Of Government Taxes, Bitcoin and the Fiction of Money

Anything can be money if individuals on both sides of the economic transaction are ready to accept it as money. As Yuval Noah Harari writes in Sapiens – A Brief History of Humankind: “Money is anything that people are willing to use in order to represent systematically the value of other things for the purpose of exchanging goods and services.” Of course, for something to emerge as a form of money at a societal level, it needs to be widely accepted.

This is the hope that the believers in bitcoin and other cryptocurrencies have been peddling for a while to make them look like attractive investments. That one day when enough number of people across the world are tired with the government backed fiat money or paper money as it more popularly known, cryptos will take over.

Of course, you can’t wait for that to happen, and you need to buy bitcoin now. This is one of the ways in which the fear of missing out or FOMO, is created.

So how logical is this argument? How much should we trust it? These are questions well worth asking.

If you look at the history of money, different things have been money at different points of time. In the prisoner-of-war camps of the Second World War, cigarettes emerged as a form of money. They are a great example of the fact that anything can be money if both the sides of the economic transaction are willing to accept so. Also, any system where conventional money is not around, like in a prison, does not continue to stay in a vacuum, and newer forms of money emerge.

Different agriculture commodities including tobacco have been money at different points of time. So have been different metals, everything from iron and bronze to silver and gold.

Hence, different things have been money at different points of time, during the course of human history. What this tells us is that as long as enough people accept something as a form of money, it can continue functioning as money, until it doesn’t.

This means that bitcoin and cryptocurrencies can also become a form of money, over a period of time. Nevertheless, if we leave it at just this, it will be lazy reasoning at best. Also, this is where things get a tad complicated.

Allow me to explain.

Pure paper money or fiat money or money not backed by any commodity (gold, silver, tobacco, iron, copper etc.) has been around for many centuries, nevertheless, it has flourished and been widely accepted only in the last hundred years.

Why is that the case? Why do people happily and readily accept money not backed by any commodity as a form of payment, on most days?

As L Randall Wray writes in Modern Money Theory:

“The typical answer provided in textbooks is that you will accept your national currency because you know others will accept it. In other words, it is accepted because it is accepted. The typical explanation thus relies on an “infinite regress”: John accepts it because he thinks Mary will accept it, and she accepts it because she thinks Walmart will probably take it.”

To put it a tad simplistically, paper money is accepted because paper money is accepted. Are we saying there is a mass delusion at work? Is fiat money fiction?

As Jacob Goldstein writes in Money – The True Story of a Made-Up Thing:

“Money is a made-up thing, a shared fiction. Money is fundamentally, unalterably unalterably social. The social part of money—the “shared” in “shared fiction”—is exactly what makes it money. Otherwise, it’s just a chunk of metal, or a piece of paper, or, in the case of most money today, just a number stored on a bank’s computers.”

Now that maybe true, but that’s not important. What is important is to understand what keeps this shared fiction, this mass delusion, this myth, or whatever else you might want to call it, going. And this is where the government, which issues fiat money and controls the fiat money system, comes in.

For the government, it is important that its citizens continue to believe in the shared fiction of fiat money and continue accepting it as a form of payment. What keeps it going? Before answering this question, it is important to understand that there are three things that make a government a government: a) The right to tax. b) The right to legal violence. c) The right to create money out of thin air.

Two out of three rights are important to the context of bitcoin and cryptocurrencies. The right to tax and the right to create money out of thin air. In the past, I have talked extensively about the fact that any government letting bitcoin and cryptocurrencies operate smoothly is essentially giving away its right to create money out of thin air. And they aren’t exactly waiting to do it. (You can read about this here, here and here).

So, what about the right to tax that any government has?

As Wray writes:

“One of the most important powers claimed by sovereign government is the authority to levy and collect taxes (and other payments made to government, including fees and fines). Tax obligations are levied in the  national money of account: Dollars in the United States, Canada, and Australia; Yen in Japan; Yuan in China; and Pesos in Mexico. Further, the sovereign government also determines what can be delivered to satisfy the tax obligation. In most developed nations, it is the government’s own currency that is accepted in payment of taxes.”

And not just in developed nations, even in lesser developed ones, the governments accept tax payments in the fiat money of the country. This is what keeps the fiat money system going. As Wray writes: “It is because anyone with tax obligations can use currency to eliminate these liabilities that government currency is in demand, and thus can be used in purchases or in payment of private obligations. The government cannot easily force others to use its currency in private payments, or to hoard it in piggybanks, but government can force use of currency to meet the tax obligations that it imposes.”

In simple terms, government taxes can only be paid in fiat money and that creates demand for fiat money or paper money not backed by anything, and keeps the system going.

A counter argument to this might be that while this might be true in countries where taxes form a significant part of the economy, but how does it work in countries where taxes are not a significant part of the economy. Why does the paper money system still hold?

The answer lies in the overall structure. Companies which operate in a country need to pay taxes to the government in fiat money. So, they carry out their business in fiat money; accept and make payments in it. This means their employees, suppliers (their employees), contractors (their employees), distributors (their employees) and so on, everyone gets paid in or must pay in paper money as well.

When people who are a part of the overall business system, which needs to pay different kinds of taxes, get paid in paper money, they go out and spend that paper money. Hence, individuals and institutions who sell to these people, must then accept paper money. So, the cycle keeps going. And there is demand for paper money or fiat money.

