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Summer Reading

This set of book reviews originally appeared in the July 2008 issue of the HS Dent Forecast month and cover a wide variety of topics: financial bubbles, pension funding, healthcare, immigration, population control, and of course, age demographics. Before your next trip to the beach, make a stop by the bookstore and toss one of these in your bag.

The New Paradigm for Financial Markets
by George Soros

We will start our summer reading list with George Soros’s most recent book, The New Paradigm for Financial Markets. In the opening pages, Soros gives a good history and analysis of the 2007-2008 credit bubble and crisis using some rather sobering language:

We are in the midst of a financial crisis the likes of which has not been seen since the Great Depression of the 1930s. To be sure, it is not the prelude to another Great Depression. History does not repeat itself. The banking system will not be allowed to collapse as it did in 1932 exactly because its collapse then caused the Great Depression. At the same time, the current crisis is not comparable to the periodic crises which have afflicted particular segments of the financial system since the 1980s…. This crisis is not confined to a particular firm or a particular segment of the financial system; it has brought the entire system to the brink of a breakdown, and it is being contained only with the greatest difficulty. This will have far-reaching consequences. It is not business as usual but the end of an era.

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Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Genetics, the China-Tibet Dispute, and Investment Psychology

In “Human and Economic Evolution,”  I discussed how natural selection is alive and well among humans, and used such examples as genetic resistance to malaria among Africans and high aptitudes in the maths and sciences among Ashkenazi Jews.  Today I’d like to discuss an interesting finding reported in The Economist that is relevant to the China/Tibet dispute, and I’m going to tie it into a broader discussion of the human brain and investment psychology.

Tibetans and their supporters in Western countries have long contended that the Han Chinese do not belong in Tibet.  New genetic research suggests they may be correct–to an extent.
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Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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The Ghosts of Milton Friedman and John Maynard Keynes

I originally penned this article for the August 2007 issue of the HS Dent Forecast–nearly three years ago.  My comments on deflation and consumer spending turned out to be right on the mark.

The late Milton Friedman may be the most accomplished economist of his generation. Just as his predecessor John Maynard Keynes influenced every aspect of economic thinking and policy in the 1930s, 40s, and 50s, virtually every significant development in recent decades towards free and open markets bears Friedman’s mark. Friedman’s Chicago School provided much of the intellectual fuel for the Reagan and Thatcher Revolutions in America and Britain. Even Augusto Pinochet, the Chilean military dictator, staffed his government with “Chicago Boys” who eventually gave Chile one of the most competitive economies in the developing world. Milton Friedman was a revolutionary who truly changed the world, though this piece is not about his intellectual exploits. Rather, it explains the economist’s theories on consumer behavior and relates them to our own research. We will attempt to add demographic insights into the venerable Milton Friedman’s work and discuss the implications for the next economic season.

But First, a Word on Keynes…

Any discussion of consumption must first start with a review of John Maynard Keynes and his work. Pre-Keynes, most economic theory was focused on production, or the supply side of the equation. Consumption, driven by end-user demand, was merely an afterthought, something that just “happened” and didn’t need to be explained. This was best summarized by Say’s Law, a maxim memorized by every freshman economics student: “Supply creates its own demand.” By virtue of manufacturing something, you have created a demand for that something, since it can be traded for other goods. This could be called a “build it and they will come” strategy, to borrow a line from the movie Field of Dreams.

But what happens when supply doesn’t create its own demand. What happens – as in the Great Depression and in 1990s Japan – there is not sufficient demand to absorb a plentiful supply?

During the Great Depression in the US and UK, consumers stopped consuming, virtually snapping their wallets shut for more than a decade. This lead Keynes to his study of consumer behavior, which is best summarized by his Consumption Function (also required memorization by freshmen econ students), seen below in Figure 1.

Figure 1: Consumption Function

In a nutshell, Keynes’s formula says that people spend a constant percentage of their current incomes, once basic necessities are taken care of. So, Joe Sixpack cashes his paycheck every two weeks and spends, say, 75% of that paycheck each and every pay period of his life. When he gets a raise and his check rises, he spends 75% of the now higher amount. When times are hard and he takes a pay cut, he instantly cuts his spending down to 75% of the new, smaller, amount. Joe’s spending is completely flexible and based solely on his current income.

