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My Law of Crazy Big Numbers

Equations are not required to understand my law of crazy big numbers

One consequence of the financial crisis has been number inflation.

I don’t mean the everyday cost of living inflation that measures how your shopping basket becomes more or less expensive from year to year (although such inflation is ahead of target, and many fear worse).

Rather, I mean how the numbers you read in news reports are far more ginormous than ever before.

Remember when a million meant something? Even a billion got a bit of respect before the credit crisis.

Nowadays it takes a trillion to make anyone sit up and pay attention.

Newsreaders dismissed the GDP of an economy like Cyprus – $24 billion – as embarrassingly tiny. They seemed almost offended by the clumsy way the Eurozone handled that crisis. Why couldn’t it have just chucked a few billion Nicosia’s way, and saved us all a lot of bother?

A 10 euro billion bailout? Pah! Wake me up when there’s a real crisis.

Mind-bogglingly massive debts

Our complacency about not-so-big-but-actually-still-very-big numbers may yet prove to be misguided. The Archduke Ferdinand was just one man, but his assassination still plunged Europe into World War I.

I’m thinking today though about the opposite problem – the way behemoth numbers are thrown about or plotted onto graphs to terrify and confound.

You see this a lot with the national debt of the UK and US economies. When you hear the gigantic amount we will need to repay in future years, it’s tempting to spend whatever resources you’ve got now on a wild bender in Brighton before throwing yourself off the pier.

Don’t be so hasty!

Let’s look at the US situation, where the numbers are especially massive, and where constant rankling among US politicians keeps those numbers in the news.

As every numerate American schoolboy knows, his country’s national debt is approaching $12 trillion.

But how many know that the GDP of the US is $15 trillion? Or that as of the end of 2012, the household wealth of the citizens of that country was estimated at $79.5 trillion, versus liabilities of $13.5 trillion?

Net those figures out and the US populace has a net worth of $66 trillion.

The US is staggeringly rich, even if you also tack on the national debt.

Yet how often do we hear it’s bankrupt?

The law of crazy big numbers

I postulate a new law for the economic textbooks:

The Investor’s Law of Crazy Big Numbers: Whenever there is a chance to use one side of the balance sheet to shock and awe the audience, be sure you ignore the other side. And better yet forget to mention anything about revenues and income – as well as the fact that in 30 years time we’ll all very likely be far richer, not least through inflation, which will make some of today’s large numbers seem a mere bagatelle by tomorrow.

My point is not that the US – or the UK – should duck getting its house in order.

Ultimately, the Micawber Principle applies, even in the realm of Crazy Big Numbers. Income and outgoings must eventually be brought into line.

But would you say a 30-something couple with a joint income of £150,000 a year, a house worth £1.5 million, and a mortgage of £500,000 is in financial dire straits?

Of course not, and neither is America.

Number crunched

I hope you will remember to look at the big picture the next time you stumble across an insanely-bearish blog that’s predicting global collapse on the back of some very large number or another.

Who knows, I don’t expect it but we might collapse. Even I’d make an each ways bet on environmental catastrophe.

But it won’t be because of the tricks that large numbers play with our minds.

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{ 16 comments… add one }
  • 1 rjack (Mr. Asset Allocation) March 28, 2013, 12:33 pm

    I agree the absolute debt numbers are used to inspire fear and shock. A better number to use is national debt to national GDP. That ratio’s trend for the US doesn’t look good:

    http://en.wikipedia.org/wiki/File:U.S._National_Debt_-_Dollars_and_Relative_to_GDP.png

  • 2 The Investor March 28, 2013, 12:42 pm

    @rjack — It doesn’t, but remember much of that recent trend higher is due to the recession. When (not if IMHO) the US economy really gets going again and GDP grows, it should fall more back into line.

  • 3 Neverland March 28, 2013, 12:44 pm

    “But would you say a 30-something couple with a joint income of £150,000 a year, a house worth £1.5 million, and a mortgage of £500,000 is in financial dire straits?”

