Review – From Third World To First: The Singapore Story (#Singapore, #history, #economics, #politics, #books)

From Third World to First: The Singapore Story, 1965-2000

by Lee Kuan Yew, published 2000

Extended Introduction

This book has two parts (well, really, three, but the third part is about 20 pages and isn’t as significant as the other two parts), the first of which is about how Lee Kuan Yew describes the building of political institutions and the development of the economy of Singapore under the leadership of himself and his People’s Action Party over almost four decades, the second of which is a country-by-country exploration of Singapore’s foreign relations or what might best be called the exercise of Lee Kuan Yew’s political power abroad. I have an essay planned which will cover the first part of the book separately, focusing on the economic development of Singapore “from Third World to First” and the related political issues with specific emphasis on the myth of Singapore as an example of free market economics at work. Confusingly for some readers, I will argue both that according to Lee Kuan Yew himself Singapore was not a free market and was not intended to be one, and that despite this most of the credit for Singapore’s amazing economic development over the forty year period observed still belongs to the workings of the free market and not to intelligent central planning and wise stewardship of the economy by protectionist politicians.

Therefore, this review will only cover part of the book, but a still substantial one (pg. 225-660) and one which touches upon enough issues that will be raised in the upcoming essay that the reader should be able to get most of the story. I also plan in this review to meander quite a bit and talk about the things I found most interesting or meaningful, rather than summarizing the themes. I took extensive notes on the used copy I bought, annotating almost every other page. There’s a lot to chew on here and I probably won’t cover it all even between this review and the later essay, but might come back to it and comment on individual issues as my thoughts or interest allow. For those who are so inclined, you may wish to read some personal observations and experiences I had during a recent trip to Singapore, as well as some of the comments I made about Singapore’s history and political story, by reading the earlier posts tagged about Singapore. They may add meaningful context.

The Role of International Affairs in Little Singapore

Imagine I described to you a tiny, natural resourceless island nation situated strategically along a major shipping lane, whose historical role was one of trade entrepot and for whom fluid commercial volumes with every people and country possible were key to its economic survival. What kind of foreign policy would you imagine such a country would conduct? Do you imagine it’d have a standing army, or rely on the goodwill of other nations for its existence? What do you think it’s chief executive would spend most of his time doing and where would he most frequently be found?

According to LKY’s memoirs, though a small country dependent upon trade and commerce, Singapore nonetheless had a big role to play in international politics and was not above taking hostile stances even toward other southeast Asian nations (and even looked on approvingly at various wars in the Middle East!). Establishing a robust Singapore Armed Forces was one of the first priorities of LKY when independence was gained in 1965, reportedly to ward off threats from Malaysia and even Indonesia. And during my reading, I lost count of the number of times various chapters and paragraphs began with LKY meeting with other political and academic elites outside of Singapore.

Rather than adopting a strict foreign policy of peace and goodwill towards all nations, LKY comes across as almost bloodthirsty in his description of Singapore’s role in the Vietnam War, describing American intervention as good and necessary, claiming the Vietnamese regime deserved to be “punished”, first in a cross-border skirmish with China and then by continuing sanctions and non-normalized trade and diplomatic relations between Vietnam and Singapore even a decade after the conflict ended and even going so far as to throw his lot in with the Khmer Rouge to counterbalance the Vietnamese puppet government in Cambodia, describing the decision as one arrived at after having “no choice”! If choice doesn’t play a role in designing policy, what need have we of great leaders like LKY?

And then there is Singapore’s role as arms merchant at various times in various conflicts…

And why was it so important to LKY to get agreements with other countries to host SAF detachments for training in unusual environments? Though we are told that the SAF was created to defend tiny Singapore, the desire to train in environments alien to the tiny tropical island seem to lead logically to one place– interventionism. I doubt LKY planned to militarily dominate the globe, but surely he hoped to have his forces participate in struggles that had nothing to do with the direct defense of the island.

While many of the political tours were related to commitments imposed by being part of the British Commonwealth and its former colonial possessions, there seem to be just too many instances of LKY as a global jetsetter to excuse. Why was this man hobnobbing seemingly everywhere but Singapore?

I don’t know what the meaningful difference is between a currency board and a central bank, but assuming there is one, LKY said that Singapore did not have a central bank because,

a central bank is an easy way out for a finance minister who likes to juggle [his figures] when he has a deficit in his budget. I do not think we should put such a temptation before the finance minister in Singapore.

And yet, we witness numerous examples throughout the book, including episodes in Indonesia, Malaysia, Thailand and the Asian Financial Crisis during which Singapore attempts to “defend” the value of other countries’ exchange rates through currency intervention in Singapore. Why? What excuse could their possibly be for this behavior other than trying to be a “player” in world affairs?

But it’s not all baffling. The book has its charming moments, too, including many glimpses into how world political figures really think and what they say about their regimes and records of governance behind the scenes. Take, for instance, this phallic competition between Indonesia’s Sukarno and Lee Kuan Yew:

[Sukarno] asked, “How big is your population?” “One and a half million,” I replied. He had 100 million. “How many cars do you have?” “About 10,000,” I said. Jakarta had 50,000. I was puzzled but readily conceded that he occupied first place in Southeast Asia in terms of size.

Or, the behavior of Indian officials in the face of new golf balls:

It was a gradual slide in quality of a once elite service [Indian Civil Service], now caught up in the throes of a social and economic revolution which had reduced living standards… they could not buy good (i.e., imported) golf balls because their import was forbidden… Our high commission had advised me to bring several boxes of golf balls to distribute to the committee members of the club. It was depressing to see top brass and civil servants breaking up the packages and taking fistfuls of golf balls to stuff into their golf bags.

Indeed, golf balls were so precious that caddies would dash into any house or rough to find them. Once, at the former Bombay Royal Golf Course in 1965, I sliced my ball into a squatter area [what is a squatter area doing within driving distance of a Royal Golf Course?] and heard the loud clatter as it fell on a zinc roof. My caddie dashed off, I thought to find out who was hurt. But no– a little boy emerged with the golf ball, not to complain of injury but to bargain over the price of the ball.

