by David Galland: Health
The concept of entropy is one of the most useful terms for understanding
just about everything. While it has its origins in natural law —
thermodynamics, specifically — the concept holds true pretty much
across all closed systems.
In the simplest of terms, every closed system will ultimately degrade
toward a state of maximum entropy.
I'll use the current political system of the U.S. as a convenient
example. When American democracy was first shoved out of the nest
by the founding fathers, it was new, fresh, and energetic. It took
the world's breath away at its boldness and unlimited promise, and
set the wheels turning on tangible change across much of the world.
Before the ink dried on the Constitution, however, the degradation
began. From the beginning, the country's political operations fell
into the hands of a strictly limited number of parties, which quickly
coalesced into just two. Since then, they have essentially shared
power, with only minor differences in policies between the two.
Simply, absent a disruptive external force, the closed political
system quickly matured into an institutionalized "sameness"
that all but assures no serious challenges — leading, ultimately,
to the certainty it will degrade to only a shell of its former self.
It was, perhaps, because of his own understanding of natural law
that Thomas Jefferson was heard to remark, "The tree of liberty
must be refreshed from time to time with the blood of patriots and
tyrants. It is its natural manure."
That doesn't mean I am advocating revolution — just pointing out
the fact that any closed system, no matter how well constructed,
will degrade. To expect the United States of America to avoid this
fate is to expect the impossible.
Switching to a corporate example, I used to be a regular buyer
of Toyota cars. They were well made, innovative, and suited my changing
needs over the years. And I wasn't alone — in 2007 they became the
world's largest automobile maker, with a global manufacturing and
distribution system that made them appear dominant. Behind the scenes,
though, entropy was at work.
In 2008, when the time had come to lease a new car, I reflexively
headed over to the local dealer fully expecting to drive off with
yet another Toyota, just as I had done several times over the previous
decade or more. But as I walked around the showroom, it was impossible
not to notice that the company had lost its edge. The cars on offer
were not only more expensive than the competition, but even the
newest models had that "so yesterday" look about them.
Surprising even myself, I walked out and ended up leasing from
another company. I remember vividly at the time saying to my wife
that we should short Toyota's stock. Of course we didn't — but if
we had, it would have been a good play, as you can see in the chart
of the company's stock price here. Note that Toyota's share price
peaked in 2007, almost concurrently with it becoming the world's
largest car company.
As I said at the onset, you can see entropy at work in virtually
every closed system. Consider the U.S. dollar, which became the
world's de facto reserve currency as a result of Bretton
Woods. What an amazing advantage for the United States — this unique
ability to provide the world's central banks with their primary
reserve component! And to have all the world's commodities dealt
in dollars. In short, the dollar became the centerpiece of the global
It was, of course, damned to entropy, with Nixon's ending the dollar's
gold backing just being part of the natural progression. And if
he hadn't done it, one of his successors would have — due to some
"emergency" or as a "temporary" measure, or
some other flimsy political cover. Regardless, the degradation of
the currency gained speed and, systematically, it's been all downhill
You may also want to think about entropy when pondering the Chinese
miracle. No question, China is having a heck of a run. As James
Quinn writes in his article "Is China's Recovery a Fraud?"
in the February edition of The
Casey Report, in 1970 that country's GDP was just $92 billion.
Today it is $4.9 trillion!
"Unstoppable!" cheers the punditry. The Chinese leadership,
whose capable hands are very much on the levers of the macro-economy,
are cut from special cloth, they add.
In answer to that, Quinn points out that despite China being an
export-based economy, purpose-built to supply goods to a U.S. population
engaged in a mad rush to spend themselves into debt and default
— which is to say, an economy now only a memory — there is currently
30 billion square feet of commercial real estate under construction
I'm not sure if bowling is popular with the Chinese, but with all
that spare space, some enterprising individual might want to consider
promoting it as the coming thing. Roller rinks? Indoor laser tag
Meanwhile, back in the U.S., we the people are no longer content
with a free-market system that embraces periodically burning down
the house in order to rebuild stronger and better — a system which
has been proven to create wealth, and lots of it. Instead, we are
hell bent on adopting the closed economic system of a socialist
model where everything and everyone is tightly controlled.
On that point, a recent article in the Wall Street Journal
titled "No Exit in Sight for U.S. as Fannie, Freddie Flail"
sheds light on the continuing degradation in the free market that
used to underpin the nation's hugely important housing sector…
Fannie and Freddie, for their part, remain at the core of a housing-finance
system that inflated a dangerous housing bubble. After prices
collapsed, sending shock waves around the world, the federal government
put America’s housing-finance system on life support. It has yet
to decide how that troubled system should be rebuilt.
On Dec. 24, Treasury said there would be no limit to the taxpayer
money it was willing to deploy over the next three years to keep
the two companies afloat, doing away with the previous limit of
$200 billion per company. So far, the government has handed the
two companies a total of about $111 billion.
Can't you just smell the entropy? The results are not just predictable,
they are evident — just look around.
As investors, it is, I would contend, important to understand the
notion of entropy — and to watch for it in your portfolio companies,
in your bureaucracies, and, on a more personal level, your relationships
and your health. On that last point, the human body is very much
a closed system and so, as we all are too painfully aware, will
degrade until it ceases to exist.
You can slow the degradation by taking care of yourself. But it's
also worth remembering that it's a one-way slope, so enjoy yourself
while you are fit and able to.
is the managing editor of Casey