Wednesday, February 10, 2016

If You Want To Be Wealthy, Don't Focus on Owning a House--Build a Business

The key take-away: focus on owning income-producing assets, not a primary residence.
One truism of investing is to follow the lead of those who are building wealth.This chart reveals the foundation of the wealth of the top 1% and the next 9%; business equity, i.e. ownership of enterprises. Compare the assets boxed in red:
The wealthiest households' primary wealth is businesses and shares in businesses. The bottom 90% depend on the family residence as a store of wealth, and on debt as a means of funding asset purchases and consumption.
Primary residences were once a reliable store of wealth--a store that was accessible to working families who were willing to pinch pennies and save up a down payment.
But now that housing has been financialized and globalized, it is prone to boom and bust cycles like every other risk-on financialized asset. Unfortunately, recent history shows that many middle-class households bought homes at the top and rode the post-bubble burst down.
Those fortunate enough to own homes in bubble-prone regions may benefit from speculating in housing, but playing this speculative game requires cashing out at the top of the bubble--something few have the knack for.
Building a profitable business isn't easy. That's why many of the wealthy let entrepreneurs take the risk of starting businesses and then buy the business for a premium once it has proven to be profitable.
But many entrepreneurs refuse to sell out, preferring to hold their businesses as a family asset that can be passed on to the next generation.
It's also worth noting that the wealthiest 10% own over 90% of the securities and stocks, 84% of trusts (essentially tax havens) and almost 80% of non-home real estate (i.e. second homes and income-generating properties).
Primary residences represent a mere 10% of the wealthiest 1%'s assets.
The key take-away: focus on owning income-producing assets, not a primary residence. The second key take-away:
Don't finance your assets with debt; finance your income-producing assets with savings and sweat equity, not borrowed money.
It is not accidental that the wealthiest 1% hold very modest levels of debt.
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Tuesday, February 09, 2016

How Systems Break: First They Slow Down

Alternatively, we can cling to a state of denial, and the dominant system will be replaced by archetypal systems that are not necessarily positive.
Understanding our current socio-economy as a system of sub-systems enables us to project how and when unsustainable sub-systems will finally unravel.
The reality that cannot be spoken within the conventional media is that all the primary financial systems we believe are permanent and indestructible are actually on borrowed time.
One way to assess this decline of resilience is to look at how long it takes systems to recover when they are stressed, and to what degree they bounce back to previous levels.
A compelling article on this topic was recently published by The AtlanticNature's Warning Signal: Complex systems like ecological food webs, the brain, and the climate all give off a characteristic signal when disaster is around the corner.
"The signal, a phenomenon called “critical slowing down,” is a lengthening of the time that a system takes to recover from small disturbances, such as a disease that reduces the minnow population, in the vicinity of a critical transition. It occurs because a system’s internal stabilizing forces—whatever they might be—become weaker near the point at which they suddenly propel the system toward a different state."
Recent email exchanges with correspondent Bart D. (Australia) clued me into the Darwinian structure of this critical slowing down and loss of snapback (what we might characterize as a loss of resilience).
Beneath the surface dominance of one system are many other systems that are suppressed by the dominant system.
As the dominant system weakens / destabilizes / slows down, these largely invisible systems compete to occupy more of the ecosystem.
An example in the financial realm is barter: in a system dominated by central bank/state issued money and digital transactions, barter still exists but on a very modest scale.
When central bank/state money loses its value and utility (due to hyper-inflation, etc.), then barter expands rapidly to fill the vacuum left by the demise of the dominant system.
The ecosystem example illustrates how critical transitions occur: as the dominant system loses resiliency and slows down, other systems fill the ecosystem spaces that are opened up by the weakness of the dominant arrangement. At some point, the balance or equilibrium of the ecosystem experiences a phase transition and a new balance of other dynamics become dominant.
In human systems, this process can be at least partially conscious: we can see the dominant paradigm weakening, and start developing other systems that can compete for the resulting openings in the financial/social ecosystem.
Alternatively, we can cling to a state of denial, and the dominant system will be replaced by archetypal systems that are not necessarily positive. I opt for conscious development of alternatives that can compete transparently for dominance as the status quo dissolves and is replaced by more resilient, sustainable systems.
This essay was drawn from Musings Report 3. The weekly Musings Reports are emailed exclusively to subscribers and major contributors ($50+ annually).
Musings Subscribers: If you did not receive your Musings Report this week, your subscription has likely expired. If you would like to resubscribe, you can do so via this page: How to Contribute, Subscribe/Unsubscribe to Of Two Minds.com.
Admin note: I will be busy with family commitments until mid-month. As a result, blog posts will be sporadic and email responses will be near-zero. Thank you for your understanding.

