Ricardo Anniversary

Thu, 2017/04/20 - 11:46am | Your editor
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“What should we be doing now” asks Prof WS, to “play swollen valuations yet keep on board the train?” He suggests the answer himself: high dividend stocks. In general the payout level on foreign stocks is higher than that for US ones. Playing global yield disparities is a Ricardian solution to investment risks. David Ricardo's theory on economic rent, published only after his death, discussed the surplus return over and above the opportunity cost, or what was necessary to earn it. The opportunity cost includes a transfer payment, which is what we get for investing abroad.

He also defined the role of a central bank, first to issue secured notes, and then to act as the state bank and when necessary to issue un-backed notes (in an amount greater than the gold held in its reserves). This is the justification for current Fed policy. Ricardo also wrote on how central banks should price gold bullion, and on political economy and taxation.


The world this week is celebrating the 200th anniversary of the publication of Ricardo's “On Foreign Trade”, part of his opus Principles of Political Economy and Taxation. This the British-born but Dutch-Hebrew-educated businessman produced with help from both John and John Stuart Mill, plus Robert Malthus. His classic economic theories came out at the height of the Industrial Revolution in Britain.


Ricardo published his book on April 19, 1817 after making his fortune by betting on Britain winning the Battle of Waterloo with purchase of beaten-down government bonds. (The coup is frequently mis-attributed to Nathan Rothschild. Ricardo bought first, before the battle was even fought. Ricardo was the George Soros of his day.)


He famously invented “the iron law of wages”, stating that if wages go up above the natural price, profits tend to fall. Wages, he wrote, should be only enough to enable the worker to subsist and raise children, but not enough to earn a surplus. He also wrote that the natural price of labor will fall as new markets are developed and more goods are imported and against any government interference in the free negotiations between workers and their employers on how much they should earn. Laissez faire was his call. Labor's gain would be costly to profits, hurting the economy overall.


The “iron law” and laissez faire theories gave Ricardo a bad rep. His theory was cited by Malthus against workers who had too many children to support properly. Laws setting minimum wages, Ricardo argued, would harm the country while not helping the poor. Ricardo himself was born in London in 1772, the third of 17 children, exactly the sort of breeding Malthus preached against.


Ricardo's Sephardic parents had emigrated from Holland. At age 11 he was sent to Amsterdam to a yeshiva (religious school), and at 14 he came back to London to enter his father's stock-jobbing and banking business. But he blotted his copybook by marrying outside the Jewish faith to Quaker Priscilla Wilkinson 7 years later. Both converted to Unitarianism. Ricardo then set up his own stock-jobbing business which thanks to his bet against Napoleon made him a millionaire. But he was hampered by being denied support from the Jewish community and treated as an exotic by the British. (Unlike Disraeli, who could blame his parents for falling away from Judaism, Ricardo did it himself.) He bought himself a stately home and seat in Parliament, the done thing in the early 19th century.


Ricardo's trade theory examined two goods traded between two countries, cloth from Britain and wine from Portugal (his then-home and the ancestral home of the Sephardic Jewish Ricardo clan.) He wrote it after reading Adam Smith's Wealth of Nations, published in 1776. Each country specialized in producing goods where it had a comparative advantage which made both countries better off. The input factors which cannot be moved, like labor and the cost of capital, are lost to foreign competition if a country tries to produce everything itself.


Mercantilism (which Trump's America First policies favor) attempts to block imports and favor imports, however uneconomic and senseless to Ricardo. He argued that each country should specialize in producing those goods where it has a relative advantage and use the proceeds to buy the rest. Free trade allows both England and Portugal to win by exchanging cloth for wine, and visa versa.


He summarized: a country may, in return for manufactured commodities, import corn even if it can be grown with less labor than in the country from which it is imported. There is a price for wine and cloth which helps both sides of the deal who are specializing. Ricardo also argued that high profits in business help a country achieve prosperity and happiness for its people. While counter-intuitive, Ricardo's theory of comparative advantage is the key to justifying free trade. If you cannot understand why you need to read up in almost any basic economics textbook. Alas, Donald Trump doesn't like reading very much.


Ricardo died in 1823 of an ear infection. He had three sons, only one of whom produced a grandchild or great-grandchild, so he more or less followed Malthus in his own life. His Gatcombe Park estate, built for King Charles I as a hunting lodge, and bought by Ricardo in 1816, is now the residence of Princess Anne and her daughter Zara Phillips.


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