Also, it is worth mentioning here that taxes form a significant part of the economy in any developed country in the world. For any monetary revolution to happen, the governments in these countries need to buy the idea of bitcoin and other cryptos, and also actively promote them. El Salvador classifying bitcoin in a legal tender isn’t going to help that cause. Or the fact that Nigerians have taken on to bitcoin like no one else. These are exceptions to the rule.

The larger point here is that the structure of fiat money being needed to pay government taxes, keeps the paper money system going and will continue to keep it going in the time to come. The demand for fiat money will remain. As long as that is the case, bitcoin and other cryptos will be a sideshow at best, keeping the believers interested, at least for a while.  

Also, governments are not going to give up on their right to create money out of thin air. This explains why money central banks are now in the process of planning and/or launching their respective central bank digital currencies.

Of course, people who do not like to pay their fair share of taxes also do not like the idea of being a part of the formal financial system (which is what fiat money system on its whole is at the end of the day). Therefore, people who are a part of the black economy like to convert their profits on which they haven’t paid cash, into other assets like real estate (held benami), gold (easy to store), precious stones (easy to move around) etc. It also explains why people operating in the black illegal economy love bitcoin and other new forms of crypto.

On the flip side, those who run the fiat money system have been abusing it post 2008, when the financial crisis broke out, and post late 2019, when the world was hit by the Covid pandemic.

A lot of fiat money has been created out of thin air, to get economic activity and economic growth going again. This is offered as a major reason by crypto believers, as to why the world should be shunning paper money and buying bitcoin and other cryptos. There is a lot of paper money being created out of thin air, but only 21 million bitcoin are only ever going to be mined.

Hence, the cryptosystem is built around the concept of scarcity whereas with more and more paper money being created, high inflation can become the order of the day and wealth stored in fiat money can lose value at a very fast pace.

The trouble with this argument is that while more bitcoin cannot be created, anyone and everyone, who understands these things, can create a new cryptocurrency. Which is why there are thousands of cryptos going around. As renowned investor Ray Dalio put it in a note on bitcoin: “Competition will, play a role in determining bitcoin and other cryptocurrency prices. In fact, I assume that better ones will come along and displace this one because that is the way the evolution of everything works.” Given this, in the years to come, gold will still be around, about bitcoin, we really don’t know.

So, the point is you don’t know which crypto is going to be around in the days to come. And given that, how do can you ensure that the value of your wealth remains the same, by investing in crypto. Plus, at the risk of sounding cliched, the price volatility of cryptos continues to remain a huge risk.

Something which falls by 50% in a matter of months, cannot even aim to be an asset class, forget being a form of money. The crypto believers now offer the example of stablecoins, which are basically cryptos pegged to paper or fiat money. They have price stability. But their stability comes from being linked to fiat money in the first place. 

As Mark Carney writes in Value(s) — Building a Better World For All: “The highest-profile examples of stablecoins… are best thought of as payments systems rather than money per se since they derive their moneyness from the underlying sovereign currencies.”

To conclude, a small story. Before the crypto crash happened, a gentleman on Twitter very confidently told me that he would rather buy dogecoin, which was launched as a joke on bitcoin, than the US dollar. This is because the dogecoin wasn’t being created out of thin air (which is not true, given that the amount of dogecoin goes up every year, but we will ignore that here) and the dollar was.

His point was that the US dollar was not backed by anything. The US dollar is not backed by anything in the physical sense of the term, but it is backed by the US sovereign, the biggest economy in the world, perhaps the most innovative economy in the world and the biggest empire the world has ever seen. Also, the dollar has an exorbitant privilege. While other countries need to earn it, the US can simply print it. Which explains why the demand of for the dollar continues to remain solid, despite its abuse.

Yes, to that extent, it is not backed by anything and bitcoin and other cryptos are backed by everything.

What I can’t get my head around is that if you can’t trust the government (and there are reasons not to), how can you trust a few random guys launching their own crypto in their own backyard. Something which can be moved up and down by a few tweets. How is this fiction better than the government’s fiction? I really don’t have an answer for that.

Of Suckers, Mutual Funds and the Old Rs 10 Per Unit Trick

There is a sucker born every minute. I was reminded of this earlier in the day today, when late in the afternoon, that time of the day when I snooze after having had my lunch, I got a random call. For some reason, truecaller didn’t pick up the name of the incoming caller, and I took the call.

The call was from a financial planner’s office and a female was talking at the other end. She said a new fund offer (the technical term for a new mutual fund scheme) from a mutual fund was being currently sold, and that I should invest in it. (Why in the world would I invest in a new scheme and not in something tried and tested, is a question that I didn’t bother to ask).

She started with the usual bull about the long-term returns on the mutual fund expected to be very good (Again, I didn’t bother to ask, if she knew the future, why is she making a living making calls. That would have been very mean).

I replied like I usually do when I am not interested, with a polite hmmm, which doesn’t mean anything.

And then she let it slip, very casually: “Sir, units are available for just Rs 10 per unit.” That caught my attention. It had been years since I had heard that.

The oldest mutual fund misseling trick, something I had made my career writing on during the days I used to write on personal finance, ten to fifteen years back.

It took me back to 2004 to 2007, when stocks were rallying big time and new equity mutual fund schemes were launched dime a dozen. I was reminded of one scheme which had a theme of investing in stocks depending on where the head office or the registered office of the company was (some such thing). Those were the days my friend. Anything sold.

