Chapter Four: The Journey Begins: Natural Law Societies And Societies Close To Natural Law Societies On The Road Map
The first society we visit on our journey, and the starting place, is the natural law society in Pastland:
No one owns the land around us. The reason that we don’t have ownership really isn’t important. It may be that many people in our group believe that the mountains, rivers, lakes, and forests of the world were here before we arrived and, since we didn’t create them, they aren’t ours. It may be that this was a key factor in their decision to vote in favor of the moratorium on ownability: they thought ownability was improper (or possibly impossible) any way and, even though the moratorium didn’t ban it entirely, it at least put it off of the table for a time. Others voted for the moratorium for the reason stated earlier: they saw that, if we accepted anyone could own a part of the world, people would start fighting over who owned (or which group or ‘nation’ owned) almost immediately. We would have wars that didn’t have to exist. They didn’t have any philosophical objection to the principle of ownability of land, but they didn’t want to create motivations that would lead to conflicts if they could avoid this.
Whatever the reason, no one owns the world around us. It is as unowned as before our group went back in time.
Although we don’t own the land around us, we have the same basic needs as all other animals: we must have food or we die. The world produces food. We are superior beings: humans have advantages that other animals don’t have and we can simply take the food that would have otherwise gone to other animals. We find ourselves in a very bountiful natural world. The rice grows here wild and has for thousands of years. We can simply take it. Other animals have been coming here to eat this rice for thousands of years. They will come again this year. But we will be there, ready and able to turn them into food as well.
The marsh land was not really a ‘farm’ when we arrived. But we can call it anything we want. We decided to call the land that produced rice the ‘Pastland Farm.’ Several people, most of whom had no idea how to do anything on a rice farm, stepped forward and agreed to help bring in the rice, provided someone was there to help them figure out how to do it. Kathy stepped forward and agreed to take care of organizing the harvest and replanting, so we would have food. She was the ‘manager.’ She knew that a lot of the people who had volunteered would probably get bored in a few days and stop showing up. She wanted them to be motivated to show up so she proposed the payment system.
We had a community meeting and decided Kathy’s idea was a good one. We would put the grain in the cargo hold, issue money backed by the rice, and use part of this money to pay the workers, suppliers, and people who fabricated and operated equipment, setting up the payment system so they would get pretty close to the same amounts they would have gotten back in the 21st century.
Kathy made sure everything went smoothly. She knew that we would appreciate her efforts. We were paying the others the same amount they would make back in the 21st century. She would not ask for anything, but she would hope that we would see the value of her time and agree to pay her the same amount she would have made back in the 21st century. We all were very happy that Kathy was with us in Pastland: if she hadn’t been there, the people may not have had any idea of how to harvest rice. We may have all starved. We see her value and agree to pay her.
Year after year passes while the moratorium is in effect. The system we have works a lot like the societies of the American native people before the conquest of their lands by people who had different societies.
These societies are very simple.
She brought in the rice and had it sold (traded for money) at the granary; she then gave this money to the treasurer we had elected to manage the funds that belonged to the human race. We kept our word and paid the suppliers and workers; they got a total of $700,000. We also decided to give Kathy a reward equivalent to the amount she would have gotten for doing the same work back in the future. We gave her $50,000. After we paid all of the rewards for the volunteers who helped bring in the rice and put it into storage, we had $2.4 million left over.
Since we had fully compensated everyone involved with seeding, harvesting, managing, and all other activities related to taking in the rice at rates they considered acceptable, we knew that we could expect them to continue to do all of these things, year after year, into the future. After they got too old to do these things, or if they decided not to do these things for other reasons, we knew that the rewards (pay) offered for the jobs would be enough to attract replacements, so the work would get done year after year. The farm would essentially be a money machine, producing a continuous river of free money, with each dollar of free cash being a receipt for a pound of rice that is in storage. Almost as if a magic genie were working for us, our granary would fill with rice. Each year, we would get a river of money that we could use to buy 2.4 million pounds of that rice.
