If You’d Like To Be Liked

The Gist: Honestly appreciate people.

A review of How To Win Friends and Influence People by Dale Carnegie.

If you’d like to be liked, Dale Carnegie says you already know the “greatest winner of friends the world has ever known.” Indeed, “You may meet him tomorrow coming down the street. When you get within ten feet of him, he will begin to wag his tail. If you stop and pat him, he will almost jump out of his skin to show you how much he likes you.” Yes, if you want to win friends and influence people, take as your model the family dog. 

Dog

Figure 1. “Outside of a dog, a book is man’s best friend. Inside of a dog, it’s too dark to read.” – Groucho Marx.

 

Carnegie’s fundamental advice in one of the best selling books of all time is really very simple: honestly appreciate people. Whenever you are going to talk to someone – even or perhaps especially if it’s a difficult conversation – think: what do you like about this person? At the very least, that will put you in the right mindset. And then as you meet, if you happen to think of something that is true, positive, and would be appreciated by the person, share it! As Megan McArdle observes, “‘You are amazing and here’s why’ never gets old.”

Stalin

Figure 2. In college, I got an internship with the White House Office of Political Affairs, which reported to Karl Rove. I told my grandmother what I’d be doing that summer and she, a lifelong Democrat, said that she could think of something nice to say about nearly everyone – but not Karl Rove. I inquired, “What about Stalin?” She replied, “He had a nice mustache.”

 

A related mandate is to embrace curiosity and take a genuine interest in others. After all, everyone you meet knows something you don’t. (Unless you’re a teenager. Then you know everything already.) Personally, I am fascinated by what people actually do in their job day to day, rather than simply the topline on their resume – someone may tell you she’s a teacher, but of what topics and what ages and how many kids does she see per day and how is she evaluated and what does she think of homeschooling and, my gosh, I have a thousand questions!

Carnegie advises that there’s another benefit: “You can make more friends in two months by becoming interested in other people than you can in two years by trying to get other people interested in you.” Forget the basic small talk about the weather or the weekend. Move beyond the standard “how’s it going” “fine, you?” interaction. Caroline Webb advises to ask open questions “that can’t be answered with a yes or a no” and invite people “to share their thoughts, motivations, or feelings, rather than merely facts.” Find out what makes people come alive!

Graveyard

Figure 3. I once had lunch with a man who most came alive when recalling his recreational visits to graveyards. Ironic? Sure. Atypical? Different from every other meal I’ve ever had. But bear in mind that one of the most famous subjects of classical literature came alive from graveyard visits.

 

You may recall that this is a neat echo of Carnegie’s wonderful advice for giving a speech: find your passion and you can connect with an audience. Find your conversation partner’s passion and they can connect with you! You can even just directly ask: what are you currently excited about? What are you spending time thinking about? The results are often extraordinarily interesting. And Carnegie reminds us, “the royal road to a person’s heart is to talk about the things he or she treasures most.” If it’s a commonality, you have a ready friendship. If it’s not, you can learn something new.

Carnegie published his book in 1936 so we might add a particular exhortation: put away your phone and commit to being fully present with anyone you meet one study has found that even the mere presence of your digital device on a table can lessen people’s feelings of connection.  Focus instead entirely on the person in front of you – really intentionally listen to what they have to say and try to understand what values or goals you might have in common.

Furthermore, be generally positive and specifically compassionate. Carnegie mentions you can’t wag your tail but you can and should smile to express your gratitude for someone’s time. Webb cites a study that found that “merely being near someone in a good mood can be enough to lift people’s motivation (and therefore their performance), and being near someone grumpy can do the opposite.” Remarkably “this happened even when people were working on completely different tasks—and it happened within five minutes, without any conversation.” But you of course will be having a conversation – so celebrate all the good things you can find going on in each other’s lives, laugh, swap stories and jokes. Olivia Fox Cabane defines charm as how delightful it is to interact with someone. Have a good time and you can give someone else the same.

All of this is well and good but here we arrive at an insistence of Carnegie’s that clashes with my own personality: “You can’t win an argument.” Why not? Because at most you get “an academic, theatrical victory” but you lose “a person’s good will.” People don’t like to be wrong, or made to feel so. Warren Buffett considered this lesson one of the most profound of his life and he worked hard to change his natural tendency to be a contrarian so that he could win people over. 

I haven’t quite followed that path as of yet, for better or worse. One interviewer set expectations in this way: “When you meet Grant Starrett, you’ll likely have two experiences: you’ll get in a debate with him, and you’ll like him.” Perhaps he was being generous. If he’s right, my guess is that humor plays a role. Or Bryan Caplan offers his own interpretation: “When Carnegie urges us to avoid argument, he primarily means a one-on-one attempt to reverse someone’s position even though at least one of you is upset.  He’s not against argumentative essays or public debates; neither does he oppose sportsmanlike conversations on controversial topics.” Indeed, Caplan argues that in a public debate, you want that theatrical victory. But in more personal settings, Carnegie’s warning should be in the back of your mind if tensions rise.

Indeed, Carnegie’s very first piece of advice is to insist that you should not criticize, condemn, or complain. “Criticism is futile because it puts a person on the defensive and usually makes him strive to justify himself. Criticism is dangerous, because it wounds a person’s precious pride, hurts his sense of importance, and arouses resentment.” Carnegie holds up the example of Abraham Lincoln, who as a young lawyer was quite a vocal critic until he was drawn into a duel that was barely averted and vowed to change his ways. Your best bet is to take a cue from Lord Chesterfield: “Be wiser than other people if you can; but do not tell them so.”

Flintlock

Figure 4. If you’d really like to restore civility to politics, take advice from Abe Lincoln and Zell Miller: a dueling society is a polite society.

 

This may be sensible if your utmost goal is to get people to like you – no one likes getting criticized – but as a practical matter, I don’t think that a good boss, parent, or friend should avoid it entirely. In Kim Scott’s popular matrix, Carnegie’s advice can seem awfully close to “ruinous empathy” while she encourages you to move to “radical candor.” Given that Carnegie puts such an emphasis on authenticity, a careful and honest approach may still be kosher. Cabane suggests that, before you criticize, you have to get into the right mindset of compassion:  “When people feel that you have their best interests at heart, it can change the dynamic entirely.” In particular, “try thinking of a person whom you highly respect just before you deliver criticism” – like a favorite grandparent. “If you were to make this comment to them, or in front of them, how would you word your criticism?”

Carnegie realizes that sometimes some sort of correction is needed but he encourages you to be indirect. You might engage someone socratically to raise questions they had not thought about and tease out nuance. Just make sure you truly understand their position: Marshall Rosenberg writes that “Studies in labor-management negotiations demonstrate that the time required to reach conflict resolution is cut in half when each negotiator agrees, before responding, to accurately repeat what the previous speaker had said.” Webb suggests “the trick is to express your views without making the other person wrong, by finding ways in which they could be (partly) right and building your suggestions around that.” Tell people what you like and then what would make you like it even more. 

For Carnegie, the important thing is to allow people to save face. Rosenberg warns that “When we combine observation with evaluation, others are apt to hear criticism and resist what we are saying.”  The marriage expert John Gottman suggests that a lot of perennial disagreements are unresolvable, but if you are going to raise something, follow a few intentional steps: soften your introduction to set the right tone and ask for permission for a discussion, identify a specific situation (not a general trait), acknowledge your own responsibility, describe your own feelings about it, and then specifically identify what you want done going forward. And if you are the one in the wrong, Carnegie encourages you to “admit it quickly and emphatically.” 

Of course, all of Carnegie’s advice has to do with what I mentioned in the very first sentence: If you’d like to be liked. Honestly, I have mixed feelings about that goal as one to pursue above and beyond any else. It certainly is wonderful to be blessed with friends – and I’d certainly like to influence ideas. But I also am interested in pursuing truth, which often best emerges through argument and bringing up uncomfortable ideas. I’ve been told that it’s impossible to know me without becoming more conservative and the trick may be to try to disagree without being disagreeable. And yet sometimes when I think of Dale Carnegie, I think of Will Rogers, a charming humorist who claimed he never met a man he didn’t like – but he had met Mussolini

The critic of capitalism Sinclair Lewis was also a critic of Carnegie, claiming that the advice above taught people to “smile and bob and pretend to be interested in other people’s hobbies precisely so that you may screw things out of them.” But I think Lewis misses the boat on this one – if there’s one thing Carnegie is very clear on, it’s to give honest and sincere and genuine appreciation and interest. This contrasts entirely against more manipulative advice built on insincerity. Relatedly, one of the reasons older people tend to be happier is that, over the years, they edit their friend group and spend more and more time with people they actually like.

Bryan Caplan, another natural contrarian, has the most insightful take on Carnegie’s work. Caplan argues that likability is not the only key to success, but it is certainly one of the easiest ones. “If a toxic genius builds a multi-billion-dollar company, the reason is probably his genius – not his toxicity.  And though you can’t choose to be a genius, you can choose to treat others well.” Caplan suggests that “While [the Carnegie method] isn’t a good way to accurately assess another person, it’s a good way to make friends and influence people.” The “big picture” is to “Stop demanding reciprocation from others. Unilaterally smile.  Unilaterally show interest.  Unilaterally encourage others to talk about themselves.” Ask yourself: “Before you treat another person in a less-than-perfectly-pleasant way, always ask yourself, ‘What am I trying to accomplish?’  You’ll rarely have a good answer for yourself…. Before you speak to another person in a less-than-perfectly-pleasant way, always ask yourself, ‘Is there a more constructive way to say this?’” Ultimately, he teaches his “kids to be the kind of positive person we’re delighted to meet.” May you do the same!

I’ll close with an anecdote about two different kinds of charm. In the late 19th century, Benjamin Disraeli and William Gladstone were two giants of British politics and the great offices went back and forth between them. One woman managed to sit next to each at different occasions and reported: “After dining with Mr. Gladstone, I thought he was the cleverest person in England. But after dining with Mr. Disraeli, I thought I was the cleverest person in England.”

How to win friends and influence people

Figure 5. Click here to acquire How to Win Friends and Influence People by Dale Carnegie. Carnegie claims that he “hired a trained researcher to spend one and a half years in various libraries reading everything [he] had missed, plowing through erudite tomes on psychology, poring over hundreds of magazine articles, searching through countless biographies, trying to ascertain how the great leaders of all ages had dealt with people.” And, amazingly, they “read over one hundred biographies of Theodore Roosevelt alone.” Which is appropriate in that TR every night used to look at who he was meeting the next day and stay up late reading books about whatever they were interested in. I’ll leave you with perhaps Carnegie’s most famous line: “Remember that a person’s name is to that person the sweetest and most important sound in any language.”

 

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I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

    Let Me Follow My Bent

    The Gist: What happens if kids have no curriculum at all?

    A review of multiple books on the topic of unschooling and early childhood education.

    “Nancy was concerned for her son. At eight years old, in school for the first time in his life, Tom was not doing well. After three months, his teacher, Mr. Engle, called him ‘addled,’ or unable to think clearly. Tom had spent his childhood up to that point freely playing and exploring near his home, and he found the adjustment to school difficult. He especially disliked the emphasis on sitting, memorizing, and repeating, and he found the teacher’s ways harsh and rigid. Tom was miserable. Nancy went to speak to Mr. Engle about her son, but she was turned off by his sharp ways. Frustrated by the teacher’s tactics and his low opinion of her son, Nancy removed Tom from school and homeschooled him. Thomas Edison was done being schooled.

    At home, free to be a curious boy once again, Edison developed a passion for books and knowledge. Nancy mostly allowed Tom to learn naturally, following his own interests. Edison biographer Matthew Josephson writes that ‘she avoided forcing or prodding and made an effort to engage his interest by reading him works of good literature and history that she had learned to love.’ A former teacher, Nancy Edison facilitated her son’s learning by noticing the things that interested him and gathering books and resources to help him explore those topics more fully. Tom became a voracious reader, reading at age nine the great works of Dickens and Shakespeare and many others. Also at nine, Tom became interested in science, so his mother brought him a book on the physical sciences… and he performed every experiment within it. This led to a passion for chemistry, so his mother gathered more books for him. Edison spent all of his extra money to buy chemicals from a local pharmacist and to purchase science equipment, and he conducted his first experiments in a makeshift lab in his home’s basement while still just a tween. Josephson writes that in allowing Edison so much freedom and autonomy, his mother ‘brought him to the stage of learning things for himself, learning that which most amused and interested him, and she encouraged him to go on in that path.’ Edison himself wrote about his mother: ‘She understood me; she let me follow my bent.’”

    Lightbulb

    Figure 1. Enlightened learning in this case led to much broader enlightenment.

     

    This story about Thomas Edison is provided by homeschooling mother of four and Harvard education school graduate Kerry McDonald in her book Unschooled and demonstrates an especially different approach to education in which children self-direct their own learning. But – my gosh! – if children choose what to do day in and day out, will they learn anything at all? Won’t kids endlessly play games, fail to get into college (much less the Ivy of their parents’ dreams), and then be totally unprepared for the “real world” that awaits them in adulthood? There is a really small sample size of kids who are brought up this way but advocates claim that trusting children yields amazing results. Whether you’re prepared to completely abandon the traditional curriculum or not, there’s something to learn from their experiences.

    It’s probably worthwhile exploring the origin story of the Sudbury Valley School, one of the rare institutions that practices unschooling. Daniel Greenberg was a popular physics professor at Columbia University who became frustrated that his students “seemed motivated to get the highest grades they could while learning the least possible amount of the subject matter.” Students gave him high marks for teaching but practically none used his class as inspiration to read and learn deeper about physics outside his curriculum. Greenberg became convinced that conventional school had so strangled the natural curiosity of kids that college was much too late to fix them and so he abandoned his prestigious position to found Sudbury, a 10 acre campus in rural Massachusetts. His ideal was “a free market place of ideas, a free enterprise system of talents” where “students should be free to explore any ideas that engage their interests” and, incredibly, without any required curriculum at all. Operating since 1968, about 75% of alumni have gone on to college and, according to one survey done by Boston College psychologist and Sudbury parent Dr. Peter Gray, the vast majority have been “remarkably successful in finding employment that interested them and earned them a living.”

    Panda

    Figure 2. I once took a seminar on the history of Chinese-American relations in which one of my peers soon confessed that she was a proud “panda-hugger” who adored the People’s Republic. That description seemed to capture the mood of the class, except for myself and a couple of others who vigorously dissented against the party line (thankfully, there was no Cultural Revolution to dispense with us.) My professor was not exactly sympathetic to the minority. At one point, he proposed a rule that each person get equal time to air their views; I countered that each view deserved equal time and there wasn’t much learning from continuous echoes. But, more remarkably, he asked me to stop reading material outside the curriculum because my unique knowledge of the area disadvantaged my classmates.

     

    What unschooling relies on is children’s natural curiosity about how the world works – and then fanning that curiosity into a roaring flame. As McDonald insists, “The deepest, most meaningful, most enduring learning is the kind of learning that is self determined.” Adults unschooling kids do three things: model the behaviors you want your kids to pursue, give your kids a rich variety of opportunities to explore, and empower your kids to chase their curiosities to the maximum.

    Lighter

    Figure 3. Be an arsonist of curiosity! 

     

    John Holt, who became so frustrated with conventional school that he helped popularize homeschooling as an alternative, described an incredible semester at an open-minded 1960s-era elementary school in which the teacher was in the habit of writing down any unanswered questions that her children had on big pieces of paper hung around their homeroom, to be investigated at leisure as much as children’s curiosity persisted. One spring, as children put away their winter clothes, one asked why they could not be washed. “Many of them knew that it was because the wool would shrink. But why did wool shrink?” The class wrote a letter to the state university asking for use of a microscope, which eventually arrived. The kids excitedly learned how to use the microscope and soon examined “wool fibers before and after washing,” followed by a “number of other fabrics,” noticing differences based on how they were woven. So these elementary school children then decided that they wanted to learn how to weave, wrote another letter to get raw wool, “washed it, carded it, spun it, and wove it.” One kid “thought it would be interesting to find out how much work it would take to make the cloth” and so they tracked the man hours to produce one “small square of cloth” and were shocked to discover it was 72! They then got interested in calculating “how long would it take to make a whole suit,” which “brought in a good deal of arithmetic, plus the problem of calculating the area of an odd-shaped object.” Once discovered, “they began to wonder how people like the early colonists ever managed to find time to make their own clothes” and researched history, which led to both to looking at the innovations of time-saving devices and labor relations, even prompting a class field trip to a textile mill. From there, they researched how to dye their cloth (which led to an exploration of botany); then they got interested in the diversity of wool and wondered why different kinds cost different prices, so one kid began to map out the origins of wool across the world, others investigated the different animals wool came from and how hard they were to raise. They did all this while investigating other questions of interest. “In a year the class of thirty-five children borrowed seven hundred books.”

    Warren Buffett

    Figure 4. Sure, this sounds like an impressive semester. But, with just a little more effort, the class could have discovered the undervalued textile mill stock Berkshire Hathaway.

     

    Perhaps the most vital skills your child should learn are literacy and numeracy – both subjects wind up being tested ahead of college (for now) but they are also genuinely useful in the real world. Unschooling seizes on that second point: showing your kids the actual uses you and they have for math and reading will be infinitely more engaging than a compulsory examination of abstract blackboard formulas or reading at a preset pace a boring book of no special relevance or interest. Between kindergarten and 6th grade, the average Tennessean spends over 7,000 hours attending school. But according to award-winning public school teacher John Taylor Gatto, “reading, writing, and arithmetic only take about one hundred hours to transmit as long as the audience is eager and willing to learn. The trick is to wait until someone asks and then move fast while the mood is on.” Sudbury more specifically reports that “it takes about twenty hours to learn the entire K–6 mathematics curriculum when a child is interested in learning it.”

    Many unschoolers initially get excited about math due to interest in games – adding and subtracting from their Monopoly money, calculating probability for Dungeons and Dragons dice rolls, comparing on base percentages for baseball players. McDonald insists that her kids just treat math workbooks as fun puzzles to work on, the same way you might fill in the daily crossword for your own fun. The idea is to explicitly discuss all the math around your kids – the measuring and timing of daily cooking, the list-making and bargain-hunting of weekly shopping – and then cultivate their interests until the political kid examines campaign contributions and creates a pie chart of the federal budget, the budding businesswoman follows stock market price-to-earnings ratios and learns accounting, the hands-on tinkerer reads manuals and takes apart and rebuilds equipment to precision. Notably, unschoolers are openly skeptical that every child should study all advanced math that never comes up in day to day life – if a child loves the subject and wants to study it further, by all means, they should do so; if a teenager wants to go to a college with certain requirements they have not yet hit, they’ll be incentivized to hit them on their own.

    Ace of spades

    Figure 5. One economist helpfully suggests making bets with your kids. This can be especially profitable shortly after a birthday check arrives from Grandma: kids make perfect poker marks!

     

    Meanwhile, perhaps the primary motivation for unschoolers to read is envy. In an institution like Sudbury, children “became motivated to read primarily by observing older students reading and talking about what they had read.” As one reported, “I wanted the same magic they had; I wanted to join that club.” In a home, if you want your children to read, you should read – yes, aloud to them, but also tell them about what you’re reading and let them see you read and let them see the fruits of your reading, including the books spread across the house for little hands to thumb through. The same principle applies if a particular subject is important to you: if you want your kids to love the Gospel, then make it a center of your home with your own personal Bible study, grace at meals, your own prayer at bedtime, etc. If you really want your child to love reading, let them read what they’d like. According to the Oxford Dictionary of National Biography, Samuel Johnson is “arguably the most distinguished man of letters in English history;” he advised:

    “I would put a child into a library (where no unfit books are) and let him read at his choice. A child should not be discouraged from reading anything that he takes a liking to, from a notion that it is above his reach. If that be the case, the child will soon find it out and desist; if not, he of course gains the instruction; which is so much the more likely to come, from the inclination with which he takes up the study”

    Once they have the basics, the world is their oyster! Gatto insists anything in the world of any significance is accessible to a 13 year old mind – the question, as ever, is what engages your child’s ambition and delight? Gatto recalls that “until pretty recently people who reached the age of thirteen weren’t looked upon as children at all” and that “only a few lifetimes ago, things were very different in the United States. Originality and variety were common currency.” Draw attention to the heroes of America: “A considerable number of well-known Americans never went through the twelve-year wringer our kids currently go through, and they turned out all right. George Washington, Benjamin Franklin, Thomas Jefferson, Abraham Lincoln…” And, yes, these are exceptional historical figures who had meaningfully different experiences from contemporaries who instead had to spend their time cultivating fields or practicing a trade – but presumably your kids don’t have to do those things, either. Indeed, “if David Farragut could take command of a captured British warship as a preteen, if Ben Franklin could apprentice himself to a printer at the same age (then put himself through a course of study that would choke a Yale senior today), there’s no telling what your own kids could do.” 

    This flexibility can lead to kids truly pursuing their passions. At Sudbury, “Classes in specific subjects are offered when students request them, but no one is required or particularly encouraged to join a class and many students never join one. Classes have no formal status and last only as long as student interest lasts.” One girl, Carol, “developed a love of boats,” first playing with small models in a pond on campus but later “took advantage of the school’s open-campus policy to spend as much time as possible at a nearby seacoast area, where she studied navigation and sailing.” She became captain of a cruise ship. Another girl, Fran, got fascinated with making clothes for her dolls, “then, as a teenager, she began making clothes for herself and her friends.” She graduated to become a “master patternmaker and head of a facility in the high-fashion clothing industry.” One boy, Henry, was enchanted with science and biology – and was able to regularly retrieve dead animals for dissection. He wound up becoming a successful mortician!

    Lightning

    Figure 6. A tad more challenging, at least for a muggle, would be if your child is primarily interested in a wizarding career. To this end, you may instead embrace the advice of Cal Newport, who argued that most people’s biggest passions (such as sports or movies) do not have commensurate employment opportunities and that you should instead focus on what you’re good at. But don’t count out flexibility! Perhaps your child may become, if not a wizard, a magician.

     

    The core of unschooling involves entrusting children with responsibility with the understanding that it’s the best preparation for adulthood they could receive. In Gray’s survey,

    “Graduates explained that at Sudbury Valley they had always had to make their own decisions about how to spend their time, that there was nobody to blame but themselves for mistakes they made, and that they had had to work through the school’s democratic procedures for any changes they had wanted in the school. The resultant sense of personal responsibility remained with them, they said, and served them well in higher education and employment.”

    But if your kid does not have a particular, immediate focus to pursue to the ends of the earth, then try to draw it out. At its purest, unschooling repositions education as an invitation – for better or worse, “A primary characteristic of unschooling is its emphasis on noncoercive education, or the ability to say no.” McDonald offers the analogy of a museum: 

    “Information, exhibits, and lectures are offered, usually centered on the museum’s focus (art, science, nature), and museum guides are available to answer questions or lead a demonstration. Nothing is forced. If you want to explore a particular exhibit for a long period of time and ignore the other ones, you can. If you want to spend time in the contemporary art wing and ignore the impressionist painters, go for it. If you want to listen to a lecture on animal behavior or do a hands-on geology activity, it’s there for you. If you don’t want to, that’s OK too. You can come and go as you choose. The museum won’t cajole you or evaluate what you know. With unschooling, as with museum learning, resources, materials, and opportunities are made widely available for exploration and discovery—without coercion.”

    For reasons that are probably obvious, the small number of kids who are unschooled can underperform conventionally schooled kids on early standardized tests (though those conventionally schooled kids underperform structured homeschoolers). Unschoolers are not especially concerned. William Stixrud argues that “brain development makes it easier to learn virtually everything (except foreign languages) as we get older.” Gatto notes that there was no widespread formal schooling in the American colonies, yet literacy was near-universal among free adults. When it matters, it will come – and stay. “Most of us learned the periodic table through a preestablished schooling curriculum with various learning objectives and assessments. How much do you remember? In one family McDonald describes, most of the kids learned to read early – but, incredibly, the parents let one kid’s illiteracy persist until he was 13 – at that time, he really wanted to read his sports schedule – and he went from reading Dr. Seuss to Shakespeare in a matter of weeks.

