Tag: Finance

12 Books Every Investor Should Read

If you’re looking for something to read that will improve your ability as an investor, I’d recommend any of the books below. All 12 of them are deeply informative and will leave an impact on you.

1. The Intelligent Investor by Benjamin Graham
Described as “by far the best book on investing ever written” by none other than Warren Buffett. “Chapters 8 and 20 have been the bedrock of my investing activities for more than 60 years,” he says. “I suggest that all investors read those chapters and reread them every time the market has been especially strong or weak.”

2. The Little Book that Beats the Market by Joel Greenblatt
As Buffett says, investing is simple but not easy. This book focuses on the simplicity of investing. Greenblatt, who has average annualized returns of about 40% for over 20 years, explains investing using 6th grade math and plain language. Putting it into practice is another story.

3. Fooled by Randomness by Nassim Taleb
The core of Taleb’s other books — The Black Swan and Antifragile — can be found in this early work. One of the best parts, for me, was the notion of alternative histories. “Mother Nature,” he writes, “does not tell you how many holes there are on the roulette table.” This book teaches you how to look at the world probabilistically. After you start doing that, nothing is ever the same again.

4. The Most Important Thing by Howard Marks
“This is a rarity,” Buffett writes of Howard Marks’ book, “a useful book.” More than teaching you the keys to successful investment, it will teach you about critical thinking.

5. Poor Charlie’s Almanack by Charlie Munger
Charlie Munger is perhaps the smartest man I don’t know. This book is a curated collection of his speeches and talks that can’t help but leave you smarter. Munger’s wit and wisdom come across on every page. This book will improve your thinking and decisions. It will also shine light upon psychological forces that make you a one-legged man in an ass-kicking contest. Read and re-read.

6. Common Stocks and Uncommon Profits by Philip Fisher
Buffett used to say that he was 85% Benjamin Graham and 15% Phil Fisher. That was a long time ago, the Buffett of today resembles more Fisher than Graham. Maybe there is something to buying and holding great companies.

7. The Dao of Capital by Mark Spitznagel
Spitznagel presents the methodology of Austrian Investing, where one looks for positional advantage. Nassim Taleb, commenting on the book wrote: “At last, a real book by a real risk-taking practitioner. You cannot afford not to read this!”

8. Buffett: The Making of an American Capitalist by Roger Lowenstein
This book, perhaps more than any other, has changed the lives of many of my friends and investors because this is how many of them first discovered Warren Buffett and value investing.

9. The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success
An outstanding book detailing eight extraordinary CEOs and the unconventional methods they used for capital allocation. One of them, Henry Singleton, had a unique view on strategic planning.

10. The Misbehavior of Markets: A Fractal View of Financial Turbulence by Benoit Mandelbrot
A critique of modern finance theories, which usually gets built on the underlying assumption that distributions are normal. Nassim Taleb calls this “the most realistic finance book ever published.”

11. Why Stocks Go Up (and Down) by William Pike
This is a basics book on the fundamentals of equity and bond investing – financial statements, cash flows, etc. A good place to start on the nuts and bolts. If you’re looking to learn accounting also check out The Accounting Game: Basic Accounting Fresh from the Lemonade Stand, I’m serious. This is the book I recommended to classmates in business school with no accounting background to get them up to speed quickly.

12. Bull: A History of the Boom and Bust, 1982-2004 by Maggie Mahar
The first and perhaps best book written on the market’s historic run, which started in 1982 and ended in the early 2000s. Mahar reminds readers that euphoria and blindness are a regular part of bull markets – lessons we should have learned from studying history.

Keep in mind that if investing were as easy as buying a book and reading it, we’d all be rich.

Charlie Munger: 20 Book Recommendations That will Make you Smarter

“In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time—none. Zero. You’d be amazed at how much Warren reads—and how much I read. My children laugh at me. They think I’m a book with a couple of legs sticking out.”
– Charlie Munger

That comment is what really kickstarted my own reading habits.

