2244 FBF: Our Winner Take All Society with Robert Frank Author and Professor of Management & Economics at Cornell University

Welcome to this week's edition of Flashback Friday. Your opportunity to get some good review by listening to episodes from the past that Jason has hand picked to help you today in the present and propel you into the future. Enjoy.

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Welcome to Creating wealth with Jason Hartman. During this program, Jason is going to tell you some really exciting things that you probably haven't thought of before. And a new slant on investing, fresh new approaches to America's best investment that will enable you to create more wealth and happiness than you ever thought possible. Jason is a genuine, self made multimillionaire who not only talks the talk, but walks the walk. He's been a successful investor for 20 years and currently owns properties in 11 states and 17 cities. This program will help you follow in Jason's footsteps on the road to financial freedom. You really can do it. And now here's your host, Jason Hartman with the complete solution for real estate investors.

Welcome to the Creating Wealth Show. This is your host, Jason Hartman, and this is episode number 202. Thank you so much for joining us today. We've got a great show for you today. We're going to talk with a professor and author and I got to warn you, some of you will like this, some will not. But it has a slight socialist bent, which I don't like, by the way. But I wanted to interview this author and professor because I like the title of his book and this is a conceptual show. We're not going to talk much about specifics of investing or anything like that. This is more societal today. But he's the author of the Winner Take All Society and I think that is very applicable to the times in which we are living because we live in a time where business and government and things have become very scalable and the reach of people and companies that develop big brands and systems to go after markets has become, frankly, enormous. I mean, and look at the financial services industry. We're always talking about that on the show. I think that is largely a scam meant to rob the middle class. And that's why we are so in favor of having your own real estate portfolio, having your own business, being the master of your own destiny. That's what the Creating wealth show is all about, controlling your future. And so we'll kind of look at some of those issues today and I think you'll find this interesting. But again, it does have a pretty leftist bent. So we'll be with that in a few minutes here. But first I want to talk to you about a couple of other things. One, of course is the Meet the Masters event that is coming up in March and this is shaping up to be just a fantastic Meet the Masters event. We have got the room number one, just the physical location of the room within the Hyatt Regency Irvine. By the way, you can get rooms for $99 per night and that's a four star, really. Just a beautiful property, beautiful hotel. And you can fly into John Wayne Airport, the shuttle will take you right to the hotel. From there you don't need to rent a car. The hours of this event, of course it's three days, it starts Friday and it goes through Saturday and Sunday all day. It'll be jam packed with information for you. But we start Friday at 1pm and we go until 8pm on Friday. So if you want to fly in on Friday rather than Thursday evening, wherever you're coming from, depending on flight schedules and such, that may be a possibility for you. It'll save you an additional night's hotel room. So you can just stay potentially Friday evening and Saturday evening and leave Sunday evening after the event. So it gives you some more options. And that's why we decided to start later on Friday, starting after lunch at 1pm and we'll have dinner together and we'll conclude at about 8pm that night. And we're weaving in a lot of the creating wealth content and then the content from Meet the Masters where we have multiple speakers talking about asset protection. By the way, I just did a show today with Garrett Sutton, the rich dad attorney. He wrote one of the rich dad books about own your own corporation about entity structuring. And we're just going to have a lot of great content at this event. So that'll be coming up as a show. We have Mark Kohler who you just heard on the show, back to speak at Masters weekend. He's a very in demand speaker and very, very well liked speaker at prior Masters events. So this will fantastic Meet the Masters event. The room we've got, which I kind of got off on a tangent there and didn't talk about, is the stadium room. And it is like a college lecture hall but a luxurious version of it. So you've got built in desks, you've got built in big leather comfy seats and they say that the mind can only absorb as much as the, the rear end can endure. So this will be a very comfortable room. It's rounded so you don't even have to turn your neck. You're always looking straight on at the presenter and I think that'll make this a very, very comfortable setting for learning and getting all the information you need to be very, very successful in income, property investing and defending yourself from the vast Wall street conspiracy. And really it's just going to be a fantastic event. I'm so excited about it. So Again, that's the first weekend of March. Register@JasonHartman.com Price has been increasing but you've still got some early bird pricing. So register asap. We've also got a nice little contest. We're for information registration on that go to jasonhartman.com contest and if you want to produce a little YouTube video, the grand prize winner will win an all expense paid trip from anywhere in the United States where we'll fly you in, we'll pay for your flight, we'll pay for your hotel and of course free tickets to the event. There's just one winner like that though. Be sure to enter@jasonhartman.com contest and if you already registered and you win, we'll refund your admission and pay for your trip as well. So or reimburse the expenses of course within reason for that and register@jasonartman.com contest. The straight out registration just click on store then events and register as well. That's it on the Meet the Masters of Income property event coming up and there's no prerequisite. If you have not been to Creating wealth, come to the Meet the Masters event because we will be covering a lot of the Creating wealth concepts there. And by the way, if you're a previous attendee of the Creating wealth events come every six months. The content changes a number enough that it's worth the every six month review on that event. Want to draw your attention before we get into today's show and interview to some properties. We have been doing a lot of business with our Phoenix vendor and we've just got a fantastic relationship there. A group that really knows what they're doing in Phoenix. Got to hand it to them, we just had a closing on a 32 unit apartment building in Phoenix. We've got some tremendous fourplex properties there. I'm probably going to pull the trigger and buy one of these myself real soon. Of course our other markets doing great. Atlanta, Indianapolis, Dallas, et cetera, et cetera. Denver. Just a lot of good stuff out there. But I want to just talk a little bit about Phoenix today because we're really liking some of the opportunities we're seeing there lately. In particular, if you look on the website, Jason hartman.com, click on Properties, you'll see properties there with returns anywhere from 27% up to, let me see the best one there is, 38% ROI. And I think a lot of these are really going to do a lot better than that because if you were on our conference call that we did recently, and we've got another one of those coming up, by the way, for the predictions for 2011.