    Now, I don’t know about you, but I personally would have a difficult time letting illiteracy persist into teenage years. My own read on unschooling is that it can give you hope that if a complete abandonment of the traditional curriculum seems to work out not too shabbily, giving kids substantial autonomy to pursue their interests within the broad goals of advancing literacy and numeracy offers a lot of promise. If our goal is to teach kids how to effectively communicate ideas, I don’t mind if they read and write about topics that they themselves are curious about rather than are imposed upon them – but I do rather think they may need the broad requirement to indeed read and write on a regular basis. I’ve reviewed the work of the economist Bryan Caplan before on how schools are wasting lots of time – he homeschooled his kids and gave them lots of flexibility on what to read but required that they do math problem sets for at least 90 minutes a day. But beyond those basics – read, write, and calculate – there’s a lot of room for parents to curate kids’ adventures and curiosities.

    There are still other elements of unschooling that I have mixed feelings about.

    Unschoolers are very wary of evaluation. At Sudbury, there are two exceptions: “students who wish to use expensive or potentially dangerous equipment… must first become ‘certified’… by proving they can use it appropriately” and, if they wish to acquire a diploma, they must “prepare and defend a thesis explaining why they are ready to graduate and how they have prepared themselves for responsible adult life outside of the school” – to be graded by outside reviewers not present at the school. Unschoolers do this because they want kids to constantly explore their curiosity rather than chase grades and scores. They also argue that testing does not necessarily enforce genuine learning and that it’s artificially outside the real world experience with arbitrary restrictions (such as forbidding the use of calculators or notes). They also point to evidence that the very act of knowing you’re being evaluated has two effects: people are generally less creative and novices in particular underperform. But on the flip side of that equation, experts actually perform better when they know they’re being evaluated. My sense is that mastery requires relatively constant feedback on performance and I am not sure, based on my reading, whether unschoolers reject that entirely or are open-minded to it so long as kids are actively asking for it. 

    Unschoolers are also quite zealous about the opportunity for kids to play – some of the benefits of which you may very well agree with. Gray argues:

    Free play is nature’s means of teaching children that they are not helpless. In play, away from adults, children really do have control and can practice asserting it. In free play, children learn to make their own decisions, solve their own problems, create and abide by rules, and get along with others as equals rather than as obedient or rebellious subordinates. In vigorous outdoor play, children deliberately dose themselves with moderate amounts of fear—as they swing, slide, or twirl on playground equipment, climb on monkey bars or trees, or skateboard down banisters—and they thereby learn how to control not only their bodies, but also their fear. In social play children learn how to negotiate with others, how to please others, and how to modulate and overcome the anger that can arise from conflicts.

    Sudbury believes that free play is especially powerful for kids playing with other kids, especially of mixed age and without adult interference (in other words, a pick-up sandlot baseball game rather than Little League). Sudbury believes that by mixing children of different ages, younger children can get exposure to advanced topics familiar to their older peers and also be effectively taught by near-peers who might better understand their difficulties. Further, mixing ages allows younger children to participate in activities that would otherwise be beyond their skill level, such as a game of catch where their throws aren’t very precise. Meanwhile, older children get the benefit of reinforcing their skills by teaching younger kids, apparently inducing more nurturing behavior. Younger children also apparently inspire older kids to be more creative. For better or worse, Sudbury also rejects adult-organized sports in order to foster kids’ ownership of their activities, including negotiating mutually satisfactory conclusions to disputes. There are some interesting arguments here and I am quite open-minded to letting kids play but I am not quite there at letting it go on indefinitely and I do wonder if fully embracing every kid’s opportunity to exit at any time undermines resilience.  Of course, all of these benefits of play with other kids can be more difficult to regularly achieve in a homeschooling environment.

    Baseball

    Figure 7. The real question is how kids on the sandlot resolve the infield fly rule.   

     

    I suspect, however, that there is a bigger problem: what if a kid only wants to play video games? At Sudbury, “all [kids] have unlimited access to computers and television, and almost all of them play and enjoy video games.” Unschoolers argue that it’s essential to give kids exposure to and understanding of the tools of the adult world – and that prohibition may even make tech more appealing. Sudbury further reports that kids are learning to read faster as a result of early exposure to social media – and various authors cite additional benefits to video gaming, including problem solving and hand-eye coordination. One homeschooling parent suggests that her kids were inspired by playing video games to learn Japanese, take music lessons to be able to play the theme song to their favorites, and work to earn money for more games. And, ultimately, Sudbury argues that, for most kids, video games are a release from their hyper-controlled daily life, the digital realm being a place where they can “make their own decisions and strive to meet challenges that they themselves have chosen. At school and in other adult-dominated contexts they may be treated as idiots who need constant direction, but in the game they are in charge and can solve difficult problems and exhibit extraordinary skills.” Sudbury reports that their students strike a healthy balance – and indeed prefer to be out in the woods playing with their friends than playing a game. Unschoolers generally advise that as kids are given control over their time, the appeal of screens dissipate. 

    I am not so sure. If you look at time data on unemployed adult men, who have presumably complete control over their time, they are spending 7.5 hours a day on leisure via screens. Further, as Stixrud notes, “If you’re a kid, the formula begins to look like this: the more technology you use, the poorer your self-regulation. The more technology you use, the worse your executive function (your Pilot). This matters a lot; self-regulation and executive function are about twice as good predictors of academic success as IQ at all grade levels, including college.” Screen leisure has significant opportunity cost: sleep and time in real life with family and friends, not to mention reading, writing, and math. I’ve reviewed Andy Crouch’s thoughtful take on technology for families before – and he recommends a total prohibition on kids using screens until age 10, with limits thereafter. I also think of the neurosurgeon Ben Carson, who was doing pretty poorly in conventional school until his mother limited his television time and required that he write for her two book reports a week and – wouldn’t you know it? – his grades improved as he went on to bigger and better things.

    Amidst all their trust for kids, unschoolers do like to cite the doctrine of A.S. Neill, who said he gave the children at his British boarding (un)school Summerhill, “freedom, not license” – that is, responsibility, not permissiveness. It meant that kids were welcome to play the trumpet – but not in the middle of the night when people were trying to sleep. It also meant that kids were welcome to swear – but were not allowed to insult each other. A related concept is distinguishing hazards and risks: “The minute a child thinks an adult is in charge of the space, and in charge of determining risks, setting limits, and managing conflicts, the play space can become both more sterile and more dangerous. In such instances, the responsibility for safety rests outside the child.” All of which sounds like at least some cabining of total freedom, except that Summerhill allegedly permitted underage sex and had anarchic problems associated with its completely democratic operating structure (in which students, outnumbering teachers by a significant margin, exercised full power – Sudbury operates similarly but without the same reported problems). As if that wasn’t enough, some of its teachers were prominent British Communists and Neill himself was sympathetic – though, to his credit, he realized that his anarchic school was rather inconsistent with totalitarian Stalinism.

    All of which is to say: I both recognize the benefits of play but also think it ought to have limitations – that kids should be directed to learn but with empowerment to take that whatever direction they might. Especially with more structure, I don’t think college should be much of a problem – McDonald reports that one successful applicant remarked “For my application transcript, my dad and I sat down and tried to list out all of the books I had read. Books were my curriculum.” The standard curriculum has problems – especially if it is true that it teaches in 7,000 hours what only takes 100. Ultimately, trusting kids to pursue their own interests has great promise, especially in that it much better prepares them for the “real world” than the compulsory abstractions of conventional school.

    Unschooled

    Figure 8. Click here to acquire Unschooled by Kerry McDonald, a Harvard education school graduate and homeschooling mom of four. In addition to her overview of how to unschool your kids at home, she also thinks ahead to a broader reform: “When trying to envision what an unschooled future might look like, public libraries are ideal examples. Publicly funded, sometimes supplemented by private donations, libraries are free, self-directed learning spaces in the truest sense.”

    Free to learn

    Figure 9. Click here to acquire Free to Learn by Dr. Peter Gray, a Boston College psychologist who sent his son to Sudbury Valley School. Much of the book is a profile of how the school works, though he does begin with some underwhelming anthropology about the nature of childhood. Gray rather boldly predicts that most schools will adopt the Sudbury model in the decades to come – but also notes that at Sudbury, there’s quite a bit of self-selection going on, with about half the students having trouble in conventional school before arriving and the other half being the children of true-believing parents. To give you a sense of how much he entrusted his son with responsibility, I relay this anecdote:

    When he was thirteen, my son went to London for two weeks by himself. I must admit, that was back in 1982, when it was easier to be a trustful parent than it is today. He had approached his mom and me in the spring, when he was still twelve, with this proposal. He would earn all the money for the trip himself, so we couldn’t use cost as an excuse to stop him. He would plan the whole trip himself—in fact, he had already planned much of it. He wanted to prove to himself that he could organize and do something this complicated without adult help. He also wanted to see certain castles and museum treasures, which he had been reading about and which were prominent in the Dungeons and Dragons games he played. He had never been abroad. Neither, for that matter, had his mom or I.

    Free to learn

    Figure 9. Click here to acquire Free to Learn by Dr. Peter Gray, a Boston College psychologist who sent his son to Sudbury Valley School. Much of the book is a profile of how the school works, though he does begin with some underwhelming anthropology about the nature of childhood. Gray rather boldly predicts that most schools will adopt the Sudbury model in the decades to come – but also notes that at Sudbury, there’s quite a bit of self-selection going on, with about half the students having trouble in conventional school before arriving and the other half being the children of true-believing parents. To give you a sense of how much he entrusted his son with responsibility, I relay this anecdote:

    When he was thirteen, my son went to London for two weeks by himself. I must admit, that was back in 1982, when it was easier to be a trustful parent than it is today. He had approached his mom and me in the spring, when he was still twelve, with this proposal. He would earn all the money for the trip himself, so we couldn’t use cost as an excuse to stop him. He would plan the whole trip himself—in fact, he had already planned much of it. He wanted to prove to himself that he could organize and do something this complicated without adult help. He also wanted to see certain castles and museum treasures, which he had been reading about and which were prominent in the Dungeons and Dragons games he played. He had never been abroad. Neither, for that matter, had his mom or I.

    Unschooled

    Figure 10. Click here to acquire How Children Learn, by John Holt, an educator who helped popularize homeschooling. The book is a bit odd, sometimes reading like diary entries of interactions with specific children, other times having general observations of education. The edition I read also included commentary by Holt more than a decade after he first wrote the book about how his thinking had developed – and that actually was often quite interesting as a contrast. Holt said: “this book can be summed up in two words—Trust Children. Nothing could be more simple—or more difficult.”  Holt was an advocate of youth rights and believed that “A child has no stronger desire than to make sense of the world, to move freely in it, to do the things that he sees bigger people doing. Why can’t we make more use of this great drive for understanding and competence?” Kids needed to get real exposure to the real world because “[Children] want to be able to do what the bigger people around them do—read, write, go places, use tools and machines. Above all, they want, like the big people, to control their immediate physical lives, to stand, sit, walk, eat, and sleep where and when they want.

     

    Thanks for reading! If you enjoyed this, forward it to a friend: know anyone who is a parent? How about a grandparent? How about anyone who is a former child?

    For more, check out my archive of writings, including my review of the Case Against Education

      Houstraining Your Teen Wolf

      The Gist: “Kids need responsibility more than they deserve it”.

       

      A review of The Self Driven Child by William Stixrud and Ned Johnson, and the Coddling of the American Mind by Greg Lukianoff and Jonathan Haidt.

       

      What if the reason that younger adults act like children is that older children (i.e. teenagers) are not treated like adults?

      Gavel

      Figure 1. Or perhaps what if it’s because teenagers are not tried like adults? Ever since teens stopped fearing the death penalty…  

       

      Georgetown neuropsychologist William Stixrud and tutor Ned Johnson co-wrote the Self-Driven Child, which argues that while parents should model good behavior and offer sound advice, they also need to let their children make more of their own decisions (and mistakes).

      Stixrud and Johnson start from the basic premise that all “humans have three basic [psychological] needs.” First, we need to feel a sense of competence, not necessarily of Olympic caliber, but more in the sense of comfortably handling our day to day responsibilities and challenges. Second, we need to feel a sense of relatedness, where we feel a caring connection to others. And third, we need to feel a sense of autonomy, in which we decide what we might do and whether to do it.

      Freud

      Figure 2. Unclear how that summary fits within Freud’s crucial insight that we are really just attempting to displace our fathers to be with our mothers.

       

      Various authors suggest that teens today are especially lacking in the last, autonomy – legally obligated to spend most of their time in regimented educational institutions, heavily encouraged to take on specific extracurriculars, assigned mandatory homework, relatively restricted from employment opportunities, and closely regulated in what remains of their personal life. Dr. Peter Gray argues that, “I doubt there has ever been a human culture, anywhere, at any time, that underestimates children’s abilities more than we North Americans do today. Our underestimation becomes a self-fulfilling prophecy, because by depriving children of freedom, we deprive them of the opportunities they need to learn how to take control of their own behavior and emotions.” Teenage angst may be a well-worn stereotype, but a former editor in chief of Psychology Today found that “teenage distress – whether mild or severe – is a distinctly American phenomenon.”

      State u

      Figure 3. Who knew that American exceptionalism boiled down to mopey teenagers?

       

      Over-scheduled, overwhelmed, and over-protected, today’s kids can become anxious, angry, or resigned. Indeed, one definition of anxiety is feeling a lack of control. Stixrud and Johnson believe that “autonomy is key to developing motivation” and report that over the last sixty years, “students have steadily reported lower and lower levels of internal locus of control (the belief that they can control their own destiny) and higher levels of external locus of control (the belief that their destiny is determined by external forces).” Gray notes, “the average young person in 2002 was more external (more prone to claim lack of personal control) than were 80 percent of young people in the 1960s.” Stixrud gives a practical example of this in action: “If you act as if it’s your job to see that your child does his homework, practices the piano, or plays a sport, you reinforce the mistaken belief that somebody other than he is responsible for getting his work done. He doesn’t have to think about it because, on some level, he knows that eventually someone will ‘make’ him do it.”

      This sense of helplessness among the young could be leading to broader social phenomena. The very essence of the American dream is that you, through your own efforts and hard work, can pull yourself up by your own bootstraps to achieve prosperity. But if an increasing proportion of young people believe that the events and outcomes of their life are directed from elsewhere, what motivation do they have to do much of anything? Greg Lukianoff and Jonathan Haidt warn in the Coddling of the American Mind that kids have embraced three untruths: that they should always trust their feelings, that challenges make them weaker, and that evil people are keeping them down. But, of course, feelings are not facts, overcoming adversity can make people stronger, and modernity seems to have lost a good deal of its understanding of good and evil. Sheltered kids grow into adults craving safe spaces, constantly assuming the worst of others’ microaggressions. Instead, Lukianoff and Haidt say that parents and educators should “prepare the child for the road, not the road for the child.”

      Stixrud and Johnson concede that kids, inherently, are still developing but “kids need responsibility more than they deserve it.” Their advice consists of a total rejection of helicopter parenting. “if you want to keep your children as safe as possible, the best thing to do is to give them experience and teach them judgment. Let them climb that tree and fall when they’re six—it will teach them important skills about risk and about being in their bodies.”

      But Stixrud’s ideal may require an adjustment for lots of parents. Stixrud and Johnson encourage parents to be less bosses and more consultants. Gray makes the distinction between “trustful parenting” and two related alternatives – “protective parenting,” where parents personally remove or insist on avoiding every possible challenge their kids could face (you can’t play football because it’s dangerous), and “directive parenting,” where parents take command of their kids’ lives to do whatever Mom and Dad think is best (you must play football because it builds character). The authors argue that the source of teenage angst, and often bad decisions, is an outcry for autonomy. Parents’ “attempts to assert control triggered [a child]’s determination to reassert his own control, even if it meant doing the opposite of what was in his own best interest.” To give you a sense of your kids’ feelings, 

      “Imagine if you had a conversation with your spouse in which he or she said something like: ‘How was work today? Did you get a good report on your project? You understand how important it is for you to take your work seriously, right? I mean, I know it isn’t always easy or fun, but you really should see if you can get a promotion so you’ll have more options in the future. It just seems like maybe you aren’t doing your best all the time. Like maybe you could work a little harder.’”

      But amidst this plea for autonomy, there’s also something to be learned from the Founding Fathers, who insisted that liberty can only really work alongside virtue. The authors dance around this without necessarily calming all concerns. Stixrud and Johnson insist that “‘It’s your call’ does not conflict with limit setting, which will always be an essential part of parenting.” The trick is probably establishing firm outside limits but giving kids lots of space within them. Your teenage daughter might be free to decide how to spend a Saturday afternoon, but she won’t be allowed to sleep at her boyfriend’s house. And, of course, you do not need to subsidize bad decisions – giving your kids’ latitude does not require you to buy them a video game console on demand. The specific limit Stixrud and Johnson cite is that “if frequent chemical use is a problem, remember, all bets are off and you need to intervene.” But otherwise, Stixrud encourages a thoroughly honest ongoing conversation where you “Tell your child what you’re worried about, and talk those points through. In this way, you are supportive and engaged, but you’re not steering the boat.” Generally, you want to transmit: “I have confidence in your ability to make informed decisions about your own life and to learn from your mistakes.” Ultimately, “For most judgment lapses, though, we suggest asking Dr. Phil’s question, ‘How’d that work for you?’ and discussing ways to make better decisions next time.”

      Or take a cue from Chief Justice John Roberts, who told his child’s graduating class:

      From time to time in the years to come, I hope you will be treated unfairly, so that you will come to know the value of justice. I hope that you will suffer betrayal because that will teach you the importance of loyalty. Sorry to say, but I hope you will be lonely from time to time so that you don’t take friends for granted. I wish you bad luck, again, from time to time so that you will be conscious of the role of chance in life and understand that your success is not completely deserved and that the failure of others is not completely deserved either… I hope you’ll be ignored so you know the importance of listening to others, and I hope you will have just enough pain to learn compassion. Whether I wish these things or not, they’re going to happen. And whether you benefit from them or not will depend upon your ability to see the message in your misfortunes.

      Stixrud argues that you really cannot compel anyone to do what he really does not want to do –  the question is what does your kid really want to do? Have an open-minded conversation, encourage your children to handwrite their very own personal goals, and then try to help them strategize how to get there. It’s very hard for an angsty teenager to say their parents are ruining their life if he has substantial choice about how his life is going. If your kid is an ambitious high-achiever, then it’s pretty simple to give her advice about how to set herself up for success. Stixrud’s practice inherently dealt with kids who were the least interested in school – but he found that when he talked to kids outside of their parents’ expectations about what they really wanted to do, suddenly they could find their motivation. One kid was not meeting any requirements for getting a high school degree until he realized that it would mean the embarrassment of not graduating with his friends – and experienced a dramatic turn-around. Another thought school was useless in his ambition to become a firefighter – but, after being genuinely encouraged for the first time to investigate it as a career – discovered that he needed a high school degree and became keenly interested.

      guitar

      Figure 4. Even if your child’s deepest ambition is to become a country music superstar, you can note that most of them did in fact graduate high school. 

       

      A challenge for some parents in trusting their kids is that it may mean widening their definition of success – a kid who is making his own decisions (and mistakes) may not be ready for college immediately after high school graduation. But there are plenty of worthwhile alternatives: take a cue from the Mormons, whose young men go on an evangelizing mission for a couple of years when they turn 18. Or from the Israelis, most of whose young people serve in the armed forces. Each person has got to figure out life for himself. My wife’s grandparents were educators who were passionate about school and dedicated to sending their only son to college – but he was not that interested in the classroom and instead had the skills and passion to become a master welder – and he has led a great life! Or, put another way, if you had a heart attack in the middle of a restaurant, who would you rather rush to your aid, an attorney or an EMT?

      Stixrud insists that parents need to let go of some of their stress and control without giving up caring about their children. And it means embracing a literal world of opportunity for children and adults to make their own way – on their own time. Indeed,

      If a thirty-year-old came into Bill’s office and said that his life had been wasted because he’d made a bad decision in the eighth grade, or in high school, and had closed off all his options, Bill would say, “Buddy, get over it. You still have plenty of opportunities to shape your life.”

      In our next correspondence, we’ll talk about a specific way of embracing kids’ autonomy in their education but I also want to observe that,  even to the degree that teenage angst is an American phenomenon, it’s not obvious to me that teenage empowerment is the norm elsewhere. Indeed, tiger parenting would seem to suggest the exact opposite of the advice that Stixrud et al offer in the preceding paragraphs, with rather dramatic results in the form of BAs, MDs, JDs, and other letters following names. Generally, in the United States, do we suffer more from over-parenting or under-parenting? As a former child myself, I certainly appreciate the idea of autonomy to pursue things of interest – but I also had lots of interests to pursue. I look forward to exploring this more with you but I think it’s certainly safe to say that the most important thing kids need is engaged parenting.

      self driven child

      Figure 5. Click here to acquire The Self Driven Child, a book about how to give kids the space they need to grow up.

      coddling of the american mind

      Figure 6. Click here to acquire the Coddling of the American Mind by Greg Lukianoff and Jonathan Haidt. While both authors fear the collapse of the marketplace of ideas to oversensitive kids, neither has ever voted for a Republican. They agree with former UChicago President Hanna Holborn Gray that “education should not be intended to make people comfortable; it is meant to make them think.” and have found that cognitive behavioral therapy is especially effective at countering the tricks one’s mind plays. 

       

      Thanks for reading! If you enjoyed this, forward it to a friend: know anyone who is a parent? How about a grandparent? How about anyone who is a former child?

        Why Homeschool?

        The Gist: Individualized attention and pacing through a customized curriculum to achieve, on average, higher academic performance.

         

        Imagine a free market university. You are probably thinking of (or perhaps hoping for) something that turns out thoughtful capitalists instead of woke Marxists, maybe with a mandatory curriculum in classical economics and an aggressive internship placement office that gives kids a taste of entrepreneurial America.

        David Friedman has something different in mind.

        What if a university used free market principles in its operations? No more central planning by increasingly expensive administrators who allocate alumni donations and government-subsidized tuitions according to their whim. In fact, no one annual price (“tuition”) that covers a wide smattering of services within the commune from housing to food to recreation to, occasionally, education. Wonder of wonders: Students pay rent for apartments of various quality and convenience! Magically: students patronize restaurants of various specializations and health department grades! Amazing: students join a gym (or not), subscribe to a local newspaper (or not), grab tickets to a play or game (or not), take three months off to travel the world (or not), go see a psychologist (or not), or pay dues to support a club (or not).

        forget teacher

        Figure 1. Have you ever, years after being in school, run into one of your teachers and they had no idea who you are? That tends not to happen with parents. 

         

        Conventional school teachers are also charged with teaching en masse. Within a single class, teachers must teach at an average pace, leaving some behind and some bored. But teachers can also be responsible for a much larger group of kids that they see throughout the day, such that there may be a 16:1 student to teacher ratio at the entire school, but a single teacher is not always closely tracking the same 16 kids throughout their education but may instead be looking after a slice of 100+ kids’ education. And, of course, teachers are likely to change every year, with new adults trying to get a fresh handle on your kids.