We also learn of the need to be street-wise when dealing with foreign communist dictatorships looking to play a little development scam on a credulous leader:

In February 1994, I signed the Suzhou Agreement with Vice Premier Li Lanqing in Beijing, witnessed by Premier Li Peng and Prime Minister Goh… the essence of the project was to transfer our knowledge of how to plan, build and administer a comprehensive industrial, commercial and residential park that could attract high-quality foreign investors… Instead of giving SIP their full attention and cooperation as was promised, they used their association with Singapore to promote their own industrial estate, Suzhou New District (SND), undercutting SIP in land and infrastructure costs, which they controlled… It was a chastening experience… For the Suzhou authorities, a signed agreement is an expression of serious and sincere intent, but one that is not necessarily comprehensive and can be altered or reinterpreted with changing circumstances… China has an immensely complex government.

But LKY was something of a shakedown scam artist himself as Singapore was seen as a “developing” but not “developed” economy for some time. After catching some American personnel spying in Singapore,

I told the British commissioner, Lord Selkirk, that we would release these men and their stupidity would not be made public if the Americans gave a hundred million U.S. dollars to the Singapore government for economic development. They offered US$1 million, not to the Singapore government, but to the PAP [LKY’s political party]– an unbelievable insult.

He engineered something similar with Japan,

The only important business I raised with Prime Minister Hayato Ikeda was the “blood debt”, a request for compensation for their wartime atrocities… We eventually settled this “blood debt” after independence, in October 1966, for $50 million [serious money for small Singapore when the dollar was worth something!], half in grants and half in loans. I wanted to establish good relations to encourage their industrialists to invest in Singapore.

American race-baiters like Jesse Jackson and Al Sharpton couldn’t have worked a better deal with calls for reparation that would just end up in their own pockets! He even tried the same scam on different terms with the Japanese at a later date, this time playing “Godfather” over a shipping lane:

To get the Japanese to help us, for example, in investing in a petrochemical plant, we had to remind them that their ships passing through the Straits of Malacca would have problems with toll collectors if Singapore were to join the other littoral states, Indonesia and Malaysia.

“Nice open sea lane you got there, it would be a shame if something happened to it,” said in a thick, Germanic Robber Baron accent. The shakedown later continued with “soft loan” subsidies available only to developing nations:

I protested to Fukuda that his officials had spoken of Singapore not as a developing country but as an industrialized one not entitled to soft loans from Japan… We would lose our General Scheme of Preferences (GSP) [like affirmative action for international trading partners who are non-developed countries] and other advantages before we could compete on equal terms.

“Soft loans” are a form of fraud where one entity makes loans to another entity that they never intend to be repaid and usually forgive entirely. It is an outstanding source of graft, especially in corrupt political regimes where outright bribery is outlawed by the lender nation’s laws.

When he isn’t reflecting on his own actions, LKY proves to be a biting and incisive critic and a truthful observer of laws and conditions in other people’s countries. Here he is on the European Economic Community, the predecessor to the EU:

With the other commissioners, I discussed how to avoid manufacturing those products that EEC countries would find sensitive because of persistent high unemployment. I discovered to my dismay that the list was unlimited. Any member country with any influence on Brussels, feeling the slightest pain, could appeal to Brussels for protection and would invariably get it.

This brief anecdote proves three things simultaneously– (1) contrary to propaganda, the EU is a protectionist trading bloc, not a free trading society, (2) there appears to be no nation on Earth that is led by politicians who understand the benefits of free trade, even unilateral free trade and (3) not even trade-dependent Singapore is able to gain a competitive advantage by being a true free trader because it was led by a Keynesian planner-mindset politician-in-chief, LKY, who had his own worries about managing unemployment in his country to risk upsetting bureaucrats in Brussels! Now that is global political power projection for you!!

Here’s another honest and insightful observation from LKY, this time about a faux pas made by an inept American president:

When I was leaving, he gave me a green leather-bound copy of his campaign autobiography [aw gee, what a nice gift, a hastily produced, ghost-written volume of propaganda], Why Not the Best? He had already inscribed it, “To my good friend Lee Kuan Yew. Jimmy Carter.” I was flattered but surprised by my elevation to “good friend” even before he had met me. This must have been a standard practice during his election campaign.

It makes you wonder if Jimmy Cahtah even bothered to sign it himself. If you’re going to piss off a foreign leader on a cheap gesture, spare no expense!

The book is rife with such charming episodes, I could fill the blog up with them. Instead, it’s worth saying something about Lee Kuan Yew’s somewhat confusing and arbitrary arguments for polylogist legal theorizing and the explanations he gave for the success of Singapore’s economic and national development since 1965.

As a polylogist, LKY is a skeptic of the idea of simply importing “progressive” legal principles from one population to another:

the are fundamental differences between East Asian Confucian and Western liberal societies. Confucian societies believe that the individual exists in the context of the family, extended family, friends and wider society, and that the government cannot and should not take over the role of the family. Many in the West believe that the government is capable of fulfilling the obligations of the family when it fails, as with single mothers… freedom could only exist in an orderly state, not when there was contention or anarchy. In Eastern societies, the main objective is to have a well-ordered society so that everyone can enjoy freedom to the maximum [even better if they’re ruled by people like LKY!]… Democracy works where the people have that culture of accommodation and tolerance which makes a minority accept the majority’s right to have its way until the next election, and wait patiently and peacefully for its turn to become the government by persuading more voters to support its views.

And yet, he encouraged China to join as a member of the law-abiding community of nations! How can China, whose authoritarian legal system is ostensibly appropriate for the culture and values of the Chinese, join the law-abiding international community whose laws and customs are foreign and antagonistic to the culture and values of the Chinese? One potential solution is that there exist in every society a set of elite individuals who are not beholden to local political bigotry and historical traditions but can instead transcend them and tap into a more universal logic. But if they can do this for their countries at an international level, why can’t they do this at the “local” level of their domestic politics?

This seems to present some problems for the polylogist approach of LKY, although I think there’s a perfectly simple, but embarrassingly revealing, answer that has something to do with the reality of power and how and why it is exercised in any society which the thoughtful reader can probably surmise with a bit of their own consideration.

I am not a polylogist. I believe there is one, universal human logic that all mature, physically functioning adult minds can understand and employ in their own thinking and communications. That being said, I think LKY is absolutely correct that it is absurd to believe one can foist political principles that were developed over hundreds or thousands of years of combined cultural history onto a population that has never utilized them before, such as using military Keynesianism to deploy democracy in Afghanistan and Iraq, particularly when in so doing the existing political arrangements and power structures are rapidly collapsed or, worse, ignored as if they’re unimpactful.