If someone had owned the Pastland Farm, the free cash flow the land produced would belong to her. But while we have a natural law society, no one owns or can own any part of the world. No one owns this free cash. Since no one has any natural rights to this money, we must have meetings and decide what to do with it. Each year, we have a meeting and elections. We decide to use part of this free money to reward people who volunteer to provide services for us. Some goes to the people who help maintain the electrical generators so we can have electricity. Some goes to the people who maintain our water supplies and internet. Some goes to the doctors at our little medical clinic. We reward any people who do things that bring benefits to the human race. But we have a truly enormous income. We only spend $400,000 a year on services. This leads $2 million a year as ‘surplus free cash;’ free cash that is over and above the amount we need to pay for services. We divide this money in some way we can agree on. So far, we have divided it equally, with the exception of a few minor reductions in payments for a few people who break rules and have penalties subtracted from their share.
We are very lucky to have been sent back in time onto this particular world. (The space-time warp may have sent us somewhere else.) It is a very bountiful world, pouring forth massive amounts of wealth over time. Every single human being on earth benefits from this bounty. All you and I have to do to get our share is to act responsibly, treat the world and people around us with respect, and follow whatever rules the human race as a whole has made to allow its members to live in harmony with each other. Life is very, very good for people in natural law societies, particularly if the population level is low and there is sufficient food.
Natural Law With Rental
We could have gotten to this point a slightly different way: We could have rented the property out.
After everything was said and done each year, we ended up with $2.4 million. We could have gotten the same income by simply renting the land to Kathy for $2.4 million. We could have allowed her to operate the farm, sell anything it produced, pay her costs and take care of her workers, give us $2.4 million a year, and keep everything else.
Many natural law societies rented property out. The Nez Pierce Indians, among the last to be wiped out and therefore one of the most thoroughly studied, raised a crop called ‘camas’ on their lands in the states currently called Idaho, Washington and Oregon. I have raised camas and it takes a great deal of intensive and skilled labor to raise. In order to make sure people paid the proper attention to the crop, the Nez Pierce decided to divide the camas-producing land into plots. They then rented the plots out to families. Each renter would turn over a certain number of bulbs to the tribe as rent, and could keep the rest.
Natural law societies don’t accept land can be owned. But renting is not owning. Renting is just one of many ways that people who live on land can interact with the land they live on. We can decide to rent out the land without ever even deciding whether or not it is ownable. We may decide that the issue of who owns the land is too complicated for us to figure out now. We may decide that, until we can figure this out, we will act as the caretakers or conservators of the land. Our job will be to make sure that the land remains healthy and productive, so that if we should ever find that it is ownable, and make a determination of which people, gods, or other entities own it, we can turn it over to the rightful owners in good condition. Conservators of land can treat it many different ways. Renting it out is one of these ways. We don’t have to decide we own the land to change Kathy’s title from ‘employee’ to ‘renter.’
If we rent out the land, we get the same income from it as we get if we put it under management (paying Kathy to manage it). As long as she doesn’t do anything differently, she will have the same income also. The flows of value will be the same so the incentives will be the same. The basic realities of a natural law society with rentals are going to be the same as those of a natural law society without rentals. Renting the farm doesn’t change anything critical about our society.
What if we ‘leased’ the land, rather than ‘renting’ it?
In common usage, people think of ‘leasing’ as a long-term arrangement (a year or more) while ‘renting’ is a short term arrangement, but in courts of law, the two terms are generally used interchangeably. In other words, there are no formal differences between leasing and renting; all of the differences are in the way people use the terms in normal conversation. This means that, at least formally (and legally, if we decide to apply the common legal terms from the 21st century in Pastland) we could call our arrangement ‘leasing’ or ‘renting’ if we want, but the name we give it wouldn’t affect the way it works: Kathy would have the right to operate the farm and keep all excesses it produced, in exchange for a $2.4 million yearly payment. We might call this payment a ‘lease payment’ or ‘rent’ if we want.
A lease: formal document that authorizes the use of property in exchange for a yearly payment. If the document is not marketable (can’t be transferred) it is just a ‘lease.’ If it is marketable, it is called a ‘leasehold.’
We could lease the property by drawing up an document authorizing the lease of this property for $2.4 million a year. We could then advertise to find candidates willing to lease the property and accept applications from them. We could go over the applications and select the best candidate. For this example, let’s imagine we do this, and select Kathy to lease the farm for $2.4 million a year.
