In the last issue of THE NOTE PROFESSOR NEWSLETTER , I showed you how finance companies and mortgage companies will increase their earnings by giving you a "Christmas Gift" by allowing you NOT to make your December payment. Now that Christmas is over, are you seeing all kinds of adds saying, "Zero Interest" Do you ever wonder how the merchant can do this and still make money? When you know the concepts of the time value of money, what is happening is simple. Let's look.

A furniture store advertises it will sell you a complete bedroom set for $3,000 with zero interest, for 36 months. Let's get out our friendly neighborhood calculator and see what is happening. (Remember, I usually put the minus sign in front of PV because I assume I am going to buy the note. This should give you a hint as to what is going down.)

Now for a "behind the scenes" look at what the merchant is doing. Retailers use terms like "keystone" or "three marks". Keystone means they have doubled the price they paid for the product, and three marks means the retailer has tripled the price of the product. For example, if a product cost the merchant $100, it would sell for $200 if "keystoned" or $300 if "three marked". With this in mind, we see that 25% off still gives the retailer a profit, while making the product more affordable. Retailers must, I say again, MUST move their inventory quickly, if they want to stay in business. If you think cash flow is important in the real estate business, try purchasing several hundred thousand dollars of a product and have it sitting on your show room floor.

Yet with high priced items like the bedroom set, going down on the price 25% to $2,250, still might not move expensive inventory. What can the retailer do to make the product more affordable? What if, rather than going down on the price, the merchant could sell it on credit, with 0 down, and 0 interest? Think they would have any takers? Yep! How does this look?

N= 36
I/Yr= 0
PV= $ -3,000
PMT= $83.33
FV= 0

Looks attractive to the consumer, does it not? For only $88.33 a month, the consumer can enjoy a brand new $3,000 bedroom set. But retailers cannot stay in business unless they move their products for cash, and quickly. What are they to do? You guessed it. SELL THE NOTE. Let's say that instead of giving a 25% discount to the consumer, the retailer discounted the note 25%. What kind of yield would this give to the note buyer?

N= 36
I/Yr= 19.75
PV= $ -$2,250
PMT= $83.33
FV= 0

So if the retailer "keystoned" the product, the retailer still enjoyed a $750 profit and moved the inventory quickly by offering it on credit, with 0 percent interest. Play with your calculator to see the different possibilities if the retailer "triple decked" the product. Armed with this knowledge, you might go to the retailer and offer to purchase the product for say $2,000 cash, or match the discount of the note buyer. Often times the merchant will agree just to move the product and get cash immediately. The merchant does not care where the money comes from.

Now you know another "trick of the trade". One word of caution, if you decide to purchase on such a plan, LOOK AT THE TERMS. Often the terms will state that if you are late on ANY payment, or something ridiculous such as if there are more than two reruns of "I Love Lucy" in any given week, the interest rate will go from 0% to $15%. This is going to result in either your payments going up, the length of payments increasing, or both. So be careful. What happens when they offer zero percent interest, and no payments for 3 months? Would love to get into this, but we would have to delve into Net Present Values and IRRs, however we have run out of time, and my fingers are getting tired. ( I do cover these concepts in my ADVANCED NOTES COURSE)

If you have any questions or comments, be sure to contact me. In the subject line, write ASK the PROFESSOR. I will try to answer your questions in the next Note Professor issue.

If you know of anyone who has a Note they want to convert to cash contact me at www.hpnotes.com I do pay referral fees.

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I am hearing again by pundits from both sides of the political spectrum how saving money is undesirable, and we need a stimulus to "jump start" the economy. Since our politicians are reviving their arguments of printing money, it is time we revisited the false economic premise of The Paradox of Thrift. The following is a basic reprinting of my October 2009 newsletter that is still relevant today.

There are several false economic theories that are being passed off as "accepted", but the Paradox of Thrift fallacy is one that I have heard three times in three days, from three different "experts". It is almost as if it is to be the talking point of the week. All of these pundits would do well to read Bastiat's, "What Is Seen and What Is Not Seen".