But more importantly, I think it is naive to expect any political principle, foreign or domestic, to work miracles. For example, believing the process of revealing voter preferences through democratic elections can somehow obviate the need for working within the confines of economic scarcity. Or, to use another example, instituting a vicious socialist dictatorship which doesn’t give a damn about anyone’s preferences, and expecting it to spit out the highest standard of living in the world for its people. So, there is some truth to what LKY is saying on this subject, just not much how he said it.

And how did LKY explain Singapore’s success?

the basic principles that have helped us progress: social cohesion through sharing the benefits of progress, equal opportunities for all, and meritocracy, with the best man or woman for the job, especially as leaders in government

I’d call this a bit of self-aggrandizing delusion. When LKY says “sharing the benefits of progress”, he means that he doesn’t believe the outcomes in a market society are anything but random (he makes this claim in an early section of the book), and that the wealth should be spread around by politicians through things like government housing projects and forced savings accounts. Of course, getting to hand out welfare goodies after an election is a good strategy for winning future elections– some might call this building “social cohesion” to a particular party’s cause, such as LKY’s People’s Action Party.

Similarly, it is pure fudge to claim that you provided equal opportunities for all while running a meritocracy. A meritocracy implies an inequality of opportunity– opportunity goes to those who show merit, having performed well with other opportunities. To give everyone equality of opportunity is not just wasteful, it’s impossible. Does everyone in Singapore have an equal opportunity to be Prime Minister like LKY, or just those who control a well-oiled electoral wealth redistribution machine like the PAP? The double fudge is insisting that government leaders themselves are examples of this meritocracy. Nobody wants to lose their subsidized housing for questioning the merits of their political leaders!

That being said, I don’t think LKY played NO part in the Singapore success story. There is something to be said for a stable political regime with predictable laws and regulations over a 40+ year period, especially one which tended more toward laissez-faire than most. And clearly, looking around the neighborhood (Malaysia, Indonesia, Vietnam, Cambodia… China) Singapore could’ve had worse political management than it experienced. I just think that the credit due is negative– it’s what LKY and his team didn’t do, that made Singapore great, not what they did do. That, and what they didn’t do relative to what the more eager regimes in neighboring jurisdictions did do over the time period observed. With racial tension in Malaysia, military government in Indonesia, socialist science experiments in India, a devastating civil war in Vietnam and the Great Leap Forward and Cultural Revolution in China, you didn’t have to be all that fast to win this footrace.

By just not getting out of bed and ordering an atrocity each day, LKY virtually guaranteed the investment, development and progress would come to his tiny island nation unimpeded for decades, just like it did. But since there’s no way to run a truly controlled experiment here, there’s no way to know for sure what might’ve happened under a different set of policies, so ultimately it’s Lee Kuan Yew’s word against mine.


Video – The Corrupt Origins of Central Banking in America (@mises, #history, #economics, #CentralBanking)

I thoroughly enjoyed this video recently. It’s a short talk given at the Mises Institute’s Mises University 2016 event. The speaker has researched and written extensively about Alexander Hamilton and the early efforts at establishing a central bank in the United States during the “American System” period through the 1830s.

Sorry, The Economy Is Officially Closed (#investing, #risk, #economy, #recession, #wealth)

One way to describe what I do for a living is “capital allocation.” Really, I am like an internal strategic consultant to a family business (a family of which I am a part) so there is more to it than that, but thinking about where to put our capital is one of the primary functions I serve.

One interesting problem to have when one owns things of value is receiving bids on those things from people interested in buying them when you’re not sure you want to sell. The further above your own estimate of “fair value” their bid goes, the stronger the temptation to take advantage and sell your asset. It seems like a pretty straight forward problem to solve.

The only problem is the market context of the potential sale. Generally, if you’re in a position to get more than fair value for what you’re selling, you’re going to have a hard time finding another asset to buy where the seller isn’t facing the same dynamic. In other words, you can potentially sell one asset at an inflated price and buy another at an inflated price– you’re probably better off just holding on to what you have because there’s no arbitrage in that and it could very well cost you money in terms of frictional costs like brokerage commissions and taxes on imaginary capital gains.

One thing you could do is sell your asset at an inflated value and sit and wait in cash for a better buying opportunity. The problem with that is that cash is, currently, a seemingly barren asset. If you stuff your haul into T-Bills, you’re lucky to earn a few basis points every 90 days– it might as well be zero, and when you factor in the effect of inflation and those damned capital gains taxes once again, it probably is. You could go further out on the yield curve and buy some 10YR Treasury notes, but then you’re exposing yourself to substantial interest rate risk with yields flirting with historic lows.

Meanwhile, most asset owners are earning strong internal returns on their invested capital right now. Say you’re earning 20% a year on your investments, why would you sell them to collect 1.5% over the next 10 years while taking enormous interest rate risk? Or to collect zero for some unknown amount of time sitting in T-bills or cash in a savings account? Every year you stay invested, you get ahead by almost 20% more. Could the value of your investment really drop by that much?

The business cycle is an inevitable fact of owning and operating a business in a modern economy. The question is not could it, but when will it drop by that much, or more? For many business owners and investors, the waiting is the hardest part. Giving up 20% a year for some period of time and avoiding the risk of a 50-60% or greater decline in asset values just isn’t attractive. It isn’t even attractive when thinking about the fact that buying back those same assets at half price could potentially double your return on invested capital during the next boom, an interesting strategy for shortening the compounding time necessary to achieve legendary riches.

For many, this inevitable decline in asset prices is inconceivable. It’s embedded deeply in the fear of selling and going to cash. The implication of this premise is that the economy is officially closed to additional investment. Those who invested earlier in the cycle can stay inside and watch a magnificent show as they earn outstanding returns on their capital while the boom goes on. But for everyone who sold too early, or never bought in, they have to wait outside, indefinitely, and wonder what it’s like– the cost of admission is just too high.

What makes this a stable equilibrium? By what logic has a competitive market economy become permanently closed to new investment, or a change in asset values, or a change in ownership of assets? Under what set of premises could this condition last for a meaningful amount of time and leave people who sell now out in the cold, starving and bitter for returns on capital, forever, or for so long that they would be losing in real terms over time in making such a decision?

