Before I start this evening, I have a request for readers, and a comment for new readers.  (Note: if you are reading this anywhere but directly at my blog, please realize that you have to come to my blog for me to hear what you are saying.  I do not read comments anywhere else but at Aleph Blog.)  First the request: I would like to test the robustness of the Impossible Dream TAA model on another country.  If any of you have data on any non-US market, which would require the following:

• Index price series
• Earnings series
• Dividends series
• And a fixed income return or yield series

Contact me, and we can discuss whether you should send me the data or not.  Monthly data would probably work best, but I am open to other periodicities.

Second, for new readers, welcome to my blog.  Why do I write this after 4 1/4 years of blogging?  May 2011 is my biggest month ever, largely because of the “Impossible Dream” pieces.

For new readers, here is what you have to understand about me: I write about a lot of different things.  I have lots of interests.  I almost named this blog “The Investment Omnivore” but didn’t, because I planned on creating a firm called Aleph Investments back in 1996.  It eventually happened — 14 years later.

So, if I don’t always write about investment strategy, or any other single topic (all crisis, all the time) please don’t get disappointed.  I write in proportion to what is of current interest, and what discoveries I have been making.

So, travel with me on this trail where I cover everything from the global macroeconomy to personal finance issues.  My goal is to help you learn to think about economic/finance/investment issues, and help you see the interconnections between markets, so that you can develop your own perspective on the markets, and not just parrot me.  (Not that many do… )

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All assets represent future goods.  The prices of assets represent the trade-off between present goods and assets.

I wrote a piece recently called Inflation Speculation.  The idea was to explain how it is difficult to save for the future in a way that will transfer today’s purchasing power to the future without diminution, particularly when you have a central bank trying to stimulate the economy through the creation of credit, and the nation as a whole is overindebted.

So, if the Fed is patting itself on the back for:

• lowering corporate yield spreads
• rising stock market prices

I would tell them: it is easy to change the discount rate, but hard to change the cash flows.  Yes, as you flooded the market with credit, the values of risky assets rose.  Big deal.  Most executives are smart — they still see that demand is punk, and won’t do any real creation of plant and equipment that they weren’t already planning to do.  Little new investment took place, the value of existing assets got revalued up.

When asset prices are high, it means that money today will not buy a lot of future goods.  High P/Es, low interest rates tell us that new investments will have low yields, absent some amazing transforming technology that improves productivity dramatically.

Some people will say to me, “I need more yield today.  Yields are so low.”  I say, “When yields are so low, it is time  to avoid yield and preserve capital.  The time to seek yield is when yields are high, and no one wants to part with money to lend to them.

In March of 2009, I helped to rescue the firm of a friend.  He needed cash in the midst of the crisis, and a few of us lent to him at rates exceeding 10%, with warrants, realizing that he might be bankrupt in short order.  But things turned, and not only did he survive but he thrived.  I am still receiving interest, but will likely be redeemed soon.

Maybe that’s not such a good example.  I put 40% of my congregation’s building fund into high yield and low investment grade debt in late 2008 — made up for a lot of 2008 losses.

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Think of it a different way: shares in corporations are a proxy for the future well being of the country.  When P/Es are low, the potential for capital gains is large, as is the ability to keep up with inflation.  When P/Es are high, the potential for capital gains is small, as is the ability to keep up with inflation.  Same for bond yields — better to be aggressive when rates and spreads are high, and defensive when they are low.

Thus I would tell Ben Bernanke to lay off the quantitative easing.  It has not helped.  Yes, you have pushed asset prices up, and interest rates down, but has not created any significant new economic activity.  And why should it?  Consumers are still overindebted, and 30% of those with mortgages will lose money on a sale.  The real problem was the debt overhang, and you did nothing to to address that, not that you could, or should.

Buffett once said that most people should not be glad when they see asset prices rising, because they will need to invest more in the future, and will now have to pay higher prices.  Thus times like September 2008 offer the future at a discount to those who have ready liquidity, whereas 2007 offers the future at a premium price.

To the extent that you can, commit capital when it is most needed, and avoid chasing markets up.

This book was not what I expected.  I expected a book on the current crisis, and got a book on monetary/credit policy over the whole of the existence of the US.  What is more, unlike most books that cover a long sweep of history, this book is even, and does not overemphasize the recent past, which is a humble thing for an author to do, because we don’t know the full ramifications of recent actions yet.