Of course, any non-economist would know this to be patently false, both for individuals and for entire societies. To start, most consumption in the modern economy is not really “discretionary.” Most significant expenditures – everything from the home mortgage to piano lessons for your daughter – are paid on some kind of monthly payment plan. Even though piano lessons can be stopped at any time, they generally aren’t. Likewise, your cable TV plan does not get upgraded to the deluxe, high-definition package one month and then get cut to basic cable or – gasp! – rabbit ears the next. Your cable bill is stable and changes only slightly over time.

Most expenses are very slow to change when income changes. One of the major benefits of the modern credit-driven economy is that it can provide for lifestyle stability. If money is a little tight this month, your family’s lifestyle does not have to radically change, at least not immediately. This is the primary reason that consumer spending is so resilient despite economic calamity and why economists have been consistently wrong in their forecasting of recessions. We’ll return to this theme shortly.

Keynes also fails to note that spending and saving habits are affected by level of wealth and – most importantly to our research – age and stage of life. We’ll give credit to Keynes for being the first person to approach consumption scientifically, but it is obvious that his model was incomplete and not reflective of the real world.

Many of these deficiencies were addressed by the economists Modigliani, Brumberg, and Ando in the 1950s and 60s in what became known as the Life Cycle Hypothesis (Figure 2). These economists graphically displayed what every household intuitively knows. People follow a life cycle of earning and spending. In early career, our incomes are low relative to our expenses, often forcing us to take out large debts for homes, cars, appliances, etc. In middle age, we earn enough money to meet all of our current expenses, plus save for retirement. And naturally, in retirement our income falls and we slowly spend down our savings.


Figure 2: Life Cycle

This model, though more advanced than Keynes’s, is still problematic. Notice that income makes a curve while consumption makes a straight line. This chart is suggesting that our consumer spending increases in a mild, linear fashion from birth until death. Of course, the foundation of HS Dent demographic research is that this is absolutely false. Spending follows a curve much like that of income, though on a different timeline. Consider Figure 3, what we will call the “HS Dent Modified Life Cycle.”

In this case, the income line has the same basic shape as in Figure 2, though the consumption line has been transformed into a curve.

Figure 3: HS Dent Modified Life Cycle Hypothesis

This familiar chart is the basis for the Spending Wave. We know, based on data from the US Bureau of Labor Statistics, that consumer spending is largely a function of age. We spend increasingly more raising our families until our late 40s, after which time we pare down our spending and save for retirement.

The Permanent Income Hypothesis

In 1957, Milton Friedman made his own modifications to the Consumption Function and to the Life Cycle Hypothesis, dubbed the Permanent Income Hypothesis. Friedman’s idea was this: people base their consumer spending on what they consider their “permanent” income, or their average income over time. They do this in an attempt to maintain a relatively constant standard of living, even though their incomes may vary wildly over time. This goes a long way to explaining why Americans love consumer debt as much as they do. It’s ok to spend more that you make today, because your salary will be high enough after that next promotion to pay it all back. [Note: this was true of American attitudes in 2007; it’s far from true today, as deleveraging is the rule of the day.]

Keynes’s model, remember, assumed that people spent a constant proportion of their current incomes, i.e. each paycheck. Friedman assumes that people are forward-looking and base consumption decisions today on income expectations for tomorrow. Changes in current income, if perceived to be temporary, have little effect on spending. Friedman correctly realized that a family’s standard of living is “sticky.” When dad’s bonus check is a little disappointing one year, the family does not instantly eschew Neiman Marcus in favor of Wal-Mart. Whether for pride, concern for their children, or simple inertia, Americans are slow to ratchet down their lifestyles. Consider the case of the past six years [2001-2007]. America has suffered one of its worst bear markets in history in the wake of the dot-com bust. We had the most horrific terrorist attack arguably in world history on September 11, 2001. We’ve had two wars and a commodity boom that has seen the price of oil more than triple. Yet in spite of it all, Americans never stopped spending money [during the 2001-2007 period].  Keynes might have despaired that this behavior was irrational, but under Friedman’s model there is nothing irrational about it at all. American consumers are simply optimists who, seeing better times in the future, decide to enjoy the benefits of consumption today.

