10. Pseudo-investment 1: Private Tailgating

In this and the following few chapters will set out some of the activities that the financial sector is involved in that have the aura of “investing” but upon closer inspection are simply pseudo-investments. But before we begin we need a little digression to introduce the concept of financial tailgating.

Financial tailgating

Tailgating to Glasgow

One of my pet annoyances while driving is tailgating. People insisting on driving too close to the car in front. I find it particularly irritating and stupid when on a long journey on a major road. I live in London, and Glasgow is a seven-hour journey along the M1 motorway. If someone tailgates me at the start of the journey I think to myself, “If this driver tailgates me all the way to Glasgow, they will get there about three seconds quicker than if they held back and left a reasonable distance between our cars.” In a way, the tailgater has to pay a continuous penalty in terms of increased risk of an accident, both for them and for me, and for what? A journey that is a few seconds quicker quicker? It hardly seems worth it. There appears to be an analogous phenomenon in economics which we will call financial tailgating.

Many people are so impatient to get their holiday, their car, their new furniture, that they will forever be borrowing money to purchase these things. Not just as a one-off when they are very young, but throughout their lives. As soon as they’ve finished the repayments for one item they go out and borrow money for the next. The benefit they get from this process is that they get their stuff earlier on in their lives but the penalty is having to pay a continuous stream of interest to banks.

Another way to appreciate the effect of tailgating is to compare the consumption patterns of two people born around the same time. Let’s call them Tom and Simon. Tom is a compulsive tailgater. whereas Simon always saves up until he has enough money before purchasing anything. There will be a period toward the start of their lives where the Tom the tailgater gets to have goods that Simon the saver does not have. Tom is “ahead” during this period. He gets to enjoy his goods while Simon has to endure a period of having less goods or perhaps putting up with poorer quality ones. Let’s call this the “start-up” phase. After a while, when Simon has saved up some money and can start buying things, the situation becomes equalised: Both Tom and Simon can enjoy their ownership of the goods they want. This is a far longer period than the start-up. Call this the “post-start-up” phase. During the post start-up phase Tom is in a continuous state of paying a fraction of his income on interest to the banks. Simon has no such handicap and thus will be able to purchase slightly more or better quality goods than Tom for the rest of his life.

At this point it is important to highlight the difference between a financial tailgater and a true investor. Let us introduce a third character in our tale; let’s call him Ivan the investor. Now before we continue, we need to consider their working lives. Tom, Simon and Ivan are all shoemakers. At the start of their working lives we already know that Tom borrowed money from the bank to buy new furniture and Simon simply started saving money toward new furniture later on, but Ivan the investor borrowed money from the bank to buy a new shoe-making machine that can make shoes in half the time. Now fast forward a few years. Simon is slightly ahead of Tom because he has now saved up enough to buy things like new furniture and does not have the burden of having to pay a continuous stream of interest to the banks. But Ivan is now ahead of both of them. He may still be having to pay interest to banks for the loan for the shoe-making machine, but having the machine has boosted his profitability so much that his increased income more than compensates for the interest repayments.

Hopefully this story should make it clear that tailgating is the antithesis of productive investing. Their outcomes are diametrically opposed. One results in a long-term increase in wealth, the other results in a long-term decrease. This fact makes it seem incredible how economists, politicians, the tax system and banking regulations often make very little effort to distinguish between the two phenomena. Remember also that banks in a free market do not distinguish between tailgating and productive investments because they only consider the interest repayments they can get on their loans. Banks have no incentive to consider what their loans are being used for. From the point of view of the banks, all loans are “investments” regardless of how the money is used.

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