To me, this “new normal” is absurd. It is juvenile to believe that the economy is closed and no one else is getting in. It’s silly to think that the people willing to pay those astronomical prices for admission are making a good decision, that they’re going to have a comfy seat and years of entertainment, rather than paying more than full price for a show that’s about to come to an abrupt end. It’s a topsy-turvy world in which the reckless and courageous high-bidders are the ones who get rich. If paying too much for things was the path to riches, we’d all be there by now. I think when everyone’s perception of reality and value skews toward a logical extreme like this, we’re closer to the show being over than the show must go on.

In the meantime, sorry, the economy is officially closed.

Notes – The Great Deformation, Part III, “New Deal Legends” (#economics, #newdeal #FDR)

The Great Deformation, by David A. Stockman, published 2013

Chapter 8
Stockman doesn’t go into much detail on where the boom ending in 1929 came from, but he does provide an interpretation of why the bust lasted so long and went so deep– the forcible closing off of international trade via protectionist policies and the undermining of the global gold-backed monetary regime by American and European governments alike.

In Stockman’s telling, American president Herbert Hoover was a mostly free enterprise and sound money kind of guy who wanted to avoid inflationist solutions to the economic slump. By 1932 the economy had liquidated the bulk of the malinvestments in excess inventories and capital assets and was ready to turn toward genuine recovery. This process only took as long as it did because ill-reasoned policies like the Smoot-Hawley Act in the United States and similar nationalistic policies in European states along with uncertainty about the British plans to keep the gold-backed pound sterling in place hampered international trade flows. According to Stockman, the United States between 1914 and 1929 had become, much like China circa 1994-2012, a major exporter of capital and consumer goods to the rest of the world particularly in response to trade and economic disruptions of industry and agriculture in European economies during the First World War. The US economy was geared up to provide steel, cotton, cereal grains and other commodities to the rest of the world and had a hard time adjusting output to meet domestic demand when the collapse came in 1929.

Then came FDR and his unique brand of economically inane autarkic nationalist policy. Stockman faults FDR for prolonging, nay, creating, the actual Depression singlehandedly. First, FDR began his presidency by fomenting a banking crisis and declaring a major bank holiday which Stockman saw as unnecessary. As Stockman tells it, the 12,000 some bank failures in the United States during this period mostly occurred in over leveraged regional/rural banks centered around the agricultural and export-oriented areas of the economy representing at most 3% of banking system deposits. Major money center banks in financial centers such as New York never faced a solvency crisis, making FDRs response a solution to a nonexistent problem and therefore a serious problem-creating blunder itself.

Second, FDR torpedoed the London Conference on international monetary mechanisms, throwing the whole system into chaos and instigating another round of protectionist measures at home and abroad. Third, he arbitrarily decided to undermine the USs own commitment to a constant redeemability ratio for the dollar, creating further fear and uncertainty in the economy. And finally, he created a cartel system (National Recovery Administration) which served to freeze prices, arbitrarily shift capital around the economy and buy votes as necessary but did nothing to create the kind of stable conditions preferred by business people and entrepreneurs attempting to make capital investments to serve anticipated consumer demand.

The Depression was a recession that was working itself out despite the protectionist political measures put in place which made adjusting the structure of production to domestic rather than foreign needs, but then FDR came along and made the economy his plaything as he tinkered according to his whims and played power broker on the side. That’s what turned the recession into a true Depression.

Chapter 9
Fannie Mae, which was envisioned as a way to revitalize a moribund middle class housing market during the Great Depression by creating a “secondary market” for uneconomic 30 year mortgages at subsidized interest rates, has in the 75 years since its founding led to the total corruption and now nationalization of the home loan market. The creation of the secondary market divorced mortgage underwriting from mortgage servicing as it allowed for mortgages to be easily issued, packaged up and sold to investors as government-backstopped financial products. Further, it resulted in local savings funding local housing investments being transformed into a national and now international market, with the final result being that “Red China” bankrolls $1T+ of the federal home loan market due to balance of payment issues tied to competitive currency issuance.

Social Security, rather than being the crowning social achievement of the New Deal, was its greatest fiscal folly and has created an embarrassing Ponzi legacy that is with us even today. The systems actuarial projections were based on an impossible 5% continual GDP growth rate. The payroll tax used to fund it has proved “regressive” and continues to grow over time, with a current 6.5% of GDP consumed by the tax. The $3T of “trust fund reserves” have been lent out and spent by other parts of the government and represent nothing more than future taxes due.

In so many words, the innovation of deposit insurance combined with the Glass-Steagall act, a bout of inflationary monetary policy which destroyed the profitability of traditional deposit lending under Glass-Steagall and then a round of “deregulations” designed to create new areas of profitability for banks at the expense of growing moral hazard resulted in the utter corruption of the system and the inevitability of a major financial meltdown as witnessed in 2008.

With the outbreak of war in Europe in 1914 and the initiation of a war loan program by the United States government, US farms became the breadbasket of the world. They took on massive debt to expand capital machinery and bring additional acreage into cultivation which resulted in growing farm output prices. When the war ended, the capital investments, including the debt overhang, remained. The financial collapse in the 1930s further exacerbated the situation, leaving farmers as a desperate coalition looking for a political solution to their contractual obligations.

With the nations farmers the hardest hit by the twin spikes of failing cash flow and high debt burdens, they became a powerful voting bloc that got FDR elected which allowed for the cartelization of the farming industry to take place. The thought was that cartelizing the industry and pushing up farm and farm output prices would result in a return to prosperity as rural buyers bought manufactured products from city centers. With their programs in place, the farming lobby was then willing to trade votes for growth and maintenance of these subsidies and controls going forward into the future.

The “Thomas Amendment” created four options for expanding the money supply via currency issuance or gold or silver content debauchery. This inflationary response was seen as the proper antidote to too much debt and too little money and political authorities of the day figured it would give them a free pass to avoid the pains of the bust following the ill-gotten gains of the boom.

FDR channeled the $2.8B windfall from his emergency dollar “revaluation” against gold into his Exchange Stabilization Fund, which the Secretary of the Treasury was then able to disburse at his discretion, turning him into what Stockman calls a “money czar” much like Hank Paulson and Neil Kashkari during TARP.

Chapter 10
In this chapter, Stockman argues that World War II and the Korean War were the last wars to be mostly financed by current taxation in the US. WWII in particular saw a rise in household saving and a decline in household indebtedness that offset the massive rise in public indebtedness. He attributes this in part to the fact that wartime command economy measures dictated that there was little to consume on store shelves, in part to the fact that the government’s propaganda campaigns for war bond drives were a success and in part because the government had adopted an arbitrary bond yield peg that lowered investment returns in competing assets and made government bonds more attractive as a conservative savings vehicle.