        The biggest reason why you SHOULD homeschool is that your child receives individualized attention at the pacing that is best for her. Absent unusually active procreation, the student to teacher ratio is going to be better than any conventional school – and the teacher is going to know students’ precise strengths and weaknesses for years. Kids get to zoom ahead with what they’re good at and spend more time with what they find challenging. This individualized attention tends to be credited for the results: “Numerous studies demonstrate that homeschooled students obtain exceptionally high scores on standardized academic achievement tests” – whereas public school students average the 50th percentile, homeschool kids average in the mid-to-high 80th percentiles. Relatedly, homeschool kids can be years ahead of the standard school curriculum and, though you may think that parents constitute generous graders, homeschoolers enjoy higher average GPAs in college. If you were comparing two conventional schools against each other, wouldn’t you want your kids at the place with the (dramatically) higher averages?

        bell

        Figure 2. BBBBRRRRRRRRIING!!!!!! Alright, that’s all we have time for today. Please return to this same place in this email at the same time tomorrow. Or, you could take a homeschooling philosophy: rather than bells governing the schedule, arbitrarily interrupting the brink of insight, momentum can govern the schedule. Read on, or don’t, it’s up to you!

         

        Of course, academics are not everything – the most frequent concern skeptics bring up is that kids are not properly socialized outside conventional school. This critique is rather difficult to prove or refute statistically – I often ask critics if they’ve actually met homeschoolers or if this is speculation; my own anecdotal experience is that some of the friendliest, most social people I know were homeschooled. But taking the question seriously: what exactly are your kids being socialized to? Or, put another way, would you rather your kids learn values from their peers or their parents? 

        Homeschooling parents have more options in how to socialize their kids consistent with their values –  joining an organized sports team, Bible study, co-op, or whatever they think is valuable. But there’s also something else: conventional schools, for the sake of convenience, segregate kids by age, forcing students into the study of every subject based on when they were born, not how much they get the concept. But why should kids – up until they’re 18, sometimes 22 – spend the vast majority of their time with their exact same age? John Taylor Gatto, an award-winning New York City public teacher, decried that modern kids are ahistorically separated from the adult world, prolonging adolescence. Homeschoolers have the opportunity to forge meaningful relationships with adult mentors and get real world experience through volunteering, community service, observation of workplaces, or even work and apprenticeships.

        Doc Brown

        Figure 3. Great Scott! Not enough kids have their own Doc Brown.

         

        At the heart of homeschooling is flexibility: you are not wed to the “comprehensive,” standardized, politically correct curriculum offered (and too often obligated) by the state. Your customized curriculum for your kids has almost limitless options – you can teach your kids eminently practical subjects like cooking, personal finance, and car maintenance; or you can invest deeper into the great works of Western civilization rather than whatever is trendy; or you can edit the standard curriculum to focus more on what’s important (literacy and numeracy) and less on frills (foreign languages); or you can have your kid specialize early on in whatever their passion is, taking time to pursue it as far as he possibly can, with appropriately less attention on other subjects – a budding businessman might spend the time allocated for English on biographies of industrial titans, for math on analyzing cash flow statements!

        300

        Figure 4. Great works of Western civilization like Zack Snyder’s 300!

         

        For better or worse, conventional school was literally designed by the Prussians to induce conformity and indoctrination. To that end, there’s an interesting question as to whether the 5th Amendment to the Constitution makes compulsory school problematic: “No person shall be… deprived of life, liberty, or property, without due process of law.” If adults were compelled to attend re-education camps under threat of separation from their families, you can bet a court would rule that unconstitutional. Still, some argue that conventional school imposes routine and discipline on children that prepares them for the reality of submitting to employers’ hierarchy. Of course, homeschooling can offer similar values but it can also offer different ones: do you want your child to learn conformity or curiosity, compliance or creativity? 

        There are other things at the margins that can make a real difference. Teenagers have meaningfully different sleep patterns than adults – and yet school’s start is based on adult convenience more than teenage sleep optimization. When one public school delayed start an hour, standardized test scores jumped double digits. Unless you’re in that district, you could adjust your homeschool schedule to accommodate your kids’ health. In the same vein, what is served in school cafeterias is inherently the result of a political lobbying process – you could instead ensure that your kids are eating leafy greens at every meal.

        School lunch

        Figure 5. Then again, can your kids really become adults without the modern rite of passage that is consuming mystery meat and plastic cheese with a spork?

         

        Still, any conventional school, operating at economies of scale, is going to have resources from tax dollars or tuition that allow for lab equipment, theaters, gymnasiums, and any number of other expensive facilities. Some of these can be directly accessed (Tim Tebow laws), some of these can be easily replicated (plenty of private gyms, especially available in the middle of a school day), and some can’t – which might very well limit your kids’ opportunities, especially for leadership. At the same time, homeschoolers have the flexibility to use the world’s resources not at any school – to visit museums and zoos as any field trip might, but also to factories and fire stations or anything else that a parent might think helps a kid learn.

        You may read all this and conclude that a custom education may be ideal for your kids but not realistic for your family – neither parent has the confidence, passion, time to take on the responsibility. Even if one did, parenting and homeschooling may soon become a 24-7 job with no breaks – and that can be a recipe for a lot of stress. Interestingly, when parents are polled about what they would like to do better as parents, they report that they’d like to spend more time with their kids. When kids are polled as to how their parents could be better, they report that their parents really need to reduce their own stress. Whether you pursue homeschooling or not, think about getting yourself in the right place for both yourself and for the quality of your family relationships. 

        Still – not available to all parents – if you’re spending substantial resources on your children – such as sending them to a private school – consider whether your kids might be better served by redirecting those same resources to private tutor(s) whose job security relies totally on the performance of your own kids. The real question is whether there’s a marketplace for quality tutors in your area – good places to look include homeschooling co-ops, the best local conventional school teachers who would like to make some additional money after school, graduate students in particular subjects, or even professionals to teach what they do for a living. 

        The worst reason people do not even consider homeschooling is social pressure – parents’ peers will always understand and approve of efforts to get kids into the right conventional schools but might think homeschooling is weird. It is certainly unusual in the sense that homeschooling is only done by a small minority of parents – but I hope that this email clarifies why they might do what they do! And to quote that old chestnut of parental wisdom: if all your friends jumped off a bridge, would you do so, too? 

        You may also be concerned about getting your kid into the best college possible. Assuming that college is indeed best for your kid, homeschooling actually allows maximum positioning – increased performance on standardized tests but also the flexibility for your kids to accentuate their eccentricities to tell a compelling story to admissions departments. You could also mix and match to some degree, homeschooling until the 9th grade to give your kids a head start and then send them to a high school renowned for sending kids to colleges of interest. Alternatively, you could use the time before and after conventional school hours to help kids with troublesome subjects, encourage them to advance in easy ones, or teach them new subjects altogether – but note that this practice only involves addition, not subtraction, so you won’t be able to totally pick and choose to exclude what you don’t want from conventional school.

        To sum up: conventional school allows parents to delegate education to a team of professionals (often with divided attention and mixed incentives) with substantial pooled resources for facilities, potentially providing opportunity for kids for leadership and social interaction with exact-same-age peers. Homeschooling allows for highly motivated (but perhaps inexperienced) teachers to provide individualized attention and pacing through a customized curriculum, including family values and flexible real world experiences, according to kids’ talents and desires, producing, on average, higher academic performance.

        Dumbing Us Down

        Figure 6. This email was inspired by Dumbing Us Down by John Taylor Gatto, an award-winning New York City public school teacher writing passionately about his attempts to be less juvenile prison guard and more facilitating mentor. Gatto argues that conventional school works well as a daycare and jobs program but fails to fully unleash kids’ potential. He contrasts an earlier American era filled with adventurers and tinkerers supported by families dedicated to virtue against a modernity of divorced parents divorced from fully attending their kids who themselves default to television rather than creating their own fun. Gatto set up a guerilla community service program where each of his students did over 320 hours a year! But he also routinely set up his students for individual “apprenticeships,” dispatching a litterer to apologize to the police and spend a day getting to know how cops work, other kids to learn in real workplaces about journalism or truck dispatching or whatever. Ultimately, Gatto insists that  “We could encourage the best qualities of youthfulness—curiosity, adventure, resilience, the capacity for surprising insight—simply by being more flexible about time, texts, and tests, by introducing kids to truly competent adults, and by giving each student what autonomy he or she needs in order to take a risk every now and then.” I feel compelled to relate a particular story in full:

        “It’s likely I’d have returned to advertising if a little girl, desperate to free herself from an intolerable situation, hadn’t drawn me into her personal school nightmare and shown me how I could find my own significance in teaching… It happened this way. Occasionally I’d get a call from an elementary school. This particular day it was a third grade assignment at a school on 107th Street, which in those days was nearly one hundred percent non-Hispanic in its teaching staff and 99% Hispanic in its student body. Like many desperate teachers, I lolled most of the day listening to the kids read, one after another, and expending most of my energy trying to shut the audience up. This class had a very low ranking, and no one was able to put more than three or four words together without stumbling. All of a sudden, though, a little girl named Milagros sailed through a selection without a mistake. After class I called her over to my desk and asked why she was in this class of bad readers. She replied that “they” (the administration) wouldn’t let her out because, as they explained to her mother, she was really a bad reader who had fantasies of being a better reader than she was. “But look, Mr. Gatto, my brother is in the sixth grade, and I can read every word in his English book better than he can!” I was a little intrigued, but truthfully not much. Surely the authorities knew what they were doing. Still, the little girl seemed so frustrated I invited her to calm down and read to me from the sixth grade book. I explained that if she did well, I would take her case to the principal. I expected nothing. Milagros, on the other hand, expected justice. Diving into “The Devil and Daniel Webster,” she polished off the first two pages without a gulp. My God, I thought, this is a real reader. What is she doing here? Well, maybe it was a simple accident, easily corrected. I sent her home, promising to argue her case. Little did I suspect what a hornet’s nest my request to have Milagros moved to a better class would stir up. “You have some nerve, Mr. Gatto. I can’t remember when a substitute ever told me how to run my school before. Have you taken specialized courses in reading?” “No.” “Well then, suppose you leave these matters to the experts!” “But the kid can read!” “What do you suggest?” “I suggest you test her, and if she isn’t a dummy, get her out of the class she’s in!” “I don’t like your tone. None of our children are dummies, Mr. Gatto. And you will find that girls like Milagros have many ways to fool amateurs like yourself. This is a matter of a child having memorized one story. You can see if I had to waste my time arguing with people like you, I’d have no time left to run a school.”

        But, strangely, I felt self-appointed as the girl’s champion, even though I’d probably never see her again. I insisted, and the principal finally agreed to test Milagros herself the following Wednesday after school. I made it a point to tell the little girl the next day. By that time I’d come to think that the principal was probably right—she’d memorized one story—but I still warned her she’d need to know the vocabulary from the whole advanced reader and be able to read any story the principal picked, without hesitation. My responsibility was over, I told myself. The following Wednesday after school, I waited in the room for Milagros’ ordeal to be over. At 3:30 she shyly opened the door of the room. “How’d it go?” I asked. “I don’t know,” she answered, “but I didn’t make any mistakes. Mrs. Hefferman was very angry, I could tell.” I saw Mrs. Hefferman, the principal, early the next morning before school opened. “It seems we’ve made a mistake with Milagros,” she said curtly. “She will be moved, Mr. Gatto. Her mother has been informed.” Several weeks later, when I got back to the school to sub, Milagros dropped by, telling me she was in the fast class now and doing very well. She also gave me a sealed card. When I got home that night, I found it, unopened, in my suitcoat pocket. I opened it and saw a gaudy birthday card with blue flowers on it. Opening the card, I read, “A teacher like you cannot be found. Signed. Your student, Milagros.” That simple sentence made me a teacher for life…

        I never saw Milagros again and only heard of her again in 1988, twenty-four years later. Then one day I picked up a newspaper and read: Occupational Teacher Award Milagros M… has won the Distinguished Occupational Teacher Award of the State Education Department for “demonstrated achievement and exemplary professionalism.” … Miss M. was selected as a Manhattan Teacher of the Year in 1985.”

        Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend: know anyone who is a parent? How about someone who went to a conventional school? Or perhaps someone who was once a child?

          Literally Making Money

          The Gist: 4 ways that conservatives might handle monetary policy to grow the economy and limit government.

          For 73 years, from 1886 to 1959, you could buy 6.5 ounces of Coca-Cola for a nickel. Customers may have just come off a horse or a jet, but the price did not change. Today, more than six decades later, glancing at my neighborhood grocery shelves, you might pay more than eight nickels for the same amount of the same product.

          Coke

          Figure 1. Though it lacks the pep of the original formula which, of course, contained cocaine. You also would be hard-pressed to find just 6.5 ounces to purchase as the nation’s waistlines have inflated along with its currency.

           

          On a surprisingly related note, you probably dislike writing a check to the government (or having the government directly take money out of your paycheck). If a politician were to advocate for an increase in your personal taxes (rather than the always promised increase in taxes on someone else), you likely would not be happy with them. Worse, if a politician advocated a tax not just on your income but on your wealth, perhaps 2-3% a year, you’d be outraged. And yet that’s not too different from what actually happens with inflation: all of the money in your bank account is worth that much less in Coca-Cola.

          Inflation is a hidden tax and an especially clever one because you might think you have more when you in fact have less. But, of course, it does not affect just you. As Murray Rothbard observed, “By creating illusory profits and distorting economic calculation, inflation will suspend the free market’s penalizing of inefficient, and rewarding of efficient, firms. Almost all firms will seemingly prosper.” As F.A. Hayek added, “including some which ought to fail.” Beyond distorting the price system at the heart of our economy, inflation also punishes savers. At its most extreme, during the Weimar Republic, factory workers were given multiple breaks a day to rush out and buy anything they could with their rapidly depreciating currency. But even at its most gentle: the same number in your account gets less than last year. Rationally, you are tempted to spend it now or even borrow something valuable today to be repaid with something less valuable. The benefits accrue to the nation’s largest debtor, the government, who is largely responsible for inflation. But if one day the government can no longer freely determine the value of its debts, then it faces a reckoning with its profligate spending.

          “Monetary policy” can sound oblique and intimidating but it’s the least familiar, most important topic in American politics. Beyond its hiding behind technical gobbledygook, it’s probably especially unfamiliar because inflation has been fairly low since the 1980s so people aren’t crying out for reform. If (when?) more noticeable inflation makes a comeback, that’s an opportunity to consider alternatives. The ideal system grows the economy, not the government, by sending clean signals to businesses and consumers while restricting the government’s ability to borrow. As a conservative, here is your menu of options:

           

          1. Appoint the right God-King to run the Federal Reserve

          This is actually the easiest route under our present system and about as far as conservatives have ever gotten. It helps considerably if you surround the God-King with like-minded nobility (those anonymous other members of the Federal Reserve that 99.9999% of Americans would not be able to pick out of a line up). The idea is that, at least for the time he is in office, the God-King will astutely manage the nation’s money supply to avoid inflation and, in particular, pursue potentially unpopular policies like the classic example of taking away the punch bowl when the party gets too rowdy or, to continue the analogy, refusing to bail out the friend who gets arrested for drunk driving out of fear that it might prompt other friends in the future to not better manage their own drinking.

          Greenspan

          Figure 2. You might, for example, look to see if there’s some dispositionally unthreatening radical who once served as Ayn Rand’s personal economist

           

          The trouble is that the President appoints the God-King and Senators confirm him and their job security can be intimately related to the God-King’s decisions, which makes them extremely interested in his being pliable to goosing the economy whenever an election is around a corner (which is always). But that’s not all. Because the nation’s elected representatives want to deliver goodies at minimal cost (for maximum re-electability), they want to borrow ever greater amounts and have a compliant central bank aid them along their merry way. 

          This is why conservatives tend to dislike the God-King system, which is basically rigged against sound money – indeed, a nickel in 1913, when the Federal Reserve was created, had more purchasing power than a dollar does today. Insofar as the God-King system is preserved, there is no guarantee (in fact, little hope) that you’d get the right God-King (indeed, you might even get one swept up with magical monetary theory). 

          Importantly, even if you have an extremely smart, fairly independent, very well-meaning God-King, any hint of crisis will tempt him (as fallible as any man) to use the heavy-handed powers of the Fed – to lend out money at generous rates, to buy and sell bonds in vast quantities, to regulate how much reserves banks have – to try to fix the problem. Conservatives generally think that the Fed has no idea what the right interest rate ought to be and should get out of that business altogether to let the market work it out. Conservatives also have very different perspectives from the mainstream on banking reserves (to be discussed later). The power to buy and sell bonds – intimately related to printing more money and the ability of the government to finance its operations – is where there is some acknowledged room for maneuver. But Milton Friedman feared there were excessive, destabilizing lags between a problem like unemployment arising; central bankers discovering and interpreting the problem through statistic collection; and central bankers finally conjuring and applying unpredictable, bespoke, and ham-handed responses. Adeptly deploying sledgehammers with discretion proves impossible.

          And yet, among the options we are going to discuss, this is how things will probably work for the foreseeable future. At the very least, conservatives ought to pay a lot closer attention to who gets nominated to the Fed. Indeed, we probably need a Federalist Society for monetary policy. Who knows if any alternative will ever be politically palpable but one thing is significant: the advocacy of alternatives tends to make the God-King behave.

          andrew jackson

          Figure 3. You can replace Fed Soc’s James Madison silhouette logo with a similar one depicting the magnificent mane of Andrew Jackson. Motto: “The Bank, Mr. Van Buren, is trying to kill me, but I shall kill it!” Since a central bank came back, might as well bring back AJ, too. 

           

          2. Compel the Federal Reserve to follow a simple rule

          The theoretically easiest change to make to our system would be to impose upon the central bank a rule it must follow. The trouble comes quickly in determining what the exact rule ought to be. The Fed currently is supposed to maintain stable prices and “full employment”, the pairing of which actually gives the Fed more discretion as it pursues two goals that tend to require opposite practices. Conservatives tend to favor eliminating the Fed’s goal of reaching full employment not because more people working isn’t great but because the Fed has only so much to do with achieving the dang thing (i.e. is there unemployment because businesses don’t have easy access to capital… or because of regulations or unemployment subsidy or workforce suitability or what?) Nevertheless, Stanford’s John Taylor came up with a mathematical formula that takes into account both goals and spits out a rule that the Fed could follow – but Republican presidents have passed over appointing him God-King because even that limit on discretion has proven too controversial. 

          Conservatives are far more attracted to a rule that simply tracks stable prices or purchasing power. While attractive in principle (isn’t reducing inflation what we want?), there are two significant problems: first, there is substantial disagreement on what prices the Fed ought to track and how it ought to do so. Second, deflation (i.e. cheaper prices) is not necessarily a bad thing – it could be that the cheaper prices are the results of gigantic productivity improvements. Note two things about this chart: healthcare, education, and housing are major and escalating costs for Americans but are not included in the typical government inflation index; screened devices have dropped their prices like a rock. How should the Fed deal with prices moving in opposite directions? It would be silly for the Fed to print more money so that you always had to spend $1,000 on a television even as the manufacturers figured out how to make it for less and less. Simultaneously, increasing healthcare costs may be partially the result of loose money – but they also are more likely to be reflective of a broken system simultaneously subsidized and regulated by the government. Milton Friedman ultimately concluded that such a rule was “too loose and too imperfect” – and that it, too, would easily invite central bankers to tinker. 

          Viagra

          Figure 4. Central bankers are constantly self-conscious about deflation and so they often needlessly take “corrective” actions. But when their inflation lasts for more than four years, they don’t bother contacting anyone, they just pile on.

           

          Reflecting his belief that money was responsive to the laws of supply and demand, Milton Friedman instead suggested that the Fed should simply increase the money supply by a small amount every year – equal to the long-run growth rate of the United States, or about 4%. Interestingly, by doing so, Friedman was actually targeting 0% inflation, hoping that the increase in the money supply would be taken up by economic growth. Relatedly, one of the big worries about a monetary rule is that the Fed would not have discretion to react to a crisis. At first glance, Friedman’s rule looks unresponsive but, because a crisis is often accompanied by a shrinkage in the money supply, a constant 4% increase in the nation’s money supply over last year’s total would actually result in a bigger cash infusion to make up the difference. The trouble with this rule is that the money supply is surprisingly difficult to determine and, due to the constant innovation of the banking system, determination gets harder all the time (Of course money is cash in your hands and your savings accounts – but does it include the surrender value of a life insurance policy?) Notably, this is the rule that has come closest to adoption in the United States, as Paul Volcker broke inflation by letting the market set interest rates and instead managing the money supply. But the God-Kings didn’t stick to it.

          The newest conservative proposal is for the Federal Reserve to target a certain percentage growth in how much is spent in the economy (nominal gross domestic product). That number would combine both inflation and actual economic growth, thus policy would be attempting to balance the two. While it may suffer from some problems we’ve seen before – errors in statistic collection, lags, perhaps punishing good deflation – it tends to be the presently favored rule. There are still other rules out there – smaller countries might, for example, peg their exchange rate to the currency of a country better at fighting inflation than they. Ideally central banks around the world would have different rules and we’d see what happens to their currencies – but because they are subject to the same political pressures as us, we have not seen that level of experimentation in restraint.

          George Selgin argues that “Of countless monetary rules that have been proposed at one time or another, the vast majority would eventually have led to some extremely undesirable outcomes, if not to outright disaster.” He continues, “The argument for a monetary rule isn’t that sticking to such a rule will never have adverse consequences. It’s that the adverse consequences of sticking to a rule may be less serious than those of relying upon the discretionary choices of fallible monetary authorities.” And yet that brings up an important question: even if there was a Constitution for the Fed, would they actually follow it in an emergency when the temptation is greatest to deviate? Milton Friedman mischievously suggested that the Fed be replaced with a computer preprogrammed with the rule – and yet even he suggested that maybe Japan ought not to have such a rule until they break out of their slump. And who is feeding the computer its information? Still, there was once a quasi-automatic standard.

          Hal 2001

          Figure 5. “Grow the money supply by 30% in one year? I’m sorry, Jerome. I’m afraid I can’t do that.

           

          3. Define the dollar as a certain amount of a commodity (such as gold) and require the government to exchange that commodity for anyone who shows up with a dollar.

          The more you think about a fiat currency, the more your head might hurt. The dollar is worth something because you and other people believe it’s worth something and are willing to trade goods and services for it. But that value might change at any time in the future, such that your dollar is worth considerably less (indeed, your nickel might buy 8x less Coca-Cola). Government is responsible for managing the value of the fiat currency but it instead irresponsibly mismanages, mostly because it does not share the same incentives as other users of money. To keep the government honest and limit its ability to infinitely and freely increase the money supply at any time, you could restore the requirement that the government convert the dollar to a preset amount of commodities for anyone who demanded it. This was in fact how paper currency originally worked – the British pound earned its name by once being defined as a pound of silver – the name of the currency was simply a weight and measure, like a yard of yarn.

          Scales

          Figure 6. A dollar was originally an ounce of silver. No longer. But how familiar are you with the Imperial system’s next smallest unit of weight measure? A dollar is now worth an awkward 1.5 drachm. Only a few more years until we have to measure the dollar in grains of silver!

           

          Attractively, a currency backed by commodities almost inherently cannot undergo hyperinflation – and, indeed, has a ceiling on the amount of inflation it can experience based on how much of the stuff there is. For 500 years between 1260 and 1760, English prices rose 0.38% a year, topping out at a whopping 1.28% a year with the massive influx of Spanish colonial silver. Michael Bordo reports that  “Between 1880 and 1914, the period when the United States was on the ‘classical gold standard,’ inflation averaged only 0.1 percent per year… It was also a period of unprecedented economic growth with relatively free trade in goods, labor, and capital.” No wonder Andrew Carnegie agreed to sell his company in exchange for fifty year bonds. Little did he know what was to come: the U.S. dollar was once pegged at $20.67 per ounce of gold. In 2020, an ounce of gold crossed $2,000.

