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If you are still a taxpayer, you are Atlas. I am Atlas. There will come a time when Atlas will shrug. I have written about this before:
When will he shrug? Before I can answer this, I want to discuss another factor, compound economic growth
COMPOUND ECONOMIC GROWTH
As residents of the West, we all know about the effects of compound growth. Beginning around 1800, Great Britain and the United States began to experience 2% economic growth per person per year. This spread to Europe by 1820. This phenomenon has created a new civilization. Nothing like it was dreamed of in 1800. We live in a world that was literally inconceivable in 1800.
As I have written before, no economist has yet published a definitive book on why and how this began where it did and when it did. Prof. Dierdre McCloskey’s third volume of The Bourgeois Era is supposed to present the evidence for a unique thesis: a change in rhetoric regarding the legitimacy of wealth, beginning around 1600 in the Netherlands and spreading to the British isles by 1700. The thesis is plausible, but we need to see the evidence.
No one can perceive an increase of 2% per year. But, over time, he cannot miss the effects.
It was not clear to observers in Great Britain in 1820 that people were getting richer. Even in the early 1840s, this was not clear to critics of the Industrial Revolution, whether conservatives or radicals. But, by the great London exhibit in 1851, the intelligentsia knew. The man in the London street knew. The West had visibly entered a new era.
What is my point? This: in the early phase of any compounding process, the participants do not recognize the change. It takes time. Then, almost without warning, the results of the process become clear to almost everyone.
French children are told a story in which they imagine having a pond with water lily leaves floating on the surface. The lily population doubles in size every day and if left unchecked will smother the pond in 30 days, killing all the other living things in the water. Day after day the plant seems small and so it is decided to leave it to grow until it half-covers the pond, before cutting it back. They are then asked, “On what day that will occur?” This is revealed to be the 29th day, and then there will be just one day to save the pond.
This story is more popular with the zero-growth movement than it is with free market economists. But the mathematics are the same. If anything grows at 100% per day, the day before the space fills up is the half-way mark physically. It is late in the process temporally.
Let us call this the day 29 phenomenon. It could be year 29 if the doubling date is a year. The point is this: people pay no attention to a compounding process until late in the process. The first half of the time period may go by, yet only a handful of specialists notice. The time period is linear; the growth process is exponential. We notice the time period, because it is what we are familiar with. Compound growth is not readily recognized.
Yet even the time period perceptually speeds up. The year from the day after Christmas until the next Christmas seems interminable for a young child. It does not seem so long for a grandparent. “You’ll be 30 before you know it,” my grandmother told me on my 25th birthday. I was 50 before I knew it.
A year is less and less of a fraction of our lifetime as we age. The numerator stays at one. The denominator gets larger.
“Where did the time go?” Just where our grandparents said it would go.
The combination of these two processes is important in any valid program of retirement. The earlier you plan to retire, the more crucial the combination is.
Ben Franklin wrote 250 years ago, “A child thinks that 20 pounds and 20 years can never be spent.” He wrote “pounds,” but he did not mean weight. (When you are 70, you revise this: “20 pounds can never be shed.”)
The speed at which 25 years flow by is one of life’s unpleasant surprises. This is why finding ways to gain compound rate of return is crucial. The younger you are when you discover this method, the sooner you can retire — the sooner that “year 29” arrives.
Years ago, Richard Russell wrote what became the most popular article he ever wrote. Russell is the grand master of financial newsletter writers. He has been at it for over 50 years. He is probably the most successful: lots of subscribers, nearly automatic renewals, and no advertising expenses. The article was on compound growth. He showed that a 10% rate of return, if attained early enough in life, produces an amazing result.
In order to emphasize the power of compounding, I am including this extraordinary study, courtesy of Market Logic, of Ft. Lauderdale, FL 33306. In this study we assume that investor (B) opens an IRA at age 19. For seven consecutive periods he puts $2,000 in his IRA at an average growth rate of 10% (7% interest plus growth). After seven years this fellow makes NO MORE contributions — he’s finished.
A second investor (A) makes no contributions until age 26 (this is the age when investor B was finished with his contributions). Then A continues faithfully to contribute $2,000 every year until he’s 65 (at the same theoretical 10% rate).
Now study the incredible results. B, who made his contributions earlier and who made only seven contributions, ends up with MORE money than A, who made 40 contributions but at a LATER TIME. The difference in the two is that B had seven more early years of compounding than A. Those seven early years were worth more than all of A’s 33 additional contributions.
It is not easy to make 10% per annum after taxes. But the numbers do not lie. Because of the power of compounding, the early starter reaps an advantage. Steady Eddie, if he is steady from age 19, is the winner.
People do not figure this out at age 19. So, they do not discipline themselves to get on board the compound growth train. The longer they wait, the more difficult it is to reach the destination.
2000-2011: BREAKING THE STREAK
On August 13, 1982, the Dow Jones Industrial Average bottomed at 777. It peaked in terms of purchasing power on January 14, 2000, at 11,723. Since that time, the dollar has depreciated by about a third.
The handful of stock investors who put 100% of their money in a no-load mutual fund did fabulously, 1982-2000. They saw riches ahead. But then the stock market faltered. The dot-com bust took it down. It has never regained its high point almost a dozen years ago.