Now, I respect the writings of Chris Whalen at Institutional Risk Analytics and elsewhere — a bright guy.  But this outperformed my high expectations.  Some books I glide through because I know the topic well.  This was a book where I thought I knew the topic well, but found that I did not know as much as I thought, and so I read more slowly than I usually do.

But this book changed my view on financial crises.  Whether one is under a gold standard or a fiat currency standard, the main order for assuring stability is the regulation of banks and credit.

In the same way that people need help in verifying whether a drug is effective or food is pure, they need to know that promises to pay will be honored.  It does not matter what backs the currency if banks are allowed to overlever, or mismatch assets long — there will be a financial panic, and it is not due to gold, silver, or fiat money necessarily, but that that banks made promises that could not be kept under all scenarios.

Yes, I think it is better to be under a gold standard, because it restricts the power of the government.  But that is not the main issue with financial crises; we need to restrict that ability of banks to borrow short and lend long; we also need to restrict their overall leverage.  Do that, and crises disappear — also, banks are far less profitable, and that is a good thing.  We will get fewer banks, and bright people will go to more useful places in the economy.

Other things that stood out to me were the First and Second National Banks of the US, and how their creation led to booms, and dissolution led to busts.  Lincoln is unique in every way, even in monetary policy terms, as he created unbacked paper money to fight the civil war, which funded a lot of it.  After the war, the return to the gold standard, much as it should have been done, was depressive, but it was an effect of paying off the war.

I came away from this book with a more balanced view of US politics — many of those I like came off worse, and those I did not like were shown to have been better than I thought — with the exception of Lincoln, who in hindsight seems to be a radical in most senses.  I am very glad that slavery is gone, but not the way that it got done.

Quibbles

Ignore Roubini’s introduction.  Better Whalen should have gotten a real intellect like James Grant or Caroline Baum.

Also, in the middle of the book, in WWII, the US spends far more than its GDP on the war.  I get it, but I think it would be more reasonable to classify defense spending inside GDP so that we can see what proportion of national output is going to the war effort.

Who would benefit from this book:

Anyone with a moderate intellect or better could learn from this balanced account of America’s monetary and credit policies.  It is very well written; those with little knowledge will learn much, but those with greater knowledge will still learn something.

If you want to, you can buy it here: Inflated: How Money and Debt Built the American Dream.

Full disclosure: This book was sent to me, because I asked for it.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

In the end, economic systems work, and judicial systems modify to accommodate that.  The only exception to that is when a culture is dying.

I have been scratching my head over all the problems in the residential mortgage market.  How can foreclosure take place, when there is no note, properly endorsed, to display?  How can certificate holders of securitizations be comfortable when the transfer of ownership interests in mortgages was never completed.

But, I’m not all that worried.  In one sense, the bigger the problem, the easier it is to solve.  Why?  Because the political systems that surround the economic systems tend to focus better on big problems than little problems.

As in Cordwainer Smith’s “The Instrumentality of Man,” the first priority of any government is to survive.  This is one reason why it is easier for them to survive large crises than small problems.  That’s why I give Rudy Giuliani relatively little credit for what he did on 9/11, but give him more credit for what he dealt with on budget issues.

In large crises, the range of options becomes limited.  Also, it becomes easier to see which option is the best one.

So, given the systematic and severe errors that occurred in residential mortgage securitization, shouldn’t there be an obvious answer to what must be done now?  Yes, but a solution here will take time.  Banks will have to make the effort to secure the notes that allow them to foreclose.  And then, they will foreclose.  Will that mean a lot of upset for the residential property market in the short run?  Yes.  Will the residential property market survive this?  Yes.

Foreclosures will take place.  But the legal niceties that protect our property rights in other areas must be observed by the banks.  Courts should not give in to pressure that they must do something to preserve the proper functioning of the market.  Yo, courts.  The markets will survive even if you delay.  Take your time and do it right. Yo, lenders; delay is the price for not having done it right in the first place.

As for the securitization certificateholders, let me remind you of the investment banks and AIG.  AIG absorbed subprime mortgage risk from all of the investment banks.  The investment banks thought they were pretty clever, until they realized that they all had taken advantage of AIG, and thus, AIG might not be able to make good on all the risks that they had absorbed.