    They would if they bost lost their jobs/their business collapsed, the value of their house halved and their mortgage was in Swiss Francs

    This is exactly the situation that is playing out in Ireland, Cyprus, Greece, Portugal and Spain right now…so I wouldn’t be so complacent as you seem to be advocating

    The valuation of “household assets” is very subjective given most of it property (simply based on recent historic sales, which can quickly reverse) and future pension benefits (only partially funded and hugely dependant on the discount rate used to value the future cashflows)

  • 4 The Investor March 28, 2013, 12:45 pm

    @Neverland — I’m extremely complacent about the US.

  • 5 Neverland March 28, 2013, 1:09 pm

    @Investor

    Shame you live and work in one of Europe’s worst performing economies then 😉

  • 6 The Investor March 28, 2013, 1:41 pm

    @Neverland — Indeed, but I have invested directly into the US. 🙂

    I don’t mean to sound flippant above, but I do think the pendulum over the past few years has swung far too much into the doom and gloom camp. Lots of people have been scared witless by things they don’t understand, on the back of a crash that’s already happened, and it’s made many of them poorer as a result as they’ve cowered under their blankets and on top of their mattresses stuffed with cash.

    Your retort to my analogy is fair enough, as far as it goes. I’d say the chances of *America* losing its job is zero. In terms of the metaphor, an upset would be more like one of the couple having to go down to part-time work (a recession). Even in the doomster scenario, it’s more a matter of the Jones’ next door earning more than they used to (China etc) and Mr and Mrs America feeling a bit poorer.

    I’m really not Panglossian. Before the crisis, I was known as someone who cried wolf among my friends due to my fears about the debt/housing boom. (You get just a taste of this in early pre-crash posts on this blog like this one and this one).

    But we’ve gone full circle, despite the recovery over the past few years. Countless blogs and doomster pundits were spawned by the credit crisis, and while they’ve continually predicted doom for the US economy, it’s turned around and taken its market up higher with it. I foresee house prices, bank earnings, and so forth growing for years to come in the US (minus the occasional setback of course). The country has rarely looked stronger.

    And despite all those prophets of doom, the US can borrow at a rate of under 2%. Much of this is Fed buying of course, but not all of it. Clearly, global investors are intensely relaxed about the prospects of getting their money back from the supposed basket case that is the US. And with good reason.

  • 7 BeatTheSeasons March 28, 2013, 2:07 pm

    @ The Investor – How have you invested directly in the US? Is there an article about it on Monevator?

    The UK may be solvent overall, but I don’t want my savings and investments to be overtaxed or otherwise confiscated to pay government debts when we eventually have our (IMHO) inevitable Cyprus moment.

  • 8 BeatTheSeasons March 28, 2013, 2:48 pm

    “But would you say a 30-something couple with a joint income of £150,000 a year, a house worth £1.5 million, and a mortgage of £500,000 is in financial dire straits?”

    Things wouldn’t have to get as bad as Neverland suggests for this to be a dodgy financial situation, and it’s one that millions of people should perhaps worry about.

    A 30 year repayment mortgage at a ‘normal’ interest rate of 5% works out at about £2,700 per month. If the £150,000 income was made up of two salaries of £75,000 then each would be earning £4,200 net per month (assuming no tax rises after the next election).

    In any month where only one of them was working (due to e.g. health issues, unemployment, deciding to have children, etc) then their family budget would drop to £1,500 after paying the mortgage. (4,200-1,700).

    That doesn’t leave much for heating, maintaining and paying council tax on that expensive property! And what if interest rates rise higher than 5% at some point over the term of their mortgage?

    Of course they could downsize, but this would bring it’s own problems:
    – they are used to living in the nice house so would suffer a drop in quality of life
    – they can’t move too far away from the job(s) they are dependent on
    – it may be hard to sell the house for all sorts of reasons, especially if lots of other people are trying to sell at the same time

  • 9 The Investor March 28, 2013, 3:02 pm

    @Beat the Seasons — So even if their income halves, they can still meet repayments, and they have £1 million of net assets.

    I’ll take it!

    Sure bad things can happen, and if you don’t earn any money and you have a debt you’re potentially in trouble (or more accurately you’ll need to take action). But bad things can always happen. It was the same in 1953, and 1963, and 1973, and 1983, and 1903 for that matter.

    Someone will probably come along eventually and tell us the US has most of its money in ‘paper’ assets. That’s their last great bogeyman. But again was also ever thus, at least since we left the feudal system. 🙂

    Regarding my investments in the US, perhaps “directly” was somewhat misleading. I have about 20% of my portfolio in US-listed individual shares. (I don’t own an alligator farm in the Bayou, or what have you!)

