ERE and the Four Horsemen

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The Old Man
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ERE and the Four Horsemen

Post by The Old Man »

William Bernstein in his book “Deep Risk: How History Informs Portfolio Design” distinguishes between two classes of risks: (1) shallow risks – risk of temporary fluctuations in wealth and (2) deep risks – risk of permanent loss of wealth. Deep risks are those that arise over time periods of greater than twenty years.

Deep Risks – permanent loss of wealth:
(1) Inflation
(2) Deflation
(3) Confiscation
(4) Devastation

I think it would be useful to discuss whether ERE is resilient in the face of deep risks.

World War II made a shambles of most normal businesses; however, business carried on. A globally diversified portfolio should be sufficient to weather a future world war (assuming it doesn’t go nuclear). ERE’s emphasis on skills should also be helpful in the event one’s own country is invaded.

I know a lady whom at the time of World War II was a young teenager. She was a member of the League of German Girls and her unit was posted to Poland. Being mechanically inclined she repaired the units bicycles. One day a man came to their unit and said the Russian’s were invading and they would be needed to assist in the evacuations. After the evacuations were completed they were informed their unit was disbanded and they were now on their own. She used one of the repaired bicycles to cycle out of Poland to Germany and later surrendered to the Allied forces. Her bicycle repair skills were very handy in deed.

I define deflation to be where output declines and not just merely falling prices. The 1930’s deflation was very damaging to business, but recovery eventually ensued. A globally diversified portfolio should be sufficient to weather a 1930’s style deflation. Of more concern would be if the deflation were to be of a long term nature. Long term decline has happened before. There was the Bronze Age collapse, Iron Age collapse, and the fall of the Roman Empire. While historians debate the reasons for the decline I believe climate change was a principal factor. ERE’s emphasis on skills should be most helpful in dealing with this type of long term decline.

The most likely long term risk and one where there are many options available. ERE doesn’t seem to add anything to one’s toolbox for dealing with this scenario.
Confiscation: ... internment ... 03079.html

In time of war, the laws fall silent.

When your country considers you an enemy of the state, what are you to do? In such a scenario the traditional career-job consumerist lifestyle is a disaster. ERE, with its emphasis on passive income, creates options. He can just leave the country. Hopefully, he has already obtained a second passport or maybe refugee status could be easily obtained in such a situation.

I think ERE is resilient in the face of deep risks. It does well in creating options for three out of four of the above scenarios. For the fourth scenario – inflation – ERE doesn’t help, but it doesn’t hurt either.

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Re: ERE and the Four Horsemen

Post by jacob »

This four-way split sounds almost like the permanent portfolio's design basis.

I don't think global diversification is a benefit. If anything, it makes the systemic problems worse. Diversified financial instruments have made the world's finances so interconnected that problems in Chinese banks immediately show up in the US equity markets because they have become tied together through the debt and currency markets---even if they otherwise have little to do with each other. Diversification solved the problem of not knowing which company or which market to invest in, but in solving for this particular form of ignorance, another problem has been created and the markets turned into a risk-on/risk-off kind of trade where you're either in cash (which thanks to central banks carries its own risk now) or you're in anything else, doesn't matter anymore. These concerns can be summarized in the pithy "there's now nowhere to hide".

Here's my take on the four horsemen:

Devastation - ERE should make it so that practitioners are not particularly tied to obligations; a particular place; or a particular job or career. We won't be stuck needing to earn $100k in a job in city X to pay a huge mortgage. We will be able to leave when early signs of trouble appear years before devastation impacts. If we get hit, we should be resourceful enough to not have to depend on a single solution method of spending money or storing supplies but be able to make or improvise solutions.

Deflation - The focus on quality and not wasting should make it much easier to live will in a world of declining supply. What do I care that economic production is down when I don't need what the economy is producing anyway and when I don't need a full time job to support my wants and needs.

Inflation - Those of us who have savings and investments have been thoroughly blessed with a massive asset inflation over the past few years. Thanks for all the money Bernanke. Conversely, those who saved a tiny 10% and still rely on their salary have stood still. In particular, those who know how to move their assets around depending on what's currently bubbling should be able to benefit very handsomely from inflation.

