Blinded Rationality

In the journey of life, individuals often happen to be at a point from where they have to choose a path from among many paths laid before them. Once they choose a particular path, the other paths are automatically closed and never be available to them in their life. The individuals think that their chosen path is better than other paths and start believing that is the right path for them. However, in reality, there is a chance that one of the other paths could have been a better one. The irony is the other path cannot be seen or experienced unless it is chosen. This other path can only be visualized or imagined and the individuals visualize the other path as less favorable than the chosen path. I call this situation ‘blinded rationality’ because their choice is rational but blinded by the limitation explained above.

Understanding this concept is important because we as individuals, organization, or institution take decisions for self or group or for public to achieve a certain goal. Even the chosen path has inherent problems and opportunities. Each chosen path has multiple lanes and each lane leads us to different destinations. We reach different destinations depending upon how we manage our problems and opportunities. For example, what could have been the state of the U.S. economy had they chosen some ‘X’ as their President instead of President Trump? What could have been the state of the economies of other countries or regions? It could have been better or worse but we would never be able to see that. The world under ‘X’ would have been different with its inherent problems and opportunities. Those problems and opportunities might have been managed with different policy decisions. Consequently, it might have led us to a different destination, a destination that can only be imagined or visualized. No one can prove that. It can best be only in our mind or in a paper.

Another setting example is the Indian stock market. India’s growth rate was around 8% from 2014-2016. Since then it has never seen the previous level though it is growing at or above the Hindu rate of growth. However, the Indian stock market has climbed to its historical peak recently. The stock market community was in jubilation and celebrated the achievement. Skeptics questioned in the media why the stock market is climbing while India has been registering less growth rate in the last 2 years. Let us see the BSE Sensex from 2014-2020. The highest Sensex numbers from 2014 to 2020 are 27739, 28044, 27714, 32683, 37128, 38460, and 40478 respectively. In the first 3 years, the index has not grown. It has been stagnant though India has been registering 8% growth rate. The Sensex has grown more than 15% though India’s growth rate was less than 8%. In the following year, the Sensex has again grown around 15% though India registered a growth rate less than the previous year. In the last 2 years, the Sensex registered less than 5% though Indian economy registered more than 5% growth rate. The recent peak was actually overdue. If we do a bit of math multiplying 27739 with India’s growth rate in the said period, we almost reach 40000 level. This peak is normal in accordance with India’s growth rate. However, people look at this figure differently. Some think that it is irrational exuberance. Some others think that the Sensex should have reached 45000 had the growth rate for the last 3 years been around 8% or more. What is real is 40000 due to our chosen path. The 45000 or 50000 is only in our mind or in paper because the other paths are closed as a path was chosen with some rational thinking. However, 45000 or 50000 was not improbable. We cannot just prove that because of human limitation. We cannot see simultaneously different worlds.

Author: Mathivanan Palraj.

Is John Rawls’ ‘beneficial inequality’ possible?

Inequality

According to John Rawls of the United States, inequalities-either social or economic-are only to be allowed if the worst off will be better off than they might be under an equal distribution. This is precisely the meaning of beneficial inequality. Is ‘beneficial inequality possible, plausible, and practicable at the aggregate level? The following example elucidates that  the application of this principle and judgement of results thereafter to a particular economy is humanly impossible. Consider,

Scheme A: Inequality(benefits are distributed unequally)

Scheme B: Equality(benefits are distributed equally)

To illustrate, let there be 5 persons and total benefits be 100.

In scheme A, the benefits are distributed as: 22, 21, 20, 19, 18. The sum of total benefits is 100 units. The worst off person gets benefits equal to 18 units.

In scheme B, the benefits are distributed as: 20, 20, 20, 20, 20. The sum is again 100 units. Here, everyone gets benefits equal to 20 units.