The Other Side of the Coin

Interestingly, none of these theories go into much detail on consumption as a function of age and what this implies in an aging society. Keynes’s model does not incorporate time at all, and Life Cycle theorists and Milton Friedman both assume that consumption rises in a linear fashion from birth to death. Keynes’s model may be the least dangerous in this sense, as nothing is as destructive to a forecasting model as linear thinking and extrapolation. The tendency to project current conditions into infinity leads to booms and busts. Remember the dot-com boom? It seems ridiculous now, but professional investors implicitly assumed that growth rates that were far in excess of historical norms would continue indefinitely into the future: “Our website is attracting 100,000 new eyeballs per day….”

Milton Friedman was an optimist and a true believer in the market system, and these are some of his most memorable and endearing qualities. They are what allowed the man to spread his views so effectively and radically change the world for the better. It is only natural, in Friedman’s optimistic mind, for consumer spending to march upward more or less continuously with only mild setbacks here and there. But we know that this is not true. People do indeed increase their spending for most of their lives, but once they hit their 50s they spend less on virtually everything.

Friedman is partially right, of course. A person’s income and expectation of future income clearly affects the level of consumption today. A janitor is not likely to buy a Porche, because at no time in his life will his income justify such a purchase. But how many Porches (or boats, or expensive clothes, or Rolex watches) do you see 70-year-old men buying?

These are luxury goods, of course. What about more mundane items? How many washing machines, sofas, or coffee machines does a 70-year-old man buy? Common sense would tell you that the answer is “not very many.” Is the reason, as Friedman’s hypothesis would suggest, because an elderly man realizes that his future income with which to pay for these items is modest? Or might it be for the more obvious reason that the man has already accumulated more than enough of these things in his 70 years?

Conclusions

Demographic trends suggest a decade-long lull in consumer spending starting around 2009 or 2010 as the Baby Boomers begin to spend less and save more for retirement. This will be a repeat, almost twenty years later, of the same scenario that Japan faced during the 1990s. When US consumer spending begins to falter, there will no doubt be plenty of economists attempting to explain the phenomenon by using some variation of Friedman’s permanent income hypothesis: “Americans are spending less money today because they see dark economic times ahead with declining incomes and standards of living….”

Then, any and every policy under the sun will be recommended on how to “fix” the problem. No doubt, Keynes’s Depression-era work will also be resurrected, and phrases like “liquidity trap” will become popular again in economic circles. [Note: Real world events followed this part of the forecast like a movie script.]

None of these ideas are likely to make much difference in spurring demand. They certainly didn’t in Japan, and there was no lack of trying. Japan eventually recovered to an extent, as the US will too. But the recovery in demand was a result of changes in demographic trends, not a policy miracle.

 

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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The Ascent of Money

We have always believed that history—and particularly economic and market history—tends to follow long cycles. For this reason we find a lot of value in reading economic history books. One well-researched economic history book can add clarity that can get lost in the daily barrage of newspaper and magazine articles. The problem is that many are mind-numbingly dry or, like Charles Mackey’s classic Extraordinary Popular Delusions and the Madness of Crowds, written in an English vocabulary from the Victorian period and incredible dense to read.

Once in a while, you find a real gem that is both insightful and eminently readable. We would put Niall Ferguson’s recent book in that category. The Ascent of Money: A Financial History of the World is exactly what it claims to be. It is a comprehensive history of the development and rise of the financial industry and its impact on the world. As Ferguson writes,

Behind each great historical phenomenon there lies a financial secret, and this book sets out to illuminate the most important of these. For example, the Renaissance created a boom in the market for art and architecture because Italian bankers like the Medici made fortunes by applying Oriental mathematics to money [starting as far back as 1202 with the publication of Fibonacci’s Liber Abaci and climaxing in the high Renaissance of the 1500s].

The Dutch Republic prevailed over the Habsburg Empire because having the world’s first modern stock market was financially preferable to having the world’s biggest silver mine [in the Dutch independence wars from 1568-1648]. The problems of the French monarchy could not be resolved without a revolution because a convicted Scots murderer had wrecked the French financial system by unleashing the first stock market bubble and bust [in 1719-1720]. It was Nathan Rothschild [and his bond trading] as much as the Duke of Wellington who defeated Napoleon at Waterloo [in 1815]. [See “Sorting Though the Rubble in Spain” for the SIL’s comments on Rothschild.]

