## Marginal Propensity To Invest

There are some simple ideas that are central to a lot of economics.

One of them is “The Marginal Propensity To Invest”.

It isn’t a particularly rare term. A google on it gives “About 849,000 results” (not too bad for a small corner case of The Dismal Science).

It basically says that as income increases, we invest more of our income. Pretty simple, really. If you are starving, you will spend all you have on food, and then some. As you move to ‘lower middle class’, you will put a bit into savings. Maybe in a jar in the closet, maybe in a bank (where ‘intermediation’ can move it into investments as loans are made – so sometimes ‘marginal propensity to invest’ is treated as the related concept ‘marginal propensity to save’, which gets “About 656,000 results” including the wiki). Sometimes we turn our savings into direct investments (taking a leap and buying that franchise…). As you reach the rich and super rich, most of their money goes into investments. Stocks, bonds, direct investments. You name it. It’s hard to eat a $Billion, so most of it gets invested. The result is a graph that rises as incomes rise. An example is here: http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=marginal+propensity+to+invest The change in business investment expenditures induced by a change in income or production (national income or gross domestic product). The marginal propensity to invest (abbreviated MPI) is another term for the slope of the investment line and is calculated as the change in investment divided by the change in income or production. ### Wiki? The surprising thing is that a search on “propensity to invest wiki” does not find a wiki. All they have is a ‘save’ version, and it’s pretty darned poor: http://en.wikipedia.org/wiki/Marginal_propensity_to_save So small that I’m going to quote the whole thing here: Marginal propensity to save The marginal propensity to save (MPS) refers to the increase in saving (non-purchase of current goods and services) that results from an increase in income. For example, if a household earns one extra dollar, and the marginal propensity to save is 0.35, then of that dollar, the household will spend 65 cents and save 35 cents. It can also go the other way, referring to the decrease in saving that results from a decrease in income. It is crucial to Keynesian economics and is the key variable in determining the value of the multiplier. Mathematically, the marginal propensity to save (MPS) function is expressed as the derivative of the savings (S) function with respect to disposable income (Y). MPS=\frac{dS}{dY} In other words, the marginal propensity to save is measured as the ratio of the change in saving to the change in income, thus giving us a figure between 0 and 1. It is the opposite of the marginal propensity to consume (MPC). In a two sector closed economy MPS = 1 – MPC. Then for the example above, the marginal propensity to consume would be 0.65. Notice the complete lack of anything linking the concept of 'saving' with 'investing'… We don't need any of those evil dirty investors in the Wiki View of Economics…. I can’t help but wonder if this is an indication of a socialist bias in the Wiki collective Point Of View as they see no need for ‘investing’… Yes, it could simply be an odd omission. I doubt it, though. ### Why this matters I’d planned to just do a quick posting on why “Rich People Are Good”, even though I’m not one. The thesis is pretty simple. Investment over time drives economic growth. Economic growth lifts all boats and we all gain from the economic improvement. Therefor more investment is better. To get more investment, you need more folks investing more money. That means either more folks entering the “richer” classes or richer folks getting richer. So: If you want a better aggregate economic performance, you need more rich folks (or higher concentration of wealth). What is the socialist mantra and class warfare all about? Concentration of wealth is evil and we need ‘economic justice’ which means taxing the 1% and giving it to the 99% as government goodies. Yet the Marginal Propensity To Invest tells us that doing this will result in greater poverty as economic growth reduces (and eventually stagnates or reverses). Do I like this? No, not at all. I’m as attracted to the Socialist Equality Ideal as anyone else. Even the Catholic Church has come out in favor of wealth redistribution and ‘redistributive justice’. The attack on the rich is in full force, with everyone from Occupy Wall Street to the Pope on the bandwagon. It’s an attractive meme. Make those wealthy suckers pay! BUT… I know about the Marginal Propensity To Invest. And my reason triumphs over my desire. If we tax those rich folks and take their wealth, if we let our envy and greed dominate our reason, we will have either fewer rich folks or poorer rich folks. That, inevitably, means a lower aggregate Propensity To Invest. A weaker economy. Fewer jobs, and stagnation or recession (in the extreme case). It’s really pretty simple. Poor folks eat their seed corn. Rich folks save more of it and plant more acres next year. Which one gives you more to eat in future years? Sometimes The Dismal Science can be a real bitch. (And no, you can’t change the truth in it via passing legislation…) ### Socialism and Investment In the Socialist model, The State does the ‘investing’. It builds the factories and does the job creation. It is The Rich Guy. Only one is needed, and it is The State. (That socialists are happy with ONE Monopolistic Rich Guy, the government, while railing against a competitive landscape of capitalist Rich Guys has often caused me to ponder their thinking processes… Monopolies are evil, so they want to fix it with a single Super Monopoly? Go figure…) So in discussing socialist banking one often hears about ‘savings’ of the common man; investing not so much… As that is a the province of The State. And that is why the lack of a ‘propensity to invest’ on the Wiki causes me just a momentary doubt about their POV and what bias it might have (intentional or accidental). But, back at ‘propensity to invest’: In Greece and in Italy right now we have a large ‘propensity to consume’ and not enough ‘propensity to invest’. They are living off of the collective ‘savings’ of the German people and looking for more folks to pony up some ‘savings’ to be used for Greek and Italian consumption. Notice what’s missing in that? Savings are NOT going into investment that will create greater future productivity (and thus more future wealth so the existing savings / wealth can be paid back with some gain / interest). Turning savings into consumption will, inevitably, result in LESS economic productivity over time, less wealth, more poverty, and collapse of the economy leading to collapse of the country(s) involved in the extreme end case. The root cause being a reduction in “propensity to invest” in favor of “propensity to consume”. Even capturing Other People’s ‘savings’ and turning it into consumption and an I.O.U. that will never be payable (as there is no wealth created from productive investments from which to pay it.) “Why?” is an interesting question that I’m mostly going to dodge. (As it’s a book or two ;-) But at the core is a Socialist emphasis on ‘spreading the wealth’ that results in too little investment and too much consumption. Spreading the wealth inevitably causes lower investment and increased poverty; just sometimes it can take a generation to show up. ### What To Do? Well, first off, recognize the core cause. The problem is too little propensity to invest and too much propensity to consume. Second, recognize that the solution is two fold. Part A: Less consumption. (Often called ‘austerity measures’ when applied at the country level by the IMF – International Monetary Fund). Part B: More investment. And it’s that second part that causes the larger grief. You will hear a lot of politicians, on both sides of the ocean, talking about “investment”. By this they usually mean “handouts to my favored friends and consumption by voters.” So we get “investment in education” that often means “grants to young student voters and higher payrolls to liberal college professors”. That money gets consumed, not invested. There IS an educational byproduct, but it isn’t all that much. (“Black Studies”, “Sociology”, “English Lit.” etc. are widely taught and do NOT result in a whole lot more economic product, either for society or for the students. They are more ‘entertainment consumption’ than actual economic investment.) Even “Physics” doesn’t yield all that much in the way of economic increase. Who employs Theoretical Physics PhDs? Well, schools and weapons programs and ??? Yeah, some get employed as ‘sort of an Engineer’ in private industry, but they would be more economically productive AS engineers. So even then there is an efficiency loss of personal interest beating out investment…) “Investment in infrastructure” often means “payments to Unions for folks to lean on shovels” as we dig up one road and put a new one it its place, or hand large payments to friends of the government for “studies” with little work product delivered. Sometime it means money handed out to folks to influence the political process or move a social agenda (viz Acorn). Hardly an economic investment that increases production of goods. As ‘what is a service’ is highly debatable, these things are often called ‘services’ so as to hide the actual political aspect. Private industry is much more efficient at actual investment. Among other things, they actually expect a net increase in wealth at the end of the process or they go out of business. So when a PhD Physics gets a job in private industry R&D, it tends to be focused on things like making better optical fibers or finding oil and less on things like String Theory and quantum mechanics. That is, the ‘investment’ is more of an investment and less of an entertainment charge. FWIW, I’m all in favor of spending on things that are fun, interesting, entertaining, and generally improve knowledge even if that knowledge is not particularly economically beneficial. Just don’t call it “investment”. It isn’t. It’s Patronage or it’s entertainment or it’s just curiosity, but it isn’t investment and we don’t have more wealth at the the end of it, we have less. Modulo the sporadic side bar when someone takes bit of theoretical physics and figures out how to do engineering things with it… In essence, I’m all in favor of Shakespeare Plays, just don’t call them an ‘investment’. They are a highly valuable form of consumption. Like a fine wine or a great prime rib dinner. Well worth having, but not creating more wealth when done with the consumption. The consequence of these things is pretty simple: We need MORE rich folks, not less. We need to let them keep their money, not take it away. We need to get the government out of the business of picking winners and losers and very much out of making “investments” as they don’t even know what it really is. Do I like that? No, not at all. I’d rather have about$100,000 of Bill Gates money given to me as an ‘investment’ in my personal development… But I don’t need to like something to know that its good for me.