Welcome to this week's edition of Flashback Friday, Your opportunity to get some good review by listening to episodes from the past that Jason has hand picked to help you today in the present and propel you into the future. Enjoy.

If you were on that call or you attend the next one, you're going to hear us talk a lot about. And I know many of you purchased the report, which we've got for sale, so 80 pages or so predicting 30 markets across the United States and how they'll perform. And if you were on that call or you read the report, you know that we're talking a lot about what we call regression to replacement cost. Regression to replacement cost. And as we're doing that, I think Phoenix is going to be one of the markets that performs particularly well. The reason is that all of our markets now that we're recommending are pretty much linear markets. But remember Phoenix, Arizona is a hybrid market, whereas at it always has been linear. That's its history to be linear. In other words, it just chugs along and does moderate nice performance on appreciation. But now in the last boom cycle, which obviously created a bubble, it became a hybrid market where it really became cyclical. And of course, those prices have just totally collapsed. And now it's a particularly good buying opportunity. So I think the regression to replacement cost will be more extreme and that means it's more in your favor because these prices, I believe, will come back more dramatically in a market like this. So take a look at Phoenix. We've got some great opportunities in there, a good group that we're working with, rehabbing properties and so forth. And again, we've had a lot of clients buying there lately. So just check it out, go to the website, talk to our investment counselors. They'll tell you more. And one of the other thoughts that I want to give you is that many, many people think that the stock market is really in a bubble now. Frankly, I'm shocked myself. In the worst of times, I had predicted that I the dow would hit 6,000. I got close. The Dow hit 6,400 and change. So I wasn't far off. It didn't quite go down to 6,000 and now look at it. I mean the stock market is really, I think responding to the money printing as much as the precious metals market is and then of course the uncertainty that's going on in the Middle east and so forth. But if you think about it, the last thing to recover is really real estate. So if you buy in and you buy stocks today, you're taking a pretty big risk. If you buy precious metals today, I still think they've got some upside to go for sure. But they don't have the multi dimensional characteristics that the income property does. They don't produce income, they don't produce tax benefits, they have lousy capital gains treatment. So again, not much there. But the real gem, the real opportunity in income property I think is, is pretty darn good. Again now is definitely the time to be buying and I am noticing lately a lot of money coming off the sidelines moving in business for us is very good last, I mean last year was a pretty darn good year. I've got to say. It wasn't our best year for sure. 2008 was our best year in the company's history, but last year was pretty darn solid and this year is shaping up to be a great year for us. So a lot of people moving in buying properties and that is solidifying a real bottom in a lot of these markets. Again, some markets have a lot of pain ahead. Get a copy of our predictions report and for sure we'll be talking about a lot of this in more depth at the Meet the Masters event. So register for that event. I want to see you there. Very important that you're so without further ado, let's get into the winner take all society again. More conceptual topic today, but I think you'll enjoy it nonetheless. And we will be back with the interview in just a moment.

Welcome to Jason Hartman's Financial Freedom Report. Financial Self Defense in Uncertain Times Regression to Replacement Cost One of the things that have come into focus lately is the impact of inflation. While the government statistics are showing that core inflation is still mild, many other indicators such as the price of food, building materials and energy are all beginning to increase. However, the impact of increased money in the economic system does not impact all asset classes equally. Assets that are purchased with cash at a high transaction velocity will be the first to feel the impact of inflation. The reason for this is that inflation fundamentally results from an increase in the amount of money circulating relative to the goods and services that are produced. When more money chases fewer goods, prices must necessarily rise. For items such as food, energy and building materials, there is a rapid churn of transactions that result in monetary increases relative to production showing up very quickly. For credit based purchases such as homes and buildings, the supply of money has a much more indirect impact on prices since it moves based on the availability of financing instead of in direct correlation to money supply. One of the key benchmarks that we study is the Turner Construction Building Cost Index. This index shows the aggregated cost of construction in the United States relative to a 1967 base index value of 100. This index is inclusive of both building materials and labor. From 1998 through 2008, the index shot up as credit availability drove demand for building. This escalated prices for both building materials and labor.