Munger, of course, is the billionaire business partner of Warren Buffett and the Vice Chairman at Berkshire Hathaway.

Not only is Munger one of the smartest people on the planet—his lecture on the psychology of human misjudgment is the best 45 minutes you might spend this year—but he’s put all of those brains to use in a practical way.

If you’re looking for a book to read, this list of books recommended by Munger is a great place to start.

***

1. Faraday, Maxwell, and the Electromagnetic Field: How Two Men Revolutionized Physics

It’s a combination of scientific biography and explanation of the physics, particularly relating to electricity. It’s just the best book of its kind I have ever read, and I just hugely enjoyed it. Couldn’t put it down. It was a fabulous human achievement. And neither of the writers is a physicist.

2. Deep Simplicity: Bringing Order to Chaos and Complexity

… it’s pretty hard to understand everything, but if you can’t understand it, you can always give it to a more intelligent friend.

3. Fiasco: The Inside Story of a Wall Street Trader
I remember reading this shocking book and thinking, holy shit. This book will make you sick.

4. Ice Age
Of this book Munger said: “(The) best work of science exposition and history that I’ve read in many years!”

5. How the Scots Invented the Modern World
A lot of really important stuff like: the first modern nation, the first literate society, the ideas for (modern) democracy and free markets, all originated with the Scots.

6. Models of My Life
An autobiography of Nobel laureate Herbert A. Simon, a remarkable polymath who more people should know about. In an age of increasing specialization, he’s a rare generalist — applying what he learned as a scientist to other aspects of his life. Crossing disciplines, he was at the intersection of “information sciences.” He won the Nobel for his theory of “bounded rationality,” and is perhaps best known for his insightful quote “A wealth of information creates a poverty of attention.” (Also part of five books that will change your life.)

7. A Matter of Degrees: What Temperature Reveals about the Past and Future of Our Species, Planet, and Universe

… a wide-ranging exploration of how the fundamental scientific concept of temperature is bound up with the very essence of both life and matter.

8. Andrew Carnegie
The definitive biography of an industrial genius, philanthropist, and enigma. At the meeting in May of this year, Munger also mentioned the Mellon Brothers as people to study.

9. Guns, Germs, and Steel: The Fates of Human Societies
A book recommended by Bill Gates and Charlie Munger? Gates said, the book “had a profound effect on the way I think about history and why certain societies advance faster than others.”

10. The Third Chimpanzee: The Evolution and Future of the Human Animal

What is it about that two percent difference in DNA that has created such a divergence between evolutionary cousins? … renowned Pulitzer Prize–winning author and scientist Jared Diamond explores how the extraordinary human animal, in a remarkably short time, developed the capacity to rule the world … and the means to irrevocably destroy it.

11. Influence: The Psychology of Persuasion
A frequent and persistent recommendation from Munger. I believe he’s given away more copies of this book than any other. Here is a quick overvie of influence.

12. Living within Limits: Ecology, Economics, and Population Taboos
While both books are exceptional, I actually prefer Hardin’s other book — Filters Against Folly.

13. The Selfish Gene

Dawkins explains how the selfish gene can also be a subtle gene. The world of the selfish gene revolves around savage competition, ruthless exploitation, and deceit, and yet, Dawkins argues, acts of apparent altruism do exist in nature. Bees, for example, will commit suicide when they sting to protect the hive, and birds will risk their lives to warn the flock of an approaching hawk.

14. Titan: The Life of John D. Rockefeller, Sr.
At 800 or so pages this is the perfect book for a week-long vacation. From humble beginnings to the height of great power Rockefeller did it all. I think you’ll find he has more in common with Marcus Aurelius than today’s billionaires.

Born the son of a flamboyant, bigamous snake-oil salesman and a pious, straitlaced mother, Rockefeller rose from rustic origins to become the world’s richest man by creating America’s most powerful and feared monopoly, Standard Oil. Branded “the Octopus” by legions of muckrakers, the trust refined and marketed nearly 90 percent of the oil produced in America.