That is a lesson that Greece and Italy have yet to learn.

Now if I can just find a way to become one of those Rich Guys with a high Propensity To Invest, I promise to spend all my time creating more excess wealth to invest even further in new wealth creating enterprises; even if I have to hire a bunch of folks to leverage my time and money in the process. ;-)

A technical managerial sort interested in things from Stonehenge to computer science. My present "hot buttons' are the mythology of Climate Change and ancient metrology; but things change...
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### 33 Responses to Marginal Propensity To Invest

1. TGSG says:

Yes! Great post this. Too many people cannot grasp this concept at all and we are all poorer because of that lack.

2. By coincidence, the Wikipedia user “Skysmith” has “propensity to invest” on his long list of economics articles that need to be added to Wikipedia.

The Wikipedia writers seem to refer to the “propensity to invest” from the Marxian economics point of view:
http://en.wikipedia.org/wiki/Capital_accumulation

Marx is certainly highly esteemed, in topics ranging from economics to literary criticism. The fact that his notions led to the intentionally inflected deaths of more than 100 million people doesn’t faze his admirers at all. Nor would it have deterred him.

===|==============/ Keith DeHavelle

3. By the way, I’m aware of one theoretically workable true socialist model depicted in film: The movie WALL•E. This seems surprising, but I think that it works: The spaceship, a giant cruiseliner called the Axiom, was essentially a self-contained economy that demonstrated the only way for socialism to work.

There were no human laborers. One human had a ceremonial job; everything else was done by robotic labor, fed ultimately by harvesting hydrogen and processing it (apparently through nuclear fusion).

Effectively unlimited material, effectively unlimited labor, and the ultimate in nanny states, all in a pristine, hotel-like environment. It had reduced the humans to dependent, overgrown babies and basically robbed them of humanity. Once awakened from this stupor, the humans came back to Earth and launched into farming, rebuilding the cities, and creating industry again from scratch.

This “happy ending” of repopulating the Earth with humans again should have made the environmentalists cringe. Instead, they promoted the film, focusing on the giant trash piles depicted early on and equating this in their minds with “global warming” (though the film’s depiction of the future, the seas did not rise much if at all).

But this excellent film — really a charming love story with an exquisitely realized science fiction background — showed the only way in which socialism really could work. And the triumph of the film was putting an end to this ultimate dehumanizer.

===|==============/ Keith DeHavelle

4. R. de Haan says:

I really hope you stumble on this killer application concept that will make you filthy rich beyond belief.

I’m confident you have it in you.

Opportunity and timing however is key.

5. Robin Melville says:

The majority (by a long way) of stock market and other investments don’t come from rich individuals but from OPM, other people’s money — in the form of pension funds, savings and the like.

