Fragility and Robustness

The fragility of a salary

A common perception would be that the salary as an employee at a large, developed-world company is safer than income from scattered investments in a small West African country.  I’m not so sure.

The developed world salary, (like mine), always comes on time and is always of a known amount, which on the face of it feels quite reassuring.  However, it can go to zero quite abruptly, as as companies, even large ones, have a nasty habit of failing quite frequently. For more on that I’d recommend Paul Ormerod’s book Why Most Things Fail where among other things the extinction of species for the last 250 million years is shown to have the same type of probability distribution (power law) as companies going out of business since 1912.

It can be argued that one’s safety as an employee doesn’t lie with the employer, but with one’s skill set and ability to get another job based on these skills.  On the other hand, with technological advances and well, stuff happening, whole sectors can decline and even disappear and with them the demand for whole ranges of skills can also disappear. And a fixed regular salary can give the impression that everything is fine and that there’s no need to change anything (like learning new skills) until just before a crash.

Doom and gloom

I might be reading too much zerohedge and papers by the Bank for International Settlements (ok, I’ve read precisely one), but I’m thinking that the western world has experienced unusually good times in the last decades, and that going forward things might get rougher. What’s approaching can be described as a flock of grey swans involving the effects of:

  • insolvency of western sovereign states (+ Japan)
  • insolvency of  banks
  • poor demographics in developed countries
  • a potential real estate crash in China
  • and most likely issues I haven’t imagined, ie “unknown unknowns” or true black swans
As for insolvency of banks and systemic international debt crisis, looking back at history, it is a very common phenomenon:

the first true international debt crisis had its roots in loans made by Italian merchants to England starting in the late thirteenth century. In that era, it was Italy that was the developed financial center and England the developing nation rich in natural resources, especially sheep’s wool. As we have already discussed, a sequence of Italian loans helped finance various stages of wars between England and France. When Edward III of England defaulted in 1340 after a series of military failures, the news reached Florence quickly. Because the major banks had lent heavily to Edward, a bank run hit Florence’s economy. The whole affair played out in slow motion by modern standards, but one major Italian lender, the Peruzzi Bank, went bankrupt in 1343, and another, the Bardi Bank, did in 1346.

If England is replaced by Greece, and Italy by France or any country where banks are in trouble for lending to Greece, you kind of get what seems to be happening right now. And with human nature – in an evolutionary sense – not having changed that much since the 14th century, I wouldn’t be too confident that the current crisis will be handled better than that of the 1340s.

An example of confidence that people have learned to handle/avoid financial crisis better than in the past, would be this advertisement that ran in Saturday Evening Post, on September 14, 1929:

when all Europe guessed wrong

The date — Oct. 3, 1719. The scene — Hotel de Nevers, Paris. A wild mob — fighting to be heard.

“Fifty shares!” “I’ll take two hundred!” “Five hundred!” “A thousand here!” “Ten thousand!”

Shrill cries of women. Hoarse shoats of men. Speculators all — exchanging their gold and jewels or a lifetime’s meager savings for magic shares in John Law’s Mississippi Company. Shares that were to make them rich overnight.

Then the bubble burst. Down went the shares. Facing utter ruin, the frenzied populace tried to “sell”. Panic-stricken mobs stormed the Banque Royale. No use! The bank’s coffers were empty. John Law had fled. The great Mississippi Company and its promise of wealth had become but a wretched memory.

Today, you need not guess.

History sometimes repeats itself — but not invariably. In 1719 there was practically no way of finding out the facts about the Mississippi venture. How different the position of the investor in 1929!

Today, it is inexcusable to buy a “bubble” — inexcusable because unnecessary. For now every investor — whether his capital consists of a few thousand or mounts into the millions — has at his disposal facilities for obtaining the facts. Facts which — as far as is humanly possible — eliminate the hazards of speculation and substitute in their place sound principles of investment.

200 Varick St
New York, New York

Source: Also This Time is Different – Eight Centuries of Financial Folly

Robustness of investments in the Ivory Coast

The income from my real estate investments (+taxi) in the Ivory Coast, is very different from a salary.  Even if rents are fixed the income flows are variable as tenants don’t always pay on time (or at all) and move in and out, and in addition there are repair costs from time to time. However, the income flows come from nine relatively independent tenants plus a taxi driver and do, unlike a salary, not depend on one big organisation.  The flows may vary from month to month but are unlikely to go to zero, making them possibly more robust than a salary. The variability comes from the way the business is set up, random events, plus the ebbs and flows of the Ivorian economy, and can in itself provide signals that the business need to be adapted – whereas a fixed salary can lull you into a possible false sense of security.

During the post-electoral crisis, income held up relatively well, and despite two shops being looted and partially destroyed, the business as a whole was far from being destroyed. The business being in one single developing world country is an issue though, as it makes all income flows more correlated. My main worry isn’t another crisis though,  but the business being targeted by some sort of mafia in collusion with, or consisting of corrupt officials.  Now, I don’t think I will have problems of this kind, but it’s the most likely way I can imagine that the whole business will be killed, and it’s unfortunately a reason not to be too specific about the business on the blog.

The Souk and the Office building

This blog post was very much inspired by a chapter called “The Souk and the Office Building” from Nassim Taleb’s next yet unpublished book. It’s a great read, but it seems to unfortunately have been removed from Taleb’s website. I downloaded it before it was removed and any interested reader can drop me a line and I’ll send it!   It might still be available on google cache too.


One thought on “Fragility and Robustness

  1. Pingback: A Window to Another World « Hotel Ivory

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