the malinvestments by covering up the errors as they grow) and cut back spending (freeing up resources for the private sector). This theory was on the edge of widespread acceptance until Keynes presented his theory – which did not refute Mises’s theory, but simply led many to forget about it.

Hayek’s “Can We Still Avoid Inflation?” – The answer: obviously yes, from a technical standpoint. However, politically, it’s not clear that it is possible, because, in industrialized countries, we have a combination of strong labor unions who will fight any drop in money wages – so that any change in relative wages requires that nearly all wages rise – and a central bank holding to a full employment policy – so they will increase the money supply in response to any increase in unemployment that the unions’ demand for higher wages brings about. [Lucas’s Note: Hayek’s essay is a bit dated. At least in the US, labor unions have seen a significant decline in recent years, and the Fed has developed a more balanced approach to employment and price inflation, and acknowledge that they have more impact on prices than employment in the medium to long run.]

Rothbard’s What Has Government Done to Our Money? – Parts 1-3

~1250 words, ~6 min reading time

[Since this series is focused on the Mises U readings, I focused only on the sections that are required for that. Full book available from the Institute or Amazon.]

I – Introduction – Discussions of money are confused, largely because of a desire to be “realistic” – to consider only minor deviations from the current system. This constraint on thinking prevents us from thinking about what a free market in money would really look like, since government has interfered in the monetary system for such a long time.

II – Money in a Free Society

1 – The Value of Exchange – because of the variety of locations of natural resources and the variety of people’s wants and abilities, exchange is a useful way to get what you want from those who are most able to provide it.

2 – Barter – barter runs into issues of the “double coincidence of wants” (that is, I have to have what you want and you have to have what I want) and indivisibility of many goods. So, barter’s ability to be the primary means of exchange is limited.

3 – Indirect Exchange – It may be beneficial to receive something that I don’t directly want if it is widely marketable. So, I will exchange what I have for something I don’t want, but can easily get rid of for what I DO want.

4 – Benefits of Money – Money allows for more specialization – and the resulting productivity boost. Money prices also allow for economic calculation, which opens the way to complicated production processes.

5 – The Monetary Unit – in a free market, money is a commodity like any other, and so will be denominated in the natural unit of physical goods: by weight.

6 – The Shape of Money – the entirety of the stock of the monetary commodity counts as the money supply – coins, bars, dust, etc. – as it is the commodity rather than the form that makes it money.

7 – Private Coinage – in a free market for money, private companies would mint the monetary commodity into easily recognizable coins. They would determine size, shape, etc. based on consumer demand, and consumer demand combined with reputation would ensure quality – just as happens with other goods.

8 – The “Proper” Supply of Money – like with any other good, the proper supply is the supply entrepreneurs provide. The purchasing power of money can adjust to accommodate any money supply. At the same time, production of the monetary commodity is not inherently unproductive because the commodity has nonmonetary uses.

9 – The Problem of “Hoarding” – all hoarding does is increase money’s purchasing power. And there is no clear distinction between hoarding and simple money holding.

10 – Stabilize the Price Level? – Like all commodities, the value of money would fluctuate based on changes in supply and demand. It’s not clear why this is a bad thing. Some suggest that it changes the relationship between creditors and debtors – yet, these are free to adjust based on a price index if they wish. Yet, we do not see private lenders and borrowers doing this, suggesting the alleged benefit of stabilizing the price level is minimal in the eyes of those who are supposed to be the ones benefiting.

11 – Coexisting Moneys – we can’t rule out that there may be more than one money in a free market for money. (Example: gold and silver) If so, the two would have a floating exchange rate between them.

12 – Money Warehouses – in a free market, banks would be money warehouses. They would simply charge fees to store money – they would not engage in fractional reserve banking. But, even if we adopt free banking, the extent of fractional reserve banking would be quite limited.

13 – Summary – in short, the free market can provide money just like it provides anything else.

III – Government Meddling with Money

1 – The Revenue of Government – Governments often resort to monetary inflation to fund themselves, as the effects are less obvious than the effects of taxation.

2 – The Economic Effects of Inflation – Inflation redistributes wealth from late receivers to early receivers of the newly created money, makes economic calculation more difficult, which leads to economic inefficiency, can destroy the monetary system through hyperinflation if it goes unchecked, and leads to business cycles.