In the same way, if all residential mortgage-backed securitizations are unwound at the same time, the sponsors of the mortgage-backed securitizations will not be able to make good on their obligations.

As I see it, residential mortgage-backed certificate holders have an incentive to work with the sponsors to see how this crisis can be worked through.  And as I see it, perhaps the solution is to pay a consent fee to the certificate holders in exchange for waiving their rights to sue over the malfeasance of not transferring the notes from the originator all the way to the trust.

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As with other crises, the probability of total failure is remote.  Total failure only occurs when those at the top of the power structure are so self consumed that they do not see the threat to their lives.

That’s why I see a slow but reasonable solution coming through the court system to solve the malfeasance engendered through the sloppy execution of securitizations.  Yes, things are bad.  Yes, our current politicians are clueless.  But there is enough interest in coming to a solution for society as a whole that an equitable solution will be arrived at in the courts – not through Congress, not through the President.

That doesn’t mean that things won’t be choppy and messy.  Indeed, there will be many ugly times en route to a solution.  But things are not so bad in our judicial systems, as a whole, that we will not come to the correct solution, after exhausting all imaginable alternatives.

There is room for a new risk model based on the idea that risk is unique among individuals, and inversely related to the price paid for an asset.  If a risk control model has an asset becoming more risky when prices fall, it is wrong.

After doing my talk for the Society of Actuaries last Wednesday, I got inspired to write something about modern portfolio theory, the capital asset pricing model, the efficient markets hypothesis, etc.  This particular rule deals with two things:

• The same event can have different risk for different individuals.  Risk is unique to each individual.  It cannot be summarized by a single statistic for comparative purposes across individuals.
• In general, with a few exceptions, risk is inverse to price.  As the price gets higher, so does risk.  As the price gets lower, so does risk.  The major exception to this rule is when trends are underdiscounted, because estimates of intrinsic value are flawed.

Let’s deal with these issues one at a time.  Start with a simple question.  Why do academics want to have a single measure for risk?  It allows them to write papers, and it keeps the math simple.  That’s why we have concepts like beta and standard deviation of total return.  It’s why we have concepts like the Sharpe ratio and other ratios that purport to measure return versus risk.

If our total planning horizon was similar to the periods that these figures are calculated over, they might have some validity.  But most of the time are planning horizons are longer than the periods that these figures are calculated over.  Even worse, most of these statistics are not stable.  The value calculated today may likely have a statistically significant difference from the value calculated a year ago.

But what is worse still is the idea that by taking more risk you will get more return.  If anything, the empirical research that I’ve been reading, and the value investors that I have talked to, indicate that the less risk you take, the more you’ll make.  A good example of that would be Eric Falkenstein and his book Finding Alpha.  Minimum beta and minimum standard deviation portfolios tend to outperform the market.  Junk grade bonds tend to underperform investment-grade bonds.

If it hurts too much, don’t do what I’m about to say.  Think about Lenny Dykstra.  When he and I were writing at RealMoney.com at the same time, I would often ask him about what his method would be to control risk.  He never gave me a good answer; actually he never ever gave me an answer at all.

My concern was for small investors, dazzled by the celebrity, and the simple approach that he would take that seemingly yielded huge profits, would adopt the approach, and not know what to do when things went wrong.  For Dykstra, who seemingly had a lot of money, losing a little on a deep in the money call trade would not hurt him much.  But to an unfortunate average guy reading Dykstra’s work, a similar sized loss could be very painful.

That said, that greatest risk was in plain view, which Steve Smith, I, and a few others went after — Larry didn’t know what he was talking about.

Risk varies by differences in wealth; risk varies with age.  Risk varies with the level of fixed commitments you have in life.  To give you an example there, when I went to work for a hedge fund, the first thing I did was pay off my mortgage so that I would feel free to take big risks for the hedge fund.  It is far harder to take risk, the higher the level of fixed obligations that one must pay month after month.

To make it more practical, think of all the malarkey that has been spilled talking about “animal spirits.”  I don’t believe that businessmen are irrational; many Keynesian economists are irrational, but no, not businessmen.  Businessmen will not take risks when they are overleveraged, or, when a broad base of their customers is overleveraged.

Risk is unique to everyone’s individual situation.  Any time you hear someone bring up risk factors that are generic, you can either ignore them, or, more charitably think that they have a proxy that might have something to do with risk, maybe.