The worst off person in scheme A is no better off than in scheme B. Scheme B is advantageous for the worst off person of scheme A. Instead, in scheme B, if the State distributes benefits as: 17, 17, 17, 17, 17, taking away 15 units from 100 units, then scheme A is constructed, and construed as advantageous for the worst off person. Therefore, without the State’s intervention, beneficial inequality is not possible.

Or, keeping 100 units as constant in scheme B, the distribution in scheme A should have been: 25, 24, 23, 22, 21, in order to support the principle. In that case, the total benefits in scheme A has to be inflated to 115 units. This will not happen simultaneously unless the State print additional currency worth 15 units. Economists and the Central Bank will question the monetary policy.

We observe from the above example that the two schemes cannot be executed simultaneously.  They are two different worlds that cannot exist together. It might be possible in different dimensions that we humans can conceive but cannot perceive. On temporal consideration, however, it can exist at different time periods or regions. Yet, there are practical difficulties in assessing the results of the two schemes. It is obvious that the two schemes operate on different frameworks, each is built with different systems inherent to its nature.

Hence, comparing an economy in two different frameworks that are real is improbable. Only one world exists at a time that can be experienced. Once we opt for a world, the other worlds are automatically closed.

 

 

The Economic Crisis was Not an Economic One

economic crisis

The economic crisis of 2007 was not an economic one. Why?

The inflation adjusted US housing price index in 1900 was close to 102 (Base year 1890, 100). In 2000, it was 120, and in 2007 it was close to 195. From 1890 to 1990 (100 years), the percentage increase was 25%. From 2000 to 2007 (7 years), it was a whopping 62.5% (Source: Observations, Saturday, July 23, 2011).

For 100 years, the framework in people’s mind was an average annual price growth of 0.25% for housing. All of a sudden, people’s framework of housing price growth changed phenomenally. What was the cause? It was nothing but financial innovation and a conducive environment.

Is financial innovation bad? Consider this. More than 60% of Americans own a house. The remaining 40% of Americans need a house. This is a huge opportunity in the housing industry. We need to build a lot of houses and we need fund for this. Who will finance a huge amount to this housing sector? Neoliberalism does not allow the government to take an active role of this social benefit. The free market forces will find a way to solve this housing problem. In deed! The free market forces found a way.

The total asset value of houses (Single family owning a house) in US was about $20 trillion in 2000. These assets are not productive except that it meets the cost of staying in a house. If you own a house you don’t need to pay rent. If not it costs you a rent. These assets are investments made in the past. What if these house owners are encouraged to build houses for the rest of 40% Americans who do not own a house? Great idea. The house owners can be financed taking the collateral security of their houses. In turn, the house owners can build a second home that can be rented out. As there is huge demand for houses, the asset price will continue to increase. In addition to house rent, the second home will also produce capital gains for the owner. A safe bet for the financial institutions.

Besides, there are other positive aspects for the US economy. Demand for raw materials, capital goods, and labor will place the economy in robust growth. Wage increase will improve income level and purchasing power. In turn, consumption will increase resulting in higher GDP. This really sounds good. Then what went wrong?

It is the greed of financial institutions and some people. The financial innovation was not executed prudently. Loans were sanctioned on bad assets and these bad assets were clubbed with good assets (Securitisation, another financial innovation) in order to get more funds from other higher financial institutions in the hierarchy. The higher financial institutions did not scrutinize the securities. Hedge funds were brought into the game to avoid risks (yet another financial innovation). All these unscrupulous financing happened just to make more profits while the Sun is shining. The Sun was shining but a volcano erupted and spewed dirt that screened the Sun. The edifice built by the financial innovations collapsed. The weak pillars could not withstand the huge load.

Once you start feeding you should not break it before the task is completed. In case of housing loans, the repayment period is very long. People need income continually in order to repay the loans. Otherwise, the loans will require liquidation. The bubble bursts and asset prices come down drastically that deteriorates liquidation process. This is what happened once you stopped feeding. Greed screens prudence.

