Monthly Archives: December 2015

Captive Capital: A Reply

Assiduous reader LH posted a thoughtful reply to the last post on the idea of captive capital in Dickens’ A Christmas Carol:

I’m wondering about the logic in this line of argument. There is too much absolutist terminology for my liking such as “If you don’t like Scrooge, you are against captive capital. If you are against captive capital, you think money should be free, not hoarded. ” It’s not either/or – there’s a balance. Saving does not equate to hoarding.
As one who does not have a pension (as is the case for most in our country) if I do not save (or “hoard” in your language) I become the grasshopper not the ant. My income is such that I can (and should) do that. At the same time I give and it has become a significant part of who I have become. Through this all I have been struck by two truisms: 1) the love of money is the root of all kinds of evil and 2) it is better to give than receive. I am by no means the poster child for these truths but when I have opportunity to encounter those (all too rare) “aha” moments I am always struck by them and would like to think that on some level this affects me at a deeper level to cause change and, perhaps, bring me more in alignment with God (or whatever you want to call that Transcendent Other).
This is what I think happened to Scrooge. When he gave he was having a profound encounter with a notion that moving away from a sense of “self and self alone” (which I think is really at the core of hoarding) and other narcissistic values brings surprising happiness and freedom. I think part of Dickens’ genius in his story (and in other bits of his extensive writing) is in communicating the serendipity of this action. If you read a biography of Dickens you will learn that he was a philanthropist at heart and found great joy in indulging in his giving.
I wish all readers the opportunity to experience that freedom and joy this Christmas and perhaps wonder where this comes from – is it some objectifiable neuronal endorphin-related phenomenon or is there something more consequential “out there” that our soul is responding to?

Captive capital is capital in the form of stocks and bonds which is no longer traded. It is held by hoarders (such as Scrooge), university endowments, pensions, and sovereign wealth funds. Once capital becomes captive, it desires to grow. It does not want to be disturbed. It does not want to be drawn down. It may make disbursements–such as when university endowments pay out scholarships–but the idea is for the principle to grow. The danger is that captive capital supports a class of consumers, who, owing to the fact they have an income stream, can now consume without producing. A second danger is that since captive capital grows faster than the GDP, at some point it will become the entire economy. The example I used was the Norwegian Sovereign Wealth Fund. You can see the original post here.

Saving Does Not Equate to Hoarding

Saving does not equate to hoarding: that is the one of the points LH brings in his reply. It’s true. So, in terms of producers and consumers, the following options are possible:

  1. those who produce and consume in equal amounts (i.e. one who makes $10 and spends $10). These are the workers.
  2. those producers who invest a portion of their earnings. Their investments work for them, allowing them to consume more than they produce with their own hands (i.e. a saver who makes $8 with his own hands but, thanks to investment income, can spend $10). These are the savers.
  3. those producers who invest all (besides what is necessary to subsist) of their earnings. Their investments work for them, but they reinvest all the proceeds (i.e. one who can spend $100 but only spends $1). These are the hoarders.

Perfect! Saving does not equate to hoarding. It is a sliding scale. In the most efficient economy (the least captive capital), those who produce consume an equal amount. A less efficient scenario happens when investors begin ‘captivating’ capital: investing it for the purposes of spending the income it generates. But this is not all bad, since these savers are at least spending it. The capital is not entirely captive. The hoarders are the worst case scenario. They invest, but spend the bare minimum. If production and consumption is a cycle, by hoarding they bust the cycle.

The True Problem Isn’t Even the Hoarders

Even though the hoarders’ investments grow faster than the economy (because rates of return on stock market investments typically exceed a country’s GDP), the hoarders aren’t the true problem. Eventually their savings will be freed and will return into the economy. The reason? We all die in the end.

The bigger problem are pensions, endowments, and sovereign wealth funds: they have an indefinite lifespan. The bigger they get, the more privileged one class gets and the less privileged another class gets. To be sure, pensions, endowments, and sovereign wealth funds are beneficial, but at what point do they become too big? Anyone ponder that?

One solution that LH pointed out would be to give back to society. But would enough people do that to offset the damage of captivated capital?

And with that thought: Happy New Years! Party like it was 1999!

