Then there are those who expect not only to have a non-negative real return, but at least a market return. This is the expectation that during the consumption period, we will get at least as much value as we “stored” proportionally to the fraction of output we produced in the economy at the time of “storage.” For example, if technology improved, we would expect that our “stored” widget version 1, would be returned to us as the much improved widget version 10. This seems greedy yet fair. In contrast, the expectation for non-negative real return seems rather tame now, doesn’t it? Until you consider that the economy might actually contract. What if, due to whatever circumstances, the excess producers during the consumption period do not produce enough value to proportionally divide among those who “stored” value an amount that is more than what they stored? This could be by will or by necessity. What if all we had were widget version 0.5? Would it still be plausible to insist on non-negative returns? It would not.

In fact, following a period of great excess in production, especially one that prematurely fulfilled useful work for some time into the future (until new technology and demand develop), the right view is that the nominal amount of stored value is irrelevant — it is not exchangeable.

Now the second assumption. Capital markets are a great invention. They solve the centralized allocation problem in a distributed way. We assume that rational actors freely acting in their own self interests will produce a solution that allocates capital in the “optimal” way. Perhaps it isn’t a global optimal (requires cooperative strategies), but a more basic question is what planning problem do they solve in the first place? Let us give individual actors the benefit of the doubt that they can do planning and are perfectly rational. Nevertheless, it seems difficult to imagine that any would do planning much beyond their own lifespans. That would not be rational. Thus, capital markets are essentially solving an allocation problem based on each individual’s preferences for maximizing their own utilities during their lifespans. This has great implications. First, it puts an upper bound on the planning period for the allocation problem at the longest remaining lifespan among individuals. This is like 80 years or so. That is pretty myopic. It seems like a long time, but for many decisions, especially concerning resources, it is very myopic.

It gets worse. That was just an upper bound. Inputs into capital markets are weighted by the amount of money committed to a trade. It is a given that older (working) people have greater wealth, and as a consequence their inputs as expressed by capital commitment are weighted more in the allocation decisions. That is exactly what you don’t want, because a shorter remaining lifespan is now correlated with larger weight in decisions. The net result is that the capital allocation decisions are being carried out for optimality over very short planning periods, possibly only on the order of 10 or 20 years at most. It isn’t even optimal for most people alive any more.

So this is a fundamental problem in capital markets. Under the law of one price for open markets, only one view can be ultimately carried out, and it is one that is too myopic, and even myopic for most people. The only way to correct for this is to weight the inputs properly, and that would require external intervention to enforce a political planning decision.

What to make of this? Is social media any more viable than e-commerce of the first dot-com bubble?

This is difficult to answer. Both technology eras rested on the assumption of consumption. E-commerce startups of the 1990s figured that the ease of online shopping would convert offline shoppers to online ones. Of course many didn’t make a profit as the conversion didn’t materialize to the scale that they projected (for the benefit of VC’s — I doubt they really believed in it). Social media startups of the present believe that better preference information driving targeted advertising would do that offline-to-online conversion better. Whether that will materialize is equally dubious.

There is a difference, however. This time, the risk is diffused as abstract online properties are monetized piece by piece. Some of the risk, for example, is offloaded onto advertisers, as they pay upfront for preference information in exchange for clicks, whether or not they generate increased sales. The latter question is left to the competing merchants to sort out.

The value chain is a lot more complicated this time, but ultimately will it be profitable? Ostensibly, there is an information trade on the front-end: content for personal information. We know that content has value since you used to pay for it; now it’s “free.” The cost went somewhere. Was it paid in personal information? But personal information should have no value, unless they generate additional consumption, and there is no evidence of that. One theory is that the cost of content (i.e. the cost of ads) went into generic business expenses. If your competitors are placing ads, you place them, too. Eventually an equilibrium is reached whereby some items (e.g. brand-name items) become more expensive by the cost of “free” content they support at the other end, and the people viewing those ads are not deterred by this invisible tax since they are convinced of the value proposition posited by the ads. In such a world, the startups survive. If, however, the amount of “free” content becomes too much for consumption to support, then we have another bubble on our hands.

Now let’s turn to the other model of behavior, where things are swapped around. Here, consumption is the default. To consume is what happens if you do nothing; that is the raison d’etre. All other actions service that need. In other words, why bother to “save” or “invest” or “work” if you do not consume? See how this is inverted? Again, this is tightly coupled with the notion that borrowing is a tool of persistent leverage for greater return. This is typically risk taking behavior, in technical parlance of course.

To make the cases even more distinct, here are two graphs of model behaviors:

“savers”

“consumers”

So people try to analyze why East Asia saves so much and why China especially cannot get internal demand going due to excess savings, whether it’s because of the lack of a social safety net, or because of an inequitable distribution of wealth. Yes, these have some effects, but no. I don’t think those are why. It has to do with how personal financial behavior is internalized from the past, as much as influenced by conditions in the present. I think risk averse behavior is ingrained into people in times of scarcity (credit scarcity or capital scarcity) and how long this behavior lasts depends on the severity of a downturn and the subsequent period of prosperity. (As an aside, it can be argued that risk taking behavior isn’t entirely risk taking behavior but partly a bad estimation of the actual risk.)