In the aftermath of the financial crisis, building costs dropped precipitously as the number of foreclosures skyrocketed. This effectively halted new construction since foreclosure properties were available for significantly below the cost of construction. This meant that there were very few situations where construction could be done profitably due to the collapse in market prices. This compressed building costs in 2009 and the downward trend continued into 2010. However, as we are coming to the end of 2010, the building cost index has halted its downward trend and is increasing by 0.4% from quarter three, 2010 to quarter four, 2010. This represents what may be an important turning point in the real estate market. Increases in the cost of energy and building materials is beginning to drive up construction costs as quantitative easing by the Federal Reserve is rolling through the monetary system. To date, these cost increases have had their impact offset by softness in the cost of labor, but it is getting to the point where these cost increases cannot be absorbed by lower labor costs anymore.

For income property investors, this represents an especially important inflection point as it signals an increase in replacement costs that will eventually push up market values. We refer to this phenomenon as a regression to replacement cost. As market values regress toward the cost of building new housing during bubble markets, this regression takes the form of a value collapse. During the aftermath of a collapse, this regression to replacement cost pushes up the market value of properties as the supply of foreclosure inventory evaporates and new demand must be supplied with new construction. Once market prices recover sufficiently to trigger new construction, there will be a lag between when the building permits are issued and construction is completed. During this time, there will be demand for homes, but no new homes being built. For investors who purchased properties at the value trough. This will result in forced appreciation toward replacement cost.

Action item, take advantage of the deals that are currently available below the cost of construction so that regression to replacement cost works to your benefit. By understanding the dynamics of market prices and acting on those insights, it will place you in an advantageous situation relative to other investors.

I'd like to welcome to the show Robert H. Frank. He is the author of a book that caught my attention about a year, maybe a year and a half ago. I think it's a fascinating title for today's times, which is the Winner Take all. Why the few at the top get so much More than the rest of us. Bob, welcome to the show.

My pleasure.

Jason, tell us a little bit about your background first, if you would, and what inspired you to write a book with this title.

Oh, I consider myself an economic naturalist. I've been teaching economics at Cornell for decades now, and mostly what I do is I see things out in the world that puzzle me and I think about them and write about them. I've been very fortunate to get away with doing that in a profession that's become increasingly technical and, and mathematicized. There aren't very many naturalists left out there. So, you know, I have always had a faith that markets are basically competitive, and yet you see vivid examples of people who seem just as talented as one another, and yet one will earn thousands of times more than the other. What's going on there? That was a question I've always been curious about. In the Winner Take all society. My co author, Philip Cook, and I decided we would try to tackle that systematically and investigate. Well, why is it that people who seem to produce about the same, seem to work just as hard, seem equally talented, often end up earning vastly different salaries.

And part of the reason for that is, I guess I'll use the word scalability Today, people that have a certain talent and are lucky enough to find the way to scale that talent out there or broadcast that talent or be discovered in some way or have distribution channels really earn disproportionately, you might say unfairly, much more than those who don't.

Right? Yeah. It's really been a revolution in terms of the technology that enables the good players to scale their services up. If you're the person that the radio audience likes best, then there's no extra cost to providing your broadcast to an extra listener. If 10 million listen, it costs the same to produce that podcast as if five people listen. So the people who are listening, they want to listen to the most interesting hour they can if they've got an hour to devote to something. And if, if one program is 1% more interesting than another and people agree on that, then everyone goes to the more interesting program and the, the one that's only a little bit less interesting gets nothing. So that, that's really the trend we're seeing.

Does that sort of incentivize more radical viewpoints from say, talk show host? Because I, I've always kind of thought that the, the extreme in society always seems to win the attention of, of listeners or viewers, and nobody wants to really tune in and listen to like a reasonable guy. It seems like you've got to be, if you're talking politically to the far right or the far left, would you say that that sort of engenders this kind of thinking and behavior?

Right. Yeah. So it's an interesting question whether these contests are decided purely on the basis of merit. And you're right that if you have one option that's plain vanilla, that doesn't sensationalize the issues in any way, and then an alternative that, that mixes it up and is colorful and always takes an extreme view, it's just, to the human ear, more interesting to have sparks fly. And so you will tend to see a slightly bigger audience go to the offering that has that as part of it. And then once you get a little bit of a tilt, then on the merits, there are reasons for people to choose that option, even if it's not what they prefer. People like to talk about what they heard on the radio today. And if you want to do that, you got to have somebody to talk with. And that means talking with somebody who's listening to the same shows you are. And that's an enormous advantage for the most popular show. You know, if you want to talk about the show you heard, your best bet, whether you like the show or not, is to listen to the most.

Popular one, because then you have sort of a camaraderie with other, other listeners or viewers.

Exactly, exactly. And often, often the most listened to show will have strong features that you could say, well, that show deserves to be the best. But not always.

