What's a reasonable price for a gambling ban?

The most interesting thing about the on-line gambling ban imposed on US residents is the settlement the US reached with other countries. Most notably, the part that says that the settlement is a matter of national security, and thus the exact amount cannot be disclosed. We only now that a separate settlement, with Antigua, will cost the taxpayers $21 million annually. The estimates for the larger settlement with the EU and other countries range in tens of billions of dollars, presumably as a lump sum.

Making a wild and completely unjustified assumption, let's say that American lawmakers have enough common sense to make this settlement economically viable. For that, they should estimate the amount of economic damage to US gambling providers. Further, let's make a stupid assumption that without the ban US gambling operation would not launch their own on-line presence, and focus only on the current off-line revenues as a basis on the damage calculations.

The federal and state governments derive most of their gambling revenues from two sources: lotteries and casinos. Lotteries are justly called taxes for the stupid. In fact, as early as the Revolutionary War, lotteries were used to finance the American side. Last year, lottery spending has reached nearly 1% of all household spending in the US, with rates varying from 0% (six states have banned lotteries) to nearly 5% (with the exception of Rhode Island, where spending was at 7.47%, but most of it came from out of state purchases). The total lottery revenues reached $56.7 billion.

It is important to realize that lotteries offer much lower chances of winning than casino games. Usually, about fifty cents on each dollar is being paid off in winnings; the rest is officially used to pay for lottery expenses and special projects, such as school funding. (In truth, that money more often than not replaces budgetary spending, and thus can be considered budget income in the first place.) Lotteries also feature very steep double taxation. In addition to the 50% tax one pays by purchasing a lottery ticket, the winners have to pay income taxes, and the large winnings put them automatically into the 35% tax bracket. At the end of the day, on aggregate lottery players receive only 32 dollars and 50 cents for each 100 dollars spent. Subtracting lottery costs, the states and federal government end up with 52.5% of all lottery revenues.

So we have our first number - government's income from lotteries was around $29.8 billion last year. But how about casinos? Their revenue varies wildly, depending on who you ask. Some place their revenue at $637 billion for last year, but that's the total amount of wagers placed in the casinos. The casinos themselves report a total revenue of $54 billion, which is the amount they won from the players, but before their operating costs (by the way, that's only about 8.5 cents for each dollar wagered). Casinos have reported income taxes of $5.2 billion for commercial venues and $1.44 billion for racetrack operations, for a total of $6.64 billion.

So the total number of gambling income was $36.44 billion last year. To estimate how much would on-line gambling damage this income is impossible. Anyone who gives you a number just pulls it out of thin air. Last year, worldwide wagers in on-line gambling reached $18 billion. Assuming the absolutely worst-case scenario, that this amount would displace revenues for lottery games, this would cost various US governments about $9.5 billion in spending. Most likely, assuming the current distribution of wagers in the US, 92% at casinos and 8% for lotteries, the damage to government budgets would go down to $0.95 billion. All this, of course, assuming that the 100% of on-line gambling revenues came from the US, total displacement of revenues at other gambling sources (as opposed to increased gambling spending), and no on-line gambling operation based in the US and thus paying income taxes.

There you have it: the highly unrealistic, worst-case scenario would cost American federal and state governments between $0.95 and $9.5 billion last year. At the same time, the government refuses to release the settlement amount, despite the very public estimates that it reached tens of billions of dollars. This leads me to believe that the final amount may have been higher. Again, let's make some wild assumptions: let's say the settlement was between $20 billion (the lowest possible amount for "tens of billions"), and $100 billion (just a convenient number), and a 4% interest rate (within the range of this year's federal funds rate). It would take the US gambling industry 3 to 120 years to repay that settlement. (Note: I made one assumption against the government, by not suggesting any revenue growth for the on-line gambling industry, and while in a short to medium range this should not have a significant effect, at the high end of the range the number is probably way out of whack.)

From how I see it, the settlement caused by the on-line gambling ban was not paid for economic reasons, as the repayment period may be longer than any of our lifetimes, and definitely longer than the lifetime of the Internet in the form we know now. Let me rephrase that: the settlement was not paid for the "greater good" economic reasons; as some lawmakers already so eloquently showed us, gambling bans may have significant personal economic benefits. Even those would be just a fraction of the cost of the settlement. I just can't shake the feeling that I'm paying at least a hundred dollars for the privilege of not having the choice to spend my money in a different way. Kind of like the prisoners paying for the privilege to be kept in jail. Actually, with the insane already running the asylum, that may not be a bad analogy...