          The principal trouble for consumers is that a commodity-based currency can undergo short-term volatility in its value. For better or worse, the supply of a commodity-based currency can only be increased by an increase in the commodity. If the economy as a whole grows faster than the money supply, the money will actually increase in value – for advocates of the gold standard, this is a virtue: the increased value invites miners to find more gold and for foreigners to export more gold to the country under the standard. Milton Friedman argues that, before World War I, “The blind, undesigned, and quasi-automatic workings of the gold standard turned out to produce a greater measure of predictability and regularity — perhaps because its discipline was impersonal and inescapable — than did deliberate and conscious control exercised within institutional arrangements intended to promote stability.” Mark Skousen argues that, somewhat intriguingly, the supply of gold grows at about the same rate as historic U.S. growth, even during the big shocks, between 1-5% a year, and that it functions more similarly to Friedman’s favored rule than you might guess, though obviously it would not grow at the same rate every year. 

          But the short-term volatility of money’s value has a particular problem with sticky wages: nobody likes to get paid less, even if “less” actually buys more. You tend to think in terms of the stated amount – “I’m paid $30,000 a year” not “I can buy this amount of groceries.” Rather than reduce employees’ wages (which are increasingly expensive), companies might fire them and try to hire someone else. But that someone else might not have mentally adjusted for purchasing power themselves and not be willing to work for less than a certain price. It’s a problematic cycle. Murray Rothbard suggests that money inherently can’t have price stability as a commodity but that if businessmen, consumers, employees were interested in it, they could contract around it by tying their payments to some mutually agreed index.

          A conventional criticism of a commodity standard is that it wastes resources. Austrian economist Roger Garrison seems to have undermined the critique by demonstrating that after the gold standard was abandoned, contrary to Keynesian predictions, substantial resources were still expended pursuing precious metals – in fact, more than before, because of fears about paper currency being worthless. But even were resources specially expended for the purposes of money, George Selgin argues, “Trying to save resources by forcing a switch from a commodity standard to a fiat standard is like trying to save resources by forcing people to take off the locks on their doors and give them to scrap-metal dealers. It is obvious that the cost of making locks is far less than the cost of losing one’s property.” 

          The fact that a commodity standard actually employs resources is what keeps the government honest. If the government wants to expand, it can raise taxes (never popular), borrow (usually at a good rate from its central bank), or it can just overprint money (which is cheap and even gives people the temporary illusion of prosperity). The last is the easiest – unless the government is obligated to exchange its money for a commodity, thereby requiring it to use real resources. Notably, this is something the Founders appeared to understand –  the U.S. Constitution says that “no state shall… make any thing but gold and silver coin a tender in payment of debts” (alas, unincorporated against the federal government) and also gives Congress the power to “coin” alongside, not coincidentally, the power to fix weights and measures. (For what it’s worth, the Federal Reserve itself is of questionable constitutionality, as are all “independent” agencies)

          Though it may sound fairly simple, there are several ways to run a commodity-backed currency and how it’s run affects how “good” it might be. The biggest question is this: does the dollar supply equal the government’s gold supply? For the period that America was supposed to be on the gold standard, the answer was no. The government overprinted dollars on the hope that not everyone would show up at once to claim physical gold. During the Great Depression, the government not only closed the opportunity for citizens to get gold for their dollars, they made private gold ownership illegal. But to at least maintain the fiction we retained the standard, we allowed foreign governments to exchange dollars for gold. But by the time of the Nixon administration, we had overprinted so much that foreigners were rationally demanding gold redemptions for their depreciating dollars. Rather than painfully reign in the money supply, we ended redemption. Given this record, can you really trust the government to maintain the gold standard in a crisis? In the past, the gold standard only really worked because it was considered a source of national shame to abandon it. No longer.

          Isaac Newton

          Figure 7. Isaac Newton spent a good portion of his life trying to figure out alchemy when the secret was right in front of him the entire time: as master of the Royal Mint for 30 years, he just needed to convert to a fiat currency and start printing!

           

          If we were somehow convinced of the government’s benevolence (perhaps through a Constitutional amendment), the economic transition would be a challenge because we have overprinted so many dollars. For maximum benefit, gold standard advocates tend to favor 100% backing, but it’s also 100% theoretical. Indeed, Hayek feared that the global economy was too large for everyone to be on the gold standard. The U.S. government has trillions of dollars of gold in its vaults but not as much as the supply of dollars, which means that it would have to expend resources to get more gold (or, dangerously, restore the gold standard at not 100% backing, thereby tempting the government to gamble on lesser and lesser reserves and you’d quickly get into the problem of defining the money supply). There’s even some questions about whether the government could secure enough gold to back our current money supply. An intermediate step might be the U.S. government selling bonds which promised interest payments in gold ounces, but the U.S. government defaulted on its last issue of those, again raising the question of government trustworthiness. 

          Of course, the dollar does not have to be backed by just gold – gold just happens to have been historically demonstrated over a long time, relatively convenient as a medium of exchange, and somewhat mystical in the public imagination. This last part is fairly intriguing: does gold really have much intrinsic value or does it, like the fiat currency that replaced it, have value because people believe it has value? Some economists have argued for the currency to be backed by a basket of goods, thus limiting the impact of any one commodity’s shortage or glut. But like the problem of determining the price index, what should be in the basket? Relatedly, some supply siders have suggested that the government need not keep any gold at all, just use its powers to try to get an ounce of gold to equal a certain amount of dollars. But, given the short-term volatility of the price and the Fed’s heavy-handed imprecision, implementation would be challenging – and the most significant benefit of a commodity standard is that convertibility keeps the government honest.

          Scissors

          Figure 8. Has anyone in the history of rock, paper, scissors ever really thought that paper beats rock?

           

          As Hayek sums up, “The gold standard… served no other purpose than to impose upon the issuers of money such a discipline and, by making its regulation automatic, to deprive them of the power arbitrarily to change the quantity of money. It is a discipline that has proved too weak to prevent governments from breaking it.” But Hayek points to a fourth option: “so long as the management of money is in the hands of government, the gold standard with all its imperfections is the only tolerably safe system. But we certainly can do better than that, though not through government.”

           

          4. Restore private currencies to compete with and perhaps replace the government one.

          Fundamentally, if you don’t think the government does an especially good job of anything, why trust it with the fundamental responsibility of maintaining currency? Or, at the very least, why require that the government have a monopoly on currency? As Hayek observed, government’s exclusive control over currency “has the defects of all monopolies: one must use their product even if it is unsatisfactory, and, above all, it prevents the discovery of better methods of satisfying a need for which a monopolist has no incentive.” Friedman thought that the law of supply and demand applied to money in managing the supply – but why not take the perspective further? Whatever you personally want out of money – stable purchasing power, for example – the free market might be able to deliver if left to its own devices. Hayek argued we should have “the control of money in the hands of agencies whose sole and exclusive concern [is] to give the public what currency it liked best among several kinds offered, and which at the same time staked their existence on fulfilling the expectations they had created.”

          Why the heck would you want a Deutsche Bank mark rather than the United States government dollar? Well, Deutsche Bank would have to convince you that their currency had value. In the real historical examples of free banking, private currency issuers operated on their own commodity standards, offering to convert their currency to a commodity, usually gold, whenever a customer showed up and demanded it. Essentially, your Deutsche Bank mark is really just a claim on something in Deutsche Bank’s vaults, while your Chase yen is a claim on something in Chase’s vaults, etc. You would accept a salary in DBM because Amazon would accept payment in DBM because ultimately it could be converted into something tangible and useful as a medium of exchange. What sounds novel and scary at first seems a lot more grounded than the system we have.

          Hayek strongly believed that the free market would deliver an inflation-resistant currency: “Money is the one thing competition would not make cheap, because its attractiveness rests on it preserving its ‘dearness’.” Free banking allows money to be chosen by consumers – you and me – not imposed by the nation’s largest debtor. Politicians not only can be but want to be irresponsible with a monopoly state currency. Bankers have to be responsible or else no one would use their currency and they might go out of business. Hayek concludes, “Blessed indeed will be the day when it will no longer be from the benevolence of the government that we expect good money but from the regard of the banks for their own interest.”

          But just how free ought to be banking? An interesting aspect of historic free banking systems is that they were largely self-regulating. Currency issuers not only competed for consumers with better offers of service and reliability but, due to the magic of redeemability, they also were constantly testing their competitors by redeeming other currencies for their promised gold. In other words, a customer might deposit Chase yen with Deutsche Bank, who would then trade Chase for any marks it held – but if the trade were uneven, Deutsche would demand Chase turn over additional gold. As Lawrence White notes, “The overexpansive bank will discover that its specie reserves are draining away, a situation it cannot let persist.” An aggressive bank might quickly get to the point where no competitor would accept their deposits, no credit card would process their currency, no merchant would accept it, no consumer would use it. Contrast this against the experience of the Savings and Loans industry heavily regulated by the U.S. government: in the 1980s, over 2,800 banks and S&Ls failed.

          soccer

          Figure 9. In a professional soccer match regulated by refs, a light tap inspires an Academy Award caliber performance of a career-ending injury. In a self-regulated street game, players play on, lest they not be able to play again.

           

          The United States once had private currency issuers but over-regulation produced more problems than benefits. Rural banks feared that city banks would gobble them up and so successfully lobbied state governments to impose branching restrictions that limited any bank from opening many locations, sometimes not more than one. As a result, banks were not big nor diversified enough to deal with crises and often failed. Furthermore, state governments attempted to make banks partners by requiring that they carry state debt as their reserves – but that debt often was not worth very much, thus leaving banks with a fundamentally unstable foundation. Finally, entry into the banking industry was tightly controlled by state legislatures, meaning that one had to be a better lobbyist than a banker in order to get a license to print money. 

          Across the border, Canada’s contemporary free banking experience was a model of stability (and, indeed, their lack of branching restrictions meant that in contrast to the thousands of American banks that failed after 1929 in the Great Depression, zero Canadian banks failed). Scotland had a free banking system for about 150 years with considerably less regulation and, in particular, zero barrier to entry, such that one of the largest ultimate banks began as a linen exporter. Our modern world feels so vastly different from a proliferation of currencies that it can be hard to contemplate. Hayek began thinking about the idea in the context of border towns and tourist centers that took multiple government currencies. Cryptocurrencies give you a bit of insight but ultimately differ in their lack of redeemability for a commodity as well as their very limited present use in purchases of goods and services. But consider your possible enthusiasm for airline miles or credit card points or any number of other practically private currencies in effect today, where you can redeem them for some product, perhaps only at their offering store – but why should they not be allowed to trade on the open marketplace? There’s a small secondary market for gift cards, where Amazon trades basically at par and less popular retailers you can get at a discount. To the degree that you’re afraid the airline will devalue your miles on the open marketplace, that’s the point: you would not want to be paid in such a currency. But if a merchant found that its rewards program was circulating at par around the economy, perhaps because it offered redeemability in a commodity, then it might quickly find out that it’s actually a currency-issuing bank.

          Notably, most Scottish banks had a feature that is very unusual in today’s world: they were unlimited liability corporations, meaning that shareholders were completely on the hook for their problems. As you can imagine, this led to a great degree of prudence in their operations. Even when Scottish banks did (rarely) fail, currency holders were made whole. While the purest free bankers believe that banks should be able to choose their liability exposure and then advertise to customers to choose between them accordingly, this is one simple, significant regulation that could head off a lot of future issues while not even requiring any regulators.

          Jail

          Figure 10. As if personal liability was not enough, this was also a time of debtors’ prisons!

           

          The more contentious bank regulation – something that is considered across all four possible ways to reform our monetary system we’ve been discussing – is how to deal with regulating bank reserves. Conservatives have tended to believe that the financial system relies on a myth that money can be in two places at once – you have your money in a bank account that you can withdraw entirely at any time, but the bank is simultaneously using that money to lend out to others. That’s why a run can ruin a bank. Presently, the government requires that banks hold a certain relatively small percentage (about 10%) of their outstanding loans in reserve in case depositors need it and, through the FDIC, it also guarantees that, eventually, accounts under a certain size will be restored to full value by taxpayers in case of the bank’s failure.

          Conservatives have tended to consider this a pre-bailout inviting banks to moral hazard and have for a long time favored 100% reserve banking (also called single-purpose banking). Banks would be split between two functions, warehouses for money and lenders. You could either have total access to all of your money at any time (as if it was in a safe deposit box) or you could agree to eliminate your access in exchange for an interest payment (as if you bought a bond). An unpopular feature of this is that you may have to pay to store your money – but perhaps not if banks ran it as a loss leader to attract customers. But conservatives have nevertheless advocated for the position as a way to stabilize the banking system (if your bank must keep 100% of your money, no reason to make a run on on it) and (especially for Friedman) control the money supply (banks no longer have discretion on what proportion of their reserves to lend out). Notably, no lender of last resort is necessary.

          If banks were legally able to issue their own currencies, the outstanding currencies would be, from an accounting perspective, very similar to the liabilities that banks possess in savings accounts. The freest bankers insist that the government really ought to have a 0% reserve requirement and let competition work out the problems. Notably, in the Scottish system, this occasionally meant that banks were down to as little as 2% of their reserves – and, as a result, they sometimes instituted policies that meant customers might have to wait 6 months from a redemption request in order to get their gold. Interestingly, though this delayed redeemability was unpopular and attracted some limited regulation, the notes circulated at par in the interim and were indeed redeemed as promised. While no restrictions on reserves worked for the Scottish banking system, it might have been due to other factors like their unlimited liability and (eventual) convertibility to gold. If we had instant totally free banking today, there might be more risk if consumers were prepared to accept, say, cryptocurrency, as a reserve. Compared to our current system, though, Selgin suggests, “If consumers were willing to accept a fiat standard voluntarily, banks could induce them to do so by offering higher interest rates than competitors who still held commodity-money reserves, reflecting the lower operating costs of not having to hold non-interest earning assets. If this does not happen, one must conclude that consumers perceive a commodity standard as a higher-quality good than a fiat standard.” Notably, if there is no reserve requirement, there is dramatically less pressure on having the exact amount of resources to match the money supply.

          Mark Skousen asks, “On a practical level, who wants to deal with potentially dozens of different kinds of privately issued bank notes?” Hayek responds, “If the public understood what price in periodic inflation and instability it pays for the convenience of having to deal with only one kind of money in ordinary transactions, and not occasionally to have to contemplate the advantage of using other money than the familiar kind, it would probably find it very excessive.” The point is that there is no natural monopoly in currency where competitors are allowed to produce. Hayek continued, “in the field of money I do not want to prohibit government from doing anything except preventing others from doing things they might do better.” Sweden for seventy some years had a system of begrudging free bank acceptance in addition to a government-preferred bank with a very explicit policy that no private bank would be bailed out. But the government favoritism backfired: the private banks were so responsible that none failed – indeed, despite the facts that their currency was not legal tender and was actually taxed, they were so successful at attracting consumers that the preferred bank successfully lobbied that it could only survive if given a monopoly on currency issue, thus ending free banking in Sweden.

          Walmart

          Figure 11. On a practical level who wants to deal with potentially dozens of different kinds of private grocery stores or newspapers or anything else free enterprise competitively offers? Very probably: You.

           

          I must conclude with the sad story of the Liberty Dollar. For nine years, Bernard von NotHaus sold tens of millions of dollars in gold and silver medallions to hundreds of thousands of Americans who either could take delivery outright or receive a certificate that allowed them to redeem their precious metals at any time. The George W. Bush administration responded by raiding his vault, seizing nine tons of precious metals (some medallions depicting Ron Paul), publicly accusing von NotHaus of “domestic terrorism,” and trying him for counterfeiting. Tragically amusing, his lawyer insisted “the last thing Mr. von NotHaus wanted was for Liberty Dollars to be confused with coins issued by the United States government.” We shall see what happens to cryptocurrency, but the U.S. government does not appear to be interested in currency competition in the near future. 

          As stated near the beginning, the ideal monetary system sends as clean signals as possible to business and consumers while restricting government’s ability to grow.  If government’s growth was fueled by central banks, then reverse engineering the process means eliminating the central bank. As Hayek noted, “There can be little doubt that the spectacular increase in government expenditure [-] with governments in some Western countries claiming up to half or more of the national income for collective purposes [-] was made possible by government control of the issue of money.” So, “Unless we restore a situation in which governments (and other public authorities) find that if they overspend they will, like everybody else, be unable to meet their obligations, there will be no halt to this growth which, by substituting collective for private activity, threatens to suffocate individual initiative.” Indeed, “Under the prevailing form of unlimited democracy, in which government has power to confer special material benefits on groups, it is forced to buy the support of sufficient numbers to add up to a majority. Even with the best will in the world, no government can resist this pressure unless it can point to a firm barrier it cannot cross.”

          Adam Smith, the father of modern economics, wrote eloquently about the power of capitalism to bring us wealth. Perhaps not surprisingly, he lived right in the middle of Scottish free banking with redeemability for commodities. At the time that he wrote, he considered his advocacy of free markets practically utopian, and yet within the coming decades Britain embraced most of his agenda. If you desire limited government and sound money, don’t be deterred by what is seemingly politically possible. Fight for the firm barrier that government cannot cross.

          vienna chicago

          Figure 12. For background about conservative economic approaches, check out Mark Skousen’s Vienna & Chicago: Friends or Foes? Chicago tends to prefer a rule-based solution to our monetary predicaments, though Milton Friedman softened on gold and free banking in his later years. Austrians tend to be split between those who favor a gold standard and those who favor free banking. See my two part review: first, about the history of how the schools came to be; second, about what their differences are. For a primer on what the Fed actually does, Steven Horwitz’ introduction from the Mercatus Center is quite good, though the Fed’s response to covid will require an update.

          capitalism and freedom

          Figure 13. For more details on a monetary rule, check out Milton Friedman’s Capitalism and Freedom, which tackles a lot of topics but also explains his preference for a rule slowly growing the money supply. You should also read Scott Sumner’s case for NDGP targeting. You can also read George Selgin’s caution about monetary rules in this blog post. 

          What has gov done to our money

          Figure 14. For more details about a commodity based standard, check out In Search of a Monetary Constitution, an anthology of various bright conservative scholars arguing about different potential monetary systems in 1962. Ben Graham favors a basket of goods, James Buchanan playfully argues for a brick standard, someone else argues for a fractional reserve gold standard, and Murray Rothbard argues for a 100% gold standard (and there are still others, including Milton Friedman, arguing for various non-commodity standards). Though this book is quite good, it can be hard to pin down. If you’re eager to read something on this, try Murray Rothbard’s What Has the Government Done to Our Money?, which includes both his contribution to In Search of a Monetary Constitution and an additional essay.

          denationalisation

          Figure 15. For more details on free banking, check out F.A. Hayek’s Denationalization of Money; Lawrence White’s Free Banking in Britain; and George Selgin’s The Theory of Free Banking. Hayek revitalized interest in free banking and his book is a smart, speculative take on what free banking might look like. White did significant research into how free banking worked in practice during his longest run: some 150 years in Scotland. Selgin surveys other historical examples but spends most of his book digging deep into the theory of how it might work. Notably, the works of White and Selgin are available for free!

          Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend: know anyone interested in economics or history? How about someone who wants limited government? Or do you know anyone who ever uses money to pay for things?

          I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

            Invisible Hand or Iron Fist

            The Gist: How the ideas of free market capitalism triumphed over Marx and might still over Keynes.

            A review of Vienna & Chicago by Mark Skousen.

            If you desire limited government, there are a couple of things you need to get right first. 

            Acme Time Machine

            Figure 1. Time travel and/or a well-regulated militia ready to tar and feather select politicians.

             

            The first prerequisite of limited government is the law, and in particular, a governing constitution. Why is kind of obvious: if you actually enforce the rules that say the government can only do a finite number of things, you’re already there. The trick is setting up institutions that will see that project through. The second is the most important, least familiar topic in American politics: sound money. Here, the relationship to limited government might not be immediately clear – but so long as government can unilaterally determine the value of its debts (i.e. the value of the dollar), it has a lot of flexibility around its supposed limits.

            Home

            Figure 2. Pro tip from governments and little kids when they discover they’re losing a game: next time you arrange a mortgage with a bank, surreptitiously add a clause to the contract that indicates that all payments are to be made in your very own currency. Whatever the interest rate, print off whatever denomination of your own portrait you’d like!

             

            We have a long ways to go on restoring the original meaning of the Constitution, but we’ve at least spent decades trying to build a farm team of potential jurists with the right mindset while winning over the public to the need for them. Nominees to the Supreme Court attract mass attention and intense scrutiny to match their importance. Nominees to the Federal Reserve, on the other hand, barely get a notice beyond the financial pages of dying newspapers. Can you name any currently serving governors, beyond the chairman? That kind of quiet would be fine if we were getting what we wanted but, until we do, money is too serious a matter to be left to the central bankers.

            But what is a “conservative” view of money and what should we want? At a very high level, conservatives have tended to be skeptical of both inflation and intervention, which in the last few centuries typically means limiting the discretion (or existence) of central bankers. Because unrestrained central banks empower further already powerful interests – the government and banking industry – conservatives have always fought an uphill battle. (Not to mention that bankers often support much of the rest of a conservative financial agenda, so they’re thought to be friends). But conservatives have also faced a significant challenge in that they’ve never been able to agree on exactly how to limit central bank discretion. In 1962, a collection of essays was released by a number of prominent free market oriented economists, including future Nobel prize winners, called In Search of a Monetary Constitution – and their smart proposals were all over the map, often contradicting each other. 

            I want to dig into the potential solutions to this problem in another email, but to really understand them, you have to be familiar with two schools of economic thought associated with the right, how they came into being, and why and where they disagree with each other. What follows is primarily a review of Mark Skousen’s Vienna & Chicago: Friends or Foes?, describing the histories of the Austrian and Chicago schools of economics. 

            For several centuries, there was a general “mercantilist” understanding that there was only so much gold and silver and worthwhile objects in the world and so national economic policy was about trying to get and keep as much of that value as possible. Loath to give away precious metals to potential rivals, royals aggressively taxed and restricted international trade, instead preferring to pursue self-reliance, initially to the microscopic point of individual agricultural manors, eventually at a national level that spurred global colonialism. At one time or another, there were substantial debates about the morality of lending at any interest rate (even the morality of freely-set prices) or about the value of private versus public property. Royals were often keen to deal with convenient, cooperative, taxable economic actors like guilds or monopolies. Mercantilism’s virtue was that it embraced savings (but only because they didn’t want any gold to leave the country). Economics was understood to have very clear winners and losers, especially internationally, and every state naturally wanted to be a winner.

            smeagol

            Figure 3. Among the most famous mercantilist economists is Smeagol, known for putting the precious in precious metals.

             

            1776 saw the popularization of a different model. The year may not point to what you think. Though America was founded by free trade radicals, what started to alter government officials’ perception of how much they should intervene was a book: the Wealth of Nations by the Scottish philosopher Adam Smith. Smith famously argued that the path to national (and personal) riches did not come through careful management by government officials but instead from allowing people to be free to pursue their own interests through which they might be guided, as if by an invisible hand, to efficient ends for society at large. “It is not from the benevolence of the butcher, the brewer or the baker, that we expect our dinner, but from their regard to their own self-interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.” Smith advocated for low and simplified taxes, open business competition free of subsidy, “free trade, limited government, balanced budgets, the gold standard, and laissez faire; in short, maximum economic freedom.” Smith’s views would generally be adopted by the British government, spurring the industrial revolution and massive wealth creation (as well as imitation around the world). Remarkably, there even emerged a powerful political lobby for the freest market possible that only began to fray as Britain faced trouble paying for its new promises of welfare.

            But tangential to Smith’s variety of good points, he also advanced a theory that the value of anything came from the labor that went into it. You yourself only have so many hours in a day to do your own job, to raise cattle and butcher and prepare it to eat, to grow cotton and fashion it into clothing, etc. With wealth, however, you could pay for others to do this for you – i.e. their labor. “The real price of everything, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it,” Smith claimed. 