I was sort of thinking about that today as I drove into the office and thinking about our discussion. It's almost like the best product, hopefully is chosen by the marketplace and becomes popular. But maybe by virtue of it becoming popular, it becomes better too, because all of the stakeholders in that company or in that enterprise have more at stake. So hopefully they want to perform better, to expand it even more. I mean, I think that might work Both ways.

Hopefully it can work both ways. That's exactly right, yeah. You've got more scale, you have more resources, you can invest more in improving product.

Well, give us some examples of this maybe across the whole spectrum from entertainment to law to business and the financial markets, academia.

Sure. On the point you just mentioned, an interesting example was the competition between the video recording formats. This is going back now, but there was Beta and vhs. Your younger listeners won't even remember anything about that.

They don't even know what tapes are.

The first video recording format was Sony's Betamax. It was remarkable. You know, we couldn't believe it. You could actually make a recording of a TV show you're watching. Then came Panasonic's vhs. It wasn't as good as Sony's Betamax in terms of picture quality or other features, but it did make one breakthrough and that was to be able to record for two hours at a time. And it turned out that one feature was a critical one for market success because the main thing people wanted to do with these recorders was tape movies off of, off of the air. And if you could do two hours at a time, that let you capture a whole movie and you weren't forced to come back and for reset up right in the middle. So suddenly the sales of VHS started growing very rapidly. That meant the rental stores had greater incentives to stock VHS rental titles. The Beta titles weren't moving as fast as before and gradually it just wasn't worth their while any longer to stock the Betamax. Betamax solved the problem. They were able to extend their recording times past the two hour limit too. But by then the numerical advantage that VHS had captured was just insurmountable. I remember myself going, I was one of the late adopters, as I usually am in these things, going to buy my first video recorder outfit and then seeing the two formats side by side and it was clear that the Betamax machine was way better. But I bought the VHS machine because by then, you know, you just couldn't rent, rent tapes in Beta.

So one of the lines from Al Ries and Jack Trout, the marketing gurus, is in the 22 immutable laws of marketing, they say it's better to be first than it is to be better. But it's not always better to be first, is it? That's not really always true. It's better to be popular, it would seem, than it is to be better. Maybe we can modify their rule there. I don't know. Comment on that by any chance?

Yeah, it's A good question. Would you rather have your audience be disappointed or pleasantly surprised if you get a flowery introduction when you give a talk? Sometimes the audience ends up saying, well, gee, that was as good as I'd expected. So yeah, it can cut both ways. Obviously. I think if you're the most widely circulated example of what you're trying to do, that's in general an advantage.

No question about it. Well, other examples. So that's the beta vhs. Of course there have been battles in Microsoft Windows and Apple Computer. But what about academia? What about business? Sort of the non product world? And how does this infect consumers and the rest of us?

Well, what we're seeing in academia is that because the pay scales in the top jobs have gone up so much, everybody wants one of these massively high paying jobs when they come out. But the main challenge for you is how you get in the front door. I mean, if everyone else wants the jobs, how do you even get to the interviewer's attention? And so I think it's become much more important, at least for certain kinds of jobs, that you have impressive academic credentials. What does that mean? Well, different things to different people. But if you go to an Ivy League school or to MIT or Stanford, those schools are generally recognized as having the best students on the average. And so many employers decide that if they've got already mail sacks full of applicants and no time to interview them all, they'll limit their attention to students who are applying from those best schools. And so that creates a real demand on the students part to get admitted into the best schools. It creates a demand on the administration's part to move up into that category if they're not there already. And so you see bidding wars for the most visible factors, bidding wars for the best research labs. It's just a huge arms race to acquire the elite credentials that give you a shot at the top payment. So that's the story we're seeing in academia. Tuition's being forced up year by year as a result of these arms wars. So it's not so clear that it's a benefit for the country as a whole that this is happening that way. But that's the dynamic.

Because fewer people have access. It seems these universities are now so into the business side of expanding their brands and licensing agreements, it seems kind of ridiculous.

Well, but that's the nature of competition. If you don't invest in your brand, then others pass you in the ratings list and you're even worse off. A lot of this is inefficient in the same way that standing up to see better is inefficient. Everybody stands up to get a better view of what's going on, but nobody sees any better than if everybody remains seated.

Right, but the problem is, what's the answer for that? Tell everybody to just stay seated. And like at a concert, it's much more comfortable if everyone just sits down. I agree.

That's pointedly not the answer. You've got to take some firmer measures than that. You know, there are policies we could adopt that would, that would make some of this waste less severe.

So that's what you mean by the positional arms race, I assume. Right. Okay. All right, got it. You see this big disparity between top schools and what they charge and the war to get into them on the student perspective and other tier schools. There's just a huge difference. And maybe the education isn't that different, but the arms race to get in is different. What about in law? What about in some other areas of the corporate world?