I’m Edwin Wong and I look forward to Doing Melpomene’s Work in 2016. See you there!

A Christmas Carol (Belfry Theatre)

FB treated me to Belfry’s production of A Christmas Carol on December 1st, opening night! It stars Tom McBeath as a corrigible Ebenezer Scrooge. Written by Dickens and adapted for the stage by Shamata. Here’s what the party looks like. That’s Scrooge in front of the door, wearing a grey housecoat:

Dancing Scrooge

Dancing Scrooge

Christmas Carol Synopsis

Everyone knows the story of Scrooge. Consumed by avarice, he is offered an opportunity to change. Three ghosts visit him: the Ghost of Christmas Past, the Ghost of Christmas Present, and the Ghost of Christmas Future. They show him how his miserly ways have made Christmas miserable to those around him. The shock of seeing himself from the perspective of the other changes him. How does he change? He starts spending the capital (money) on those around him. A donation to the charity. A raise for Cratchit. A turkey for Tiny Tim. Forgiving the debtor. And so on.

A Revisionist Reading of Christmas Carol

The usual reading of Christmas Carol is that Scrooge lacks holiday spirit. He is miserly and miserable. He makes those around him miserable as well. The commonplace interpretation of Christmas Carol is surely what Dickens had in mind. It might be right but it is, well, commonplace. If the role of art is to challenge, what is needed is not a commonplace interpretation but a revisionist interpretation. A revisionist reading goes something like this:

If debtors owe Scrooge money, is that Scrooge’s fault that he collects his debts? If Scrooge is paying Cratchit too little, why doesn’t Cratchit tell him to go to hell? Is Scrooge the only employer in town? If a charitable gentleman donates to charity, does his donation place a moral obligation on others to do likewise?

That’s the standard revisionist reading of Christmas Carol. I like it. But it doesn’t go far enough. Let’s take the extreme revisionist position.

Scrooge and the Problem of Captive Capital

Part of the complaint against Scrooge is his wealth. Specifically, he hoards his wealth. In other words, the capital that he has accumulated isn’t being pumped back into the economy. It isn’t making him happy. And it cannot make others happy. Like it or not, implicit in the story is the idea that money buys happiness. Happiness isn’t going around because his capital is captive: it sits in his vault. It does not circulate. How do we know this is correct? At the end of the play, when he starts circulating the captive capital (turkey for Tiny Tim, raise for Cratchit, donation to charity, etc.,) everyone becomes happy. So Christmas Carol is a play about the problem of captive capital. Or at least that’s what a revisionist stance would argue.

If you don’t like Scrooge, you are against captive capital. If you are against captive capital, you think money should be free, not hoarded. By producing things (or services) one creates capital. By spending money, capital is returned back into the system, where it can work. It goes around in a cycle. If the cycle is broken, then the capital has become captivated. It is useless.

Are you still with me? Captive capital (i.e. all the money Scrooge has hoarded) is bad. Circulating capital is good (turkeys for Tiny Tim). Capital follows the cycle of production (creation) and consumption (spending). Now the $10,000 question: can you think of an example of captive capital today? Not any example of captive capital, but the largest example of money that is doing nothing. Scrooge money, if you will. So big that it threatens to undermine the economies of the world.

Did you say billionaire heirs and heiresses? Yes, that is captive capital, but that is not the biggest and most damaging example. Did you say corporations and cash hoards? Well, sort of. Maybe. The jury is still out on that one. Apple justifies its cash hoard ($200+ billion and equal to the GDP of a medium sized nation such as Czech Republic) because it gives it autonomy. It’s harder for lenders to boss Apple around. The cash hoard gives Apple autonomy from Wall Street. Berkshire Hathaway is like that too. They’re both well run companies in my eyes. Did you say Buckingham Palace (as EK suggested)? Yes, that’s true. But what I was thinking of is bigger than Buckingham. The biggest and most dangerous example of captive capital are pension funds, sovereign wealth funds, and endowments.

Pension Funds, Sovereign Wealth Funds, Endowments & Other Forms of Captive Capital

The popular argument is to make pension funds, sovereign wealth funds, and university endowments larger. Pensioners benefit from pension funds, citizens benefit from sovereign wealth funds (social benefits), and students benefit from university endowments (bursaries and scholarships).