Stockman claims that William McChesney Martin, who headed the Fed through the 1950s, was a “tribune of sound money” and saw it as his mission to restrain credit expansion and tame the inflation rate, rather than to stoke it like modern Fed heads. He also claims that the Fed only lent on liquid commercial receivables during this era, compared with the present where the Fed has become a warehouse for illiquid claims on real assets.

Chapter 11
Stockman argues that President Eisenhower was the “last of the fiscal Mohicans” dedicated to trimming federal budgets and making government spending respectful of tax revenue means. At the same time, a growing chorus of voices on the right and the left begin arguing for a “new economics”, Keynesian government planning of the macro economy, to not only fight recessions but “fine tune potential GDP” during recoveries and booms. This theory comes at the expense of sound money and has a pro-inflation bias.

Chapter 12
Following World War I, Great Britain attempted to return to the pre-war parity between the pound Sterling, gold and the US dollar despite a massive inflation during the war years. At the same time, the British government embarked on an expansion of its domestic welfare programs which ultimately broke the back of the pound culminating in the London gold conference in 1931 which proved the futility of maintaining the old exchange ratios in the face of inflationary chaos.

At the end of World War II, the United States attempted to take the lead with a gold-backed dollar as the world’s reserve currency in a new arrangement, the gold exchange standard, engineered at the Bretton Woods conference in 1944. Of course, the architect of this scheme was the exact same architect of the doomed British plan (monetary and social policy), the imperious Lord Keynes. And rather than a true gold standard, what Keynes wrought was a feeble attempt to hide dollar inflation by creating a scheme where foreign exchange was to be exchanged for dollars, not gold, which was ostensibly suppose to allow additional credit and currency to be pyramided atop the same amount of gold reserves at formal exchange rates.

For a time, this precarious system seemed to work, helped along by the US-led international “gold pool” which sought to exchange gold against currency to calm price increases in the private London gold market.

However, the decision to engage in fiscal expansionism in the US via welfare spending increases and costly wars abroad (ie, Vietnam) all financed by deficit spending rather than real tax increases led to an unhinged inflation and a boiling London gold market. The international gold pool was quickly depleted in a series of panics in the late 1960s, eventually culminating in Nixon’s infamous closing of the US gold window.

This “guns and butter” policy, led by the intellectual disciples of Keynes ensconced in major US universities, was the final nail in the coffin of sound money in the US, and perhaps even the world, and ushered in a new era of freely floating currencies, chronic deficits, massive credit expansion and a seemingly never-ending series of financial and economic bubbles that we are all living with the consequences of today– ironically, the media at the time was fooled into believing this “enlightened” policy had permanently tamed the (government-policy induced) business cycle.

Chapter 13
Milton Friedman, hailed as a staunch libertarian and champion of small government politics and free market economics, gave intellectual blessing to the greatest economic bastardization of all time– the transformation of the gold standard US dollar, once and for all, into the “T-bill Standard”.

Friedman’s erroneous analysis of the cause of the Great Depression — a crashing M1 money supply caused by an overly tight Federal Reserve — led him to faith in a new standard for monetary policy, a simple inflation targeting of 3% per annum, with the market smoothing out the rest. Friedman believed that if the Fed could credibly adhere to a uniform rate of inflation over time, the business cycle could be banished and the economy would be free to grow without abatement and without the restrictive context of a gold-backed currency.

This new policy proved its danger almost immediately with the out of control inflation of the 1970s and opened the door for unending deficit finance by the federal government. And while Friedman had hoped for a series of Fed chairmen who would objectively guide the M1 money supply along this path (a strategy destined to failure because it turns out the Fed doesn’t control M1, market demand for loanable funds does) instead the office has been inhabited by activist acolytes since the tight money days of Volcker.

The current global monetary regime of competitive free floating currencies is truly without precedent and much of the modern US’s largesse was financed by willing mercantilist politicians in foreign trading partner nations. It remains to be seen what happens to this system when one or more countries reach the end of their rope, domestically, and are not longer willing to import the United States’ inflation as they export their wealth to foreigners for consumption.

Doing The Hugh Hendry (#debt, #diversification)

Below is some commentary from Hugh Hendry I found in an editorial I since can not access as I don’t have a login. But I thought it was interesting when I first read it awhile back and I still think it’s interesting now. I meant to post it earlier. Rectifying my mistake:

For the moment, let us forget the chances of a hard landing in China. Forget the drama of Europe’s circus of politically inspired economic incompetency. Forget that the good news of the US economy’s succession of positive economic surprises is really bad news as fixed income managers have sold copious amounts of too cheap volatility and because it has made equity investors turn bullish, sending stock market volatility back to 2007 levels. This is dangerous. Improved US data may represent a classic short-term cyclical upturn amid a profound global deleveraging cycle.

Such moves have been commonplace for the past three years and have yet to prove a harbinger of any structural upswing. I worry that the pathological course of the last several years will see volatility rise sharply once again. Even so, there exists, in terms of my parochial world of hedge fund investing, a bigger issue.

I fear that my no longer small community has been compromised. Last year was generally very tough for long/short strategies and I commiserate with all concerned. But last year world class funds lost more than 15 per cent in just two months. Today they are celebrated again for making double digit returns in the last quarter even though they still languish below high water marks and their reputation for risk management, at least to those clients who have poured over their copious due diligence statements, has been sorely compromised.

You can probably live with that if you are a pension scheme or a large, sophisticated fund-of-fund because you have a global macro sub-sector that can benefit from short-term shifts in volatility. But the unfortunate thing is that this group exercised its stop losses somewhere between the great stock market rallies of 2009 and 2010. That is to say, they honoured the pact they had with clients. They adhered to the terms of their risk budget: they lost money and they reduced their positions. I fear that owing to this nasty experience the financial world is in danger of harvesting a monoculture of fund returns that could prove less than robust should the global economy suffer another deflationary reversal.

To my mind the situation has parallels with the plight of the banana. Today the world eats predominately just one type of banana, the Cavendish, but it is being wiped out by a blight known as Tropical Race 4, which encourages the plant to kill itself. Scientists refer to it as programmed death cell destruction. In stressful situations bananas fortify themselves by dropping leaves, killing off weaker cells so that stronger ones may live to fight anew. They operate a stop-loss system.