Financial history is a long recurring cycle in which power shifts alternatively from creditors to debtors. The same can be said of the cyclical nature of the reputation of financiers. During boom times, “masters of the universe” are viewed as virtual gods and as the bringers of bountiful prosperity, but during busts—as the present Federal suit against Goldman Sachs attests—they are vilified and hunted down.

In his study of financial bubbles over the centuries, Ferguson identifies five typical stages :

  1. Displacement: Some change in economic circumstances creates new and profitable opportunities for certain companies.
  2. Euphoria or overtrading: A feedback process sets in whereby rising expected profits lead to rapid growth in share prices.
  3. Mania or bubble: The prospect of easy capital gains attracts first-time investors and swindlers eager to mulct them of their money.
  4. Distress: The insiders discern that expected profits cannot possibly justify the now exorbitant price of the shares and begin to take profits by selling.
  5. Revulsion or discredit: As share prices fall, the outsiders all stampede for the exits, causing the bubble to burst altogether

Though the focus of this analysis was the stock market, the same insights would hold true in the most recent housing and mortgage bubble and burst. “Revulsion” and “discredit” are words that aptly describe public views of investment real estate, mortgage lending, and the financial sector in general.

Of course, it could be worse. The boom and subsequent bust that has caused so much misery today is nothing compared to those that afflicted France in the early 1700s. After decades of warfare under Louis XIV, the French crown was burdened by an unmanageable debt load. The French government found itself at risk of bankruptcy—for the third time in less than a century.

Desperate times called for desperate measures, and the French crown turned to a smooth-talking Scottish gambler by the name of John Law for a solution. His plan—later called the Mississippi Land Scheme—brought a temporary boom to France, but the aftermath was years of economic contraction, deflation, and a general feeling of mistrust towards financiers that arguably persists in France to this day.

Though his newly chartered bank, the Banque Générale (which would eventually evolve in the France’s first central bank, the Banque Royale), Law would monetize the debts of the French crown, using government debt to provide the bulk of the bank’s capital base. The bank issued paper banknotes which were declared to be legal tender, thus creating a surge in the money supply—and an inflationary boom in the process.

Much of newly created money went directly into the shares of the second part of Law’s scheme, the Company of the West (later called the Mississippi Company). The Mississippi Company was France’s answer to the Dutch East India Company, but with one critical difference: the Dutch company actually had profitable trading routes. The French trading company had the mosquito-infested swamp we today call Louisiana and little else.

In addition to accepting cash, Law allowed investors to trade in their existing French government bonds for shares in the new company; a rather creative way to retire outstanding debts. But the true excesses were yet to come.

Law’s central bank allowed investors to borrow money at low interest rates using their Mississippi shares as collateral. This would be like the Federal Reserve lending you money directly to buy shares of a new, unproven technology start-up company…using your existing shares of the company as collateral, creating something of a self-contained Ponzi scheme of sorts. (Our own recent excesses in the mortgage markets, in which government-sponsored entities like Fannie Mae and Freddie Mac provided almost unlimited capital for additional mortgage loans on increasingly generous terms shows that, as the French say, “Plus ça change, plus c’est la même chose.”)

Not surprisingly, speculative mania swept the country, sending the value of Mississippi shares up by a factor of 19.6 (making the 1990s Nasdaq bubble look mild in comparison).

When the bubble finally burst, the loss of wealth—which had been illusory, having been created by financial alchemy—proved to be catastrophic for France. The collapse of the Mississippi Company and the Banque Royale wiped out much of the aristocracy and middle classes. But, as Ferguson writes, “The losses to France, however, were more than just financial. Law’s bubble and bust fatally set back France’s financial development, putting Frenchmen off paper money and stock markets for generations.” Furthermore, the French crown was weakened and thoroughly discredited, making the bloody French Revolution possible before the end of the century.

Furthermore, the crash brought with it a period of prolonged deflation. And this is the most important point that we would take from Ferguson’s book. Niall Ferguson is one of the few economic commentators that shares our view that deflation—not inflation—will be the threat going forward. The end result of all bubbles is a prolonged period of deflationary weakness in which the excesses of the boom are worked off. In the wake of the Internet bubble and bust we did not see large-scale consumer or producer price deflation, but we did see severe deflation in the areas most directly affected. As Thomas Friedman explained in The World Is Flat, the massive price deflation in fiber optic communications is what make the boom in Indian outsourcing possible.

