Parachuting Cats of Borneo

A Favorite Story

We are going to reprise one of our favorite stories for you this week, a story of good intentions and all the ill that can befall people with good intentions. It is the tale of the Parachuting Cats of Borneo.


Back in the 1960s, the US created the Peace Corps, a group of mostly young Americans who went out into the world to bring progress and development to the less developed corners of the world. The Peace Corps built clinics, dug water wells, taught agronomy and developed industry all over the world. They also tried to bring modern science to bear on the problems that plagued many backward areas.

One such Peace Corps volunteer was assigned to a remote village in Borneo. When he arrived, he was greeted by the village elders and shown around the village, shown where he was to live, and all the facilities at his disposal. That night, our volunteer had a terrible time sleeping for all the mosquitoes that were everywhere in the village. The next morning he asked the village headman if the mosquitoes were always this bad. “Oh yes,” he was told “mosquitoes made life in the village very difficult.”

The volunteer asked if he could help with the mosquito problem and was encouraged to use all his modern science to help the village. A call to the regional office, a call to the US and the next thing you know modern science arrived in the form of a crop duster spraying insecticide on the swamps and marshes around the village. In only a day or two, the mosquitoes were gone.

The village celebrated their salvation from the constant torment of the mosquitoes. But, soon they faced a different dilemma. Rats began to run amok in the village, eating the food, chewing on the foundations of their homes, fouling their beds, getting into everything.

You see, when the Peace Corps sprayed the marshes, they were very successful in killing the mosquitoes and the frogs gorged themselves on the dead and dying insects. The village cats could easily catch the frogs as they were sickened by the same poison that killed the mosquitoes. Soon, the cats had eaten enough poisoned frogs that they too were poisoned. Once the cats were dead or at least very ill, there was nothing to keep the rats in check and they ran amok.

The villagers came to the Peace Corps volunteer begging to put things back the way they were. The mosquitoes were a nuisance, but the rats were a menace. Take away the rats and give them back their mosquitoes.

Another call to the regional headquarters and thence to the US and soon another plane was flying overhead but this time, they didn’t drop insecticide, they dropped hundreds of cats, each with their own tiny parachute. The cats soon wreaked havoc with the rat population and with another rainy season the mosquitoes were back. All was the way it had been before modernity had struck the village.

This is a tale of unintended consequences. The spraying of the marshes had the intended consequence of killing the mosquitoes. It also had the unintended consequences of poisoning the frogs, the cats and loosing the rats from the cats. Though the intended consequence was a great success, the unintended consequences were horrible.

Whenever we start out to change a system, be it a village ecosystem in Borneo or the market for derivatives or the healthcare system for a great country, we must consider all the consequences, not just the intended consequences. It is our belief that the Parachuting Cats of Borneo ought to be read every year before our legislatures and the Congress (the opposite of progress) begin their sessions.

We cannot vouch for the veracity of this story. We only received it as a parable told by Ray DeVoe, our favorite market newsletter writer. We give full credit or blame to Mr. DeVoe, t’was his story to tell, not ours.

Issue of the Week

If you haven’t been living under a rock lately (and don’t knock it unless you’ve tried it) you’re aware that our governments’ finances are in a shambles at all levels. The state and local side of this issue is fairly well discussed and generally fixable through a combination of tax increases, spending cuts and the occasional privatization (offloading some chore on the private sector that government didn’t do well enough to break-even.)

Let’s face it, government isn’t all that good at a lot of things it tries to do. There are a few things that are hard to imagine anything other than a government agency doing, say sustaining a judicial system, but there are many areas of life that government is involved in where there just isn’t any crying need. We ranted about schools a couple of weeks ago, but there are many other examples. Why do we look to government to build, maintain and own the roads? Why do we look to government to build, maintain and operate airports? What about water, sewage and garbage disposal? There are a lot of areas where government is doing something that might well be done better by a profit-seeking organization. We seem to fall into the trap that the same purse that pays the wages of our policemen also covers the cost of fixing the potholes in the streets and developing a new garbage dump. When times are tough, which do you think will get top priority? Which is more immediate? Why isn’t each looked at with the same priority?

In many parts of the world, private enterprise develops, owns, and operates things like airports, roads, garbage systems and the like. It is a system that seems to work. Why should you pay for my road use? Why should I subsidize the airport you use? How do we fairly divide the cost of so many things through the same tax? We are compelled to prioritize our spending which does a terrible job of meeting all the potential needs. If many of these things are handled through private enterprise, those that truly are needs will survive, others will not. But, it will not be the public purse that takes the beating when something turns out to be a want rather than a need.

Matching costs and revenues is a basic accounting precept that we tend to forget when it comes to government finances. Why shouldn’t the people who benefit from a service pay for it? Direct user fees are used all the time to allocate resources to those who have the greatest need or the greatest ability to pay. Everybody loves Disneyland, but if the government ran it, it wouldn’t be the happiest place in the world. It would be overrun with homeless people, vagrants and other folks who currently can’t pay the $76 a day to get in. Private ownership may not be a panacea for every need, but it sure as heck is a better way to run a railroad than letting the government determine how things get done. The profit motive may not be the only determinant of who gets a service and who doesn’t, but it usually beats the arbitrary nature of political decisions.

Maybe this round of fiscal crisis will convince many state and local governments that distinguishing between wants and needs is an economic rather than political question. Maybe it won’t. Maybe we will get into roughly the same predicament in years to come. Hopefully we will learn something from this disaster. Probably not.