A Market System
Rather than simply offering the lease with a fixed lease payment, we might conduct an auction.
We might advertise that we are willing to consider leasing the Pastland Farm. We can tell people that we will conduct an electronic auction to see how much money people are willing to pay each year as a lease payment. Once we get the final bid in, we (the landlords) will have a meeting and make a decision about whether to lease the property to the high bidder.
How would we expect such an auction to turn out?
Remember this premise: Kathy likes farm work. She is willing to farm the land if she can get $50,000 a year for her time and skills. The farm generates net operating profits of $2.45 million a year. Kathy can afford to pay up to $2.4 million a year as a lease payment; if she pays this exact amount, she will get $50,000 a year for herself after the lease payment.
Some other people understand farming. They have seen the farm run and know it can generate net operating profits of $2.45 million a year. Some of these people are also willing to run the farm for $50,000 a year. These other people can also afford to offer up to $2.4 million a year as lease payment.
At any auction like this, some, and often most, of the bidders will be people who have no interest in actually running the farm; they are bidding because, if not many people are bidding and bids are very low, they may be able to get the rental for a very low rate; they can then hire someone to run it and make a nice profit. These people are called ‘speculators’ and they play a very important role in all land auctions: they make sure that the rental rate will not be extremely low. (The technical term is this: ‘.’ Consider this example:
Say we set the opening bid at $1 million and, since we have never had an auction like this before, people are initially afraid to bid and, for several days, no one enters a bid. You are in Pastland. Consider what would happen if you bid $1 million and win. You can hire someone to run the farm for $50,000. (Kathy has already made it clear that she is willing to run the farm for this; others are also interested either at this price or at a slightly higher price.) The farm generates $2.45 million in net operating profits. You can pay your manager $50,000 of this, us $1 million to make your lease payment, and be left with $1.4 million for yourself. Obviously, this is a great deal for you: you do nothing and end up with $1.4 million.
A great many people come to auctions hoping to get what they consider ‘a great deal.’ Because these people are always there, great deals are very rare. The speculators bid against each other hoping to get a great deal until the lease payment gets up to a reasonable level. At a certain point, the deal won’t be good enough for speculators and they will drop out. After all of the speculators have dropped out, only people who are interested in running the farm themselves are left in the bidding.
The saying ‘speculators provide liquidity to markets’ means that speculators will do most of the bidding in markets. If there were no speculators in markets, only a few people or perhaps only one person may be bidding. In this case, Kathy may be the only person interested in renting the farm. That doesn’t mean she will be able to win the bidding for a very low rate: Speculators will bid against her, to make sure this does not happen.
The auction is electronic and will last 30 days. Terry sets the minimum bid at $1 million. No one bids for the first week. You do the calculations above and realize that, if you can win for $1 million, you will get a really great deal. You enter this bid.
Kathy can afford to offer $2.4 million. But she isn’t going to enter her highest offer right away. She is going to try to win for a much lower number. (This is not going to happen for the reasons discussed above, but people can still hope. A lot of people go to bed the high bidder for an item on Ebay and hoping they will win; when they wake up, they generally find the item sold for about the same price they would have had to pay if they had simply shopped for the item from a shopping site.) She is dreaming of a windfall and offers $1,000,001.
I am in Pastland. I know I can easily afford to offer $2 million, I can then hire a farm manager for $50,000. After paying all costs, including the cost of the farm manager and the lease payment to the landlords, leaving me with $400,000 a year for myself, without doing anything.
I have been to and bid at a lot of auctions and I know there really isn’t much chance of me winning. But I don’t lose anything by bidding. I can only win or lose. If I win, I get the windfall; if someone bids higher and I lose, I am no worse off than I would have been not bidding. It doesn’t hurt me to bid either way so I will bid.
Other people will see the same opportunity. They would like to end up with a $400,000 windfall but will settle for less. You can offer $2.3 million. After paying your manager and lease payment, you will end up with $400,000. This is still a great deal. You lose nothing by offering this rent and can hope to gain if you win. As the bid gets closer and closer to the free cash flow ($2.4 million), the speculators will drop out of the bidding, one at a time. At a bid of exactly $2.4 million, they make no money at all: they have to pay out all of the net operating profits either to the manager or the human race as a lease payment. At a bid slightly below $2.4 million, they won’t be interested in the deal: if they can only make a few hundred dollars, most people won’t want to get involved.
