Home > Economic Musings, Economics, Economy, Finance, Gold, Inflation, Money, War > Economic Musings IX: We could all be millionaires …

Economic Musings IX: We could all be millionaires …

… if we hadn’t destroyed literally trillions over the last 200 years!

(See statistical material in our References section!)

As a child when I would put some small change into my piggy bank I always wondered: if I kept adding to my funds constantly, however little, wouldn’t they be likely to grow? Why would there ever be an end to it? And if my parents had done so and their parents … and if I later as a parent would bequeath my children (who by that time would already also have their own well-lined piggy banks …) with what I had not spent during my lifetime … then why was there so much poverty and why did even hard-working people and double-income households often have such a hard time “to make ends meet”? (One quip I liked went: “Why is there so much month left over at the end of the money?”)

Not very long after beginning to save with my little piggy bank did I realise there even was such a thing as “interest” and if I put my money into the bank not only would I myself constantly add to it but the bank would further gratify me for whatever I left with them for any length of time. So my reasoning went: “if I can save money and that money earns interest and if everyone else would be able to save why then would after so many hundreds of years not everyone be at least reasonably well off?”

With each year I added more information to my perspective. I learned that people paid taxes and that many of them complained that the money deducted they believed wasn’t spent very well (which made me always wonder why they kept voting for the same government repeatedly).

I then heard from my parents that they had gone through hyperinflation and two wars (my father, born in 1900, actually actively fought in both WW I and World War II) and how literally everything they owned was burned down in the bombardments towards the end of WW II. I was fascinated when my father told of his father’s hair dresser salon and how during the 1920s hyperinflation they would hoard bank notes that carried millions and billions denominations in empty cigar boxes until these boxes filled a whole wall. Later I was able to buy some old banknotes from that time, one of them reads “20 Billionen Reichsmark” (in UK English: “20 Billion”, in US English: “20 TRILLION” – German: “20 Billionen”).

I also heard an Irish friend tell me how impressed he was with a BBC documentary that showed a queue outside a bakery in some German city in the 1920s and how a woman carried a basket full of banknotes, obviously to buy one loaf of bread and how she had to leave the basket for a short while only to return to find her money still there … but the basket stolen! It’s these examples that I actually use to tell children what hyperinflation means because with the clever Keynesian central banks of today they might never have their own chance to experience one, poor kids … (though I’ve heard it said that one repeats one’s mistakes until achieving mastery).

I heard when I advise younger people to buy life insurance for their retirement how their parents tell them not to … because during the war, both their policies were burnt as well as all the files in the insurance company and they never got one cent/dime/penny after saving for decades …

Last not least I vividly remember how a friend told me how his mother as a young German girl had gotten a job as an interpreter with the US-American army (she was an English teacher) in Nuremberg in May 1945 and how she received a telegram from her mother still on their huge family farm back in Silesia that the mother was being evicted by the Polish authorities and would her daughter not collect her from Nuremberg station at such and such date and time. So daughter, knowing the size of their farm went to the US officers and asked for two big trucks to accompany her to the station to collect her mother with all her stuff … only to see her mother leave the station with barely her clothes on, a small handbag and just a tattered suitcase.

So despite all these people being hard workers all they experienced was “from riches to rags” so to speak.

In 1981 I visited members of Solidarnosc in Gdansk (Danzig) when the Polish economy was ailing. We were shown the city by a church caretaker who also spoke German and could translate. While we looked at the beautifully restored old city center I saw a queue just forming outside a shop that not only seemed completely empty but which was also closed and with no one inside. So I asked our guide if she couldn’t ask someone in the queue what these people were waiting for. After a short while she came back and told us “there’s a rumour they shall receive a delivery of wallpaper today”.

While this may be a lengthy introduction I could of course have written an even lengthier book and called it a “general theory”. However, I fear it might not have shed more light on the subject than these anecdotes that all “average people” who have not been “trained as mathematical economists” can hopefully relate to.

Where have all these riches gone?

And how rich could we be had they not gone? Why is there still poverty in the world after at least two to three centuries of a productivity growth much greater than in the thousands of years before?

