Charlie Munger Article on Slate

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By Charles Munger

Updated Sunday, Feb. 21, 2010, at 3:30PM ET

In the early 1700s, Europeans discoveredin the Pacific Ocean a large, unpopulatedisland with a temperate climate, rich inall nature's bounty except coal, oil, andnatural gas. Reflecting its lack of

civilization, they named this island"Basicland."

The Europeans rapidly repopulatedBasicland, creating a new nation. Theyinstalled a system of government likethat of the early United States. There wasmuch encouragement of trade, and nointernal tariff or other impediment tosuch trade. Property rights were greatly

respected and strongly enforced. Thebanking system was simple. It adapted toa national ethos that sought to provide asound currency, efficient trade, andample loans for credit-worthy businesseswhile strongly discouraging loans to theincompetent or for ordinary dailypurchases.

Moreover, almost no debt was used to

purchase or carry securities or otherinvestments, including real estate andtangible personal property. The oneexception was the widespread presenceof secured, high-down-payment, fullyamortizing, fixed-rate loans on sound

houses, other real estate, vehicles, andappliances, to be used by industriouspersons who lived within their means.Speculation in Basicland's security andcommodity markets was alwaysrigorously discouraged and remainedsmall. There was no trading in optionson securities or in derivatives other than"plain vanilla" commodity contractscleared through responsible exchangesunder laws that greatly limited use of financial leverage.

In its first 150 years, the government of Basicland spent no more than 7 percentof its gross domestic product inproviding its citizens with essentialservices such as fire protection, water,sewage and garbage removal, someeducation, defense forces, courts, andimmigration control. A strong family-oriented culture emphasizing duty to

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Basically, It's OverA parable about how one nation came to financial ruin.

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relatives, plus considerable private

charity, provided the only social safetynet.

The tax system was also simple. In theearly years, governmental revenues camealmost entirely from import duties, andtaxes received matched governmentexpenditures. There was never much debtoutstanding in the form of governmentbonds.

As Adam Smith would have expected,GDP per person grew steadily. Indeed, inthe modern area it grew in real terms at 3percent per year, decade after decade,until Basicland led the world in GDP perperson. As this happened, taxes on sales,income, property, and payrolls wereintroduced. Eventually total taxes,matched by total governmentexpenditures, amounted to 35 percent of GDP. The revenue from increased taxeswas spent on more government-runeducation and a substantial government-run social safety net, including medicalcare and pensions.

A regular increase in such tax-financedgovernment spending, under systemshard to "game" by the unworthy, wasconsidered a moral imperativea sort of egality-promoting national dividendsolong as growth of such spending waskept well below the growth rate of thecountry's GDP per person.

Basicland also sought to avoid troublethrough a policy that kept imports andexports in near balance, with eachamounting to about 25 percent of GDP. Some citizens were initially nervousbecause 60 percent of imports consistedof absolutely essential coal and oil. But,as the years rolled by with no terribleconsequences from this dependency, suchworry melted away.

Basicland was exceptionally

creditworthy, with no significant deficitever allowed. And the present value of large "off-book" promises to providefuture medical care and pensionsappeared unlikely to cause problems,given Basicland's steady 3 percentgrowth in GDP per person and restraintin making unfunded promises. Basiclandseemed to have a system that would longassure its felicity and long induce other

nations to follow its examplethusimproving the welfare of all humanity.


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But even a country as cautious, sound,and generous as Basicland could come toruin if it failed to address the dangersthat can be caused by the ordinaryaccidents of life. These dangers weresignificant by 2012, when the extremeprosperity of Basicland had created apeculiar outcome: As their affluence andleisure time grew, Basicland's citizensmore and more whiled away their time in

the excitement of casino gambling. Mostcasino revenue now came from bets onsecurity prices under a system used inthe 1920s in the United States and called"the bucket shop system."

The winnings of the casinos eventuallyamounted to 25 percent of Basicland'sGDP, while 22 percent of all employeeearnings in Basicland were paid topersons employed by the casinos (manyof whom were engineers neededelsewhere). So much time was spent atcasinos that it amounted to an averageof five hours per day for every citizen of Basicland, including newborn babies andthe comatose elderly. Many of thegamblers were highly talented engineersattracted partly by casino poker butmostly by bets available in the bucketshop systems, with the bets now called"financial derivatives."