After the speculators drop out, the only people bidding will be those willing to operate the farm. Kathy is willing to operate the farm for $50,000 a year. Say that another person, let’s call him ‘Harry,’ is willing to work the farm if he can make $50,001 a year. The most Harry can offer as lease payment is $2,399,999 a year. Kathy can afford to offer more and, since she can still make enough money to justify the work she does at a bid of $2.4 million, she will enter this bid.
A society with a ‘market leasing system,’ is still a natural law society. Market leasing is not owning. The person with the lease does not own any rights. She is only leasing the property for a rate determined in the market. People who deal with real estate and leases know that there is a very simple formula that tells them how much a property will lease for in a market transaction. This formula is:
Market Lease Rate = Free cash flow
This makes sense. The free cash flow is the amount of surplus money left over after subtracting all operating expenses, including the pay of the person managing the property, from the revenues. People don’t work for the free cash flow: it is the bounty or unearned wealth the land produces. If they have to pay this entire amount out as a lease payment to get the right to operate the farm, they will still be left with enough for themselves to justify the work they do.
They can’t pay more than the free cash flow because, if they do, they won’t be left with enough to pay everyone involved with collecting production, including themselves. They would like to pay less but the market forces discussed above will make this impossible: if a property is leased in a market and the current bid is substantially less than the free cash flow, speculators can enter higher bids, hire people to run the property, and make a windfall for themselves. They will keep bidding against each other until that windfall is basically gone, meaning that the winning bid will wind up being equal to the free cash flow of the property, or some amount so close to the free cash flow that any difference isn’t important for practical purposes.
Later, we will look at other land tenure systems, including freehold ownership. We will see that the most commonly used method of appraising these properties (determining the amount they would sell for in a market transaction) involves dividing the free cash flow by the market interest rate on assets with similar risk at the time of the transaction, called In order to appraise properties, the appraisers need some figure to use as the ‘free cash flow.’ If the property is leased out at a market rate, the appraisers take the market lease rate as the free cash flow.
This is the only really objective way to calculate the free cash flow: let the market do it for them. If they make guesses about the revenues, operating costs, and costs of running and operating the property, they can be way off. But the market tells them how much people are willing to give up each year to control the property. Since people are not willing to give up money they need to cover the value of their time or their costs, they will offer up to the free cash flow, but no more; other bidders will force them up to the free cash flow or to a number so close to the free cash flow that any difference isn’t important for practical purposes.
If we start with the simple natural law society in Pastland without leasing and then visit an identical one with market leasing, we would expect the lease payment to be $2.4 million a year. The flows of value are identical to those in a natural law society without leasing, so the incentives will also be identical.
A Leasehold (A Marketable Lease)
In some cases, people setting up leases do not allow the people who lease the property to sell or otherwise transfer their rights. In other cases, they don’t care. Often people who are leasing property only really care about getting their money and making sure the property remains in good condition. They don’t care who, specifically, is living on the property, operating it, making day-to-day decisions on the property or even whose name the lease is in. They don’t mind if the people who first sign the lease decide to sign it over to someone else. They allow leases to be transferred. A lease that is not assigned to a specific person, but may be purchased or transferred as many times as desired during the lease term, is called a ‘leasehold.’
At times, leaseholds can be very valuable. We saw this with the examples in Book One, which used the socratic leasehold ownership system. The first time Terry sold the leasehold, she created a document that granted the right to lease the Pastland Farm for a yearly payment of $2 million. She then sold the leasehold for $10 million.
When Kathy bought the leasehold for $10 million, she borrowed the money at 4% interest, making her yearly interest costs $400,000. She made this payment and the leasehold payment of $2 million, so her payments totaled $2.4 million a year, the exact amount of the free cash flow. She was willing to make payments of $2.4 million a year to control the farm because, after the payments, she was left with the $50,000 she needed for her time and effort.
(Why was it worth $10 million? See sidebar.)
Since leaseholds can be worth a lot of money, people care a great deal about making sure all of the paperwork and details are right and they list the name of the person with rights to the leasehold in the proper places. The person with rights under the lease is called the ‘leasehold owner.’