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Monday, February 08, 2016

If Knowledge Is Power, Is It Also Wealth?

Ironically perhaps, the ideas that are scarce are those that disrupt "business as usual" by automating what has not yet been automated.
Let's consider a syllogism: Knowledge is power, power equals wealth, so knowledge equals wealth.
Is this true? Author George Gilder thinks so. His book Knowledge and Power: The Information Theory of Capitalism and How it is Revolutionizing our World, proposes that (in Bill Bonner's apt phrase) "the economy is fundamentally a learning system, not a way for distributing wealth."
In Gilder's view, new information (i.e. knowledge) enables us to do things better, i.e. increase productivity. New knowledge is what creates value.
New knowledge is always surprising, and it naturally disrupts "business as usual." So those earning money from business as usual must suppress the disruption arising from new knowledge to maintain their incomes/profits.
Bonner summarizes the conflict between vested interests (cronies and zombies) and those with new knowledge in this lively fashion: "In an economy, the person who is the source of most important new information is the entrepreneur. He is the fellow who takes risks and builds a new business.
The cronies want to stop him, before he undermines the value of their old assets and old business models with new information. The zombies want to drag him down, leeching on him so greedily that he runs out of energy."
Gilder views vested interests limiting new knowledge as the real threat to the economy. This is the danger of "regulatory capture," when vested interests bribe the state (government) to erect barriers to competition to maintain monopolies and rentier privileges.
But what's missing from this view of the economy as a learning system is that value flows to what's scarce, and information is abundant.
In other words, only very specific kinds of knowledge are scarce--the kind that create new goods, services and business models.
These new models are precisely what destroys not just "bad" cronyism but "good" jobs. What's scarce is ideas that automate existing processes.
As Michael Spence and co-authors Andrew McAfee and Erik Brynjolfsson observed in their 2014 essay, Labor, Capital, and Ideas in the Power Law Economyneither capital nor labor have scarcity value in the age of automation and nearly-free credit. “Fortune will instead favor a third group: those who can innovate and create new products, services, and business models.”
Value in the knowledge economy is not distributed equally. The return on abundant human labor and capital are very low, while the scarcity of skills and knowledge that create new products, services, and business models drives most of the gains to the creative class: “The distribution of income for this creative class typically takes the form of a power law, with a small number of winners capturing most of the rewards. In the future, ideas will be the real scarce inputs in the world -- scarcer than both labor and capital -- and the few who provide good ideas will reap huge rewards.”
Learning--the acquisition of skills and knowledge--is difficult and costly. Developing new ideas and applying them in the real world is an uncertain process and therefore risky.
From this perspective, rewards flow not just to what’s scarce but to what is inherently risky. Since most ideas fail to reach fruition, new ideas that succeed in boosting productivity are intrinsically scarce.
In other words, there is no risk-free way to identify and exploit scarcity in a knowledge economy in which vast troves of information and knowledge are free and have no scarcity value.
The wild card here is knowledge is increasingly unownable and therefore it cannot be kept scarce for private gain.
It seems that while knowledge may be powerful in terms of empowering the learner to improve their own lives, knowledge can only generate wealth if it is scarce and ownable.
Ironically perhaps, the ideas that are scarce are those that disrupt "business as usual" by automating what has not yet been automated.
This essay was drawn from Musings Report 12. The weekly Musings Reports are emailed exclusively to subscribers and major contributors ($50+ annually).
Musings Subscribers: If you did not receive your Musings Report this week, your subscription has likely expired. If you would like to resubscribe, you can do so via this page: How to Contribute, Subscribe/Unsubscribe to Of Two Minds.com.
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The Increasingly Fragile Upper-Middle Class