15. The Wealth and Poverty of Nations: Why Some Are So Rich and Some So Poor
A best-selling exploration of why some nations achieve economic success while others don’t. As you can imagine, it’s complicated.

16. The Warren Buffett Portfolio: Mastering the Power of the Focus Investment Strategy
This book has been recommended by both Buffett and Munger on a few occasions.

17. Genome: The Autobiography of a Species in 23 Chapters
Science writer Matt Ridely unfolds the genome for us. Munger recommended in 2001.

18. Getting to Yes: Negotiating Agreement Without Giving In
The book is one of the primary business texts in North America. So it shouldn’t surprise you that I was first introduced to this as part of my MBA program.

19. Three Scientists and Their Gods: Looking for Meaning in an Age of Information
What is the meaning of life? This book takes a look at the work and beliefs of three leading American scientists: Edward Fredkin, Edward O. Wilson and Kenneth Boulding.

20. Only the Paranoid Survive: How to Exploit the Crisis Points That Challenge Every Company
Grove gives us an inside account of how he, virtually overnight, changed the path of Intel forever.

***

Of course this is a condensed list of his recommendations. Consider this a look at one of Munger’s many bookshelves. For another shelf, see 19 More Book Recommendations from Charlie Munger.

Two other books that might interest you are Damn Right!: Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger and, one of my all time personal favorites, Seeking Wisdom: From Darwin to Munger.

And before you email me to tell me how expensive some of these books are consider this: ignorance is more expensive.

Follow your curiosity to Adding Mental Models to Your Mind’s Toolbox.

Benoit Mandelbrot — The Fractalist: Memoir of a Scientific Maverick

“I have never done anything like others,” Benoit Mandelbrot (1924-2010) once said.

That statement is proven time and time again in his autobiography: The Fractalist.

Mandelbrot is independent almost to a fault, his book an interesting memoir from the man who revitalized visual geometry, and whose ideas about fractals have changed how we look at physics, engineering, arts, medicine, finance, and biology.

Nearly all common patterns in nature are rough. They have aspects that are exquisitely irregular and fragmented—not merely more elaborate than the marvelous ancient geometry of Euclid but of massively greater complexity. For centuries, the very idea of measuring roughness was an idle dream. This is one of the dreams to which I have devoted my entire scientific life.

Let me introduce myself. A scientific warrior of sorts, and an old man now, I have written a great deal but never acquired a predictable audience. So, in this memoir, please allow me to tell you who I think I am and how I came to labor for so many years on the first-ever theory of roughness and was rewarded by watching it transform itself into an aspect of a theory of beauty.

Mandelbrot was full of insight.

What shape is a mountain, a coastline, a river or a dividing line between two river watersheds? … Clouds are not spheres, mountains are not cones, coastlines are not circles, and bark is not smooth, nor does lightning travel in a straight line.

While that sounds obvious it wasn’t at the time. In showing that triangles, squares, and circles are more prevalent in textbooks than reality, he brought to life the discipline now known as fractal geometry, a general theory of “roughness.”

Mandelbrot was fascinating, in part, because he never stayed in one place very long.

An acquaintance of mine was a forceful dean at a major university. One day, as our paths crossed in a busy corridor, he stopped to make a comment I never forgot: “You are doing very well, yet you are taking a lonely and hard path. You keep running from field to field, leading an unpredictable life, never settling down to enjoy what you have accomplished. A rolling stone gathers no moss, and—behind your back—people call you completely crazy. But I don’t think you are crazy at all, and you must continue what you are doing. For a thinking person, the most serious mental illness is not being sure of who you are. This is a problem you do not suffer from. You never need to reinvent yourself to fit changes in circumstances; you just move on. In that respect, you are the sanest person among us.”

Quietly, I responded that I was not running from field to field, but rather working on a theory of roughness. I was not a man with a big hammer to whom every problem looked like a nail. Were his words meant to compliment or merely to reassure? I soon found out: he was promoting me for a major award.