            Within a few decades, free market economics faced its most serious theoretical challenge: Communism. Earlier than you might think, in fact: the infamous Manifesto was published in 1848. Karl Marx built his critique of capitalism on the foundation of this labor theory of value – clearly the rich were exploiting the poor! People were contributing their labor without capturing all of the profit! Marx seized on a flaw in Smith’s analysis and came to radically different conclusions as a result: “While Adam Smith views the commercial world as harmonious, progressive, and socially stabilizing, Karl Marx sees capitalism as brutally exploitative, alienating, poverty-stricken, and crisis-prone.” There was no invisible hand of the free market – just an iron fist wielded by greedy capitalists. In essence, Marx insisted, laborers were slaves. Proclaiming that he had discovered scientific laws of economics, Marx promised a better system – if only workers of the world would unite and seize control of the means of production. Then a workers’ paradise might emerge, where resources might be extracted and distributed “from each according to his ability, to each according to his need.” This perspective proved more popular than was beneficial for those who would live under it.

            The Austrian School of economics emerged to defend capitalism in its first great crisis of credibility. Carl Menger, an economist literally from Austria, argued that the whole labor theory of value is wrong. Products and services are not valued on the basis of how much work is put into them – they’re valued differently and subjectively by every consumer. In particular, if you’re hungry, that first bowl of ice cream looks delicious and you will readily pay handsomely for it. But the 11th bowl of ice cream may require the exact same amount of labor to produce but you may be willing to pay NOT to eat it. Or as Menger himself noted, if people stopped smoking tobacco, the tobacco would lose value in the marketplace even though the amount of labor that went in didn’t change at all. “He noted that farm land used to grow tobacco doesn’t fall to zero, but is valued according to its next best, or marginal, use, such as growing wheat or raising cattle.”  This “marginal revolution” pioneered concepts like marginal utility and opportunity cost.

            Collectibles

            Figure 4. If you’ve ever been puzzled by your grandmother devoting substantial resources and countless hours to collecting obscure knick knacks or by your grandson devoting substantial resources and countless hours to following an offensive musical genre easily confused with totally random very loud noises, then you’ve discovered the subjective theory of value. 

             

            But the Austrians didn’t stop at correcting Smith’s error. They proceeded to demolish the whole Marxist framework. Another literally Austrian economist, Eugen von Bohm-Bawerk, argued that the Marxist theory of exploitation ignored the plain fact that capitalists were efficiently contributing capital to projects that would otherwise not exist. In particular, a capitalist was willing to forgo the use of his money in the short term to pay a construction crew to build a factory and workers to manufacture products in the hopes that he’d eventually get paid back (and hopefully more), thus bearing a risk that the presently-compensated workers do not. In the Marxist model, should workers forgo wages, possibly for years as initial costs are paid off, until and unless the profits come in? To ensure that every worker captures the full value of his labor according to Marx, how should any profits be split between the workers who built the factory, the workers who supplied the raw materials, the workers who manufactured the end product, all the other workers who somehow contributed to the outcome? True slave labor would emerge in self-titled Marxist economies where workers did not have much choice about how to deploy their efforts; by contrast, in a free market, workers could offer their labor to the highest bidder, before their work even produces profit to pay for it. Free to contract, both worker and employer benefit – otherwise, they wouldn’t make the deal. Skousen argues that this “critique of Marx’s exploitation theory is considered so devastating that Marxian economics never really took hold of the economics profession as it did in other fields. He demonstrated that entrepreneur/capitalists deserve the fruits of their labor because they take greater risks than workers fulfilling a vital creative use in the market system.”

            As if that was not thorough enough, another literally Austrian economist, Ludwig Mises, took on the reality of centrally planned economies as they came into existence. Marx never got a hold of the national means of production himself, but he inspired others who did. Setting aside their tendencies toward mass murder, their practical application of Marxist ideas involved a small number of central planners replacing the spontaneous agreements of consumers and capitalists as deciders of how to distribute resources. Mises pointed out that, in a complex national economy, this was not only extremely difficult but actually impossible to do well -“without prices and competitive bidding, a centrally planned totalitarian state could not operate an efficient, progressive economy.” Real, unsubsidized, unregulated prices instantly demonstrate to everyone the economic value of a product or service. As F.A. Hayek expanded on how this works in a capitalist system, 

            Assume that somewhere in the world a new opportunity for the use of some raw material, say, tin, has arisen, or that one of the sources of supply of tin has been eliminated. It does not matter for our purpose—and it is very significant that it does not matter—which of these two causes has made tin more scarce. All that the users of tin need to know is that some of the tin they used to consume is now more profitably employed elsewhere and that, in consequence, they must economize tin. There is no need for the great majority of them even to know where the more urgent need has arisen, or in favor of what other needs they ought to husband the supply. 

            In contrast, a central planner must decide how much resources to devote to mining tin and how to disperse the tin across the entire economy – but how would they know how valuable tin is to users without knowing what they’d pay for it? Or, as Mises simply asked: how does a central planner know whether to build a bridge? If it should be built, where along the river? With what materials? How does he weigh the opportunity cost of countless alternatives? How will he be held accountable for the decision? The far better solution was to empower capitalists to put their capital at risk when prices signalled that a profit could be made. Or, to paraphrase Winston Churchill, socialists criticize profits but the absence of profits is far worse. 

            All of these arguments helped restore laissez-faire to a position of preeminence in the late 19th and early 20th centuries, at least among economists, and certainly versus Communism. In practice, British and American politicians were more or less pursuing the right path, but were also pursuing fresh socialist schemes, central banks, tariffs, antitrust, and any number of economic interventions that Austrians found anathema.

            But in addition to savaging Marx and salvaging Smith, the Austrians were promulgating new ideas about economics, including a theory of the business cycle, wherein the drunken hazes of booms are followed by the correctional hangovers of busts. In the Austrian view, the booms were fueled by over-aggressive bankers (later, central bankers) who lent out too much money at rates that fooled consumers into overspending and capitalists into malinvestments. When money is cheap to acquire, everyone is tempted by (marginal!) buys that wouldn’t normally make sense. Busts were the inevitable outcome where people realized their mistakes.

            gator

            Figure 5. When money is cheap (and you’re drunk), suddenly the numbers on that real estate deal upgrading alligator-infested swampland start to look real promising.

             

            Throughout the roaring 1920s, Mises and Hayek were predicting that a big crash was coming – a fairly easy prediction, given the theory, and why Austrians are known for predicting 8 of the last 2 recessions. When the crash did come in 1929, Austrians were suddenly the belles of the ball – everyone wanted to know what the economists who called the crisis recommended what to do next. But the response of the Austrians did not satisfy their listeners: Don’t just do something, stand there! The Austrians insisted that the bust would work out the problems of the boom – and if the bust was especially severe, it was because the boom was especially irresponsible. Austrians warned that government intervention would actually make the economy less stable because you would be sending the wrong signals, again, to capitalists about the desirability and safety of possible investments. Instead, the harsh medicine of the Austrians was to let the pain happen: every unemployed person would be willing to work for less and less over time and capitalists would eventually look at the bargain offered by labor and rebuild the economy on a firmer foundation. Relatedly, all in accordance with supply and demand, any product already produced would eventually drop in price to become consumed. Creative destruction would replace old, inefficient firms with new, spry ones.

            This was not what government officials wanted to hear. “In the United States, industrial output fell by 30 percent and nearly a third of the commercial banks failed. The unemployment rate soared to 25 percent. Stocks lost nearly 90 percent of their value. Europe and the rest of the world faced a similar fate.” Capitalism faced its second major crisis of credibility. Unable to withstand the pain, many governments turned to John Maynard Keynes to try to “fix” rather than fully replace capitalism. “Keynes’s principal thesis is that financial capitalism is inherently unstable and therefore inescapably flawed” – a free market economy could not always guarantee full employment, for example. Keynes offered the flattering and enabling solution that brilliant government officials only needed to tinker with the economy – at its most basic, in rough times, government should borrow against the future and stimulate by spreading money around (perhaps the money would be used frequently, thus you’d be getting a multiplier of the effect!) When the crisis was past, when prosperity returned, governments could raise taxes and reduce spending, paying off the debt. (Except somehow otherwise dedicated Keynesians mostly forget about cutting spending in the good times).

            barbell

            Figure 6. The motto of the Austrian Gym is “No pain, no gain”. No trainers, of course: you just hit the machines and build those muscles. Result: Arnold Schwarzenegger. The motto of the Keynesian Gym is “No judgment.” There are no trainers, either, just “Buddies” assigned to encourage you between opulent snacks at the in-house ice cream bar whenever you’re tired. Result: Chris Farley.

             

            But that wasn’t all. Austrians insisted that people needed to be free to save their money because saving itself represented a valuable signal as to whether profit opportunities were worthwhile. Keynes instead called this the paradox of thrift: saving might be nice for an individual but, according to Keynes, was bad for the economy at large because money was on the sidelines during a crisis. Furthermore, Keynes charged, the wealthy were disproportionate savers and so must be induced through progressive taxation and estate taxes and whatever other penalties can be politically applied to get them to go out and spend. As a result of Keynes winning this argument, America has built nearly a century of policy on the very successful attempt to get our citizens to consume – never mind the Austrian insights about saving for the right opportunity or “that an increase in consumer spending is the effect, not the cause, of prosperity”; never mind the general benefits of saving for a rainy day; never mind practically no one puts their money under their mattress, so money in a bank means loans to others are cheaper.

            conjunction junction

            Figure 7. Consumption function, what’s your injunction? 

             

            Austrians dismissed Keynes as a passing fad – and were stunned that not only governments but that the economics profession embraced his theories wholly and at length. Though the pioneering earlier work of Austrian economists on marginal utility, opportunity cost, price signals, and other concepts were integrated into mainstream economics, Austrians’ continued belief in the true freedom of markets amidst and after the Great Depression invited – pun intended – marginalization. The Austrians made occasional headway in popular books – in very likely the last time that a political movement attempted to win power by distributing a book, Britain’s Conservative Party sent out thousands of copies of F.A. Hayek’s Road to Serfdom in a fruitless attempt to persuade voters to return to the free market – but they were otherwise on the outs for decades as Keynes reigned supreme.

            But in the years after World War II, some questions about Keynesian economics started to come from scholars at the University of Chicago. Whereas the Austrians had tried to engage Keynes on the abstract level of theory, Milton Friedman started to run the numbers on Keynesian formulas, predictions, and theories and discovered… they didn’t actually work. The supposed multiplier of government spending during a recession may not even add. Whether the government taxes or sells debt, it has to take money from somewhere else. Friedman and Chicago School colleagues further unraveled data that demonstrated that consumers did not act like Keynes predicted, specifically that they could not be so easily induced to spend their own money with a temporary prod from the government. “Friedman, a scholar intimately familiar with the Keynesian language, apparatus and policy implications, used Keynes’s own language and apparatus to prove him wrong on every count.”

            Furthermore, whereas Keynes had made government fiscal policy (how much the government spends) the center of his attention, Friedman came to realize that far more important, perhaps the only important thing, was actually monetary policy (how much the dollar is worth). Friedman revived an old theory originating with, of all people, the astronomer Copernicus: money acted according to the same principles of supply and demand as any other product, thus the value of the dollar can be influenced by how many dollars are in circulation. Friedman concluded that the Federal Reserve is generally quite bad at managing their work, partially because they don’t actively manage the money supply but instead try to manage the interest rate at which money is lent, too often excessively favorably to the government; partially because supposedly nimble discretion involves lags between a problem like unemployment arising, central bankers discovering and interpreting the problem through statistic collection, and central bankers finally conjuring and applying unpredictable, bespoke, and heavy-handed responses.

            sun

            Figure 8. Both embracing truth attacked as heresy, Friedman fared better than Copernicus’ other disciple Galileo. But then, the Fed doesn’t yet have the power of house arrest. Wait for the next crisis, though.

             

            Initially, in the prosperous 1950s and 1960s, Friedman’s work consisted of an extremely well-researched historical argument, especially famous for recasting the reasons for the Great Depression (the severity of which he blamed on the central bank bungling the money supply). But soon the argument became very real. After Keynes’ death, the next generation of his followers had come to believe that there was a fundamental relationship between inflation and employment – and that the trick of the bureaucrats was to have full employment with manageable inflation. But in the 1970s, something impossible seemed to occur: high inflation and unemployment happened simultaneously! Keynesians grasped for solutions (wage and price controls?) but lost serious credibility as “stag-flation” continued unabated. Chicago’s thoroughly backed research revived the credibility of laissez-faire economics. Eventually, the Fed (and the British equivalent), having exhausted Keynesian suggestions, under the threat of the Austrian recommendation to return to the gold standard, managed the money supply for long enough to bring inflation under control. But, significantly, Chicago did not fully win the debate: whereas Milton Friedman ideally wanted the Fed replaced with a computer that would automatically grow the money supply by a small amount, he otherwise suggested that the Fed be constrained by rules they must follow. Though Chicago remains deeply influential to the Fed (which did not start publishing estimates of the money supply until Friedman estimated and published them himself), it operates under no especially binding rules.

            Great lakes

            Figure 9. Because the University of Chicago is proximate to the Great Lakes and its Keynesian rivals tended to be based at universities near the coasts, the debate was amusingly referred to as a battle between “freshwater” economists and “saltwater” economists. In case you didn’t realize, drinking saltwater is hazardous to your health (and wealth).

             

            While Friedman was a giant of the Chicago school and the primary debunker of the Keynesian challenge to laissez-faire, the Chicago School also diligently and numerically advanced the principles of free market economics across a wide range of disciplines, prompting them to win a cornucopia of Nobel Prizes for work on transaction costs, regulatory capture, law and economics, public choice, the efficiency of the stock market and more. Chicago’s work may not yet have cut government, but it has certainly made lots of government programs less credible. As Friedman argued, “One of the great mistakes is to judge policies and programs by their intentions rather than their results.” To describe their role in the battle of ideas, George Will once quipped, “The cold war is over and the University of Chicago has won.” 

            Today, our economic battles are often impenetrable debates between math nerds in the Chicago School or Keynesian persuasion, the latter freshly ascendant after the 2008 financial crisis shook faith in the capital system (never mind the massive government involvement in housing). Keynes can never quite be killed off because he is Santa Claus to politicians (except that he rewards the especially naughty ones). But the Austrian way of thinking never went away – the Austrians are not merely Chicago’s predecessors. The two schools have important, notable disagreements that we shall explore in our next correspondence.

            vienna chicago

            Figure 10. Click here to acquire Mark Skousen’s Vienna & Chicago, a good overview and introduction to its subject matter. If you have not already, check out the entertaining and insightful rap battles between Marx and Mises, Keynes and Hayek.

            Free to choose

            Figure 11. Click here to acquire Milton Friedman’s Free To Choose (also a miniseries well-worth watching), a powerful introduction to Chicago by its most famous member. Click here to acquire Howard Baetjer’s Free Our Markets, a modern introduction to the Austrian way of thinking.

            Red plenty

            Figure 12. Click here to acquire Francis Spufford’s Red Plenty, a revealing exploration of Soviet central planners trying their best to work without prices. (Spoiler: It doesn’t work.)

            Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend: know anyone interested in economics or history? How about someone who wants limited government? Or do you know anyone who ever uses money to pay for things?

            I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

              Worse Than a Stock Market Crash

              The Gist: You’ll eventually recover from a crash. Not so much from confiscation, inflation, deflation, and devastation.

              A review of Deep Risk by William Bernstein.

              The easiest ways for our government to dispatch its massive and increasing debt are not especially pleasant for you – Uncle Sam could either take your money through ever more taxation or make it worth less (or worthless) through ever more inflation. If you’re a U.S. bondholder, you could even see a default, which is really just another form of confiscation. Such actions aren’t likely to be salubrious for the economy around you, either. 

              Axe

              Figure 1. Or, of course, the government could cut spending, but what are the odds?

               

              Worse, these are financial risks that you don’t really recover from. A 90% loss in the Great Depression might have been a disaster for your U.S. stock portfolio but, if you held on, you would have eventually not only completely recovered but also made substantial gains. Far less likely: the government imposes a wealth tax, seizes your assets, and then somehow makes it up to you in the future.

              So, how do you insure your personal portfolio against these risks? Paying premiums to the Republican Party only gets you so far – the party’s undying enthusiasm for tax cuts is not appropriately matched with undying enthusiasms for spending cuts and sound money. Even if the GOP’s platform was perfect and vigorously pursued, it does not enjoy the political hegemony of Singapore’s People’s Action Party, which has ruled for six decades without interruption. 

              William Bernstein gives advice in his brief book “Deep Risk,” which identifies four threats to your portfolio that could result in a “permanent loss of capital” over 30 years: inflation (especially of the hyper variety), deflation (especially if you’re a debtor), confiscation (primarily by your government), and devastation (primarily by someone else’s government).

              commencment

              Figure 2. As one Boglehead quipped, Bernstein missed “tuition

               

              Bernstein’s book is partially inspired by the Permanent Portfolio created by former Libertarian presidential candidate Harry Browne and articulated for present audiences by Craig Rowland. The Permanent Portfolio is a conservative, uncorrelated asset allocation recommendation designed to weather a variety of economic conditions. Boldly, Rowland claims that “the four economic conditions (or some combination of them) are the only ones that can exist in a modern economy. In other words, at any point in time, the economy is either expanding (prosperity) or contracting (recession) and the money supply relative to the supply of goods and services is either expanding (inflation) or contracting (deflation).” Browne recommended an even split of assets he thought would do well in each environment – gold to counter inflation, long-term U.S. bonds to take advantage of deflation, an index of U.S. stocks to ride prosperity, and cash or short-term Treasury bills for flexibility in a recession. Bernstein notes “For the 37.5 years between 1976 and June 2013, the PP, rebalanced at year end, returned 8.66%”; further, “the PP shone in [the financial crisis of] 2008, with a nominal loss of just 1.38%.” But while Bernstein is impressed with elements, he believes the allocation is both too conservative (not enough exposure to the real long-term gains available in stocks) and miscalculates the risks (not all four of the economic conditions are equally likely and recessions are recoverable). In particular, inflation is the deep risk our wealth is most likely to face.

              Mondale

              Figure 3. “Here at Mondale & McClellan, we believe that the portfolios of presidential losers can make you a winner! Try out our Willkie Forty – a value-tilted portfolio of dividend-distributing private utilities – or perhaps our Hoover Hundred – an international collection of precious metal miners. If you’re looking for a bargain, our Landon Energy Fund is the place for you! If you’re seeking more excitement, the Perot Growth Index offers the chance to get in early on the hottest information technology; the DoleMcGovern Fund captures the whole pharmaceutical sector; and the Gore Group offers a mix of green bonds and stocks. For the discerning investor, Mondale & McClellan is also pleased to announce the special opportunity to participate in our private equity fund of funds – the Romney Fund – as well as our KerryMcCain Matchmaking Services (primarily consumer-products oriented)”

               

              Americans of my generation have no earthly idea what really bad inflation can look like. Millennials might have waited hours for the latest iPhone or Harry Potter book – but none have had to wait for gasoline. But my father’s double-digit interest mortgage payment in the late 1970s was nothing compared to the horrors of living through hyperinflation, infamously captured in the German Weimar years with the image of a man using a wheelbarrow of cash to pay for basic groceries. At the time, industrial workers were given multiple breaks a day – not to smoke or grab coffee – but to run out and buy anything they could before prices multiplied again. Sadly, that’s not our only example. Milton Friedman recalled traveling around Europe right after WWII and people preferring American cigarettes to local cash (Bernstein notes that “The highest denomination banknote ever printed was the Hungarian 100 quintillion pengõ bill, issued in 1946”). And we’ve seen what happens with Venezuela and Zimbabwe in more modern days. So what do you do, stockpile cigarettes?

              Pengo

              Figure 4. Do you happen to have 100 billion trillion-pengo bills? I am looking to break 100 quintillion.

               

              Here’s the remarkable thing: if you had had been a German stockholder before Weimar’s hyperinflation – and you managed to hold on to your stocks throughout the crisis “when the nation’s currency inflated by a factor of one trillion” – you would have come out with a real return. In the early stages, there was a large sell-off as people were desperate for cash but as the crisis endured, people realized: high inflation is certainly not ideal for stocks but ultimately you own pieces of businesses that have sustainable value. Now, caution is merited: Americans enjoyed no real return from holding stocks in the 1970s and Bernstein cites one study that found that when inflation breaks 4% in the US, stock valuations fall off. But,

              “Interestingly, while severe and persistent inflation seemed to reduce equity returns, it did not always savage them: over the 70 years between 1927 and 1996, Chile experienced 33.16% annualized inflation, enough to produce a 508-million-fold rise in prices. Yet its stock market sported real price-only returns of 2.99% per year, within shouting distance of stocks in the United States. Similarly, over the 40 years between 1957 and 1996, Israel had 33.02% yearly inflation and 3.03% real price-only stock returns.”

              But there’s an even better asset allocation decision for Germans in the 1920s and Americans in the 1970s and you today: own a basket of international stocks. When you buy an index of them, you may be warned that there’s a risk that you’ll be exposed to international currencies – but when it comes to protecting yourself against the inflation of the American dollar, that’s a feature, not a bug. (In fact, were I in Zimbabwe I am not sure I’d want any domestic stocks!) Contrary to the popular phrase, Rowland argues “The world is not flat. Each country will have its own unique economy and economic cycles that are not necessarily going to match up with other countries around the world.” Bernstein concludes that hedging the biggest deep risk is both easy and profitable, perhaps not coincidentally echoing precisely what financial theory would suggest you do otherwise: own an index of global stocks, tilted toward value (because cheaper stocks tend to be overleveraged and thus would benefit from the reduced debt burden). If you were especially concerned, you might further tilt your stocks toward companies that produce commodities and profit from natural resources (though those won’t necessarily do as well outside an inflationary environment.)

              Simultaneously, you need to be aware that the apparently ultra-safe part of your portfolio is most threatened by inflation’s deep risk: bonds and cash. At its most basic, when someone – government, corporation, or brother-in-law – owes you money, and that money becomes worthless, you’re the loser. Bondholders in the Weimar republic collected a fraction of the original value of their holdings – and only that much because the government bailed them out. Bernstein cites a study that “amalgamated the 2,128 country-year returns and found that the returns for stocks and bonds, unsurprisingly, were negatively correlated with inflation: during the 5% of country-years with the highest inflation, stocks did badly, losing an average 12.0%, but bonds did even worse, losing 23.2%.” Of course, if you are the debtor, then this might be great – just make sure you have a fixed-rate mortgage and the rest of your assets are invested in overseas stocks. You may also benefit from inflation-protected securities, like the TIPS U.S. bonds or even your Social Security payments. Rowland is more skeptical, noting the example of  how Argentina understated their consumer price index adjustments and warns “Don’t buy inflation insurance from the people causing the inflation.” Bernstein, for what it’s worth, responds that messing with the adjustments will make new debt much more difficult to issue as the bond market would view such shenanigans as a form of default.

              Notably, Bernstein omits two classic inflation hedges from his advice: real estate and gold. Real estate really does go unmentioned – unfairly, in my view, but I may be biased. Gold’s absence is intentional and especially interesting because it is the asset recommended by the Permanent Portfolio to withstand inflation. As Rowland relates, 

              “Gold doesn’t change over time and a government can’t print more gold when it starts to run low on funds. Gold does not rack up massive debts and unfunded government liabilities. Gold does not care about political speeches or promises about the strength of any particular currency. Gold to a politician is like holy water to a vampire. In terms of purchasing power protection, gold has a long track record of preserving wealth that is unmatched.”

