A Valuable Piece of Advice

What I learned from Milton Friedman…….

Several decades ago, I would take seminars everywhere in the world. If the topic was interesting and it gave me a chance sit with the smartest minds in the world on that topic, I would hop on a plane and I was gone. Milton Friedman was a Nobel Prize winning economist and started an entire new tradition in economics that came to be called the Chicago School. Friedman was a full professor at the University of Chicago. He was the most influential person in the world on certain economic topics. If one of your children is a Brainiac the University of Chicago is one of the top schools in the world in just about anything. It’s not fun, but its tops intellectually.

So I’m sitting in the room with this genius for more than week at a seminar he’s conducting. Everyone around me is a top guy and we are paying big bucks for this. Most of it probably paid for by corporations with money to burn so it doesn’t matter what it costs. Sort of like baseball tickets for a thousand dollars a ticket. If the company is buying, who cares right?

Milton Friedman starts off, “What is CONSUMPTION A FUNCTION OF?”  This is classic Economics 101, undergraduate economics. We all know consumption is a function of income. You spend what you earn; if you earn more, you spend more. Get a new job at a 50% higher level of pay, and you spend more out of the 50%. Its common sense. Then Friedman starts going through the variations. Well “What if you can get a loan, like if you are buying a car, would you be willing to buy a car using the loan value of your reputation?” We all answer yes, because we have done it. Therefore consumption is also a function of how much you can borrow, and how much you are willing to borrow.

Now we think we have got it down pat. How about if you are in your last year of college. You have a part time job, you make a couple of bucks, and you are finishing up school. You know that in 6 months, you are going to be offered a job paying somewhere between this and that. Would you not be willing to buy something today, based on knowing 6 months down the road you are going to be easily capable of paying for it? The answer is yes. “Well then, consumption is also a function of FUTURE ANTICIPATORY INCOME.

These statements were enormously impactful to our way of thinking, and frankly helped to reshape the way I thought about money. There was one more variation that none of us would probably ever think about right even up to now. Friedman said, “What about the past, how do your past behavior patterns and learnings influence what goes on today, what you spend money on here and now?”

Maybe your parents drummed some things into you growing up that still shape your spending habits today. Who knows maybe growing up your family always drove old cars and taught you never, ever buy a new car and gave you wonderful sensible reasons why this is true, and you went for it hook, line, and sinker. You are still living off of those learnings taught to you at a younger age. Up on the black board, no white boards in those days, Milton Friedman wrote, “CONSUMPTION is a FUNCTION of PAST SPENDING HABITS. If you lived through the 1930’s Depression, you have a tough time spending money, even today.

An example is this. I can remember in the early 1990’s going to a Broadway show with a wife and two children and she mentions the children would like some water. I gave her a $20 bill, she comes back with 4 bottles of water from the refreshment stand and hands me a couple of bills. I look down it’s four dollar bills. I just paid $16 for 4 bottles of water. All I said to myself but out load quietly, “My father would turn over in his grave.” It’s past spending habits.

In my investment banking days, I raised tens of millions of dollars for companies that sold bottled water. One of them had the franschise rights to use the name “Canada Dry pure drinking water”. We made money on the deal, but I have to tell you how difficult it was emotionally to believe that people would pay for water like that. This was years before it became a common way of life to drink bottled water or believe we had health issues with the water supply. Friedman was right, past spending habits have to be taken into consideration.

Milton Friedman has changed my life and taught me to reflect on why we do the things we do. What are the hidden reasons why? The hidden compulsions drive us on an individual level. The hidden agendas we should seek to understand. Now on a macro level, it has helped explain whatever current economic conditions the nation faces. It has helped us understand why things are as they are. Sometimes 50 years of thinking about something is not as helpful as simply learning it from a genius who has spent his life understanding this one thing and has it down pat.


What it all Means Right Now?

At this point in time, we are headed for recession. How do we know this? Forget the economists – most of these guys are lucky they have work. They know a thousand ways to make love and have never been with a woman as they say. You know the recession is coming because the stock market is telling you. The stock market is a predictive mechanism that divines the future usually about 6 months sometimes 9 months down the road. It never tells you much about what is currently happening.

This market has taken such a hit since January that it is telling you the recession is coming. By the time the recession actually hits, stock prices will already be on the ascent again. This is always true at least for the last 120 years or so. We have reliable stock prices and graphs going back to about the 1870s. We haven’t gone back that far, but we have explored the history since about 1900, and this is what we have concluded.

Consumers are already starting to tighten up their spending habits. The reason is because of Milton Friedman’s comments. Future anticipatory income is one of the key factors affecting whether or not people will spend money. They are concerned about their future. Will they keep their jobs? Will their income begin to decline? They know that their stock portfolios are less than what they were at the beginning of the year. None of this augurs well for OPTIMISM. If you are not optimistic about tomorrow or next year, you are less inclined to spend money NOW. You will husband it for a rainy day, for a protection fund. You will stretch out your haircuts, take less expensive vacations, search for cheaper gas prices, and not drive as much. This is simply how economics works according to Milton Friedman. We can all learn something from following in the footsteps of our masters.

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