Thursday, July 16, 2009

Krugman: Deficits Saved The World

From Krugman's Blog:

The private sector financial balance—defined as the difference between private saving and private
investment, or equivalently between private income and private spending—has risen from -3.6% of GDP in the 2006Q3 to +5.6% in 2009Q1. This 8.2% of GDP adjustment is already by far the biggest in postwar history and is in fact bigger than the increase seen in the early 1930s.

That’s an interesting way to think about what has happened — and it also suggests a startling conclusion: namely, government deficits, mainly the result of automatic stabilizers rather than discretionary policy, are the only thing that has saved us from a second Great Depression...

Saturday, May 30, 2009

The Economist: Business in America

The latest issue of The Economist has a special report on Business in America. You can view it here. Some passages which stuck out to me:

Second, one can look at America’s admirable record of dealing with turmoil. A study by the Ewing Marion Kauffman Foundation, a think-tank that studies entrepreneurialism, found that America’s high rate of economic “churning” boosts productivity and hence material well-being. Between 1977 and 2005 some 15% of all American jobs were destroyed each year as firms closed or cut back. Thanks to the expansion of successful firms and the entry of new ones, however, many more jobs were created than destroyed. Start-ups (ie, firms less than five years old) provided a third of the new jobs during this period.


But the central problem is that most Americans get their health insurance through their employers. This dates back to the era of post-war wage controls, when firms offered benefits instead of pay rises. Today’s tax code sets it in stone. Employers can buy health insurance with pre-tax dollars. Individuals cannot.

This creates an agency problem. When a typical patient goes to the doctor, he has no idea what anything costs. He pays only about 15% of the bill, so if the doctor recommends something he will probably say yes. The doctor gets paid for everything he does, so he has a powerful incentive to perform costly, unnecessary procedures. Besides, he may be socked for damages if he omits a test that a lawyer subsequently convinces a jury might have been useful. The costs are passed on to insurers, who pass them on to employers in the form of higher premiums, who then pass them on to workers in the form of lower pay.


…Managed care will return. This is the model whereby doctors work for the insurer, which pays them to keep people well. Instead of letting patients go straight to a specialist, managed-care firms like Kaiser Permanente make them see a primary-care doctor first, who will figure out whether the problem is serious. This is crucial. Specialists tend to recommend their own specialism—surgeons advocate surgery, and so on. The lack of a gatekeeper in traditional fee-for-service insurance leads to over-doctoring that is often harmful as well as costly, as that IBM executive discovered.

Monday, May 25, 2009

Wednesday, May 20, 2009

Let's Have Cap and No Trade

A real good op-ed by David Sokol, CEO of Mid-American, regarding the cap and trade proposal:

The real hidden catch of the cap-and-trade system, though, is that it will require consumers to pay twice: first for emission allowances and then for the construction of new low- and zero-carbon power plants.

The solution? Keep the cap and remove trading from the equation: Mandate that the industry, over the same 40-year period, simply limit its emissions to the same levels proposed in the Waxman-Markey bill. This can be accomplished with a clear plan that gives states an option: Either they participate in a cap-and-trade program or they elect an alternative compliance mechanism to reach the same greenhouse gas emission goals by working with their utilities to develop a 40-year program of shutting down aging coal plants, retrofitting plants to capture carbon dioxide if the technology becomes available, and/or building zero-carbon energy plants. More important, the carbon dioxide reductions in this proposal can be achieved while providing adequate time to plan to minimize price shock and economic dislocation. It is the states, through their public utilities commissions -- not the federal government -- that have both the interest and obligation to manage citizens' costs while transitioning to a carbon-free future.

Friday, May 01, 2009

"The Wire": The Men Behind The Scenes

Some argue it is the best TV series ever written- and I would be one of them. "The Wire" was an amazing HBO series dealing with the inner-workings of the Baltimore city. And for me, its writing and directing were in a class of its own. So, I got interested in learning about the leading men behind the scenes, David Simon and Ed Burns, and I loved what they had to say. Below are links to a good summary article as well as two interviews I quickly came across. There is surely plenty more.

The Angriest Man In Television

and then, the interviews...

*Update: PBS interview with David Simon (hat tip to comments)

Interview With David Simon

Slate: One thing that struck me about the show, from the get-go—and this may sound like base flattery: It reminded me of Shakespearean drama for the way that even the villains are humanized. No one is just a bad guy. Even Avon, whom I loathed at the opening of Season 1, I came to like.