Buying shares or bonds from an enterprise (in an IPO, for example) is investment. Buying shares from other shareholders is speculation — not the same thing at all. It has no effect on the development of industry. This is particularly true if you’re buying shares in the hope they’ll go up in price rather than to hold them for the dividend.This is not to malign speculation, just to point out that it’s not the same as investment.

What we’re suffering from at the moment is an overhang of massively leveraged speculation which will inevitably have to unwind at huge cost to everybody before we get back to something resembling a sane economy. Rich individuals are just riders in the same train (though in the Pullman compartment, of course) as the rest of us. They are, however, less likely to become income-less or starve than the bulk of the population.

[ While it’s true that the primary investment happens at the first sale of shares, the secondary market existence means that more companies can float those shares. So while you are in the limited definitional sense correct, the existence of a secondary market serves more than just speculative purposes. It DOES have an effect in that it lets more money net flow into investment. The folks who sell their IPO shares into the secondary market often turn around and use those proceeds to buy more IPO shares.

Per the overhang of massively leveraged speculation: Yup. CAUSED by the progressive push to give home loans to everyone and mandated by the CRA as modified under the Clintons and pushed by Barney Frank. Bubble creation at its finest. -E.M.Smith ]

6. Pascvaks says:

(Sarc Galore On) It won’t work! People are just too damn dependent on the FDR/LBJ/Obama Nanny State. Turning the tide of human stupidity is like stopping lemmings from taking the Big Leap Off the Cliff, nothing works but old fashioned, super-dupper, catistrophic Mother Nature, electric shock therepy. Some call for a “Great Big Depression”, others say an Ice Age would work, a few say a pandemic like the Black Death might do the trick, but even then the chances of turning a world bent on Freebees around and back into the time machine of reality has a .0001 in 100 chance of success for even the most brutal method. Nope! We’ve long since passed the Point of No Return on this trip of the ill fated Starship Earth.(Sarc Galore Off)

I really do wish that my children and their children were/will be smarter than my generation and their grandparent’s generation. But a little voice is telling me that they’re not. Me thinks we’re all on a very slippery slope and that there’s not much ahead that’s going to slow us down. Indeed, I have a feeling that the 20th Century was not very unique at all and the 21st is going to be a whole lot more of the same.

7. Richard Ilfeld says:

Three generational pain: I’m not enough of an historian to go way back, but I think a semblence of economic conservatism, ie savings, investment, growth began with the great depression and lasted three generations. Then we forget. There is a private company proverb rags to riches to rags in three generations that expresses this.
The first generation suffers a painful event – the survivors then know about the seven lean years and act accordingly. Many were forced to change their life patterns. (a lot o great companies trace their beginnings to someone forced into entrapaneurship in the depression)
The children have good habits and inherit a going concern. Some gorw, some shrink, but overall things go well — the old folks are still there to advise and moderate.
The grandchildren are rich and removed from the reasons this is so, and become profligate.

Rinse and repeat.

Are thing bad enough yet to start a cycle? Or does the “safety net” have to fully tear first?

8. H.R. says:

E.M. observes:
“[…] or hand large payments to friends of the government for “studies” with little work product delivered. […]”

My father pointed that out to me more than 40 years ago. Politicians have been proposing light rail in my city for 30 years with 1-2 studies every year and a vote (always “nay” from the citizenry) every 2-3 years. If they had just save up the study money from the last 30 years the could have built a north-south line with that money and never had to ask for a penny.

9. P.G. Sharrow says:

Bureaucrats and politicians need monuments to their stupidity. Monuments created by the wealth extorted from the wealth producers.
Only the monuments outlast the civilizations that created them as the creation of the monuments destroy the society that built them. The only way to preserve civilization is to starve the politicians and their bureaucrats.
If you feed them, they only grow more powerful and multiply like rats. pg

10. Serioso says:

An economy grows both by increases in investment AND increases in spending. Your argument that the US economy needs more investment is flawed: There is ample evidence that our economy is suffering from an investment glut — too much money chasing too few investment opportunities, resulting in a decrease in the rate of return. See, for example, the calculator at http://www.moneychimp.com/features/market_cagr.htm, which shows that while very long-term stock market investments have grown at an average annual rate of 6 or 7 percent after accounting for inflation, returns in recent decades have been lower, in the 4-6% range. Investment funds are crowding out spending funds. The wealthy have a smaller marginal propensity to spend, and (IMHO) that is at the heart of our current economic doldrums.

[ Well, first off, I was speaking in general, not just about the USA. I also was stating the nature of investment vs The Rich, not saying that the USA had any particular status of too much or too little at the moment. So on the face of it the most flawed thing looks like your reading of the post. Try again. So it IS a simple truth of The Propensity To Invest that fewer rich or poorer rich mean lest investment. Get over it. Now, as per recent US gains on US stocks, think that maybe the present political climate might be having an influence on that? Think our Tax & Spender In Chief might be discouraging folks from investing AND sucking away a chunk of the return that ought to be there? Think our Regulate To Death administration might be reducing ROI? Guess what, NONE of those makes a statement about too much vs too little captial investment level. It says a lot about Sovereign Risk writ large. So until you can figure out that maybe more things than ‘quantity of investment money’ determine aggregate rate of return, I’d suggest not making grand pronouncements about economic causality. Finally, the notion that you can spend yourself to increased wealth is laughable on the face of it. Tell you what, go spend all the money you have and all your net worth on consumption goods, and I’ll invest mine. In a year we’ll see which of is is wealthier… If consumption lead to more wealth creation we could all take hammers and start breaking car window and bashing fenders. We’d be rich in no time as all that repair work was “demanded”. It doesn’t work that way. Destruction is just destruction and consumption is just consumption. It is a Markist idea that we need ‘creative destruction’ and it’s just silly. -E.M.Smith }

11. Libertarian says:

EM – Its not enough to have rich folks. There are lots of rich people in the Philipines and other similar countries. I dont see them investing. There is some other key ingredient needed.