It’s been said that all economic endeavour is speculation, so let’s speculate a little.

While there’s a debate as to when industrialisation really began and esp. since when productivity has risen to a level or attained a growth rate that would allow to potentially lift all people from poverty, for argument’s sake and to make calculation easy we say that “modern industrial history began (only) 200 years ago”.

Let us first try and calculate a realistic monetary return for these last 200 years.

Say, a family in 1807 had set aside a “nest egg” of one guilder (Gulden) which originally was meant to contain 3.5 grams of fine gold (23 2/3 carat – guilders varied over the centuries, but this is a good guide). In June 2007 3.5 grams of gold were worth an equivalent of between 15 to 20 Euros (but that was due to the low rate of the US dollar at that moment). In 1700 one reckons a Dutch guilder had the equivalent purchasing power of 40 to 50 EU-Euros today, so we peg that value back then at 30 Euros today, for argument’s sake. (Note: gold has “gone up” considerably in the past two years, however, we try to argue purchasing power or “real” value here from the historical perspective, current gold prices are not high, the fiat currencies are only at a historic low.)

So let’s say that family had invested their one guilder into some municipal bond that had yielded a constant return of 3.5% per annum. 3.5% means that the capital stock roughly doubles every 20 years, at 7% every 10 years and at 14% every five years approximately.

When you look at long term interest rates then you will find that for centuries 3.5% has been not unrealistic, esp. when you consider this to be a real long-term investment which generally yields higher rates than short-term investments.

So, we assumed that family at the time could have parted with that money. The guilder or 30, 40 or 50 Euro equivalent were maybe one or to days’ wages for, say, a master carpenter at the time, so it is certainly not inconceivable that he could have set aside two days’ wages then and … not looked at it for another 200 years, wouldn’t you agree?

While we cannot tell exactly how the gold price would have fared over all these years all we can safely say though is that if that money had for that 200 years always been pegged to the gold equivalent that master carpenter started with, that then today his offspring would now be exactly so much richer as that money has increased by calculating 3.5% interest reinvested over two hundred years (a gold backed currency knows no devaluation other than caused by the price of the underlying gold).

Now how much would that be? Exactly 29.187,12 Euros (if the Euro were a gold-backed currency) or 973 times as much as back in 1807!

So let’s pause for one moment and recapitulate: even if that family had not added to their wealth since then by saving more (i.e. additionally) from their continuing working income, and if their children hadn’t and not their grand children … still then that family would now be 973 times richer than back in 1807.

Now one might argue (a little as Malthus did), that during that time that family would have multiplied so much that all that wealth would have dissipated and been distributed amongst all the children and grandchildren. However, while we may never know how exactly that particular family would in actual fact have multiplied we could assume that every generation (or every thirty years) the family’s members might have doubled in number. Then, beginning with mother and father in 1807, in 1837 the family would have consisted of 4 adult earners, in 1867 8 and so forth until in 2007 that family would then count about 150 direct descendants of the two initial savers. Still the capital stock would have multiplied to about (973 divided by 150) 6.5 guilders per head! Mind you, that is all assuming no one ever added to that capital stock in the meantime which is very unlikely.

But is that figure of 75 times progeny against 2 parents in 1807 realistic? Not quite and the reason is that families do actually not tend to multiply as fruit flies do in biology books. Because when you in your phantasy go back to Adam and Eve and only believe, as Protestant Bishop James Ussher (1581–1656) did, that the world is no more than 6,000 to 6,600 years old, then if each of us had two parents and then four grand parents then paradise at the time would have been a pretty crowded place: it would have held a population of over 1,684,996,666,696,910,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000 “ancestors”!!! However, the estimate of “The number who have ever been born is 106,456,000,000” or about 15,828,104,256,189,600,000,000,000,000,000,000,000,000,000,000,000,000,000 times less than squaring your ancestors would suggest.