Hoardings on bus stands across Mumbai were plastered with the advertisements of new mutual fund schemes, with the Rs 10 price at which you could buy a single unit of the scheme, being prominently displayed. Even the mutual fund was trying to anchor the prospective investors to the price of Rs 10 per unit.  

As Jason Zweig writes in Your Money and Your Brain in the context of anchoring:

“That’s why real estate agents will usually show you the most expensive house on the market first, so the others will seem cheap by comparison and why mutual fund companies nearly always launch new funds at $10.00 per share, enticing new investors with a “cheap” price at the beginning. In the financial world, anchoring is everywhere, and you can’t be fully on guard against it.”

The stupid me had assumed that all these misseling tricks would have been replaced by newer ones by now. But I guess with every bull run a new set of suckers are produced and India is a big country.

Anyway, I told the caller, madam no money. She then made some polite noises about this being a good opportunity and I should invest in it, and that was that.

For people who don’t know about this misselling trick this is how it works.  When a new mutual fund scheme is launched, the price is set at Rs 10 per unit. Investors buy these units. If the mandate of the scheme is to invest in stocks, the mutual fund collects the money and invests it in stocks.

The price of a unit at the launch is set at Rs 10 per unit. This creates a perception of a cheap price in the mind of the investor. The older schemes, given that they have been around for a while, have higher prices.

Let’s say an older scheme which has been around for a while has a price of Rs 100. This higher value is because the scheme was launched many years back and the stocks that the scheme invested in over the years have gone up in value. In the process, the price of the scheme has also gone up.

Now let’s say you invest Rs 1 lakh in the scheme with a price of Rs 100. Assuming no expenses for the sake of simplicity, you will get 1,000 units (Rs 1 lakh divided by Rs 100) of the scheme. Now let’s say instead of investing in the old scheme, you end up investing in the new scheme at Rs 10 per unit.

You end up with 10,000 units (Rs 1 lakh divided by Rs 10) in the new scheme. 10,000 units is ten times 1,000 units. This creates the perception of a cheap price in the mind of the investor, thus misleading the investor into buying the new scheme and not the old scheme.

But does it really matter? Let’s say the new scheme invests in exactly the same set of stocks as the old one. The price of these stocks goes up 10%. Thus, the price of a single unit of the old scheme goes up to Rs 110 and that of a single unit of a new scheme to Rs 11. But the value of the overall investment in both the cases is Rs 1.1 lakh (Rs 1 lakh plus 10% return on Rs 1 lakh).

Let me explain this in even simpler way. Let’s say you have Rs 10,000 cash lying with you. You can have it in five notes of Rs 2,000, 20 notes of Rs 500, 50 notes of Rs 200, 100 notes of Rs 100, 200 notes of Rs 50, 500 notes and/or coins of Rs 20, 1,000 notes and/or coins of Rs 10, 2,000 coins of Rs 5, 5,000 coins of Rs 2, 10,000 coins of Re 1 or in different combinations of these notes and/or coins. 

But at the end of the day, the total amount of money would still be Rs 10,000. It wouldn’t matter what denominations of notes and coins you have that money in. In the same way, the number of units you own in a mutual fund doesn’t really matter. What matters is how well the money you have invested in the mutual fund scheme, is invested further, and at what rate it grows (or falls for that matter).

Which is why, it makes little sense in investing in new schemes. But it makes absolute sense in sticking to old schemes which have had a good track record. Of course, for the mutual funds it makes sense to rely on these subtle misseling tricks because more the money invested with them, more the money they make. 

Anyway, I didn’t think I would need to write this in 2021. But as the old French saying goes (and I don’t know how many times I have ended a piece with this), “plus ça change, plus c’est la même chose.” The more things change, the more they remain the same.

Of course, whether you want to be a sucker  or an informed investor, the choice is clearly yours. As the old Delhi Police ad went, marzi hai aapki aakhir sir hai aapka.

PS: An added bonus the legendary Baba Sehgal’s all time classic, mere paas hai mutual fund

Charles Ponzi and Bernie Madoff Would Have Been Proud of the Ponzi Schemes of 2021

Bernie Madoff, the man who ran the biggest Ponzi scheme of all time, died in jail on April 14, 2021, fifteen days shy of turning 83.

A Ponzi scheme is a fraudulent investment scheme in which older investors are paid by using money being brought in by newer ones. It keeps running until the money being brought in by the newer investors is greater than the money being paid to the older ones. Once this reverses, the scheme collapses . Or the scamster running the scheme, runs away with the money before the scheme collapses. 

The scheme is named after an Italian American, Charles Ponzi, who tried running such an investment scheme in Boston, United States, in 1920. He had promised to double investors’ money in 90 days, which meant an annual return of 1500%. At its peak, 40,000 investors had invested $15 million in Ponzi’s scheme.

Not surprisingly, the scheme collapsed in less than a year’s time, under its own weight. All Ponzi was doing was taking money from newer investors and paying off the older ones.

Once Boston Post ran a story exposing his scheme in July 1920, many investors demanded their money back and Ponzi’s Ponzi scheme simply collapsed, as money being brought in by newer investors dried up, while older investors had to be paid.

