Financial, Human and Social Capital
Global financial markets and institutions appear increasingly unstable. The temptation is to expound on that, endlessly rehashing the problem. To do so is to avoid thinking about possible solutions. It is a logical extension of denying there is a problem to solve.
Rehashing the problem could be an attempt on my part to recruit a multitude of followers to my point of view before I act. Wasting time convincing others is a way to postpone and evade dealing with the problem itself. My best interest is served by getting out of a burning building, not convincing others it is on fire.
Truthfully, I do not know for certain that the financial markets and institutions are indeed increasingly unstable. I may be misinformed or I may be misinterpreting the information I have. Or maybe I am just another grumpy old man living comfortably while lamenting the state of world affairs. Then again maybe I am crazy, obsessing on problems that exist only in my fevered mind. While recognizing these and other possibilities, I choose to explore investment opportunities outside the financial capital markets. You are free to take it or leave it as you choose.
The sad, frightening, infuriating fact is that it is difficult and expensive remove the bulk of my life savings from the financial institutions that hold them. The system is like a "Roach Hotel" - easy to get into and hard to get out of. How so?
- The "financial system" is all inclusive - in general, taking money out of one institution involves putting it into another.
- In regular IRAs, withdrawals are taxed as ordinary income (fair enough because no taxes were paid on the money deposited into them). Small withdrawals are taxed at a low rate but taxes on large withdrawals run to near 40%. The incentive is to make small withdrawals, leaving most of the money in the account.
- Financial transactions require an institutional intermediary to be completed in most cases. For example, I cannot receive Social Security without a bank account. Paychecks, credit and debit cards and online payments and receipts require bank-to-bank transfers. As a practical matter, very few transactions can be completed today with a hand-to-hand cash exchange or by barter.
For these reasons, it is impractical if not impossible for me to exit the "financial system". I suspect that is true for most people with capital to invest. The net result is that most of my financial capital will remain in the financial system simply because I don't know of any practical alternative. Realistically, there is a small but rising probability that my life savings will be confiscated by taxation, lost in a financial collapse or inflated into worthlessness.
Fearlessly facing the fact that I cannot escape the financial system and that it may collapse is liberating. I can put my mind to work on solutions instead of problems. What possible solutions are there to managing financial capital in today's environment? Here is what I have done and am doing:
- Pay off all debt. Savings earn near zero interest but debt (particularly credit card debt) is expensive. Not owing the financial system anything is the first and most important step in being free of it and out of the way if it blows up.
- Accumulate enough cash on hand to live at a basic level for several months if the "clearing function" of the financial system (i.e. - your paycheck, SS or other auto transfer doesn't get deposited automatically on time) falters. This is easy if you are debt free and live frugally. It is almost impossible if you have numerous monthly payments and an extravagant lifestyle.
- Make annual withdrawals from regular IRAs with an eye toward taxes if you are over 59½ (even if you don't need the money). Tax-paid balances are worth more than tax-deferred balances after that point in life. Work with an accountant to figure out just what withdrawal will put you in the next higher tax bracket.
- If you have a mortgage or student loan, it may be possible to withdraw IRA (or 401-k) funds before age 59½ without penalty to pay them off. Work with an accountant who knows the latest rulings. Being debt free is more valuable than cash savings in an unstable economic environment.
- Invest whatever money you do not (or cannot - same net effect) remove from the financial system with the goal of capital preservation instead of maximum return. `There is no way to know whether a collapse will be deflationary (prices fall and purchasing power of money goes up) or inflationary (prices rise while the purchasing power of money falls). One thing is certain, having money will be better than not having money. Take the sure thing.
- Be aware that an economic collapse will affect everyone adversely. Living standards will decline. No one will escape unscathed. Take whatever steps are necessary to survive with much less or no financial capital.
That may involve getting familiar with the concept of Human Capital and Social Capital outlined in the following sections of this article.