              All very well and good. The problem is that, while gold has maintained its value over a very long time, say, a century, it has not been quite as neat a store of value over a shorter term: from 1981 to 2001, gold lost 80% of its real value (even as the U.S. merrily inflated away). Bernstein also happens to think that gold is overvalued by conservatives in the same way that green energy companies are overvalued by liberals – not necessarily always judged rationally. And, of course, gold produces no income and does not magically multiply – Warren Buffett once quipped that gold involved digging a hole to find it then digging another hole to store it with no additional utility. Also notable is the large proportion of the global gold supply owned by governments that could one day flood the market.

              But gold should not be written off entirely: Bernstein cites a study by researchers from the London Business School who looked at 19 nations over 112 years and found, surprisingly, in “deflationary years, gold returned an average of 12.2% in real terms, and in the 5% of country-years with the highest inflation, its average annual return was actually slightly negative. In other words, although gold bullion provided little protection against inflation, it did superbly with deflation.” Close to home, “During the three-year period between 2007 and 2009, for example, when inflation was nearly nonexistent, gold’s price rose by 71%.” Bernstein summarizes, “gold does best when the public loses faith in the financial system; this happens during panics, which are almost always associated, at some point, with low inflation or deflation.” Rowland echoes the point “Some investors believe that a basket of commodities will work just as well (or better) than holding gold. They won’t.” Specifically he relates that in 2008, “some commodity funds lost more than 45 percent of their value compared to the 5 to 10 percent gain that gold had for the year. When the financial system was teetering on collapse, people wanted gold, not oil futures.” The mining companies that Bernstein himself prefers didn’t do that great either.

              James Bond

              Figure 5. The more you contemplate the dastardly plan of Goldfinger’s “crime of the century”, the more you appreciate the genius of his villainy. 

               

              All of which brings us to the much less likely second potential deep risk to your wealth: severe, prolonged deflation. Whereas inflation effectively reduces any of your debts, deflation effectively makes your debt bigger. As a result, the Permanent Portfolio’s response is to hold long-term U.S. bonds, trying to take advantage of not only actual deflation but also reductions in inflation because the plan requires you to continuously sell your bonds on the secondary market before they become medium term. Part of the reason the Permanent Portfolio did comparatively well in 2008 is that while the stock market was crashing, its bond portfolio was up 30%. But while 2008 involved brief deflation, the severe and prolonged version is not an experience many Americans are familiar with. Bernstein suggests that the last time it was experienced anywhere was when countries were on the gold standard (including during the early years of the Great Depression) and that a much milder version has been present since 1990 in Japan. There are arguments about whether deflation is good or bad for the economy as a whole – Austrian economists argue that deflation is a correction to the economy’s irrational exuberance or the result of productivity gains, other economists argue that deflation holds back investments as people weigh keeping a dollar that is of increasing value versus spending it. 

              Regardless, Bernstein argues that deflation isn’t good for your stock holdings – but is it especially bad? Between 1866 and 1896, America’s “price index fell by an astonishing 41%” and over about that same period, “stocks returned 5.4% per year in nominal terms.” After accounting for deflation, stocks returned about the historical average, though Bernstein worries that a large part of that was in dividends that are not as widespread and generous as they once were. If you accept that Japan is subject to this specific problem (where prices fell, but only by about 2%, over 25+ years), then you should be worried that your Japanese stocks lost more than half their value – but is that the only thing going on in Japan? According to Bernstein, the only other incidents of deflation have been in Hong Kong between 1998 and 2004, where 17% deflation came alongside “low but positive real stock returns” and modestly in Ireland after the great financial crisis. 

              So, deflation’s harms may not be terrible – unless you’re a debtor – and deflation itself is rather unlikely in today’s inflation-happy world of fiat currencies. Still, there’s an easy way to hedge against it: international stock diversification (again, because of the currency differences). If you accept the Permanent Portfolio thesis, long-term bonds will also work (again, with decreasing inflation as well) but most other advisers recommend against going long term with bonds. And, according to Bernstein’s data, gold might perform well as well. Regardless, you might want to hold gold to insure against another deep risk: confiscation.

              Bernstein argues that “the confiscation scenario is very unlikely, but if you think it’s impossible, you haven’t read enough history.” At its most benign, the government will tax 20-50% of your income, estate, capital gains, or whatever else they can. Bernstein “tend[s] to view taxes more as the dues [he] pay[s] for membership in a club with a billion person waiting list.” At its most severe, Marxists seize 100% of your assets. Shareholders in the once-thriving St. Petersburg stock exchange, sugar plantation owners across Cuba, export-importers in China never recovered. There are in-betweens: in 2001, Argentina froze all bank accounts, converted any held in foreign currencies into the local peso, then devalued the peso by 2/3. Citizens weren’t even allowed to collect what was left for a year. In the 1930s, the United States government demanded citizens turn in all their gold at a discount. Bernstein argues that “even Bernie Sanders supporters cannot doubt that their retirement savings are at risk from a federal government hungry for revenue. During the 1980s congress arbitrarily imposed a 15% tax surcharge on retirement plan distributions of over $150,000, an unexpected penalty on those who chose to save rather than consume; it was quietly repealed in the mid-1990s.”

              Your only solution is to situate assets outside your country that plausibly might resist confiscation by your government. You also, naturally, need the ability to escape and actually access said assets if things go really south. Under our current regime, citizens “are saddled with onerous taxes” on foreign investment accounts and have to fill out gobs of paperwork or risk felony prosecution. Bernstein warns, “over the past few years, the United States government has made life so miserable for foreign banks and brokerage houses that most are loath to take on American clients.” There may also be motivations beyond taxing every dollar they can: “Think of it as a form of ‘soft capital controls,’ or perhaps a subtle attempt by United States banks, which generally provide a much lower level of service than their foreign competitors, to keep their business at home.” If you wanted to bid farewell to the land of the free, “United States citizens are, in any case, liable for substantial ‘expatriation taxes’ on personal and retirement assets on renunciation of citizenship.”

              As a practical matter, what all this means is that your options are to buy foreign real estate or store physical gold bullion abroad – with the idea that they are both difficult to seize and produce no taxable income unless you sell them. Cryptocurrencies like Bitcoin might also be of interest in that they are accessible worldwide but their intrinsic value is so hard to gauge (and their resulting volatility is so high) that they may not serve your needs. And, indeed, you have to gauge for yourself how likely confiscation is, how inconvenient international dealings are, and how much you can really afford to put somewhere else (is it enough, for example, to start over if your domestic assets are seized by the new Red Guard?).

              On gold, Craig Rowland has some rules of thumb:

              1. Only deal with first-world countries with stable governments and legal systems that provide strong protections of private property.

              2. Avoid dealing with institutions where accountability rules are opaque or unclear.

              3. Try to do business in legal jurisdictions that support financial privacy.

              4. Always follow all legal disclosure requirements.”

              Specifically, “the first choice” for your holdings should be “physical gold bullion stored in a safe location and insured against loss.” Think Gringotts. When Harry Browne was writing, Switzerland was the natural home for foreign assets, where apparently the Swiss treat financial privacy as seriously as we treat free speech. But that all changed during the Obama administration, which cracked down so hard on Swiss banks that they now are actively disinterested in US consumers. Instead, Rowland suggests buying and storing standard gold coins – such as the delightfully named Australian Kangaroo – at the New Zealand Mint (a private group insured by Lloyd’s of London), the Perth Mint (founded in 1899, backed by the government of Western Australia, advertised as akin to Texas), or Das Bank (an Austrian safe deposit box company with robust anonymity protections, including cameras that monitor but don’t record). Amidst this, don’t forget: acquiring and maintaining gold does have costs, is not terribly convenient, and, just like what happened with Switzerland, conditions can change that affect the security of your assets.

              Scrooge

              Figure 6. Scrooge McDuck proved you either die a villain or live long enough to be a hero. As befitting his name, Scrooge was originally intended to be an antihero but proved so popular that he was given a rags-to-riches backstory as he dispensed advice on thrift. Today, the New Zealand Mint will sell you an actual gold coin featuring him but it is unclear whether they allow you to swim through your collection.

               

              Rowland also recommends holding at least some of your gold holdings instantly accessible:

              “Gold can be an asset of last resort. Which means that gold is an asset that you need to be able to access when there may be significant disruptions occurring within the economic or political system. In order to have ready access… you should aim to have as few pieces of paper and people between you and your gold possible.”

              This is, of course, part of gold’s appeal – a “benefit of gold is that it is a compact and universally recognized form of wealth.  Gold can be owned directly by an investor and is not a paper promise as other investments are.” For the purposes of the Permanent Portfolio’s rebalancing, this also makes it easier to sell off over-allocated gold. Notably, there are various reports of people using their gold to get out of a country – or sewing it into their clothes to have it when they get out.

              Treasure chest

              Figure 7. Discreetly bury your precious metals in a national park and, if you get bored, invite everyone to participate in a treasure hunt. 

               

              But there may be one other consideration when it comes to gold: how expensive is it relative to its historic price? That answer is what prevented the person who wrote the otherwise kind introduction to the Permanent Portfolio from diving full in. Rowland insists,  “A common question about the Permanent Portfolio is whether it is better to buy all of the assets at once or wait and move in slowly over time. Go all in. Waiting is a euphemism for market timing.” And that may be true for the specific benefits of the Permanent Portfolio. But as an insurance policy, you have to weigh the risks of confiscation versus the risk that gold is going to have only 20% of the value that you bought it at. It’s also debatable how much value gold would have in various scenarios involved in our final deep risk: devastation. 

              My parents are in their seventies and have lived through about 30% of American history since 1776 – it’s been a spell, but it has not been too long since Atlanta was burned (or certainly not since New Orleans was flooded). Bernstein sensibly notes that this is of much greater concern to South Koreans and Israelis – were the United States to be devastated in this nuclear age, the world might have ended. But just for historical context, let’s revisit the losers of World War II as we again think about how deep risk affects our “safe” assets:  

              “Japanese and German bondholders saw losses of more than 95% during and immediately after the Second World War; stocks in both nations fell by about 90%. Whereas the bondholders held what was, in most cases, nearly worthless pieces of paper that never regained their real value, the stockholders owned claims on the assets of the likes of Siemens, Daimler, Bayer, and Mitsubishi, which when recapitalized and rebuilt regained their real prewar value in less than a decade in Germany, and in about a decade and a half in Japan.”

              Rocket

              Figure 8.  Bernstein recounts “During the Cuban Missile Crisis of 1962, when apocalypse seemed more than possible, an apocryphal story has a young derivatives trader asking an older one whether to go long or short equity options. The immediate reply, ‘Long, of course. If things turn out all right, we’ll make a ton of money.’ Quavered the younger trader, ‘And if they don’t?’ To which the older trader cheerfully replied, ‘Well then, there won’t be anyone on the other side of the trade to collect from us!’”

               

              Ultimately, Bernstein suggests you insure against local devastation in similar ways to previous descriptions: if only your hometown is destroyed, your global stock index is probably fine. If you’re Israeli and your country is destroyed, you need assets situated outside your country just as if you were ensuring against confiscation. The only scenario Bernstein doesn’t really discuss is if we’re in more Mad Max post-civilization territory where gold is of really debatable value (will it still be treasured by whatever traders remain?) If you’re inclined to prepping for the apocalypse, do your best to rationally calculate the odds but, if you remain afraid, bullets may be your best bet!

              Inflation, deflation, confiscation, and devastation are the four deep risks Bernstein says threaten your portfolio. Figure out what you should fear and plan accordingly. Bernstein recommends that “Capital managed for near-term liabilities should be guided by shallow risk, while capital managed for very long-term liabilities should be guided by deep risk; the stickiest problems occur in the no-man’s land, very roughly between 10 years and 30 years, where both have to be considered, as well as in those rare situations where shallow risk evolves into deep risk.” And in fact, for the rare “25 year old saver” reading this, “not only should you protect against deep risks, you should actively seek shallow risk, since it will enable you to buy at lower prices.” Bernstein insists: “Younger investors should navigate by the deep-risk lighthouse.”

              Deep risk

              Figure 9. Click here to acquire William Bernstein’s Deep Risk, a short brilliant booklet (10/10). Indeed, every book of Bernstein’s is worth reading. See my previous review of his work, on general asset allocation, here: Get Rich Slow

              Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend: know anyone interested in keeping the government away from their money? How about keeping their money generally?

              I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

                Free Market University

                The Gist: How to make college much cheaper and better.

                 

                Imagine a free market university. You are probably thinking of (or perhaps hoping for) something that turns out thoughtful capitalists instead of woke Marxists, maybe with a mandatory curriculum in classical economics and an aggressive internship placement office that gives kids a taste of entrepreneurial America.

                David Friedman has something different in mind.

                What if a university used free market principles in its operations? No more central planning by increasingly expensive administrators who allocate alumni donations and government-subsidized tuitions according to their whim. In fact, no one annual price (“tuition”) that covers a wide smattering of services within the commune from housing to food to recreation to, occasionally, education. Wonder of wonders: Students pay rent for apartments of various quality and convenience! Magically: students patronize restaurants of various specializations and health department grades! Amazing: students join a gym (or not), subscribe to a local newspaper (or not), grab tickets to a play or game (or not), take three months off to travel the world (or not), go see a psychologist (or not), or pay dues to support a club (or not).

                LSU lazy river

                Figure 1. “Students” will just have to look elsewhere for college necessities like LSU’s $85 million recreation center and lazy river, MTU’s 112 acre ski resort, and Syracuse’s unlimited tanning services.

                 

                That’s the easy part – turns out that Free Market U. itself does not need to offer any of these and students can bid farewell to the debt they incur as a result of subsidizing all the services and amenities they never use. 

                But what about the purported purpose of college? F.M.U. is proud to own and operate world-class facilities but, true to its name, it allocates resources according to the market. Every hour in every classroom is auctioned off to faculty who themselves auction off seats to students. Naturally, there is no tenure at FMU. In fact, there’s not necessarily faculty employment, either. But a popular teacher could capture precisely her worth. If she couldn’t be bothered with the auctioneering mechanics, she could give a percentage to a service that specialized in the arrangement. Other universities can force their professors to publish or perish, delegating the fate of faculty to the editors of obscure journals. FMU forces its faculty to create value for its students. Or, in other words, teachers teach.

                auction bid

                Figure 2. F.M.U. is naturally a placeholder title until the naming rights can be auctioned off – though we’re willing to be preempted by an attractive initial offer to become, say, Peter Thiel University. 

                 

                Notably, teachers themselves don’t require any credential at all. Friedman notes, “Some members of the community might be simultaneously teaching elementary courses in a subject and paying other members for advanced instruction.” One professor might depict an alphabet after his name but if his expertise in ecofeminist interpretations of park squirrels  does not attract paying students, he won’t get paid. On the other hand, if a college dropout – Bill Gates or a more typical American who has nevertheless developed a teachable skill – proves to be popular, he is welcome to reap the rewards. FMU even welcomes one-off guest lectures from people who happen to be in town. Ivory being a scarce resource, we don’t plan any fancy towers.

                There does not have to be an admissions department. Students could just log onto the FMU app and bid. But perhaps students would not have to pay at all. A student might interview and present his standardized test scores to a near-campus bank which would then make a judgment about lending risk, either giving the conventional lump sum to be spent however the student desires to be paid back with interest or perhaps staking the student in specific courses the bank knows from experience actually yield positive results and taking a small percentage of the graduate’s future income. Other universities assign an indifferent professor or a random bureaucrat to advise students on their educational journey (though their primary knowledge might be getting hired by a university). FMU empowers students to find an informed adviser who has a personal stake in their goals.

                guitar

                Figure 3. For example, aspiring musicians and actors might be guided to courses preparing them for their exciting careers in the restaurant industry.

                 

                Alternatively, the bank could facilitate scholarships provided by charities or generous donors – but, crucially, students are not given automatic rights to sit in whatever class they’d like. The charities or donors could of course dictate that they’d like students to take certain classes – but otherwise, students are empowered to responsibly shepherd their finite resources to get the best education (and send a price signal to educators about what students value). Ideally, students would keep whatever money they didn’t spend! Relatedly, FMU would be sensitive about taking government funds – government-subsidies are a big driver of other colleges’ costs: according to the New York Federal Reserve Bank, colleges may increase tuition by 65 cents for every dollar increase in government lending. 

                But maybe other universities have completely misunderstood who their consumer really is. FMU gladly accepts money from the students themselves or their parents or their bankers – or also prospective employers. Any company that wants employees who know certain things is welcome to bid for space to teach a subject and evaluate those who take the course or stake students in courses and see how they do. Different from a bank, a company might agree to stake a student through FMU in exchange for the opportunity to employ them for a certain number of years of service at a specified salary. Employers’ desire for genuine evaluations of prospective employees may be the very best solution to grade inflation (where the average grade, but not necessarily the average performance, has crept up and up and up) as well as superfluous but otherwise popular classes.

                At this point, you might think that FMU is really just a real estate firm (not a bad business) that may be exempt from property taxes, but there is something else. While students of any age are of course welcome to take courses at FMU forever (so long as they have the funds!), the vast majority are expected to seek some sort of credential. The second (and final) part of FMU’s tuition consists of students paying to take exams (and have them graded). If a student desires a degree in American history, she must pay to have her knowledge evaluated in the subject. She might build that knowledge through bidding for the best classes in the subject – FMU might publish the grade curve for how every class’ students do on associated exams. Or she could simply hit the library and learn the facts herself. FMU is happy to warrant to the general public that a graduate has requisite knowledge for a degree regardless of whether they took any classes at all. 

                There may be still other things consumers want and FMU may contemplate providing them (at the right price, of course) or simply defer to a nimble entrepreneur to provide it instead. FMU’s majestic Latin mottos are Quid Pro Quo and Caveat Emptor. You get what you pay for. If college is about community or networking, sororities, the local Chamber of Commerce, Mensa Club, and lots else stands ready to help. If college is about dating, there’s an app (or 100) for that. If college is about drinking rather than thinking, a thriving local bar scene is likely to develop. FMU is even willing to build a stadium if it can rent it out at a profit. And let’s not forget our faculty associates: if a company would like to pay them to research something or if a publisher would like to sell their books, FMU is happy to facilitate the connections – and let the personnel collect!

                robber baron

                Figure 4. In 1975, students voted to become the Stanford Robber Barons – a democratic decision thoroughly rejected by the administration which instead went with the perpetually confusing choice of the color, not the bird, Cardinal. F.M.U. suspects that the railroads of the 19th century were too subsidized to be a proper model for its students but, as always, welcomes with open arms those with open checkbooks.

                 

                Ultimately, the cost of college in the United States has grown a lot faster than any other expense except medical care in the last 20+ years. We’ve already discussed one reason why: colleges have raised their prices to capture the most that they can from federal loan subsidies. The Manhattan Institute adds others: “administrative bloat, overbuilding of campus amenities, a model dependent on high-wage labor.” F.M.U. tackles them all to give students the best bargain in the world: a bare minimum of administrators and amenities, with labor that is paid according to its value, not its credentials. 

                Could FMU ever work? Maybe it could not attract the best faculty because they desire the prestige and low responsibility of tenure at a major university – but that would be reflected in the price students would pay. (And, of course, if an existing prestigious university wanted to switch things up, that’s welcome!) Maybe students would want something more conventional because of fears of employability or because they enjoy the present all-expenses-paid extended vacation that is so much of the present college experience or because of some other preference that consumers express every single day in how they spend their money. But I, for one, would love to see, somewhere, amidst the 4,000+ colleges in the United States and more beyond, some institution try something different. Maybe we can start with an economics department!

                machinery of freedom

                Figure 5. Click here to acquire David Friedman’s the Machinery of Freedom, a book that questions basically everything that the government provides. This newsletter is inspired by a couple of short chapters within the whole book (one of which is just a reprint of Adam Smith’s critique that Oxford professors didn’t really care about their students because they were paid by an endowment. Friedman says that’s now supplemented by the government). There are of course potential problems with a total dedication to catering to the preferences of students, some proportion of whom will want high grades for occasional attendance of edu-tainment. Shifting the perspective to treat employers as consumers may help fight that – but also bear in mind that qualified students are also highly interested in expressing their skills and diligence and F.M.U. can hopefully create a standard that employers trust will actually mean something. One final thought: F.M.U. would ideally be open to all comers, but disruptive students who actively make learning harder on others would very likely have to be ejected (sadly, the price of related security would therefore have to be incorporated into the costs of the facilities!)

                 

                Thanks for reading! If you enjoyed this, forward it to a friend: know anyone interested in education? How about resource allocation? Or do you know someone who has been to college and might find this alternative take illuminating?

                I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

                  Warren Piece

                  The Gist:  How the Oracle of Omaha refined his investment strategy to become a billionaire.

                  The second of a two-part review of multiple Buffett biographies.

                  Read the first part here: My Warren Report.

                  Where last we left off, Warren Buffett was just starting to get back into the stock market as it underwent a sustained downturn during the 1970s. In other words: businesses were on sale! 

                  Sale

                  Figure 1. “C’mon down to Wall Street because EVERYTHING MUST GO! Your favorite brands are 50 – 70 – even 90% off! We are SLASHING prices MARKETWIDE for this decade only – so get in while you can and tell ‘em Cowboy Pete sent you!” 

                   

                  His vehicle was rather unusual: the publicly-traded Berkshire Hathaway, originally and ostensibly a northeastern textile manufacturer. Yet Buffett was using the profits of the manufacturer to invest in other companies – and those investments were paying off far better than the troubled underlying business. His partner in success – the man who refined Buffett’s investing approach from the pure bargain-hunting that had led to Berkshire’s acquisition in the first place – was Charlie Munger.

                  Munger was also an Omaha native but, unlike Warren, was determined to get out. Bouncing around different colleges but never getting a degree amidst military service in World War II, he was at one point assigned to California and quickly concluded he preferred western winters. As the grandson of a federal judge, Munger was able to solicit a family friend’s help in getting into Harvard Law School without the college prerequisite – and, despite the dean’s skepticism, wound up graduating in the top 10% of his class. Soon making a sizable income at a California law firm, Munger began investing with a notable caution: he did not want to put his money into people and companies that made good law firm clients because they had so many legal problems. 

                  While Munger was a great lawyer – he even co-founded a super-star law firm – he was an outstanding investor and soon was investing other people’s money. Wall Street Journal reporter and Buffett biographer Roger Lowenstein reports: “Munger was no Ben Graham disciple. In his view, troubled companies, which tended to be the kind that sold at Graham-like discounts, were not easily put right.” As Buffett would sum up, “Time is the friend of the wonderful business, the enemy of the mediocre… It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie understood this early; I was a slow learner.”

                  Troubadour

                  Figure 2. Literally bought for a song from a troubadour, Ye Olde Renaissance Fair franchisor turned out to have an array of pending lawsuits related to its attempt to genuinely recreate its time period with Bubonic plague infections, burning of heretics, malnutrition for most participants, and explanations of danger only available in hand-drawn Latin brochures sold for hard currency.

                   

                  But what was a “wonderful company”? Munger was on a mission to find out and asked everyone he met “What’s the best business you’ve ever heard of?” In 1959, Munger was back in Omaha to settle his father’s estate when he got to ask his favorite question to a new acquaintance, the grandson of the owner of the grocery store he once worked at (in his words, “slaved” at) as a teenager: Warren Buffett. It was an instant friendship that would last a lifetime and they began talking every single day by phone. Soon, Buffett would be asking a variant of Charlie’s question: “If you were stranded on a desert island for ten years, in what stock would you invest?”

                  Wilson

                  Figure 3.  Among those actually castaway on a desert island for years, the answer was Anta Sports Products Limited, traded as ANPDF on the Hong Kong Stock Exchange, perhaps better known for its subsidiary, Wilson Sporting Goods. 

                   

                  The understanding that drove the intensity of the duo’s search was that concentration on the right bets – the equivalent of putting it all in on the royal flush – would pay off better than diversification. The difference, of course, is that you know a royal flush is the best hand while you don’t know the future of a company. Diversification is really risk management because concentration can mean you lose it all as well – maybe you’re really putting it all in on a pair of twos. Buffett would later advise students that “You’d get very rich if you thought of yourself as having a card with only twenty punches in a lifetime, and every financial decision used up one punch. You’d resist the temptation to dabble.” 

