When Hubris and Poverty Mix

I have just read a recent journal article by the brilliant scholar Peter Turchin, in which he elaborates on his theory of the dynamics of social instability over time and tests it on the United States from 1780 to 2010. Put briefly, his theory holds that one can expect a society to suffer greater social violence (such as riots or lynchings, as opposed to routine crime) in a relatively predictable cycle. The larger "secular" cycle occurs every 150 years; a smaller cycle of violence occurs roughly every 50 years, superimposed on the secular cycle. Thus in the United States, we had peaks of societal violence near the years 1870, 1920, and 1970, with the Civil War being the peak of the secular cycle. Turchin forecasts that the next secular peak should hit sometime around the year 2020. Turchin's previous work has detected the same sorts of cycles in societies from ancient China to revolutionary France.

Of course, detecting a pattern does not tell you what has caused it. Turchin's theory for when violence intensifies depends on two major factors. Both of these factors might derive from excessive population growth; in the early version of Turchin's work, he was focusing on agrarian societies in which population growth leads directly to food shortages. But now that he is considering Industrial societies, Turchin is focusing more on the immediate causes laid out below.

First, whether from excessive population growth or technological disruption or whatever, there emerges a labor glut. The average wage drops in response, leading to diminished standards of living. Thus you see larger segments of the populace who are in a precarious situation, with the potential for violent outbreaks such as labor struggles, or ethnic competition with minorities, or political upheaval.

Second, there emerges "an oversupply of elites." This can happen for a few reasons, and Turchin focuses on the economic one. The low cost of labor means that it is easier for those on the top to become far wealthier than they might have done in a more normal setting, leading to the accumulation of vast fortunes and a polarization of society. A consequence of this is that there is much more competition for the leadership positions in society, such as control of government offices. Politics becomes more nasty and partisan, leading in extreme cases to violent rivalries between elite factions struggling to secure their hold on power. Such violence is made easier by the larger number of poor, desperate people in society who can serve as a demagogue's muscle.

In Turchin's research, he finds that oversupply of elites has the strongest association with societal violence. This is easy to understand when one looks at places like the Philippines, in which politicians routinely employ armed militias to attack competitors (a horrifying example was the Maguindanao Massacre of 2009), or the Congo, which has been wracked with coup after coup. But even in the United States, a surplus of would-be leaders will tend to produce extreme ideologies, such as militant unionism in the 1920s, or the present upsurge in eco-terrorism.

Yet a disparity in wealth is not the only way to create an oversupply of elites. Joseph Schumpeter, in his book Capitalism, Socialism, and Democracy, proposed that the growth of an intellectual class was profoundly dangerous to society. Intellectuals, he argued, are alienated from the society around them and believe themselves to be the natural leaders of a new, better, society that they will create. Philosopher Robert Nozick expands on this theme, arguing that intellectuals are those who are most successful in the artificial environment of the classroom; when (after two decades of endless success in school) they are exposed to the unforgiving "real world," many of them cannot handle no longer being the top dog. Seething with resentment and humiliation, they turn to radical ideologies and reject the society around them. After all, they should be the leaders! Aren't they brilliant, aren't they better than those who got C's on their tests?

It seems to me that many more people today aspire to being an "elite" than ever before. And the expansion of university education is to blame. For people in the "softer" side of the academic world, college does a poor job of preparing one for success in the real economy. At the same time, college students are constantly being told that they are America's elite—never mind that nowadays, around 68% of high school students go on to college! Combine that with the prevalence of revolutionary ideologies on campus, and we have a dangerous brew. (No coincidence that the Peruvian Maoist group Shining Path was begun by a university professor, and its initial members were hundreds of his students.)

Not to say that economic factors aren't at work either. American politics is becoming a contest of billionaire against billionaire, quite tedious to watch, quite alarming to live through. It remains to be seen whether the growth of mass connectivity will break this dynamic, or feed into it.