Simon: It's funny you should say that, because the portrayals in Deadwood are in the Shakespearean model. On The Sopranos, there's an awful lot of Hamlet and Macbeth in Tony. But the guys we were stealing from in The Wire are the Greeks. In our heads we're writing a Greek tragedy, but instead of the gods being petulant and jealous Olympians hurling lightning bolts down at our protagonists, it's the Postmodern institutions that are the gods. And they are gods. And no one is bigger.

Interview With Ed Burns

So is there a message that you think people can take away from this year's arc?

I think the idea we're trying to bring across is that kids are going to get educated. And that we're going to see where. It's not about kids making bad mistakes and becoming caught in the Criminal Justice system. They don't have an option of choice. We in society have the choices. So you might see a kid who clearly doesn't have a prayer and it will be very apparent why he doesn't have a prayer. It's not about blaming kids. They will survive. They will learn. It's just a question of where.

Monday, April 27, 2009

Sunday, April 05, 2009

The Paradox of Choice

"The absence of alternatives clears the mind marvelously" - Henry Kissinger

You just bought a brand new pair of pants and bring them back home. You try it on again and this time notice that the waist is actually a little loose. Your satisfaction drops. You regret not having a better fit; in fact, you've already come to expect it. And you blame yourself for not making a better choice- because (or maybe even though) the options at the store were mind numbingly endless.

Sound familiar? Some particular variant of the story must ring true. That is the Paradox of Choice which has been created by our society, and it is something which has been studied closely by Barry Schwartz (who, with one look, you'll find has risen above this ).

Seriously though, how can we avoid this cycle of negative feeling? Well for one, I would acknowledge what you do have, instead of focusing on what you could. Keep things in perspective; it is one thing to err in a critical way, but chances are we are dealing within the realm of minor inconveniences. Finally, learn from the experience, and move on. There's no sense in getting riled up when what's done is done. Keep your focus on what lies ahead, and feel the weight of choices lift off your mind.

Thursday, March 26, 2009

Coming Down To Earth?

The Economist says Obama's Presidency is coming down to Earth, and they cite Buffett:
Mr Buffett has given voice to widespread worries about the administration’s failure to prioritize. “Job one is to win the war, the economic war. Job two is to win the economic war—and job three. And you can’t expect people to unite behind you if you’re trying to jam a whole bunch of things down their throat.”
Buffett is wrong to criticize. Obama and his team have done everything feasible and necessary to handle the financial crisis and restart growth. People will be surprised by how quickly things will change, and there's a glimmer of hope that it is already beginning. The major threat for America now lies in the structural problems it faces. And in this, Obama is right to be strong and efficient in trying to move us forward. He is sacrificing his own interests and tranquility for the benefits of our future. For this, he should be praised.

This Economist article, however, does the opposite, and in the process displays an all-too-familiar logical problem of keeping things in perspective. His faulty qualities, according to this article, are his optimism, hard-work and ambition (really?); his mistakes include mis-chosen cabinet members and 165 million in bonuses. These are very obviously minor in scale. Do I even need to list off the hundreds of real, serious, structural problems which were caused or left to us by the previous administration? And yet for some reason, the Economist was hesitant to rule Bush's presidency a disaster after 8 years, and it is already citing Obama's as potentially such.

Sunday, March 22, 2009

Geithner: My Plan For Bad Bank Assets

Posted on WSJ:


However, the financial system as a whole is still working against recovery. Many banks, still burdened by bad lending decisions, are holding back on providing credit. Market prices for many assets held by financial institutions -- so-called legacy assets -- are either uncertain or depressed. With these pressures at work on bank balance sheets, credit remains a scarce commodity, and credit that is available carries a high cost for borrowers.

Today, we are announcing another critical piece of our plan to increase the flow of credit and expand liquidity. Our new Public-Private Investment Program will set up funds to provide a market for the legacy loans and securities that currently burden the financial system.

The Public-Private Investment Program will purchase real-estate related loans from banks and securities from the broader markets. Banks will have the ability to sell pools of loans to dedicated funds, and investors will compete to have the ability to participate in those funds and take advantage of the financing provided by the government.

