This is the second book (1993) in a series of three written by investment advisors Davidson and Rees-Mogg. It is a fascinating history and commentary on megapolitics and the changing scale of violence in the world since World War I. They argue powerfully that economic power is shifting away from mega states like the U.S. to smaller entities, corresponding to decreasing scales of effective military force. Lots to consider, much to draw from the lucid writing style, and not a dull moment. Be forewarned.
Excerpts
History shows that once nominal growth slows in a heavily indebted economy, there can be no recovery until the excess debt is eliminated.
Just as we believed it was impossible to sustain an economic system which attempted to prevent anyone from profiting, so we believe it will prove impossible to sustain a political economy which attempts to prevent anyone from losing.
In a world with growing legions of unhappy losers, it may be important for you to anticipate coming episodes of delusional thinking.
The industrial economy based primarily upon the manipulation of raw materials at a large scale is giving way to the information economy based upon the manipulation of data at a small scale.
By 1992, gross interest on the national debt claimed 62 cents of every dollar of federal income tax.
More than you may now imagine, you are vulnerable to financial, economic, and political collapse. You may even be vulnerable to physical violence.
The Information Revolution made possible by the microchip helped overturn Communism and will contribute to the death of the welfare state.
Estimates of total losses in the Japanese property market range as high as 50 percent or $10 trillion, a loss wealth equivalent to every stock market on earth plunging to zero. Even more modest estimates, in the range of $3 trillion, amount to a loss of wealth roughly equivalent to that if all China had disappeared.
… the theory of “megapolitics.” According to this theory, historic changes in the ways that societies organize are largely determined by the physical limits on the exercise of power. In essence, we imagine how the world would change if there were no laws or constitutions, and human affairs fluctuated solely according to the changing dictates of physical force … As technology and other factors change the limits within which force can be exercised, they change society … Yet even the most polite and prosperous nations ultimately have no choice but to evolve according to the changing costs and rewards of projecting and resisting power.
You can depend on the fact that normal channels of information will seldom give you advance warning of major political and economic events.
Before violence in society can be controlled, the costs of policing violence must be low. It must be relatively easy to overpower those who act in violent and predatory ways. Whether this is possible depends on many factors beyond the reach of political authorities.
The 1990 will be a cold decade for the weak who must battle the strong for the savings of the thrifty.
… the ultimate logic of the Information Revolution is to undercut the effectiveness of offensive weaponry and undermine all organizations operating at a large scale.
Future aggression will be undertaken by guerrilla war, subversion, and terror, tactics that cannot be countered by cruise missiles and bombardments targeted from space. Henceforth, Third World dictators will rely less on armies and more on terrorists. When they gain nuclear weapons, they will deliver them by overnight express, not by missiles that can be shot down.
The military equipment and structure the United States has purchased with trillions in Cold War spending is largely unsuited to combating the threats of the 1990s. The new and ancient enemies of Western civilization that will emerge to disrupt the peace will not be continental powers like the former Soviet Union, or even anachronistic 1930s-style dictators like Saddam, but small countries and fragments of countries, bands of terrorists, religious fanatics, drug lords, and criminal gangs.
For forty-five years, the map of Europe was frozen by the Cold War. This was the longest period of stable borders in Europe since the fall of Rome. The 1990s will be a boom time for map-makers. It will be a period of devolution, not just in Europe, but throughout the globe. Multi-ethnic empires will come apart. We will see the breakup not just of the Soviet Union .. but of India, Canada, China, Yugoslavia, Ethiopia, and other countries.
In the days before TV newsmen started describing every story as a “crisis”, the word was not merely a term of suspense. It had a specific meaning now largely lost. A “crisis” was “a turning point, a critical time, or a decisive turn.” It was “a state of affairs in which a decisive change for better or worse is imminent.”
A society that has no use for information about getting ahead is likely to have little use for reason, either. Its day-to-day life is likely to be ridden with demons and delusions.
The hope that government can provide everyone with a high standard of living, good health, and security against misfortune, quite apart from his abilities and values, has been an article of faith in all Western democracies for most of this century. It is now an anachronism, bound to be disappointed, no matter how reckless the monetary or fiscal policy any set of leaders chooses to adopt.