Yeah, it's very similar there too. I mean, there are, there's a hierarchy of law firms. If you're in a big case, you want to hire a very well regarded law firm. But you know, those law firms didn't get to be well regarded by accident. They've been in a dogfight with one another trying to recruit the best graduates from Yale and Harvard and they're paying very high salaries. And once you've got a little bit of an edge in that battle, then the big cases start coming to you. You get a reputation, you get some experience that's relevant for dealing with cases like that. So there's a lot of sort of self reinforcing advantage in dynamics like that. And so I think, yeah, basically we see a lot of money invested in these races to get to the top. Not all that money is wealthy.

It seems that in the corporate world the disparity is just getting wider and wider. And I mean, it is getting really big. I remember reading one of Lou Dobbs books and he talked about how in 1992, the typical corporate CEO at a publicly traded company was making X times the average worker there. And by 2002, just 10 years later, the disparity had become enormous. I mean, it just totally eclipsed by geometric proportions what that difference used to be, which used to be sort of a reasonable difference. And now it seems totally unreasonable what's happening in the corporate world. And then I want to kind of lead that into the sort of the financial world, if you will.

Yeah, I think the Corporate example is instructive. It's very similar to what we saw in professional sports. So if you look at baseball salaries, the top players have always had a big impact. You know, if you have a Babe Ruth on your team, you're way more likely to win the pennant. Those players are worth a lot economically. They didn't get paid accordingly. In the 50s and 60s, you saw a huge increase in the revenue that came into baseball. In the 1950s with the advent of television in the old days, you'd be playing for 30,000 fans. With television, you're playing for millions. And so the revenue coming into the sport went up very fast. But if you watch player salaries on the average throughout those years, they were flat as a pancake. In real terms, what you saw by way of a. A really significant change didn't happen until 1975 when the free agency court decisions were handed down. So before then, baseball teams owned their players. You couldn't offer your services to the highest bidder. Basically, you were the property of your team. They could sell you or trade you if they wanted to, but you couldn't opt out on your own. After 75, there was free agency among baseball players who. And that's exactly when we see the upward spike in salaries start to begin. The trajectory was very steeply upward sloping from then on. Every time there was a new TV contract, you'd see another increase in the slope of player salaries. Now they're several million dollars a year on average. It's just a competitive dynamic that we've seen play out. Now in the corporate realm, there never was a formal reserve clause. There wasn't a law saying you, you couldn't hire executives from other companies. But there was a fairly wide belief that it wouldn't work. So if you wanted to be a CEO of a big company, basically the unwritten rule was you had to come up through the ranks of that company your whole career. What that meant was that if the time came for a new CEO, they had one or two people who were credible contenders. And it was really just a matter of bilateral negotiation between the corporate board and the better of the those two contenders. Suddenly the gestalt shifted in that arena. RJR Nabisco had a CEO that turned them around. The big tobacco company, Lou Gerstner. Well, IBM was struggling. The big computer giant, they said to themselves, well, let's take a plunge here. Gerstner's good at marketing. He's good at motivating people. He can do finance. Maybe there's just a general skill that's all you need. You don't have to have been steeped in the details of the industry. They took their gamble. It worked. IBM shares rose tenfold. Lou Gerstner made a bundle. And from then on, the mindset has been who's the best executive. So you're not really trying to choose from two who've spent their whole careers with your company. You're out there shopping in a spot market, and that means you pay a competitive rate, basically the same as the baseball team. Teams now have to. It's a big gamble. Obviously, nobody knows who will be the best CEO in any given circumstance. But if you've got a company like IBM where the earnings each year are 10 billion or more, if you hire somebody who's just 1% better than the next best person, you know, you're talking about a very huge sum of money, different on the bottom line.

And that obviously makes a huge difference. If you look at competitive athletics like the Olympics, the difference in the. In the winner of the race is a millisecond. You know, it's just such a small difference.

They're just a fraction difference. And nobody's ever heard of the silver medalist. Five years later, the gold medalist is still doing endorsements.

Boy, I just don't know what to think of this. It's hard to sort of place a value judgment on whether this is good or bad. Certainly in the sports example and the example of the corporate executives, there's no such thing as sort of the home team anymore. There's no real loyalty to a company. I mean, I know being an employer for many, many years now, there's certainly no loyalty to the company. People just kind of change around, and it takes a lot of energy, and it seems like it wastes a lot of time for people to be perpetually shopping. We look at now we have an era of Monster.com and Craigslist and these employment services where everybody's resume is sort of always online, they're always shopping. You look at people in marriages or in relationships and the dating websites, they're always shopping. I mean, it's just.

It's the same way in the university system. You know, we're going to recruiting dinners all through the academic year. There's an enormous amount of church people leave. We have to recruit replacements. It didn't used to be that way. And I agree there's a lot of waste in that process, too. We could slow some of this down without losing most of the benefits that come from the competition. I think partly it's that since the Rewards have become so unequal. The striving to get to the next level has just gotten way, way more intense. If we taxed the rewards of the biggest winners, there'd still be of a lot, lot of striving to get to those positions, but there'd be a little bit less churning than we see now. Plus we generate some revenue that would be available to spend on things that I think in the end would be more valuable to everyone than just building a bigger mansion for the people who win these races.