Disbelief is one important factor that put the break on feeding. A mere 25% growth of asset price over a period of 100 years from 1890 to 1990 had changed to around 62.5% from 2000 to 2007 over a period of just 7 years. Suddenly, people realized that this growth is unbelievable. How long will it go?

Secondly, the wage growth of the 40% American who do not own house was not matching with the asset price growth of 62.5% from 2000 to 2007. Let us see some data: From 1948 to 1973, the productivity was up at 96.7% while the hourly compensation was up at 91.3% for the same period. However, from 1973 to 2013, the productivity was up at 74.4% while the hourly compensation was up at a mere 9.2% for the same period (Automation could be the reason behind that, added by author). Source: EPI analysis of Bureau of Labor Statistics and Bureau of Economic Analysis of data.

That means the wage growth was absolutely not changing and it was stagnating for quite a long period (40 years!). To whom the new houses are built? The newly built houses are just show-pieces, owned by the rich.

Thirdly, the shelter costs have been increasing faster than the costs of other items. Shelter is considered a minimal human need, along with food and other consumer items. Median monthly housing costs, which include utility costs, have increased by 128%, from $348 in 1985 to $793 in 2005 (Source: U.S. Department of Housing and Urban Development Office of Policy Development and Research). While wage is almost stagnating, the shelter costs increased by 128%. That means people reduced their expenditure on food and other consumer items in order to pay the increased shelter costs. When 40% of Americans reduce an expenditure of $445 monthly on food and other consumer items, what is expected to happen? Recession.

Conclusion:

The economic crisis was just one of the dimensions of social order. While the American Social Structure (groups, strata and class, as well as the system of relations between them) provided an opportunity to build numerous houses to the 40% of Americans who do not own a house, the interactions between the sub-structures were not in order. While the American people have not yet completely shifted their mindset (framework) from the past, unbelievable asset price increase instilled doubt in their mind and in the institutions. The crisis within the institutions was another dimension that was not in order. Demography is another dimension which is undergoing severe crisis currently.

Why are Fat People Fat?

fat man

Yesterday, I traveled in a public transport bus. There were a few seats available. Three vacant seats, one in a two-seat and one each in the other two three-seat, were available to me. They were not bucket seats. The two persons in the three-seat were sitting at the extreme seats comfortably. They never bothered me. When I approached, they offered me the middle seat. But it was quite difficult to get into the middle seat. I had to physically disturb them to get into the middle seat. They were not ready to get up and ease my going to the middle seat.

They were ready to get disturbed. However, I decided not to disturb them. Instead, I opted to take the one in the two-seat. In that case, I don’t need to disturb anybody. But the person in the two-seat was really a big fat boy. He was keeping his two legs so wide that only 20% of seating area was available to me. I decided to take that seat. The boy did not bother to adjust for my comfort. He was playing with his cell-phone. He bought only one ticket. I also bought one ticket. However, he boarded the bus before I.

Bus fare is not charged according to a person’s weight. Why? I was thinking to find a solution for this problem while traveling the rest of my journey. Finally, I realized that this problem is a complexity. If a rule comes into force that bus fare should be collected according to the weight of a person, then that rule will benefit only the bus owners because the thin and lean persons will be charged the same old fare while the fat persons will be charged more and that extra amount goes straight into bus owners’ pocket. Therefore, people don’t bother to raise this issue. Consequently, the thin and lean continue to suffer. It’s at the sacrifice of the thin and lean that the fat is enjoying.

Why is the problem a complexity? There are practical problems. How do you weigh a person before they board the bus? Even if a weighing machine is available, it will take extra time to weigh a person and a calculator to calculate a fare proportion to their weight. Busy buses cannot do this.  Assuming that this is done, how do you seat them so that all passengers are seated proportionate to their fare and weight? Ultimately, the bus needs AI to allocate seats to optimize maximum number of persons in order to get maximum profit. Execution of this rule involves a cost. That will be again collected from the passengers. One simple solution, though not perfect, is to have bucket seats for all buses. But again you have to pay more for this comfort and this will be collected equally from all passengers fat or thin. In any case the thin and lean is not benefited financially.

