The Year That Was, Part Three

When I started counting down my top posts from 2012 this one surprised me the most.  It’s the least topical and by far the most economic theory I’ve ever posted but someone it clocks in at number 3 on my list of the top 5 most viewed posts of 2012.

Late last winter while researching economic theory for my Meekonomics book I came across the work of a little known Italian economist named Vilfredo Pareto.  At least I thought Pareto was fairly obscure, I’d never heard of him before.  But the more I read about him the more his theories, originally published over one hundred years ago made a lot of sence to me.  As a result, what came be known as Pareto Efficiency has become a fairly significant peice of my other theories outlining Meekonomics. 

On March 30 I posted the following summarly of Pareto Efficiency, to date it has been viewed 57 times.  I hope you enjoy it…

Pareto Efficency and Income Redistribution

Pareto Efficiency and Income Redistribution


This is a continuation of my last post when I introduced the economic concept of Pareto Efficiency. 

It is my assertion at our globalized economy is approaching the point at which it is no longer possible for one person to improve their lot in life without the necessity for someone, somewhere to lose ground.  That is the classical definition of Pareto Efficiency as coined by Italian economist Vilfredo Pareto in the 19th century.

Nothing raises the ire of right wing politicians and economists more than the notion of income redistribution.  “Communism!” they scream and point to the failed economies of the former Soviet Bloc, without realizing that the totalitarian Stalinist form of communism that gained influence in the latter half of the 20th century had about as much to do with the original ideas of Karl Marx as the NFL has to do with FIFA.  True Marxism was extremely democratic and goes beyond mere majority rule to the point of consensus.  Karl Marx himself famously declared;

“I do not know communism, but a social philosophy which has as its aim the defense of the oppressed cannot be condemned so lightly.”

That doesn’t sound much like Stalinism to me!  But I digress…

Before I go any further it must be noted that a discussion of Pareto Efficiency is not a moral one.  Pareto Efficiency is a mathematical concept and is about as moral is 2+2.  The fact that we are approaching Pareto Efficiency on a global scale assumes no moral imperative but it does have huge moral consequences.

The right wing argument is that if we force the wealthy, through taxation to give up some of their income to help the less fortunate the loss at the top of the ladder will be far greater than the gain at the bottom and there will be no incentive for those that at the bottom to strive for something better.  But as our economy approaches Pareto Efficiency the lie of that argument is exposed. The fact is that in a Pareto Efficient economy everyone, the wealthy and the poor, must run faster and work harder just to stay in the same place and the only way you move up is if somebody moves down.  Our resources are finite so for one to have more, someone must end up with less.    

In short the only way for the poor to move up is through some form of income redistribution.    That’s not communism and it’s not capitalism, it’s just first grade math.   2+2 =4 but so does 1+3 and 3+1.  Not to belabor the point but if 4 is all there is and you have 3, the only way for this to equal out is for someone to only have 1.   If the person with 1 wants 2 the only way for that to happen is for you to give it to him.

So where am I going with this? 

Honestly, I don’t know.  Since the Arab spring and the occupy movement of 2011 hardly a day goes by when we don’t hear about growing income inequality.  In my humble opinion that’s because the so called free market no longer works in a world that has reached Pareto Efficiency.  I don’t have any solutions.  All I know is that the rich need the poor to buy their goods and the poor need the rich to keep producing.  We are locked in a sort of symbiotic relationship and if we are to avoid conflict we need to recognize the situation for what it is.

 I’m not naïve to the fact that we will never reach true income equality.  I don’t believe that is any more practical or sustainable than a world in which 1% percent of the population controls 99% of the wealth.  But I am also not naïve to the fact that what we have now is nothing more than a giant pyramid scheme and we all know what happens to a pyramid once the people at the bottom figure out they’ve been duped.

Pareto Efficiency, Pareto Improvements and Meekonomics

It’s been a while since I’ve written specifically about economics.  Odd, considering that’s what this blog is supposed to be about but as with anything that has wide ranging implications on how we live our lives,  a discussion of economics must often run off on a tangent or two now and then. 