When you, when you start talking like that, it smacks of not free market, it smacks of socialist, it smacks of you build those big mansions and hey, don't those employ people to build those big mansions. And I sort of don't know where to settle on that debate. And it's very difficult to understand.

That's a very common reaction. I think we're used to hearing about Adam Smith's invisible hand. Just turn people loose and they'll trade for their own advantage in the marketplace and somehow that will result in the greatest good for all. It's a fabulous story and it's right in many circumstances. If a bunch of producers are competing for business and they adopt better product designs and introduce cost saving innovations, the competition eventually drives prices and profits back down. And so really the consumers do benefit in the end from all that. But there's another view of competition. It's similar to Smith's in a way, but I attribute it to Charles Darwin, his evolution model of competition said that, well, what's the focus here? It's on traits that benefit individuals. Those traits may or may not benefit the larger groups, Darwin said, and it's easy to think of examples where they do so. So if there's a mutation that makes an individual hawk see better, that's good for him, obviously. But as that spreads throughout the population, it's good for hawks as a whole. Too. So that's like the Adam Smith invisible hand story. But Darwin had other examples where what was good for the individual wasn't so good for the group. So if you think about the antlers of the male elk, if one animal had bigger antlers than his rival, he was more likely to win his fight with the rival for access to mates. And so that meant the genes for bigger antlers would get passed on, the genes for smaller antlers wouldn't. And so there was an arms race on antler size. Now the surviving elk have antlers five feet across. Is that a good thing? Well, it helps you win your battles with other males. But if they were all smaller by half, that would be better still because the big antlers are a huge encumbrance. If a wolf chases you into a wooded area with those five foot antlers, you're dead meat. So competition sometimes helps the group. In other cases it gives rise to arms races that are bad for the group. And you just have to, I think, adopt a more open posture on whether competition is good. In each individual case, the answer is going to be sometimes yes, sometimes no.

Let me take a brief pause. We'll be back in just a minute.

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Those are very interesting examples. I'm trying to think of how to apply them to real life, but one thing comes to mind. Well, two things actually. Number one is that you look at the accumulation of wealth and sort of the old concept of sometimes you don't own your possessions, they own you. You have all this stuff to manage, like those big antlers, right? And the big antlers have to be managed and they really become an incomplete encumbrance a lot of times. So there's a maybe a certain amount of moderation there that is sensible and logical and really for a better quality of life.

But that's not likely to happen spontaneously because you Know, if you're an executive, you're expected to entertain in a certain style. And if all the other executives are getting paid more each year, then they're building bigger mansions. And so in order to be able to entertain in the style of that has been set by them, you've got to build bigger, too. So you really need some incentive for all of you to scale back at once. That's the problem.

That's kind of like the other thing I was going to say is even if you win the rat race, you're still a rat. Exactly.

Yeah. It's a nuisance when all the mansions double in size. You just need to recruit and supervise a bigger staff. It's a pain in the neck.

Well, with the economy the way it is now, though, I heard someone coin a term in one of my readings a few months back, and they said the new thing is that it's cool to be frugal. And in fact, people are becoming frugalistas. And I like that term. And you know, it's true. I see it all across society now where even people that have a lot of means and wealth, they're becoming pretty frugal too. It just doesn't seem as cool, quote unquote, to be a conspicuous consumer the way it is.

Well, partly it's unseemly when, you know, a lot of people are struggling. They've lost their jobs, they're about to get kicked out of their house. It's unseemly to be spending conspicuously. So I think people have cut back in the current environment in some part because of that. But I think once the downturn's over, and it eventually will be, then income trends will resume. The winner take all forces are still playing out. And so I think we'll see again the tendency for people to spend in line with their incomes. And so there'll be again pressure on people to spend more than. Probably makes sense from the perspective of society, society as a whole. Be better to take some of that money and spend it. For example, we cut the budget for the Energy Department's program to round up loose nuclear materials in the former Soviet Union. That's not a good thing to cut. We've got those materials guarded by soldiers who drink too much. They don't get paid regularly. That's a very dangerous situation. We should be spending more on that.

Program, not less, because eventually they'll sell out to a bribe or nobody's going.

To bribe them and you'll get a dirty bomb exploded in New York and Los Angeles.

Well, Hope that doesn't happen, that's for sure. Hey, since you mentioned it and we've got you on the phone, you're obviously qualified to give us some insight on this. What are your thoughts about the direction of the economy and what people should be doing now? And any advice or thoughts there?

People have been saving more. Our savings rate had gone dangerously low, below, below zero.

It was negative years.

That's obviously a recipe for disaster in the long run. But to get out of a downturn, saving, saving a lot isn't exactly the most helpful posture either. So if you can afford to spend, and I think it's good to spend for the immediate economic needs of the country. But if you're having a hard time making ends meet, by all means, don't go out and borrow on your credit card to spend. That's ridiculous. But what you can do in many cases is you can spend on things that will improve your balance sheet. So, for example, if you live in a cold climate and you don't have a lot of insulation in your attic, there's some money you can spend. Hire a contractor, have an energy audit done, put extra insulation your walls and in your attic. You will be borrowing money to do that. Perhaps. But the monthly savings on your utility bill will be more than enough to carry the payments on that loan. That stimulates the economy and it puts you in better financial condition. So there's an example.

