Prospering During Economic Fragility
As the COVID-19 pandemic draws on, our nation's economy has become increasingly fragile and vulnerable to an economic collapse unlike any of us has seen in our lifetime. In his best-selling book Antifragile, Nassim Nicholas Taleb used the example of Damocles from mythology to illustrate the concept of fragility. "The Sicilian tyrant Dionysius II has the fawning courtier Damocles enjoy the luxury of a fancy banquet, but with a sword hanging over his head, tied to the ceiling with a single hair from a horse's tail. A horse's hair is the kind of thing that eventually breaks under pressure, followed by a scene of blood, high-pitched screams, and the equivalent of ancient ambulances. Damocles is fragile. It is only a matter of time before the sword strikes him down." Our politicians today continue celebrating a lavish banquet unconcerned that our economic future hangs by a hair. We must prepare ourselves to not only survive, but to prosper when the sword eventually falls.
Due to the nature of the market, it is impossible to know when the sword will fall. Rather than trying to predict the collapse, we should prepare ourselves now to understand the nature of the market, and set ourselves up to prosper no matter what happens.
The market is an incredibly complex system that is impossible to understand or predict due to its ever-evolving nature. Every time you interact with the market, you change the market. Let's imagine, for example, that you are in the check-out lane at the grocery store, and you decide to purchase a stick of chewing gum. Unnoticed by you, that small purchase sends a message to the market that chewing gum is in demand. That, in turn, creates an almost imperceptible increase int he price of sugar, rubber, mint oil, glycerin, and other ingredients. These create a demand for truck drivers, shipyard workers, chemists, who all spring into action to meet this increased demand. At the same time, by not purchasing the chocolate bar next to the chewing gum, the market sends a signal that cocoa beans, milk, and vanilla are in less demand. All this happens with no coordination. The sugar farmer does not know about your gum purchase, he is just trying to provide for his family. The market is made up of billions of these interactions every day, each transaction changing the market to provide customers with the the products they desire through the most efficient means, and at the best price possible. The market is never perfect, but it is always self-correcting.
When markets operate freely, they appear chaotic and disorganized, but ultimately prove to be extremely efficient. When people attempt to manipulate the markets through artificial external influence, the markets inevitably become less efficient, and sometimes collapse. We see this time after time, when people with presumably good intentions interfere with the market, causing the opposite of what they had intended. Some examples include rent control, which cause housing shortages and higher rent, minimum wage laws, which increase unemployment, and centralized medical care, which increases the cost of medicine. The 2008 Great Recession was not caused by greed, but by government intervention in the housing market which led to a massive market correction.
Our nation's economy has historically been mostly free, strong, and even antifragile. However, it has become increasingly fragile, and on the verge of collapse. As our states open up from the COVID-19 lock downs, the unemployment rate continues to go down. As of August, 2020, the unemployment rate had fallen to 8.4%, down from a high of 15% earlier this year, according to the Bureau of Labor Statistics. This certainly is good news, but we do not see the real unemployment rate, as the Payroll Protection Program (PPP) and other government subsidies hide the true unemployment figures. As of the end of June, the PPP supported 51.1 million jobs, or 84% of those employed by small businesses. Many government employees have not worked, or only worked part time since March. They do not count in the unemployment figures, as they have continued to receive a salary. Even if we were to return to full employment today, it would likely take years to recover from the months we lost due to the shutdowns. Some industries continue to suffer economic losses, and may never recover. The airline industry, for example, expects over$84 billion in total losses this year, according to IATA. Restaurants, hotels, tourism and entertainment venues, and many small businesses may never recover. If all of that weren't enough, our nation sits on a political powder keg of increasing violence and instability that will only get worse between now and the November election - and possibly longer.