Many people, particularly foreigners withsavings to invest, regarded this situation

as disgraceful. After all, they reasoned, itwas just common sense for lenders toavoid gambling addicts. As a result,almost all foreigners avoided holdingBasicland's currency or owning its bonds.They feared big trouble if the gambling-addicted citizens of Basicland weresuddenly faced with hardship.

And then came the twin shocks.Hydrocarbon prices rose to new highs.And in Basicland's export markets there

was a dramatic increase in low-costcompetition from developing countries. It was soon obvious that the same exportsthat had formerly amounted to 25percent of Basicland's GDP would nowonly amount to 10 percent. Meanwhile,hydrocarbon imports would amount to30 percent of GDP, instead of 15 percent.Suddenly Basicland had to come up with30 percent of its GDP every year, in

foreign currency, to pay its creditors.


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How was Basicland to adjust to this

brutal new reality? This problem sostumped Basicland's politicians that theyasked for advice from BenfranklinLeekwanyou Vokker, an old man who wasconsidered so virtuous and wise that hewas often called the "Good Father." Suchconsultations were rare. Politiciansusually ignored the Good Father becausehe made no campaign contributions.

Among the suggestions of the GoodFather were the following. First, hesuggested that Basicland change its laws.It should strongly discourage casinogambling, partly through a complete banon the trading in financial derivatives,and it should encourage former casinoemployeesand former casino patronsto produce and sell items that foreignerswere willing to buy. Second, as thischange was sure to be painful, hesuggested that Basicland's citizenscheerfully embrace their fate. After all, heobserved, a man diagnosed with lungcancer is willing to quit smoking andundergo surgery because it is likely toprolong his life.

The views of the Good Father drew someapproval, mostly from people whoadmired the fiscal virtue of the Romansduring the Punic Wars. But others,including many of Basicland's prominenteconomists, had strong objections. Theseeconomists had intense faith that any

outcome at all in a free marketevenwild growth in casino gamblingisconstructive. Indeed, these economistswere so committed to their basic faiththat they looked forward to the daywhen Basicland would expand realsecurities trading, as a percentage of securities outstanding, by a factor of 100,so that it could match the speculationlevel present in the United States justbefore onslaught of the Great Recessionthat began in 2008.

The strong faith of these Basiclandeconomists in the beneficence of hypergambling in both securities andfinancial derivatives stemmed from theirutter rejection of the ideas of the greatand long-dead economist who hadknown the most about hyperspeculation,John Maynard Keynes. Keynes hadfamously said, "When the capital

development of a country is thebyproduct of the operations of a casino,


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the job is likely to be ill done." It was

easy for these economists to dismiss sucha sentence because securities had been solong associated with respectable wealth,and financial derivatives seemed sosimilar to securities.

Basicland's investment and commercialbankers were hostile to change. Like theobjecting economists, the bankers wantedchange exactly opposite to change wanted by the Good Father. Such bankersprovided constructive services toBasicland. But they had only moderateearnings, which they deeply resentedbecause Basicland's casinoswhichprovided no such constructive servicesreported immoderate earnings from theirbucket-shop systems. Moreover, foreigninvestment bankers had also reportedimmoderate earnings after building theirown bucket-shop systemsand carefullyobscuring this fact with ingenioustwaddle, including claims that rationalrisk-management systems were in place,supervised by perfect regulators.Naturally, the ambitious Basiclandbankers desired to prosper like theforeign bankers. And so they came tobelieve that the Good Father lacked anyunderstanding of important and eternalcauses of human progress that thebankers were trying to serve by creatingmore bucket shops in Basicland.

Of course, the most effective political

opposition to change came from thegambling casinos themselves. This wasnot surprising, as at least one casino waslocated in each legislative district. Thecasinos resented being compared withcancer when they saw themselves as partof a long-established industry thatprovided harmless pleasure whileimproving the thinking skills of itscustomers.

As it worked out, the politicians ignored

the Good Father one more time, and theBasicland banks were allowed to openbucket shops and to finance thepurchase and carry of real securities withextreme financial leverage. A couple of economic messes followed, during whichevery constituency tried to avoidhardship by deflecting it to others. Muchcounterproductive governmental actionwas taken, and the country's credit was

reduced to tatters. Basicland is nowunder new management, using a new


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governmental system. It also has a new

nickname: Sorrowland. Become a fan of Slate on Facebook.Follow us on Twitter.

Charles Munger is vice chairman of Berkshire Hathaway.


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