But modern mass production of single type bananas has replaced jungle diversity with commercial monocultural fields that provide more hosts to harbour the blight. The economy keeps producing stressful volatility events. Good managers keep shedding risk and monetising losses and are duly fired, leaving us with a monoculture of brazen managers who will never stop loss because they are convinced central banks will print more money.

Diversification has proven the most robust survival mechanism against failures of judgment by any one society, hedge fund manager or style. But what if we are now a single global hedge fund community afraid to take stop losses and convinced of an inflationary outcome to be all short US Treasuries and long real assets?

This is pertinent as I have always been fascinated by that second rout in US Treasuries in 1984, long after the inflation of the 1970s was met head on by Paul Volcker’s monetary vice and a deep recession. How could 10-year Treasury yields have soared back to 14 per cent and how could so many investment veterans have been convinced that a second even more virulent inflation wave was to hit the global economy?

Psychologists tell us the explanation is embedded deep in the mind. They refer to the “availability heuristic”. Goaded by the proximity to the last dramatic event, investors overreacted to the news that the US economy was pulling out of recession in 1984. They saw high inflation where there was none.

With this in mind, I would contend that it may take several more years before the threat of debt and deflation can be successfully exorcised from investors’ minds, even if the global economy were not set on such a perilous course. Such is the potency and memory of 2008’s crash that anything remotely challenging to the economic consensus could be met by a sudden and severe reappraisal to the downside.

Should such an event send 30-year Treasury yields back to their 2008 low of 2.5 per cent, we believe enlightened investors might better be served by thinking the opposite. Only then might it prove rewarding to short the government bond market and embrace what may turn out to be a much promised once in a lifetime buying opportunity for risk assets.

Kleptocracy Via Inflation Is The Global Model, Not Just Chinese (@John_Hempton, #china)

Australian hedge fund manager John Hempton is out with a new piece on his blog about “The Macroeconomics of Chinese kleptocracy“, the main takeaway of which is:

But ultimately the Chinese establishment like inflation – it is what enables their thievery to be financed.

The more serious threat is deflation – or even inflation at rates of 1-3 percent. If inflation is too low then the SOEs – the center of the Chinese kleptocratic establishment will not generate enough real profit to sustain the level of looting. These businesses can be looted at a negative real funding rate of 5 percent. A positive real funding rate – well that is a completely different story.


The Chinese establishment has a vested interest in getting the inflation rate up in China. Because if they don’t all hell will break loose.

Unless the Chinese can get the inflation rate up expect a revolution.

I know John (who appears to be a well-intentioned but generally naive political conservative) would likely strongly disagree with the following characterization but…

This is the kleptocratic model prevalent in all major developed and developing world economies– inflation is the keystone piece of these systems and it is why CB presidents from Bernanke to Draghi to Shirakawa are all intent on creating and maintaining it.

If the inflationary engine fails to turn over, the loot-truck stops making its rounds. If the loot-truck stops making its rounds, the elite and their scumbag offspring don’t get paid and all the world’s peasants (you don’t have to work a farm to be an economic peasant) suddenly wake up to just how desperately poor they are after being continually ripped off for decade upon decade.

But, I’m a cynic, so of course I’d see the world that way. More reasonable men, like Mr. Hempton, are more prevalent in the world than I, so everyone is spared my dark view of things and can instead bask in the glory of knowing that, while our systems may not be perfect, at least they’re not as bad and out in the open as China’s.

Review – More Money Than God (#hedgefunds)

More Money Than God: Hedge Funds And The Making Of A New Elite

by Sebastian Mallaby, published 2010

A veritable pantheon of masters of the universe

Mallaby’s book is not just an attempt at explaining and defending the beginning, rise and modern state of the hedge fund industry (the US-focused part of it, anyway), but is also a compendium of all of the hedge fund world’s “Greatest Hits.” If you’re looking for information on what hedge funds are, where they come from, what they attempt to do, why they’re called what they are and how they should be regulated (SURPRISE! Mallaby initially revels in the success “unregulated” funds have had and feints as if he’s going to suggest they not be regulated but, it being a CFR book and he being a captured sycophant, he does an about-face right at the last second and ends up suggesting, well, umm, maybe SOME of the hedge funds SHOULD be regulated, after all) this is a decent place to start.

And if you want to gag and gog and salivate and hard-to-fathom paydays and multiple standard deviations away from norm profits, there are many here.

But that wasn’t my real interest in reading the book. I read it because I wanted to get some summary profiles of some of the most well known hedgies of our time — the Soroses and Tudor Joneses and such — and understand what their basic strategies were, where their capital came from, how it grew and ultimately, how they ended up. Not, “What’s a hedge fund?” but “What is this hedge fund?” As a result, the rest of this review will be a collection of profile notes on all the BSDs covered by the book.

Alfred Winslow Jones – “Big Daddy”

  • started out as a political leftist in Europe, may have been involved in U.S. intelligence operations
  • 1949, launches first hedge fund with $60,000 from four friends and $40,000 from his own savings
  • By 1968, cumulative returns were 5,000%, rivaling Warren Buffett
  • Jones, like predecessors, was levered and his strategy was obsessed with balancing volatilities, alpha (stock-picking returns) and beta (passive market exposure)
  • Jones pioneered the 20% performance fee, an idea he derived from Phoenician merchants who kept one fifth of the profits of successful voyages; no mgmt fee
  • Jones attempted market timing as a strategy, losing money in 1953, 1956 and 1957 on bad market calls; similarly, he never turned a profit following charts even though his fund’s strategy was premised on chartism
  • Jones true break through was harvesting ideas through a network of stock brokers and other researchers, paying for successful ideas and thereby incentivizing those who had an edge to bring him their best investments
  • Jones had information assymetry in an era when the investment course at Harvard was called “Darkness at Noon” (lights were off and everyone slept through the class) and investors waited for filings to arrive in the mail rather than walk down the street to the exchange and get them when they were fresh

Michael Steinhardt – “The Block Trader”

