Tuesday, June 18, 2013

Paper Billionaire

"The Queen of Versailles" I suspect should become mandatory viewing for anybody embarking on a business degree, so salient and brutal are the lessons contained within.

You can as of this writing still watch it on ABC iview, if you are in Oz, but otherwise track it down.

It's hard to feel sympathy for billionaires, or rather people who at one stage or another command more wealth than the vast majority of beings that have ever lived, ever have or will. But even so, I can totally believe that it is more terrifying for most people to lose their money than to lose their lives.

What is lacking in public discourse is that there are many and varied varieties of 'billionaire' and the differences between them are meaningful.

So Steve Jobs died, and I can understand the reverence the world displayed for the passing of this figure, even the Onion was highly flattering. People kept mouthing the opinion that he 'changed the world!' and I guess in a way less trivial than usual, he fucken did.

People have a natural kind of respect for wealth, and it leads to an informal logical fallacy that's something like 'it has merit because they are rich.' (there is a corresponding one for meriting an argument based on the proponents poverty). In short, if I with my sub $10,000 in savings gave you advice on what the future of the economy was, versus a conflicting view of the economy from some fat turd in a suit with $100,000,000 people would be inclined to believe the multi-millionaire because of who he is, rather than the intrinsic merits of his prediction.

Thus, Australian's should probably slap themselves awake to realise that there's a huge difference between Gina and Steve. Gina is no Steve, she is a rent collector. And by 'rent' I don't mean it in terms of what most of my friends have to pay each month, but in the economic sense: an unearned increment.

That is to say, Gina just has a claim to the proceeds of sale of natural resources. She is in mining, and the 'value added' activities in mining are as follows: exploration (discovery of mineral resources, a risky venture), extraction (digging the shit up) and transporting (bringing it from the top of the shaft to the factories that refine  them etc). and for all those activities a mining company is entitled to compensation, hopefully yeilding a profit.

But the ore itself is a natural resource, created by nobody, and irreplaceable. Once sold it is gone. The sale price is an economic rent, and these should be collected ideally by government in the form of taxation.

Thus, if you 'taxed Gina out of Business' it's not the same as taxing Jobs or Gates or the Google guys or Ai Wei Wei out of business. Why? Because the other three are people who use their brains to create value, they don't collect economic rents, they innovate and create products that provide value. If you sent them out of business, there's absolutely no guaruntee that anything would spring up to replace them.

But Gina would be replaced tomorrow. Because so long as there is demand, anybody can operate her business, perhaps not as efficiently or whatever when it regards the actual value-added activities, but the resources will remain the same.

So that's one difference.

Another meaningful difference, valuable to everyone to understand is the difference between a real Billionaire and a Paper Billionaire.

That's much harder. But basically, a Paper Billionaire has not achieved 'wealth' per se, they do not hold an asset in their name that can generate steady income for ever, they do not have a patent or intellectual property that makes them money. A paper billionaire has secured an extraordinary line of Credit.

I mean they are probably cash flow wise, actually very wealthy - they may for example command a salary in the hundreds of millions with million dollar bonuses and have income coming off their assets that is also more than the next 100 household's investment income combined.

But their billion-dollar purchasing power is based on debt, they have a small fortune in the hundreds of millions and a business up to it's eyeballs in debt - billions of dollars of debt.

And that is very different from having billions of dollars in cash.

Peter Schiff explained it sort of this-a-way, under GNP we measure 'success' as how much we consume right now. So one person with a $30,000 wage goes and saves $10,000 and puts it in a savings account. Another person with a $30,000 wage goes and gets a credit card and personal loan, and winds up with a fancy car and italian suit and eats at some very nice restaurants all year with expensive escorts.

GNP says the clear winner here is the latter. The saver is worse off because they have foregone consumption in favor of savings (future consumption) whereas the borrower is better off because he consumed a lot of stuff last year.

It's patently ridiculous to say that somebody with a debt that is 60% of their annual income is better off or more successful than somebody who has 30% of their annual salary sitting in a bank account earning interest.

That's easy to see, but chances are if you live in Australia, you feel you have taken steps towards 'financial security' by buying a home. The thing is, you don't own a home, you have a mortgage, you are still in the process of buying that home for probably the next few decades.

Thus you are similar to guy who blows his wages and borrows money, different only in the respect that the asset you have gone into debt for is different. A house holds the prospect of appreciating in value relative to the debt you have taken on. Whereas if you borrowed money to buy a car there's no real hope your car will be capable of paying off your debt via sale.

But that's really it. You're not financially secure, your wealth is on paper. It isn't 'realized' you are financially secure when you aren't dependent on an income, either to live or to service your debts. Without that you have obtained no financial security, you have simply obtained a line of credit.

If you do watch the Queen of Versailles, whether you muster up sympathy for the documentary subjects or not, realise they are not so much extraordinary people so much as extra-ordinary. They are just your average domestic household raised by a couple of powers.

Fascinating stuff.

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