So, while we would expect continued deflation in the housing sector for years to come, there will likely be some residual benefits. The oversupply of housing will mean that young families in the years ahead will get phenomenal bargains on their homes, values perhaps not enjoyed in a generation.

As the history of bubbles has proven, it is deflation that accompanies a bust, not inflation. And the broader the scope of the bubble, the more likely it is that deflation spreads to consumer prices in general.

 

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Human and Economic Evolution

Demographic trends and their effects on the economy are a big part of our research. We generally have a practical goal, such as estimating the demand for a company or industry’s products. However, sometimes we like to look at the long term—the extreme long term. This month we are going to take a look at some fascinating new research from Gregory Cochran and Henry Harpending, both professors of anthropology at the University of Utah. Their new book, The 10,000 Year Explosion: How Civilization Accelerated Human Evolution, is a revolutionary new look at modern human evolution with several important implications for the future.

The traditional view among both natural and social scientists is that human evolution stopped before the advent of civilization and that all human progress in the millennia that followed was a result of cultural rather than physical evolution. The belief is that complex brains enable humans to create and harness the power of new technology, making biological evolution unnecessary. In order to fly, modern humans do not have to mutate and sprout wings, they can instead invent the airplane. Darwinian natural selection now is applied to ideas, technologies, and economic systems rather than to the human genome.

Cochran and Harpending take a very different view. Rather than make continued evolution unnecessary, civilization and its new innovations actually accelerated human evolution by increasing the rate of reproduction and creating new criteria for reproductive fitness and advantage. As the authors describe their approach,

Conventional social sciences, such as history and anthropology, chiefly concern themselves with brain software, by which we mean cultural developments such as mores, mythology, or social structure. Genetic history addresses changes in the underlying hardware, changes in the body and brain, which also matter. If they didn’t, dogs really could play poker.

Those early humans who were better adapted to a settled, agrarian lifestyle had more children survive than average and thus left a larger genetic “footprint” on the human race over the course of several generations. Over time, genes favored in a given cultural and economic environment spread to an ever-larger percentage of the population. One such example is lactose tolerance. Early humans were lactose intolerant. Those lucky enough to have developed the mutation that allowed them to drink animal milk well into adulthood were able to enjoy a higher-calorie diet at a lower cost (it’s far cheaper per calorie to milk cows than to slaughter them for meat). The benefits of this are obvious. Healthier, stronger, and more energetic adults will be more economically productive and will have an advantage in military struggles as well. As a result, the lactose tolerant had a significantly higher fertility rate than the intolerant, and today lactose tolerance is the norm.

Other, more regional mutations are also obvious today. Sub-Saharan Africans developed a mutation that gave them strong genetic resistance to malaria. It’s not hard to see how this mutation could spread quickly across a continent; resistance to such a deadly disease would obviously enable the first Africans who developed it to enjoy a much higher fertility rate and also a military advantage over their disease-weakened rivals. (Sickle-cell anemia, which is common among African Americans, is an unfortunate genetic side effect of the malaria-protection gene.) This beneficial mutation also kept Sub-Saharan Africans safe from outside invaders for centuries, until the British began mixing their gin with tonic water flavored with quinine—thus acquiring “medically” what native Africans were lucky to be born with.

Europeans, however, had genetic advantages of their own, fit for their climate. In northern Europe, the days get short in the winter. The lack of sunlight can cause diseases related to vitamin D deficiency, such as rickets. A diet high in meat, such as that practiced by hunter-gatherers, generally will have sufficient vitamin D, but a diet high in grains will not. Thus, Cochran and Harpending contend that the adoption of agriculture favored mutation that led to lighter skin in Europe and northern Asia. Lighter skin absorbs more solar radiation, thus enabling the body to produce vitamin D on its own. Lighter skin is clearly not a favorable mutation in areas with more intense sunlight. (The high rate of skin cancer in Australia is unfortunate proof of this.)

Europeans, like Africans, also developed mutations that gave them resistance to certain diseases, such as smallpox. This, as Jared Diamond outlines in his excellent study Guns, Germs, and Steel, is what enabled a small band of Spanish conquistadors to conquer entire empires in the Americas. As a result, the Spanish and Portuguese were able to leave a cultural as well as genetic imprint that is far more significant than in other areas of European colonization.