12. @Libertarian, who wrote:

EM – Its not enough to have rich folks. There are lots of rich people in the Philipines and other similar countries. I dont see them investing. There is some other key ingredient needed.

Indeed there is. It is, I think, the rule of law in a free-enterprise based environment.

You can have strict laws without free enterprise — as in many totalitarian societies. Investments there tend to be criminal in nature. And a free-enterprise society with capricious laws, such as China, mean that your investment can vanish away based on some government functionary’s whim, as evaporated as the GM bondholder’s claim.

America had both, the free-enterprise setting and the rule of law supporting contracts between persons. We are attacking both, through legislation, litigation, and fiat, and these effects are causing many investors to hold tight for the moment hoping for a Better Time.

In the meantime, the Obama administration has only one approach to encouraging investors: “The beatings of the rich will continue until their morale improves!”

===|==============/ Keith DeHavelle

13. Pascvaks says:

Once upon a time we said of this country that it was “The Land of Opportunity”. We don’t say that anymore.

14. Jason Calley says:

One of the worst things about a fiat money system is that it invariably distorts the time value of money (aka “interest”) by the constant inflation of the monetary supply. If — hypothetically — the money supply was absolutely fixed, the slow accumulation of knowledge and invention would lower the cost of manufacturing goods. Our alloys would improve, our techniques for energy utilization would get better, etc., goods would become cheaper. Because goods become cheaper, people are automatically encouraged to save. If we know that houses will rise in price by 15% this year, we buy houses because of that. If we know that houses, or calculators or automobiles will be just as good but cheaper next year, we wait to buy. Either way, we have deferred consumption and accumulated capital. Even putting your money under the mattress — while it would not increase productive capacity the way real capitalism does — would slightly decrease the money supply and again create a pressure toward lower priced goods.

Ah, but who wants a society where goods become cheaper, where people are encouraged to save toward their later consumption? Who wants a world where capital cannot be imagined into existence and then be put toward frivolous and uneconomic use?
:)

15. Tim Clark says:

I’m sorry that I can’t remember the economist who I am about to paraphrase. He was Indian, Indira Gupta? His thesis correlated well with yours to a point. Where it deviated was at a point where the amount of money the rich folk could invest raised to a point where the “super rich” resorted to conservative investments, thereby reducing the ROI, reducing the efficiency or velocity of money. In other words, (from memory), after reaching 15% disposable income above necessary annual expenditures and reinvestment for inflationary pressures, rich people would invest money in ultra conservative investments that did not benefit wealth creation nearly as much as the 10% or so that the middle class investments returned. His thesis was that a larger middle class increased natiional wealth roughly 25% greater than ultra rich. i have seen no evidence, including your diatribe, convincing me otherwise.

16. Tim Clark says:

Whar economic growth does philantrophy do? Same as government spending…

17. Are you seriously suggesting that bringing in 15% more than expenditures makes you “rich”? And that a 10% ROI investment is too scary for “rich people”?

Those of great wealth can (and do!) participate in experiments that have very high wealth creation aspects in the US. The middle class tend to have “necessary” expenditures take up the slack, so that a nicer car, bigger home and so on become necessary, leaving little for wealth-building investments. That’s a shame, but is borne out by evidence.

Capital-intensive startups are not generally created by large numbers of small contributions from the middle class.

I suspect, as well, that you are confusing proportional effect for total effect. If you are arguing that this fellow proved in India that the investments of their middle class brought a higher ROI than wealthy folks, it might be true (I’d like to see definitions). But the total dollars invested, and total wealth-building return, is not likely to favor the same side.

===|==============/ Keith DeHavelle

18. Tim Clark says:

He was Indian, but from texas. He gave some good evidence.
We are not discussing you and me. This relates to people who net millions. If you and I have 1,000,000 invested, on average, we could maybe net 80,000 consistently. 1% to us makes a lot of difference. If my required outlays are 1,000,000/annum and that represents a 10% return, I must have 10,000,000 on ice. 15% additional is another 1.5 mil. I have to watch my assets very closely to ensure I have my 80,000/annum. To them, it’s chump change, subject to loophole investments, tax write-offs. So yes, you are correct, it related to proportionality.

19. We are not discussing you and me. This relates to people who net millions.

Well, you specifically identified what seemed like a much smaller number. You had written:

In other words, (from memory), after reaching 15% disposable income above necessary annual expenditures and reinvestment for inflationary pressures, rich people would invest money in ultra conservative investments.

I don’t have the paper, of course, so we are both relying upon your memory. But be careful of your assumptions — you only know about you, not me.

A high risk investment can be structured as a tax write-off if it fails. (This must be done carefully, otherwise there’s a 3% cap on the recovery. I have a template for this, but it has not been changed to keep up with the tax code over the past several years. It worked then.) Persons of high net worth are interested in increasing their worth; this is where most of their income comes from (and thus the huge majority of income tax/capital gains tax revenue).

You assert (if I understand you correctly) that high net worth people tend to invest at smaller rates of return and/or less toward wealth-building. This is completely counter to my experience, and I’d like to see the evidence for this. Have I understood you correctly?