Madoff was smarter that way. His scheme gave consistent returns of around 10% per year, year on year. The fact that Madoff promised reasonable returns, helped him keep running his Ponzi scheme for decades. But when the financial crisis of 2008 struck, it became difficult for him to carry on with the pretence and the scheme collapsed.  

As I wrote in a piece for the Mint newspaper yesterday, Madoff was Ponzi’s most successful disciple ever. While Ponzi’s investment scheme started in December 1919, it collapsed in less than a year’s time in August 1920. On the other hand, documents suggest that Madoff’s scheme started sometime in the 1960s and ran for close to five decades.

Nevertheless, both Madoff and Ponzi, would have been proud of the Ponzi schemes of 2021. The only difference being that the current day Ponzi schemes are what economist Nobel Prize winning Robert Shiller calls naturally occurring Ponzi schemes and not fraudulent ones like the kind Ponzi and Madoff ran.

A conventional Ponzi scheme has a fraudulent manager at the centre of it all and the intention is to defraud investors and take the money and run before the scheme collapses. A naturally occurring Ponzi scheme is slightly different to that extent.

Shiller defines naturally occurring Ponzi schemes in his book Irrational Exuberance: 

“Ponzi schemes do arise from time to time without the contrivance of a fraudulent manager. Even if there is no manipulator fabricating false stories and deliberately deceiving investors in the aggregate stock market, tales about the market are everywhere. When prices go up a number of times, investors are rewarded sequentially by price movements in these markets just as they are in Ponzi schemes. There are still many people (indeed, the stock brokerage and mutual fund industries as a whole) who benefit from telling stories that suggest that the markets will go up further. There is no reason for these stories to be fraudulent; they need to only emphasize the positive news and give less emphasis to the negative.”

Basically, what Shiller is saying here is that the stock markets enter a phase at various points of time, where stock prices go up simply because new money keeps coming in and not because of the expectations of earnings of companies going up in the days to come.

Ultimately, stock prices should reflect a discounted value of future company earnings. But quite often that is not the case and the price goes totally out of whack, for considerably long periods of time. 

A lot of money comes in simply because the smarter investors know that newer money will keep coming in and stock prices will keep going up, and thus, stocks can be unloaded on to the newer investors. Hence, like in a Ponzi scheme, the money being brought in by the newer investors pays off the older ones. In simpler terms, this can be referred to as the greater fool theory.

The investors buying stocks at a certain point of time, when stock prices do not justify the expected future earnings, know that greater fools can be expected to invest in stocks in the time to come and to whom they can sell their stocks.

Of course, this is not the story that is sold. If you want money to keep coming into stocks, you can’t call a prospective fool a fool. There is a whole setup, from stock brokerages to mutual funds to portfolio management services to insurance companies selling investment plans, which benefit from the status quo. Their incomes depend on how well the stock market continues to do. 

They are the deep state of investment and need to keep selling stories that all is well, that stocks are not expensive, that this time is different, that a new era is here or is on its way, that stock prices will keep going up and that if you want to get rich you should invest in the stock market, to keep luring fools in and keep the legal Ponzi scheme, for the lack of a better term, going.

 — Bernie Madoff 

This is precisely what has been happening all across the world since the covid pandemic broke out. With central banks printing a humongous amount of money, interest rates are at very low levels, forcing investors to look for higher returns. A lot of this money has found its way into stock markets. The newer investors have bid stock prices up, thus benefitting the older investors. The deep state of investment has played its role.

Of course, the counterpoint to whatever I have said up until now is that unless new money comes in, how will stock prices ever go up. This is a fair point. But what needs to be understood here is that in the last one year, the total amount of money invested in stocks has turned into a flood. Take the case of foreign institutional investors investing in Indian stocks.

They net invested a total of $37.03 billion in Indian stocks in 2020-21. This was almost 23% more than what they invested in Indian stocks in the previous six years, from April 2014 to March 2020. This flood of money can be seen in stock markets all across the world.

Clearly, there is a difference, and the stock market has worked like a naturally occurring Ponzi scheme, at least over the last one year.

This Ponziness is not just limited to stocks. Take a look at what is happening to Indian startups…oh pardon me…we don’t call them startups anymore, we call them unicorns, these days. A unicorn is a startup which has a valuation of greater than billion dollars.

How can a startup have a valuation of more than a billion dollars, is a question well worth asking. I try and answer this question in a piece I have written in today’s edition of the Mint newspaper.

As mentioned earlier, there is too much money floating all around the world, particularly in the rich world, looking for higher returns. Venture capitalists (VCs) have access to this money and thus are picking up stakes in Indian startups at extremely high prices.

Many of these startups have revenues of a few lakhs and losses running into hundreds or thousands of crore. The losses are funded out of money invested by VCs into these unicorns.

The losses are primarily on account of selling, the service or the good that the startup is offering, at a discounted price. The idea is to show that a monopoly (or a duopoly, if there is more than one player in the same line of business) is being built in that line of business and then cash in on that through a very expensive initial public offering (IPO).

As and when, the IPO happens, a newer set of investors, including retail investors, buy into the business, at a very high price, in the hope that the company will make lots of money in the days to come. Interestingly, IPOs which used to help entrepreneurs raise capital to expand businesses, now have become exit options for VCs. 

If an IPO is not possible, then the VC hopes to unload the stake on to another VC or a company and get out of the business.

