Our brief is not a political one.
“Sajid Javid should’ve put down his pitchfork instead of stripping Shamima Begum of her British citizenship. Not the way to deal with this problem.”
“I agree. It seems that if you want to go abroad and consort with terrorists, it helps to be over 60 and have a beard. Then they make you leader of the Labour Party.”
“Westminster voting intention:
“A new centrist party opposed to Brexit”: 8%
“Spare a thought for the Lib Dems, a centrist party opposed to Brexit that is behind in the polls to an imaginary centrist party that is opposed to Brexit.”
Tweet by Christopher Snowdon, author and journalist.
In 2010, we chanced upon the Adam McKay-directed comedy The Other Guys, starring Will Ferrell and Mark Wahlberg. The film is a workmanlike but perhaps otherwise unremarkable piece in the “buddy cop” genre. But then come the end credits.. Here is what we wrote at the time:
Something rather interesting happens during the end credits of the latest Will Ferrell comedy, The Other Guys; to the somewhat arch soundtrack Pimps Don’t Cry, animated sequences show:
How a Ponzi scheme works;
How the $700 billion T.A.R.P. bailout equated to a $2,258 payment from every man, woman and child in the United States (the children won’t of course have the money, but they’ll be paying for it as part of the government deficit for the foreseeable future);
That 73 employees of failed insurer AIG received $1.2 billion in taxpayer-funded post-bailout bonuses;
That the ratio of CEO pay to that of the average US employee rose from 7:1 in 1917 to 107:1 in 1990, and to 319:1 in 2010;
How the recent stock price history of Goldman Sachs compares to that of the average US listed business;
That the average CEO retirement benefit package amounts to $83,600,000 while the average American 401K account has recorded a 47% loss over the last five years.
In other words, not exactly Hollywood as usual.
Wall Street in action
Source: Columbia Pictures / Picture Mill Studios
We have no problem with an inherent economic balance between a genuinely entrepreneurial, risk-taking and value-creating elite, and the average employee. It’s called meritocracy (or a genuine free market, if you prefer), and a degree of imbalance may well be a fundamental factor in any unmanipulated economic system. In 1995, for example, Joshua Epstein and Robert Axtell of the Brookings Institution conducted an experiment to see whether they could create a model of a working economy from scratch. Their aim was to replicate economic life within a computer. Going back to first principles, they created little economic “agents” and then built a rudimentary environment for those agents to run around in, a silicon desert island in the form of a fifty-by-fifty square. Epstein and Axtell then gave their island one economic resource: virtual sugar. The experiment, and the name of the island, was Sugarscape.
Each square in the island of Sugarscape had different amounts of sugar piled on it. Some squares had none, and others up to four units’ worth. The virtual sugar piles were arranged so that the north-east corner of the island contained a mountain of sugar, as did the south-west; in between was a “Badlands” area where the sugar was meagre or non-existent.
A variously sweet economy – the world of Sugarscape
Source: https://sugarscape.sourceforge.net/ (where you can rerun the experiment)
Although Sugarscape was an obviously simplified version of a real economy, Epstein and Axtell continued to add broadly realistic attributes of one. Each virtual inhabitant of the economy would take in information about the island, analyse it through its code, and make decisions as a result. In the initial version of the simulation, agents could do three things: look for sugar, move, and eat sugar. Epstein and Axtell subsequently granted these agents a metabolism to digest sugar. The rules for the game’s agents were as follows:
The agent looks around as far as its vision will allow in each of four directions within Sugarscape (north, south, east and west);
The agent assesses which unoccupied square within its field of vision contains the most sugar;
The agent moves to that square and eats the sugar;
The agent is credited with the amount of sugar it consumes and debited by the amount of sugar burned metabolically. If it eats more than it consumes, it accumulates sugar in a “bank account”. If it eats less, it uses up its savings;
Each agent is given a “genetic endowment” for its vision and metabolism. Agents with good vision can see up to six squares ahead; those with poor vision, only one. Those agents with slow metabolism need only one unit of sugar per turn to survive; those with fast metabolism need four;
If the amount of sugar stored by an agent drops to zero, it dies and is removed from the game. Otherwise it lives until it reaches a pre-agreed maximum age;
As sugar is eaten, it grows back on Sugarscape like a food crop, at the rate of one unit per turn of the game.
Sugarscape began with 250 economic agents dispersed randomly throughout the island. How did the simulation evolve ?
Things began with chaos. Agents ran around looking for sugar, and those unfortunate enough to end up marooned in the badlands ended up dying of starvation. But order was quick to emerge. Agents discovered the sugar-rich mountains, and started to settle around them. It also transpired that agents were very efficient grazers. Sugar never ended up lying around for long. Agents quickly organised themselves into two “tribes” and settled on each mountain.
But perhaps most remarkable was what happened in relation to the agents’ wealth. At the beginning of the game, Sugarscape was a broadly equal society. The distribution of sugar wealth was like the bell curve, with just a few rich agents, a few poor agents, and a large “middle class”. But as time passed, the distribution shifted dramatically. Average wealth rose as the agents discovered the mountain supplies. A new class of super-rich agents emerged, along with a sizeable upper class, a shrinking middle class, and a large and growing underclass of poor agents. How, from a random set of initial conditions, did Sugarscape end up with a highly skewed distribution of sugar wealth ?