===|==============/ Keith DeHavelle

20. @Tim Clark:

Whar economic growth does philantrophy do? Same as government spending…

If I understood this correctly, there are several sorts of funding that fall into the category of philanthropy, but two of particular interest for this question:

First, some philanthropy is aimed at research, invention, and education, in areas ranging from scientific work to local schools and university endowments as well as specialized education programs. These can (and regularly do) spin off entire industries. I am acquainted with one gentleman who has given about $200 million to exactly such causes, and has generated more than that in economic activity as a result. Second, philanthropic work to help the poor is typically rather more controlled than similar funding from the government. Local charities don’t generally want to encourage dependence, and so the recipients are motivated to get back in the game/back to work/back on their feet quickly. For government spending, such people are “clients” and they don’t like to lose clients. A rather blatant example of this last attitude shows up in California: Recently, the level of welfare fraud was demonstrated to be very high, resulting in (and measured by) the number of prosecutions for perjury. The state government fixed the problem — by removing the requirement to sign the welfare form. No perjury, no prosecution, and hey presto! The percentage dropped. Of course, the actual fraud increased — but California kept its “clients” so it was a win-win for them. ===|==============/ Keith DeHavelle 21. P.G. Sharrow says: @ Keith DeHavelle, I agree. The rich people that I know demand 10% return on no risk ventures as a friend. On a risk venture they plan on a 10 times return on an investment of 5 years. It’s the middle class that will make a few thousand dollar bet on new ventures. If that works out then the rich will consider an investment at their 10 times rate. Warren Buffet did not make his billions by being a nice guy. pg 22. E.M.Smith says: @Tim Clark: (I hope ‘diatribe’ was a friendly ‘diatribe’ ;-) Unfortunately, much of economic theory consists of massive hand waving with a graph of a wiggly line. Advanced econ uses 2 or even sometimes 3 wiggly lines… So the most common game is to change the shape of the wiggle to match YOUR favorite point of view, then call the other folks idiots. Done really well (and especially if it pokes at conservative and non-progressive ideas) it can even get a Nobel Prize. So, COULD it be the case that the super rich become coupon clippers? Sure. Especially if it’s the widow of the Ketchup King who knows nothing about catchup and/or her kids and Gigolo, er, ‘husband’… BUT, then we have ‘existence proofs’ of folks like Buffet, Gates, Jobs, Ellison. An investor. A crafty monopolist (hey, the European Court said so…). An exquisite innovator and marketer. A roll-up king buying out the competition. THEY are clearly heavily invested in their companies and ideas. They also tend to be the Top End of the Super Rich. Now, if you would like to, you can make the wiggle dip in the far 1/4 then curve back up, claim that the Indian Economist was right, but only in a small segment, and that the Super Duper Rich return to trend. Could likely get published, too, if you select enough of the right Super Rich to document the wiggle. But don’t expect any Nobel Prize, as you are not advancing the Progressive Point Of View… For an advanced paper, add a second line showing the ‘generation’ of The Rich and a correlation between inherited wealth and coupon clipping (if you then suggest massive inheritance taxes you might be in line for that Nobel…) The problem with this, of course, is that BONDS are also investments in business. The Clipping Rich who buy conservative bonds in GE are funding the expansion of that business into new ventures and / or building Jet Engine factories (perhaps in China with their light bulb operations that fled America). So to assert that The Clipping Rich are not investing is, er, um… how to put this nicely… simply wrong. The bond lets happen the separation of the innovative intelligent risk taker from the owner of the invested capital. That does NOT mean the capital is not invested. It means that the “new idea guy” gets some of the benefit of his new idea (via profits above interest rate) and the “clipper” gets some of it to (but with a stronger claim if bankruptcy happens). The investment still exists. Now, if your Indian Economist attributed all that economic gain to the stock holders and direct investors, while disparaging the capital invested by the bond holders, he did a great disservice to the truth… Showing THAT would likely also be publishable (but would certainly guarantee never getting a Nobel even if true as it throws much mud on a Progressive Idea Advocate, so makes you an enemy…) So I’d suggest phrasing it such as to hide that Inconvenient Truth… In short: It doesn’t matter if the money to create the iPod came from direct venture capital investment, retained earnings of the company, sale of a secondary stock issue, Jobs own pocket, OR sale of corporate BONDS. They are ALL investments that lead to the new product. What varies between them is the percentage of the gain from that investment that returns to the investor and their relative position on the risk / reward food chain. (Stock holders get gain ‘over a threshold’ and corporate control but get screwed if things go bad into bankruptcy. Bond holders get ‘first gain’ but limited by a cap, and get first position in bankruptcy where they can take control of the company… unless it’s a Government Railroaded BK as was done with GM, then the ‘Friends Of Obama’ get first position… so ask the GM Bond holders if they had ‘risk capital’ or not…) What does NOT happen: The iPod was not created by the folks making minimum wage living below the poverty line as they bought neither stock nor bonds and put no money into a venture capitalist firm nor made direct investments… Only to the extent that some ‘middle class’ folks are indirectly invested via things like teachers retirement funds in Cal-Strs or other public employees in Cal-Pers do you get the lower payed folks buying in significantly. (Most middle class investment is for retirement and via some kind of ‘plan’… few folks ‘self direct’). And what do they buy? Why, a mix of stocks and bonds… FWIW, I do think it would be interesting to unscramble all those stock vs bond investment profiles and see if a decent paper could be made out of it. I’m less sure that the data are available to do it (so you end up in the land of statistical hand waving of your wiggly line…) For more in bonds as investment vehicles in company growth, research the area of “corporate capital structure” with an emphasis on the bond vs secondary stock issuance decision (especially in growing companies). Or just spend a couple of years reporting to the V.P. Finance and V.P. Business Affairs at a small tech company and sitting in their staff meetings ;-) That’s what I got to do as we went through our I.P.O. then the eventual issuance of “special Class D” stock to Microsoft… and some Bond issuance decisions and… M.S. insisted on rights to the patent library for their ‘investment’… basically buying the patents on the cheap. Eventually the bankruptcy came, but I’d been