Some leaseholds are worth a lot of money. Some are not worth anything at all. After Kathy wins the market leasing auction, she may find that she gets a kind of bonus when she signs the papers. The leasehold agreement may say something like:
This leasehold is ownable property and the first people to have rights under it are to be called ‘leasehold owners.’ The leasehold owners may sell or give away the rights under this leasehold. If they do and both the sellers and buyers agree to this, all rights under this leasehold may be transferred to the new owners.
The reason the leasehold in Book One was extremely valuable was that it leased the property for far less than the $2.4 million. In that example, it leased the property for only $2 million a year, $400,000 less than the free cash flow. The buyer of the leasehold would get to keep this $400,000 a year. If you happen to have money to pay the price of the leasehold and pay it in cash, you will end up with a $400,000 yearly income from the farm. (It produces $2.45 million in net operating profits. You can hire someone to run it for $50,000, make the leasehold payment of $2 million, and end up with $400,000 for yourself.) If you have $10 million of your own money to pay cash, you will get exactly a 4% yearly return on your investment.
Kathy didn’t have the money to pay cash for the leasehold in the example in Book One, so she had to borrow it. She borrowed at 4% and, after paying her interest, she didn’t get anything more from the leasehold in Book One than she will get from the leasehold here.
If a leasehold is set up so the leasehold payment is exactly equal to the free cash flow, the leasehold is not worth anything. If Kathy wins this auction and then tries to sell the leasehold, no one will want to buy it for any positive amount of money.
The first leasehold ownership system we look at is one where the leasehold is marketable, but the leasehold payment is exactly equal to the free cash flow. Technically, Kathy will own rights to the land. That means that this is no longer technically a natural law society. But the flows of value are identical to those of a natural law society with market leasing system, and the incentives will be identical. If we were to look at two societies, side by side, one that had ‘market leasing’ and the other with ‘leasehold ownership with the leasehold payment set to be equal to the free cash flow’ we would not expect to see any difference.
An Almost Non-Change Change
In this book, I want to show that it is possible to get from a sovereign law society to any other society, including a socratic leasehold ownership society and including a natural law society, by infinitely tiny steps.
Why does this matter?
We were born into sovereign law societies. People are often told that there is nothing we can do about the basic realities of our existence, because they can’t be changed without a revolution. Since revolutions hurt everyone (and don’t really change anything over the long run), we are helpless. If we can’t do anything, we are wasting our time try and any mental effort we put into thinking about change is wasted effort. Why think about it if you can’t change it?
The truth is that it is possible to get from the societies that we were born into to societies that can meet all of our needs by infinitely tiny steps. Each step may be too tiny to even notice. But by taking one tiny step at a time, we will eventually get to societies that can meet all of our needs. If you understand this, you will see that the common notion that we are helpless is totally wrong. We can change the realities of our societies and make them work any way we want, without revolution, without violence, and without ever taking anything away from anyone.
Why does this matter?
If we can accept this in our minds, we can accept that mental effort spent working out other societies is not wasted effort. We will see that the only reason we don’t have sane societies now is that we are unwilling to even think about creating them. Obviously, if we never even think about how to build descent societies, we will never find a path to these societies.
It may seem that the discussions above go into unnecessary detail to describe changes that are so tiny that they would have no impact on society that anyone could notice. But that is exactly the point I am trying to make here: this is possible. We will see that we can go all the way from the simple natural law societies that the American native people had to the societies that now use nuclear weapons to protect the sovereignty of nations by infinitely tiny steps. Then, we will see that all of the steps can take us the other way if we want to take them.
To really understand that we can make changes to make our world better, without violence, you must first understand that there is a continuum of options. The old saying goes ‘a journey of a thousand li begins with a single step.’ If there is a path from where you are to where you want to go, and this path has no blockages, holes, or gaps, you can get there. Perhaps it will take a long time, but you can get there.
I need you to know that this path does exist.
Virtual Natural Law Leasehold Ownership
The next change is so tiny it doesn’t even appear to be a change at all. It doesn’t alter the flows of value in any way that anyone would notice and therefore doesn’t alter the incentives in any way that anyone would notice. But it is a real change that takes us our next baby step toward the other end of the spectrum, a sovereign law society.