For those of you who’ve been tracking with me from the beginning you may recall my very first post in which I likened this study to falling down a rabbit hole. [Down The Rabbit Hole] You never know for sure where a particular tangent is going to take you and it might be quite some time before you find your way back to the original point.  As I’ve learned, a study of economics, politics, religion and life in general has a tendency to become just one rabbit hole after another. 

It’s with that in mind that I return to a classical economic theory and how it relates to the theory of Meekonomics.

Pareto Efficiency, named for Italian economist Vilfredo Pareto, essentially says that since goods and services are finite, for one person to become better off someone, somewhere must therefore become worse off.  According to this widely held economic theory a true Win-Win within any given economic system simply doesn’t exist.   A Pareto Improvement on the other hand is a situation in which by allowing a less well of individual to gain the overall benefit to society as a whole makes everyone better off.  A rising tide floats all boats; so to speak.  This theory works fine in a closed economic system but one thing Globalization has shown us is that there is no such thing as a closed economy anymore we are all playing in the same ocean and subject to the same tides.

As a society stabilizes, the opportunities for Pareto Improvements become fewer and at the point at which it is no longer possible to initiate a Pareto Improvement a society is said to be Pareto Efficient.  No further improvements can be made without lowering the standard of living of one person in favor of another. 

The terminology used makes it seem like Pareto Efficiency is the most desired outcome of a mature society.  However; I believe that much of what we are seeing today is the result of a society that has come very close to achieving maximum Pareto Efficiency and as the members of the occupy movement and others will readily tell you, that is far from a good thing.

In a Pareto Efficient society, those at the top of the ladder have absolutely no motivation to help those below them, the risk to their own position is too great.  We have been taught all our lives that we are in a Pareto Improving society and that in order to do our part to help raise the tides for everyone we must strive for a better life for our selves, get a better job, buy a bigger house and send our kids to college so that they can get even better jobs and spend even more money.  We are told that the money we spend flows down to the people who made those goods and services there by helping them to raise their standard of living, but that’s not the way it works at all. 

In the last few decades; as we have approached Pareto Efficiency the reality has changed.  Now in order to just hang on to our position we have to work even harder and live on credit or risk slipping backwards and those above us are just as worried about slipping down as we are.   The ugly side of Pareto Efficiency is this; in order for us to maintain our position we have to convince everyone below us that Pareto Improvement is still possible so they keep spending and supporting us.  It’s the opposite of trickle down economics, it’s a pyramid scheme!   

To Pareto Efficiency and Pareto Improvements, Meekonmists say ENOUGH!

Enough is enough.  Stop trying to move up the ladder and stop trying to stay on a position that you know you cannot maintain.  Take a good hard look at the numbers.  A recent study showed that Canadians, who are by nature much more conservative with their spending than our American neighbors, are carrying a debit to income ratio of 153%.  That means that for every dollar we make, we spend $1.53 to maintain our lifestyle, most of it servicing debt.  How do we do that?  By taking on even more debt! 

It doesn’t take a masters degree in economics to know that is just not sustainable.

We are now living in a Pareto Efficient society, the problem is that in order to maintain their position those at the top of the ladder are still trying to convince the rest of us that it’s a Pareto Improving society, while using their power and influence to sabotage our ability to move up the ladder. 

That is one of the main drivers of our politics and has help to fracture our society into left and right, haves and have-nots.  Pareto Efficiency is what has stalled our economy and the continued desire for Pareto Improvement has driven us into an unprecedented crisis of debt.  Until we recognize what is happening and make a conscious decision to allow or society to become Pareto Inefficient (i.e. allow ourselves to have a lower standard of living) there will be no relief. 

We must act now, before it’s too late.  Sooner or later a Pareto Efficient society that continues to behave as though it is a Pareto Improving society will collapse on itself.  That collapse will primarily be economic in nature but it could also lead to violence.  We are already seeing the rumblings of the coming collapse through the civil disobedience of the occupy movement, Tea Party politics and the so called Arab Spring.   How long before these mostly peaceful protests turn violent?   

Enough is enough.