Here’s the problem, however. It can be summarized in a little equation r>g. or the rate of return of captive capital is greater than g or the growth rate of a nation’s GDP. Pension funds, sovereign wealth funds, and university endowments invest in the stock market. Nowadays, the stock market is projected to grow 7% a year (historically it has been closer to 10%). The GDP of developed nations such as USA or Canada grows 2% a year if we are lucky. So, if r>g, pension funds, endowments, and sovereign wealth funds will grow to become a disproportionate amount of a country’s national wealth. To compound the problem, pension funds, endowments and sovereign wealth funds also grow tax free, a fact which further exacerbates the equation “r is greater than g.”

The tax free is a big deal. Think of the monasteries in the middle ages. They were tax free as well. They grew to such an extent that eventually, they were a drain on the national income: at some point, everything became part of the monastery, choking the government of revenue. Some say that this is why the kings had to make war on the monasteries, to reclaim the missing economy.

You ask, well, what’s the problem if captive capital gets bigger? Some might even want captive capital to get bigger. Students, pensioners, and the citizens of nations who have sovereign wealth funds would benefit. This brings us back to Scrooge.

In a healthy economy, there are producers and consumers. Producers produce, make money, and release the money back into the cycle by consuming. Scrooge is a danger because he produces, but does not consume. Well, pension funds, endowments, and sovereign wealth funds are sort of like that. Except on the other end of the chain: by paying out benefits, they support consumption but they are not producing anything.

Take the Norwegian sovereign wealth fund. It is a highly praised and successful model: instead of spending their North Sea oil revenue, it goes into this fund to provide benefits to Norwegian people. In 2014, it had $857.1 billion of assets (in USD). That’s 1% of the whole world’s stock market. Now, Norway’s population is 5.1 million. Conventional wisdom says that one can spend 4% of a stock portfolio each year indefinitely without drawing down on the principal. Since sovereign wealth funds grow tax free, the safe drawdown percentage is even a little higher, say 4.5%. So, a $857.1 billion investment should yield $38.569 million per year. With a population of 5.1 million, that means that each year, every man, woman, and child in Norway could receive $7562 USD for doing nothing at all.

Now, the Norwegian sovereign wealth fund started out in 1990 and, in 24 years, has grown to $857.1 billion. If it continues to grow, sooner or later, everyone in Norway can retire. Even the children. This is good. Or is this good? Someone still has to produce the goods the Norwegians are consuming. So, in effect, by managing their capital well, they have enslaved other people in the world. Sort of like what Scrooge has done.

Ba humbug.

I’m Edwin Wong, and there is little problem of captive capital when it comes down to Doing Melpomene’s Work.

Enough – Bogle

Enough Author Blurb

John C. Bogle is founder of the Vanguard Mutual Fund Group and President of its Bogle Financial Markets Research Center. He created Vanguard in 1974 and served as chairman and chief executive officer until 1996 and senior chairman until 2000. In 1999, Fortune magazine named Mr. Bogle as one of the four “Investment Giants” of the twentieth century; in 2004, Time named him one of the world’s 100 most powerful and influential people; and Institutional Investor presented him with its Lifetime Achievement Award. Enough., Bogle’s seventh book, follows his 2007 bestseller The Little Book of Common Sense Investing.

Enough: True Measures of Money, Business, and Life

Bogle, Enough Cover Illustration

Bogle, Enough Cover Illustration

I like Bogle. I like him for starting the index fund revolution in the 1970s. He created the first mutual fund that mirrored an index: the S&P500. It held whatever was in the S&P 500 and its holding were weighed by market capitalization. No active manager, no stock picking, no speculation. The result was rock bottom fees. Back then, they called it “Bogle’s Folly.” The big investment firms derided him. Bogle had to start up his own investment company in 1974 (the year I was born) to sell the product. Today, that company–The Vanguard Group–is one of the largest money managers in the world with 20 million + investors and 3 trillion of assets under management. Yes, I am proud to invest my money with them.