laid off a year or two before that. Oh, and it was also covered well in some of my Econ classes and in the MBA Finance classes. “Capital Structure” is a fascinating area and one I’d love to specialize in (IFF I was going to specialize). So take a while to look into it before embracing the idea that Bond Holders are not investors… And while their ROI and velocity of money may fall, they have handed that money to other folks who are using it for higher ROI (and sometimes higher velocity) things, just creaming off some of it for themselves as payment for their higher risk tolerance and management skills. The money still does the work and still ‘moves’… just from other hands… 23. Jason Calley says: @ E.M. “So the most common game is to change the shape of the wiggle to match YOUR favorite point of view, then call the other folks idiots. Done really well (and especially if it pokes at conservative and non-progressive ideas) it can even get a Nobel Prize.” Hmmmm….. you don’t mean this guy, do you? I’m trying to remember. How did that housing bubble thing work out? 24. E.M.Smith says: @Jason Calley: That is a GREAT find! 25. P.G. Sharrow says: @ Jason & EM ; And the housing bubble replaced with what? Money bubble? stagflation? pg 26. H.R. says: @P.G. Remember, investors in bubbles usually end up in a bubble bath. 27. Jason Calley says: @ P.G. Sharrow “And the housing bubble replaced with what? Money bubble? stagflation? ” Very good question. I am sadly reminded of the nuclear fuel sequence in stars. OK, we’ve run out of hydrogen, let’s fuse helium. OK, the helium is all gone; lets fuse carbon. And oxygen. Then magnesium. Then… and so on, but not forever. Things will eventually go BANG! The miscellaneous financial bubbles can bubble on for longer than I would have thought possible, but each time that a new bubble is created (to prevent the rational reallocation of misused resources from the previous bubble, ) things get worse. The market becomes more and more inefficient; it takes more imaginary capital to be created and injected to prime the bubble, and the bubbles grow and pop ever faster. Eventually the market has become so distorted that a new dollar injected cannot even stimulate a dollar’s worth of growth. This evolution of bubbles is very similar to the economic damage done by centralized planning during the days of the USSR. Decisions made by the central committees could never be as accurate as the pricing decisions made by individuals in the free market. After all, individuals know which things they wish to buy and which things they value over other alternate goods. Factories and shops became increasingly inefficient and misallocated their productive capacities into ever more stupid forms of output. The central committees tried to compensate with mandated goals and quotas — which of course pushed things even further into imbalance. Eventually factories were producing goods which were actually LESS valuable than even the raw materials which went into their creation. Not only had all that labor and capital been ineffective at creating wealth, it was actually destroying wealth during what was supposed to be productive acts! Most people do not see the similarity between US style banking and Soviet style planning, but they really do lead to very similar sicknesses. Metaphorically, one is like a drug dealer selling you barbiturates. The other is a drug dealer selling amphetamines. In the long run, both produce the same result. 28. @Jason Calley, who wrote: The market becomes more and more inefficient; it takes more imaginary capital to be created and injected to prime the bubble, and the bubbles grow and pop ever faster. I don’t see this reflected in recent history. The Dot-Com bubble and the housing bubble were two different animals. The housing bubble lasted about twice as long, and took almost as long to “burst” as the entire Dot-Com run-up. We had a housing peak in March 2007, major reverberations in August, and it still held on for another year until the collapse was needed for the election. It wasn’t healthy, but it hadn’t been a bubble-burst prior. But the Dot-Com peak was March 10, 2000 (pubic perception of this happened April 15) — and by the end of December that same year NASDAQ had lost over half of its value. This is described as happening in 2001 to make it look like Bush’s watch; for example, Wikipedia describes the bubble as 1999-2001. But the actual timing in 2000 is evident on the charts. So we have a later bubble that was slower to build and slower to collapse than the one before it. And the housing bubble was an artifact of federal regulations that forced the low-income mortgage market into a preeminent position; the entire process would not have happened had the FMs been reined in. Without their overextension (2% asset backing!), the credit default swaps and similar derivatives would not have themselves faced default. Of course, Europe and the US were (and are) still careening toward a spending crisis, which wouldn’t have been much different (except, obviously, for Obama’s profligacy). ===|==============/ Keith DeHavelle 29. E.M.Smith says: @H.R.: Groan…. (Got another one?) ;-) @P.G. Sharrow: It all depends on ‘how soon’? Or what is your time horizon. IMHO, the ‘end game’ is a nuclear war that breaks out somewhere on the Egypt – N. Korea line. The most probable initiator varies from year to year as folks get into fights. At present, it’s near the Egypt / Turkey / Iran triangle around Israel. Sometimes it over near N. Korea when they do something really stupid. Every so often it’s near Pakistan / India. Essentially when things get too bad, wars are trotted out. Most likely near Israel as they deal with Iran (given that the US has let it fester too long for diplomacy or strong-arming). There’s a much smaller chance it will be a frozen Russia in a few years deciding that the old southern provinces ought to be rejoined to the whole. A similarly small possible of a very Grumpy China getting pulled into something with the folks around it. But they usually sit back to pick up the good bits after the fight, if possible. Before then, I expect Europe to slowly continue the Euro Death Spiral as they continue to enjoy the slow frog boil of Euro Socialism from the European Parliament. But I don’t expect them to break down completely until after some external violence erupts. They will try to get China to loan money, but that won’t happen unless China wins big, and Europeans are at least smart enough to not let that happen (even if the USA isn’t). Then they will try to get the USA to loan them money (i.e. China money with a US cosigning…) and that won’t happen as we’re broke and China is already thinking it might not get it’s principle back in full, diversifying out of US Bonds and into gold. The USA is on track for Stagflation. We’ve got about 4% inflation already (no, not in the buggered numbers, in the real numbers…) and it will still take a couple of years for past spending to get fully reflected. “The Game” will be to have so much inflation that the home prices are ‘justified’ and all the loans don’t have to default. Never mind that it IS a default in real terms AND will have the real consequences. I suppose it has a chance of working, but I think it more likely that we end up in the same kind of stagflation / malaise we had post