Basically, It's Over - A parable about how one nation came to financial ruin

[Cees Binkhorst]

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Charles Munger is vice chairman of Berkshire Hathaway.
De side-kick van Warren Buffett over de casino-banken.

Groet / Cees

Basically, It's Over - A parable about how one nation came to financial
ruin.
By Charles MungerPosted Friday, Feb. 19, 2010, at 1:51 PM ET
http://www.slate.com/id/2245328/
Wall Street.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 for ordinary daily purchases.

Moreover, almost no debt was used to purchase or carry securities or
other investments, including real estate and tangible personal property.
The one exception was the widespread presence of secured,
high-down-payment, fully amortizing, fixed-rate loans on sound houses,
other real estate, vehicles, and appliances, to be used by industrious
persons who lived within their means. Speculation in Basicland's
security and commodity markets was always rigorously discouraged and
remained small. There was no trading in options on securities or in
derivatives other than "plain vanilla" commodity contracts cleared
through responsible exchanges under laws that greatly limited use of
financial leverage.

In its first 150 years, the government of Basicland spent no more than 7
percent of its gross domestic product in providing its citizens with
essential services such as fire protection, water, sewage and garbage
removal, some education, defense forces, courts, and immigration
control. A strong family-oriented culture emphasizing duty to relatives,
plus considerable private charity, provided the only social safety net.

The tax system was also simple. In the early years, governmental
revenues came almost entirely from import duties, and taxes received
matched government expenditures. There was never much debt outstanding
in the form of government bonds.

As Adam Smith would have expected, GDP per person grew steadily. Indeed,
in the modern area it grew in real terms at 3 percent per year, decade
after decade, until Basicland led the world in GDP per person. As this
happened, taxes on sales, income, property, and payrolls were
introduced. Eventually total taxes, matched by total government
expenditures, amounted to 35 percent of GDP. The revenue from increased
taxes was spent on more government-run education and a substantial
government-run social safety net, including medical care and pensions.

A regular increase in such tax-financed government spending, under
systems hard to "game" by the unworthy, was considered a moral
imperative—a sort of egality-promoting national dividend—so long as
growth of such spending was kept well below the growth rate of the
country's GDP per person.

Basicland also sought to avoid trouble through a policy that kept
imports and exports in near balance, with each amounting to about 25
percent of GDP. Some citizens were initially nervous because 60 percent
of imports consisted of absolutely essential coal and oil. But, as the
years rolled by with no terrible consequences from this dependency, such
worry melted away.

Basicland was exceptionally creditworthy, with no significant deficit
ever allowed. And the present value of large "off-book" promises to
provide future medical care and pensions appeared unlikely to cause
problems, given Basicland's steady 3 percent growth in GDP per person
and restraint in making unfunded promises. Basicland seemed to have a
system that would long assure its felicity and long induce other nations
to follow its example—thus improving the welfare of all humanity.

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."

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."

Many people, particularly foreigners with savings to invest, regarded
this situation as disgraceful. After all, they reasoned, it was just
common sense for lenders to avoid gambling addicts. As a result, almost
all foreigners avoided holding Basicland's currency or owning its bonds.
They feared big trouble if the gambling-addicted citizens of Basicland
were suddenly faced with hardship.

And then came the twin shocks. Hydrocarbon prices rose to new highs. And
in Basicland's export markets there was a dramatic increase in low-cost
competition from developing countries. It was soon obvious that the same
exports that had formerly amounted to 25 percent of Basicland's GDP
would now only amount to 10 percent. Meanwhile, hydrocarbon imports
would amount to 30 percent of GDP, instead of 15 percent. Suddenly
Basicland had to come up with 30 percent of its GDP every year, in
foreign currency, to pay its creditors.

How was Basicland to adjust to this brutal new reality? This problem so
stumped Basicland's politicians that they asked for advice from
Benfranklin Leekwanyou Vokker, an old man who was considered so virtuous
and wise that he was often called the "Good Father." Such consultations
were rare. Politicians usually ignored the Good Father because he made
no campaign contributions.

Among the suggestions of the Good Father were the following. First, 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. Second, as this change was sure to be
painful, he suggested that Basicland's citizens cheerfully embrace their
fate. After all, he observed, a man diagnosed with lung cancer is
willing to quit smoking and undergo surgery because it is likely to
prolong his life.

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.

The strong faith of these Basicland economists in the beneficence of
hypergambling in both securities and financial derivatives stemmed from
their utter rejection of the ideas of the great and long-dead economist
who had known the most about hyperspeculation, John Maynard Keynes.
Keynes had famously said, "When the capital development of a country is
the byproduct of the operations of a casino, the job is likely to be ill
done." It was easy for these economists to dismiss such a sentence
because securities had been so long associated with respectable wealth,
and financial derivatives seemed so similar to securities.

Basicland's investment and commercial bankers were hostile to change.
Like the objecting economists, the bankers wanted change exactly
opposite to change wanted by the Good Father. Such bankers provided
constructive services to Basicland. But they had only moderate earnings,
which they deeply resented because Basicland's casinos—which provided no
such constructive services—reported immoderate earnings from their
bucket-shop systems. Moreover, foreign investment bankers had also
reported immoderate earnings after building their own bucket-shop
systems—and carefully obscuring this fact with ingenious twaddle,
including claims that rational risk-management systems were in place,
supervised by perfect regulators. Naturally, the ambitious Basicland
bankers desired to prosper like the foreign bankers. And so they came to
believe that the Good Father lacked any understanding of important and
eternal causes of human progress that the bankers were trying to serve
by creating more bucket shops in Basicland.

Of course, the most effective political opposition to change came from
the gambling casinos themselves. This was not surprising, as at least
one casino was located in each legislative district. The casinos
resented being compared with cancer when they saw themselves as part of
a long-established industry that provided harmless pleasure while
improving the thinking skills of its customers.

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.

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