The original fund is still going strong today and trades under the ticker VOO. It’s expense ratio is a negligible 5 basis points. What’s 5 basis points? Well, 5 basis points is 5% of 1%. Expressed as a percentage, 5 basis points is 0.05%. For every $1000 invested in VOO, an investor would pay 50 cents each year for Vanguard to rebalance the holdings to track changes in the S&P500. Considering that the average mutual fund in Canada charges 2.35%, 0.05% is a steal. The difference is 4600% In dollar terms, on $1000, the average mutual fund would charge $23.50 and VOO would charge $0.50.

If, as they say, in the long run you can safely draw down 4% of an investment portfolio each year, if you’re paying 2.35% in fees, the investment firm is leaching over half of your returns from you each year. Think about it in those terms: 2.35% is over half of 4%! In effect, you’ve handed over over half of your money to the investment company. When Bogle says that the most important thing is to keep costs low, he’s right!

Think of assets not in terms of net worth, but in terms of the income stream that it generates. If you think of assets in terms of net worth, it’s easy to be careless with money: “2.35% of $1000? That’s only $23.50 a year, that’s not much at all,” someone might say. But if $1000 produces a $40 income stream each year and you have to pay $23.50 of that $40 in expenses, well, all of a sudden, whoa, that seems like a lot of money!

To think of money in terms of an income stream instead of net worth is to go back to an 19th century perspective. Back then, the question wasn’t: “How much is your farm worth?” but rather “How much income does your farm generate?” Think of Jane Eyre or Magic Mountain. To characters in those novels, net worth means nothing. Income is everything. You can’t buy bread or pay rent with net worth. You can, however, purchase shelter and food with income.

How can Vanguard keep fees so low? Most investment firms are there to make money from the people that buy its products. Not Vanguard. Vanguard is structured as a coop. Coops are structured so that profits are returned to its shareholders, who are also its customers. With a traditional company like Fidelity or State Street, they are there to make money for their shareholders. As much money as they can. With Vanguard, all the profits are returned to its customers. How does it return the profits to its customers?–by lowering the management expenses. So that’s how Vanguard works: it creates value for its customers, who are also its owners. Their interests are aligned.

Creating Value For Society

Bogle is all about creating value for society. By structuring Vanguard as a coop, he aligned shareholder and client interests and created value for investors by returning profits to the clients. To Bogle, 21st century America has lost its way: there is too much cost and not enough value, there is too much speculation and not enough investment, there is too much complexity and not enough simplicity, there is too much counting and not enough trust, there is too much managemen, and not enough leadership, there is too much salesmanship and not enough stewardship, there is too much focus on things and not enough focus on commitment, there is too many success and not enough character. In short, with Enough, Bogle thinks that America has lost its way because it has too many 21st century values and not enough 18th century values.

What Is Enough?

Bogle begins and ends Enough with this true story, printed in the 2005 New Yorker written by the writer Kurt Vonnegut:

True story, Word of Honor:

Joseph Heller, an important and funny writer

now dead,

and I were at a party given by a billionaire

on Shelter Island.

I said, “joe, how does it make you feel

to know that our host only yesterday

may have made more money

than your novel ‘Catch-22’

has earned in its entire history?”

And Joe said, “I’ve got something he can never have.”

And I said, “What on earth could that be, Joe?”

And Joe said, “The knowledge that I’ve got enough.”

Not bad! Rest in Peace!

What is enough? If you talk to the fellow on the street, enough might be a thousand dollars more than he earned last year. Enough is funny. Money is also funny. Its like productivity at work: whatever tasks workers are given, they will make it fit their 8hr shift. So too with money: if you make more, you will spend more. You will never have enough.

One of the statistics in the book stuck in my head. America has 4% of the world’s population. If you ask the average American, they’ll say they want more. They don’t have enough. Well, Americans already consume 25% of the world’s output. How much is enough?

America–and Canada–are probably the best place to be born in the world right now. There is universal medicare. Universal pensions. They are the lands with the greatest social and economic mobility. They have safety nets in EI and welfare. There is religious freedom. If you could be born as an average person in any other time or place, do you think you’d have a better chance somewhere else? How much is enough?

I’m Edwin Wong and enough for me is the opportunity to be Doing Melpomene’s Work.