the stock market crash / great depression. The Roosevelt years… The fantasy is that with just enough inflation the housing bubble will be stabilized avoiding a full crash / blowup… while the Government Debt is evaporated relieving the debt crisis. What this ignores is that someone is dependent on those debts for their spending. Retirements. Medical care. Folks building roads and companies. Abrogating those debts (in real terms) means less spending along with less production. That leads to stagnation or contraction in real terms, with inflation attempting to cover it up, but failing starting a few years in. Oh, and all the banks and corporations holding government bonds get that wealth fleeced so can’t put it into real physical investments. More stagnation. Just like the companies today posting Great Earnings… yet folks are not buying it. Why? They think it’s not sustainable. They think ‘next quarter will have issues’. They think that the Plain Folks are just kind of tapped out. So you can juice your profits ONCE with a new fee, or fired workers, or jacking prices (as many have); BUT, The Folks are just not able to ratify those higher prices and fees. They don’t have the jobs. They don’t have the Home ATM. They don’t have the credit cards. So all that stuff will just show up as inflation of prices as the base investment to make that much wealth increase was not done. In the end, they are playing a zero sum game in a context where The Government is creaming off a larger chunk (making it a net negative sum game) when what we need is the positive sum game of real economic investment and growth. As The Boomers hit the retirement and Government Goodies queues, the whole thing falls apart. Not enough productive bodies to make the goods and services that were promised. Doesn’t matter what the government does; those promises WILL be broken in real terms. Expect rationed medical care. No other choice from government. Expect retirement and S.Sec. payments in ‘inflated away’ dollars. No other choice given demographics of tax payers vs tax goody takers. Expect the result being increased poverty in real terms as nominal dollars are printed and spent. Expect that to make folks very very cranky… (That’s not just a USA problem. The Europeans have the same demographic problems in many ways, but with a higher socialism load from social promises… Saudi has made a load of such promises that they can’t quite meet if things go bad economically. Etc.) So there may be some attempt to ‘re-inflate the bubble’ but it will founder on the loss of productive workers. There may be some attempt to create some new bubble via ‘stimulus’ but it too will fail as there’s no real money coming into the ponzi… Somewhere in there China cuts off the China Credit Card and it gets ugly… Oh, and South America will likely try a European Style Continental Socialism with an unelected UberGovernment, and we revisit the various Latin economic implosions of the 1970s but with China as the banker, not the USA, and with a supernational overlay. They voted to start down this path just a while back: http://en.wikipedia.org/wiki/Union_of_South_American_Nations December 2010 if I read it right. It’s likely to take a decade plus to get it all rolling well. Just about in time for a bit of a ‘splat’ elsewhere in the world… There will be a lot of flailing and a lot of attempts to describe things as “all going great now” but in the end, folks know when they are cold, hungry, and can’t buy enough gas to drive to the beach… But Demographics Is Destiny, and demographics have a bunch of old US Americans and Europeans hoping to retire on the backs of Chinese and S. American workers via the Chinese Credit Card, and that just isn’t going to happen. About then the Muslim World hits it’s own demographic bomb wall as their “Children For Allah” behaviours run into declining oil production, rising gas production in China, Europe and Americas, and run into revenues being constantly divided into ever more folks pockets in ever smaller units. About then is when., IMHO, “something gives”. Frozen North (Russia, Canada, China with a mega-drouth ) meets overpopulated and very grumpy Muslim World wanting The Good LIfe (and food for ever more kids) with an aging and suddenly feeling cheated European and N. American population and some very frantic Millenials and Gen-X ers trying to figure out why they are unable to make it all work. IFF a war has not already happened, that is when we have the choice of a major war or a complete economic melt down. IMHO, the politicians will select a war over blame… Could we escape that model? Maybe. Barely. IF the world walked away from The Socialism Shiny Thing. IF the USA embraced non-inflationary monetary policy. IF the Euro Zone divides into at least a N and S group with different currencies (or at least tosses out the PIIGS). IF we returned to a market driven society and we honestly told folks “You will be substantially on your own for medical care and retirement.” IF Muslims stop the ‘be fruity and multiply’ behaviours, expecting to emigrate to the rest of the world in masses. IF China decides that mercantilism has bad end case behaviours. IF Russia does not end up in a Winter From Hell as the modern solar minimum hits hard in 2030 or so. IF Latin America changes it’s spots from the last 100 years of cultural / monetary habits. In short: If a snowball can escape it’s fate in hell… I’m sure some of the details are wrong, but that’s what I see coming, in broad strokes. Dismal, yes. But not hopeless. We could avoid a major world war and keep things regional. We could avoid global famine with a bit of technical magic. We could avoid total economic collapse with some minor policy changes. We could even have a newly powerful China deciding not to invade Taiwan and ‘destroy the village in order to save it’… in stead letting Taiwan rejoin of their own free will… BUT: “Demographics is Destiny” and we’ve already sent those dice rolling. So the broad strokes are pretty much set. Not enough Western Kids to keep the societies and economies running and pay all the IOUs. Too many impoverished Muslims in The Muslim World with little hope and no jobs. To much productivity being concentrated in China without imports from us. Europe in a mutual ‘reach around’ while the other hand is desperately picking pockets… and nervously eying the Muslims moving in and milling about on the borders. While Israel sits surrounded by ever more violence prone enemies and N. Korea sells them munitions from a starving cold country… Just not liking the odds much at all… If Australia hadn’t started going a bit nuts in the last 30 years, I’d have headed down there to the Out Back… but as it is, they are too busy disarming and indulging in economic stupidity to survive a ‘walk over’ from Asia / Indonesia. So not ‘good odds’ there any more either. At any rate, my ‘best hope’ is that the timing has some parts implode / blow up / suffer wars enough ahead of the rest that we in the USA can come to our senses in time and hunker down to get through it relatively intact.. Maybe even have the Euro Zone break up happen fast enough that economic collapse and wars can be missed there, too We’ll see. I suppose the Really Good News is that I think most of this stuff comes about 2030-2040, so odds are many of us can be dead first… Then again, if the Israel / Iran trigger is the deal that sets things off, it could start as soon as next year… IF the republicans had anyone with a decent backbone and some brains win the whitehouse, and some more congressional seats, the USA at least could back away from the debt precipice and repudiate its unfunded mandates and social programs sufficiently to make things stable But I’m not holding my breath given the present crop… 30. Jason Calley says: @ Keith DeHavelle “The Dot-Com bubble and the housing bubble were two different animals. The housing bubble lasted about twice as long, and took almost as long to “burst” as the entire Dot-Com run-up.” You make some very good points, especially about the extended time of the housing bubble crash. On the other hand, I think the times of bubble growth (for dot com and housing) until popping are actually much more comparable than you indicate. You say “for example, Wikipedia describes the bubble as 1999-2001. But the actual timing in 2000 is evident on the charts.” 