  • 10 Monk March 28, 2013, 3:54 pm

    The aforementioned young couple may well have opted to fix their mortgages for the next five years at the rather tempting rate of 2.99% currently being bandied about?

    I know I have.

    Not that I’m a young couple mind, not anymore anyway….

  • 11 Neverland March 28, 2013, 5:42 pm

    @Investor

    The ironic thing is I am less confident than you in the US, but I have about a third of my equity exposure there by country of listing – which is 50% more than you

    The US stock market looks like the least ugly girl in the pub at the moment, but that is only because we have our central bank supplied beer goggles on

  • 12 The Investor March 28, 2013, 9:37 pm

    @Neverland — Yes, guess that’s what makes a market. 🙂 I see the US as a land of opportunity. The energy problem has gone away. The population is young and growing. Most of the world’s greatest companies are based there. It’s loaded. My qualm (and what stops me putting even more money to work there) is I think the valuations there more fully reflect that reality, compared to say European or even UK shares, which seem closer to cheap than fair value to me.

  • 13 William @ Bite the Bullet April 1, 2013, 6:17 pm

    Awesome to see someone step back and take a bigger picture view! Wonder what China’s “household picture” looks like…

  • 14 SteveB April 1, 2013, 9:01 pm

    From a slightly different interpretation of the situation:

    From Planet Ponzi, p.86 [Mitch Feierstein]…..
    “Laurence Kotlikoff…..uses CBO data to determine the present value of our unfunded commitments – that is, he uses government data to model the country’s true level of indebtedness. That type of calcualtion is is the only mathematically and financially complete way to calculate overall debt. On this basis, Kotlikoff puts the true level of US indebtedness somewhere in the region of $202 trillion.”

    From Wikipedia………..
    “Laurence Jacob Kotlikoff (born January 30, 1951) is a William Warren FairField Professor at Boston University, a Professor of Economics at Boston University, a Fellow of the American Academy of Arts and Sciences, a Research Associate of the National Bureau of Economic Research, a Fellow of the Econometric Society, a former Senior Economist, President Reagan’s Council of Economic Advisers, and President of Economic Security Planning, Inc., a company that markets ESPlanner – an economics-based personal financial planning software program, a simplified version of which is available on-line for free use by the public.

    Kotlikoff ran for President of the United States in the 2012 election, and sought the nominations of the third party platform Americans Elect[1] and the Reform Party of the United States before ending his campaign in May 2012 when Americans Elect shut down.

    Kotlikoff has written that the economic future is bleak for the United States without tax reform, health care reform, and Social Security reform in his book The Coming Generational Storm and other publications”

  • 15 The Investor April 2, 2013, 12:04 pm

    @SteveB — Thanks for the references in this comment. I haven’t got the time/motivation to dig into his figures (nor the Harvard chops!) but from a cursory inspection I’m certain this doesn’t violate my law of crazy big numbers. To use accounting that reaches a figure of $202 trillion on the liability side, I’m sure you’d also see wildly different figures on both the asset side and also on the earnings power side. (The UN reckons the US workforce has a present value of over $100 trillion, for instance, from memory). And I certainly agree with his thoughts (referenced in the Wikipedia article) that all presentations of deficits are an opinion (well, he says fiction).

    Finally, just to re-iterate, I’m not saying the US can spend more than it earns forever. In fact, I state the opposite in the article.

  • 16 NoMoreKickingCans April 3, 2013, 12:36 am

    I am afraid that 30 something couple are as mad as the general population. How can a sensible financial strategy involve taking your net worth of £1m leveraging it up by 50% and investing every penny into just one asset class i.e. domestic property. Especially when that asset class has significant holding costs (maintenance etc) and is relatively illiquid. They would be much better off trading down to a £750k house, halving their mortgage and investing 500k in other assets.

    Of course changing tack would require giving up on their pointless ego boosting quest to have a bigger/nicer home than their peers and their never ending self defeating aspirational delusion that their own worth is measured in floors space and swimming pools owned. It would also require some independence of thought which is generally beyond most such people despite their high incomes.

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