Go back to Buffett’s dictum: far better to have a bumpy 15% return than a smooth 12% return.

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The second part of the rule says that risk models should reflect higher risk as prices rise and lower risks as prices fall.  The implicit idea behind this is that it is possible to calculate the intrinsic value of an asset.  Can I disagree with one of my own rules?  Well, since I do the writing here, I guess I get to make up the rules about the rules.

There are many assets that it is difficult calculate the intrinsic value thereof.  Examples would include commodities, growth stocks, and anything that is highly volatile.

Though I believe my rule is correct most the time, markets are subject to momentum effects.  Often when a stock is at its 52-week high, that’s a good time to buy, because people are slow to react to changes in information.  And, when stock is falling hard, and is at a 52-week low, that is often a good time to not buy the stock, because there are maybe bits of information about the stock, or its holders, that you don’t know.

In general, though, higher prices are more likely to be overpayment and lower prices are more likely to indicate bargains.  Why?  Because returns on equity tend to mean revert.  Companies with poor returns on equity tend to find ways to improve business.  Companies with high returns on equity tend to find increased competition.

Thus, as always, I counsel caution.  Don’t ignore momentum, but also don’t ignore valuation.  Ask yourself how much upside there could reasonably be, and how much downside.  Play where the downside is limited relative to the upside, because the key to investing is margin of safety.  Play to win, yes, but even more, play to survive, so that you can play longer.

When rules become known and acted upon, the system changes to incorporate them, making them temporarily useless, until they are forgotten again.

When a single strategy becomes dominant, it can become temporarily self-reinforcing.  Eventually, it will become self-reinforcing on the negative side.

A healthy market ecology has multiple strategies that are working in separate areas at the same time.

I have been invited to speak twice in the next two months on the efficient markets hypothesis [EMH].  Once in Denver, once in NYC.  Fortunately for me, the folks in Denver are paying my way, and I will take a regional train to NYC and back.

I grew up on the idea that the EMH in its weak form was true, no doubt.  No one can make money looking at past price movements.  As for the semi-strong form of the EMH, which says that you can’t make money off of any past or present public data, I believed it with some reservations.  My mother was a self-taught investor who regularly beat the markets.  She used a discipline of half utilities (“they are my bonds”) and half “growth at a reasonable price” [GARP] stocks.  She is why I went to Johns Hopkins, rather than the University of Wisconsin.

The EMH in its strong form, that no one can make money off of insider information, was doubted by almost all.  Even today, we track insiders, and there is money to be made by following them.  Even following 13F filings of successful investors is profitable to many.

Yet, the EMH is compromised even in its weak form.  When one reads academic research on the markets, what is the most durable and powerful of all of the anomalies? Price momentum, which violates the weak EMH.  That said, a lot of economic actors know that price momentum works well, and so it gets used.  And overused.

Any strategy can be overused.  Before a strategy peaks, the overuse of a strategy makes the strategy work overly well, as prices for stocks are pushed above equilibrium levels through strategy momentum.

In the long run the stock market is a weighing machine, so the short-term overshoot will correct itself eventually.  But when too many follow momentum, the market goes wild.  Volatility rises; daily moves tend to be up or down a percent or more.  During such a period, price momentum stops working for a time, until enough abandon the strategy.

The same applies to longer term strategies, like value investing, or overweighting small companies, or overweighting companies with sound financials, or low price volatility, etc.  Any one of these can be pursued too much.  When any of them is pursued too much the stocks involved will overshoot and plunge.

There is no magic strategy that works all of the time.  Smart investors have to be aware of almost all of the strategies that exist in the market, and understand when they are underplayed (buy) and overplayed (sell).

Healthy markets have multiple strategies that work.  When the strategy becomes monoculture, e.g. tech stocks, then beware.  When there is only one road to wealth, the market is in a bad place, and smart investors will hold cash, or invest conservatively away from the one thing that is working now.  Broad leadership is needed in a true bull market.  When leadership thins to one idea, it is time to take profits.

Don’t confuse brilliance with a bull market.  Try to understand where you are in the cycle of your stock picking strategy.  It does not work all the time, so when things are at the best that you have seen, wait a bit, and then take two steps back.  When things are horrible, wait a while and redouble your efforts.

Factors in investment returns move in cycles. Be aware of where you are in the cycles, and maybe you can profit from them.