Is mental health compatible with being possessed by barely contained restlessness? In Dante’s Divine Comedy, the deceased sentenced to eternal searching are pushed to the deepest level of the Inferno. But for me, an eternal search across countless scientific fields beyond obvious connection managed to add up to a happy life. A rolling stone perhaps, but not an unresponsive one. Overactive and self-motivated, I loved to roll along, stopping to listen and preach in lay monasteries of all kinds—some splendid and proud, others forsaken and out of the way.

He had a different way of looking at things. For example, he saw math problems as geometry.

I would raise my hand and describe my findings: “Monsieur, I see an obvious geometric solution.” I quickly grasped the most abstract problem that the teacher could contrive. And then — with no effort, conscious search, or delay — I continued along a path that somehow avoided every difficulty…. I managed to be examined on the basis of speed and good taste in, first, translating algebra back into geometry, and then thinking in terms of geometric shapes. My analytic skills remained so-so, but that did not matter — the hard work was done by geometry, and it sufficed to fill in short calculations that even I could manage.

Ultimately, The Fractalist is proof that “force of character and independence” can take some to great heights.

Michael Mauboussin’s Behavioral Economics Reading List

Michael Mauboussin is one of the smartest people you’ll ever meet. Need proof? Just listen to this podcast interview we did.

If you’re looking to learn about behavioral economics, he recommends you start with the following books and articles.

Books

1. Thinking, Fast and Slow by Daniel Kahneman
Comment: A sweeping review of the work of the greatest psychologist of the past half-century.

2. Judgment in Managerial Decision Making — Seventh Edition by Max H. Bazerman
Comment: A great source for heuristics and biases

3. Expert Political Judgment by Philip Tetlock
Comment: Are you still listening to expert prognosticators? A devastating, empirical study of how bad expert predictions are in complex realms.

4. The Halo Effect by Phil Rosenzweig
Comment: Lots of lessons in 175 pages–you’ll never look at the world the same way after reading this one.

5. The Winner’s Curse by Richard Thaler
Comment: The contents are the foundation of what we call behavioral finance.

Recommended Articles

1. On the Psychology of Prediction by Daniel Kahneman and Amos Tversky (Psychological Review, Vol. 80, No. 4, July 1973, 237-251)
Comment: Kahneman said this was his favorite paper. This explains the inside-outside view.

2. Prospect Theory: An Analysis of Decision Under Risk by Daniel Kahneman and Amos Tversky (Econometrica, Vol. 72, No. 2, March 1979, 263-292)
Comment: A clear and compelling discussion of how behavior varies from what utility theory predicts.

3. A Survey of Behavioral Finance by Nicholas C. Barberis and Richard H. Thaler (in George Constantinides, Milton Harris, and Rene Stulz, eds.Handbook of Economics of Finance: Volume 1B, Financial Markets and Asset Pricing, Elsevier North Holland, Chapter 18, 1053-1128)
Comment: Exactly as advertised–what you need to know about behavioral finance in one place.

4. Conditions for Intuitive Expertise: A Failure to Disagree by Daniel Kahneman and Gary Klein (American Psychologist, Vol. 64, No. 6, September 2009, 515-536)
Comment: We overestimate the abilities of experts. But they do work in certain settings. This explains when you can trust an expert.

5. Hindsight ≠ Foresight: The Effect of Outcome Knowledge on Judgment Under Uncertainty by Baruch Fischhoff (Journal of Experimental Psychology: Human Perception and Performance, Vol. 1, No. 3, August 1975, 288-299)
Comment: Hindsight bias and creeping determinism. Big problems.


Read Next

The Ultimate Behavioral Economics Reading List

Seth Klarman: The Forgotten Lessons of 2008

In this excerpt from his annual letter, investing great Seth Klarman describes 20 lessons from the financial crisis which, he says, “were either never learned or else were immediately forgotten by most market participants.”

