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The Great Global Crisis and Family Finance

(How to look after your property in a world of catastrophe and ruin)

Author’s foreword

Friedrich August von Hayek  wrote The Road to Serfdom  while living in Great Britain during the terrible global conflict known as the Second World War. However, he did not deal with the fury of the actual combat; rather, he examined the real essence of the struggle of liberty against tyranny.

Hayek feared, and quite rightly so, the clear paradox of such moments in history. Whilst on the battlefield it was obvious who was “good” and who was “evil”, since there was a coalition of mainly democratic nations standing against a coalition of despotic (today we might say terrorist) states; on the ideological front the apples and pears  were mixed, and, quite commonly, not only added, but also multiplied.
He himself described his book as political and this with considerable pride, because he believed that correct politics should primarily defend liberty in the widest sense of the word. He begins his text with two quotations. The first one, “It is seldom that liberty of any kind is lost all at once,” comes from David Hume . The second quotation comes from Alexis Charles Henri Clerela de Tocqueville : “I would have loved freedom in all times, but I feel myself inclined to adore it in the time we are in.”

I am almost completely certain that right now, at the beginning of the 21st century, we are going through a period when we are slowly and steadily losing freedom. I mean freedom in an extraordinarily broad sense of the word, in such a broad sense, in fact, as to be historically unique. What is more, we are facing a very specific situation where we are losing our freedom not by tyrannical laws, nor by the growing influence of the socialist oriented political parties. Rather, there has appeared a completely new and even more devastating method. Society itself, with its development and its new conventions, or rules, opens the way to no small limitation of freedom. Paradoxically, our current morals are generally extremely relaxed and finances are externally quite liberal, with travel opportunities and the exchange of ideas and goods being the freest in recent history. This appears to be so, at least at first glance. However, we are, in many respects, less free than were our forebears. Therefore, we should adore freedom, not just love it.

I really do not wish to be the harbinger of dark pessimism, even though this might appear to be the case from the previous paragraph. By it I merely wished to explain why this book does not only deal with “family finance”, which is its title, but in its remit attempts to analyse a far broader background.

Whilst Hume spoke of losing political or civil liberty – and so were, and are, his words generally understood in the past and now – our present time involves the extensive “dissolution” of the very principles of traditional society and human existence, the erosion of all traditions, immense changes in democratic conventions, as well as many other phenomena, which could be very easily understood as “the gradual loss of freedom”. Many people would unreservedly agree that the post-industrial society founded on consumption has lost its freedom-based essence.

These are all topics that should be dealt with, because they concern the whole economic environment, potential political risks and many other aspects connected with the family purse. So, if somebody asks what relevance this “economic philosophising“ has to returns on shares, price volatility of the shares of software companies, the relationship between the price of oil and gold or zinc, then I have only one answer: Absolute.

The crisis of 2007–2009 (maybe to 2010 – at the time of writing this is by no means clear), has shown, among other things, that many of the generally valid investment rules do not apply, or apply only to a very limited extent. What is more, the hitherto almost endless trust in central institutions, state authority, national banks and state-managed systems will have to be revised. We will also have to change the predictions of states’ behaviour in times of economic trouble, because the traditional models have proven to be insufficient. This crisis has shown the extraordinary, or even pathological, willingness to intervene of government machinery, which churns out (and unfortunately realises) one measure after another, making it impossible to judge the impact of individual steps and their effectiveness. Although the political elites do not know the real results of steps taken by them in the past, they continue to take new measures, over and over.
These are all facts that have an incredibly close connection with the issue of family finance. Therefore, in addition to examining the advantages of government bonds, it is certainly very wise to study how their massive issue influences the entire money market. Recognising the current politico-economic laws can help us – if nothing else – to recognise in time the risks that only a few decades ago our world never dreamt existed.

At the very least, we can say that knowledge of some of the dynamic laws governing the working of the human economy helps everyone to orient themselves in the area of investment. This is no small thing. However, it is difficult in a world that changes in ways we have not yet been able to perceive properly, let alone completely understand.

My first book on family finances was published in the Czech Republic in 2007. I wrote it in 2006, a long time before the beginning of the financial crisis, which completely overturned the whole world of family finances. I even completed it before the first signs appeared, in the United States, of the real and serious problem with mortgages followed by the gradual collapse of “toxic” derivatives issued to the debt of American families. Since autumn 2007, our world has changed immensely, making it a radically different place to the one we knew before. Looking back now, I see just how different the situation was: it was built on completely different foundations. Moreover, when I look at our present efforts, those made by whole nations in crisis, then it is clear that it was not previously possible to imagine that we could, in such a short time, adopt such chaotic reactions to external events as the globalised civilisation is demonstrating in the middle of 2009.
On the other hand, I have kept some basic views on the world of economy, and family finances in particular. Luckily, there remain, even in these hectic times, certain postulates which do not change and on which it is not necessary to make any corrections or adjustments.
Therefore, I keep saying that for the practical execution of economic decisions, it is sufficient for the ordinary person to know two elementary formulas that even have a common basis, and to understand and be able to apply the simple rule of three. With this mathematical equipment it is possible to achieve (in normal situations) equally good, and maybe even better results as with the endlessly voluminous and complicated mathematical apparatus. The complexities of economic theory are necessary for economic research and scientific development. At a practical level, however, I would recommend (of course, only to amateur, not professional investors) that you “throw them out the window”.