In a panic, only two attributes of a financial instrument get priced — liquidity and quality/survivability.

In a panic, all risky assets become highly positively correlated with each other.

Given that correlations tend to rise in a panic, a reasonable measure of sentiment is to measure the average absolute value of 10-day correlations.

Markets cannot survive for long periods of time at high levels of actual or implied volatility.  They eventually revert to normal.

Panics and booms are different — they may be opposites, but they behave differently.  Panics are events, often multiple events, and booms are processes.  The nature of this is best explained through the credit cycle.  The boom phase of the credit cycle involves rising profits of corporations.  Stocks and bonds behave differently here.

Say the expectation of income moves from negative to a low positive figure.  Stocks will rally; bond may rally more, because the threat of bankruptcy is lifted.

Now suppose that the expectation of income moves from a low positive to a normal positive figure.  Stocks will rally a lot, but bonds will rally a little.  The odds of the bonds being paid rise a minuscule amount.  The stocks estimate of future distributable profits rise a great deal.

Now suppose that the expectation of income moves from a normal positive to a high positive figure.  Stocks will rally some, but bonds will not rally much.  The odds of the bonds being paid don’t change.  The stocks estimate of future distributable profits rise, but with a sense of possible mean reversion.

So in a boom, credit spreads [the difference between the yields of corporate bonds and Treasury bonds] tighten quickly, tighten slowly, and then stop tightening, even though things seem to be going great.  The end of the boom, as far as the credit market is concerned, can last a long time.

The end of the boom comes when a significant amount of companies the overextended their balance sheets during the boom find themselves in a compromised condition, and have a hard time gaining financing.  The suspicion of credit troubles travels fast, and all of the companies where investors waved their hands at problems now get a fresh look with a different set of eyes.

The moment incremental financing seems less likely or more expensive, companies that will need financing get re-evaluated by the market — stock prices move down, bond yields go up.  This is when analysis of the balance sheet and the cash flow statement are worth the most, and the income statement is worth the least.  The bull phase of the cycle is all about income statements, and estimating what future income will be.  The bear phase of the cycle is about estimating  cash flows, and the strength of balance sheets, to identify who might not survive the bear phase well.

During the boom phase of the cycle, the degree of correlation of asset returns is low.  There is noise, and not everything does equally well.  There are multiple risk factors and strategies that are working.  But in the bust phase, the acid test of survival dominates.  One factor gets priced, whether an asset is money good or not. [For bonds, "money good" means the par value of the bond will be repaid at maturity.]

But panics don’t last long — usually two years or so.  As the panic drags on three processes take place:

• Companies in horrible shape default.
• Investors examine companies in okay shape, and find weaknesses.  Some will default, and some will clean their acts up.
• Companies clean up their acts, and it becomes obvious that they will survive.

Toward the end of the bust phase, like a fire running out of fuel, there is a moment of clarity where some realize that things aren’t getting worse.  Most companies have cleaned up, and there will be fewer future defaults.  That sets the scene for the next rally.

Through the bust, equity volatility and credit spreads remain high; they are correlated phenomena, but there is a point of exhaustion.  High yields attract needed financing to companies that are mis-financed, rather than insolvent.  Credit spreads can only get so high before money comes in willing to buy no matter what the future may hold.  Equity volatility can only get so high before players begin writing short straddles, knowing that the odds of winning are tipped in their favor.

It pays to watch both the equities and bonds, and other related securities — it gives a richer picture of what is going on.  In particular, when the bull phase has gone on for two full years, watch for equity volatility and credit spreads to stop falling.  That is a sign that the bull market is getting close to the end, and most of the easy gains have been made.  Watch for telltale signs of cashflow shortfalls where banks are less than willing to plug the gap at a price.

Learn this well, and your ability to play the market will improve considerably.

Governments are smaller than markets; markets are smaller than cultures.

This rule has always had a special place in my heart.  It is an attempt to explain what drives human action in our world.  Though I think economic reasons for action are important, they are not the dominant reason for human action.  Human actions are dominated by the religious and philosophical views of each culture.  That is what men will sacrifice for.  Economics is how they fund those ideals.

Homo Oeconomicus does not exist.  Few live to merely maximize their personal enjoyment of life, narrowly described.  Yes, if one broadens the paradigm to say that enjoyment of life means achieving the unique goals that one might have for influencing society, that might make the two similar, but there is no way for that to be true for all men at the same time, because views differ there.