So in actual fact population growth is not as rapid as we would tend to assume and we do not have as many forefathers as we tend to believe nor have these ancestors so much progeny as we tend to think – from around 1807 till today for all we know the world population has grown only about eightfold to approx. 6.5 billion today. The lowest estimate for 1800 seems to be at 813 million for the world population, and for 2007 the highest estimate is around 6.8 billion.

So now we’ve broken some important ground by establishing some essential figures:

In the last 200 years the world population has grown about eightfold, let’s assume it was tenfold, while an individual family might even have multiplied 150fold during that period.

Had they conservatively invested a capital stock into a long term fund that yielded 3.5% per annum then during that time the capital plus interest would today stand at 973 times the initial investment while if the family members had multiplied by ten then each would now own almost one hundred times the original investment, had they indeed multiplied to 150 now sharing that estate they would now each own 6.5 times the initial investment. Not breathtaking but not bad overall.

I won’t make dubious assumptions here by saying they could have bought land instead and now in New York they might all be billionaires and I do not take that easy turn for two reasons: for once that land price explosion only occurred in certain places and assuming they had put their money exactly into the right spot would be speculation that might as well have gone wrong as it might have proved right, and secondly that land price is partly so high only due to the devaluation of money in the meantime.

While any estimate over such a long time tends to be fraught with pitfalls at last 3.5% is in keeping with long term sustainable interest rates.

Now let’s assume though they hadn’t just invested one guilder in their lifetime and then never been able to afford more savings. That surely is a very improbable scenario. We already learned that the original guilder was maybe the equivalent of two days’ wages for a better educated craftsman. So there is no reason not to assume someone else with a lesser wage could not have afforded to set aside the same sum even if that would have meant to dig into the equivalent of, say, ten days’ wages.

Now let’s assume that, instead of leaving it at that, said family and all their offspring (whether ten or 75 times more descendants) had done nothing but on top of the interest earned set aside another guilder (or equivalent) year after year, in all then bringing the overall direct investment (i.e. coming from their earned income other than the investment itself) to 200 guilders or equivalent. Then at 3.5% constant interest per annum they now would own about 1,900 times the original investment meaning twelve and two thirds per each of 150 offspring or 190 times the original value for a family that only increased tenfold during that 200 years. It is a manifold of that if not only the growing family as a whole but each member of the growing clan had in turn each parted with two or ten days’ wages each year!

You could ask why wouldn’t they save even more etc. and indeed all this is a rather conservative investment and a niggardly behaviour, but please also note, we are not talking about deducting income or inheritance taxes of which we will speak a little later.

We assumed a constant interest rate of 3.5% per annum. Now for any long term investment that is actually a rather low rate. Let us now explore the field of economic growth from a different angle: let’s assume that master carpenter and his wife had been rather shrewd investors and had not invested in municipal bonds (which in the meantime would not have been redeemed and all the money lost …) but they would have chosen an investment fund with a good track record.

Now, what is a good track record when it comes to investment funds one may ask?

First, let me explain: today’s surviving investment funds didn’t come into existence until after World War I, i.e. in the 1920s, but they have a much longer history.

However, there are some that exist to this day and … that even survived Black Thursday or Friday in 1929. Would you consider any fund that not only survived that share price meltdown but continued to thrive for almost 90 years a safe investment? I do and I’ll show you what leverage one could have gained from such investment over time even though these funds met with several wars and more than one major crisis along the way.

Investment Funds actually do go back almost 150 years: “The first fully diversified managed fund appeared in Britain in 1868, and the industry remained largely a British preserve until the rise of the investment company and the mutual fund in the United States during the 1920s.” “The earliest fully diversified fund was the Foreign and Colonial Government Trust, which was formed in 1868.” (Elaine Hutson: “The early managed fund industry: investment trusts in 19th century Britain”, p. 9). See also “Table 1 Chronology of some milestones in managed fund history” on p. 23. [Further reading: James E. McWhinney: A Brief History Of The Mutual Fund and K. Geert Rouwenhorst: The Origins of Mutual Funds]

