[extropy-chat] When will the equity risk premium flip?

[Robert Bradbury]

A combination of an article about the "equity risk premium" in the NY Times
today [1] combined with recent comments by Hal, Jef & others on voters
betting on past performance has caused me to consider governments, finance,
the singularity, etc. in a general way that raises some interesting
questions.

The "equity risk premium" is the effective yield difference between stocks
and bonds due to the risk associated with the different investment type.
For example, because corporations can have a bad year (declining sales
and/or profits during a recession or depression) or worse yet go bankrupt
(think Enron) stocks have to have a higher effective yield than bonds (where
you are "guaranteed" to get back your original investment).  This concept
gets extended across the entire financial market into everything from P-to-E
ratios in stocks (companies with rapidly growing sales and earnings have
high P-E ratios) to bond yields (from say U.S. Government T-bills to
corporate junk bonds).  People unfamiliar with these concepts may wish to
glance at [2 or 3].

The perception of government security explains why government bonds are
yielding ~4.5% while corporate bonds are in the 5+% range.  This gets
extended into equities but is more complex depending on whether the
companies are good credit risks or bad credit risks balanced with perceived
corporate earnings growth rates.

So let us setup a scenario.  One day we have robust nanotechnology.  People
spend $5.00 and buy their 10 kg of nanorobots and start them building their
Sapphire Mansion.  Since they don't have to work they aren't paying any
income taxes.  Government income tax revenue rapidly falls.  So there is
some quick reengineering of the tax code and all the governments shift to
VATs.  But there isn't much worth buying because the raw materials for food,
the mansion, etc. are as free as "air", "dirt", and "seawater".

The point being that governments in general have little that can be used as
a revenue source other than perhaps a real estate tax or a head tax.  People
avoid those by constructing and moving to their own personal yacht in
international waters.  Eventually these might band together forming larger
structures/organizations (Extropy Island, United City States of Extropy,
etc.).
Really no more need for governments because presumably everyone in my city
state is a close personal friend of (or clone of) myself.  One can carry on
this scenario in various ways... banding together to defend oneself against
FAIs, migrating away from Earth or the solar system if various nations,
individuals, collectives try to imprison and/or otherwise impose their will
upon the individuals, etc.

One of the primary consequences during this transition is that government
backed bonds become essentially worthless.  Current housing becomes
relatively worthless as well other than perhaps the intrinsic value of the
solar, wind, or geothermal energy the land provides.  The only thing which
might have some value is the rapidly growing companies producing cool
nanotech designs to keep the nanorobots occupied or perhaps very creative
media/entertainment conglomerates who can sell products to humans unable to
otherwise entertain themselves.  So people holding "bonds" will watch their
value evaporate while people will investing in rapid growth companies on the
leading edge may have some ROI for at least a few years.    As people have
more and more free time the entertainment providers have a market but this
is probably brief.  Eventually the supply so significantly exceeds the
demand that one will have to pay people to watch, read, etc. whatever one
produces.  (You can start to see signs of now with things like game consoles
priced below production costs, people enticing others to come read their
blog, etc.)  This suggests a brief period when bonds must become
increasingly shorter term and must provide increasingly higher yields while
equities are perceived as increasingly less risky investments.  Eventually
it is questionable whether bonds or equities will even survive.  There will
only be finance markets oriented towards the small communities that simply
must have the latest bling bling which requires financing a large quantity
of nanorobots on loan for a brief peiod.

Questions that arise are?
1) When will the equity risk premium "flip" (i.e. equities trade at
discounts to bonds because they are safer)?
2) Are there "idea futures" on when this will happen?
3) When will politicians begin selling themselves based on these concepts?
[I think this takes one form which is to mortgage the country to the hilt
(perhaps as the U.S. is doing) because it will never be able to pay back
things like 30 year bonds *or* another form where one becomes "corporate"
America which sells equity in the companies which have the greatest near
term growth prospects instead of bonds.]  Note that this a significant shift
away from selling on the basis of past performance towards a selling on the
ability to eliminate death and taxes.
4) How will perceptions of this transition impact the rate at which the
singularity happens?  [Current bond holders may wish to postpone it as long
as possible.]

Robert

Some background:

1. D. Altman, "Why Do Stocks Pay So Much More Than Bonds?", NY Times (26 Feb
2006).
http://www.nytimes.com/2006/02/26/business/yourmoney/26view.html?pagewanted=print
2. http://www.fool.com/school/basics/basics05.htm
3. http://www.investopedia.com/articles/03/110503.asp
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