Career risk

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PHOTOGRAPHER: YURI GRIPAS/GETTY IMAGES

An important principle to explain human action in today’s society is career risk. This principle is always present in participatory democracy, a form of democracy in which citizens have a policy-making influence on government. This can be achieved, for example, through a referendum, the right of petition, signature campaigns and demonstrations. Post-covid, career risk has become so important that it is increasingly influencing financial markets. The main reason that policymakers decided to proceed with lockdowns and the suspension of civil rights was the likelihood that a large group of people would die and then the policymakers would be challenged by public opinion. There is only one country in the world that has not taken this route and that is Sweden. It is therefore not surprising that in Sweden this decision was not taken by a politician, but by scientists. Scientists were allowed to take an autonomous decision in Sweden, which attracted a lot of international criticism.

It is the first time that measures to combat a pandemic are so far-reaching. The world economy did not shut down during the swine flu pandemic of 2009, nor during Sars in 2003 or the Hong Kong flu pandemic of 1969, not even during the Spanish flu of 1918. The corona crisis is therefore the first pandemic in which social media played a major role. Every decision was commented on in real-time by millions of people around the world. In such an environment, the first instinct is not to stray too far from the herd. Kenneth Galbraith has already observed that ‘in any large organisation it is much, much safer to be wrong with the majority than to be right on your own. After Denmark and Norway followed the example of the Italian lockdowns in March 2020, there was no escape for other countries. Yet there are no differences in the outcome between, for example, Florida (without lockdowns) and California (with lockdowns) or between Sweden (without lockdowns) and France (with lockdowns).

This career risk also plays a major role for professional investors, who are not rewarded for sticking their heads out of the sand. They think it is fine to buy bonds with a negative return, especially because everyone else is doing it. They also have a problem with buying Tesla at 25 times its turnover, but the moment Tesla is part of the S&P 500, this is suddenly no longer a problem. This ensures that capital is not allocated on the basis of the best return, but on the basis of the size of the company measured in market capitalisation. Since the allocation of capital on the basis of return is the basis of the capitalist system, this career risk makes one embrace socialism or communism. In the Soviet Union, too, the biggest companies got the most money. The ultimate solution to career risk is index investing. From the point of view of the individual, investing in the index is a good solution. But seen from the top-down, more and more capital goes to stocks that are rising in value and less capital to stocks that are falling in value. This is called momentum and ultimately causes price explosions and price implosions and thus more volatility. A much more important effect is the misallocation of capital. In the socialist welfare state, every worker receives the same salary, regardless of his or her performance. The moment everyone starts investing in the index, everyone gets the same return. This means that there are no more incentives to put money into young promising companies. Most of the money goes to the largest companies in the index. At the same time, these are the companies that need it the least. The only solution these companies can think of is to buy back their own shares.

Compared to the stock market, the problem is bigger in the bond market. There, the biggest buyer is the central bank. They do not look at the effective return of a bond. There are also many institutional investors who buy bonds because they have to. Here the career risk is laid down in legislation and regulations. Think of pension funds, insurers and banks. For example, the Financial Assessment Framework (FTK) imposes conditions on the financial health of a pension fund. Simply put, to hold a position in shares, you must have more money in cash than to hold a position in bonds. An absurd world, which makes pensions far too expensive. Especially with the current inflation rate, a value stable pension (which is still the promise in this system) would require more to be deposited than will ever be paid out in pensions. Since 2016, insurers have had to deal with a risk-based supervisory framework, called Solvency II, extended with technical standards and guidelines from EIOPA. As a result, every investor in listed insurers looks at solvency. This determines how many shares can be repurchased or how much dividend can be paid. In Solvency II, government bonds are seen as the holy grail in terms of low risk. That is strange because precisely with government bonds there is only risk and no return. For banks, the Basel regulations have been in place since 1992 and are being tightened with every financial crisis. This is mainly about capital requirements and capital comes in many forms and here too, government bonds are seen as absolutely safe. That laws and regulations can have a major impact are shown by the role of the Basel standards during the euro crisis 10 years ago. According to the Basel standards, Greek government bonds were just as safe as German government bonds. So safe, in fact, that they did not require any (i.e. zero) capital to be held. Instead of lending to companies that needed it, the implicit advice of the Basel committee was that banks had better buy Greek government bonds. We have seen the consequences. Within Basel, (government) bonds are still seen as extremely risk-averse.

The career risk is making everyone do the same thing and that leads to systemic risks as we have seen with the euro crisis, for example. Policymakers are not stupid and should see that. And they also read books. Keynes wrote: ‘Lenin is said to have said that the best way to destroy the capitalist system is to destroy the currency. By a continuous process of inflation, governments can, secretly and unnoticed, confiscate a significant part of the wealth of their citizens. Moreover, by this method, they confiscate at random. Although the process impoverishes many, it actually enriches some. But there is also a career risk with central bankers. Deviating from the herd is not rewarded here either. Moreover, with the current monetary policy, they are doing everything they can to remain relevant.

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