Let's start with a working definition of Human Capital from Charles Hugh Smith's ebook, "An Unconventional Guide to Investing in Troubled Times":
"Human capital can be defined by what it is not: human capital generates all income which isn’t generated by purely financial investments such as stocks, rental property, savings and bonds. In essence, human capital is expressed as productive work: the combination of skills, knowledge and experience that generates income and value from providing services and making goods. ...
Trust is an integral component of human capital; an untrustworthy person with high skills has much lower human capital than a trustworthy person with the same skills. ...
Not all human capital investments serve the goal of generating income. For example, learning how to prepare healthy, tasty meals from real food is a skill that potentially pays enormous health benefits, even though it might never generate a dollar of income".
Damn. Honesty, productive work, knowledge, skill and experience? You've got to be kidding! All that just makes a person dull, boring and glum. Fugeddaboudit.
Well, that is your choice to make, consciously or unconsciously, deliberately or by default. But, it might not hurt to make a personal inventory of Human Capital just for fun.
What skills, knowledge and experience do you have that create value (the precursor of income) from providing services and making goods? Make a list and then add a second and third column by answering the following two questions:
- Are they dependent on the financial system status quo?
- Are they productive in and of themselves or do they require a corporate or government work environment to be useful? In other words, do they stand alone or are they dependent on a network of other people's work to be of value?
With that three-column list in hand, take a few quiet hours to think about it. This is your beginning balance of Human Capital. It is what you personally have to offer in a post-collapse economy.
Then ask yourself, "How can I increase my Human Capital"? Then do it. You will be richer, no matter what happens with the economy.
We will come back to Human Capital in future articles but that is enough for now. Just taking the inventory is a big step.
Again using a working definition from Charles Hugh Smith's ebook, "An Unconventional Guide to Investing in Troubled Times":
"Social capital can also be defined by what it is not. If you arrive in a strange city where you know no one and have no contacts at all, you have no social capital. Social capital is the sum of friends, contacts, alliances, group memberships and networks that create reciprocal sources of value. The key word here is reciprocal, as social capital is a two-way dynamic: it isn’t created by entitlement or taking but by providing some value to others as well as deriving value from your association with them. Reciprocity is the heart of social capital. ...
Social capital is not just the value of various contacts, it is the opportunity to build a reputation for trustworthiness and a commitment to excellence, and to get valuable organizational skills. ...
Trust is authenticated not by a centralized bureaucracy but by those who can vouch for your work and trustworthiness. The broad base of participants is the source of verification, not bureaucratic gatekeepers. The more people who have come to trust you to perform honestly and honorably as promised, the more opportunities will come your way. ...
Human groups are built on reciprocity and trust; that is the essence of social capital. ...
Online social networks do not have the stability of faith-based or community-based organizations, but they have the advantage of being global and low-cost. ...
Social capital has atrophied in many layers of our culture; “independence” and “security” now come from an entitlement check from the Central State rather than from human or social capital. This dependency on centralized authority breeds apathy towards reciprocity and encourages the resentful self-absorption of permanent adolescence. Human and social capital have been replaced by dependence on the Central State and collusion with a corrupt Status Quo. Yet this security is not as solid as most assume; the Central State itself will devolve as the financial system it depends on devolves".
The first step in building capital of any kind is taking an inventory to get some idea of the beginning balance. Once that is done, steps can be taken to increase it. Since Social Capital is the sum of our interactions with other people, a good place to start is with a list of everyone we know and who know us. Most of us already have that in an address book or contacts list. Starting with that list, a few simple questions, honestly answered, can reveal just how much Social Capital we have at our disposal. Ask yourself about each person on the list:
- If this person asked for a favor that required some time and effort on my part, would I do it without hesitation?
- Do I have skills, knowledge or experience that would be useful to this person?
- Am I willing to freely share my skills, knowledge and experience with this person?
You will notice that each of these question is about what I am willing to give, not get. There are several reasons:
- We know our own heart and what we will and won't do. We can never know the mind and heart of others.
- Those to whom we are willing to give are likely to be willing to reciprocate.
- People we are willing to help without hesitation are people we think won't abuse our generosity. It reveals how much we actually trust a person.
For now, this honest inventory of Social Capital is enough. We will revisit the subject in future articles.