Speeding Up Natural Selection

For those familiar with animal husbandry, none of this would be surprising. Horse and dog breeds have been created by nothing more than human tinkering. Selective pairing over the centuries (or in some cases, only decades) has given us breeds as diverse as Chihuahuas and Great Danes, to use the authors’ examples.

Likewise, the Peruvian Paso Horse has been bred over the past 400 years for its distinctive high-step gait, considered by many to be the smoothest in the world. The Peruvian is one of the few horse breeds that walks with an even “1-2-3-4” hoof beat rather than the “2-2” trot common in most other breeds. This behavior is not learned; the horses are born with it. (I only know this because my wife is from a family of Peruvian horse breeders.)

This brings up interesting points for human behavior, although we wouldn’t consider gait one of them. No one would say with a straight face that John Wayne’s cowboy strut was a genetic phenomenon caused by selective breeding. (Although George W. Bush did defend his own distinct gait in his 2004 speech at the Republican convention by saying, “In Texas, we call that walking.”) But could other human behaviors be introduced through breeding?

Cochran and Harpending suggest that Ashkenazi (Northern European) Jews were, quite literally, born to be bankers. Their existence in northern Europe for 1,200 years as an unassimilated subpopulation make them an interesting case study. Today, Ashkenazi Jews are measurably more intelligent on average that the overall human population, on the basis of IQ tests, Nobel prizes won, and representation in academia and among the upper echelons of the business and even entertainment worlds. As a tiny minority, their achievement is almost unbelievable.

It was not always that way, however. According to the authors, the Jews were considered to be of average intelligence in the classical and early medieval world; nothing more, nothing less. As a culture they certainly had nothing to match the body of scientific and philosophical work of their Greek contemporaries. So what changed?

The socioeconomic conditions in Northern Europe created unique selective pressures that had never before been reproduced in history and likely never will be again. The Ashkenazi Jews, due to their own religious prohibition against intermarriage and due to European bigotry against them, remained a relatively small, isolated community—and thus provided a perfect “laboratory” for natural selection.

The Ashkenazim were attracted to the profitable professions of trade and banking because, as a religious minority, they were exempt from the Catholic prohibitions on the charging of interest. Many times, they were excluded from landowning or from other trades as well, making finance one of the few career options available. What followed, in the view of Cochran and Harpending, was an acceleration of the natural selection process. Jews who had a natural talent for finance—including a high degree of literacy and mathematical and abstract thinking skills—were far more likely to have economic success. With economic success came better marriage prospects. (Even today, successful bankers are considered highly eligible bachelors.) Furthermore, with economic success came better nutrition and a higher percentage of surviving children. As a result, over the course of several generations, an increasing percentage of the Ashkenazim began to exhibit the traits that made for successful financiers. The less adept Ashkenazim had lower prospects for marriage and children—and thus gradually were weeded out of the gene pool.

So, due to a truly unique set of selective pressures, the Jews of Europe evolved into a measurably more intelligent subset of population over the course of 40 generations (roughly 1,000 years).

It’s Good to Be King

We’ve written in the past about Gregory Clark’s groundbreaking work A Farewell to Alms. Clark proposed an unorthodox theory for why the Industrial Revolution happened in Britain and not elsewhere. Clark argues that the prevailing theories—that the UK industrialized first due to its relative political stability and traditions of liberty and property rights—do not hold water. He instead makes the case that the change was cultural, based on breeding. The upper and middle classes in medieval England had more surviving children than the national average. At the same time, primogeniture laws required that only the eldest son inherit the family estates. This left quite a few “second sons” to make their own fortune. The end result was what Clark called “downward mobility,” i.e., upper and middle class Englishman were forced down the economic ladder. There is, after all, only so much room at the top. This situation caused “bourgeoisie” values, such as hard work, delayed gratification, and an appreciation for learning, to trickle down the economic rungs of society, which provided a fertile ground for the Industrial Revolution to take root.

Clark’s theory is based on culture, not genetics. However, a genetic argument certainly can be made, and Cochran and Harpending do exactly that. Throughout much of human history, elites did reproduce themselves at much higher rates.

For example, Alexander the Great did more than just spread Greek culture; he also spread Greek genes. Today, distinctly Greek chromosomes can be found as far east as Afghanistan.