The funds established under this program will have three essential design features. First, they will use government resources in the form of capital from the Treasury, and financing from the FDIC and Federal Reserve, to mobilize capital from private investors. Second, the Public-Private Investment Program will ensure that private-sector participants share the risks alongside the taxpayer, and that the taxpayer shares in the profits from these investments. These funds will be open to investors of all types, such as pension funds, so that a broad range of Americans can participate.

Third, private-sector purchasers will establish the value of the loans and securities purchased under the program, which will protect the government from overpaying for these assets.

The new Public-Private Investment Program will initially provide financing for $500 billion with the potential to expand up to $1 trillion over time, which is a substantial share of real-estate related assets originated before the recession that are now clogging our financial system. Over time, by providing a market for these assets that does not now exist, this program will help improve asset values, increase lending capacity by banks, and reduce uncertainty about the scale of losses on bank balance sheets. The ability to sell assets to this fund will make it easier for banks to raise private capital, which will accelerate their ability to replace the capital investments provided by the Treasury.

This program to address legacy loans and securities is part of an overall strategy to resolve the crisis as quickly and effectively as possible at least cost to the taxpayer. The Public-Private Investment Program is better for the taxpayer than having the government alone directly purchase the assets from banks that are still operating and assume a larger share of the losses. Our approach shares risk with the private sector, efficiently leverages taxpayer dollars, and deploys private-sector competition to determine market prices for currently illiquid assets. Simply hoping for banks to work these assets off over time risks prolonging the crisis in a repeat of the Japanese experience.


I'm all for it.

Saturday, March 07, 2009

March 7 Weekly Address

Also, you can find some notes from a NYT interview with Obama here.

Monday, March 02, 2009

Saturday, February 28, 2009

Housing Correction

According to Calculated Risk, total housing starts were 464 thousand annualized for the month of January. Now, I remember reading a government report stating that new household units of people were forming in the U.S. at a rate of 1.5 million a year. If so, any bubble in excess capacity over the last several years is quickly reversing itself (see chart). Assuming, of course, that people can still get jobs to afford shelter.

Tuesday, February 24, 2009

Attention Under Siege

Thanks to Miguel for finding this article.

To avert a dark age, we must take several steps:

Question the values that undermine attention - Helped by influential tools that are seedbeds of societal change, we’ve built a culture over generations that prizes frenetic movement, fragmented work and instant answers. Recently, my morning paper carried a front-page story about efforts “in a new age of impatience” to create a quick-boot computer. Explained one tech executive, “It’s ridiculous to ask people to wait a couple of minutes” to start up their computer. The first hand up in the classroom, the hyper-businessman who can’t sit still, much less listen - these are markers of success in American society. Instead of venerating scattershot focus, rushed detachment, knowledge built on sound bites, we need to value whole focus, full awareness and the difficult work of knowledge creation.

Sunday, February 22, 2009

Your Weekly Address

Financial Innovation

From Volcker's recent speech:

Volcker: When it comes to innovation, I'll raise a question to you, what is the most important financial innovation of the past 20 or 30 years for the average person? I think its the automatic teller machine. It's not any high class sophisticated financial operation, its a technical improvement which has sure changed banking. I have more connection with my automatic teller machine, as do many of you, than any other part of the financial markets.

Wednesday, February 18, 2009

Watching The Greats

Berkshire Hathaway and Fairfax Financial are perhaps the two of the greatest asset allocating machines out there today. They both released their 13-F filing yesterday, listing their common stock holdings at the end of the December period. Paying particular attention to Fairfax, we see a lot of major positions:

(Value, in $)

102 mil Alcoa
99 mil Burlington Northern
271 mil Dell
162 mil Frontier Communications
195 mil GE
234 mil Intel
459 mil Johnson and Johnson
98 mil King Pharma
294 mil Kraft Foods
96 mil Level 3 Comm.
159 mil Magna Intl
318 mil Pfizer
104 mil Wells Fargo

*Note: Positions in bold are new.

Not surprisingly, there is a lot of overlap with Buffett, who holds major positions himself in Burlington Northern, Kraft, Wells Fargo, and Johnson and Johnson.

