Our Real Economic Problem: The Decapitalization of Wealth

As many economic pundits will tell you today, our current economic crisis was a long time in the making.  Some point to over-consumption, others to the accumulation of debt, and still others point at a broken regulatory system, government spending, and political gridlock.  However, the fundamental issue is none of these things, although each is a symptom of, or a bi-product of, the real issue: the decapitalization of wealth.

The value of capital is the utility that can be realized from it.  Economists generally define utility as the measure of ‘need satisfaction’ realized by a consumer in the consumption of a good or service.  Extending this concept to capital, the utility of capital is the measure of economic goods and services created through its deployment.  Wealth deployed as capital that produces economic goods and services creates healthy economies with low debt, low inflation, and low unemployment.  Unfortunately, much of the wealth created over the last twenty-five years or so has flowed to low capital utility venues.  This process has accelerated over the last decade.

So what are these low capital utility venues?  Wealth deployed for war making is a classic example.  Anyone who has taken an introductory course in economics can probably remember the guns vs. butter analysis.  Money invested in death and destruction is obviously not a creator of economic goods, and the US has spent more than $2 trillion in this manner since 2003.[1]  Financial bailouts also have low utility.  As we have seen, we may have stabilized the financial system with the massive bailout of too-big-to-fail banks, but we have not created economic goods in the process, and the bailout funds are now trapped in the balance sheets of banks; idle dollars producing little to no utility.  Our tax system, which is at least partly to blame for the inordinate concentration of wealth in the top 1% of our citizens, is also responsible for decapitalization.  Wealth concentrated among the few means that capital has flowed to idle reserves – in low risk, low velocity trust funds.  Dusty money is not happy money.  Speculation and financial ‘engineering’ is also responsible for decapitalization.  Currency manipulation, which amounts to more than $3 trillion in transactions per day worldwide, does not produce economic goods.  Nor do the billions of dollars invested in credit default swaps that produce no more capital utility than dollars dropped into slot machines on the Vegas Strip.  Another classic example is government spending and investment.  When the Pentagon spends $6,000 on a coffee pot or the White House blows $500 million on Solyndra, it is clear that government bureaucrats make lousy purchase and investment decisions, regardless of party affiliation.  Debt service payments and sovereign debt bailout funds are other examples.  By now you get the idea: most of the places our money ends up today are venues of decapitalization.  That must change.

In a recent article by the Washington Bureau Chief of The New York Times, David Leonhardt, argued that our current crisis might actually prove to be worse than the Great Depression due to one central difference: during the Depression, invention, production, and investment in public infrastructure continued at high levels.  Leonhardt suggests, “The most worrisome aspect about our current slump is that it combines obvious short-term problems—from the financial crisis—with less obvious long-term problems.  Those long-term problems include a decade-long slowdown in new-business formation, the stagnation of educational gains and rapid growth of industries with mixed blessings, including finance and health care.”[2]  “Mixed blessings” here means finance and health care are relatively low capital utility investments.  When we see job growth in these private, and almost any public sector categories, we must refrain from patting ourselves on the back.  They produce little more than single-round economic effects.

Correcting this problem is not easy, but it is doable.  As you can see from the above list, one may even argue that decapitalization accelerates in an insidious manner, spawning more and larger venues of low utility.  We need look no further than our own economic history to see that many of these venues, except war making, are relatively new developments in our economic system.  Fiscal policy and, to a lesser extent and effect, monetary policy should both be oriented to direct wealth away from these venues.  Financial system regulations and tax policy can also be changed to affect this.  Education, research and development, small business development, and yes, liberal trade and immigration policies can also help stem the tide of decapitalization.

Creating wealth requires a relentless focus on capital utility.  When capital works, it produces economic goods; when idled or addled, it leads to dire economic effects.  Decapitalization is the overarching problem.  Until we recognize this we have little hope of pulling our economy out of the ditch.

[1] This excludes the $600 to $700 billion the US spends annually as a baseline expenditure for national defense.
[2] David Leonhardt, “The Depression: If Only Things Were That Good,” October 8, 2011, The New York Times, www.nytimes.com.
By |2017-05-27T18:24:53+00:00November 11th, 2011|The Economy|0 Comments

Steding’s Unverified Theory of Strategic Inversion

In August 2008, I made a presentation to a money management firm in Dallas to attempt an explanation at what I then saw as an impending upheaval in the financial markets that would bring to question the very models of investment strategy that had existed since (at least) the Great Depression.  One month later, Lehman Brothers collapsed, and by the end of October 2008 trillions of dollars in wealth had evaporated from the balance sheets of the world.  (If you want an entertaining telling of that calamity see HBO’s Too Big to Fail, based on Andrew Ross Sorkin’s book of the same title.)  What I saw, and what is now evident not only in financial systems, but in political systems around the world (particularly in the Middle East), is the danger of employing old thinking and models of risk management in a world where complexity compounds thereby exacerbating disequilibria created by fraud and oppression.