Capital improvement, sure, yeah.

Don't consume right now.

Invest other thoughts on where we're going when we'll come out of this. How much worse is it going to get before it gets better? If we have people calling a recovery now, I'm not so optimistic.

But yeah, I've been on the pessimistic end of the scale just because there are many bad things still in the pipeline left to happen. There are some jumbo mortgage problems coming ahead. There's some commercial loans, credit card debt going into default. Yeah, we've still got some rough sledding ahead for sure, but it will end. We need more economic stimulus to accelerate the end of the downturn. But I think even without that, it will eventually end. And at that point, I think the time's ripe to think about how we can raise more revenue to pay for the services we want. You know, we want universal health care, we want safer roads, we want green energy. There are a lot of things we want to want to add to life that we think would be worthwhile. We've got to figure out how to pay for them. I think the easiest way to get some more revenue would be to put a progressive surtax on consumption beyond very high levels.

Won't that destimulate the economy though?

Well, we don't want to do that now. So what you do is you pass the legislation now saying that once the unemployment rate gets down around 5% again, we will gradually phase in a heavy consumption surtax on consumption, let's say beyond half a million dollars a year. So you report your income to the IRS, you report your savings to the IRS, same as you do for your 401k. The difference between those two is is your consumption. And then if that number is bigger than half a million, you pay your income tax the same as you would, but you'd also pay a surtax based on just the consumption component.

Oh, I don't know about that. I'm not going to know that coming.

That you want to build the mansion wing right now to escape the extra burden of that tax.

You know, you make a very good point and it sort of argues against that case in a way because whenever new laws like this are put into a effect, it seems like everybody's trying to manipulate it and work it to their advantage. And it just seems like if the government would get out of the way, it would be better because it would be more of a true market. And I know that goes in the face of some of the stuff we've talked about earlier with the scalability concepts and the winner take all stuff.

Well, and the true market doesn't give you what you want in many cases. You know, the Justice Department filed an antitrust suit against the top universities who had had been colluding to maintain financial aid availability for families who needed it. So there was kind of a, you could call it a cartel agreement not to get into competitive bidding for the students with the highest SAT scores, but instead hold back those dollars for financial aid for needy families. Well, the Justice Department thought that was anti competitive. Of course it was anti competitive. But that doesn't mean it was a bad thing to do. In fact, it was a good, good thing to do. Competition forced universities. Once that antitrust injunction had been issued, it forced universities to compete with each other for the students with the highest test scores. And now the kids who grow up in wealthy households who get the expensive SAT score, tutors are capturing all the financial aid. The students whose families earn 40,000 are left in the cold. That's not the best outcome.

Now I want to ask you about two more main things and make sure we cover your new book and we Talk about that a little bit because the title sounds really interesting and I want to hear about that. But before we do that, what do you think in terms of the future of our economy? You know, next two to five years, for example, inflation or deflation?

If you hear anybody worrying about inflation, that's way premature. We've got 9.5% unemployment right now. We've got probably peak unemployment going to be well over 10% before things really improve. And anybody who tries to raise its price right now is going to do worse than before. You can't sell everything you're offering now. How are you going to sell it if you raise the price of it? It's not going to recover overnight. This downturn. We'll see full employment approaching quite gradually. It's usually a lagging indicator and we'll have plenty of time to take steps to cool demand down if it looks like it's starting to heat up too much. So inflation, not to worry.

Not for a while, do you think, I mean, but people would say two things. They'd say, number one, look at all the money they're creating out of thin air. And then number two, they'd say a lot of the Obama administration's restrictions and central planning type controls and environmental regulations will lead to shortages and that'll create inflation. What do you say to those two points?

Well, I mean, in the case of the main example there, the carbon cap and trade system that will make goods and services, whose production spews a lot of carbon into the atmosphere more expensive.

Doesn't everything do that? Energy is everything, right?

Yeah, everything does that. And in return for that, we'll get a planet that may have a future that lasts more than 100 years. So sometimes if you got something that you need to buy, then you pony up extra dollars and you buy it. So the estimates of how much prices will go up, I think have been, have proven so far, way overblown. We had a very similar experience with acid rain.

I remember acid rain.

I remember all the articles we used to read about acid rain.

The 70s. It was all over the place. Yeah.

And we adopted a very simple cap and trade system for SO2 emissions. The cost of getting sulfur dioxide emissions in the atmosphere down low enough so that acid rain was no longer a problem was only about one eighth as much as the forecast had been. People figure out clever ways to adapt when they're forced to take the cost of these pollutants into account. People are amazingly inventive. I mean, that's putting the ingenuity of the free enterprise system to work for you. Right now people are ignoring the external costs caused by the carbon and that's.