Confiscation - The only things that governments can't take away are skills and the ability to make money. Well, in a way they can but it's pretty hard and in most cases you have to be a condemned criminal for that to happen. Hopefully, as per the devastation, presumably one would leave the area before this happens. I would say that anyone who relies solely on financial means to carry them are at risk here, perhaps even more so than a career salaryman because the latter belongs to the majority and he would have an up to date resume. On the flipside, ERE is aligned with the rich and powerful in terms of financial interests, so unless there's a revolution, they should remain quite protected by the powers that be. As long as there's no revolution, ... Keep in mind, it doesn't have to be a bloody revolution. A shift in attitudes will do. What if there suddenly was a popular motion to tax everybody 10% of their assets annually? People who have no savings would happily go along with this under a doctrine of fair share.

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Re: ERE and the Four Horsemen

Post by workathome »

There is ultimately a risk that anything could be taken away. A good reason not to compromise your health, education, soul, family, etc. for excess material gain. Also why ERE emphasizes the do-it-yourself insourcing approach with a wide skill basis. It's that whole overlapping venn diagram thing Jacob talks about in his book.

Like reading Forbes and seeing the really fat unhealthy billionaires - I'm like, man, what's up with that, eh? (I combine several forms of slang for mass appeal).

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Re: ERE and the Four Horsemen

Post by stand@desk »

I think there is a risk (not sure how large it is) that electronic networks could go down or are distorted and practical wealth becomes tangible and no longer digital.

I have heard that a Major Warehouse in Oregon holds a server that holds all of Facebook's data..How secure is it? I have no idea. There must be many more of these all across the globe.

There are retailers like Target and others that have experienced Data breaches..

I agree, that with the vulnerability of the digital systems we live by, that after a certain point, accumulating additional digital wealth becomes ultimately unrewarding because it can't be guaranteed.

I think it would be well served to hold some tangible wealth in retrievable and safe places, and ultimately wealth depends on our skills and abilities and our networks.

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Re: ERE and the Four Horsemen

Post by JohnnyH »

Inflation seems unavoidable, but investors can hedge against it... Deflation, seems unlikely with current Fed practices.

Devastation and confiscation look mostly like functions of state. ERE pursuers fight hard to decouple from "obligations" so I like Jacob said, I think most will see the warning signs and hopefully be less damaged.
I'm definitely seeing some warning signs on the confiscation; courts continue to weaken property laws in the name of fighting something (drugs, terrorism).

Hm... Going to checkout this book.
"you can borrow this book for free on your Kindle device" -My kindle broke, but I am so tired of seeing this I'm buying another post haste!

The Old Man
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Re: ERE and the Four Horsemen

Post by The Old Man »

Global diversification helps in the sense that even in a world war there will be some parts that remain relatively untouched and can serve as the foundation for a recovery. In World War II, Europe was devastated, but Latin America remained relatively untouched. Likewise during the Napoleonic Wars, Latin America prospered while the Continental System harmed Europe. You are correct that today the world economy is much more tightly coupled than in the past, so short term fluctuations are more readily transmitted in time; however, physical separation in space still has value when it comes to avoiding physical devastation.

Deflation – There are two types of deflation. There is price deflation as seen in the USA “Long Depression” of the 1870s-1890s brought on by the emergence of industrialization whereby prices declined, but output soared. There is output deflation as seen in the 1930s for reasons not fully understood whereby output crashed along with prices. In general while individuals and individual firms may have difficulties during a period of price deflation, for the economy as a whole it is generally beneficial – it is the essence of Schumpeter’s creative destruction. Output deflation is dangerous. Central Banks don’t seem to distinguish between the two and their rhetoric seems to focus on combating price deflation. I would not put my faith in Central Banks for avoiding output deflation.

Inflation - I agree with what has been said; however, one must also bear in mind the effects of the USA 1970s. Inflation was very high,but the real economy and the financial markets did poorly. That era was called stagflation - stagnant economy with inflation. That type of economic environment was not considered to be likely - much like the 1930s depression was considered not possible under classical economics.

Devastation - well put.

Confiscation - Good discussion. Social capital is probably what is most needed to avoid this risk. If it hits, then social capital again is most probably the best for mitigating its worst aspects. For those without the social capital then ERE perhaps creates the best mindset for avoiding its effects. I agree that financially ERE is aligned with the rich and powerful, but if confiscation is directed at minorities then this financial alignment is not helpful.

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Re: ERE and the Four Horsemen

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