A similar situation exists in middle class restaurants. A complete meal is priced at a fixed cost. Whatever quantity you eat you pay the same price. The fat eats more but pays the same price. The fat eats more at the cost of the thin and lean. Why does it happen perpetually? Why is the check not proportionate to quantity you eat? The lean becomes leaner and the fat becomes fatter. It seems it’s good to be fat.

In upper class restaurants you pay according to what you order but you pay more in such restaurants. The thin and lean have no choice but pay more. The restaurants are deliberately doing this in order to get more fat customers. If they increase the price the fat customers are not happy and the restaurants will lose many customers. In order to satisfy the fat customers they take something from the thin and lean and give it to fat. There is no other choice for the thin. The restaurants don’t lose the thin customers. The restaurants optimize their profit at the cost of the thin and lean. It’s taxing the thin and lean.

Why Inflation Hurts the Aged the Maximum

pexels-photo-320442

There is a convincing reason for the aged to work even after retirement from work in certain countries especially if their retirement benefits are not large enough and inflation is more than the optimum level. Inflation at best captures average price of a predetermined basket of goods. Individuals, however, have different preferences for goods. Even if inflation is kept at the optimum level, it might affect certain people unfavorably if their preferences for goods are on the wrong side. For example, if a retiree just makes both the ends, an increase in house rent of $20 per month, will force the retiree to cut his consumption of preferred goods or to find alternative residence. In both the cases, the retiree forgoes satisfaction by reducing usual consumption considering the logistic cost involved in shifting the residence. On the aggregate level, it is negative for the economy. As inequality in many advanced and developing countries widens more and more in recent times, a favorable social benefit policy is imperative. This also calls for attention to early financial planning before retirement, failing which a person’s retirement life will be in jeopardy. Financial education is in the interest of the State rather than its citizens.

The best social benefit that a central bank and a government can provide to people is controlling inflation and keeping it at an optimum level. The following data best depicts the financial pressure due to inflation that is higher than optimum level.

Suppose, your monthly expenditure is $5000 at present cost. If you are retiring after 24 years, then what will be your monthly income requirement? It depends upon where you are living, and who your central bank is.

  • If your central bank is keeping the inflation at 2%, then your monthly requirement will be $8040, after 24 years.
  • If your central bank is keeping the inflation at 3%, then your monthly requirement will be $10145, after 24 years.
  • If your central bank is keeping the inflation at 4%, then your monthly requirement will be $12795, after 24 years.
  • If your central bank is keeping the inflation at 5%, then your monthly requirement will be $16120, after 24 years.
  • If your central bank is keeping the inflation at 6%, then your monthly requirement will be $20240, after 24 years.
  • @7% your monthly requirement will be $25385.
  • @8% your monthly requirement will be $31665.
  • @9% your monthly requirement will be $39500.
  • @10% your monthly requirement will be $49270.

If you have any specific goal such as buying a home at your retirement, then you will have to look for inflation index of home. If you can buy a home for $100,000 today it will cost you $1 million after 24 years at 10% inflation. It is impossible for a person who just makes both the ends. Everyone needs surplus income and the surplus income has to be invested intelligently.

Top 6 in Foreign Reserves

FX

1. China ($3181 billion)

2. Saudi Arabia ($496.4 billion)

3. Taiwan ($451.5 billion)

4. Russia ($447.7 billion)

5. Hong Kong ($431.4 billion)

6. India ($417.8 billion)

How to become Rich While You are Young

rich persons

I would like to edit the topic question: How can I get rich on my own while I am still young? One can get rich through inheritance as well. Therefore, I’m not considering inherited wealth. How do you create wealth on your own? It’s not easy. You will have to work really hard. If luck favors, you will be rich sooner. Luck, I mean favorable conditions.