My argument was posed as Steding’s Unverified Theory of Strategic Inversion (SUTSI). SUTSI argues that as complexity compounds, enabled by technology and as manifested in globalism, the distribution of data points—of actual results—represented by the bell curve flattens. Rather than complexity validating regression toward the mean—the center axis of the bell—it produces a greater number of outliers; those events nearer the rim of the bell such that the principle of regression is moot. In the investment world, I argued further, old portfolio allocations and holding periods might be ineffective, and Federal tax policy may need to be flipped.  For example, investment strategies that target the 0 to 20% returns (‘long’ positions—the area immediately to the right of the center axis of the bell) or the 0 to -20% returns (‘short’ positions—the area immediately to the left of the center axis of the bell) actually accept greater risk due to a relatively smaller number of results within that range.  The better strategy is to play the edges, which now include a greater number of data points, taking both long and short positions, not so much as a hedge, but in pursuit of absolute gains.  Nassim Nicholas Taleb has most forcefully made this argument in his book, The Black Swan: the Impact of the Highly Improbable.

In this investment strategy scenario I suggested that perhaps a strategic inversion is warranted:

  •       Rather than a portfolio allocation of 50% equities, 30% bonds and 20% cash, maybe one should have 50% cash, 30% bonds, and 20% in equities.
  •       Rather than holding investments for the long term—the traditional investor strategy—one should look at short term investments, more of a guerrilla investment strategy.
  •       Rather than being highly diversified one should have fewer positions, mitigating risk by having only 20% of wealth ‘exposed’ in equities (and much less leverage but more due diligence).
  •       Rather than having a tax policy that penalizes short-term gains at high tax rates (35%) maybe we should swap them with long-term rates (15%) as a better way to support the creation of wealth?

These suggestions fell on polite but mostly deaf ears in August 2008.  Today, you can find many investment strategists arguing for variations of these suggestions.  Since 2008 we have witnessed a bumper crop of Taleb’s so-called black swans, not only in financial markets, but also in political systems.  (Although politicians are even slower slow to catch up than financial managers.)

In the May/June issue of Foreign Affairs, Taleb, together with Mark Blyth, Professor of International Political Economy at Brown University, apply these same notions of complexity and risk in “The Black Swan of Cairo: How Suppressing Volatility Makes the World Less Predictable and More Dangerous.”  Taleb and Blyth argue “both the recent financial crisis and the current political crisis in the Middle East are grounded in the rise of complexity, interdependence, and unpredictability” where linear models and a preference for stability—what I have called “staring at the mean”—may actually be the most, not least, risky (p. 34).  What may be called for in foreign policy may mirror the strategic inversion we have witnessed in investment strategy.  The “illusion of control and action bias” that are traditional hallmarks of US foreign policy, may in fact produce greater instability and reduced security (p. 39).  The US may be much better off playing less often, and at the margins, where the black swans live.

Three years after penning my theory and making my presentation about the prospect of strategic inversions to the investment world, it seems at least one thing is clear: compounding complexity requires new modalities of inquiry that reject the linear traps inherent in conventional thinking. While I am not ready to strip “unverified theory” from the title, changing it to Steding’s Rule of Strategic Inversion (SRSI), I am getting closer every day.

By |2017-05-23T20:08:14+00:00May 24th, 2011|General, The Economy|0 Comments

Crisis & Liberation: Toward a New Prosperity

British economist John Maynard Keynes warned in his thesis of the “Paradox of Thrift” that if everyone started to save more during an economic recession, a commensurate drop in aggregate demand would actually result in a drop in aggregate savings making everyone worse off.  But his thesis doesn’t consider the social and political effects of crisis—of the psychosocial dynamics that also offer the prospect of liberation.  His thesis, like those of today’s economic gurus who proclaim econometric prescience may fall victim to an aggregate yawn.  Regardless of whether we save more or less, or if the economy rebounds quickly or slowly—or at all—we may all be better off if we embrace the opportunity crises provide: liberation.

If crises accomplish nothing else, they bring to question all the givens—the assumptions that prevailed pre-crisis.  They offer an opportunity to cleanse us of beliefs and behavioral norms that rose to prominence not on the backs of principle, but on the exhilaration of deception.  The promise of a benevolent technocracy that would assure everyone a piece of the American dream, and the continued benign and covetous admiration of the world are over. The no-money-down McMansions are an artifact that will make cultural anthropologists giggle for many years to come.  Our challenge is to find and exploit the silver lining of crisis and affect our liberation; to stop praying at the altar of spending. To step off the treadmill of consumerism and pursue dreams that mean something. To thumb our nose at Mr. Keynes and move on.