According to Nasdaq, the total value of U.S.-listed common stock holdings at Fairfax is now up to *$4.7 billion (this excludes any foriegn holdings). Just over two years ago, the total common stock portfolio was at about $1.8 billion, and that was significantly hedged with market short positions. Prem and co. are at last putting major money into work with stocks, indicating that they see significant returns ahead. If they're right, great things lie in store for shareholders of Fairfax.


*Correction, 2/19/09: included in the Nasdaq portfolio was $2.2 billion in value of Odyssey Re shares which were not included under equities in their 2006 balance sheet. Because Fairfax reported earnings today however, we know that total common stocks is at $3.8 billion, with $2.3 billion added to investments in the quarter. So although not as large as the originally stated notional amount, there has been a considerable increase in their common stock exposure.

Disclosure: The author owns shares in Fairfax Financial, Odyysey Reinsurance, and Burlington Northern.

Sunday, February 15, 2009

Buffett's Buy Metric

...Fortune first ran a version of this chart in late 2001 (see "Warren Buffett on the stock market"). Stocks had by that time retreated sharply from the manic levels of the Internet bubble. But they were still very high, with stock values at 133% of GNP. That level certainly did not suggest to Buffett that it was time to buy stocks.

But he visualized a moment when purchases might make sense, saying, "If the percentage relationship falls to the 70% to 80% area, buying stocks is likely to work very well for you."...

See the complete article here.

Saturday, February 14, 2009

On Globalization

Ran across this during my reading:
Where one nation has got the start of another in trade, 'tis very difficult for the latter to regain the ground it has lost; because of the superior industry and skill of the former, and the greater stocks which its merchants are possest of, and which enable them to trade for so much smaller profits. But these advantages are compensated, in some measure, by the low prices of labour in every nation that has not an extensive commerce, and does not very much abound in gold and silver. Manufactures, therefore, gradually shift their places, leaving those countries and provinces, which they have already enriched, and flying to others, whither they are allured by the cheapness of provisions and labour, till they have enriched these also, and are again banished by the same causes. And in general we may observe, that the dearness of every thing, from plenty of money, is a disadvantage, that attends an established commerce, and sets bounds to it in every country, by enabling the poorer states to undersell the richer in all foreign markets.

-David Hume, Of Money- 1752

It's all just a little bit of history repeating!

Lessons From Animal Behavior

A fascinating article from The Economist:


In a study reported in a special issue of the Philosophical Transactions of the Royal Society B, researchers led by Dr List looked at colonies of honeybees (Apis mellifera), which in late spring or early summer divide once they reach a certain size. The queen goes off with about two-thirds of the worker bees to live in a new home leaving a daughter queen in the nest with the remaining worker bees. Among the bees that depart are scouts that search for the new nest site and report back using a waggle dance to advertise suitable locations. The longer the dance, the better the site. After a while, other scouts start to visit the sites advertised by their compatriots and, on their return, also perform more waggle dances. The process eventually leads to a consensus on the best site and the swarm migrates. The decision is remarkably reliable, with the bees choosing the best site even when there are only small differences between two alternatives.

But exactly how do bees reach such a robust consensus? To find out, Dr List and his colleagues made a computer model of the decision-making process. By tinkering around with it they found that computerised bees that were very good at finding nesting sites but did not share their information dramatically slowed down the migration, leaving the swarm homeless and vulnerable. Conversely, computerised bees that blindly followed the waggle dances of others without first checking whether the site was, in fact, as advertised, led to a swift but mistaken decision. The researchers concluded that the ability of bees to identify quickly the best site depends on the interplay of bees’ interdependence in communicating the whereabouts of the best site and their independence in confirming this information.

This is something members of the European Parliament should think about. In the same journal, Simon Hix, also of the London School of Economics, and his colleagues examined their voting and concluded that, as might be expected, it was along party-political lines even though the incentives to do so were far less than at national parliaments. Dr Hix and his colleagues reckon that European parliamentarians share the collection of information but, unlike the honeybees, they do not necessarily progress to investigating the issues for themselves before taking a vote.

There is danger in blindly following the party line, a danger that the honeybees seem to avoid. Condorcet’s theory fails to consider whether there is an inbuilt bias among a group that comes together to consider a problem. This “groupthink” occurs when people copy one another. According to Dr List: “The swarm manages to block and prevent the kind of groupthink that can bedevil good decision making.” Dr List adds that people demonstrate this kind of bad decision-making when investors pile into a stock and others follow, creating a bubble for which there is no good reason.