                  For Buffett, that meant staying within your circle of competence and being as sure as you could be, after much intensive and obsessive analysis, that every decision was right. From Graham, Buffett understood that he needed a margin of safety and that Mr. Market might provide it to him at the right time. From Munger, Buffett began to see that there might be more to intrinsic value than merely the price at which a company could be liquidated. Munger wanted businesses that continuously threw up easy decisions rather than hard ones. But he also became interested in a specific feature: “Munger had a Caterpillar tractor dealership as a client. To grow, the business had to buy more tractors, gobbling up more money. Munger wanted to own a business that did not require continual investment, and spat out more cash than it consumed.”  

                  The business that fit the bill and fueled Buffett’s success would be insurance. Buffett had first gotten to know the industry through studying Ben Graham’s greatest payoff, Geico, which originally and brilliantly sold insurance through direct mail (thereby removing the commissions and costs of agents) only to government employees (who, on average, filed fewer claims). While Buffett would eventually buy Geico, he started out with a profitable Nebraska insurer whose owner was a bit moody and had a reputation for getting irritated enough to threaten to sell the business – but only for about fifteen minutes once a year before calming down. Buffett let it be known that if he could get in during those 15 minutes, he’d buy. Soon enough, he did – or, as one might put it, 15 minutes saved him 15% or more on insurance.

                  What Buffett understood faster and better than the rest of the insurance industry was the opportunity to invest the float – that is, the money available between when premiums are paid in and claims were paid out. Most of the industry then just stashed it away in long term bonds (conventionally safe but soon ravaged by inflation). Buffett, while insisting on relatively safe and conservative underwriting, put the float to work in the market and in piecing together his own conglomerate. The float meant he did not have to take on debt but instead had access to his own cash source: “Charlie Munger has said that the secret to Berkshire’s longterm success has been its ability to ‘generate funds at 3 percent and invest them at 13 percent.’”

                  Flight attendant

                  Figure 4. “Welcome aboard the New York Stock Exchange! Thank you for your attention while important margin of safety information is reviewed. Your cash may be placed in an overheard compartment or completely under the seat in front of you – but taking on additional leverage is prohibited. In case of an emergency, please follow the lighted ticker signals reflecting a downward price movement and buy as much as you can. If you are an insurance company, your float is an approved cushion device. If you are seated in an exit row, you may be called upon to get as many bargains as you can as terrified sellers pass you by. If you are unable or unwilling to perform that function, you will lose a lot of money.”

                   

                  Buffett’s success ultimately came from laddering up his investments and, as he put together a conglomerate, redistributing capital to its best and highest use. Buffett had a single goal: for every dollar he could get from profits or float or wherever, where would it go the farthest? Buffett insisted “I’d rather have a $10 million business making 15 percent than a $100 million business making 5 percent… I have other places I can put the money.” William Thorndike authored a study of Buffett and other unconventional CEOs with outsized returns and concluded that their success related to this magic of capital allocation. “Whenever Buffett buys a company, he takes immediate control of the cash flow, insisting that excess cash be sent to Omaha for allocation.” Once Buffett had all the cash in one place, he would decide where to invest in existing operations, whether to acquire a new business altogether, whether to invest in Berkshire’s own stock if it was cheap, whether to pay off debt, or whether to keep powder dry – all depending on what might have the highest return.

                  Buffett’s style had another related feature: “Except on June 30 and December 31, when [a CEO of a subsidiary] was obliged to transfer his profits to Omaha, he felt as if the business were his. In a practical sense, he was free to run it for the long term, as a private owner would.” Buffett’s corporate offices had an anorexic staff – even by the time it was a Fortune 500 company, HQ had less than a dozen people. One CEO reported that he “delegated to the point of abdication” and would “always praise [his team] while he gave [them] more to do.” But “while remarkably tolerant of others’ quirks and flaws, he was less so of quirks and flaws that cost him money.” It was all about the return – and if you couldn’t deliver, none of the profits would be given back to you. 


                  Given the attractive features of the insurance business, you won’t be surprised by the business that ultimately brought together Munger and Buffett as partners: Blue Chip Stamps. Essentially a rewards program, super-markets paid Blue Chip for the ability to distribute stamps that their customers could earn by making purchases and redeem for prizes. For Buffett and Munger, the magic was that they got immediate control over the money that would only have to be given back over time – if at all (lots of customers lost their stamps). “To Buffett, Blue Chip was simply an insurance company that wasn’t regulated” – with a float of almost $100 million.

                  And yet the maneuvering of Buffett and Munger at Blue Chip did attract the unwanted attention of the SEC. Between them, Munger and Buffett owned 3/4 of Blue Chip and were using the investment committee to pursue more good deals, including making a substantial run at a savings and loan, Wesco Financial, trading at “less than half its book value”. But Wesco’s management soon announced they were going to be taken over at what Munger and Buffett thought to be a terrible price, so they maneuvered to kill the deal and then eventually themselves acquired a majority stake. The SEC, however, suspected stock manipulation and were further suspicious of Blue Chip’s convoluted and complicated ownership structure – often a sign of attempted fraud. The problem was that though Munger and Buffett controlled Blue Chip, they did so through lots of different entities, each of which may have required fiduciary duties, where Munger’s partnership owned a portion, but also a portion of a third company that owned a portion, and that third company was owned in part by Buffett’s Berkshire Hathway, which also owned a portion of Blue Chip, and then there was Buffett himself who personally owned part of Blue Chip along with other companies, and so on and so on.

                  Football

                  Figure 5. Meanwhile, thousands of kids would kill for some attention from the SEC.

                   

                  An investigation ensued, and Munger and Buffett decided to cooperate in full. By the end, instead of an indictment, the SEC “named [Buffett] to a blue-ribbon panel to study corporate disclosure practices.” By all accounts, they really were totally above board – and unusual in that they each interviewed alone without a phalanx of attorneys. But it may have helped that the SEC had been taken over by a former law partner of Munger’s. Regardless, the duo realized that their structure had organically grown into something too complicated and they decided to consolidate everything into the single entity of Berkshire Hathaway. (And Munger might have had extra motivation because, unlike Buffett, he had not returned all capital in 1970 and so his record took a rough dip as the market declined).

                  In the meanwhile, Buffett found another kind of wonderful business – and this one Ben Graham did not approve of. The specific company was California chocolatier See’s Candy, which Buffett bought at 3x book value – very expensive in Graham’s outlook and Buffett had held his nose to offer that absolute maximum. But one of the problems with book value is that it does not take into account the power of a brand – the difference between whether you’d buy a generic cola or Coke, the difference between the price of machinery on the open market versus what its capable of producing – Mustang or Edsel. See’s had established a consumer franchise where customers were willing to pay an irrational price well above cost. Around this time, Ben Graham invited Buffett to be the coauthor of a revised edition of the Intelligent Investor; Buffett wanted to add a chapter about See’s Candy and identifying great businesses but “Graham didn’t think the average reader could do it.” Buffett ultimately declined – his foundation was still Graham but Munger had helped him go beyond it. And if the stock market was as cheap and inflation as bad as the 1970s, he was ready to invest a far greater percentage in stocks than Graham’s 75% ceiling. Relatedly, 

                  Fear of inflation was a constant theme in Berkshire’s annual reports throughout the 1970s and into the early 1980s. The conventional wisdom at the time was that hard assets (gold, timber, and the like) were the most effective inflation hedges. Buffett, however, under Munger’s influence and in a shift from Graham’s traditional approach, had come to a different conclusion. His contrarian insight was that companies with low capital needs and the ability to raise prices were actually best positioned to resist inflation’s corrosive effects.

                  Coke

                  Figure 6. Pro tip for your budget: look up all the companies considered consumer franchises – and immediately and forever more replace them with generics. With Coke, a cheap alternative generic comes right out of your faucet! 

                   

                  But, of course, people could still buy chocolate elsewhere. What Buffett really wanted was the only toll-bridge in a river town, a business where people had to use the product. The best equivalent he could find was a local newspaper where businesses felt obligated to advertise. He shopped around for a few years, bought an alternative weekly in Omaha and even helped it win the Pulitzer Prize, bought Washington Post shares at a bargain and went on the board to further get to know the industry, and finally he was able to acquire, in his biggest purchase then to date, the Buffalo Evening News. 

                  Acquiring the evening newspaper (with a strong morning rival once edited by Mark Twain) without a Sunday edition (published by the rival) in a declining manufacturing town with unfavorable labor laws did not seem to be the kind of wonderful business that continuously threw up easy decisions – and it’s possible that Buffett and Munger were too influenced by their love of newspapers. And yet what happened next was even more difficult than they could imagine: when the Buffalo News tried to publish a cheap Sunday edition, their rival sued them for antitrust – and a local federal judge, perhaps skeptical of non-local interlopers, held them up in court for years. But Buffett made the bet that his balance sheet was stronger than the owners of the other newspaper and so they bitterly fought it out until the rival went bankrupt. Suddenly, Buffett had his toll bridge and the printing presses at the Buffalo News started figuratively printing money, spurring new purchases for the Berkshire conglomerate. Interestingly, Buffett was very clear on who won the classic newspaper war:

                  Soon after the [rival] Courier’s demise, Buffett attended a meeting for the newspaper’s middle-level managers, in Buffalo’s Statler Hotel. “What about profit-sharing for people in the newsroom?” Buffett was asked. On its face, this seemed reasonable. The newsroom had certainly done its bit. Buffett replied coldly, “There is nothing anybody on the third floor [the newsroom] can do that affects profits.” The staff was shocked, though Buffett was merely living up to his brutal-but-principled capitalist credo. The owners of the Buffalo Evening News had run very great risks. Employees had not come forward during the dark years to share in the losses. Nor, now, would they share in the gains. 

                  The 1980s would be defined by the image of the corporate raider: an aggressive outsider who used debt to buy companies he could not otherwise afford with the hope of paying it off by better management (or liquidation). Buffett hated that this helped Mr. Market go manic: “A raider with access to somebody else’s dough would pay a lot more than a company was worth. And Wall Street’s soaring appetite for junk bonds was providing a vast supply of easy money.” But he soon found that he could secure special deals by being the antidote to the era: as a folksy debt-shy Midwesterner with a hands-off management style, he was the perfect white knight to fend off raiders looking for easy prey. Indeed, this was a business Buffett understood well: he was going to be management’s insurance. 

                  But while pursuing private opportunities and cutting deals of special consideration throughout the decade, Buffett saw less opportunity in the public markets. In 1985, he “sold every stock in the portfolio” except for the “permanent” three: Geico, the Washington Post, and Capital Cities (lots of local television stations that wound up buying ABC). In the same year, he finally ended Berkshire’s textile business: “The equipment would have cost as much as $50 million to replace. Put to the auction block, it sold for $163,122.” For three long years between 1985 and 1988, he did not buy a single common stock. When he did, “he staked a fourth or so of Berkshire’s market value” on the sufficiently cheap consumer franchise of Coca Cola, which had been trying to concentrate on its core business after some bumps in the road. Over the coming years, Berkshire’s holdings would grow in value by nearly $19 billion, up over 1,000%.

                  The New Coke fiasco merely made the company more compelling to him. As Buffett explained it, Coca-Cola knew that Americans had preferred the sweeter New Coke, but when people were told about the switch, they wanted their old Coke back. The drink had “something other than just the taste—the accumulated memory of all those ballgames and good experiences as children which Coke was a part of.”

                  The 1990s began with a white knight deal gone wrong. Buffett had long been critical of the investment banking industry, quipping that “the bankers should be the one wearing ski masks” and “you won’t encounter much traffic taking the high road on Wall Street.” But he had a personally good experience with Salomon Brothers and when they asked for his help to fend off a raider – and offered an extremely sweet deal – Buffett took it. A few years later, however, a rogue trader repeatedly defrauded the worst possible victim: the U.S. government. When management discovered the problem, they dithered and procrastinated until it was too late – the culture of the firm tending to encourage employees to walk the line. But this scandal threatened the destruction of the entire business, either through criminal action or, even more significantly, the cutting of U.S. Treasury bond sales to the firm. As a board member and substantial investor, Buffett realized he was the only one who could put it right and took over as CEO. Quickly finding the right person to run day-to-day, more than anything else Buffett provided moral leadership. Buffett sent a short memo to all employees, “insisting they report all legal violations and moral failures to him. He exempted petty moral failures like minor expense-account abuses, but, “when in doubt, call me,” he told them. He put his home phone number on the letter.” He pledged complete cooperation with the government, stating before a Congressional committee “ I would like to start by apologizing for the acts that have brought us here. The Nation has a right to expect its rules and laws will be obeyed. At Salomon, certain of these were broken.” Through extreme cooperation, Buffett saved the company – and salvaged his investment.

                  Knight2

                  Figure 7. For Solomon Brothers, twas but a scratch

                   

                  The 1990s also saw the return of a big bull market led by technology – and many thought that Buffett had lost his touch. The market run had gone on for so long that some thought it could only go up – the old bargains weren’t there and Buffett’s record didn’t look quite as shiny next to the ridiculous instant returns of tech (including from the company of Buffett’s personal friend Bill Gates). In 1999, near the height of the bubble, Buffett gave a famous speech that conceded the internet would change the world – but he wasn’t sure where or even whether money could be made over the long term. Buffett noted two technologies in particular had upended the 20th century: automobiles and airplanes. Of some two thousand auto companies at the beginning, only three had survived: could anyone be so confident that those were the three that would? As for the other innovation, “As of a couple of years ago, there had been zero money made from the aggregate of all stock investments in the airline industry in history.” Buffett had gotten past the mechanical analysis of Graham but he could not get to the magical analysis of Silicon Valley. “Charlie Munger… said that if he were giving a test calling for an analyst to value a new dot-com internet company, he would fail anyone who answered the question.” 

                  Ultimately, what made Buffett truly remarkable was that he became so rich as an investor as opposed to an inventor or someone who plied a specific trade. Rockefeller had oil, Vanderbilt had transportation, Walton had discount retailing, Gates had software, but Buffett didn’t invent anything – he just knew a good deal when he saw it. And knew it from a very young age, so his successes compounded decade after decade, such that over 90% of his wealth has been generated after he turned 65. He had created the structure that fueled still more success, reallocating capital time and time again to quickly take advantage of operations or the market. The books reviewed here end in the late 1990s and early 2000s, but Buffett has continued to apply similar principles sometimes with non-obvious elements: Berkshire’s largest public holding would become Apple, which many think of as a tech company but Buffett prefers to see as a luxury manufacturing company with the customer franchise model he has long sought to invest in. And Buffett continues to pursue private deals – his biographer Alice Schroeder argues that “Buffett’s real brilliance was not just to spot bargains (though he certainly had done plenty of that) but in having created, over many years, a company that made bargains out of fairly priced businesses.” In the final part of his career, he reaps the rewards:

                  Remarkably, Buffett has created a system in which the owners of leading private companies call him. He avoids negotiating valuation, asking interested sellers to contact him and name their price. He promises to give an answer “usually in five minutes or less.” This requirement forces potential sellers to move quickly to their lowest acceptable price and ensures that his time is used efficiently. Buffett does not spend significant time on traditional due diligence and arrives at deals with extraordinary speed, often within a few days of first contact. He never visits operating facilities and rarely meets with management before deciding on an acquisition.

                  Of course, there’s significant academic commentary that Warren Buffett is not necessarily an uber-talent but in fact the winner of an investor lottery. As Nassim Nicholas Taleb has argued, “I am not saying that Warren Buffett is not skilled; only that a large population of random investors will almost necessarily produce someone with his track records just by luck.” The related formal hypothesis – the efficient market theory – has won economists the Nobel Prize. EMT concedes that individual investors can beat the market average – but insists that it’s impossible to predict in advance which investors would do so. EMT insists that the market’s pricing reflects the collective wisdom of participants and that you’re far better off just investing in an index. Buffett himself famously participated in a debate about the topic in the 1980s and argued that if investing really was just coin-flipping but that a certain group consistently got the right side more often, that group’s technique was worth investigating. Buffett related the outstanding records of disciples of Ben Graham and insisted that “observing correctly that the market was frequently efficient,” the academic theoreticians “went on to conclude incorrectly that it was always efficient.” In other words, Mr. Market was a manic-depressive who could be profited from. In subsequent years, the two sides have gotten a bit closer to each other. Academic theorists have found a long-term pay-off to value investing (in fact, one of the very small number of explanations for differing performance) but have differed on whether this was due to increased risk (as conventional economics would insist – perhaps because of the more troublesome companies involved) or due to cognitive biases dismissing cheap stocks (as behavioral economics would argue). Despite Buffett’s move toward Munger’s concept of wonderful companies at a fair price, he dismisses being paid for risk: if the same company with the same assets has a much lower price one day than the day before, Buffett insists that means a greater margin of safety and inherently less risk. And yet, in the end, Buffett has recommended that the typical investor be defensive and just invest in an index fund – and has even gone so far as to successfully bet that active management would not beat a typical index fund.

                  Caveman

                  Figure 8. Rather than try to find the next Geico yourself, why not just go with index funds? They’re so easy, a Caveman could do it!

                   

                  Whether Buffett’s intensity had a reward may be debatable, but it did have a price. As a friend put it, Buffett’s “real marriage was to Berkshire Hathaway,” not to his wife Susie. Their original courtship had been uneven, with Susie eventually falling in with Buffett, a family friend, because her father disapproved of her serious college boyfriend. Through the years, as he made more and more money, Buffett was not especially interested in spending any of it (or giving it away). Susie, meanwhile, liked the good things in life and was also a full-hearted philanthropist always giving her time to those she deemed in need of help. As an example, even as a multi-millionaire, when he visited New York he’d stay at a college buddy’s mom’s house. When she came with him, she insisted on their staying at the Waldorf. Buffett has always taken a relatively small salary and refused to sell any of his Berkshire shares – only in midlife did he do some extracurricular investing that gave millions in spending money. When he paid $31,500 for the home in Nebraska he still lives in, he called it “Buffett’s Folly.” Susie would eventually get him to spring for additional properties – but he spent most of his time in Omaha. Buffett would come to enjoy celebrity and high social contacts, and he would eventually even spring for a private jet he dubbed “The Indefensible,” but his principal vice was cheap: playing bridge for 12 hours a week (and even then, he kicked Susie out of his group because she was not competitive enough.)

                  As Buffett made his fortune, “the family swirled around him and his holy pursuit” – his focus was so intense that at one point he came downstairs from his office and asked about “new” wallpaper in the living room that had been installed years earlier. After their three kids went off to college, a neglected Susie rekindled her romance with her college boyfriend while pursuing a new career as a cabaret singer. Within a couple of years, Susie told a shocked Warren that she was leaving him to move to San Francisco (she did not tell him that she was also bringing along her tennis coach, a new beau). And yet the marriage didn’t end. A depressed Buffett called her everyday and part of Susie’s heart was still with him. She wound up encouraging the hostess at an Omaha nightclub she used to sing at to look in on her husband. Soon, apparently unanticipated, the hostess, Astrid Menks, moved in. They wound up in a bizarre arrangement where Astrid would accompany Warren around Omaha, Susie around the world; they’d send Christmas cards from the three of them; and Astrid would become Warren’s second wife upon Susie’s death. When Susie did die, Warren was so emotionally overwhelmed he could not attend the funeral.

                  Meanwhile, all of his kids would drop out of college, enter short-lived marriages, and sell their Berkshire stock for questionable purposes. If they had held, “they could have been millionaires without working a day.” Instead, Susie Jr. sold to buy a Porsche. Later, pregnant during her second marriage, she asked her dad for a $30,000 loan to redo their kitchen, thinking that’d be easier to acquire than a gift. He told her to try a bank. A visiting Katherine Graham was so shocked at her modest living – a black and white television! – she paid for a redecoration. “When Buffett gave his kids a loan, they had to sign a loan agreement, so that it would be plain, in black and white, that they were legally on the hook to him.” (Somewhat relatedly, his sister got herself into over $1 million in debt with some questionable stock speculation and when she asked for help, he declined to bail out her debtors, leading her to default). Howie (Howard Graham, named after Buffett’s two heroes) at least sold his stock to try to finance a business, but it went under. Howie worked for See’s for a while but his real dream was to buy a farm. Buffett tried to argue with him and tell him, based on his insights about franchise businesses, “nobody goes to the supermarket and asks for Howie Buffett’s corn,” but Howie was persistent. “After ‘torturing’ himself,” Buffett “offered to buy a farm and rent it to Howie on standard commercial terms” but insisted on getting a bargain of a price on the land. After about a hundred bids and years of looking, Howie finally got one at the bottom of the market. Buffett’s only non-commercial terms were an agreement to lower the rent if Howie lowered his weight, which never happened. Finally, Peter would wind up quitting Stanford and sold his stocks to help finance a sound studio as he pursued a career in music. Eventually, Howie got swept up into another questionable business, leading his mother to successfully pry open Buffett’s purse strings for million dollar gifts to each child every five years on their birthday.

                  Porche

                  Figure 9.  A great car, perhaps, but has not quite multiplied in value 30x.

                   

                  Buffett had always assumed that his first wife Susie would be the one to give it all away after he died. Because Buffett was so enthralled with compound interest and confident of his own ability to generate outsized returns, he did not give much away for most of his life, insisting “When I am dead, I assume there’ll still be serious problems of a social nature as there are now.” When Buffett did occasionally dabble, he was disappointed. On the board of a small college, he helped grow their endowment substantially through profitable investments – and then was distressed by their spending it down too aggressively, and not to his preferences for students’ actual educational benefits. On the board of a bank chartered with the intention to help minorities with credit, Buffett became frustrated that it was generously lending at the expense of its own sustainability as a business and refused to bail it out. Beyond civil rights, Buffett’s charitable interests were eclectic, controversial, and difficult to finance: population control and the prevention of nuclear war. The first translated into gifts for an unusual combination of abortion providers and immigration restriction advocates. More than anything else, Buffett was looking for a long-term return (as he saw it), even asking friends a version of Munger’s business question, “If you had to give money to one charity to do the most good, which would it be?” Ultimately, for better or worse, Buffett decided his highest and best use was making money and others would give it away: without Susie, he has given more than a billion dollars to each of his three kids’ charities – and the remainder to the measurement-obsessed foundation of his close friend Bill Gates.

                  If you can somehow mimic Buffett’s investment record without his personal life, then you’ve really got something going – but you’re probably better off mimicking his fanatical saving, investing the proceeds with index funds, and spending the saved time with your family!

                  Snowball

                  Figure 10. Click here to acquire Alice Schroeder’s the Snowball (9/10), titled to evoke the wintry sphere growing in size as it rolls down a mountain – just like what compound interest does to your money.  Click here to acquire Roger Lowenstein’s Warren Buffett: the Making of an American Capitalist (8/10). These two comprise the foundation of this double review and I’d recommend both, with Schroeder having a lot more detail about his personal life (including covering, before linking up with Astrid, a possible affair with Katherine Graham. Lowenstein has the better anecdote about their relationship though as Warren convinced Katherine to finally visit him in Omaha and, when they got on the plane, asked her to draw a map of the United States and mark the location of their destination. It was so awful she tore it up. Such is the knowledge of our media elites.) I also explained at some length Buffett’s father’s politics because they were central to his life but Warren’s politics are interesting as well, and I don’t know that Lowenstein fairly labels them even as he describes them. Warren drifted away from his father over time, eventually joining the Democrat Party, but, even after hosting George McGovern at his home in Omaha, he wound up voting for Richard Nixon after McGovern announced his welfare policies. Buffett has been especially vocal about taxation, advocating for a confiscatory tax on short term capital gains, a high death tax, and replacing the income tax with a progressive consumption tax – not all ideas easily placed on the spectrum. Perhaps his best idea has been a single constitutional amendment: if the federal budget has not been balanced for the last two years, no incumbent is eligible for re-election.