Secondly, it is precisely the past few months and years which have confirmed my steadfast conviction that, in most cases, the important information and facts for investors are not governed by presumable and calculable logic, but are rather influenced by the phenomena and events described by such sciences as psychology, crowd psychology, sociology, social psychology, and even anthropology. I am ever more convinced (if I now indulge in a marked simplification) that though theoretical economics can yield many answers to questions posed from the long-term view, it cannot find the right explanation for immediate and short-term phenomena.

This concerns my third conviction which I see no need to change. Our world is ever more complicated – I know that is a banal statement, and one made extremely often, but despite its being so common we are unable to accept it, far less believe in it. Let us try to comprehend, and not just keep repeating, that our world is ever more complicated. When Immanuel Kant  walked around Prussian Königsberg , talking of the starry heavens overhead and man’s moral ideals, all he needed for the creation of his amazing philosophical model was a deep knowledge of history, the work of his predecessors, and real experience of his present, which, apart from Prussia, contained the rest of what later became Germany, at the most, plus regular reports from France and England. Kant himself practically spent his entire life only in Königsberg. In spite of this, he became one of the greatest philosophers in history.

In that time, such things were still possible. It was the end of the 18th century, and when Kant wrote his key books, Louis XVI and Marie Antoinette still lived and the French Revolution with its terror was still awaiting starter’s orders. For the creation of a philosophical model which included all aspects of the then known and “real” world, it was enough to wander the streets of that Prussian port. The plurality of societies and phenomena with which we are overwhelmed, and the fact that they are all granted, by general consent, a right to exist, to their own importance, and to influence the forms of modern societies, all this turns our world into a system which cannot be described by models; in other words, it is a system which cannot be understood as a situation, but only as a process.

Economics reacts to this development, understandably enough, more slowly and with delay. With the same slowness and delay we are willing to admit to ourselves the truth of the sentence which we often utter as a universal explanatory phrase, but without reflecting on its content in any way: “Our world is ever more complicated...”

Practically all governments in the developed world have, in one way or another, been forced to confront the economic crisis, and the fact is that the vast majority of democratically elected governments has taken such measures as can boldly be termed socialist in character. The government of Great Britain and Northern Ireland has become the biggest and strongest shareholder in the country’s banking system. The governments of Germany and many other countries have acted in a similar fashion, albeit not to such a great extent. Primarily, the banks in the individual states were thus markedly supported in their existence, but also – with a certain exaggeration – they lost power and responsibility. In total, the governments of the developed countries pumped up to seven billion dollars  into the banking sector. These measures do not include the practically unlimited guarantees on deposits in the banks; they concern especially direct state intervention in financial institutions, the buying up of bad debts and a multitude of other, similar, steps.

Both the national banks and the European Central Bank reduced their key rates in efforts to revive the market with loans . The costs of these steps are for the moment unknown, and thanks to their complexity they will probably stay like that. Moreover, we have not mentioned the fact that the financial sector in Iceland ceased to exist in its original form, and in an attempt to protect it from total collapse the state stepped in. The Hungarian economic system collapsed; the Baltic States did not fare any better.

These are all events that, for many years to come, will bind the governments of the developed states closely to financial economy, and could have severe – but now completely unpredictable – results. We can be certain, therefore, that the significance of government intervention in the economy will increase. I have already dealt with this question in the first edition of Personal and Family Finances. Since that time, however, it has taken on much greater dimensions, and it appears that in the next few years it will, to a certain extent, play a tremendously important role in the economic decisions taken by families in the developed economies.

If there is not a turnaround in the trends that appeared in 2008 and 2009, we can, in an ironic twist of fate, expect the fulfilment of the dark prophecy uttered by Karl Marx , whereby capitalism will collapse in two possible ways. The first way is a proletarian revolution, and the second is the gradual state takeover of the means of production, prompted by the necessity of ever more complicated and more highly organised forms of the division of labour, which must be realised in other ways than are possible in the market environment.

Yet if the states in modern societies become more involved in the economy as regulators, or even direct owners, then great changes will come, even in the area of family finances. Firstly, the world of investment opportunities will have altered. At the moment we do not know the practical results of such developments, we do not know the conditions appertaining to concrete cases, but it is necessary to come to terms with the new situation, at least on a general level.

The main impetus for writing this book is the strong and urgent impression that we are constantly weaving and dodging before the honest answer to the key question: “What exactly led to this crisis? Is it a situation that showed up inherent errors in our political and economic systems, in our ways of organising a society we call democratic capitalism? Or is the crisis the result of a lot of coincidences and failures in the control mechanisms, bad judgment, erroneous consideration and, lastly, also criminal activities?”

These questions must be answered with the maximum amount of truthfulness. This is what I am now attempting to do...

Lubos Smrcka,
Prague 2009

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