The difficult part: The rule of compound rate of growth and the initial point of your trajectory.

Zero never gives you growth. Whatever the rate of growth you apply zero always remains zero. First, you have to enter into the positive zone. The initial amount is the biggest impact on your wealth. Therefore, you have to earn this big initial amount at the earliest. For example, you invest $1 at a compound rate of 10%, approximately after 14 years it will become $4, at the end of 21.5 years it will become $8. You will be rich by $8. At the same time, if your initial investment is $1,000,000, you will get $8,000,000 at the end of 21.5 years at 10% compound rate (800% of initial investment). The co-ordinate point from where your trajectory takes place is very important.

Wise investment will make you rich:

If you are able to get a higher rate of growth you will get rich sooner. In the previous example we considered only 10% compounded growth. In fact, you can get higher rate if you invest your money wisely. When I was young I invested in a mutual fund (tax scheme, lock-in period of 3 years) an amount of $5000 in order to get tax relief. After 3 years, the NAV was 500% of the initial offer price. I got $25,000. Had I invested more on this investment I would have been rich at 28. That was a favorable time in life. It’s rare in life. You may get this kind of favorable conditions 3 or 4 times in your life. 3 or 4, because you missed some in the past and you might miss some more in the future. Identifying such conditions is the key to become rich. In general, young people will miss out the first chance or even more as I missed. You will miss out early chances if your mind is engaged in non-financial activities. Only experience will teach you.

Short term investments will not make you richer:

Time is another important deciding factor. Accumulation takes its own time. Time and higher rate of compounded growth rate will make you rich. If you want to be rich in 7 years, then the growth rate has to be much higher. If your target is $ 1,000,000,000 and now you have only $100, then every year it has to grow 10 times in order to reach your target. That is an extraordinary growth rate. So it is quite difficult to become a billionaire with an investment of $100. The probability is very, very low. Therefore, don’t set an unrealistic target. Allow time to accumulate your wealth.

People surrounding you is another important factor:

99% of the people surrounding you will make you to spend your money. My dad asked me money to invest in plantain crop. I gave him the money he asked for. After 1 year he told me that the entire plantain crop was flattened by the monsoon wind. The return he got was zero. My money was also gone in the wind.

My uncle advised me to buy a car when I was 25. I did not have enough money to buy a car. I had to borrow money. I would have got a bank loan easily. Somehow, I postponed the idea of buying a car at that time which was really an unwanted thing. That decision was good and made me richer now.

One of my neighbors was ready to sell his house and offered me a price. I did not have money at that time. I had only half of the money. I would have got a bank loan for the remaining amount. Somehow, I declined the offer. That was really, really a bad decision I made in my life. That investment would have fetched me 100000% profit by now. This is another favorable condition that I missed out.

Do no invest in stock market without learning the basics

Once I bought 100 share of a company(IT). Each share costed me 1200. Within 6 months, the market price reached 3600. I did not sell it thinking that it was a value stock. I decided to hold long. The next month, it started coming down due to some head wind. The entire stock market was nose diving. My stock reached to the bottom of issued price of 40 or 45. I lost all my money. Yet, I did not sell it because there was nothing to lose more. I waited, and waited for 7 years patiently to see the price going up to 85. During this period, the company had been correcting and consolidating its market share. I bought more shares of the same company. After 10 years, now it is trading at its previous peak.

Another stock that I invested along with the above mentioned at around 45 had not climbed even to 100 in the initial 10 year period. In the next 3 years, it climbed to 250. In the following 3 years, it crossed 1000 and now trading at around 1500.

Yet, there are other stocks that had never been able to raise their head after the collapse.

This is how stocks behave in the market. There are reasons why they behave so. You have to learn the basics.

My advice is a mindful living. Study your surroundings and look for favorable conditions. Invest time and money to improve yourself which will always help you. One favorable condition is enough to make you rich. Be mindful. Don’t miss it.