In that sense, the hope is that a newer set of investors will pay off an older set, like is the case in any Ponzi scheme. Of course, this newer set then needs another newer set to keep the Ponzi going.

The good thing is that when investors buy a stock of an existing company or in a new company’s IPO, they are at least buying a part of an underlying business. In case of existing companies, chances are that the business is profitable. In case of an IPO, the business may already be profitable or is expected to be profitable.

But the same cannot be said about many digital assets that are being frantically bought and sold these days. There is no underlying business or asset, for which money is being paid. Take the case of Dogecoin which was created as a satire on cryptocurrencies.

As I write this, it has given a return of 24% in the last 24 hours. An Indian fixed deposit investor will take more than four years to earn that kind of return and that too if he doesn’t pay any tax on the interest earned.

Why is Dogecoin delivering such fantastic returns? As James Surowiecki writes in a column: “There is no good answer to that question, other than to say Dogecoins have gotten dramatically more valuable because people have decided to act as if they’re more valuable.”

As John Maynard Keynes puts it, investors are currently anticipating “what average opinion expects the average opinion to be.” Carried away by the high returns on Dogecoin, the expectation is that newer investors will keep investing in it and hence, prices will keep going up. The newer investors will keep paying the older ones. That is the hope, like is the case with any Ponzi scheme, except for the fact that in this case, there is no fraudulent manager at the centre of it all.

Of course, the only way the value of Dogecoin and many other cryptocurrencies can be sustained, is if newer investors keep coming in and at the same time, people who already own these cryptocurrencies don’t rush out all at once to cash in on their gains.

If this does not happen, as is the case with any Ponzi scheme, when existing investors demand their money back and not enough newer investors are coming in, this Ponzi scheme will also collapse.

– Charles Ponzi 

Given this, like is the case with people who are heavily invested in stocks, it is important for people who are heavily invested in cryptos to keep defending them. Of course, a lot of times this is technical mumbo jumbo, which basically amounts to that old phrase, this time is different.

But this time is different is probably the oldest lie in finance. It rarely is.

And if dogecoin was not enough, we now have investors going crazy about non-fungible tokens (NFTs), which in simple terms is basically certified digital art. As Jazmin Goodwin points out: “For example, Jack Dorsey’s first tweet is now bidding for $2.5 million, a video clip of a LeBron James slam dunk sold for over $200,000 and a decade-old “Nyan Cat” GIF went for $600,000.” The auction house Christie sold its first ever NFT artwork for $69 million, in March.

In a world of extremely low interest rates and massive amount of printing carried out by central banks, there is too much money going around chasing returns.

There aren’t enough avenues and which is why we have financial and digital assets now turning into naturally occurring Ponzi schemes, giving the kind of returns that the original Ponzi scamsters, like Ponzi himself and his disciple Madoff, would be proud off.

Madoff’s scheme delivered returns of 10% returns per year. Ponzi promised to double investors’ money in three months or a return of 100% over three months. As I write this, Dogecoin has given a return of more than 600% over the last one month.

Here’s is how the price chart of Dogecoin looks like over the last one month.

Source: https://www.coindesk.com/price/dogecoin.

 

Ten Things to Remember While Buying a Home

This piece emerged out of a couple of WhatsApp conversations I had over this weekend, along with a few emails that I have received over the last few months.

From these conversations and in trying to answer the emails, I have tried to develop a sort of checklist of things to keep in mind, while buying a home. Of course, as I have said in the past, when it comes to personal finance, each person’s situation is unique, and which is why it’s called personal finance.

Nevertheless, there are a few general principles that can be kept in mind. Also, this list like all checklists, is complete to the extent of things I can think of.

So, let this not limit your thinking and the points that you need to keep in mind.

Here we go.

1) If you are buying the house as an investment (not in my scheme of things, but nonetheless), please learn how to calculate the internal rate of return on an investment. Believe me, you will thank me for the rest of your life.

Also, keep track of the cost of maintaining a house and other costs that come with it. Only then will you be able to know the real rate of return from investing in a house.

Otherwise, you will talk like others do, I bought it at x and I sold it at 2x, and get lost in the big numbers, thinking you have made huge returns. While this sort of conversation sounds impressive, it doesn’t mean anything.

2) Don’t buy a house to generate a regular income. The home rentals in the bigger cities have come down post covid. Even if they haven’t, the rental yields (rent divided by market price) continue to be lower than what you would earn if you had that money invested in a fixed deposit (despite such low interest rates).

Of course, the corollary here is that as a landlord you choose to declare your rental income and pay an income tax on it. Many landlords prefer to be totally or partially paid in cash and choose not to pay any income tax. 

3) From what I have been able to gather from my conversations, people in a few cities are still flipping houses. In fact, the trick is to invest before a project gets a RERA approval and then sell out as soon as the approval comes through. This reminds me of the old days when the builder never really knew the people who ended up living in the homes that had been built.

Anyway, if you are flipping homes, do remember that many people caught in the real estate shenanigans of 2009 to 2011, are still waiting for their homes. Many of them are investors. So, if you are flipping homes, do take some basic precautions like not betting your life on any one deal. As the old cliche goes, don’t put all your eggs in one basket. 

4) Also, do remember that you are an individual and the builder is a builder. While many stories of David beating the Goliath have come out in the media, many more stories of Goliaths having crushed Davids, never made it to the media.