I heard it most recently from a Saturday morning radio talk show host who advised one of his listeners to google "Paradox of Thrift". He went on to state that it was an "accepted" theory. Accepted by whom is not mentioned. (It is accepted by poor economists like Paul Krugman and others who still support the defunct economist John M. Keynes, who is attributed to giving rise to this theory. ) BTW, have you noticed when "experts" do not have arguments to support their premises, they merely say "It is accepted" or "it is the consensus"?

In a nutshell, the Paradox of Thrift states if "consumers" save, they do not spend. If they do not spend, then local merchants will suffer and we will end up in a depression. In other words, consumers cause depressions, and savings is undesirable. BOVINE SCATOLOGY!

The major fallacy being perpetrated is there is a difference between production and consumption, and that consumption alone will "stimulate" the economy, without acknowledging that in the real world, you can only consume what is produced. The "paradox" is also based on the false premise that money not spent immediately is not spent.

What is ignored is that ALL MONEY IS SPENT. It is just a matter of when and in what form. Savings merely means the producer has decided not to spend his/her production (income) now, but rather sometime in the future. Moreover, without "thrift" or savings, there would be no real capital available for growth. Is this not what we are experiencing today? Savings declined to practically nil in the last decade and the bubble burst. As a result, banks have no money to lend. Remember, printed money is not REAL CAPITAL or production. It is merely paper.

Let's take a real estate example. Say a young couple decides they want to buy a house for $100k. In order to qualify for a loan, they must have $20k down. The couple decides rather than spend their income (production) on other goods and services now, they will save part of their earnings in order to purchase a house. All they have done is decided to spend their money at a later date. The local merchants will indeed miss this young couple immediately spending money at their stores. However, everyone from the local real estate agent, funders, appraisers, not to mention the delighted home seller, will benefit when they do "spend" their $20,000 as a down payment, some time in the future.

Moreover, is this young couple not going to want some furniture, appliances, garden hoses, and other goods and services connected to home ownership after they purchase their home? Now the local merchants start receiving benefits from the young couple's waiting to spend their income. In short, this money was "spent". Just not today. More importantly, look at all who benefited from the young couple's being thrifty.

Next let's examine what is done with their evil savings before the couple purchases their home. When they deposit their savings into an institution, let's say a bank, this institution will "spend" this savings in the form of loans. Everything from cars, tv's, to short term 90 day loans will be borrowed by other consumers or businesses. Most importantly, this savings is REAL money that was produced, not just paper printed, as in a "stimulus" package. Is it becoming clear that not only do those in the real estate industry benefit from the young couple's saving up to purchase a house, but also the auto industry, appliance industry, and other businesses that used this couple's savings to spend when they borrow money? In short, savings are spent, even before the house is purchased; only it is in the form of loans.

The Paradox of Thrift "sees" that immediately local merchants would suffer. What is not seen is the consumers who borrow the young couple's savings, and "spend" to purchase goods and services, and the merchants who benefit from the savings, nor the benefits the local merchants will receive in the future.

Let's now look at what happens when we accept the Paradox of Thrift fantasy. This same young couple, being good citizens, will spend all they earn. The local merchants will benefit, and all is right with the world. But what about the home seller, appraisers, real estate agents, not to mention other consumers who will not be able to purchase cars, tv's, appliances etc, because the bank has no REAL capital to lend because nobody saved any money. We have not even delved into the prospect that a "rainy day" arrives and the young couple have no savings to "spend now", because they spent it all in the past.

In summary, when you hear the Paradox of Thrift argument as being "accepted", ask by whom, but more importantly by what major premise is the Paradox of Thrift based? It is based on the idiotic assumption unless money is spent immediately, it is not spent. We have shown where this assumption is false. Secondly, it ignores the economic reality that without savings, there is no REAL CAPITAL to finance economic growth. Rather than being the cause of recessions, SAVINGS IS AN INTEGRAL PART OF ECONOMIC GROWTH. The opposite is also true, WITHOUT SAVINGS, DEPRESSIONS OCCUR!

I receive emails regarding my Economic Observation column. Sorry I cannot address them all.
CONTACT ME. with your questions or comments. I look forward to hearing from you.

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