Finance History Inheritance Literature

Monsieur De Norpois’ bad advice

Since the 19th century, investors were faced with the choice between different asset classes. Psychologically, people prefer a fixed income: in their eyes, this stock does not fluctuate in value. Unfortunately they are brutally wrong. A very juicy portrait of a doubtful investor and a bad advisor is given in Marcel Proust’s In Search of Lost Time. Probably the most important novel of the 20th century, it is like a treatise in a poem, or better many treatises, including a small one on investments.

The second volume of this majestic work is In the Shadow of Young Girls in Flower (À l’ombre des jeunes filles en fleurs). In this book the Narrator receives an inheritance, after the death of his aunt Léonie. His father, a diplomat, consults his friend, colleague and role-model Marquis de Norpois, a very experienced diplomat, that considers himself also the best of judges in art, literature, and investments of course.

My father, who was trustee of this estate until I came of age, now consulted M. de Norpois with regard to a number of investments. He recommended certain stocks bearing a low rate of interest, which he considered particularly sound, notably English consols and Russian four per cents. “With absolutely first-class securities such as those,” said M. de Norpois, “even if your income from them is nothing very great you may be certain of never losing your capital.”

English consols yielded from 2 to 3%, depending on the emission, whereas Russian bonds, considered less safe, guaranteed a 4% fixed income. Not much, but those were times of gold standard, deflation and low interest rates (sounds familiar?)

More than three thousand pages later, at the end of the sixth volume The Fugitive (Albertine disparue), the Narrator has spent much money for his beloved Albertine. The affair is over (no spoiler), and he finds himself quite in lack of argent. This sad consideration follows:

But time had passed; the wisest judgments of the previous generation had been proved unwise by this generation, as had occurred in the past to M. Thiers who had said that railways could never prove successful. The stocks of which M. de Norpois had said to us: “even if your income from them is nothing very great, you may be certain of never losing any of your capital,” were, more often than not, those which had declined most in value.

A World War and revolutions across the globe provoked devaluations of bonds that seemed impossible in the previous years. French investors in particular lost gargantuan sums of money on Russian bonds that were repudiated by the new Soviet Union. The matter is still not solved after more than a century!

Whereas in 1996 The Chicago Tribune wrote emphatically (1):

For nearly eight decades Russia’s Imperial Bonds decorated European bathrooms and children’s playrooms as colorful but worthless wallpaper.

Sometimes the bonds surfaced at antique stores or as curios in the flea markets of Europe.

When Vladimir Lenin’s Bolsheviks unilaterally declared the debt on the czarist bonds null and void in 1918 they were rendered worthless.

This week, however, French families were rummaging through attics in a frantic search for the once-useless certificates their great-grandparents might have bought, then tossed into a dark corner in disgust.

Russian President Boris Yeltsin agreed Tuesday to repay a nominal value of between $80 and $100 for each of the 4 million czarist bonds believed to remain in circulation in France or to have survived the European wallpaper fad, for a total payout of around $400 million

Many descendants of the bondholders are still looking for money today (2):

Around 400,000 people are seeking 30 billion euros from Russia in payments for the bonds issued by the tsarist government (…)

Between 1880 and 1917 French citizens bought a total of 30 million Russian bonds. In January 1918 the head of the new revolutionary government Vladimir Lenin refused to pay off the bonds.

However, in the mid-1990s Russia signed an agreement with France over the Romanov government’s debts and paid Paris 330 million euros. Moscow asserts that the issue is over and there are no grounds to discuss any new payments.

Meanwhile, descendants of the original bond owners argue that this sum should be 100 times bigger.

Well, M. de Norpois’ advise did not prove very useful indeed. Today most investors make the same mistake: accepting low interest rates from Sovereign Issuers that are politically unstable, or in a constant economic recession. There is a sort of blindness in fixed income by investors. Most think that fixed income is risk free, but the risk is still there, many risks indeed: currency devaluation, inflation rise, interest rates rise, default.

The SEC itself seems to agree that investors’ awareness of bond risks is quite low:

Interest rate risk, a bulletin by the Office of Investor Education and Advocacy of the SEC

The only real rentier investment is the investment at technological frontier. Proust mentions railroads, that was high tech in the 1800s and old story in the next century. Every century has its own railroad: we will talk about this in a next post.