Thursday, February 12, 2009

Daily Tip For Improvement #2

One secret recently put to words for me is that you should work hard first and foremost on yourself. To steal an example from the great motivational speaker Jim Rohn: A salesman putting in three extra hours a day at work may notice a slight increase in his sales. But that same salesman spending that three extra hours towards improving his skills and techniques, towards understanding what does and does not work, can notice a phenomenal change in his success. The slight change in focus means all the world.

So, I've been a harsh critic of myself recently, asking questions such as:
"Am I correctly communicating across my desired message?"
"Am I making the best use of my time?"
"How do my actions and habits match my long term goals?"

I end with a quote from Jim:
The only way things are going to change for you is when you change. What are you going to change that will in turn change your life? If you keep living the way you are right now, you will continue to produce the same life that you already have. That's the way it works.

Wednesday, February 11, 2009

Daily Tip For Improvement

Fascinating things are being discovered in nueroscience. One concept that has particularly caught my attention is neuro-plasticity. It describes the ability of the brain to change and strengthen itself to better cope with its surroundings Even when specific brain regions have become damaged, scientists have found that the brain can re-wire so that new sections take over the lost function.

I've been reading a fascinating book on the subject titled "The Brain That Changes Itself" by Norman Doidge. In it, two points are repeatedly stressed. The first is the following:

Neurons that fire together, wire together. Neurons that fire apart, wire apart.
That is, neurons are the centerpiece of a lot of the activity within our brain. Whenever we act, several different neural pathways all fire simultaneously and invoke certain reactions in your brain. So for example, when you think of Chipotle, it might also trigger thoughts of their delicious burritos, their free student drinks, their distinctive brown paper bags, or images of your local Chipotle brand, or the general positive feelings you have towards the brand. And each time you think about it, these neurons are firing and you are reinforcing these images and connections in your brain.

My tip today is to become more aware of the actions you perform, and what other feelings or thoughts you associate with them. Think of ways you can improve, and learn to associate that with a relevant activity. As an example, I have been making it a point to stress both speed and penmanship while taking my notes in class. Every time I emphasize this, I am reinforcing both qualities in my general writing and noticeable improvement has already taken place.

Use positive reinforcement for those admirable things you do. Do the opposite for those bad habits you've been always wanting to kick. It's a process, but in time your brain will re-wire and you can change yourself for the better.

Disclosure: The author owns a position in Chipotle Mexican Grill.

Tuesday, February 10, 2009

Math, Meet Music

This is interesting. Spotted first by Miguel at Simoleon Sense, a blog I highly recommend.

Ditch the Paper, Distribute E-Readers?

A sense of things to come:

And then there's the math: From the NYT's financial report, production costs in terms of raw materials and wages/benefits tally around $844 million a year. Carlson has info suggesting the newsroom costs total around $200 million a year, meaning it costs some $644 million to print and distribute the physical newspaper.

The Times reportedly has 830,000 subscribers. A Kindle costs $359. Thus distributing a free Kindle to each subscriber would cost about $298 million.

If the times killed its paper print-run and followed the Kindle-only model, that would leave the newspaper with $346 million in its pocket. Okay, distributing the newspaper electronically in a secure way needs some electronic infrastructure...let's stick a figure of $10 million on that. That still leaves $336 million to spare--a figure not to be sniffed at.


Saturday, February 07, 2009

Warren Buffett on President Obama

I've got a conviction about him that I don't get very often... He has as much potential as anyone I've seen to have an important impact over his lifetime on the course that America takes.
From Warren Buffett Speaks by Janet Lowe

Tuesday, January 13, 2009

A Little Something About Investing

From the General Theory of Employment, Interest, and Money, by John Maynard Keynes:

Decisions to invest in private business of the old-fashioned type were, however, decisions largely irrevocable, not only for the community as a whole, but also for the individual. With the separation between ownership and management which prevails to-day and with the development of organised investment markets, a new factor of great importance has entered in, which sometimes facilitates investment but sometimes adds greatly to the instability of the system. In the absence of security markets, there is no object in frequently attempting to revalue an investment to which we are committed. But the Stock Exchange revalues many investments every day and the revaluations give a frequent opportunity to the individual (though not to the community as a whole) to revise his commitments. It is as though a farmer, having tapped his barometer after breakfast, could decide to remove his capital from the farming business between 10 and 11 in the morning and reconsider whether he should return to it later in the week. But the daily revaluations of the Stock Exchange, though they are primarily made to facilitate transfers of old investments between one individual and another, inevitably exert a decisive influence on the rate of current investment. For there is no sense in building up a new enterprise at a cost greater than that at which a similar existing enterprise can be purchased; whilst there is an inducement to spend on a new project what may seem an extravagant sum, if it can be floated off on the Stock Exchange at an immediate profit. Thus certain classes of investment are governed by the average expectation of those who deal on the Stock Exchange as revealed in the price of shares, rather than by the genuine expectations of the professional entrepreneur. How then are these highly significant, daily, even hourly revaluations of existing investments carried out in practice?

Nevertheless the above conventional method of calculation [based on assuming that the existing state of affairs will continue indefinitely] will be compatible with a considerable measure of continuity and stability in our affairs, so long as we can rely on the maintenance of the convention.

For if there exist organised investment markets and if we can rely on the maintenance of the convention, an investor can legitimately encourage himself with the idea that the only risk he runs is that of a genuine change in the news over the near future, as to the likelihood of which he can attempt to form his own judgment, and which is unlikely to be very large. For, assuming that the convention holds good, it is only these changes which can affect the value of his investment, and he need not lose his sleep merely because he has not any notion what his investment will be worth ten years hence. Thus investment becomes reasonably “safe” for the individual investor over short periods, and hence over a succession of short periods however many, if he can fairly rely on there being no breakdown in the convention and on his therefore having an opportunity to revise his judgment and change his investment, before there has been time for much to happen. Investments which are “fixed” for the community are thus made “liquid” for the individual.

It has been, I am sure, on the basis of some such procedure as this that our leading investment markets have been developed. But it is not surprising that a convention, in an absolute view of things so arbitrary, should have its weak points. It is its precariousness which creates no small part of our contemporary problem of securing sufficient investment.


Some of the factors which accentuate this precariousness may be briefly mentioned.

(1) As a result of the gradual increase in the proportion of the equity in the community’s aggregate capital investment which is owned by persons who do not manage and have no special knowledge of the circumstances, either actual or prospective, of the business in question, the element of real knowledge in the valuation of investments by those who own them or contemplate purchasing them has seriously declined.

(2) Day-to-day fluctuations in the profits of existing investments, which are obviously of an ephemeral and non-significant character, tend to have an altogether excessive, and even an absurd, influence on the market. It is said, for example, that the shares of American companies which manufacture ice tend to sell at a higher price in summer when their profits are seasonally high than in winter when no one wants ice. The recurrence of a bank-holiday may raise the market valuation of the British railway system by several million pounds.

(3) A convetional valuation which is established as the outcome of the mass psychology of a large number of ignorant individuals is liable to change violently as the result of a sudden fluctuation of opinion due to factors which do not really make much difference to the prospective yield; since there will be no strong roots of conviction to hold it steady. In abnormal times in particular, when the hypothesis of an indefinite continuance of the existing state of affairs is less plausible than usual even though there are no express grounds to anticipate a definite change, the market will be subject to waves of optimistic and pessimistic sentiment, which are unreasoning and yet in a sense legitimate where no solid basis exists for a reasonable calculation.

(4) But there is one feature in particular which deserves our attention. It might have been supposed that competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, would correct the vagaries of the ignorant individual left to himself. It happens, however, that the energies and skill of the professional investor and speculator are mainly occupied otherwise. For most of these persons are, in fact, largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the convetional basis of valuation a short time ahead of the general public. They are concerned, not with what an investment is really worth to a man who buys it “for keeps”, but with what the market will value it at, under the influence of mass psychology, three months or a year hence. Moreover, this behaviour is not the outcome of a wrong-headed propensity. It is an inevitable result of an investment market organised along the lines described. For it is not sensible to pay 25 for an investment of which you believe the prospective yield to justify a value of 30, if you also believe that the market will value it at 20 three months hence.

Thus the professional investor is forced to concern himself with the anticipation of impending changes, in the news or in the atmosphere, of the kind by which experience shows that the mass psychology of the market is most influenced. This is the inevitable result of investment markets organised with a view to so-called “liquidity”. Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of “liquid” securities. It forgets that there is no such thing as liquidity of investment for the community as a whole. The social object of skilled investment should be to defeat the dark forces of time and ignorance which envelop our future. The actual, private object of the most skilled investment to-day is “to beat the gun”, as the Americans so well express it, to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow.

This battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years, does not even require gulls amongst the public to feed the maws of the professional; — it can be played by professionals amongst themselves. Nor is it necessary that anyone should keep his simple faith in the conventional basis of valuation having any genuine long-term validity. For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs — a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbour before the game is over, who secures a chair for himself when the music stops. These games can be played with zest and enjoyment, though all the players know that it is the Old Maid which is circulating, or that when the music stops some of the players will find themselves unseated.

Or, to change the metaphor slightly, professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees.

If the reader interjects that there must surely be large profits to be gained from the other players in the long run by a skilled individual who, unperturbed by the prevailing pastime, continues to purchase investments on the best genuine long-term expectations he can frame, he must be answered, first of all, that there are, indeed, such serious-minded individuals and that it makes a vast difference to an investment market whether or not they predominate in their influence over the game-players. But we must also add that there are several factors which jeopardise the predominance of such individuals in modern investment markets. Investment based on genuine long-term expectation is so difficult to-day as to be scarcely practicable. He who attempts it must surely lead much more laborious days and run greater risks than he who tries to guess better than the crowd how the crowd will behave; and, given equal intelligence, he may make more disastrous mistakes. There is no clear evidence from experience that the investment policy which is socially advantageous coincides with that which is most profitable. It needs more intelligence to defeat the forces of time and our ignorance of the future than to beat the gun. Moreover, life is not long enough; — human nature desires quick results, there is a peculiar zest in making money quickly, and remoter gains are discounted by the average man at a very high rate. The game of professional investment is intolerably boring and over-exacting to anyone who is entirely exempt from the gambling instinct; whilst he who has it must pay to this propensity the appropriate toll. Furthermore, an investor who proposes to ignore near-term market fluctuations needs greater resources for safety and must not operate on so large a scale, if at all, with borrowed money — a further reason for the higher return from the pastime to a given stock of intelligence and resources. Finally it is the long-term investor, he who most promotes the public interest, who will in practice come in for most criticism, wherever investment funds are managed by committees or boards or banks.[4] For it is in the essence of his behaviour that he should be eccentric, unconventional and rash in the eyes of average opinion. If he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy. Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.

(5) So far we have had chiefly in mind the state of confidence of the speculator or speculative investor himself and may have seemed to be tacitly assuming that, if he himself is satisfied with the prospects, he has unlimited command over money at the market rate of interest. This is, of course, not the case. Thus we must also take account of the other facet of the state of confidence, namely, the confidence of the lending institutions towards those who seek to borrow from them, sometimes described as the state of credit. A collapse in the price of equities, which has had disastrous reactions on the marginal efficiency of capital, may have been due to the weakening either of speculative confidence or of the state of credit. But whereas the weakening of either is enough to cause a collapse, recovery requires the revival of both. For whilst the weakening of credit is sufficient to bring about a collapse, its strengthening, though a necessary condition of recovery, is not a sufficient condition.


These considerations should not lie beyond the purview of the economist. But they must be relegated to their right perspective. If I may be allowed to appropriate the term speculation for the activity of forecasting the psychology of the market, and the term enterprise for the activity of forecasting the prospective yield of assets over their whole life, it is by no means always the case that speculation predominates over enterprise. As the organisation of investment markets improves, the risk of the predominance of speculation does, however, increase. In one of the greatest investment markets in the world, namely, New York, the influence of speculation (in the above sense) is enormous. Even outside the field of finance, Americans are apt to be unduly interested in discovering what average opinion believes average opinion to be; and this national weakness finds its nemesis in the stock market. It is rare, one is told, for an American to invest, as many Englishmen still do, “for income”; and he will not readily purchase an investment except in the hope of capital appreciation. This is only another way of saying that, when he purchases an investment, the American is attaching his hopes, not so much to its prospective yield, as to a favourable change in the conventional basis of valuation, i.e. that he is, in the above sense, a speculator. Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. The measure of success attained by Wall Street, regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield, cannot be claimed as one of the outstanding triumphs of laissez-faire capitalism — which is not surprising, if I am right in thinking that the best brains of Wall Street have been in fact directed towards a different object.

