Most unearned profit is created when we are what we are not designed to be. Money is a mechanism to drive human behavior, primarily a medium to exchange (human behavior). The reason people trade stocks is that if you get it right, you can play golf or chew the cud.
Declaimer: This article written was originally in March 2011 and some of the data points may be outdated.
The pursuit of ‘unearned income’ (a.k.a. the Free Lunch) holds special significance for us; it is El Dorado that we all seek, without asking ourselves why. We are all designed for activity, and nature forces us to be active to survive. It rewards activity with physical survival, piling on all manner of diseases and disasters on the sedentary. But conversely if ‘Activity is life’, we believe that Heaven must be ‘something else’. And hence the driving needs to define all our el Dorados in the form of something that transcends activity. Could that be the absence of activity? At least if we go by the ads which generally show heaven as the dasher lolling on the beach with a Daiquiri and a blonde.
But the human body is a chemical factory and the brain a chemical machine. Our ability to communicate only creates these visual images, which might be good for the economy and the velocity of money, but is certainly not a recipe for personal and financial happiness.
So while stock trading may be a wonderful preoccupation, it’s no replacement for happiness. Warren Buffet happily tells us that “you must let time hang heavily on your hands”, but forgets to emphasize that you need to love golf to do that. So a passion for golf is critical to the personality set of a successful investor.
Look back over the last boom, and if you had picked up any of 5-6 big trends (oil, dollar, real estate, mining/ metals, banking, over-leveraged companies) that flattered to deceive, you would have spent a short period in terror, but things would have been ok thereafter. What you needed to do was to ‘sit out’ the wait, which is where people fail.
But what has all this got to do with the Law of Unintended Consequences?
In our search for happiness, we need to be conscious of the definition of heaven. Remember the old saying: “Dream right, so you are not shocked when they come true”. The “unintended consequence” of linear, binary dreaming will give a distorted definition of heaven, which will lead to disappointment and unhappiness.
If I haven’t explained ‘unintended consequences’ well enough, here is an obvious example. The Treaty of Versailles was so unfair and onerous on Germany that it probably led to the mass upsurge of support for the Nazi movement and the holocaust that followed. This led to an even bigger war, negating the purpose of the Treaty itself.
The present bust is the consequence of Mr. Greenspan’s famous argument that it is impossible (for a Central banker) to locate a bubble until after the event; the underlying argument being that it was an excess of savings from Asia that was creating the excess Money Supply that was funding all the asset expansion and consumption binge in the US. That led to a collapse in assets, consumption-led growth, and eroded the credibility of Central Banks in general and the US Dollar in particular.
Now look at the obverse.
The fiscal stimulus grossed up across bank bailouts, corporate bailouts, IMF corpus for country bailouts, cross-country scratch-my-back bailouts, increased Government spending, and other forms of deficit financing, is already at about $ 8 trillion, half of it in Europe, and the rest in the US. As it spreads across the world, it will create about 4 times the stock of money originally injected (a.k.a. money multiplier) if it has to bring back the global economy to normal.
It may have little effect. People will stay terrified. They will take all this money, put it under their mattresses, and go to bed. In which case, Mr. Bernanke will deliver his threat of ‘dropping Dollar bills from helicopters’ till the economy goes back to normal. That is then a self-fulfilling prophecy. So it is safe to assume that all this money being injected will eventually create 4 times the bank deposits.
That is about $32 trillion in a $35 trillion global economy, roughly a one-to-one match. At the minimum, that would mean a cumulative 100% inflation, if we assume that the amount of human behaviour remaining to be influenced remains constant.
Ah!!! But that is where it could go wrong. The incremental human behavior remaining to be integrated into the global economy is not in the US and Europe but in India and China. Just like the huge excess capacity in under-sea Fibre Optic cables built as part of the 2000 TMT boom, which led to the explosion in Indian BPOs, the human behavior that will get going with this stimulus will be in the poorest countries of the earth.
And why not? If you had incremental money to lend, would you be mortgage lending to jobless, bankrupt, over-extended Americans, or would you be funding deficit supply in countries with unmet demand, low debt, and huge savings? This is, of course, retail banking; but if you were doing cross-border lending or funding investment demand, what kind of markets would you be looking at?