Finance History Inheritance Literature Mass Rentiers

A universal truth

It is a truth universally acknowledged that a single man in possession of a good fortune must be in want of a wife.

This is one of the most famous incipits in English literature: “Pride and Prejudice” by Jane Austen. We will focus on the fortune side of the equation, as money, that is unearned accumulated capital, plays a fundamental role in her books.

The novels by Jane Austen are set at the very beginning of the Industrial Revolution. In those times growth rate was around 0 percent and slowly accelerated to 1.5 percent during the 19th century. But compared to a rate of return of 5 percent, the gap between the rate of return and the growth rate did not change dramatically as compared to pre-industrial society.

Wealth was just perpetuated from one generation to the next generation, keeping the structure of society unchanged. There was always some sort of limited mobility – some people dilapidated the wealth or some people gained access to wealth through connections or other means.

This phenomenon has been explained with vast echo by French economist Thomas Piketty in his book “Capital in the Twenty-first Century.”

Piketty’s thesis is that when the rate of return on capital (r) is greater than the rate of economic growth (g) over the long term, the result is concentration of wealth, and this unequal distribution of wealth causes social and economic instability

Piketty argues that in the 20th century, very unusual shocks altered this logic. The succession of World War I, the Great Depression and World War II reduced the return to capital to a very low level because of capital destruction, inflation and taxation to finance the war, and so the rate of return to capital between 1940 and 1945 was not 4 or 5 percent anymore: it fell to 1 percent or very close to 0 percent.

Then the growth rate after World War II increased enormously: many countries experienced growth rates of 4 or 5 percent per year in the 1950s, 1960s and 1970s, in particular USA, Japan and Western Europe, that were largely due to the post-war recovery. Very high growth rates made it easier to accumulate wealth and, for the first time in history, there was really significantly higher upward mobility.

The unusually high level of upward mobility during the post-war period was greatly facilitated by the large growth rate of labour income during these decades. But starting around 1980, a growth slowdown was experienced due to the fact that the post-war recovery was over and productivity growth rate fell around 1 to 1.5 percent — closer to the pre-World War I productivity growth rate.

Growth rate in the economy is a function of the growth rates of productivity and population. So there are two ways to make GDP rise: higher productivity, higher population (more people working) or both. Historically both have been very important. Having more people who can work comes from immigration and fertility and life expectancy increasing. But this part of growth is now going down, because people are having fewer children.

There is still very substantial growth as compared to pre-industrial societies, but this is not enough to counteract the fact that the rate of return to capital earnings can typically be 4 or 5 percent. In Piketty’s view we are back to 19th century at least.

Chart adapted by The New Yorker from the original in Thomas Piketty’s “Capital in the Twenty-first Century.”

Piketty calls for action, but it is evident that these forces are beyond the control of individuals and even of political powers. In the foreseeable future, demographics will be negative in rich countries and productivity will not increase very fast. 

And so, what can we do? If we surrender to the logic that our wealth will be a function of productivity and demographics, i.e. forces that we can not influence in any way, we are set to be powerless and in the end victims of the economic system. And yet we can fight.

First of all, even the poorest worker in an advanced economy is a Mr Darcy compared to the average worker of a poor country. Piketty forgets this simple fact: we live in a globalised world, where a middle class Lebanese family can hire a Sudanese to take care of the house, and a Slovakian manager can pay a Filipino to assist his ageing parents. The world is the stage now, and many, who Piketty laments are getting poorer, are still on the wealthy side.

Second, we do not depend on land or paper to accumulate wealth. We have digitalized financial markets, we can own shares of companies, obligations and currencies with a common mobile phone and an internet connection. It is incredibly simple to manage an estate today, and, although it is not easy to save money working, we can all round up our income with some unearned income.

Jobs, that traditional economists like Piketty believe to be the only way to earn a living, may be the hardest path to affluency. The easiest one is to understand how to invest fruitfully the unearned capital we already possess, and then do a job that we love.

We must change our mentality: stop thinking as working class heroes, and act instead like decadent aristocrats who want to stay on top. Because that is what we are.