(Have I mentioned lately that my new book is available on Amazon Kindle? It's called The Best Congress Money Can Buy: Stories of Political Possibility. You can read the first story for free here, and then buy it if you like. Enjoy!)

Investing in True Value

(I should preface this post by saying that nothing in here constitutes a recommendation to buy or sell securities, etc.)

Working in finance as I have for years now, I am growing more and more convinced that our societal attitudes toward saving and investing have gone haywire. We now assume automatically that when one saves, one is chiefly saving for retirement or for your children's college; that such saving is primarily done through the financial markets; that there is nothing strange about (for example) keeping part of your portfolio in bonds that pay 2% while at the same time carrying a home mortgage charging 4% or more.

Our assumptions about saving are driven by a combination of government policy, such as the creation of tax-advantaged retirement savings vehicles like the 401k, and a financial industry that is eager to market itself as the midwife of your future prosperity. Yet it seems odd indeed to save for a time that might be thirty or forty years off, when nowadays people can be laid off from their job at short notice—and if you want access to your 401k money earlier than the government prefers, you must go through lots of red tape to "prove" that you are in hardship. Otherwise, you are penalized.

It also seems odd that our first reflex is to use savings to buy securities. The long-term return for investing in the stock market is on the order of 7% or 8%, depending on your time period, and that assumes that you can phlegmatically wait out the bad periods without panicking and taking excessive losses. During the bad years, the destruction of your savings also causes immeasurable psychic harm to yourself and those around you. Stocks are still a decent vehicle for those with the discipline to invest over a 40-year window and then forget about it; their whole appeal is that your money can work for you without your personal involvement, freeing up your attention for other things.

Admittedly, some can make a study of market trading and, if they are of the proper cast of mind, secure annual returns that are much higher than the average—assuming that you are not one of the many who jump into such trading with dollar signs in their eyes, who then lose everything in a blaze of misplaced optimism. But here is another odd thing. To achieve above-average success, you must essentially turn stock market trading into a second job, or even a first job. Yet the whole attraction of stocks was that they shouldn't take up more of your time, no? And if you want another job that can turn your savings into profits, there are many industries with much higher rates of return on capital than stock market trading. Moreover, trading profits must necessarily come from someone else's losses; while in other industries, or other uses of capital, there is a net creation of wealth.

I've been thinking about this more because in the last six months or so, I tried my hand at options trading with disastrous results. At about the same time, I commissioned a pair of artists to illustrate a children's story I have written, which is nearly complete. The process of overseeing the book's creation has taken some work, but not much; it is also extremely fulfilling to see a work of art being created that will have my name on it. It was cheaper to commission the art than to trade options; and once the book is published, it would need only 20 books sold per year to achieve a higher annual rate of return than the stock market average. (It's a fun story, too, and should provide joy to many readers. To me, that's a definite plus.)

(Oh, and if you want to hear when the book is published, feel free to subscribe either here or on my other blog. The title is The Princess, the Dragon, and the Baker: A Hanukka Fairy Tale.)

There are many talented artists out there desperate for commissions, and lots of people with frustrated visions for artistic projects that they lack the skill to realize. Yet how many of these people are maxing out their retirement savings and handing their money over to Wall Street, instead of taking a fraction of that money and trying to bring something new into the world? Admittedly, many such projects wouldn't return a profit; but it would be a lot more fun than investing in WorldCom or Enron.

Other opportunities exist. Want a quick way to make 50% on your money? Buy in bulk at the grocery store. What about residential solar panels? Do you think you could beat a 2% return per year on them? What about investing in your own professional skills? For some people, improving their skills at working with others, or selling to customers, or marketing, or project management could easily increase their income far more than the same amount of money would earn in the stock market.

What about maintaining your health with a gym membership? Health care costs are a huge fraction of costs in retirement, and anything that can improve your health will pay off big. Plus, you'll enjoy your life more now, and you might even be more effective in your job.