  • Background: between end of 1968 and September 30, 1970, the 28 largest hedge funds lost 2/3 of their capital; January 1970, approx. 150 hedge funds, down from 200-500 one year earlier; crash of 1973-74 wiped out most of the remainders
  • Steinhardt, a former broker, launches his fund in 1967, gained 12% and 28% net of fees in 1973, 74
  • One of Steinhardt’s traders, Cilluffo, who possessed a superstitious eating habit (refused to change what he ate for lunch when the firm was making money), came up with the idea of tracking monetary data, giving them an informational edge in an era where most of those in the trade had grown up with inflation never being higher than 2% which meant they ignored monetary statistics
  • One of Steinhardt’s other edges was providing liquidity to distressed institutional sellers; until the 1960s, stock market was dominated by individual investors but the 1960s saw the rise of institutional money managers; Steinhardt could make a quick decision on a large trade to assist an institution in a pinch, and then turn around and resell their position at a premium
  • Steinhardt’s block trading benefited from “network effects” as the more liquidity he provided, the more he came to be trusted as a reliable liquidity provider, creating a barrier to entry for his strategy
  • Steinhardt also received material non-public information: “I was being told things that other accounts were not being told.”
  • In December 1993, Steinhardt made $100M in one day, “I can’t believe I’m making this much money and I’m sitting on the beach” to which his lieutenants replied “Michael, this is how things are meant to be” (delusional)
  • As the Fed lowered rates in the early 90s, Steinhardt became a “shadowbank”, borrowing short and lending long like a bank
  • Steinhardt’s fund charged 1% mgmt fee and 20% performance fee
  • Anecdote: in the bloodbath of Japan and Canada currency markets in the early 90s, the Canadian CB’s traders called Steinhardt to check on his trading (why do private traders have communications with public institutions like CBs?)

Paul Samuelson & Commodities Corporation – “Fiendish Hypocrite Jackass” (my label)

  • Paul Samuelson is one of history’s great hypocrites, in 1974 he wrote, “Most portfolio decision makers should go out of business– take up plumbing, teach Greek, or help produce the annual GNP by serving corporate executives. Even if this advice to drop dead is good advice, it obviously is not counsel that will be eagerly followed.”
  • Meanwhile, in 1970 he had become the founding backer of Commodities Corporation and also investing in Warren Buffett; he funded his investment in part with money from his Nobel Prize awarded in the same year
  • Samuelson paid $125,000 for his stake; total start-up capital was $2.5M
  • Management of fund resembled AW Jones– each trader was treated as an independent profit center and was allocated capital based on previous performance
  • Part of their strategy was built on investor psychology: “People form opinions at their own pace and in their own way”; complete rejection of EMH, of which Samuelson was publicly an adherent
  • Capital eventually swelled to $30M through a strategy of primarily trend-surfing on different commodity prices; in 1980 profits were $42M so that even net of $13M in trader bonuses the firm outearned 58 of the Fortune 500
  • Trader Bruce Kovner on informational assymetries from chart reading: “If a market is behaving normally, ticking up and down within a narrow band, a sudden breakout in the absence of any discernible reason is an opportunity to jump: it means that some insider somewhere knows information that the market has yet to understand, and if you follow that insider you will get in there before the information becomes public”

George Soros – “The Alchemist”

  • Soros had an investment theory called “reflexivity”: that a trend could feedback into itself and magnify until it became unavoidable, usually ending in a crash of some sort
  • Soros launched his fund in 1973, his motto was “Invest first, investigate later”
  • Soros quotes: “I stood back and looked at myself with awe: I saw a perfectly honed machine”; “I fancied myself as some kind of god or an economic reformer like Keynes”
  • Soros was superstitious, he often suffered from back pains and would “defer to these physical signs and sell out his positions”
  • Soros believed in generalism: know a little about a lot of things so you could spot places where big waves were coming
  • Soros had a “a web of political contacts in Washington, Tokyo and Europe”
  • Soros hired the technical trader Stan Druckenmiller, who sometimes read charts and “sensed a panic rising in his gut”
  • As Soros’s fund increased in size he found it harder and harder to jump in and out of positions without moving the markets against himself
  • Soros rejected EMH, which had not coincidentally developed in the 1950s and 1960s in “the most stable enclaves within the most stable country in the most stable era in memory”
  • Soros was deeply connected to CB policy makers– he had a one on one with Bundesbank president Schlesinger in 1992 following a speech he gave in Basel which informed Quantum fund’s Deutschemark trade
  • “Soros was known as the only private citizen to have his own foreign policy”; Soros once off-handedly offered Druckenmiller a conversation with Kissinger who, he claimed, “does know things”
  • Soros hired Arminio Fraga, former deputy governor of Brazil’s central bank, to run one of his funds; Fraga milked connections to other CB officials around the world to find trade ideas, including the number two official at the IMF, Stanley Fischer, and a high-ranking official at the central bank of Hong Kong
  • Soros was a regular attendee at meetings of the World Bank and IMF
  • Soros met Indonesian finance minister Mar’ie Muhammed at the New York Plaza hotel during the Indonesian financial crisis
  • Soros traveled to South Korea in 1998 as the guest of president-elect Kim Dae-jung
  • In June 1997, Soros received a “secret request” for emergency funding from the Russian government, which resulted in him lending the Russian government several hundred million dollars
  • Soros also had the ear of David Lipton, the top international man at the US Treasury, and Larry Summers, number 2 at the Treasury, and Robert Rubin, the Treasury secretary, as well as Mitch McConnell, a Republican Senator

Julian Robertson – “Top Cat”

  • Managed a portfolio of money managers, “Tigers”
  • Used fundamental and value analysis
  • Once made a mental note to never buy the stock of an executive’s company after watching him nudge a ball into a better position on the golf green
  • Robertson was obsessed with relative performance to Soros’s Quantum Fund
  • Called charts “hocus-pocus, mumbo-jumbo bullshit”
  • Robertson didn’t like hedging, “Why, that just means that if I’m right I’m going to make less money”
  • High turnover amongst analysts, many fired within a year of hiring
  • Tiger started with $8.5M in 1980
  • A 1998 “powwow” for Tiger advisers saw Margaret Thatcher and US Senator Bob Dole in attendance
  • Tiger assets peaked in August 1998 at $21B and dropped to $9.5B a year later, $5B of which was due to redemptions (Robertson refused to invest in the tech bubble)

Paul Tudor Jones – “Rock-And-Roll Cowboy”