A quick note on inflation

The dollar keeps falling against the Euro. Oil and gold have hit new highs. Bernanke has printed a few billions of extra bills to bail out a bank. The sky is falling! I've put together a quick and dirty chart on the change in prices of oil, gold and Euro. It doesn't look all that bad for the dollar...


What we see here is a flight to commodities, but not a serious inflation of the dollar. The scale is from 100% on January 1 2007 to yesterday, and as we can see, during that time the price of Brent crude (spot) appreciated by slightly over 80%. That's a huge jump, but look at what was happening to the oil price in Euros and in grams of gold: until late August 2007 all three prices changed nearly identically. This indicates that oil prices have moved independently of the dollar until then, influenced only by supply and demand (and the perception of those). After that, two things happened: the dollar started growing weaker against the Euro, and the gold has taken off. Oil prices in grams of gold (Aug) has plateaued out.

The vast majority of the exchange rate swing took place between September and December; for the rest of the time the rate moved only very slightly. This is attributable to a number of factors, but a 15% exchange rate swing for two currencies that are not tied (in fact, they appear to be in global competition, not only for the distinction of reserve currency, but also as the price factor for two major import blocs) is not all that large. Gold, on the other hand, has grown in price primarily after the exchange rate between the dollar and Euro stabilized, and in fact, it's grown faster than the price of oil. This indicates a flight to safety, not excess inflation. Given inflation of around 3% in the Eurozone and 4% in the US, the growth in the price of gold was abnormally high, indicating a possible bubble. Moreover, considering that the commodity prices changed largely when there was little or no change in the US$/EUR exchange rate, we can safely assume that commodities have moved independently of the price of the two currencies, and not as a result of excess inflation.

On the value of US coins

Some say that money is only worth the paper it's printed on.  It's not my place to agree or disagree with that, but given that the paper is not worth all that much, I was wondering how much US coins are worth.  For my analysis, I looked only on coins from one cent to a quarter, ignoring the discontinued half dollar and the new dollar coins, as they rarely if ever find their way into my pocket.  For value, I referenced the metal spot prices (in dollars) at the London Metal Exchange.

A few words about the materials the coins are produced from.  Until 1981 (and partially 1982), 1 cent coins were produced from copper.  Since then, they were switched to zinc, whose value is negligible in our calculation.  Dimes and quarters were made of silver and heavier than today until 1964.  Since then they consist of copper core and copper/zinc plating.  If you were prepared to break the law and saw a quarter in half, you'd see that its inside color is very much like the one of a new cent.  Five cent coins have always been manufactured from a copper/zinc alloy.

Using the unscientific method of counting the coins in my pocket (actually, in my coin jar with well over 1000 coins and thus with sample results having a relatively low margin of error), I found that for each $100 worth of coins you'd have 1080 coins.  441 of them will be one cent coins, 139 five cents, 241 dimes and 258 quarters.  That, assuming, that you're like me and don't spend any of your coins in wending machines or laundromats.  On their face value, they may be worth $100, but their real (metal) value is only about $17.40.  The follwing chart shows this distribution.



You may notice that copper cents are suddenly woth more than before, but the value of other coins took a dive.  Based on my count, about one in ten one cent coins you'd get is still copper, and currently the value of copper is about 2.16 cents, more than double the coins face value.  In other coins, the copper content amount for less, compared to face value.  The following table shows the relative value of the coins.



So what to conclude from this?  Not much.  Currently, we have laws against defacing currency, which will prevent you from melting the one cent coins and making some money.  Not only it would be illegal, but also would require enormous amount of coins to make it worthwhile.  Still, if the price of the US dollar keeps falling, one day the coins may be worth much more.  Until then, though, I'll keep looking for the silver dimes and quarters that occassionally happen - they are worth roughly ten times their face value right now.

Liberty Dollar and the inflation-proof currency

On November 15, the FBI has raided the offices of Liberty Dollar and seized all its assets. Up to that point, the Liberty Dollar was the best known alternative currency in the US, a currency that cold be used by those who didn't want to pay or receive payments in US dollars. The main reason for not using US dollars was stated as the fact that US dollars are not inflation-proof. Liberty Dollar has solved this issue by linking its currency with precious metals. Its coins contain an amount of precious metals, mainly silver and gold, valued at the coins' face value. Its notes (deposit certificated) were fully backed by precious metals, including two tons of gold, which were seized in the raid.