Economic News

Personal income rose in February, just not as much as many had hoped. The 0.3% gain was nice, but not as good as the 0.4% forecast. The big income gains in January, driven by the forbearance on some of the Social Security tax levied on worker’s pay, set the bar pretty high for the rest of the year. After adjusting for inflation, personal income actually declined for the month. Whether you like to adjust for the consumer price index or the personal consumption expenditures index, consumer incomes lost out to higher inflation.

Consumer spending rose by 0.7% in February as we reacted to higher prices on many necessities. As incomes rose far less than spending, the savings rate fell to 5.8% from 6.1% in January.

Case-Shiller home prices fell by 1% in January and 3.1% from January a year ago. January’s drop was the seventh in a row and ninth month in the last twelve with declines. Case-Shiller calculates the change in value of specific houses as they change hands over time, rather than use median or average home prices for an area over a specific period.

War, pestilence and grief were too much for many folks as consumer confidence fell last month in the Conference Board telling of the public mood. The index fell from 72.0 in February to 63.4 in March in the biggest one-month drop in over a year. That said, the drop wasn’t quite as big as many forecasters had expected. If that doesn’t scare you, you are paying attention.

The ISM Manufacturing Index decelerated to 61.2% in March from 61.4% in April. Either number is a fairly strong and shows that manufacturing in the US is back. Most of the sub-indices within the purchasing manager’s index were also positive, although many showed deceleration. Importantly, the employment index was still at 63.0, a very strong number, production was at 69.0 (any number above 50 indicates growth). The prices paid index was also strong at 85.0, showing that inflation is making its way into manufacturing.

The US Monthly Payrolls Report showed continued gains in hiring across most of the economy. The one notable exception to that rule is the government sector, which lost jobs. 216,000 jobs were added in March and 7,000 more jobs were added to the job growth in January and February.

The Unemployment Rate fell to 8.8%. The unemployment rate gets a lot of air time, but does anyone really understand what it is? What the Labor Department calls U-3 (gosh, we wish it was U2, there are so many Bono jokes we’d like to insert) is the official unemployment rate. U-3 includes all unemployed people (those not currently working full or part time, who are looking for work) divided by the civilian labor force. That rate now is 9.0%. U-1 counts only chronically unemployed persons out of work for at least 15 weeks. U-2 includes four scruffy Irishmen along with U-1, no U-2 includes all people who have lost their jobs over any time period. We’ve touched on U-3. U-4 includes discouraged workers, those who have stopped looking for work along with those still trying to find a job, adding them to both the unemployed rolls and to the labor force. U-5 includes people ‘marginally attached to the labor force’ to both the unemployed ranks and to the labor force. These are people who could work if they wanted to or really, really had to. Everyone has a cousin or friend who likely fits this category.

Finally, we get to U-6, what a lot of pundits are calling the real unemployment rate. The difference is that people who work part-time for economic reasons are added. So, this likely wouldn’t include the college student who works part-time delivering pizza, or the yuppie mommy helping her friend at the candle shop, or the semi-retired professional who ‘consults’ a couple days a week. None of those people works part-time for economic reasons, they do it out of choice. Part-time for economic reasons means this used to be a full-time job but is now a part-time job.

The amazing thing is that the rolls of U-6 tend to be about 7% higher than U-3. This has been fairly safe to say at any time over the past 30 or so years that likely matter to this discussion. There has been no explosion in the numbers of U-6 that isn’t explained by expansion of U-3. The difference between U-3 and U-6 tends to vary between 6% when times are really good and 8% for short periods, but it seems to always be there. So, if you think that all of a sudden the government has changed the way it reports unemployment, you’re wrong. These definitions have been pretty consistent for decades. The unemployment reported during the Great Depression was something akin to U-3, we can only guess what U-6 might have been.

Average Hourly Earnings were flat for the month and hours worked were also flat for the month. The average worker in this survey makes $22.87 an hour and works 34.3 hours a week.

Weekly Stuff

We managed to make it back to new recovery highs before last week was done. Stocks have overcome all the bad news from Libya and Japan while many individual investors have begun returning to the markets. This shows once again that buying ‘when there is blood in the streets’ works. All the disasters that have plagued the world in the last couple of months really don’t mean a thing to the broad economy and the markets. A little patience and a little perspective will help get us through more of these disasters in the future.

Stocks were up by roundly 1% in the large cap space last week and a lot more in the small cap area. The bounce in small caps has been more than enough to overcome the greater decline in those prices during the scare. Though we still believe that small caps are very overvalued on a fundamental basis, there is also the acknowledgement that from time to time they can be very good market performers. Our view of the small cap phenomenon is that when every advisor, every foundation and pension fund wants to be overweight in a small part of the market, they will drive prices to obscene values before they are done.

Foreign stocks also gained last week. Among the developed markets, we saw a rebound in Japan along with a relief rally in Europe. The European markets showed rather modest gains overall with some barely moving. In the developing markets, there were widespread gains. The exception to that rule was China, which slipped a little. We think this was the unwinding of some ‘safe haven’ buying of China during the turmoil. China has its troubles, but among the investing public, there is little doubt that the China story is alive and well. This sort of mass psychology probably isn’t healthy for that market in the intermediate to longer term.

Bonds around the world are slipping in value now that the crises are winding down. Losses were generally modest, but given where interest rates are in the developing world especially, one can’t afford too much loss in principle before bonds become a very bad bet indeed. One saving grace among foreign bond markets was that the dollar tended to lose value last week versus many foreign currencies.

Real estate securities made a strong rebound in the US and a more muted one overseas. Commodities were mixed with energy fairly strong, industrial metals weak, precious metals modestly higher and agricultural commodities generally higher.

Have a great week.

Karl Schroeder, RFC, CSA

Investment Advisor Representative

Schroeder Financial Services, Inc.