“Once elites became possible, elite reproductive advantage kicked in,” Cochran and Harpending write, and perhaps no better example can be given than that of Genghis Khan. As the authors continue,

About 800 years ago, Genghis and his descendents conquered everything from Peking to Damascus. Genghis knew how to have a good time. Here’s his definition of supreme joy: “to cut my enemies to pieces, drive them before me, seize their possessions, witness the tears of those dear to them, and embrace their wives and daughters!” It appears that the last part of that list especially appealed to him. He and his sons and his son’s sons—the Golden Family—ruled over much of Asia for several hundred years, tending to the harem throughout. In doing so, they made the greatest of all genetic impacts. Today some 16 million men in central Asia are his direct male descendants, as shown by their possession of a distinctive Y chromosome. It just shows that one man can make a difference.

Cochran and Harpending also relate the story of Niall of the Nine Hostages, a king of Ireland around the year 400 AD. A full 8% of Ireland’s male population carry Niall’s Y chromosomes, and 2 to 3 million men worldwide carry them.

Implications for the Future

Today, in the post-WWII era of urban mass affluence, reproductive realities are far different. In all developed countries, birthrates have fallen to between 1 and 3 children per woman, and it is often the most educated and most successful economically who have the fewest children. A large family is now an economic burden, and having several children limits the time and monetary resources that can be dedicated to each child. Attempting to send six children to elite prep schools en route to Harvard would bankrupt all but the richest among us. Americans and Europeans have recreated a de facto system of primogeniture, except that rather than exclude younger children from their would-be inheritance the younger children are simply never born to begin with.

Those who do have large families tend to do so for religious reasons. Many evangelical Christians and Catholics take the Bible’s command to “be fruitful and multiply” seriously, as do Mormons, Orthodox Jews, and devout Muslims.

This brings up several questions for the future. What will the world look like in a few generations? Demographer Philip Longman (whose work we highly recommend) wrote an insightful article in 2006 titled “The Return of Patriarchy.” Longman, tracking birth trends, sees a cultural shift underway. Social conservatives tend to have more children than social liberals, and children more often than not tend to adopt the political and social views of their parents. All else equal, this points to a less libertine future, perhaps within our lifetime. This is not necessarily bad, of course. Societal views change over time. As we wrote in the April newsletter, summarizing the views of Thomas Sowell, social views on gender roles were actually more conservative in the 1950s than they were in the early 1900s. Views change and life goes on.

Of course, we see that this trend could be problematic in certain parts of the world, such as the Middle East. Barring significant immigration of socially liberal Jews from abroad, Israel will quickly become a more conservative country as more orthodox sects of Judaism have much higher birthrates than do secular Israelis. In a small country like Israel, the entire character of the state could change, for better or for worse.  (See “Israel and Turkey: How Changing Global Demographics are Affecting International Relations in the Middle East.“)

Likewise, the elites of many Muslim states tend to be secular, but the majorities of their populations are not. As birthrates among the secular elite have fallen to Western levels and decreased levels of infant mortality have enabled more children of the poor to survive to adulthood, the balance of power inevitably will shift. A case in point is Turkey. The Turkish state founded by Mustafa Kemal Ataturk after WWI was militantly secular. Ataturk himself made a strong effort to “de-Islamify” the country as a way of pulling it into the Western sphere. Ataturk went so far as to officially drop Arabic script from written Turkish, moving the language to a Latin-based alphabet instead. (To appreciate how truly radical this was, imagine today being told by the U.S. government that henceforth, English will be written in Japanese characters or in the Greek alphabet. Wouldn’t that be fun?)

It’s hard to imagine a time when a guy won’t be able to enjoy a drink overlooking the Bosphorus in Istanbul, but that day might come. Turkey is becoming more Islamic—not because of a shift in values among Turks but because devout families simply have more children.

Again, this is not to say that any of these trends are “bad” (unless you’re a bar owner in Turkey). Unlike the biological changes described by Cochran and Harpending, these changes are cultural and thus more capable of quicker adaptation. Devout Turks may suddenly decide that big-city living is more to their liking. At any rate, these shifts in attitudes are what they are: another chapter in human history.

We have no “call to arms” in this article. Any attempt to change demographic and cultural trends is likely to end in failure. (Just ask Vladimir Putin about his program to pay Russian women to bear children.) Our only recommendation is that you learn to view the world through a demographic lens. This is, in our view, the best way to understand the changes in the world around us and, ideally, to profit from them.

 

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