There is a widespread assumption that economic progress since World War II has become permanent. Practically everyone in modern industrial countries accepts the unargued conviction that another depression is no more likely than an invasion from Mars. This illusion is part of a general overestimation of the powers of governments.
People who live in delightful, well-mannered suburbs, who never have to physically contest for their lives and property, often fail to grasp the subtle logic of violence. It is a mistake seldom made by hardened criminals. Criminals are normally connoisseurs of power’s subtleties.
The challenge to prosperity is precisely that predatory violence does pay well in many circumstances. War does change things. It changes the rules. It changes the distribution of assets and income. It even determines who lives and who dies. It is precisely the fact that violence does pay that makes it hard to control.
The ultimate cure for violence is superior force. It sounds like a simple contradiction, but it isn’t. To achieve peace, a society must find ways to muster enough force to suppress predatory violence and curtail the incentives to use it.
Settled agricultural society made both taxes and crime paying propositions. Where there was accumulated wealth to take, there was always someone willing to take it.
Miniaturized technologies miniaturize institutions. In time, the microchip will destroy the nation-state. It will give small groups and even individuals the capacity to employ violence in ways that could overturn governments and destroy large organizations.
When megapolitical conditions make the attainment of sufficient military power dependent upon greater national wealth, as has generally been the case in recent centuries, leaders have stronger incentives to tolerate the emergence of private property rights, sound money, and economic freedom.
Unfortunately, the trend of technology is increasing the number of groups that can employ predatory and destructive violence.
The breakdown of large political systems and the proliferation of borders and barriers are likely to be inimical to economic growth and human freedom.
Since the eighteenth century, those who have thought systematically about the rise and fall of nations have noted similar symptoms of decline: high taxes, high prices, widening gaps between the rich and poor, strong special-interest groups, failures of motivation, a decline in education and everyday competence, a high tendency to import, high budget deficits, and more.
A characteristic of empires in their twilight is that they are burdened with high costs and inflexible leadership. In each case where a predominant country has faltered since the sixteenth century, it did so after its leaders stiffly resisted efforts to cut costs to competitive levels, opting instead for higher taxes and more spending. In each case, resources were fatally overextended. Economic supremacy was forfeited to another country enjoying lower taxes and lower costs.
The educational system of a hegemonic power is likely to be geared toward training mandarins. It is a cliché that an Oxbridge education earlier in this century trained students for the civil service, rather than civil engineering. America’s elite education today is also more adept at training persons to redistribute income than to produce it. Ten lawyers graduate in America for every engineer, as compared to ten engineers for each lawyer in Japan.
The combination of vast law firms, litigation for profit, tight government regulation, and grotesque costs is regarded by many economists as one of the reasons why American industry has ceased to be competitive with Japan.
With health care bankrupting many individuals, while making small and even large businesses less competitive with foreign companies that operate without such hideous costs, it was all but inevitable that a cry would rise up for adoption of a latter-day version of the National Health Service. People going broke always wish for someone else to pay the bills. It is a marker on the road to bankruptcy. As in so many other respects, history repeats itself.
Typically, economic downturns sharpen the demands of selfish, local interests and reduce international cooperation. Indeed, this is one of the chief reasons that slow growth periods are times of protectionism and trade war.
The message of history is that cooperation declines along with economies. As world growth prospects diminish, ethnic solidarity and nationalism increase. Horizons narrow. Groups tend to hoard political advantages and seek regulations that reserve for themselves as much as possible of the smaller pie.
Military defeat in Afghanistan meant not just the end of the Soviet empire, but the public disgrace of the command economy in Russia as well. It meant the end of a century of enchantment with the doctrines of Marx. His ideas will still be in books. And many of them will still be believed. But they will be believed mainly in American universities and backwater, Third World mining towns. Marxism at long last ceased to be a contemporary ideology.
The building of factories for mass employment, along with the spread of firearms, gave unskilled workers a rare opportunity to seize wealth. Every such shift of megapolitical power engenders a new ideology to justify the new outcome.
What is happening is not that capitalists are suddenly succeeding in exploiting the workers, but rather that technological change is making it more difficult for workers to exploit the capitalists.