* * *

The Forgotten Lessons of 2008

One might have expected that the near-death experience of most investors in 2008 would generate valuable lessons for the future. We all know about the “depression mentality” of our parents and grandparents who lived through the Great Depression. Memories of tough times colored their behavior for more than a generation, leading to limited risk taking and a sustainable base for healthy growth. Yet one year after the 2008 collapse, investors have returned to shockingly speculative behavior. One state investment board recently adopted a plan to leverage its portfolio – specifically its government and high-grade bond holdings – in an amount that could grow to 20% of its assets over the next three years. No one who was paying attention in 2008 would possibly think this is a good idea.

Below, we highlight the lessons that we believe could and should have been learned from the turmoil of 2008. Some of them are unique to the 2008 melt- down; others, which could have been drawn from general market observation over the past several decades, were certainly reinforced last year. Shockingly, virtually all of these lessons were either never learned or else were immediately forgotten by most market participants.

Twenty Investment Lessons of 2008

  1. Things that have never happened before are bound to occur with some regularity. You must always be prepared for the unexpected, including sudden, sharp downward swings in markets and the economy. Whatever adverse scenario you can contemplate, reality can be far worse.
  2. When excesses such as lax lending standards become widespread and persist for some time, people are lulled into a false sense of security, creating an even more dangerous situation. In some cases, excesses migrate beyond regional or national borders, raising the ante for investors and governments. These excesses will eventually end, triggering a crisis at least in proportion to the degree of the excesses. Correlations between asset classes may be surprisingly high when leverage rapidly unwinds.
  3. Nowhere does it say that investors should strive to make every last dollar of potential profit; consideration of risk must never take a backseat to return. Conservative positioning entering a crisis is crucial: it enables one to maintain long-term oriented, clear thinking, and to focus on new opportunities while others are distracted or even forced to sell. Portfolio hedges must be in place before a crisis hits. One cannot reliably or affordably increase or replace hedges that are rolling off during a financial crisis.
  4. Risk is not inherent in an investment; it is always relative to the price paid. Uncertainty is not the same as risk. Indeed, when great uncertainty – such as in the fall of 2008 – drives securities prices to especially low levels, they often become less risky investments.
  5. Do not trust financial market risk models. Reality is always too complex to be accurately modeled. Attention to risk must be a 24/7/365 obsession, with people – not computers – assessing and reassessing the risk environment in real time. Despite the predilection of some analysts to model the financial markets using sophisticated mathematics, the markets are governed by behavioral science, not physical science.
  6. Do not accept principal risk while investing short-term cash: the greedy effort to earn a few extra basis points of yield inevitably leads to the incurrence of greater risk, which increases the likelihood of losses and severe illiquidity at precisely the moment when cash is needed to cover expenses, to meet commitments, or to make compelling long-term investments.
  7. The latest trade of a security creates a dangerous illusion that its market price approximates its true value. This mirage is especially dangerous during periods of market exuberance. The concept of “private market value” as an anchor to the proper valuation of a business can also be greatly skewed during ebullient times and should always be considered with a healthy degree of skepticism.
  8. A broad and flexible investment approach is essential during a crisis. Opportunities can be vast, ephemeral, and dispersed through various sectors and markets. Rigid silos can be an enormous disadvantage at such times.
  9. You must buy on the way down. There is far more volume on the way down than on the way back up, and far less competition among buyers. It is almost always better to be too early than too late, but you must be prepared for price markdowns on what you buy.
  10. Financial innovation can be highly dangerous, though almost no one will tell you this. New financial products are typically created for sunny days and are almost never stress-tested for stormy weather. Securitization is an area that almost perfectly fits this description; markets for securitized assets such as subprime mortgages completely collapsed in 2008 and have not fully recovered. Ironically, the government is eager to restore the securitization markets back to their pre-collapse stature.
  11. Ratings agencies are highly conflicted, unimaginative dupes. They are blissfully unaware of adverse selection and moral hazard. Investors should never trust them.
  12. Be sure that you are well compensated for illiquidity – especially illiquidity without control – because it can create particularly high opportunity costs.
  13. At equal returns, public investments are generally superior to private investments not only because they are more liquid but also because amidst distress, public markets are more likely than private ones to offer attractive opportunities to average down.
  14. Beware leverage in all its forms. Borrowers – individual, corporate, or government – should always match fund their liabilities against the duration of their assets. Borrowers must always remember that capital markets can be extremely fickle, and that it is never safe to assume a maturing loan can be rolled over. Even if you are unleveraged, the leverage employed by others can drive dramatic price and valuation swings; sudden unavailability of leverage in the economy may trigger an economic downturn.
  15. Many LBOs are man-made disasters. When the price paid is excessive, the equity portion of an LBO is really an out-of-the-money call option. Many fiduciaries placed large amounts of the capital under their stewardship into such options in 2006 and 2007.
  16. Financial stocks are particularly risky. Banking, in particular, is a highly lever- aged, extremely competitive, and challenging business. A major European bank recently announced the goal of achieving a 20% return on equity (ROE) within several years. Unfortunately, ROE is highly dependent on absolute yields, yield spreads, maintaining adequate loan loss reserves, and the amount of leverage used. What is the bank’s management to do if it cannot readily get to 20%? Leverage up? Hold riskier assets? Ignore the risk of loss? In some ways, for a major financial institution even to have a ROE goal is to court disaster.
  17. Having clients with a long-term orientation is crucial. Nothing else is as important to the success of an investment firm.
  18. When a government official says a problem has been “contained,” pay no attention.
  19. The government – the ultimate short- term-oriented player – cannot with- stand much pain in the economy or the financial markets. Bailouts and rescues are likely to occur, though not with sufficient predictability for investors to comfortably take advantage. The government will take enormous risks in such interventions, especially if the expenses can be conveniently deferred to the future. Some of the price-tag is in the form of back- stops and guarantees, whose cost is almost impossible to determine.
  20. Almost no one will accept responsibility for his or her role in precipitating a crisis: not leveraged speculators, not willfully blind leaders of financial institutions, and certainly not regulators, government officials, ratings agencies or politicians.