1999 to 2000? Just one year? My memory is that the dot com bubble started more like the mid 1990s with each new public offering being more hyped than the last. I can see your point about 2000 being a more reasonable place to put the “pop!” than 2001, but I have difficulty placing the starting point in 1999. Please correct me if am confused on this. Still, I will agree that even if we place the start of the dot com fiasco in 1995 and the end in 2000, it is not longer than the housing bubble which went from basically 2002 or so to 2007 or 2008. I do not know just how much bigger the housing bubble was than the dot come bubble; maybe the sheer gigantic size of the housing bubble lengthened it. 31. Jason Calley says: @ E.M. Jeez…darned sobering analysis you have there. All the more so because there is not much that is arguable — although you may be a bit optimistic about the 2030 – 2040 dateline. I would think 2015 – 2020 or so. Of course, I admit to a bad track record on timing. I am always amazed at how long stupid trends can keep going on! You say: “Could we escape that model? Maybe. Barely. IF the world walked away from The Socialism Shiny Thing.” You then list a number of similar factors at work. In fact, I would say that most of the rest of those factors are different faces of “That Socialism Shiny Thing,” or at least “The Collectivist Shiny Thing.” Inflationary monetary policy is almost always the result of one-size-fits-all, legally mandated, fiat currency, Let people pick their own monetary system voluntarily and I think traditional hard money would win out. European Union vs divided Europe? Again, the push for the Union was not from the ordinary individual citizens but from the One-Big-Government politicians. Social Security and Medicare? Collectivism, enforced at the point of a gun. Muslim fundamentalism? Religious collectivism looking for more members of the hive mind. Chinese mercantilism? Business collectivism where the state controls which companies live and which die. Russian Winter from Hell? OK, you got me there. Even I can’t blame collectivism for the weather! :) The point though, is that when individuals are allowed to choose how to use their own labor, their own property and run their own lives, the spontaneous order which develops naturally is one which consistently creates wealth for the great majority of people. Way back in a kinder, gentler age we referred to this condition as “freedom.” It still works when given a chance. The good news is that information is power and new technology has distributed power to individual people who did not have it before. If we are lucky, we humans will also get at some point in the next decade or two, another form of power — horse power, or its equivalent. Cheap power and cheap information are the two things which would almost guarantee a happy resolution of today’s problems. Cheap information we already have. Cheap power — whether it turns out to be cold fusion, hot fusion, cheap solar (and storage!) or something else — is the missing ingredient. By the way, I said “Inflationary monetary policy is almost always the result of one-size-fits-all, legally mandated, fiat currency, Let people pick their own monetary system voluntarily and I think traditional hard money would win out.” I can only think of a couple of exceptions. I seem to remember that ancient Athens had an inflationary period following their capture of a major silver mining region. Likewise, Spain, following their conquests in the new World. The massive influx of gold and silver actually did to a hard currency what printing can do to a paper currency. The resulting monetary problems led to the development of a particular Spanish approach to economics referred to now as “The School of Salamanca,” a school considered to be one of the precursors of the Austrian School exemplified by von Mises. 32. @Jason Calley Yes, I too think that the start was a bit earlier than 1999. The Internet was propelling businesses and so forth in the mid-1889s as you suggest, but But the “frenzy,” the time of furious hype (called “zero gravity” by some in the industry), was around two years. Look, for example, at this chart comparing the 1929 and 2000 bubble run-ups: From this site: http://www.gold-eagle.com/editorials_01/walker030701.html It takes a bit to get the time sense. It’s measured in trading days, roughly 260 per year. So the strong build-up is on the order of 400 days, or not quite two years to the NASDAQ peak (where the focus of Dot-Com activity was). I remember reading WebVan’s 400-page prospectus, put out by Goldman Sachs at a cost of$2 million dollars, and thinking “this is ridiculous.” It was fifteen employees and three vans delivering groceries in a California neighborhood, being offered for a market cap of about $8 billion dollars. They got their money; the IPO went off well initially, and this little company was worth more on paper than General Motors. GS had packaged this quite nicely, with Louis Borders of the famous bookstore chain and other notables to take advantage of the IPO frenzy. Few paid attention to the fact that their business plan called for them to lose hundreds of millions of dollars. In the days following the IPO, the stock price stumbled and fell as people learned more about the company they’d bought. Then they began to look more closely at companies they were about to buy… April 15, 2000: An investor is driving to a company-wide meeting of a large startup software company. Hundreds of employees, all gathered to cheer while he presents a check for$15 million to continue operations. On the way to the meeting, he hears on the radio about WebVan’s trouble, and Playboy’s decision to cancel the Playboy.com IPO and other troubling news.

He arrives — and announces at the podium, to everyone’s horror, that he’s changed his mind. He leaves with the check in his pocket. The company was gone by the end of the month. Hundreds of other companies had similar fates.

If one deal could be said to have burst the bubble, WebVan would be it.

I still have the prospectus.

===|==============/ Keith DeHavelle

33. @myself (laughing)

I meant “mid-1990s” and just saw that it came out “mid-1889s.” I was aware than the 19th century had relatively little dot-com activity. My apologies. ];-)

===|==============/ Keith DeHavelle