The advent of large-scale enterprises in the late nineteenth and twentieth centuries enabled labor unions to extract higher wages for their members – higher than would be justified by their true economic contributions. They did this by threatening to strike, or, in many cases, sabotage the operations of the enterprises in which they were employed … In essence, industrial workers received a political payoff in addition to their economic wage – a legalized shakedown payment for not sabotaging the operations of the firms where they worked.
The decay of union power as economies move into the Information Age is hardly a random development. It is a predictable consequence of the declining scale of enterprise and therefore the increasing costs of redistributing income through disguised blackmail. Both the economic base and the class ideology of socialism are in rapid decline. The industrial worker, having had his summer of class power, must now give way to new interests and ideas, based on emerging rather than declining technology. Because unions can no longer extract political blackmail from employers as readily as they used to, it is hardly surprising that the share of income claimed by essentially unskilled workers is falling while the percentage earned by the well-educated and the capitalists is rising.
One of the mysteries in the ordering of human life is the way that otherwise inadequate or even dysfunctional social systems can be made functional by religion.
Freedom of religion is possible only where governments function competently on a large scale. It was the advent of new megapolitical conditions – the Gunpowder Revolution – that made religion, in Radcliffe-Brown’s words, “primarily a matter of belief.” The new technology of power facilitated the development of markets and the growth of the nation-state, developments that altered religion’s previously crucial role in organizing social life. The fact that freedom of religion became possible in the most advanced economies over the past few centuries is itself evidence of religion’s declining importance. Religion could only become a matter of choice when it no longer mattered so much what religion one chose.
Part of what makes Islamic law effective in discouraging crime is that it is “old-time religion”, unamended by modern sociology and sophisticated apologies for crime. All religions discourage theft and murder. But where Islamic law is in force, this discouragement does not speak in a soft voice.
As the scale of enterprise rose over the past five centuries, and banking developed in its modern forms, it became ever more difficult for a nation operating under Islamic law to compete. A strict prohibition on lending for interest prohibits a passbook savings account, as well as a fixed-interest government bond.
In the Information Age, the traditional Islamic prohibition against usury will be less damaging to economic efficiency. Even if it is not set aside by an Islamic Luther, the falling scale of enterprise implies lower capital costs, and thus marginally less damage done by limiting debt markets.
Long wave crises in the economy recurring every fifty to sixty years are often associated with human life span. It is commonly argued that individuals who experienced the previous crisis must die out before their descendants can repeat their mistakes. There is logic in this. But it is possible that the causality is reversed. Humans may be limited to an adult life span of fifty to sixty years because crises recur with that rough frequency.
If there is a depression as we expect, one of its consequences is likely to be a thoroughgoing disillusionment with government, and government promises on intervention to forestall fluctuations of the business cycle. Nonetheless, so long as governments retain substantial resources at their disposal, there will always be a demand for rationalizations of far-reaching government actions.
Ironically, the best place to look for a market to go straight down is in the richest country. It is there that the bias towards optimism is likely to be most acute. The best place to find a stock that will shoot straight up is in an underdeveloped market in a poor country, because savings there will tend to be hidden under the mattress, and potential investors will persistently overlook opportunities.
A wicked feedback of perverse incentives reinforces the criminal values and delusional thinking that trap the underclass in poverty. This trap is shut all the tighter because its outlines are hidden by the miasma of race.
Recent estimates suggest that fully one-third of the adult population of the United States cannot perform simple arithmetic calculations. Anything more complicated than flicking to the channel with the music videos, and they are over their heads.
Far more than is commonly acknowledged, poverty is not the cause but the consequence of perverse values and antisocial behavior.
Claims of “racism” do not explain the failures of the underclass. But they bode ill for the future of major cities in the United States, and, to a lesser extent, Europe. They fit into an ancient patter of delusional thinking among the poor that has often culminated in violence. That such claims are now so prominent is itself a hint of both megapolitical vulnerability and economic closure.
By the peculiar logic of the welfare state – which seeks to prevent anyone from losing – to be a victim is to be a winner. The more victimized one is, the higher the recompense he can claim.
The turn away from analytic rationality and the blinking of facts by black leaders are sell signals for the central city. Historically, the claim for rewards based on status rather than achievement has been associated with economic decline. And that, in turn, encourages dishonesty, counterproductive behavior, and delusional thinking.