I know people who are channeling excess savings into upkeep on their houses, rather than investing in the stock market. Stock market returns are unpredictable, they reason, and inflation is surely coming given our present central banking policies. But people will always need housing.

But for some reason, speculation is the order of the day for most people. Even those skeptical of the stock or bond markets often turn to some other form of sterile speculation, such as buying gold, a metal which is allowed to languish in inert bars rather than being turned into jewelry or circuit boards or something else of added value. In part, this is because we have been trained as a society to avoid the hard work of overseeing other people and creating new things. Far easier to speculate; you might lose your money but at least you don't have to talk to anyone in the process.

Take stock of your own opportunities. Is there any way that you can use your capital to add wealth or beauty or skill to the world, instead of merely chasing speculative profits? And would such uses actually be more lucrative than the Wall Street slot machine?

Greecing the Skids

It is superfluous at this point to rehash the usual news bits about the Euro crisis. Suffice to say that states have consistently borrowed too much in order to fund their social welfare benefits, and now they are running up against the limits of such borrowing.

Yes, the immediate crisis was brought on by a fall in tax revenue, from the recent and continuing depression. However, we must ask how healthy a fiscal system is that fails whenever everything stops going right, all the time. Governments have grown accustomed to mortgaging their futures (or more to the point, someone else's futures) in order to pay for their present. Sadly, the future is now.

How will this play out? Smarter people than I are puzzling through the intricacies of how bad the car crash will get; but in general, we are about to return to the era of recurring sovereign defaults. Whether through an outright repudiation of their debts, or through monetary debasement of the Euro which would fund "grants" to the debtor countries, the problem children of Europe are going to escape their obligations for now, at the cost of driving up borrowing costs in the future.

An interesting question that I haven't seen addressed elsewhere is: how will the bond investors be compensated for their loss? It is one thing when you are a Latin American country borrowing from overseas banks; you can expropriate from them without pity and even with glee. But when your major lenders are German and French banks, and you have to live with these people even after you default, there needs to be something in it for them.

In earlier eras, when a profligate government had to periodically default on its debts, it would do so by borrowing from its own banks, who would face the certain prospect of losing their money every decade or so. In exchange, they were given lucrative monopolies over domestic lending and money creation. (An example of this can be seen in Mexico under Porfirio Diaz and thereafter.) The deal was worth it to the banking elites, for whom the periodic defaults became just another cost of doing business.

So what concessions will the big European banks extract from their governments? Or will the governments simply nationalize the banks, as many are itching to do? And if they do, what happens next?

Being Paid to Borrow

On Friday, the 10-year Treasury yield ended up below 1.5%; shorter durations are even more ludicrous. At a time when inflation is something like 2% (and that's assuming you trust the official numbers, which I don't), what this means is that the Federal Government is essentially borrowing money for free, at worst—at best lenders are effectively paying real money to the Treasury for the privilege of letting it spend their assets.

I suppose that if ever there was a good time to run trillion-dollar deficits forever, this might be it. Of course, that all depends on whether the Treasury can roll all of its debt over into longer maturities before rates shoot back up…

Why are rates so low? John Mueller argues that interest rates are being driven down because of the Dollar's status as a reserve currency; something like $4 trillion is being held by other nations not to pay for our exports, but to stabilize their own currencies. This creates a serious problem, driving inflation and causing interest rates to decouple from fiscal and monetary policy. In short, politicians no longer suffer automatic consequences from borrowing loads of money.

Worse, if we were to stop borrowing so heavily, all it would do is to drive interest rates even lower as foreign buyers bid up the diminishing stock of Treasury bonds remaining. Eventually, the temptation of free money would grow intolerable to any responsible politician, and we'd start overspending again.

What can be done about this? Mueller suggests going back to gold as an international reserve. Short of that, I'm not sure how we solve the problem. Assuming that it is a problem to be solved.