It was, is and will remain, an unequal fight. Do remember that. For a builder this is the life that he leads, you, dear reader, on the other hand, have many other things to do. And you are looking for a home to live in, not a builder to take on. So, be careful.

5) One question that I often get is, which bank/housing finance company should I take a loan from. I don’t think this should matter much. Most big banks and housing finance companies charge similar interest rates. As we say in Hindi, bus unees bees ka farak hai.

So, go to the financial institution which seems to be the most convenient to you.

6) One story being pushed in the media is that you should buy a home now because interest rates are low. Among many dumb reasons for buying a home, this is by far the dumbest. Interest rates on home loans are not fixed but floating interest rate loans. If the cost of borrowing for banks and housing finance companies goes up, so will the interest rate on floating rate home loans.

No one can predict which way interest rates will go in the medium to long-term (That doesn’t stop people from trying. Many economists build careers around this). So, currently, the interest rate on a home loan is around 7% per year or thereabouts. If you are buying a home, make sure that you have the capacity to keep repaying the EMI even at an interest rate of 10% per year. This is very important.

7) How do you structure the amount you pay for the home? What portion of the home price should be a downpayment? What portion of the home price should be your home loan? These are very important questions. The answer varies from person to person. Nevertheless, the one general principle I would like to state here is that don’t dip into your retirement savings as far as possible to pay for the downpayment.

It might seem like a good idea with retirement far away and your parents encouraging you to do so because they did the same and it worked out fine for them. Nevertheless, do remember that on an average the current generation will live longer than its parents, and the family support that your parents had or will have in their old age, you may never have.

8) Also, from the point of diversification, it makes sense not to bet all your savings on making the downpayment for a home. Do remember, no job or source of income is safe these days. Further, do ensure that at any point of time you have the ability to pay six to 12 EMIs, without having a regular source of income.

Other than being able to continue repaying your EMI, it will also help you have some time to look for a job or another source of income, if the current one goes kaput.  Money in the bank, buys you time, which helps you make better decisions in life.

And most importantly, if your EMI is more than a third of your take home salary or monthly income, rest assured you are in for trouble on the financial front.

9) If you want to buy a home to live in, go for a ready to move in home. I have seen completion dates for RERA approved projects going beyond 2025 in Mumbai.

The other advantage with a ready to move in home is that some people are already living there and if there is some problem with the building (not a huge deal in India) then there are many more people who have a stake in solving the problem (as convoluted as this might sound). As always there is strength in numbers. 

10) Finally, be sure why you are buying a home. You want to live close to your place of work. You want your child to have some stability in life. You don’t like the idea of moving homes, every couple of years. And so on.

But please don’t buy a home because your parents, in-laws, extended family or relatives, expect you to do so and it gives them something to chat up on or some meaning to their lives. These are financially difficult times and making the biggest financial decision of your life to impress others, isn’t the smartest thing to do possibly.

To conclude, as I said in the beginning this isn’t a complete list by any stretch of imagination. Each person’s situation is unique. Also, you may not end up with a tick mark on all these points mentioned above and you may still end up buying a home. But the advantage will be that you will know clearly where you are placed in the financial scheme of things.

The points essentially help you think in a structured way to arrive at a decision. They do not make the decision for you. That you will have to do.

PS: Don’t know if you noticed that the terms house and home, have been used at different places. Hope you appreciate the difference between the two. 

On Confidence

Around mid-November 2020, I spoke to a bunch of macroeconomics students at IIM Ahmedabad on data in economics. After I had spoken, one of the questions asked was how can we use data to say things with absolute certainty (or something along similar lines).

My simple straightforward answer to the question was that we can’t. Over the years, economists had ended up portraying their subject as a science simply because it has a lot of mathematical equations built into it. But macroeconomics was always more of an art. Hence, we could say things with a reasonable amount of confidence, but never with total confidence.

I don’t think the student was convinced about what I said. And I don’t blame him for it because in the world that he lives in, economists, investors, analysts, politicians and just about everyone speaking to the world at large, is saying things with total confidence.

Let’s take the case of economists. Their economic growth forecasts are made to the precision of a single decimal point.

If we talk about investors, they forecast a stock market index reaching a particular level in a certain amount of time, with total confidence.

Analysts forecast the price of a stock or a commodity reaching a certain level at a certain point of time.

And let’s leave politicians out of this. Untangling their confidence levels will take a book.

The trouble is all this confidence comes in a world that keeps rapidly changing, where if we stick to our ideas all the time, we will largely turn out to be wrong.

As Dan Gardner writes in Future Babble—Why Expert Predictions Fail and Why Believe Them Anyway:

“The simple truth is no one really knows, and no one will know until the future becomes the present. The only thing we can say with confidence is that when that time comes, there will be experts who are sure they know what the future holds and people who pay far too much attention to them.”

And people pay far too much attention to experts who predict/forecast/comment confidently simply because confidence convinces. The audience is looking for a buy in and nothing helps get that more than the confidence of the expert talking.

Also, in these days of the social media, many a time we are simply looking for a confirmation of something that we already believe in. If the expert ends up saying something along those lines, he tends to become our go to man. Our echo chambers are really small.

Let’s take the case of the investor Rakesh Jhunjhunwala, a man known to make confident bold statements when it comes to the Indian economy and the stock market. He recently forecast that India will overtake China in the next 25 years. As he put it: “You may call me a fool… but I can tell you one thing – India will overtake China in the next 25 years.”