A general characteristic of the destitute is that they are prone to delusional thinking. They are far more likely than the rich to believe in black magic, the evil eye, predestination, astrology, and confining cultural taboos.
… the function of the delusion – to exonerate the loser from responsibility for his misfortune. The poor man’s pig cannot simply die. It must have been killed by the village “sorcerer”, who usually just happens to be the person in the village who is most successful at fattening his own pigs. It is not incidental that the farmer with the pigs is also likely to be most able to bear the burden of redistribution. For the sorcerer or conspirator to achieve this amazing feat requires that he possess occult knowledge not generally available. It also requires that the inner circle to which the sorcerer belongs have some wicked purpose. This could be devil worship, cannibalism, repugnant sexual practices, a commitment to enslave the world – or whatever seems likely to disqualify the conspiracy from common sympathy. The wicked purpose is essential. Otherwise the loser is still subject to the reproach that he failed to obtain the powerful knowledge himself. To be entirely exonerated, it must appear that he could not be privy to the occult knowledge without forgoing his moral standing – or even risking his soul.
Lacking an infrastructure capable of securing property and policing the safety of individuals, Third World countries have fallen prey to economic destitution, rampant crime, corrupt police, and guerrilla war. In these circumstances, the distinction between ordinary criminal gangs plundering the public and guerrilla movements imposing “taxes” has blurred. This is especially true as modern technology has made it easier for rebellions to sustain themselves with little or no outside help.
The drug lords are the wealthiest people on the planet … The drug cartels are not rinky-dink, back-alley criminals. They are financial superpowers, endowed with all the worst possible traits for attacking the foundations of social order. They are unscrupulous. Violent. Adept at clandestine organization. And richer than governments.
A stable system of property rights, an honest political force, and a dependable judiciary are historical accidents, rare in the experience of the world. They are hard to create, and easy to destroy, especially under current technological conditions, which make it easy for small groups to wield effective military power.
If governments, even in countries like Germany, Sweden, and France, cannot create jobs at tolerable costs during times of relative prosperity, what is the basis of confidence that they can do so in the face of true depression conditions?
We have argued that government spending per se did not cure the depression. Then what did? The answer is obvious, but not simple. World War II. The outbreak of a devastating war in Europe and the Pacific did restore demand to languishing sectors. Far from confirming the hypothesis that government spending can easily prevent depression, the World War II experience raises many doubts. Its effect did not merely rest with the fact that the war was expensive. Rather, a great part of World War II’s impact was that it curtailed supply, destroyed competitive capital, killed talented personnel, and reorganized world monetary, trade, and property rights.
The guerrilla wars that flared into the open after World War II were set in motion by the bitter reaction of peasants to the impoverishment that followed the collapse of the world price of rice.
The economies of much of Asia, Africa, and the Americas had experienced little or no growth for centuries before they were opened to European contact and their institutions forcibly changed. A reversion to old forms of misgovernment and institutional weakness could hobble growth into the indefinite future.
Dozens of economies, from Ethiopia to Mozambique, are not just temporarily depressed. They are collapsing. Falling apart at the seams. When slumps extend from years to decades, and the infrastructure decays, the roads fall apart, bridges wash away, and copper wire from the telephone lines is hammered into bracelets, this is not a temporary departure from the path of economic growth. It is something more permanent. Then end of the line.
The immense, and false, assumption was that the authorities could counteract a depression if one began. This proved untrue in 1930. It is no more likely to be true in the 1990s. Even recognizing that a slump is underway is often beyond the vision of the authorities.
We believe that a major reason why underdeveloped economies are more prone to inflationary than deflationary crises is that the great majority of assets in such economies are tangible assets, like land, mineral deposits, buildings, livestock, equipment, and inventories that cannot be completely wiped out by inflation. A plot of land and a buffalo will still be worth something, no matter how ruthlessly governments devalue the currency.
Personal property taxes are not well suited for an age of intangible assets that can be moved or hidden. But this won’t necessarily prevent some hard-pressed state and local governments from reaching for confiscatory personal property taxes in a slump – especially in jurisdictions where the owners will be a racial or ethnic minority distinct from the majority of voters. A wealth tax at the national level is also a possibility, in spite of the fact that it would be an obvious violation of the U.S. Constitution. The constitutional amendment that provided for an income tax did not repeal the earlier ban on a capital tax. But such niceties may not withstand the rush of circumstances. Remember, Franklin Roosevelt confiscated gold, which was a clear infringement of the prohibition against taking property without compensation.