These tendencies are a scarcely avoidable outcome of our having successfully organised “liquid” investment markets. It is usually agreed that casinos should, in the public interest, be inaccessible and expensive. And perhaps the same is true of Stock Exchanges. That the sins of the London Stock Exchange are less than those of Wall Street may be due, not so much to differences in national character, as to the fact that to the average Englishman Throgmorton Street is, compared with Wall Street to the average American, inaccessible and very expensive. The jobber’s “turn”, the high brokerage charges and the heavy transfer tax payable to the Exchequer, which attend dealings on the London Stock Exchange, sufficiently diminish the liquidity of the market (although the practice of fortnightly accounts operates the other way) to rule out a large proportion of the transactions characteristic of Wall Street.[5] The introduction of a substantial Government transfer tax on all transactions might prove the most serviceable reform available, with a view to mitigating the predominance of speculation over enterprise in the United States.

The spectacle of modern investment markets has sometimes moved me towards the conclusion that to make the purchase of an investment permanent and indissoluble, like marriage, except by reason of death or other grave cause, might be a useful remedy for our contemporary evils. For this would force the investor to direct his mind to the long-term prospects and to those only. But a little consideration of this expedient brings us up against a dilemma, and shows us how the liquidity of investment markets often facilitates, though it sometimes impedes, the course of new investment. For the fact that each individual investor flatters himself that his commitment is “liquid” (though this cannot be true for all investors collectively) calms his nerves and makes him much more willing to run a risk. If individual purchases of investments were rendered illiquid, this might seriously impede new investment, so long as alternative ways in which to hold his savings are available to the individual. This is the dilemma. So long as it is open to the individual to employ his wealth in hoarding or lending money, the alternative of purchasing actual capital assets cannot be rendered sufficiently attractive (especially to the man who does not manage the capital assets and knows very little about them), except by organising markets wherein these assets can be easily realised for money.

The only radical cure for the crises of confidence which afflict the economic life of the modern world would be to allow the individual no choice between consuming his income and ordering the production of the specific capital-asset which, even though it be on precarious evidence, impresses him as the most promising investment available to him. It might be that, at times when he was more than usually assailed by doubts concerning the future, he would turn in his perplexity towards more consumption and less new investment. But that would avoid the disastrous, cumulative and far-reaching repercussions of its being open to him, when thus assailed by doubts, to spend his income neither on the one nor on the other.

Those who have emphasised the social dangers of the hoarding of money have, of course, had something similar to the above in mind. But they have overlooked the possibility that the phenomenon can occur without any change, or at least any commensurate change, in the hoarding of money.

Friday, January 09, 2009

Weekend Reading

1. Secrets of Greatness (hat tip to Joe)

The best people in any field are those who devote the most hours to what the researchers call "deliberate practice." It's activity that's explicitly intended to improve performance, that reaches for objectives just beyond one's level of competence, provides feedback on results and involves high levels of repetition.

2. Interview With Bruce Berkowitz (give your thanks once again to Joe)

I was extremely surprised that anyone would invest simply on a level of trust. I believe in “trust but verify.” [Editor's note: I like that phrase] Even businesses that might seem to operate simply on trust really employ a level of verification. For example, in the Diamond District in New York, millions of dollars may appear to change hands simply on the basis of a handshake. But, behind the scenes, there is a careful evaluation of the diamonds that were just sold. Those transactions take place at a single point in time and, if something goes wrong, the participants will never do another transaction. In Madoff’s case, investors continued to put money in over many years, without any verification.

3. " What Would Sir John Say?"

Now, with well over 100 independent nations on earth and rapid advances in communication, people with superior educational backgrounds are likely to progress more rapidly than others. These people with more advanced education are likely to be true innovators.

Comparisons show that prosperity flows toward those nations having the greatest freedom of competition. Especially, electronics and computers are likely to become helpful in all human activities, including even helping persons who have not yet learned to read.

Hopefully, many of you can help us to find published journals and websites and electronic search engines to help us benefit from accelerating research and discoveries.

Not yet have I found any better method to prosper during the future financial chaos, which is likely to last many years, than to keep your net worth in shares in those corporations, which have proven to have the widest profit margins and the most rapidly increasing profits. Earning power is likely to continue to be valuable, especially if diversified among many nations.