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Mark's Market Blog

11-26-08: The Hot Dog Stand Theorem

By Mark Lawrence

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There's a principle in economics called the "hot dog stand theorem." Imagine you have a beach 1 mile long, and the city decides to issue permits for two hot dog stands, A and B. The city tells the stand owners to locate their stands at the 1/4 and 3/4 mile mark, so that any individual beach goer need only walk 1/4 mile at the worst.

------A------------B------

However, the guy who owns stand A notices that if he comes by at 3am and moves his stand 100 yards towards the center of the beach, everyone to the left of his stand still comes to him, plus he's grabbed 50 yards of people from the center. He gets an extra 150 yards of hungry beach teens.

--------A----------B------

B notices this immediately, of course, and that night he moves his stand 200 yards towards the center, grabbing even more customers.

--------A-----B-----------

The two hot dog stands wind up side-by-side in the center of the beach. They split the customers evenly. However, now there are beach goers that have to walk 1/2 mile for their hot dog.

This is why the car dealerships are always next door to each other, the good prime time shows are always on at the same time (ok, I'm using the word "good" loosely here), and it's why in most years you can't tell the republican candidate from the democratic candidate.

Under Reagan, Republicans decided deficits were good things, as they forced Democrats to make tough budgetary choices. In the following 12 years, the Democrats learned from this game, and under Clinton they balanced the budget. Under Bush II, the Republicans decided that deficits don't matter, and spent money at a rate that has never been before been seen - imagine 1,000 drunken sailors, all named Bill Gates, each worth $50B. Effectively, Republicans got up at 3am and pushed their hot dog stand almost to one end of the beach.

Obama just announced that his lead economic adviser is Larry Summers, the guy who balanced the budget under Clinton (he also was the president of Harvard who announced that women weren't as good as men at physics and engineering, hence the lack of female professors in the science and engineering fields, and was burned in effigy.) He also announced his budget director will be Peter Orszag, previously the head of the Congressional Budget Office, the guys who crunch the numbers and tell us how much Congress' laws will really cost. No one ever predicts perfectly, but these guys are good. They're honest about what money is really coming in and what things really cost, and "they know where all the bodies are buried." Obama also announced three more economic advisers, all highly regarded centrists, including Volker, the chairman of the Fed before Greenspan, the guy who conquered the 70's inflation. Including Geithner at treasury, Obama has hit about four home runs and a couple doubles here. Frankly, I'm impressed.

Obama has located his economic hot dog stand right in the center of the beach, arguably even perhaps a touch onto the conservative side, at least for economics. I'm pleased that Obama is showing these centrist leanings. I'm completely mystified that the Republicans have turned themselves into the party of credit card addicts. While I certainly expect that Obama will show his leftist roots in various social fashions, it's shaping up that he will be running the economy in a very responsible way. Truth be told, I'm a lot more interested in a well running economy than in whether gays can marry and adopt. And I totally don't get the whole Republican anti-stem-cell thing.

One thing scares me about Obama: he has shown great mistrust for private industry. He seems to think that the only real jobs are government jobs. While there's no question that there were a bunch of amoral crooks getting away with murder on Wall Street for the last 12 years or so, it's also true that someone out there has to be actually making something and paying taxes, or the government jobs can't last either. Everyone feels that we're at one of those historically defining moments, the choices made in the next four to eight years will set the tenor for our economy for the next fifty years. Some believe this is the end of the free market and the beginning of Eurosclerotic Socialism. Others think this is where the fat cats get reined in appropriately, and the wealth is spread in a more "fair" fashion to the benefit of all, including the wealthy who benefit from the increased spending base of the consumers. Reagan had his "trickle down" beliefs, apparently now we're going to try "trickle up." I honestly don't know what to think, I just know we live in interesting times.

And one thing scares me about this whole bail-out thing: I'm having trouble counting, but I believe we're currently between $4.5T and $5T into this bailout. Our economy produces about $1T per month, so we've effectively put about five months of our national income onto a credit card. There will be a bill to pay, and we don't get airline miles.

House prices fell in the third quarter like Ford Pintos dropped out of a 747. Zillow.com reports that my house has lost 10% of its value in the last 45 days. Consumers have started really getting serious about cutting expenses and paying down debt - this year's Black Friday (that's the sale day after Thanksgiving, not some weird health or stock market thing) will have some really exceptional deals, like a $800 50" LCD TV at Walmart. Retailers are near panic that this will be the christmas that wasn't. Many retailers just break even for ten months, then make their money on Christmas. If Christmas doesn't happen, there will only be more layoffs and bankruptcies.

The stock market took off this week. But for my deeply skinned prognosticating knees, I would say this is clearly a bear market rally.

S&P 500, week ending 11-26-08

Looking at a broader view, this really smells like a rally. Historically, one would expect this market to continue upwards to an S&P of about 900 to 1000, a Dow of about 9,000 to 10000. However, I'm confused: there will soon be bad consumer spending news in the weeks leading to The Christmas That Didn't Happen, followed a couple weeks later by Very Encouraging News from The New Congress That Will Save Capitalism. It's tempting to call this rally something that will last into at least February, perhaps even May, but it's equally tempting to say that in a week or three the party will break up and we'll all wake up with massive hangovers. Here's some important news days coming up: Monday Dec.1 we'll find out how the post-Thanksgiving sales went. About December 10th we'll find out if the automakers manage to get to DC with their plans, without their Gulfstreams, and if congress can put together some kind of bridge loan that Bush will sign. Later in December we'll find out if Christmas has been canceled.

S&P 500, last 90 days, 11-26-08

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