This anti-consumerism notion, blasphemous though it may be, could be just what America needs.  We may actually win our future back.  On the domestic side, we might learn to enjoy the experiences of life, rather than worship the banality of false prosperity.  While GDP and taxes would fall, it may finally reign-in our useless elected leaders who continue to spend money we don’t have while lining their pockets with lobbyist’s ‘appreciations.’  Families may have to take care of their own, rather than point their finger at the government.  We may have to participate in the education of our children, while schools return their focus to core subjects and away from stylized babysitting programs.  We may have to banish our sense of entitlement and replace it with the principles of equity.  In short, we may have to become stronger individuals, closer families, and more effective communities.

On the global front, can you imagine the hue and cry from countries like China if the American consumer found greater happiness in less stuff?  Can you imagine a world where Americans consume less fossil fuel? We would stop funding our enemies, while improving both our environment and health. Do we really believe that the rest of the world would stop adopting (and/or pirating) our inventions?  What if we brought our troops home and decided to reduce our global military footprint?  Would we be worth hating anymore?

It’s time to pursue liberation—to question the givens and turn those away who leverage our future with a kaleidoscope of deceptions. To honor our capitalist heritage and allow creative destruction room to work. Isn’t it about time we freed ourselves to apply our unique skills and make something new—something truly great?  Crisis and liberation allow us to craft a new perspective and a new, more resilient, identity that just might make us stronger, happier, and yes, even more powerful. Let’s not let this opportunity pass.

By |2017-05-25T22:55:24+00:00January 6th, 2010|General, The Economy|0 Comments

The Spending Myth

In George Cooper’s The Origin of Financial Crises: Central Banks, Credit Bubbles and the Efficient Market Fallacy, he credits a relatively prolific Norwegian-American economist, Thorstein Veblen, for coining the term “conspicuous consumption.”  Veblen studied the “leisure class” at the turn of the 20th century and used the term to identify markets where demand actually increased as price increased for the same amount and quality of goods—suggesting that markets were, perhaps, far from perfect.  He was one of the first to suggest that the tidy models of economic behavior were false; they ignored man’s capacity to make irrational choices—an appetite of irrationality that would prove insatiable and cause Federal Reserve Bank Chairman Alan Greenspan (many years later) to, reluctantly, warn of “irrational exuberance.”  Of course, this irrationality was largely contained in Veblen’s day by the small number of people who had the financial capacity to behave irrationally, ergo the “leisure class”—a pleasing term for those with more money than sense.  But that would change.

As the 20th century unfolded and American power expanded after each of the first two World Wars, the numbers of those reaching a level of affluence rose steadily together with a hubristic claim to perception of value defined more frequently than not by price. More people had more money and, therefore, the capacity to make irrational assessments of price and value.  We segued from “conspicuous consumption” to “Keeping up with the Joneses,” a phrase originated by Arthur R. “Pop” Momand in a comic strip of the same name in the latter years of World War I.  The expansion of the “leisure class” meant our answer to the question, “What is wealth?” would be defined not by savings or investment—by Robber Barons’ tally of track miles or oil wells—rather, by consumption.

Cultural anthropologists must salivate about where we are today.  They have more than one hundred years’ evidence of our ingenuity and stupidity.  A perfect storm of brilliance and madness, frequently quelled by theological innovations replacing Calvinist notions of sacrifice with televangelist’s promotion of prosperity as the new benchmark of piety.  We traded the Sermon on the Mount (Matthew 5) for Luke’s prescription to enjoy the fattened calf (Luke 15:23).  Let the feast begin!  We embraced consumption—how much we spend—as the definitive yardstick of wealth. No money?  No problem; just charge it.  In doing so we placed our future in the hands of those who find value not in price, but in our debt.  We tethered the future of our children and grandchildren to a pirate ship.  We are betting on mercy where ingenuity and innovation once stood. We have succumbed to our perversion of price and value.

This is the unique, albeit shameful legacy of my generation, of those who rose to the challenge of Sputnik; found freedom at Woodstock; and embraced the alchemy of Reagan, swagger of Clinton, and hubris of Bush. Our masterpiece of contrivance was papering the world with ether-backed credit default swaps—vapor paper—trillions of dollars of securitized myth that makes Bernie Madoff look like rounding error.  Our current prescription?  Spend more!  We continue to measure our prowess by total spending rather than savings and investment.  Our military is presumed to be most powerful because we outspend the rest of the world, combined.  Yet, suicide bombers and improvised explosive devices bring us to our knees.  We believe we have the greatest healthcare and education systems because we spend more than anyone else, while forty-plus million go without care and our high school rankings in math and science plummet. Every data point we stare at to forecast an economic recovery is fathered by spending. As the economy sputters, we contemplate more “stimulus.”  After all, it got us where we are and that can’t be all bad, right?  Wrong.

It is time to straighten the irons.  It is time to change the discourse of wealth.  It is time to return consumption to the altar of avarice and rebuild America. It is time to save, invest, and yes, sacrifice.  Wealth enables spending; spending does not create wealth.

 

By |2017-05-27T16:50:05+00:00September 8th, 2009|General, The Economy|0 Comments