This system uses a kind of leasehold ownership called ‘virtual natural law leasehold ownership.’ In this system, the leasehold is not given away, it is sold for a price. The bidders must offer a price for the leasehold and it will go to the highest bidder. The bidding will be in millionths of a cent (for reasons that will become apparent shortly) and the leasehold payment the winner pays will depend on the price she bids: it will be exactly 100,000 times the price. For example, if the leasehold sells for exactly 24¢, the leasehold payment will be exactly $2.4 million.
Before I describe the auction, I want to tell you how it will turn out: Kathy will win the bidding for a price of 24¢. This will set her leasehold payment to $2.4 million a year.
Now let’s see why:
Terry has prepared a document she calls a ‘leasehold title.’ This title will grant rights to the buyer/owner of the document. She will then sell the rights to the property by selling the leasehold title. Here is the leasehold title people will be bidding on:
Although this may seem quite complicated, it really isn’t: People aren’t going to really care about the price: it is just a number. They will bid up in millionth of a cent increments. But a millionth of a cent is obviously not going to affect anyone’s decisions. It can’t even be paid because we don’t have any coins smaller than a cent; it will round off and become meaningless.
The bidders won’t care about the price for its own sake, they will only care about it because it determines the leasehold payment. They will bid as if they are bidding on the leasehold payment. Speculators will be in the market if the bidding is very low (say 23¢, leading to a leasehold payment of $2.3 million.) As the price gets within a few thousandths of a cent of 24¢, the speculators will drop out of the bidding and only people like Kathy—those who intend to operate the farm—will be in the bidding. At a price of 23.99998¢, the leasehold payment will be $23,999,998, and both Harry and Kathy will still be in the bidding. Harry can bid 23.99999¢ and be left with $50,001 after his leasehold payment. Kathy can bid up to 24¢.
Improvement Incentives In Virtual Natural Law Leasehold Ownership Societies
Book One we looked at socratic leasehold ownership systems in detail. In socratic leasehold ownership systems, people could make a lot of money buying leaseholds, improving them, and selling them. If she improves the property so its free cash flow is 20% higher, the price goes up by 20%. In that example, the starting price was $10 million; it went up by 20% to $12 million so Kathy made $2 million improving the property. She spent $400,000 on the improvements, so she made $1.6 million on the improvement.
In the virtual natural law leasehold ownership society, if she improves the property so its free cash flow is 20% higher, the price will also go up by 20%. (See sidebar for reason.) But 20% of 24¢ is only 4.8¢. Kathy could level the land for $400,000, then sell the leasehold for a total of 28.4¢. She would make a 2.4¢ as a gain, but she would have had to invest $400,000 to make this gain, so she will end up with a net loss of $399,999.976 on the entire project.
This not as much money as she would have lost in the natural law leasehold ownership society: in that case, the price would have started at 0¢ and gone up by 20% to 0¢, for a gross gain on the sale of 0¢ and a loss on the project of $400,000. But the difference between these two numbers is so small that they wouldn’t affect anyone’s decisions. If Kathy wouldn’t have made the improvement in the natural law society, and wouldn’t have made it in the natural law leasehold ownership society, she wouldn’t make it in the virtual natural law leasehold ownership society either.
Natural law societies existed and were stagnant for millions of years. People who want to make improvements must invest far more in the improvements than they can ever hope to recover. If they use money for transactions, they lose money; if they don’t use money, they lose their time, skills, resources, and other forms of wealth. People are motivated to avoid losses, not create them. We would not expect to see any more progress or growth in a virtual natural law leasehold ownership system than in a true natural law society.
1,000K Leasehold Ownership
The next system we look at will sell this document:
To offer us a leasehold payment of $2.4 million a year Kathy must offer a price of $24.
It is true that this is a hundred times more than in the previous example. But it is still not a significant amount of money relative to the amounts of money that Kathy will be handling. She may worry a little more and be a little more upset about having to pay this $24, but it isn’t going to affect her decisions or those of other bidders. The leasehold title will sell for $24 with a leasehold payment of $2.4 million. The flows of value will be the same, the incentives will be the same, and if we look at the two societies side by side, we would not expect to see any differences worth noticing.