                  Damn Right

                  Figure 11. Click here to acquire Janet Lowe’s Damn Right! (5/10), a wandering biography of Munger, unfortunately just about the only one. It’s hard to recommend, though I did learn some things, especially about how Munger’s law practice affected his investing philosophy. Also notable: while both Warren and Charlie are voracious readers, Warren is nearly completely focused on financials while Charlie reads extremely widely into psychology, physics, biology, history, etc. 

                  The Outsiders

                  Figure 12. Click here to acquire William Thorndike’s The Outsiders (8/10), which studies a select number of CEOs with outsized return to shareholders and concludes their secret was capital allocation. Remarkably, Buffett is not only profiled but was a key investor in and adviser to others profiled such as Katherine Graham at the Washington Post and Tom Murphy at Capital Cities. Buffett argues that most CEOs get the job due to relatively narrow skills in their previous junior position – they were great at marketing or manufacturing efficiency or legal maneuvering or whatever – but they really have no experience in allocating capital, which Buffett believes is the #1 job of the CEO. The book is most applicable to public corporations and it does have a winners’ bias – among the reasons these CEOs had such a good record was buying back their company’s public shares at cheap prices before their management made them more valuable again, but it’s plausible that other CEOs used the special sauce of buying back shares – but at the wrong time – and their management wasn’t up to snuff. Regardless, a great exploration of capital allocation.

                  Value investing

                  Figure 13. Click here to acquire Value Investing (7/10), an exploration of the concept followed by a series of profiles of practitioners. The Buffett section is almost entirely excerpted from Berkshire annual reports – which are worth reading and very accessible (Buffett liked to imagine that his not-financially-sophisticated sister was traveling for a year and he was updating her on the family business). Of particular interest might be how Graham’s disciples have been jiggering his mechanical rules that are far harder to apply in today’s market. If you’ve gotten this far, you have no doubt repeatedly seen my evangelization of index funds, which most people think of as taking on the whole market, but it’s also worth noting that there are passive index funds that capture the cheapest parts of the market, too (though they are best held in a tax-advantaged account).

                  Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend: know anyone who invests in the stock market? How about anyone who appreciates a good biography? Or perhaps anyone young and needing to benefit from compound interest?

                  I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

                    My Warren Report

                    The Gist: The origin story of an investing superhero.

                    The first of a two-part review of multiple Buffett biographies.

                    Access the second part here: Warren Piece.

                     

                    A few years ago, a close friend invited me to a weekend enjoying the finest that his home state of Nebraska had to offer: steak, a unicameral legislature, and the Berkshire Hathaway annual shareholder meeting.  We ate well, ran into the Governor while he was out walking his dog, and mostly had a great time shooting guns and talking by the evening fire at the farm.

                    Carhenge

                    Figure 1. Sadly, we missed Carhenge, a Nebraskan’s reconstruction of Stonehenge using cars.

                     

                    But the weekend opened with a visit to the Woodstock of capitalism. By the time we arrived at the basketball arena where it was held – before 6 AM, more than an hour before doors were to open – the line circled the million-square-foot building several times and appeared to include the entire population of Nebraska (and perhaps a couple neighboring states). Once finally inside, you could partake in the Berkshire conglomerate’s diverse products: Dairy Queen Blizzards, cowboy boots, auto insurance, private jet gift cards, and much more. Yet the real treat was being able to ask any question you’d like of Warren Buffett, one of the greatest investors of all time. In this email, we’ll explore the origin story of this investing superhero.

                    Make money

                    Figure 2. The vibe was a bit different than 1969. Less hippies, more yuppies. Less heroin, more ritalin. Less free love, more free markets. 

                     

                    Warren was born in Omaha in 1930 and his earliest “hobbies and interests revolved around numbers.” He saw their magic everywhere, even becoming skeptical of religion when he calculated in church that hymn composers did not live longer than average. Wall Street Journal reporter and biographer Roger Lowenstein relates that the jump from math to money was early: “When Warren was six, the Buffetts took a rare vacation to Lake Okoboji, in northern Iowa, where they rented a cabin. Warren managed to buy a six-pack of Cokes for twenty-five cents; then he waddled around the lake selling the sodas at five cents each, for a nickel profit.” By age 7, Warren begged Santa to give him the nearly 500 page then-definitive book on bonds. At age 10, his father Howard offered to take him on a trip to the east coast (something he did with each of his kids) and Warren naturally wanted to see the New York Stock Exchange. At 11, Warren was confident enough to buy his first stock – and got his sister in on the deal. She tormented him as the stock price dropped and, when it recovered, he sold at $40 for a small profit. The price then zoomed to over $200 and he vowed never again to be so oriented toward the short term. 

                    There was one idea in particular that gripped Warren’s young mind: compound interest. He understood and appreciated early on what Albert Einstein called the most powerful idea in the universe: every nickel he saved might, with enough time, benefit from growth and growth on that growth, and end up being worth much more in the future. Warren would imagine his future riches and ask, “Do I really want to spend $300,000 for this haircut?” With that in mind, Warren soon announced he would be a millionaire by 35 – the equivalent of a kid today saying he’d be worth $18 million.

                    Scissorsz

                    Figure 3. Presumably back then each strand of hair was individually cut with bejeweled gold scissors by specially imported barbers who required luxury accommodations and all-expenses-paid during the multiple day process. No wonder kids wound up growing their hair out!

                     

                    Warren’s hero was his father Howard, whose portrait would hang prominently in his office. Howard’s principal passion was politics and he had wanted to become a journalist but his father Ernest, having paid his college tuition, insisted that he get a more commercial job. So Howard joined a bank – which turned out to be not to be as stable as imagined once the Great Depression took hold. When the bank failed, Howard asked for a job at his father’s grocery store. Ernest replied he already was employing one son and couldn’t hire another – but he’d let Howard run a tab at the store so his family could eat. Howard then made the extraordinarily bold move to start his own stock brokerage at a time when no one wanted to buy stocks. Despite the headwinds, the business quickly turned a profit and served as an early hangout for young Warren, who often fled the house to escape the wrath of his mother, who had significant mental health issues.

                    Fishing pole

                    Figure 4. The Buffett clan was known for their God-fearing debt-fearing pinch-every-penny austerity. After a long day’s work, Ernest would dictate to Warren a memoir – “How to Run a Grocery Store and a Few Things I Learned About Fishing, feeling these were “the only two subjects about which mankind had any valid concern.” Buffett reported that “I’d write it on the back of old ledger sheets because we never wasted anything at Buffett and Son.”  

                     

                    In 1942, Howard volunteered to be the sacrificial Republican nominee for Congress and, to the surprise of everyone, including the candidate, won. Richard Nixon would soon be the Buffetts’ neighbor but Howard was the Ron Paul of his day and “considered only one issue in voting on a measure: ‘Will this add to, or subtract from, human liberty?’” Concluding that most proposals were subtractions, Howard voted for very little, instead hopelessly crusading for a return to the gold standard and a more humble foreign policy. Above all, Howard was known, in politics and out, as a man of unflinching ethics, refusing “a raise because the people who elected him had voted him in at a lower salary.” He always carried a piece of paper inscribed “I am God’s child. I am in His Hands. As for my body—it was never meant to be permanent. As for my soul—it is immortal. Why, then, should I be afraid of anything?”

                    Warren initially did not like Washington but soon made the most of it by insisting that his father get him every book – literally, the number ended up being in the hundreds – the Library of Congress had on horse handicapping. While Warren made some money at the tracks, he made far more with a paper route, eventually delivering “almost 600,000” papers. Not content with merely delivering the Washington Post, “he asked all his customers for their old magazines as scrap paper for the war effort.” Warren then checked the magazines for their subscription expiration dates, established a card system for tracking all his customers, and sold them renewals for commission. From these efforts, Warren was making more money per year than any of his teachers and, bored at school, taunted them by shorting the AT&T stock they had their retirement savings in. Despite his smarts, Warren’s grades were mediocre – until Howard told him he’d have to give up his profitable paper route and instantly the marks improved. Yet Warren was still entrepreneurially restless, redirecting his paper profits into operating pinball machines in local barbershops, renting out a 40 acre tenant farm back in Nebraska, and experimenting with whatever money-making scheme he could conjure. By 16, he wondered why the heck he would want to go to college when he was making so much money.

                    Spite

                    Figure 5. A deeply under-studied strategy is investing for spite. Thumb your nose / stick out your tongue / see how it goes / in the long run!

                     

                    Howard insisted, so Warren went off to Wharton, where he was, again, completely bored. “His professors had fancy theories but were ignorant of the practical details of making a profit that Warren craved.” About the only notable aspect of his time there was his arrangement “with the Philadelphia Zoo to ride an elephant” down a main avenue to celebrate the expected victory of Republican Thomas Dewey in the 1948 presidential election. Dewey, of course, did not beat Harry Truman, and the carnival stunt had to be canceled. More close to home, his father Howard lost his congressional seat, probably due to his rare vote for successful legislation – Taft-Hartley – which, among other related labor reforms, forbade unions from compelling employers to only hire their members. Though Howard would briefly return to Congress, he was part of the Robert Taft wing of the Republican Party and Dwight Eisenhower’s Nebraska allies oversaw the end of his career. Howard would spend the remainder of his life back at the stock brokerage, worried about the country’s bad choices.

                    Elephant

                    Figure 6. Modern zoos are really missing out on the profits involved in renting out their animals to college students.

                     

                    Warren thus transferred home to the University of Nebraska and graduated at 19 to get it over with. Warren considered an alternative education far more practical than college: Dale Carnegie. Till now, Warren had always been an argumentative contrarian but 

                    “He decided to do a statistical analysis of what happened if he did follow Dale Carnegie’s rules, and what happened if he didn’t. He tried giving attention and appreciation, and he tried doing nothing or being disagreeable. People around him did not know he was performing experiments on them in the silence of his own head, but he watched how they responded. He kept track of his results. Filled with a rising joy, he saw what the numbers proved: The rules worked. Now he had a system. He had a set of rules [for winning people over]”

                    More significant to his future, Warren would soon get the practical financial education he craved. Still running his various side rackets, Buffett confidently applied to Harvard Business School – and got rejected. Reconsidering his options, Buffett successfully applied to Columbia Business School, where he could study with the Wall Street legend of that era now known as the father of value investing: Ben Graham. Graham would become his personal mentor and give Buffett the intellectual foundation for his future success. 

                    Born in 1894 to a comfortable life, Ben Graham’s introduction to the stock market had been unpleasant: his widowed mother had over-borrowed to play the market and been wiped out in the Panic of 1907. His family was saved, in his own words, “from misery, though not from humiliation” by the generosity of relatives. Undeterred by his childhood experience, Graham went to Wall Street and started making a name for himself – then lost 70% when he assumed Black Tuesday 1929 was the bottom and borrowed to buy in. Still undaunted, with everyone else scared of stocks, Graham saw bargains. Over the rest of his career, he assembled one of the best long-term Wall Street records ever, beating the market average by about 2.5%. Buffett biographer Alice Schroeder advises “That percent might sound trifling, but compounded for two decades, it meant that an investor in Graham-Newman wound up with almost sixty-five percent more in his pocket than someone who earned the market’s average result.” Incredibly, Lowenstein reports that “the figure, though, does not include what was easily its best investment, its GEICO shares, which were distributed to Graham-Newman’s stockholders. Investors who kept their GEICO through 1956 did twice as well as the S&P 500.”

                    Graham made no secret of his approach and in fact considered investing just another intellectual exercise along with the study of classics, the suggestion of novel inventions, and the seduction of women. He claimed that he wanted to do something foolish, something creative, and something generous every single day. Graham endlessly annoyed his business partner by sharing in real time his insights about stocks with his Columbia business school class. His still-popular book, the Intelligent Investor, inspired Buffett to apply to the school in the first place

                    At the core of Graham’s philosophy is the attempt to buy a dollar for fifty cents. Graham advised that all companies have an intrinsic value derived from their actual business operations but detached from the price that people are willing to pay for them at any given time. Graham intoned that “you are neither right nor wrong because the crowd disagrees with you” and that “in the short run, the market is a voting machine. In the long run, it’s a weighing machine.” At the most basic level, a value investor would look for companies trading at a small multiple (say, 1.5x) of or even less than their book value – that is, the value of the company if all of its assets were liquidated. Graham initially got famous in the 1920s by buying lots of shares in an oil pipeline company who he realized owned bonds of 50% greater value than the company was selling for on the stock market – and then putting himself on the board and distributing an enormously profitable dividend. Buffett quips: “Price is what you pay, value is what you get.”

                    Graham conjured the analogy of an obliging but manic Mr. Market who is always prepared to buy or sell stocks, often at nonsensical prices. Jason Zweig summarizes: “The intelligent investor is a realist who sells to optimists and buys from pessimists.” “The secret of getting rich on Wall Street,” Buffett told a class of his own, is “try to be greedy when others are fearful and… very fearful when others are greedy.”

                    Capitol

                    Figure 7. Unfortunately, while we can often profit from Mr. Market, we can often suffer from Dr. Democracy, who is subject to similar nonsensical swings unless slowed down. 

                     

                    Because you can’t anticipate when Mr. Market will be manic or depressive, Graham says “selling short a too popular and therefore overvalued issue is apt to be a test not only of one’s courage and stamina but also of the depth of one’s pocketbook.” The market can remain irrational for longer than you have capital. The opposite side of the equation is preferable, but “buying a neglected and therefore undervalued issue for profit generally proves a protracted and patience-trying experience.” Graham’s advice to derisk was to buy so cheaply so as to create a “margin of safety.” As Buffett would later say in one of his famous shareholder letters, “This is the cornerstone of our investment philosophy: Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.” For Graham, to do otherwise would be a game of chance – or speculation that some greater fool would pay more than you. “An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” And, if the stock market is too expensive, trading at large multiples of an average of the past few years’ earnings, Graham advised to buy bonds instead (indeed, Graham instructed never to own less than 25% bonds nor less than 25% stocks, adjusting the exact split in contrarian spirit to buy low and sell high)

                    Fight club

                    Figure 8. Buffett would also say that the first rule of investing is don’t lose money. The second rule is to remember the first rule. But the truth is that the first rule of value investing is that you don’t talk about value investing. Don’t let other people in on your bargains. The second rule is the same. The third rule is that someone yells “STOP!” when the market is too high and buying is over. The fourth and fifth rule have to do with concentrating your investments. The sixth rule: No shirts, no shoes. The seventh rule is that investments will go on as long as they have to – be patient for that return. And the eighth and final rule: if this is your first time value investing, you have to buy something cheap.

                     

                    When Buffett met Graham, Schroeder records that “the rest of the class became the audience to a duet.” Lowenstein relates what happened after graduation: “Having racked up the only A+ that Graham had awarded in twenty-two years at Columbia, Buffett made what seemed an irresistible offer: to work for Graham-Newman for free.” But Graham turned him down – the Wall Street firms did not hire Jews, so he only hired Jews. Deflated, Buffett returned to his father’s company to be a stockbroker, unhappily a salesman rather than an investor. But Buffett kept in contact with Graham and, after a couple of years, Graham relented and invited Buffett back to New York.

                    In that era, market information was relatively scarce – there were no quick Google searches to discover endless reams of data about stocks. So instead Buffett was put to work endlessly reading annual reports and financial information to discover bargains in the depths of the market. Graham’s methods were remarkably mechanical. He was almost myopically focused on a company’s balance sheet and almost indifferent to what a company actually did for its money – if anything, knowing more might constitute a distraction from the opportunity. When Buffett or another would present a stock, “Graham would decide on the spot whether to buy it. It wasn’t a matter of persuading Graham. A stock either met his criteria or it didn’t. He did it by the numbers… when anyone tried to talk to Graham about a company’s products, ‘Ben would look out the window and get bored.’” Buffett soaked up everything he could but, within a couple of years, Graham decided to quit while he was ahead and returned capital to investors.

                    Buffett was not going to return to stock salesmanship so, despite cautions from his father and Graham that the stock market was overpriced, he opened up his own investment partnership. It had two unusual aspects. First, he based himself in Omaha at a time when “no serious American money man worked anywhere but New York City.” Second, Buffett offered not the friendliest terms: he would give investors an annual summary of results but not tell them anything they were actually invested in and he’d only allow them to take out money once a year on December 31. Otherwise, investors would receive 100% of profits up to 4% and 75% of any profits that Buffett generated thereafter. Around Omaha, the initial whisper was that he was a sophisticated conman. And, to be fair, this is the kind of thing that lured investors to crooks like Bernie Madoff. 

                    But Buffett wanted to spend more time analyzing stocks than having to explain and defend to his average investor why he had money in unwanted, problematic, or broken companies that were therefore cheap to buy shares in. As incredible as it may seem, by then, “Buffett was familiar with virtually every stock and bond in existence. Line for line, he had soaked up the financial pages and the Moody’s books; day after day, he had built up a mental portrait of Wall Street.” He later advised that the secret to success was to read “Read 500 pages every day. That’s how knowledge works. It builds up, like compound interest. All of you can do it, but I guarantee not many of you will do it.” It wasn’t easy but “intensity is the price of excellence.” That intensity, Schroeder says,

                    made him burrow into libraries and basements for records nobody else troubled to get. He sat up nights studying hundreds of thousands of numbers that would glaze anyone else’s eyes. He read every word of several newspapers each morning and sucked down the Wall Street Journal like his morning Pepsi, then Coke. He dropped in on companies, spending hours talking about barrels… or auto insurance… He read magazines like the Progressive Grocer to learn how to stock a meat department. He stuffed the backseat of his car with Moody’s Manuals and ledgers on his honeymoon. He spent months reading old newspapers dating back a century to learn the cycles of business, the history of Wall Street, the history of capitalism, the history of the modern corporation. He followed the world of politics intensely and recognized how it affected business. He analyzed economic statistics until he had a deep understanding of what they signified. Since childhood, he had read every biography he could find of people he admired, looking for the lessons he could learn from their lives… He ruled out paying attention to almost anything but business—art, literature, science, travel, architecture—so that he could focus on his passion. He defined a circle of competence to avoid making mistakes… He never stopped thinking about business: what made a good business, what made a bad business, how they competed, what made customers loyal to one versus another. He had an unusual way of turning problems around in his head, which gave him insights nobody else had… In hard times or easy, he never stopped thinking about ways to make money. And all of this energy and intensity became the motor that powered his innate intelligence, temperament, and skills.

                    Some friends, family, and acquaintances – around Nebraska or associated with Graham – saw something in that intensity and invested. If you had been crazy and lucky enough to invest $10,000 at the beginning and had stubbornly stuck with him, you’d have over $500 million today (versus over $5 million if you had gotten the market return). But even by the sixties, Omaha now whispered that Warren Buffett could make you rich. Per Buffett’s childhood vow, by 35, he was a millionaire – worth over $50 million in today’s money. 

                    Buffett was doing it by applying Graham’s principles about intrinsic value – but also learning new things along the way. As a new generation started trading on the stock market, fears of another crash disappeared and the market began to get frothy – especially about new technology. With tech trading at crazy multiples, Buffett pledged to his partners that “We will not go into businesses where technology which is way over my head is crucial to the investment decision.” (And while you hopefully can see that this was prudent, you also should know that he declined the opportunity to invest in Intel when given a special opportunity to do so at the beginning). At the same time, with an ever-increasing amount of capital to put to work, it was harder to find bargains that Buffett could take advantage of without moving the entire price – so he contemplated buying entire companies. But as Buffett got more involved in the operations of the companies he bought into, he understood better why they were so cheap: they really did have significant problems. And yet he’d be hesitant to get rid of a company that still generated a return – even if it was measly – because he resisted confrontation and enjoyed the collection.

                    Mcdonalds

                    Figure 9. Turns out the incredible savings of eating every meal at McDonald’s are overwhelmed by later medical expenses.

                     

                    But Buffett thought that if he could get management right that the value would pay off. Knowing relatively little about the underlying businesses, even after much research, he tried to find the right kind of obsessive. He loved to tell the story of when he bought a grocery store chain and convinced the owner, Ben Rosner, to stay on to manage the asset. Rosner was so consumed with his business that, when he went to a black tie event at the Waldorf Astoria and ran into a rival, he started asking him all about what prices he paid for different goods and discovered that he was paying a lot cheaper price for toilet paper. Rather than gloat, Rosner thought something was wrong and immediately left in his tuxedo, drove out to one of his warehouses, tore open a box and individually counted the sheets of toilet paper, discovering that his vendor had screwed him over, providing less sheets than promised.

                    Following the Graham playbook, Buffett would eventually acquire a controlling stake in a Massachusetts textile manufacturer called Berkshire Hathaway, whose stock was selling at a 2.5x discount to its liquidation value – presumably plenty of margin of safety. But Berkshire was in an extremely tough industry that would eventually leave the United States but by then had already basically left the northeast and fled south. Partially because of uncooperative management who was idealistic about making textiles and not money, Buffett got mad enough to buy them out. Putting in his own team, he explained “the basic theory of return on investment. He didn’t particularly care how much yarn [Berkshire] produced, or even how much [it] sold. Nor was Buffett interested in the total profit as an isolated number. What counted was the profit as a percentage of the capital invested.” This was wise direction, but there was too much headwind in the industry. He would ultimately reflect: “I would have been better off if I’d never heard of Berkshire Hathaway.” 

                    And yet Berkshire would be his destiny: in 1970, after years of warning investors that he could not sustain his track record amidst the Go-Go years of an overheated market, he closed his partnership and offered to return all capital. With the market so crazy, Buffett said he would invest his own money in municipal bonds – and Berkshire Hathaway. For some lucky investors, knowing that Buffett would be in control was enough to roll over their investment into Berkshire. When the market came down again, Buffett told people now was the time to get rich and he would use Berkshire to propel his further investments. But he also partnered with the man who would redefine his investment style, building on and adjusting from Graham: Charlie Munger. 

                    More on that partnership and the rest of Buffett’s career in our next correspondence.

                    Snowball

                    Figure 10. Click here to acquire Alice Schroeder’s the Snowball (9/10), titled to evoke the wintry sphere growing in size as it rolls down a mountain – just like what compound interest does to your money. A former insurance analyst, she spent over 5 years working on this book, interviewing hundreds of people who knew Buffett. More or less authorized, Buffett told her “Whenever my version is different from somebody else’s, Alice, use the less flattering version.” Unfortunately for their relationship, she apparently used a few too many versions different from Warren’s memory – but it still comes across as a tribute to the man. Published in 2008. 

                    Buffett

                    Figure 11. Click here to acquire Roger Lowenstein’s Warren Buffett: the Making of an American Capitalist (8/10). A Wall Street Journal reporter and Berkshire investor, he spent three years working on this biography, published in 1995. Some of his descriptions of politics seemed off and he is very dismissive of academic commentary on Buffett’s investing history, but it’s a good book!

                    Intelligent investor

                    Figure 12. Click here to acquire Ben Graham’s The Intelligent Investor (8/10) – appropriately, Buffett’s purchase of the book had an outstanding rate of return. This version has commentary from Wall Street Journal columnist Jason Zweig after every chapter offering additional context through the early 21st century. Graham distinguished between an entrepreneurial investor – like Buffett – who would have to put in a ton of work to find bargains and a defensive investor who was just trying to get the market return. While there is timeless wisdom here, Graham found it harder and harder to apply his mechanical rules even in his day and it’s only become harder. Toward the end of his life, he recommended the average investor defensively invest in index funds, then a new-fangled instrument of John Bogle’s, now a standard offering.

                    Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend:  know anyone who invests in the stock market? How about anyone who appreciates a good biography? Or perhaps anyone young and needing to benefit from compound interest?

                    I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!