3 – Compulsory Monopoly of the Mint – Government has to take over the monetary system step-by-step. The first step is claiming a monopoly over minting coins, which allows government to charge a monopoly premium for minting.

4 – Debasement – once they have a monopoly over minting, the government can begin decreasing the size or at least the precious metals content of coins. The profits from reminting old coins as new can be used for revenue.

5 – Gresham’s Law and Coinage

a. Bimetallism – in setting a fixed ratio between gold and silver prices, government ended up creating a situation in which one money was used while the other was hoarded – and the two would switch back and forth. This led to an elimination of bimetallism and adopting a gold standard.

b. Legal Tender – legal tender laws require people to accept the standardized money in payment for debts. This gives the legal monetary standard an advantage, which opens the way for government to intervene more in the monetary system.

6 – Summary: Government and Coinage – The final step is making use of all foreign coin illegal. This, in turn, disrupts international trade and therefore the international division of labor. To increase government control beyond this point, the economy must move beyond hard money.

7 – Permitting Banks to Refuse Payment – One privilege that banks have been given is the ability to simply refuse to pay their obligations while staying in business. This allows banks to inflate without having to worry about bank runs as much. However, it does not provide much control over the inflation from the government’s perspective.

8 – Central Banking: Removing the Checks on Inflation – One of the key moments in the government taking over the banking system’s operation is when they monopolize note issue and centralize reserves in the central bank. This removes one of the key limits on banks’ ability to create money: the extent of their own clientele.

9 – Central Banking: Directing the Inflation – Government effectively controls the money creation process by injecting new reserves into the banking system through open market operations and discount window lending, and by controlling the legal required reserve ratio.

10 – Going Off the Gold Standard – While central banking loosens the restrictions on individual banks in their ability to inflate, the system as a whole faces the problem of gold outflows if they overinflate compared to other countries. This problem leads governments to take their currencies off of the gold standard entirely – leading to currencies that are purely fiat.

11 – Fiat Money and the Gold Problem – By leaving the gold standard, government increases the number of moneys as it is unreasonable to assume that people will just stop using gold as money and instead rely entirely on paper. This leads governments to ban the holding of monetary gold.

12 – Fiat Money and Gresham’s Law – in a world of fiat currencies, any attempt to peg exchange rates will lead Gresham’s Law to kick in – that is, the overvalued currency will fall out of use in international transactions while the undervalued currency (historically the dollar) will find more use. This leads to a shortage of the undervalued currency. The end result of this intervention seems to be a single, world fiat currency.

13 – Government and Money – In the end we have seen that the government got into money to acquire an easy source of revenue, and that to take full advantage of this required a series of increasing interventions – but each of these created a series of problems leading to more intervention. The world of national paper moneys creates barriers to the international division of labor – lowering our productivity.

Leonard Read’s “I, Pencil”

~100 words, ~1 min reading time

This is a short essay that I will attempt to make shorter…

No one knows the full process of how to make even a simple pencil. Rather, it is accomplished by each person using their limited know-how to accomplish tiny steps in the process, with the steps being coordinated by mutually beneficial exchange.

Because simple things are so complicated, it is important to allow people maximum freedom to create and improve processes, and to engage in exchange.

Lessons from Bullet Journaling

~500 words, ~3 min read time

I started using a bullet journal back in early April in an attempt to have some kind of organizational system that would actually match what I wanted. I made some mistakes along the way, but on the whole I like the bullet journal method. So, here are some lessons I’ve learned in the past couple months.

(1) Choose your size wisely – My first attempt at using a BuJo failed because I tried to use a standard sized composition book. This was too big to fit in my pocket, so I could only carry it if I was bringing my briefcase, or if I specifically decided to carry a notebook with me. This was inconvenient, so I stopped using it. This time around, I chose a small notebook – about 3.5″x5.5″ (like this), so roughly cell phone sized. This fits in my pocket with my phone, and is FAR more convenient. At the same time, I’m sure many would find the thing cramped.

(2) Dedicate enough space for your index – My notebook has 131 pages in it. But, I only dedicated 34 lines to an index at first. Surprise! I ran out of lines in the index, so now I have a secondary index around page 80. Dedicate a line per page, just to be safe.

(3) It’s okay to be simply functional – I’ll be honest. I am not artistic. So, my BuJo is not pretty. Mostly, it’s a dated task list with a few pages of checklists. That’s it. But, it works for me.