10k Leasehold Ownership
The next system we look at will sell this document:
To offer us a leasehold payment of $2.4 million a year Kathy must offer a price of $240.
She could ignore 24¢. She didn’t think $24 was much compared to the amounts the farm generated. But $240 is quite a bit of money. She might start to think about this decision a little differently.
Kathy is putting her $240 at risk. Back in the future she occasionally made investments where she put her money at risk. She didn’t do this because she liked risk, but because she expected to make returns on her investment, and she wanted the returns. Kathy knew that, if she put money at risk in enough different ways, she might lose money on some of the investments. In order break even she needed to make a certain return on every dollar she put at risk.
Back in the future, she realized she could make money on farm investments if she got a 4% return on her ‘at-risk’ money. Here, she is willing to make the investment if she can get 4%, but not if she doesn’t get 4%.
She works through the math and figures that she can get her 4% return if she reduces her leasehold payment bid by $9.60. In other words, she could offer $2,399,990.40 as a leasehold payment. (She will have to bid 1/1000000% times this figure or $239.99 and 904/1000 of a cent as a price. Since we have no coins less than a penny, when she pays, this will round up to $240.) If she does this, she will get $9.60 a year as a return on her invested capital, the same 4% return she would have made back in the future.
The same math works for any leasehold ownership system we look at, so I will repeat this description of the math several times, inserting the appropriate numbers into the same formulas:
We are on a trip through various possible societies. We started at a natural law society with a ‘pure’ rental (a rental with no deposit, price, or other investment or security required). We then went to the virtual rental leasehold ownership system. This system is a tiny, tiny bit lower on the road map of possible societies than the natural law society. We then went to the almost rental leasehold ownership system. This is a tiny bit below the virtual rental system on the road map of possible societies.
Although these systems are different from each other, the differences are so small that they aren’t going to have any real incentives of these societies. For practical purposes, these systems will have the same incentives as natural law societies.
1K Leasehold Ownership
The next system we visit will sell this leasehold title:
Kathy goes through the math in the yellow box below. She calculates that she can offer $23,990.4038 as a price and $2,399,040.38 as a leasehold payment. If she wins, she will borrow the $23,990.40 at 4% from investors, with an interest payment of $959.62. Add this to her leasehold payment to get a total mortgage payment of exactly $2.4 million a year.
Note that Kathy’s decision is exactly the same in every case: she will agree to make a total mortgage payment of $2.4 million a year. She has to do a little math to figure out how to make this happen, but this is what she cares about: she wants to run the farm and end up with $50,000 after all her costs. She can afford to pay out $2.4 million as a total mortgage payment and, if other bidders force her up to this bid, she is willing to go this high, and no higher. Although Kathy’s situation is the same, the situation of the human race is different.
A Trade Off
Note the human race gets $959.62 a year less money in the ‘nearly natural law leasehold ownership’ system than in the natural law society. We don’t give up the $959.62 for nothing. We get a kind of ‘deposit.’ When Kathy comes to sign the documents and pay for the leasehold, she will bring a check for $23,990.40 for the price of the leasehold. We will have this money.
Because of the buyback agreement, this is not really our money. Kathy can ask for it back at any time, so we have to hold it in a ‘buyback reserve account.’ As long as the leasehold is private, the money will stay in the buyback reserve account.
As long as Kathy makes her leasehold payment as promised, the leasehold will remain private. If she ever misses it, however, the leasehold terminates and is no longer private property. All rights to the Pastland Farm revert back to the landlords. If this should ever happen, we won’t have any reason to continue to hold the $23,990.40 in reserve. It will become ‘our money.’
The nearly rental leasehold ownership system is very similar to a rental with a deposit. Kathy puts up $23,990.40 when she signs the document, and we hold this money aside for her in case she wants it back. If she has met all of the terms of the leasehold agreement and asks for it back, she gets it back, just as if it were a deposit.
If landlords have deposits on rentals, they have more security than if they don’t have deposits. In this case, we have a deposit on the Pastland Farm. Although the amount is quite high compared to nothing at all (or the mere 24¢ we got with virtual rental leasehold ownership), it is still small relative to the yearly leasehold payment. In fact, we only get 1/100th of the yearly leasehold payment as a ‘deposit.’
