Tuesday, February 23, 2010

Munger's Parable

Charlie Munger recently wrote a parable that was published in Slate. It starts by describing a fictitious place called "Basicland". Historically, this fictional place encouraged trade, strongly enforced property rights, had a sound currency, and a rather simple banking system.

Unfortunately, "Basicland" ends up morphing into something altogether different over time.

A parable about how one nation came to financial ruin

Here are a couple of short excerpts from the parable:

"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.'"

Basicland's politicians, dealing with the mostly self-inflicted hardship, asked for suggestions from the "Good Father"* (even though they historically didn't pay much attention to him since he didn't contribute to their campaigns).

What did he suggest?

"...he suggested that Basicland change its laws. It should strongly discourage casino gambling, partly through a complete ban on the trading in financial derivatives, and it should encourage former casino employees—and former casino patrons—to produce and sell items that foreigners were willing to buy."

Munger says that while these suggestions drew some approval but prominent economists had strong objections because of intense faith in free markets (i.e. all forms of casino gambling were considered by them to be useful activities).

Somehow, enough were convinced that placing this kind of hyperactive casino activity right in the middle of a financial system made sense.

Munger references a quote by what he calls a "long-dead economist" who knew the most about the ill-effects of hyperspeculation, John Maynard Keynes.

"When the capital development of a country is the byproduct of the operations of a casino, the job is likely to be ill done." - John Maynard Keynes

Read the whole article. In parable form it sums up much of what is, and has been, of real concern to the likes of John Bogle, Paul Volcker, and Warren Buffett among others. The current state of affairs would likely have troubled John Maynard Keynes and John Kenneth Galbraith as well. This obviously does not fall down political party lines. There is a good mix of Democrats and Republicans here.

What they seem to have in common is an awareness of financial history and how much the same kinds of mistakes seem to get repeated.

The tools and schemes just have new names. From John Kenneth Galbraith's book, A Short History of Financial Euphoria:

"...for practical purposes, the financial memory should be assumed to last, at a maximum, no more than 20 years. This is normally the time it takes for the recollection of one disaster to be erased and for some variant on previous dementia to come forward to capture the financial mind. It is also the time generally required for a new generation to enter the scene, impressed, as had been its predecessors, with its own innovative genius." - John Kenneth Galbraith

I have heard more than one pundit and policymaker discount Volcker's thinking as being out of touch with today's realities.

I am sure this parable will be pretty much be ignored or discounted much the same way.

It's also likely, sooner or later, we will regret doing so.


* Named Benfranklin Leekwanyou Vokker in the parable.
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