How to Make Money out of Thin Air

I’m going to be rich! I just figured out a fool proof way to create wealth and because I’m such a nice guy I’m going to share it with you. Are you ready?  Here we go!

Step One:  Get someone to lend you $1000.00.  Tell that person that you will pay them back in one year, one lump sum with 10% interest.  So they make $100.00, they just have to wait for a full year.

Step Two: Lend $900 to someone else at 15% interest for one year.  They pay you back in equal monthly instalments of $86.25 per month.  At the end of the year you would have received back $1035.  Add that to the $100 you held in reserve from the original loan an you just pocketed $65. Not a whole lot but here`s the genius of the plan.

Step Three: Beginning on month two, from the payments on the $900 loan make several small loans of $80 each at 20% interest.  For each $80 loan you will make back $16 over the course of the year.  If you make just one loan a month 11 months you will have made an additional $528 over and above the original $1000 loan.  Mind you; after deducting $80 off the payments received on the original $900 loan for 11 months you would actually only have $683 in the bank so you would need to refinance your original loan to cover the $417 still owing but with such a strong `balance sheet` you wouldn`t have any trouble doing that would you?

So pay back $600 and refinance another $500 at 10%, hold $50 in reserve and repeat the process with the remaining $450, this time lending even smaller amounts of $40 at 20% interest.

At the end of 2 years you would have balance sheet of $1227 with which to pay out the second loan of $550 and you will still only have $677 in the bank and out-standing loans of $440.00, but $677 is now more than enough to pay back the second loan.  Now you will have profited $210 off original loans of $1500.

On the original loans you`ve made 14% in two years, or 7% a year.  That`s a pretty decent return, especially considering you haven`t spent one cent of your own money.  What you’ve actually done is created money out of nothing but time and patience.

This is called loan pyramiding and it is fool proof, all you need is one fool willing to give you $1000.  The only problem is; it`s illegal!

Well not exactly. It`s illegal for an individual like you and me to do it on a small scale but that is exactly what the banks, governments and other lending institutions do every day on a massive scale.

In banker speak step one is called a bond.  Governments and big business issue bonds everyday to raise money and pay it back at a fixed interest rate for a term of 1 to 10 years.  The investor cannot redeem the bonds until the end of the fixed term which allows the issuing institution to lend that money out again at a higher interest rate and for a shorter term in hope that the payments received will be enough to pay back the original bond holder on the maturation date.

Steps two and three are things like mortgages and credit cards issued to consumers who wish to make purchases on instalments.

The whole system works perfectly until someone can`t pay. If enough people stop paying the pyramid collapses on itself like the house of cards it truly is.  It stars innocently enough.  Individuals declare bankruptcy and the banks just write off the loss.  But then banks begin to fail so governments step in to prop them up.  Eventually though governments begin to default on their bonds and entire economies collapse taking the only really productive piece of the system with them.

Who gets hurt the most when the house of cards collapses?  The investor/taxpayer at the base of the pyramid who, through hard work and the creation of value added goods and services had access to the only real money available to in the system in the first place.

Pyramid and Ponzi schemes are illegal because they are inherently unstable and far too risky. They are peddled by slick con-men to unscrupulous and naive investors with promises of big pay outs if only they stay in long enough to reap the rewards.  Governments have written laws to protect investors from cons like this only to turn around and offer the same products, dressed up and backed by confidence in big business or government itself.

But a con is a con is a con, no matter how big the backer.  Indeed con is just short for confidence anyway right?

Governments and big business would rather you have confidence in them than Jimmy Knuckles up the street who offers investors a modest return while giving customers high interest loans out of the back of his van.  But at the end of the day there is no difference in what big government or two bit con-men are peddling.  It’s predatory finance, extractive investment, usury and a big fat con!

As the clock ticks down to Aug 2, debt default day for the United States, people all over the world are waking up to the fact that we’ve
been coned and when the pyramid collapses it will be the workers, the ones who truly create value who will be crushed by the weight of it all.  If you are heavily invested in the markets, especially in bonds, get out while you still can!

Cash is king; it’s the only real money in the system anyway.