Not what we want. What about the first point about money printing?

You know, I'm a co author of Ben Bernanke's. We have a textbook that we wrote together. He is probably more sensitive to the dangers of inflation than anyone I personally know. He's, he's the author of many very widely cited articles on inflation targeting, which is the main method that central banks around the world use to keep inflation in check. He's also a student of the Great Depression, and I think his interest in it is primarily stimulated by the vast human suffering that's caused by unemployment rates of 25% like we saw in the Great Depression. If you had to compare the cost of slightly higher than normal price increases against the cost of really high unemployment, there'd be no discussion. I mean, the unemployment is vastly more costly.

That's the old Phillips curve.

It's not the Phillips Curve. No, it's, I mean, economists don't any longer believe that there's a permanent trade off between inflation and unemployment. If you try to reduce unemployment beyond its normal level, then you're going to just get an accelerating inflation. That's why it's so important not to do that. But when you have a deep downturn, the way to get out of it is to stimulate spending. Print money, borrow money, do whatever you can to increase aggregate demand. And no one is going to be more sensitive to the risk of inflation as the economy gets closer to full employment than Ben Bernanke.

I have to just point out that Bernanke has been criticized for being helicopter Ben, the guy who will throw the hundred dollar bills out from the helicopter. He gave that speech before he was Federal Reserve.

And that's exactly what he should be doing under current, current circumstances. He'll, he'll, he'll have his vacuum cleaner on reverse when the time comes.

Yeah, okay. He'll suck up all that money. And I mean how, when he saw his 60 Minutes interview, it seemed like he was kind of cavalier about that. He just said, well, we have tools we'll use when inflation comes. And I'm just kind of thinking, so you'll just suck up all that liquidity and all that money somehow.

Well, in fact, they do have tools.

And I know they do.

But he's been creating new tools to help get more money into the economy. I think he's been very imaginative. Now he's managed to do that and he will be very aggressive if there's any credible indication that inflation's on the horizon.

What are some of the tools that he's going to use to do that? I'm curious. I mean, obviously you raise interest rates.

Monetary tools are quite effective at curbing monetary growth. I mean, you raise the discount rate, the rate at which banks can borrow overnight from the Fed. You tighten reserve requirements to lend out money. You have to have more in reserve than you used to have to have.

Those are old standard tools, though. Those have been around. I mean, Volcker used that. What are the new tools, though? I'm curious about that.

Volcker had an inflation to kill and he killed it.

He sure did. And he killed it partially.

We don't have an inflation to kill and we have a Fed chairman who's very sensitive to inflation. So he will take steps like the one that Volcker took. Unfortunately, inflation had already already gotten to 16%, 15% when Volcker acted. So it was pretty stern unemployment that we had to live through in order to kill that inflation. But we won't see any price pressure even if unemployment got to 5% here. With the world economy in a deep downturn, there are really lots of products around the world that will come flooding in at good prices if we try to raise prices here. So I think that's just not really the danger now.

And do you see more of a movement, though, with the Obama administration being supportive of unions, of protectionism at all? I mean, other countries are starting to squawk about protectionism and America is a little bit too. Do you see that as not a significant threat to keeping foreign goods coming in at low prices?

There's some talk that we will use international protection to keep goods out that are produced without paying a carbon tax. So if we have a carbon tax or cap and trade, the functional equivalent of that, in order to curb global warming, and China doesn't do anything about global warming, then can the US Keep Chinese products that are made with dirty technologies out as a step to encourage them to adopt global warming control measures? And the answer to that, I think, is yes. It's trying to keep environmental problems at bay here. That would be the motive for doing that. So it would pass muster with the World Trade Organization. Any other kind of step to protect against imports is not legal under the World Trade Organization. So I don't think really that's a major worry.

Tell us about your new book. I am fascinated with the title the Economic Naturalist, Is that correct?

It's called the Economic Naturalist Field. Common Sense Principles for Troubled Times is.

A subtitle what is it all about?

It's a collection of my New York Times columns. They appear in the Sunday Business section and in those I try to show how economic reasoning of a broader sort really can help both individuals and policymakers think more intelligently about the kinds of problems we face. Yeah, it's really discussion along the lines we've been having during our session today.

Great. So do you have a website that you'd like to get?

I do, yeah. It's www.roberT-H-Frank.com. yeah, I've got my New York Times columns and other writings posted there, plus some miscellaneous stuff.

Excellent. And people can look you up on Amazon.com and at bookstores as well, I'm sure too.

Right, sure.

Excellent. Well, thank you so much for joining us today. Anything in closing you'd like to say wrapping up the winner take all society what people can do, action steps. Any other thoughts?

Yeah. Just remember that Darwin's view of competition was probably more in line with the world we actually see than the invisible hand view. The invisible hand works great in some circumstances, not always.

Excellent. Well, Adam Smith is not here to debate that.

But neither is Darwin.

Neither is Darwin. That's true. Excellent. Well, thank you so much for joining us today, Bob. It's been a very interesting conversation.

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