In a free market, our economy could adjust and correct itself from the impact of the COVID-19 pandemic. Unfortunately, our market is increasingly not free. It is burdened by an ever-growing government sector, which could precipitate the implosion of our economy. According to the Office of Management and Budget, federal government expenses were the equivalent of 3.4% of GDP in 1930. In 2019, the federal government spent the equivalent of 21% of GDP. State and local spending added even more. Even before the COVID-19 pandemic, government spending burdened the economy, as government spending does not contribute to GDP, but it takes from it through taxes. The response to the COVID-19 pandemic further exacerbated our economic fragility by artificially preventing the market from recovering. State-imposed lockdowns drastically slowed the economy. "Stimulus" measures took funds from the productive parts of the economy to feed the stagnant parts, and thus disrupted the market's ability to correct itself. So far this year the federal government has approved $11.6 Trillion in COVID-19 related spending (or approximately $35,000 per person). For the sake of comparison, the four years of World War II, which was the most expensive war ever for the U.S., cost $4 Trillion in today's dollars. Looming over all of this is the ever-growing public debt. Public debt is much different than private debt. When you take on private debt to purchase a car, for example, you know that you will eventually have to pay back that debt. When politicians take on more public debt on your behalf, they rest assured that they will never have to pay back that debt. As of September 2020, the US National Debt approached $27 Trillion, or 137% of GDP (or over $81,000 per citizen). To get an idea of how much that is, check out the (outdated) visual of the public debt in 2017. The U.S. federal government spends approximately $340 Billion in interest every year during historically low interest rates. An increase in interest rates to even historical average could cause the U.S. to default on its debt.
See the video below where Nassim Nicholas Taleb described the fragility of the U.S. economy. Keep in mind, he said these things before the COVID-19 pandemic.
In light of the incredibly fragile state of the economy, what can we do to not only survive the drop of the sword, but prosper? As mentioned earlier, the market is complex, and impossible to predict. Even Taleb, who has spent his life studying risk and fragility, was unwilling to predict when the economy could collapse. Because the market is the sum of billions of daily transactions, it represents the actions and knowledge of every participant. Unless we know something before all the billions of other market participants do, we will have no way of predicting or timing any market move. History has shown, though, that centralized planning and artificial manipulation of the market inevitably lead to poverty and oppression. Keeping in mind the impossibility of predicting the market, below are some considerations of various ways you can prepare now.
Cash: It is a good idea to keep cash in your wallet, go bag, vehicle, and at your bug out location. If conditions deteriorate to the point where the city is burning, banks are closed, and credit cards don't work, you will have enough cash available to bug out. There is no reason to keep much more than that, though. Keep a few months' worth easily accessible in a bank, in case of a longer term loss of your income. In the short term, keeping cash on hand provides you options to jump on investment opportunities as they emerge, but as a long term investment, cash is a loser. You lose 2-3% to inflation every year, and possibly much more if we get hyperinflation. Inflation is a tax on savings. While 2-3% per year may not sound like much, using math that would horrify any algebra teacher, you could lose 30% of the value of your cash in a decade. That is in the best of times. In hyperinflation, the value of paper money could be wiped out overnight. Hyperinflation is like ketchup. You can smack the bottle repeatedly, and nothing comes out. Then you are suddenly completely covered with inflation. While inflation is hard to predict, the historically low current rates can't go much lower, but they could suddenly go much, much higher.
Real Estate: Real Estate generally has shown to be a solid long-term investment. If you are young and can comfortably take on the burden of debt, this is a good time to take advantage of historically low interest rates. Real Estate will likely retain its value in the long term, and could generate value in the near term. Real Estate will likely not be a good short term investment, as it will tie up your funds or place you in debt. Both of these reduce your options, which are critical to remain antifragile. If you are older, or do not expect to gain from a long-term investment, you may be better off with more liquidity.
Stock Market: If you can accept a high level of risk, investing in the stock market may be a good option. Think about the next six months, though. If the stock market dropped by half, how would that affect you? If it doubled, how would that affect you? Is the possible gain worth the risk? For most people, a doubling of their investment would not make a substantial difference in their lives, but a halving of their investment could be devastating. The stock market tends to make steady gains over time with sudden collapses. Do not invest in the stock market if you cannot afford to withstand these inevitable sudden collapses.