The answer, as Eric Beinhocker makes clear in his fascinating book The origin of wealth (Random House, 2006), is that the apparently unfair distribution of wealth was an “emergent property” of the Sugarscape economy, “a macro behaviour that emerges out of the collective micro behaviour of the population of agents. The combination of the shape of the physical landscape, the genetic endowments of the agents, where they were born, the rules that they follow, the dynamics of their interactions with each other and their environment, and, above all, luck all conspire to give the emergent result of a skewed wealth distribution.”
In other words, although Sugarscape was a vastly simplified model of a real economy, it was also a true reflection of a real economy as well. Wealth did not end up being evenly distributed. Just as Vilfredo Pareto when studying Italian society discovered a lot of people at the bottom end of the ladder, a wide range in the middle class and then a few super-rich, so Sugarscape ended up with a real world Pareto distribution of wealth.
But what the title sequence to The Other Guys depicts, along with the environment we now inhabit as workers and investors, is not a reflection of even a crudely simplified economy, but an economy in which those who have made it to the ranks of the “elite”, whether in business, banking or both, now command rewards out of all proportion to any sense of supposed social utility and to any rules-based system. In banking, this putative elite has achieved a spurious and untenable primacy through aggressive lobbying of the political classes, meritocracy be damned, with taxpayers holding the bag and writing the bonus cheques. In saving the banks, governments cut the worst deal in the world: out of some extraordinary deference to the banking lobby we’ll keep you alive and bankrupt ourselves (i.e. impose draconian penalties on non-financiers), and we will require not one iota of sensible reform by way of response.
The artificial world of Sugarscape may seem unfair to those who believe in enforced mediocrity and the redistribution of wealth; but what currently passes for our market economy is plainly and simply unfair, not least for taxpayers who face sustainedly higher demands on their income indefinitely into the future in order to pay for a banking sector that remains self-interestedly resistant to the sort of reforms that would otherwise make future sovereign bailouts redundant. Nor are the bankers in isolation responsible; the government and regulators have each played their part in this unholy trinity.
What is most striking today is the lack of resistance to ongoing plans by administrations in the industrialised world to maintain quantitative easing, despite its conspicuous failure, ad infinitum. Where is the public debate ? When, if ever, will central banks be held accountable for the savage currency depreciation which QE2 and its kissing cousins will inevitably bring in their wake ?
We do not blindly have to play ball. As QE2 marches relentlessly closer, so too does the gold price march relentless higher, an increasingly strident alarm bell that should give the politicians and central bankers pause. But there are other dimensions to this crisis. The conflict is not merely between the financial lobby and the taxpayer. It is also a generational dispute, between near- or current retirees and the younger and increasingly put upon working constituency who will be pyrrhically obliged to finance their pensions. It is a class dispute, as the increasingly fractious debate between the beleaguered UK private sector and unions-in-denial should make clear. And it stretches across geography: tensions will undoubtedly build between an increasingly impoverished, and defensively inclined West, and the emerging economies that perhaps for the first time in history represent a fundamentally sounder base for wealth creation and capital growth. The business of investment has traditionally been focused on underlying assets as a means of capital growth. But the focus has now shifted to capital protection in real terms. It will, in turn, shift toward structures that can put investor capital beyond both the vicissitudes of the markets, and beyond the increasingly desperate grasp of governments that have earned no right to be trusted.
Investment risk has previously been somewhat two-dimensional. Now it is a hydra.
The commentary above was written in September 2010. Now, from the vantage point of February 2019, we have a better idea of how long it takes for a Global Financial Crisis and the resultant policy “remedies” to wash onto the shores of our culture, society and politics. Roughly a decade. After roughly a decade of fundamentally unreconstituted finance, in which the splitting seams of a debt-dependent economy and debt-dependent government have been papered over with yet more debt, and the wounds adulterated with policies like QE, ZIRP and NIRP, we have seen a popular reaction by electorates (in countries that at least notionally subscribe to democratic principles). Thus far this reaction has included developments like the Brexit referendum, the election of Donald Trump, and now the ‘gilets jaunes’ protests across France.
In our latest State of the Markets podcast, with our special guest, MoneyWeek’s executive editor John Stepek, we discuss the relationship between government intervention and what persists of free market capitalism. The definitive text on this topic is Robert Schuettinger and Eamonn Butler’s Forty Centuries of Wage and Price Controls: how not to fight inflation, which can be downloaded for free as a PDF from the Mises website. The clue is in the title: governments throughout history have failed to learn the lesson that intervention in markets invariably fails, is often counter-productive to the original intent, but always and without fail has unintended consequences. As investors we are living with those consequences today. The financial analyst Russell Napier, for example, points out that with 10 year German government bond yields currently at 0.09% or so, much of the German insurance industry is now flirting with insolvency, having offered guaranteed returns to investors that they cannot possibly meet with bond yields at such derisory levels. Russell points out that German pension funds typically have 77% of their assets “invested” in bonds.
Our brief is not a political one. We are charged with stewarding and preserving the capital entrusted to us by our clients. In the investment realm, conspicuously high risk and low return markets (e.g. euro zone bonds – now, arguably, euro zone stocks) can be ignored in preference to comparably lower risk and higher real return markets (e.g. high quality listed businesses across Asia trading at entirely undemanding multiples, notably in Japan and Vietnam). But actions have consequences. It is long overdue that western politicians and their agent central banks wake up to that fact.
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