The media and the investors as usual lapped it up, without putting that simple question to him: How?

The Indian gross domestic product (GDP) in 2019 was at $2.94 trillion. And that of China was at $11.54 trillion (World Bank data, 2010 constant US dollars). What this means is that if Chinese GDP stagnates at its current level for the next 25 years, India still needs to grow at 5.62% every year for the next 25 years to get where China currently is.

So, the chances of something like this happening are minimal, given the current state of things. But Mr Jhunjhunwala might know something that ordinary mortals like you and I, probably don’t.

The funny thing is that the Big Bull, as the media likes to call him, has made similar such forecasts in the past, which have gone horribly wrong. In October 2007, he had forecast that the Sensex will touch 50,000 points in the next six to seven years.

And he is not the only one making such forecasts. In June 2014, the domestic brokerage Karvy had forecast that the Sensex will touch 1,00,000 points by December 2020.

People making a living out of the stock market (or any other market for that matter) have an incentive in saying that future will be better than the present is. Many analysts make a living by simply doing this on the business news TV channels, on a regular basis.

The media looking for bold headlines to run, laps it up. And the investors who are more like sheep ready to be slaughtered, follow the sheep in front of them.

In fact, the trick is to make bold bigger forecasts and not small ones. I mean, if you currently forecast that Sensex is going to touch 55,000 points this year, no one is going to pay interest. But if you say Sensex is going to cross 1,00,000 points by 2023 or 2024, everyone is going to sit up and take interest.

An excellent example of this is Jhunjhunwala’s 2014 forecast on the stock market index Nifty touching 1,25,000 points by 2030.

Of course, if he turns out to be right, everyone will be dazzled by the forecast he had made. If he turns out to be wrong, no one will remember. Did you remember that Karvy had forecast the Sensex touching 1,00,000 points by December 2020? That’s how the game is played.

Big investors are trying to drive up stock prices, so that their investment portfolios can also gain in the process, which is why they publicly need to be seen as being confident.

A similar game is now played on the social media where traders claim to have generated a humongous amount of return in a short period of time. Of course, there is no way to verify this, except believing him or her.

This is accompanied by other confident predictions of how the future is going to be. The idea is to sell some training programme that they are offering. And no one is going to buy a training programme from a trader who doesn’t sound confident.

For the economists, the game is a little different. They tend to treat their pet theories as gospel. So, an economist who believes in free markets will keep parroting the free market line on everything.

As Scott Galloway writes in his excellent book Post Corona—From Crisis to Opportunity:

“The libertarian argument… is that…regulation and redistribution is inefficient, that left to its own devices the market will regulate itself. If people value clean rivers, the argument goes, they won’t buy cars from companies that pollute. But history and human nature shows that this does not work.”

An excellent example of this is the river Ganga in India, which people keep polluting despite the fact that at the same time they look it as a holy river.

Galloway offers a few more examples. “Nobody wants to see children working eighteen hours a day in a clothing factory, but at the H&M outlet, the $10 T-shirt is an unmissable bargain… Nobody wants to die in a hotel fire, but after a long day of meetings, we aren’t going to inspect the sprinkler system before checking in.” The point being that some sort of regulation is necessary.

There is economic theory and then there is how things play out in real life. As Adam Grant writes in Think Again—The Power of Knowing What You Don’t Know: “In theory confidence and competence go hand in hand. In practice, they often diverge.”

Other than continuing to believe in their pet theories, there is one more reason for economists to portray confidence. Over the years, they have sold their subject as a science, if not to others, at least to themselves in their heads. I mean the first step before convincing anyone else is to convince oneself first.

Hence, the economic growth figure is forecast to the precision of one decimal point. I have always wondered about how economic growth, which is something very complex and is impacted by so many factors, can be forecast in such a precise way.

Now, this is not to say that the forecasting economic growth is not important. It is very important, simply because without that governments and corporations won’t be able to plan for the future.

Without knowing the economic growth number for the next year, a government wouldn’t be able to forecast its fiscal deficit or the difference between what it earns and what it spends expressed as a percentage of the country’s GDP. Without forecasting the fiscal deficit, the government wouldn’t know what kind of money it has to borrow in order to meet this gap. Without the government knowing the government’s borrowing target, the country’s central bank won’t be able to set the country’s monetary policy. And so on.

Nevertheless, the world would be a much better place if the economists started forecasting in ranges. Like, in 2020-21, the Indian economy is likely to contract by 8-10% or even 8-9%, rather than saying something as specific like the Indian economy is likely to contract by 8.3%.  In this scenario, the governments could also forecast a range when it comes to their fiscal deficit.

As John Maynard Keynes is said to have supposedly remarked: “It is better to be roughly right than precisely wrong.”

Hence, forecasting ranges and pointing towards the right direction is more important than being extremely precise about the economic growth.

As Tom Bergin writes in Free Lunch Thinking—How Economics Ruins the Economy:

“If economic models or theories can point us in the right direction and give us a reasonable estimate of the scale of a force or impact, they’re helpful. For example, if consumers are building up levels of personal debt that will require ever-rising house prices and wages to sustain – think the United States in 2006 –economists don’t need to tell us exactly how much a drop in GDP this situation will likely result in. If they can simply show the risks are unsustainable and material, this can prompt and inform government action and protect society.”

