Saturday Serendipity
Quote, Mental Model, Twitter Thread.
Hi there!
This post will only take you about 3 minutes to read.
Quote
“Planning is important, but the most important part of every plan is to plan on the plan not going according to plan.” ~ Morgan Housel
Mental Model
Gresham’s Law:
I will borrow a story I read on Vishal Khandelwal’s blog.
Muhammad Bin Tughluq from the Tughluq dynasty noticed that there were very few silver coins in circulation and mainly only bronze and copper coins were in circulation. He decided to make the bronze and copper coins the same value as the silver coin. This was to increase the use of silver coins. But due to unintended consequences, this ended up backfiring.
You see, the copper and bronze coins were easy to forge and so people forged them and this led to hyperinflation as money was easily attainable by nearly everyone. Tughluq had to withdraw his new law and he brought back the value of bronze and copper coins to where it was before and let the silver coins be superior.
According to Gresham’s Law, bad money (bronze and copper) is driving out good money (silver). This is the law. Bad money drives out good money.
Now in the modern world, how do we apply this model? Let’s ask the mental model expert and one of the world’s best thinkers Charlie Munger.
In economics textbooks they teach you Gresham’s Law: Bad money drives out good. But we don’t have any bad money that amounts to anything. We don’t have any coins that are worth a lot, that have precious metals that you can melt down. Nobody cares what the melt-down value of the quarter is in relationship to the dime, so Gresham’s Law is a non-starter in the modern world. Bad money drives out good.
But the new form of Gresham’s Law is ungodly important. The new form of Gresham’s Law is brought into play – in economic thought, anyway – in the savings and loans crisis, when it was perfectly obvious that bad lending drives out good. Think of how powerful that model is. Think of the disaster that it creates for everybody. ~ Charlie Munger in his speech at Havard- westlake school in California.
He gave an example of bad lending driving out good. How?
Well, think of it this way you are the bank. You have to make loans to the public. Now the markets are booming and to earn more money you decide you will make more loans regardless of how reliable the person you are giving the loan is. This can create a situation in which only the "bad" lenders who are willing to take on higher-risk borrowers remain in the market, while the "good" lenders who are more conservative and selective in their lending practices are driven out. This can lead to a decline in overall lending quality and potentially even to financial instability. This is exactly what happened in 2008.
Conclusion
You can apply this model in investing and in life as well. A few examples are; bad stocks drive out the good stocks in the portfolio, bad morals drive out good, bad information drives out good information, etc. Make sure though to put on your mental model hat when you think about mental models and don’t apply just one. There are multiple models at play as the world is very complex.
Twitter Thread
That’s it for this week, Enjoy the weekend and Happy learning!