Tuesday, February 23, 2010
Back in 2003, Warren Buffet wrote the memorable Squanderville vs. Thriftville in which he lamented the growing U.S. trade deficit and wondered how long we Squandervillians could continue down a road where Thriftvillians in Asia would go on accepting our IOUs in exchange for goods they worked so hard to produce.
Buffet proposed some common sense solutions to remedying the problem and it was a timely warning that, if heeded, may have made the events of the last few years much less traumatic for the global financial system. But, ultimately, nobody really listened.
Fast forward to 2010 and Buffet's partner Charles Munger now has an equally important commentary over at Slate (hat tip JW) and, it too is a desert island parable. This time, instead of Squanderville, it's Basicland, where, after hundreds of years of responsible living, casinos seem to have destroyed the place.
Basically, It's OverBased on the title of Charlie's commentary and the one atop this post, it's not too hard to figure out where this is all going - it all has to do with what was done with debt.
A parable about how one nation came to financial ruin.
In the early 1700s, Europeans discovered in the Pacific Ocean a large, unpopulated island with a temperate climate, rich in all nature's bounty except coal, oil, and natural gas. Reflecting its lack of civilization, they named this island "Basicland."
The Europeans rapidly repopulated Basicland, creating a new nation. They installed a system of government like that of the early United States. There was much encouragement of trade, and no internal tariff or other impediment to such trade. Property rights were greatly respected and strongly enforced. The banking system was simple. It adapted to a national ethos that sought to provide a sound currency, efficient trade, and ample loans for credit-worthy businesses while strongly discouraging loans to the incompetent or...
The piece is well worth reading in its entirety - here are a few highlights. If you only read these, be advised that "the Good Father" is Paul Volcker.
But even a country as cautious, sound, and generous as Basicland could come to ruin if it failed to address the dangers that can be caused by the ordinary accidents of life. These dangers were significant by 2012, when the extreme prosperity of Basicland had created a peculiar outcome: As their affluence and leisure time grew, Basicland's citizens more and more whiled away their time in the excitement of casino gambling. Most casino revenue now came from bets on security prices under a system used in the 1920s in the United States and called "the bucket shop system."Apparently, Charlie doesn't think too much of derivatives or economists.
The winnings of the casinos eventually amounted to 25 percent of Basicland's GDP, while 22 percent of all employee earnings in Basicland were paid to persons employed by the casinos (many of whom were engineers needed elsewhere). So much time was spent at casinos that it amounted to an average of five hours per day for every citizen of Basicland, including newborn babies and the comatose elderly. Many of the gamblers were highly talented engineers attracted partly by casino poker but mostly by bets available in the bucket shop systems, with the bets now called "financial derivatives."
The views of the Good Father drew some approval, mostly from people who admired the fiscal virtue of the Romans during the Punic Wars. But others, including many of Basicland's prominent economists, had strong objections. These economists had intense faith that any outcome at all in a free market—even wild growth in casino gambling—is constructive. Indeed, these economists were so committed to their basic faith that they looked forward to the day when Basicland would expand real securities trading, as a percentage of securities outstanding, by a factor of 100, so that it could match the speculation level present in the United States just before onslaught of the Great Recession that began in 2008.
As it worked out, the politicians ignored the Good Father one more time, and the Basicland banks were allowed to open bucket shops and to finance the purchase and carry of real securities with extreme financial leverage. A couple of economic messes followed, during which every constituency tried to avoid hardship by deflecting it to others. Much counterproductive governmental action was taken, and the country's credit was reduced to tatters. Basicland is now under new management, using a new governmental system. It also has a new nickname: Sorrowland.