Many of these apparently high incomes are completely absorbed by high-cost upper middle class expenses.
Since the top 10% takes home 50% of all household income, it follows that this top slice has most of the discretionary cash, i.e. net income left after taxes, servicing debt and paying for essentials such as food, utilities and housing.
It also follows that the discretionary spending of the top 10% is supporting much of the economy that is dependent on discretionary spending: tourism, eating out, personal trainers, etc.
The top 10% includes the thin slice of Financial Oligarchy (top .01%) and the top 1%. This skews the income and wealth of the top 10%. But if we set aside the top 1%, the next 10% still earns the lion's share of household income.
The top .1% can prop up Maserati sales and buy $5 million vacation homes, but there simply aren't enough super-wealthy to support the U.S. economy. As for the top 1%, they can prop up the local Porsche dealership and pay dock fees at the yacht club, but there aren't enough of them to support the entire economy, either: around 1.5 million qualify as top 1%.
So that leaves the upper-middle class, the roughly 12 million households that earn a disproportionate share of household income, with the task of spending enough discretionary cash to prop up an economy that depends heavily on consumer spending.
Many of these upper-middle class households are far more financially fragile than their substantial incomes suggest. The vast majority of these high-income households depend on two earners, each making substantial salaries, bonuses and benefits such as 401K retirement contributions.
Many of these apparently high incomes are completely absorbed by high-cost upper middle class expenses. $250,000 a year may look like a lot until you throw in a couple of kids attending private prep schools or college, healthcare costs that aren't covered by insurance, an enormous mortgage and sky-high property taxes.
The upper-middle class includes many people with wealth, but it also includes many people who have saved very little, and what they do have is in IRAs and 401Ks trapped in the stock market. Their slide to insolvency can be very quick once one high-earner loses their job and can't find another equally lucrative position in a few months.
Many of these people are vulnerable to a downturn because they own/operate small businesses in discretionary spending sectors--the ones that will get creamed as people cut discretionary spending. Others are sandwiched between kids in college and elderly parents, and their seemingly big incomes are fully allotted to essentials and the generations they are sandwiched between.
One job loss will crumble the entire house of cards. As local government revenues start crumbling along with corporate profits, many high-cost jobs in both thr public and private sectors will suddenly be vulnerable as managers are forced to seek the largest possible savings from job cuts.
The upper-middle class that's supported the "recovery" with massive discretionary spending is far more vulnerable to implosion/insolvency than is generally appreciated.
Subscribers: If you did not receive your Musings Report this week, your subscription has expired. If you would like to resubscribe, you can do so via this page: How to Contribute, Subscribe/Unsubscribe to Of Two Minds.com.
Admin note: I will be busy with family commitments until mid-month. As a result, blog posts will be sporadic and email responses will be near-zero. Thank you for your understanding.

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Friday, February 05, 2016

The Chart of Doom: When Private Credit Stops Expanding...

Once private credit rolls over in China and the U.S., the global recession will start its rapid slide down the Seneca Cliff.
Few question the importance of private credit in the global economy. When households and businesses are borrowing to expand production and buy homes, vehicles, etc., the economy expands smartly.
When private credit shrinks--that is, as businesses and households stop borrowing more and start paying down existing debt--the result is at best stagnation and at worst recession or depression.
Courtesy of Market Daily Briefing, here is The Chart of Doom, a chart of private credit in the five primary economies:
Why is this The Chart of Doom? It's fairly obvious that private credit is contracting in Japan and the Eurozone and stagnant in the U.K.
As for the U.S.: after trillions of dollars in bank bailouts and additional liquidity, and $8 trillion in deficit spending, private credit in the U.S. managed a paltry $1.5 trillion increase in the seven years since the 2008 financial meltdown.
Compare this to the strong growth from the mid-1990s up to 2008.
This chart makes it clear that the sole prop under the global "recovery" since 2008-09 has been private credit growth in China. From $4 trillion to over $21 trillion in seven years--no wonder bubbles have been inflated globally.
Combine this expansion of private credit in China with the expansion of local government and other state-sector debt (state-owned enterprises, SOEs, etc.) and you have the makings of a global bubble machine.
In other words, the faltering global "recovery" and all the tenuous asset bubbles around the world both depend on a continued hyper-velocity rocket rise in China's private credit. What are the odds of this happening? Aren't the signs that this rocket ship has burned its available fuel abundant?
Three out of the five major economies are already experiencing stagnant or negative private credit growth. Three down, two to go. Helicopter money--government issued "free money" to households--is no replacement for private credit expansion.
Once private credit rolls over in China and the U.S., the global recession will start its rapid slide down the Seneca Cliff: The Global Economy Could Fall Farther and Faster Than Pundits Expect.
Admin note: I will be busy with family commitments until mid-month. As a result, blog posts will be sporadic and email responses will be near-zero. Thank you for your understanding.

NOTE: Contributions/subscriptions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.
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