It is not my goal to explore the legalities of using Liberty Dollars or government theft; other blogs have covered it already. I was more interested in the claim that Liberty Dollars or other precious metals-backed currencies were inflation proof. The currency's Web site is prominently featuring a well-known chart showing the decline in the value of US dollar. I recreated the chart using government inflation data:


What the chart does not address, though, is the growth in prices and wages. Inflation causes harm primarily if the growth in personal income is lower than the rate of inflation. The following chart shows the level of disposable (after-tax) personal income. Note that to normalize this number and account for differences in industry-specific wages and number of household members, I averaged the total personal income by the number of people in the US. This chart shows income in current dollars, not adjusted for inflation.


The graph seems to grow faster than the decline in dollar value. This is not an illusion - translated into 1914 dollars, the average disposable personal income grew from $400 to $1600, a four-fold increase. This despite the fact that the average tax burden grew from 2% to 12%, a six-fold increase. In other words, if the US dollar didn't change its value, we'd earn four times as much today as nearly 90 years ago.


In fact, it seems that wages have almost always outpaced inflation in the US. The following chart shows the inflation-adjusted change in wages, as well as the price in two staples that haven't changed much for the past century: a gallin of milk and housing costs. As can be see, we not only earned more in real wages, but we spent less on housing and food. The reason we don't feel much richer is that we find new things to spend our money on.


In fact, we are not saving much at all. Gone are the Jimmy Carter days of nearly 10% saving rates; for the past two years we saved less than 1% of our disposable income. Given that all my savings (with the exception of a small sum in the bank I need for liquidity) go into gold, I was wondering how well gold would hold up against the dollar. The following chart shows two things: the number of gold the average American could purchase with his savings every year, and the total profit or loss generated by holding onto the gold, given the gold spot prices.


As can be seen, if a person started purchasing gold since the abandonment of the Breton Woods System (given that that's when the price of dollar began floating against gold), by 2001, 30 years later, that person would lose money. That despite the fact that at that time the person would accumulate over 25 pounds of gold. Only thanks to the most recent fall in the price of dollar the value of gold holdings would yield a profit. Thanks to this, the current return on investment averages 7.74% annually for the past 36 years. That is still less than putting all savings into a Dow Jones index fund, which would at this point yield around 8.67% annually and increase the total gain in savings from $140,400 for investing in gold to $177,300.

I believe that historical inflation data doesn't support the claims than precious metals based currency was safer than US dollars. That doesn't mean it will be true for the future, though. As the past few years show, the US dollar may be on the verge in a long-term slide, and with no clearly dominating currency in the next few decades, gold may be the safest investment. I'm betting on it.

The Oil Prices Fallacy

With oil closing to $100 per barrel, I explored the history of oil prices and their correlation to a few items. My results are summarized in the chart below; click for a full-sized version.

First thing I found was that oil prices are nowhere near their peak of 4.54 grams of gold (AUG) per barrel. Today, Nov. 6, the price is at 3.6g AUG per barrel, or nearly a quarter lower than their peak. The price that changed was the price of the US dollar, not the price of oil (of course, prices are relative, but given the relatively low volatility of oil prices and higher volatility of the price of dollar I'd blame the dollar in this case).

Second, I'd like to point out to the longest run in oil price increase, which began with two mega mergers of oil companies and ended with another merger and the first electoral victory of G.W. Bush. Given the fact that during the same run there appeared to be a deficit in oil supply, possibly caused by increased refinery capacity (these two resulted in a decreased refinery utilization), I assume that the oil processing industry entered a time period of reduced competitiveness with two large conglomerates and four smaller companies. Once other companies merged to offer adequate competition to Exxon Mobil and BP, the price stabilized. Bush's election victory over Gore was also seen as a positive development, as the industry observers hoped that it would open access to new drilling areas, such as expanding oil production in Alaska.

One last observation, which is not apparent from the charts, is that the oil prices are highly correlated with refinery utilization (85%), and there seems to be a positive relationship between the two (regression with p=0.0004). Why this is so is anybody's guess; my assumption is that there is no shortage of refinery capacity in the US, and thus seasonal changes in demand for gas affect both the refinery utilization and oil prices.

Be it as it is, for me the most important finding was that oil is still far from its record price, and that it's unlikely it'll get there anytime soon. Unlike the US dollar, whose price keeps tanking.