The balance sheet of the United States has been run into the ground, not by the rich, but by politicians catering to constituencies who want something for nothing … part of the problem has been the growth of income redistribution – which reflects the deteriorating capacity of governments to maintain order.
We expect that taxes on the rich will rise in the coming depression, especially income taxes, because deflation increases the return to creditors.
As you consider the future, remember, it is unusual for a debtor country to allow its citizens free latitude to move capital outside its borders.
There is a likelihood of a surge of downgrades in asset prices of municipal bonds that will be triggered by defaults and redemptions of muni bond mutual funds that will drive down prices in illiquid markets. We anticipate a multi-stage process of collapse for instruments of state, municipality, and agency debt – much like that undergone by Third World debt during the 1980s.
We are optimists in believing that America will take a deflationary course, and thus retain its institutions. But make no mistake. At the depths of the coming depression, the very survival of the U.S. government will be widely questioned. Disillusionment and delusion will abound. Violence will be widespread. Tribal and nihilistic antagonisms will lead to greater terrorism, especially in the cities of America.
Part of the reason that Americans save so little is the assurance that they will be protected from many of the high-cost contingencies, like retirement security and medical care in old age, that induce savings in the first place. Too much income redistribution and too much income equality can actually undermine stability.
We can forecast with firm conviction that the government will not acknowledge that a depression has begun until it has been underway for eighteen months to two years.
A major confirmation of the onset of the depression will be a concerted effort on the part of political authorities to locate scapegoats for the slump. Every slump and market crash in history has been blamed on something other than a decline in economic prospects. The pattern is infallible.
Governments hungry for reelection will panic as the asset deflation gathers force. Their first response will be an attempt to counter the contraction with easy money.
Many believe that services are depression-proof. This is wrong. Spending on services is relatively stable in an ordinary recession, because most recessions are inventory adjustments. A depression is a different story. Services are slower to fall, in some cases, but when they do, they take longer to recover.
Insurance coverage will change to reflect the hardening attitude of society toward drug addition, alcoholism, and “illnesses” that reflect life-style choices. When potential employees are eager and plentiful, there will be less reason for employers to foot the bill for personal difficulties.
Within three to four years of the onset of the slump there will be significant reforms in the practice of law in the United States.
Oil was only one of three industries (the others being food and tobacco) to report net profits in 1932, the deepest year of the depression.
Because the U.S. government in particular is insolvent at its current level of promises, you almost can count on seeing more regulation that will do the wrong thing. It will protect dying industries, suppress innovation, and slow the transition to the new economy. The glacial pace of court action to resolve bankruptcy filings and provide clear titles to repossessed properties will also inevitably retard the adjustment process.
… it is more likely than most people now imagine that public schools in the United States will more or less disappear in the coming decade. Educational entrepreneurs will enjoy a rare opportunity to compete in providing effective elementary and secondary education to children whose parents will be able to spend vouchers on their services.
The hope of thinking people must be that the retrenchment leads to a more enlightened, nonlinear liberalism with enhanced appreciation for the market as a complex system, not to a fascist closure of the economy.
The U.S. government is destined to become the world’s largest pawn shop, converting and liquidating assets inherited from bankrupt financial institutions, failed government-sponsored enterprises, and citizens defaulting on government-insured mortgages.
To protect your liquid funds we recommend that you buy Treasury bills to park cash. U.S. Treasury bills will remain the lowest-risk debt instrument issued in America.
In investment, it is when things look their best that false values are being created. It is when things look their worst that the foundation for growth is being rebuilt.
Quotations
Daniel Patrick Moynihan
From the wild Irish slums of the 19th century Eastern seaboard to the riot-torn suburbs of Los Angeles, there is one unmistakable lesson in American history: a community that allows a large number of young men (and women) to grow up in broken families, dominated by women, never acquiring any stable relationship to male authority, never acquiring any set of rational expectations about the future … that community asks for and gets chaos.
G.J. Whitrow
Since the state of equilibrium between survival and starvation which they normally experience is often finely balanced, it is not surprising that they usually consider it dangerous to deviate from their traditional customs and habits.
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