(4) Don’t dedicate a page to each day ahead of time – I should have known better. The BuJo guidelines on Bulletjournal.com say this. I had used a Franklin Covey page a day planner for years. I should have known that with a dedicated page per day, many pages would be basically empty while others would be full. Poor planning.

(5) Don’t rewrite your to-do list every day. It’s easy to flip through the Daily Log and find what you need to do. Just migrate at the beginning of the month and you’ll be fine.

(6) A BuJo is not a productivity strategy. It is simply a tracking system that is beautifully flexible. But, you still need a separate strategy for how to deal with the information you store in it. But, in my experience, a BuJo can pair extremely well with Mark Forster’s Do It Tomorrow. I suspect it would also work well with David Allen’s Getting Things Done, but I always found GTD too undirected to motivate me. Now, not everyone needs a system for dealing with tasks. I find it very useful, as it removes the mental load of having to figure out what to do. But, as always, it’s up to you and what works for you.

(7) Use checklists for routine tasks. I have 3 checklists: a yearly, a monthly, and a daily. I prioritize in that order, making exceptions in the evening’s  for particularly pressing tasks.

Mises’s Profit and Loss

~650 words, ~4 min reading time

Full text here.

The Economic Nature of Profit and Loss

The Emergence of Profit and Loss – Profit and loss emerge as entrepreneurs purchase factors of production in anticipation of future prices of consumer goods. If the future were perfectly predictable, profit and loss would not exist. They only exist because change is constant.

The Distinction Between Profits and Other Proceeds – Entrepreneurial profit is not interest. It is not wages for the labor of entrepreneurs. It is not monopoly gains. Entrepreneurial profit or loss is what is earned because of the quality of decision making. If you want to identify an entrepreneur, identify who would take a loss if things went badly.

Non-Profit Conduct of Affairs – In the absence of profit and loss, bureaucratic rules and regulations are the only viable alternative. This applies to governments as well as other non-profit organizations.

The Ballot of the Market – while entrepreneurs are the decision makers in the market, consumers have the final say, as they vote with their dollars for what they want.

The Social Functions of Profit and Loss – Profit and loss are the return on good (or bad…) entrepreneurial decision making – that is redirecting resources to their highest valued ends, in the minds of the consumers.

Profit and Loss in the Progressive and the Retrogressing Economy – in a progressing economy, profits are greater than losses, allowing for an accumulation of capital, which allows increased production. This requires real saving. An economy that is consuming capital will have greater losses than profits, and will retrogress.

The Computation of Profit and Loss – profit and loss are naturally psychological. However, in a monetary economy we can calculate them.

The Condemnation of Profit

Economics and the Abolition of Profit – Some, inspired by Marxism, have declared that profit should be abolished. If this is a purely moral claim, then economics has little to say about it. However, if the claim is that this would benefit workers and consumers, then economics can analyze whether this is true.

The Consequences of the Abolition of Profit – profit is what makes entrepreneurs accountable to the consumer. Abolition of profit would then turn entrepreneurs into unaccountable managers, resulting in chaos.

The Antiprofit Arguments – All the arguments against profit are  wrong. They ignore that profit and loss put the consumer in charge. The reasonn the US is so rich is that it has tolerated the existence of very rich entrepreneurs.

The Equality Argument – The typical progressive argument against profit is that it leads to inequality. However, for some reason, those advocating for equality only believe in “leveling out upward” – expropriating those wealthier – not “leveling out downward” – giving to those who have less than the equality advocates. A true belief in equality would result in nearly every American having a substantially lower income, since even poor Americans are wealthy by world standards.

Communism and Poverty – Some say that people turn to communism and socialism because they are poor. But, this skips a step. People turn to a set of policies because they think it will improve their situation. However, people often don’t understand the long run impacts, resulting in choosing policies that are harmful in the end.

The Moral Condemnation of the Profit Motive – Some people treat the pursuit of profit as morally dubious. But the rational pursuit of long-run profits is what best serves society and encourages social cooperation.

The Static Mentality – Most people treat reality as if it were static. As such, they don’t understand the importance of entrepreneurs adjusting production in the face of uncertainty and change. So, socializing production looks feasible – as all you have to do is keep doing what we’ve been doing. This, however, is unrealistic, since the world changes and the content of changes is uncertain.

The Alternative – socialism. Production will either be driven by entrepreneurs seeking profit or by some kind of central planner. There is no third option.