Cultures are not Neutral with Respect to Economics

Let’s take a step back.  The embedded beliefs of cultures affect what can be done by its inhabitants economically.  Does the culture permit/encourage:

• Borrowing and lending with interest? (In non-stilted ways)
• Taking risks?  Having a bankruptcy code that is not too punitive?
• Avoiding big risks, that might harm parties two or three links removed?
• Education of children, such that they are motivated to learn.  (Note: only parents can do this effectively.  Teachers will try, but school cultures depend on parenting cultures.  Lazy parents –> lazy kids.  This applies to children in public, private and home schools.)
• Education, so long as we don’t get too many people in any area where there is not enough demand.  (I am thinking of the science and math deficit here.)
• Labor flexibility; will a significant subset of people retrain when their area of the economy is no longer in so much demand?
• Basic honesty in business dealings?  Business is based on trust.
• A strong view of the value of time?  Time is money, and cultures that say “tomorrow” will not prosper as much.
• Allowing freedom to business within the basic boundaries of ethics?
• Government officials don’t commonly take bribes, or political action committee contributions?
• People to have an interest in building something through their lives, and free to pass on the benefits as they wish?
• Charity, not welfare, to those who have had a rough go of it.
• Fair courts that will adjudicate rights and claims impartially.
• Legislatures that will be restrained?
• Executive officers and bureaucrats that will balance the varying needs of society in accordance with the laws, and not become pseudo-dictators?
• Honest money, where a stable unit of account is maintained, rather than trying to trick people into doing more or less through monetary policy.
• And more, I hope you get the idea.

Cultures set the backdrop for what men will value and do.  More than laws and regulations, cultures have the soft power such that it is difficult for a man to imagine other ways to do things rather than the accepted norms of the culture.

Cultures are not contiguous with nations; it is more of a tribal thing.  Some cultures exist inside a single nation, some exist across nations.  I think it boils down to a similar view of life that gets propagated through families sharing a similar world view.

Each nation has a meta-culture that is a weighted average of the influences of the cultures inside it.  The weightings depend on size, and willingness to exert effort.

Over the long haul, I think that culture has a bigger impact on the growth of GDP/person than natural resources of an area.  Hong Kong and Singapore are small examples of successful meta-cultures.  Russia and Venzuela would be examples of a resource-rich places that did not capitalize on its opportunities because of the lack of honesty in government.

Governments Have Limits Relative to their Economies

The present time helps show the limits of governments.  Yes, governments have taken bold actions to prevent a banking crisis.  And, it may have worked, but who can tell two years out?  But the governments took on a lot of debt to do so.  Debt-based systems are inherently less flexible than equity-based systems.  As such, the governments of our world are less capable of meeting a significant crisis than they were ten years ago.

Governments that try to do too much run the risk of growing beyond their meta-culture’s willingness to fund them.  It makes sense for governments to focus on the few things that they should do well: internal security, defense, public health, justice, etc.  Beyond that, the effectiveness of governments breaks down.  Governments that try to favor/disfavor a wide variety of actions through tax and stimulus policies don’t typically achieve what they wish for.  Instead, they get populaces that get a minority of clever people who milk the legal code to their advantage, and pay lobbyists to continue the practice, while the average person is frozen out through barriers to entry.

There is something similar to the Laffer Curve that applies to governments, though the shape is unknown to me.  At some point, increasing tax rates stops leading to an increase in revenues, and at some point beyond that increasing tax rates leads to a decrease in revenues.  Those break points will vary, but the clever rich forever reduce their taxes through loopholes.  For the second break point to be hit, taxes have to rise such that the middle class starts to seek shelter from taxes.

Conclusion

Governments can’t dominate economies or meta-cultures.  If they do, they will enforce relative poverty on their countries.  They have to reflect the basic ethics of their meta-cultures, or they won’t survive for long.  Economies will only grow to the degree that their meta-cultures allow them to do so.  Willingness to take and fund risk are culture-driven.

When you consider international investing, examine the culture that you are investing in and ask whether it will be fair to foreign shareholders.  Ask whether they will have standards of governance as good or better than in your home country.  Ask whether they will be motivated to do their best for themselves and their owners.

Don’t underestimate cultural effects in economies.  Men are not the same everywhere; their cultures lead them to think differently.