While it is difficult to judge today’s existing investment funds in historical perspective because the world has changed so much during the 20th century and since the only national currency worth noting that has survived that long is the US dollar it is difficult to establish a yield curve yet there are historical data that date back before the 1929 disaster, e.g. US Historical Returns (slide 14 of the “Risk and Return” Study by Gordon M. Phillips). There we can clearly see that over the period from 1926 (well before the crisis) until 1999 US capital market returns were 13% for large capital stocks, even 17.7% for small cap stocks per annum, long term bonds around 6% and inflation at about 3.8% on average for all those years. Now let’s not forget this is including all the catastrophes and crises which happened along the way – I think you might agree that it is safe to say returns would be higher, but certainly not lower had there be no World War II, no Cold War, no Vietnam War, no Korean War, no Black Thursday 1929 followed by a decade long depression, no New Deal diminishing capital stocks by 10% by virtue of over-regulation, no inflation in the 1960 and 70s and no arms race that alone took a heavy percentage toll on GDP for about half of that period in question.

So if we can agree all that to be a very conservative estimate in the face of all the adversities these investments survived, then we may safely assume an average funds manager (or a family as in our example) had done nothing but invested half their funds in small and the other half in large cap stocks thus resulting in an overall average performance of about 15.35% (fifteen!) and after the annual inflation of 3.8% deducted would still have managed 11.5% net performance. Now, we say that this fund manager did try to outsmart the market … and failed as they often do (although there are examples of funds averaging 17% or more for similar periods!) and that in the long run that manager or private investor would only have managed a 10% return annually after inflation, i.e. less than had they just held the stock market index.

Surely no one can say that this was not imaginable in light of this historic evidence.

Well, due to arithmetic calculus a capital stock that yields a ten percent return per annum doubles every seven years approximately! So that family of old, putting aside only one guilder and never adding to it but leaving only the interest untouched and reinvested would, based on an initial investment of a contemporary 30 Euro equivalent in gold, today sit on no less than 5,697,158,293 Euros (5.7 billion or milliards depending on which side of the Atlantic you live) or 189,905,276 times (yes, about 190 million times!) their original small investment. Had they added to it it would be several times that even. That is still 1,266,035 (one million two hundred and sixty six thousand) in today’s Euros (I told you “we could all be millionaires“) for each of potentially 150 descendants and 18,990,528 (almost nineteen million) for each of the more probable 10 survivors today.

Now where has all that money gone? Well, if you wage about half a dozen major wars during that relatively short span of time, bankrupt your economy by hyperinflation or several revolutions or “Imperial Overstretch” on the way, (over-) regulate your economies to an extent where most value is created on the black market or in unregulated niches (the 2.7% unregulated niches of agricultural activities in the EU are said to be responsible for about 80% of real net profits in the EU agricultural sector, i.e. ex subsidies – incidentally a similar figure was once published for the Soviet Union, and so on and on).

If then you take away from that income and often from the capital stock itself by virtue of progressive income taxes, wealth tax, inheritance tax, social security that in the end doesn’t pay and a lot of instruments that discourage private initiative or wealth creation, small wonder you are left with nothing but the bare hands to begin yet again and yet again. One example: If you invested about 2,500 to 5,000 Euros when your child is born into a well managed mutual fund and only let it sit there until your child retires at age 60 or 65 he or she gets more pension income from that your initial small investment than he or she can ever gain from the average Western states’ compulsory “social” pension scheme even if your child began his or her career in the highest contributing income bracket and continued to pay in for 45 years straight (which is ten to one hundred times your initial investment)!

Friends, we could all be millionaires by now, mothers or fathers could afford to take time off to raise their children in their early years, watch them grow and give them some reassurance that when they themselves grow up there is “enough to go round”. Instead some of you now work 80 hour weeks and suffer from burn out while others are on the dole watching TV, over-regulated and fenced-in markets in the “first world” suffocate agriculture and home industries in the “third” to the extent that they can’t even subsist on their negligible wages because they are still too expensive to compete with the EU’s and the US’ heavily subsidised agricultural products.

It’s been that constant drain on our human and natural resources, the constant wars, destruction, pillaging, discouraging of private initiative and the ensuing lack of hope and subdued spirit that has held us back these past two hundred years.