We do have security. But we don’t have much security.
If we wanted more security, we could get more, by choosing a price leasehold payment ratio that leads to higher prices.
10X Leasehold Ownership
The next society we visit on our journey is called ‘10X leasehold ownership.’ In this system, the human race sells this leasehold title:
Kathy calculates that if she offers $239,043.8247 as a price her total mortgage payment will be $2.4 million a year.
Kathy only wants to be a farmer. She would like to be a farmer, get paid for everything she does, AND get free money (a part of the free cash flow) if she could find a way to make this happen. If she can buy this leasehold on terms that make her yearly total mortgage payment anything less than $2.4 million a year, she will get this kind of bonus free money. However, if the other bidders force her to pay out her maximum, by bidding against her, she will not get this free money. In this example, at least one other bidder has enough background in farming to have come up with the same figures as Kathy (for revenues, costs, amounts of work required, and value of her time), and is therefore willing to offer the same total mortgage payment as Kathy. As a result, we know that the bidding will go up at least until the total mortgage payment is $2.4 million. If anyone were willing to make a total mortgage payment higher than $2.4 million, the bidding will go higher. But no one is willing to pay out more than her opinion of the free cash flow, and no one here thinks the free cash flow is more than $2.4 million. This means that no one is willing to make an offer that will lead to a total mortgage payment of more than $2.4 million. Since we know the bidding must go at least this high, but can’t go higher, we know how the auction will turn out: the leasehold will sell on terms that make the leasehold payment exactly $2.4 million a year.
Kathy (and other bidders) is making the same decision she has made in each case so far. In all of the auctions that will follow, she will make the exact same decision. She will need to get all of the money she earns. The farm produces more than she needs for the work and, of course, she would like to get the amount she earns plus some free money. But if the other bidders force her to give away all of the money she does not need for work she does or labor/materials she pays for (the entire free cash flow) she is willing to do this. We know this is true because of the assumption about her personality made when she was first introduced: she likes to farm and is willing to farm the land as long as she gets paid for the work she does. Because we know how much she thinks the free cash flow is ($2.4 million a year) and we know that other bidders will force her to offer whatever numbers make her total mortgage payment equal to the free cash flow in the auction, we know how all of these auctions will end up: the total mortgage payment will wind up being exactly $2.4 million in all of them.
Kathy has to do some math to figure out the correct amounts to bid. But Kathy doesn’t care about these details. She just wants to be a farmer. She needs $50,000 a year for the work she does and will farm if she gets it. The math may be difficult for her, and in fact, it may be too difficult for her to do herself. (She may go to a professional and ask the professional to work through the math for her, as she has done in every case so far.) But the decision she will make, in every case, will be very simple.
In some of the systems we get to later in the book, she will realize some things after she has purchased the leasehold that will make her realize that she can get very rich by improving the property and then selling the leasehold rights to the property. But before she buys, she will probably not go to the trouble of going through calculations to determine what may happen if she treats the property differently after she buys. Before she buys, all she really cares about is making enough money to justify the work she will do operating the farm. As long as her total mortgage payment is no higher than $2.4 million a year, she is willing to operate the farm.
We are taking a mental a journey through possible societies. We will end up at societies that are a great deal different than the ones we saw in this chapter, but the changes we will see are yet to come on our journey. So far, this system looks very much line a rental with a deposit. The final system, the ‘tenth of rent deposit leasehold ownership’ system, looks very much line a market-based rental system, where people have to post deposits that are 1/10th of the rent.
Note that the ‘price’ Kathy pays is exactly 1/10th the leasehold payment she offered. Although we call it a ‘price,’ it is ‘acting’ like a rental deposit. The landlords will collect this at the time the documents are signed. We will then hold this money as long as Kathy operates the farm. (If she transfers it, she can transfer her right to get this money back to the person who takes over, provided she follows the rules). If Kathy wants it back, and has followed the terms of her leasehold agreement, she can turn the property back over to the landlords and get it back.
Technically, it is not a deposit for a rental, but in practice it works very much like a deposit on a rental. The next system we look at will be the first that has different incentives.