Below, we itemize some of the quite different lessons investors seem to have learned as of late 2009 – false lessons, we believe. To not only learn but also effectively implement investment lessons requires a disciplined, often contrary, and long-term-oriented investment approach. It requires a resolute focus on risk aversion rather than maximizing immediate returns, as well as an understanding of history, a sense of financial market cycles, and, at times, extraordinary patience.

False Lessons

  1. There are no long-term lessons – ever.
  2. Bad things happen, but really bad things do not. Do buy the dips, especially the lowest quality securities when they come under pressure, because declines will quickly be reversed.
  3. There is no amount of bad news that the markets cannot see past.
  4. If you’ve just stared into the abyss, quickly forget it: the lessons of history can only hold you back.
  5. Excess capacity in people, machines, or property will be quickly absorbed.
  6. Markets need not be in sync with one another. Simultaneously, the bond market can be priced for sustained tough times, the equity market for a strong recovery, and gold for high inflation. Such an apparent disconnect is indefinitely sustainable.
  7. In a crisis, stocks of financial companies are great investments, because the tide is bound to turn. Massive losses on bad loans and soured investments are irrelevant to value; improving trends and future prospects are what matter, regardless of whether profits will have to be used to cover loan losses and equity shortfalls for years to come.
  8. The government can reasonably rely on debt ratings when it forms programs to lend money to buyers of otherwise unattractive debt instruments.
  9. The government can indefinitely control both short-term and long-term interest rates.
  10. The government can always rescue the markets or interfere with contract law whenever it deems convenient with little or no apparent cost. (Investors believe this now and, worse still, the government believes it as well. We are probably doomed to a lasting legacy of government tampering with financial markets and the economy, which is likely to create the mother of all moral hazards. The government is blissfully unaware of the wisdom of Friedrich Hayek: “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”)

***

Still curious? Check out Basically, It’s Over: A Parable About How One Nation Came To Financial Ruin by Charlie Munger.

Basically, It’s Over: A Parable About How One Nation Came To Financial Ruin

An excellent parable by Charlie Munger on how one nation came to financial ruin.

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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