It’s been like that for at least the last two hundred years and I believe I have been able to show there would have been another fate for our ancestors and hence for us, their progeny, had all that investment been allowed to grow. Despite two hundred years of constant wealth destruction still there’s some left, although it could be far greater.

[Some may argue the growth figures might not be sustainable, i.e. wars may have come at times when humankind was at a cross-roads; to this CrisisMaven has to say: look at companies like Apple, Microsoft, Branson's Virgin etc. - some companies even managed three-digit growth over several years sustainably. Examples can be found everywhere, e.g. in the mobile phone market, in the Internet domain, look at Google, Facebook, Twitter, Youtube etc. So CrisisMaven's guess is he has rather underestimated the potential for economic growth if left to its own devices!]

Now, my friends, in the light of all this and for the sake of your children: do you really want to sit and wait and waste another two hundred precious years???

Table showing the development depending on four different interest rates and some of the world events that made sure it wasn’t so …

Year

3,50%

7,00%

10,00%

14,00%

Historic

Event

1807

30

30

30

30

Begin of saving 1 guilder

1848

122

480

1.493

6.459

European Revolutions

1866

228

1.624

8.304

68.313

Prussian-Austrian War

1871

271

2.278

13.373

131.532

German-French War

1900

735

16.211

212.148

5.878.579

Turn of century

1913

1.150

39.066

732.395

32.287.580

Before WW I

1929

1.994

115.329

3.365.339

262.732.088

Black Thursday (US) & Friday (Europe)

1933

2.288

151.174

4.927.193

443.744.029

Hitler comes to Power

1939

2.813

226.871

8.728.823

974.005.997

Begin of WW II

1945

3.458

340.472

15.463.642

2.137.916.500

End of WW II

1953

4.554

584.995

33.147.691

6.098.591.580

Korea Crisis

1968

7.629

1.614.022

138.466.133

43.531.368.456

Student Revolts/Vietnam War

1989

15.713

6.682.958

1.024.683.996

682.031.130.489

Iron Curtain comes down

2000

22.940

14.066.639

2.923.543.029

2.882.421.991.982

Turn of century

2007

29.187

22.587.948

5.697.158.293

7.212.594.593.857

Today

Total

973

752.932

189.905.276

240.419.819.795

Multiplied over 200 years

Share

6,5

5.020

1.266.035

1.602.798.799

Each of 150 descendants

Share

97

75.293

18.990.528

24.041.981.980

Each of 10 descendants

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  1. ducati998
    2010-04-11 at 00:48

    cm,

    Compound interest, the eighth wonder of the world. However I question some of your rather heroic assumptions with regards to the natural interest rate, which I have posted here http://leduc998.wordpress.com/2010/04/10/on-the-essence-of-interest/#respond

    jog on
    duc

  2. 2010-04-10 at 09:58

    C’mon, let’s face the economy like a man, CrisisMaven! SUPER WELL WRITTEN and DEMONSTRATED, once again!!!

    On “How is Green Growth Possible?” [http://greengrowth.info/] I’m writing about “environmental economics from a mathematical perspective”.

    On “US Budgets (since 1901) and the Credit Crisis” you can see how the two World Wars were financed. [See http://bit.ly/ceURM3%5D

    And on “The Purpose of the Credit Crisis” I’m summarizing the conclusions of the US and UK budgets. See http://bit.ly/aGrAbn

    This morning, however, I was sent this link about the Maastricht Treaty that prohibits “overdraft facilities or any other type of credit facility”. See http://www.financialreform.info/f_r_chancellor_non_reply.html

    Now you know why I am feeling and sighing like Cassandra and am proud to be part of your blogging sphere!

    But economics is just the firewall for bankers and central bankers to do what they like. And The Law is behind their pockets that are always deeper than anybody else’s… As signatory no 157 of our petition has written: Biggest con on humanity that ever existed and most are completely oblivious to it all. See http://bit.ly/bVYZkd

    Let’s face it like a man!

    Sabine

    http://publicdebts.org.uk

  1. 2010-04-11 at 00:39

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