How to BEAT the Financial System

The Financial Hamster Wheel [0:00]

• The speaker introduces the concept of feeling stuck financially, likening it to a spinning hamster wheel, and explains this is by design, potentially the greatest financial achievement or method of enslavement in 500 years.
• This phenomenon is called the "cost of capital," and understanding it allows for smarter financial decisions.
• The speaker, Rich Gilbert, aims to provide insights into what's really going on by drawing from his MBA from Wharton and experience at BCG.
• The financial system is often discussed in complex, esoteric language, but the core of its impact is rooted in the cost of capital.

"So it is called the cost of capital and it is everywhere and once you understand this and how it works you can make smarter financial decisions and what you do with that is is up to you."

Historical Productivity and the Rise of GDP [2:02]

• In the 1850s, before the 1800s, gross domestic productivity was flat, with little year-to-year or decade-to-decade advancement.
• A significant boom in GDP occurred in the mid-1800s and accelerated in the 20th century, leading to the modern sense of needing to constantly strive to stay financially level.
• This economic shift is directly linked to the cost of capital and the ability to "tax time," meaning a need to constantly produce more to keep pace.
• Before this, people could live on subsistence, trade, and be "okay," but the modern system demands more than just being okay, incorporating inflation and debt.

"But all of a sudden over a few decades we got into a position where you can't be just okay. You have to make more somehow every year."

The Debt-Based Financial System and the Federal Reserve [3:41]

• The entire financial system, including currency, is fundamentally debt-based, with every piece of currency representing borrowed money.
• This system's key development occurred in the early 20th century with the creation of the Federal Reserve in 1913.
• Contrary to its name, the Federal Reserve is not a federal agency but a consortium of private banks, including major figures like J.P. Morgan.
• It was established through a congressional act, often described as happening quickly, and has been the foundation of the monetary system ever since.
• The Federal Reserve can print money and lend it to the federal government, not from a cash reserve, but through a reserve of debt or credit.
• The Federal Reserve independently sets interest rates and is not subject to the authority of the President of the United States, as demonstrated by past interactions with figures like Donald Trump and Jerome Powell.

"It is not a federal agency. It is a consortium of private banks."

The Discount Rate: The Hamster Wheel's Speed [6:53]

• The debt system has an interest component, referred to as the "discount rate," which is the core of the "hamster wheel" feeling.
• The discount rate directly influences inflation, job creation, corporate investment capacity, and market liquidity.
• For the federal government, the discount rate is its cost of capital; for every dollar borrowed, that rate must be paid back.
• This rate cascades through the system: the Federal Reserve's rate influences bank-to-bank borrowing, government treasuries, mortgage rates (often subsidized by the government), credit card rates, auto loans, and so on.
• These rates then fan out and become larger at each subsequent level of borrowing.

"This is called the discount rate, right? It sounds great. I get a discount. I'm like money. Wow. But it's not that at all."

Business Operations and the Cost of Capital [9:30]

• Every business globally must contend with its cost of capital, depending on where it falls within the financial machine and which "gear" it connects to.
• Whether a business uses government-backed loans or credit card debt to bootstrap, it must account for its cost of capital, which varies significantly.
• Large companies like Apple can secure low costs of capital due to their financial stability, whereas startups on credit cards face much higher rates, around 24%.
• The fundamental objective for any business is to generate returns that exceed its cost of capital. If the return is less than 10% when the cost of capital is 10%, the loan cannot be serviced, and money is lost.

"The name of the game is you got to run faster than that cost of capital. You got to make more money than the cost of capital."

Student Debt and the Cost of Education [11:16]

• Student loan debt is presented as an example of the cost of capital issue.
• Historically, education was seen as an investment in oneself that would yield returns to pay off loans.
• However, with degrees in less marketable fields, the cost of capital for that education can exceed the future earnings potential, leading to people being "underwater" on their loans.
• This perpetuates the debt cycle, with accumulating interest and confusion due to a lack of financial education, which the speaker suggests is by design.

"Well, now it becomes a point where people get a degree in, you know, underwater, you know, eco-friendly basket weaving with a minor in in in whatever, you know, uh, moon studies and they can't pay off the cost of capital, right?"

