The Financial Riddler - 12/30/22

Financial Knowledge Is Financial Power

Happy New Year!

And welcome back to The Financial Riddler, where losing is winning. Either way, you’ll learn new things about the global, our domestic, and your personal economy. Answers appear after each question. Don’t peek! Instead, scroll slowly and stop at “And the answer is.” Then check how you did. Also, check out prior riddlers, which are posted at larrykotlikoff.substack.com.

1. Is the advertised range of electric cars reliable?

   a) Yes

   b) No

And the answer is …

In my experience, the answer is no. My wife and I recently bought a brand-new, expensive plug-in Volvo hybrid. We’d never purchased such a pricey car. But with inflation raging, it seemed smart to buy durables. I also need to drive several times a week from Providence to Boston. So saving on gas was enticing. So was the $7,500 plug-in tax credit. Our salesman said we’d get 45 miles just off the battery. So we traded in our beloved 2015 Patriot stick-shift Jeep. The Volvo has incredible acceleration and the smoothest ride imaginable. But that 45 miles off the battery, well, it was fab until it wasn’t. The electric range on the car after a full night’s charge started to fall over time. Now, with cold weather, it’s reading just 29 miles. The dealership says the charger’s fine and that the battery uses juice to keep itself warm. They also said the range reported on the dash incorporates your driving habits, i.e., spending time in traffic. But it’s not that cold and our driving habits haven’t changed. So I’m befuddled. We still love the car but feel somewhat duped.

2. As of 2033, what will be the age at which you are forced to take RMDs — Required Minimum Distributions — from your IRA?

   a) 70

   b) 72

   c) 73

   d) 75

And the answer is …

The answer is d. The Secure 2.0 Act raised the age from 72 to 73 in 2023 for those, like me, turning 72 next year. Starting in 2033, it will be 75. A note of caution. Waiting that long to start withdrawals may actually cost you taxes as this column makes clear. It can also do a number on your cash flows.

3. Which country had the highest income per capita in 2022?

   a) Qatar

   b) Brunei

   c) Luxembourg

   d) Norway

And the answer is …

The answer is c. Luxembourg’s per capital income is $118,001. That’s 155 times higher than Burundi’s $760 level of per capita income. Burundi is the poorest of the 194 countries listed here. The top five are Luxembourg, Singapore, Ireland, Qatar, and Switzerland — in that order. The U.S. ranks 7th, with per capita income of $63,416. China ranks 77th with per capita income of just $17,192. Russia ranks 53rd with $27,903 in per capita income.

4. The federal deficit in 2021 was 12.3 percent of GDP. In 2022, it was 5.5 percent. The deficit is the increase in debt. If the deficit was positive, why did the U.S. ratio of debt in the hands of the public to GDP fall from 99.7 percent of GDP in the fourth quarter of 2020 to 94.5 percent in the third quarter of 2022?

   a) The Federal Reserve printed money to buy up the debt.

   b) Inflation raised the dollar value of GDP, but didn’t impact the book value of the debt that was outstanding in the fourth quarter of 2020.

   c) The Chinese and other countries bought more U.S. debt, keeping it out of the hands of the public

   d) a and b

And the answer is …

The answer is d. It’s not c. Debt held by the public includes debt held by foreigners. On the other hand, debt held by the public excludes debt held by the Federal Reserve. Thus, if the Fed monetizes the debt — prints money to buy up new or old issues of government bonds — debt in the public’s hands will fall. In addition, inflation is leading GDP to rise in dollar terms, but isn’t increasing the amount of debt, carried at face (book) value, that was outstanding before inflation kicked off. When the Fed monetizes the debt and when inflation waters down the value of existing debt, the government is, in effect, using monetary policy to pay for government spending. This is called seignorage by economists. The expression dates to the Middle Ages when local feudal lords — seigniors — would mint coins and swap them for chickens, cloth, goats, and all manner of other real goods and services with townsfolk who lived under their dominion. The townsfolk would be left holding the pieces of metal and the seigniors would be left holding the chickens, etc. This led to increases in the prices of commodities and services in the towns as less of everything was available for townsfolk to buy. Consequently, the value of the existing coinage was watered down in terms of its purchasing power. This is why economists call seignorage the inflation tax. Over the last 18 months, Uncle Sam has watered down outstanding federal debt by over $2 trillion! That’s an additional tax that doesn’t get counted in the official deficit. One other thing. The economy can grow faster than the debt due to productivity and population growth. The 2022 U.S. growth rate is almost 2 percent.

5. What’s the main reason Mark Zuckerberg lost $78 billion this year?

   a) He changed his company’s name from Facebook to Meta

   b) Apple new operating system reduced Meta advertising revenue by making tracking users’ preferences more difficult

   c) A major drop in Meta users

   d) Over investment in Meta

   e) Failure to diversify his portfolio

And the answer is …

Clearly, e is the right answer. Had Mark diversified, he would have sold almost all his holdings of Facebook years ago and experienced a minor decline in his wealth as a result of the recent meteoric (two thirds!) drop in Meta’s price. This is the same story for Elon Musk who lost $115 billion this year. And then there’s Jeff Bezos who lost $80 billion. How did these and other global billionaires manage to collectively lose nearly $2 trillion? The answer is they made the simplest mistake possible when it comes to investing. They put all their eggs in one basket — their own companies. No rational person would invest virtually all of their wealth in a single company. But these business geniuses were morons when it comes to personal finance. Yes, I know that if the largest shareholder of company X sells their shares it can lower their company’s stock price. But doing so in the context of making clear that this is a matter of diversifying one’s personal risk is a different matter. It’s also clear that selling more than half of your company’s shares risks losing control of the company. But if you are a billionaire with a huge company, your brilliance can hardly be essential going forward. You can hire plenty of brilliant people who are as likely, if not more likely than you to direct the company to its next success. The idea that you and you alone are essential to keep a massive business alive is pure hubris — the kind of hubris that Musk has exercised to the enormous cost to Twitter and now Tesla. Finally, selling means realizing capital gains and paying taxes. Better to do so and diversify than risk losing your shirt.