I learnt this the hard way. In 2013, when I first started writing about real estate, looking at the situation at hand, I started predicting a real estate bust very confidently. In the years to come, I turned out to be partly right, with parts of the country seeing a substantial fall in prices.

But the deep state of Indian real estate (the bankers, the builders and the politicians) essentially ensured that a real bust never really came. Of course, having learnt from this, now I point out more towards the perils of owning real estate at a price you cannot really afford because that is point people looking to buy a house to live in, essentially need to understand.

Also, one can more confidently say that the real estate sector will continue to remain moribund in the days to come, than confidently predict a bust. As far as investors are concerned, the real estate story has been over for a while.

Sometimes the confidence of economists comes from the prevailing narrative. As Daniel Acemoglu and James A Robinson write in Why Nations Fail – The Origins of Power, Prosperity and Poverty:  

“The most widely used university textbook in economics, written by Nobel Prize-winner Paul Samuelson, repeatedly predicted the coming economic dominance of the Soviet Union. In the 1961 edition, Samuelson predicted that Soviet national income would overtake that of the United States possibly by 1984, but probably by 1997. In the 1980 edition, there was little change in the analysis, though the two dates were delayed to 2002 and 2012.”

Of course nothing of this sort happened, and the Soviet Union broke up in December 1991. But those were the days, and the narrative framed around the success of the Soviet style of economics, driven by its Five-Year Plans, was very popular. Samuelson was not the only one to be seduced by it. In fact, an entire generation was.

Interestingly, the economist Phillip Tetlock has carried out extensive research on experts and their predictions. Gardner, from whose book I have quoted above, documents this in Future Babble.

As he writes:

“Tetlock recruited 284 experts— political scientists, economists, and journalists—whose jobs involve commenting or giving advice on political or economic trends…Over many years, Tetlock and his team peppered the experts with questions. In all, they collected an astonishing 27,450 judgments about the future.”

It turned out that the expert predictions were no more accurate than random guesses. As Gardner writes: “Experts who did particularly badly… were not comfortable with complexity and uncertainty. They sought to “reduce the problem to some core theoretical theme.” This means that they had this one big idea and they stuck to it, without trying to realign their view to the new information coming in.

An excellent example of this is all the gold bulls who came out of the woodwork post the financial crisis of 2008. They talked about gold reaching very high price levels (The highest I encountered was $55,000 per ounce).

As a journalist I interviewed many such individuals and the confidence they had in their forecasts was amazing. In that round, gold didn’t even touch $2,000 per ounce. But the audience lapped the interviews I did. Why? Because these experts exuded confidence in their interviews, even though they eventually turned out to be wrong.

In 2012, when I turned into a freelance writer, I exuded the same confidence on gold while writing about it. And when the prices actually started to fall, it sort of struck at a core belief I had developed over the years and it took me a couple of years to get around to the whole thing.

As Grant writes: “When a core belief is questioned… we tend to shut down rather than open up. It’s as if there’s a miniature dictator living inside our heads, controlling the flow of facts to our minds.” This is referred to as totalitarian ego and a decade later I can see this ego among many bitcoin experts, whenever one questions the entire idea of bitcoin as money, and that has me worried.

Now getting back to Gardner and Tetlcok. Experts who did better than the average of the group that Tetlock had recruited had no template or no big idea. They tried to synthesise information from multiple sources.

As Tetlock writes: “Most of all, these experts were comfortable seeing the world as complex and uncertain—so comfortable that they tended to doubt the ability of anyone to predict the future. That resulted in a paradox: The experts who were more accurate than others tended to be much less confident that they were right.”

This explains why most business TV news anchors, podcasters, YouTuber, social media influencers, etc., who are popular, sound very confident. They believe in this one big idea, which sounds sensible to people, irrespective of whether it is right in the real world or not, and they keep hammering it over and over again, to their audience.

It also explains why guys who are normally right about things aren’t really popular with the media or the public at large. This is simply because they are not totally confident about what they are saying. They have their ifs and buts built into what they say and are constantly revising the information in their heads. And as and when they feel like it, they are ready to revise their views as well. This constant revision comes across as lack of confidence to the world at large. Tetlock called such experts foxes and experts who believed in that one big thing as hedgehogs.

The categorisations were from an essay written by political philosopher Isaiah Berlin, in which Berlin had recalled a small part of an ancient Greek poem. “The fox knows many things… but the hedgehog knows one big thing.” After knowing this, it is easy to figure out who is a fox and who is a hedgehog.

As Gardner writes:

“If you hear a hedgehog make a long-term prediction, it is almost certainly wrong. Treat it with great skepticism. That may seem like obscure advice, but take a look at the television panels, magazines, books, newspapers, and blogs where predictions flourish. The sort of expert typically found there is the sort who is confident, clear, and dramatic. The sort who delivers quality sound bites and compelling stories. The sort who doesn’t bother with complications, caveats, and uncertainties. The sort who has One Big Idea.”

Hence, the kind of expert found in the media is the kind of expert who is more likely to be wrong. One of the key findings that emerged from Tetlock’s data was: “The bigger the media profile of an expert, the less accurate his predictions are.”

In a world filled with confident forecasts, this is a very important point that needs to be kept in mind. If we really need to make sense of the world we are in, we need to figure out who the foxes are and follow them, however mentally disconcerting it might be. The hedgehogs need to be discarded.