The Role of Debt in Personal Finance [12:12]

• The average consumer faces three or four main types of debt: mortgage, credit card, car loans, and student debt, all heavily marketed.
• Car loans and houses are not always productive assets; cars are depreciating assets, and houses require ongoing maintenance investment to retain value.
• The system encourages taking on debt for ventures that aim to beat the cost of capital.

"The the four main pieces of debt that people get into and they they they you know, car loans are not that that productive."

Driving GDP Growth Through Capital Access [13:19]

• The availability of capital has dramatically increased since the pre-20th century era, where starting a company was nearly impossible due to the lack of access to finance.
• Now, individuals can access capital as long as they can service the interest rate, which is based on creditworthiness.
• This access forces every company to strive to beat its cost of capital, driving innovation, scale, and productivity to generate returns that surpass borrowing costs.
• This constant pressure to beat the cost of capital is a primary reason for the significant explosion in GDP and productivity observed historically.

"So, you got to get really really productive. You got to come up with innovations. You got to come up with scale. You got to come up with all these ideas to beat the cost of capital."

The 2008 Financial Crisis and Systemic Stability [16:15]

• The lack of criminal accountability for major figures in the 2008 financial crisis, despite a $700 billion bank bailout, is explained by the system's foundation.
• If bankers feared jail time or the system itself collapsed, companies would lose access to capital, halting GDP growth.
• The bailout ensured the continuation of the debt-based system, which is crucial for economic expansion.

"Why? Right? That that it seems crazy until you realize that is the foundation of the entire system."

Universal Debt and Financial Reality [17:05]

• All finance is debt-based; every transaction has a debt component somewhere in its history.
• Even employment is debt-based: when you work, you are essentially providing credit to your employer until you are paid.
• Attempts to avoid debt are futile within the fiat money system.
• Even cryptocurrencies like Bitcoin are valuable only because they can be converted into fiat currency, which is part of the debt system.

"So, so for many people that are like, I'm not going to do any debt. I'm not going to okay, you you you can try and live that life, but basically everything is debt based, right?"

Investing as Beating the Cost of Capital [18:43]

• The entire financial system is debt-based, and the key to navigating it is to consistently beat the cost of capital.
• Investing in diversified assets like the stock market is a good long-term strategy because companies within indices like the S&P 500 are inherently working to beat their cost of capital.
• The system is structured to select and perpetuate companies that are successful in this endeavor; those that fail are delisted.
• To invest, one needs disposable income that isn't needed for immediate living expenses.

"And so, so if you buy into things that are beating the cost of capital, that's why the stock market is such a good bet long-term diversified."

The Global Debt-Based System and Alternatives [20:27]

• The significant explosion in GDP and productivity is directly linked to the "hamster wheel" speed of the discount rate or cost of capital.
• The global system is designed to make everyone run to keep pace with this rate.
• Some leaders, like Gaddafi, are rumored to have attempted to move away from debt-based, non-interest-bearing monetary systems, with controversial outcomes.

"So, so everybody's running. Everybody has to run as as when that system is in place."

Personal Financial Education and Debt Management [21:22]

• The speaker emphasizes that this understanding of the financial system is not widely taught, highlighting the need for financial education.
• He suggests that obtaining an education that makes money, which beats its own cost of capital, is crucial.
• Debt itself is not inherently bad but should be managed wisely; it's a reasonable way to finance ventures based on future earnings.
• The system has mechanisms for dealing with debt, including negotiation with lenders, bankruptcy, and legal structures like LLCs to protect assets.

"The the one is you don't have to be afraid of debt. Debt is a very reasonable way of financing a business or or whatever, right? A lifestyle based on future earnings."

Assets, Growth, and Life's True Values [24:27]

• The feeling of running in place is by design; without assets that generate returns above the cost of capital, one falls behind.
• The solution is to acquire assets that can be invested into companies making more than the cost of capital, allowing that money to grow.
• While risks exist, the system is structured for growth.
• Ultimately, while the monetary system is a powerful story that shapes society, true value lies in family, love, friendships, and experiences.

"So that's the name of the game. Get assets that you don't need to feed your family with."