Meanwhile, people who had great dreams for their golden years, and who got in early enough (1982), have had their hopes shattered. Why? Because of the fact that the compound rate of return ended in 2000. It reversed. But the investors got older.
They have experienced the double whammy: (1) the end of compound growth in stocks; and (2) the perception of accelerating time. They sense that the road to easy street is over. The rate of return of over 15% per annum, 1982-2000, has never returned. The faithful have hung on, but without benefits.
With short-term T-bill rates at approximately 0, and with 30-year T-bond rates at about 3%, high compound rates of return have disappeared. Even real estate reversed after 2006.
This has created a crisis. The prospective retirees who thought they could not be stopped in 2000 have been stopped. They are getting older. Their perception of accelerating time is inescapable. This is the warning that old people have been giving ever since the first generation turned gray.
The capital required to enable people to retire is melting away. The growth rate offers no hope. The Federal debt increases relentlessly. Capital flows into the government, not the private sector.
Investors keep pouring money into stocks in the vain hope that the Federal deficit will be overcome by economic growth. It won’t be. They have hope that capital markets can lose $1.3 trillion a year to the Federal government and still produce sustained growth. They are wrong. But if that capital-absorption pit can be closed, the 200-year-old process of compound growth can be restored.
The lily pads of economic growth have no known limit, unlike the lily pads on the lake. There are always limits in life. There is always scarcity. But the limits keep extending as we learn more and find better ways to serve each other. There are limits to growth, because there are still prices, but there are no known limits to growth.
The effects of capital investment, when coupled with the arrival of Asians into the growth zone of Western capitalism, offer us tremendous possibilities. We are 200 years into this compounding process. Doubling at 2% per annum takes 35 years. In a little more than a century, wealth will double, then double, then double again. The effects will be felt by billions of people.
The lily pad of wealth is facing a period of no growth or even contraction. This is because of the expansion of civil government and its concomitant debt. But debt can be abandoned through political action, and it will be.
ATLAS WILL EVENTUALLY SHRUG
Atlas will shrug. I do not mean the Atlas of Ayn Rand’s novel about a tiny band of heroic elite producers. I mean the Atlas of non-heroic taxpayers. They will say, “we’re stopping the gravy train,”
In Rand’s novel, society collapses when the tiny band of heroes of enterprise departs into their Happy Entrepreneurs’ Valley in the Rockies. They shrug; society collapses. But society is not what she envisioned. Its productivity comes from the decentralized efforts of billions of entrepreneurs. Hayek was right: this is the spontaneous order in action. It has little to do with heroic figures. It has mostly to do with common people finding ways to serve other common people. This is the division of labor.
The mark of social collapse in Atlas Shrugged is a train crash in a tunnel: the result of common men’s incompetence coupled with government regulation. Rand was dead wrong. The train that will end in the tunnel is the government’s gravy train.
The image of Atlas is wrong: a giant carrying the world on his shoulders. It should be a giant carrying two loads on his shoulder, one marked “customers” (right shoulder) and the other marked “geezers” (left shoulder). All he has to do to get solvent is to shrug his left shoulder.
Atlas will shrug one load: the aging dependents who have trusted governments’ promises. He will do this in order to carry better the load of serving paying customers. Serving customers is not often heroic. It is commonplace in a free society.
Atlas will shrug. He will send people to Congress who will vote to reduce the burden of fulfilling political promises of long-dead and recently retired politicians. The voters can reverse the giant sucking sound of government spending at any time. When the pain gets bad enough, Atlas will shrug.
THE RIVAL POLITICS OF GUILT AND PAIN
The welfare state is based on a misplaced sense of guilt. It is based on guilt-manipulation. Special-interest political groups persuade the government to provide them with bailouts when the free market would otherwise impose negative sanctions.
The bailouts are a way of life. Every recipient says his IOUs from the government are legitimate. They all say: “Stop the bailouts for them, and give us the money.” Modern politics is all about ratcheting up the bailouts and then campaigning for votes to get the funds transferred to different groups.
The reversal never comes. That’s because the pain has been deferred. How? By the compounding process. Atlas gets stronger because of the growth of capital.
Now that capital is flowing into the U.S. government at the rate of $1.3 trillion a year. The bursitis in his shoulders is increasing. The weight of the government’s burden is increasing. Atlas is leaning to the left. It is clear what he must do. He must cut the flow of funds to the government and keep them for himself. He cannot serve the customers and the IOU-holders much longer.
The IOU-holders are better organized politically than customers. But the IOU-holders face a threat: the IOUs to the banks, the military, and the oldsters are a far greater burden than promises made to everyone else. Voters will figure out that the ratchet must be reversed.
They do not see this yet. That is because they do not feel the pain. When the compounding process of free market production slows or reverses, while the compound growth of government IOUs accelerates, voters will figure out where their self-interest lies.
The Retirement dreams of most Americans will fade, because most Americans count on Social Security and Medicare to provide them with a comfortable retirement. They will find that this is not after Atlas — the broad mass of taxpayers and voters — at long last shrugs.
This may take a decade. It may take a bit longer. But it will come. Voters are not fools. They will figure out what that pain in their left arm is. They will figure out that they can relieve themselves of this pain, not with the cortisone of fiat money inflation, but by shrugging.
For those who are not yet retired, I recommend that you make other plans. Be a shrugger, not a shrugee.
November 16, 2011
Copyright © 2011 Gary North