  • Jones started out as a commodity trader on the floor of the New York Cotton Exchange; started Tudor Investment Corporation in 1983, in part with an investment of $35,000 from Commodities Corporation
  • “He approached trading as a game of psychology and high-speed bluff”
  • Superstition: “These tennis shoes, the future of this country hangs on them. They’ve been good for a point rally in bonds and about a thirty-dollar rally in stocks every time I put them on.”
  • Jones was a notorious chart reader and built up his theory of the 1987 crash by lining up recent market charts with the 1929 chart until the lines approximately fit
  • Jones was interested in Kondratiev wave theory and Elliott wave theory
  • “When you take an initial position, you have no idea if you are right”but rather you “write a script for the market” and then if the market plays out according to your script you know you’re on the right track
  • Jones made $80-100M for Tudor Investment Corp on Black Monday; “The Big Three” (Soros, Steinhardt and Robinson) all lost heavily in the crash
  • Jones, like Steinhardt, focused on “institutional distortions” where the person on the other side of the trade was a forced seller due to institutional constraints
  • Jones once became the catalyst for his own “script” with an oil trade where he pushed other traders around until they panicked and played out just as he had predicted
  • PTJ never claimed to understand the fundamental value of anything he traded
  • PTJ hired Sushil Wadhwani in 1995, a professor of economics and statistics at the LSE and a monetary policy committee member at the Bank of England
  • PTJ’s emerging market funds lost 2/3rd of their value in the aftermath of the Lehman collapse

Stanley Druckenmiller – “The Linebacker” (my title)

  • Druckenmiller joined Soros in 1988; while Soros enjoyed philosophy, Druckenmiller enjoyed the Steelers
  • He began as an equity analyst at Pittsburgh National Bank but due to his rapid rise through the ranks he was “prevented from mastering the tools most stock experts take for granted” (in other words, he managed to get promoted despite himself, oddly)
  • Survived crash of 1987 and made money in the days afterward
  • Under Druckenmiller, Quantum AUM leaped from $1.8B to $5B to $8.3B by the end of 1993
  • Druckenmiller stayed in touch with company executives
  • Druckenmiller relied on Robert Johnson, a currency expert at Bankers Trust, whose wife was an official at the New York Fed, for currency trade ideas; Johnson himself had once worked on the Senate banking committee and he was connected to the staff director of House Financial Services Committee member Henry Gonzalez
  • Druckenmiller was also friends with David Smick, a financial consultant with a relationship with Eddie George, the number 2 at the Bank of England during Soros and Druckenmiller’s famous shorting of the pound
  • Druckenmiller first avoided the Dot Com Bubble, then jumped aboard at the last minute, investing in “all this radioactive shit that I don’t know how to spell”; he kept jumping in and out until the bubble popped and he was left with egg on his face, ironic because part of his motivation in joining in was to avoid losing face; Druckenmiller had been under a lot of stress and Mallaby speculates that “Druckenmiller had only been able to free himself by blowing up the fund”

David Swensen & Tom Steyer – “The Yale Men”

  • Swensen is celebrated for generating $7.8B of the $14B Yale endowment fund
  • Steyer and his Farallon fund were products of Robert Rubin’s arbitrage group at Goldman Sachs; coincidence that Rubin proteges rose to prominence during the time Rubin was in the Clinton administration playing the role of Treasury secretary?
  • Between 1990 and 1997 there was not a single month in which Steyer’s fund lost money (miraculous)
  • Farallon somehow got access to a government contact in Indonesia who advised Bank Central Asia would be reprivatized soon and Farallon might be able to bid for it
  • Some rumors claimed Farallon was a front for the US government, or a Trojan horse for Liem Sioe Liong (a disgraced Indonesian business man); it is curious that Yale is connected to the CIA, Farrallon is connected to Yale

Jim Simons & Renaissance Capital – “The Codebreakers”

  • Between the end of 1989 and 2006, the flagship Medallion fund returned 39% per annum on average (the fund was named in honor of the medals Simons and James Ax had won for their work in geometry and number theory– named in honor of an honor, in other words)
  • Jim Simons had worked at the Pentagon’s secretive Institute for Defense Analyses (another possible US intelligence operative turned hedgie?)
  • Simons strategy was a computer-managed trend following system which had to be continually reconfigured due to “Commodities Corporation wannabes” crowding the trades by trending the trends
  • Simons looked to hire people who “would approach the markets as a mathematical puzzle, unconnected to the flesh and blood and bricks and mortar of a real economy” (this is distinctly different than the Graham/Buffett approach, and one wonders how this activity is actually economically valuable in a free market)
  • “The signals that we have been trading without interruption for fifteen years make no sense. Otherwise someone else would have found them.”
  • Renaissance treated employee NDAs like a wing of the CIA– anyone who joined could never work elsewhere in the financial industry afterward, and for this reason they specifically avoided hiring from Wall St in the first place; they were required to invest a fifth of their pay in the Medallion Fund and was locked up as bail payment for four years after they departed (money hostage)

David Shaw & D.E. Shaw

  • Began trading in 1988, the same year as the Medallion fund
  • Shaw was originally hired by MoStan in 1986 into their Analytical Proprietary Trading unit which aimed at beating Steinhardt at his block-trading game using predictive computer technology
  • In 1994, Shaw’s 135-member firm accounted for 5% of the daily turnover on the NYSE
  • Jeff Bezos, of Amazon, was originally a DE Shaw employee
  • The strategy was heavily reliant on pair-trade “arbitrage”, looking for securities in similar industries which were temporarily misaligned in price/multiple
  • Circle of competence: in 1995 the firm launched the ISP Juno Online, as well as FarSight, an online bank and brokerage venture

Ken Griffin & Citadel

  • Created in 1990, grew to $15B AUM and 1400 employees by 2008
  • Griffin’s goal was to develop an investment bank model that could compete with traditional, regulated ibanks, but which was actually a hedge fund
  • Flagship funds were down 55% at the end of 2008, losing $9B (the equivalent of two LTCMs)

John Paulson

  • Paulson graduated from HBS in 1980 and went to work for Bear Stearns; he launched his hedge fund in 1994 with initial capital of $2M which grew to $600M by 2003; by 2005 he was managing $4B
  • Paulson’s main strategy was capital-structure arbitrage
  • He looked for “capitalism’s weak spot”, the thing that would blow up the loudest and fastest if the economy slowed even a little; cyclical industries, too much debt, debt sliced into senior and junior tranches, risk concentrated
  • Paulson spent $2M on research related to the US mortgage industry, assembling a proprietary database of mortgage figures and statistics
  • Many of Paulson’s investors doubted him and threatened to pull capital in 2006
  • Paulson enlarged his bets against the mortgage market through derivative swaps on the ABX (a new mortgage index) and eventually acquired over $7.2B worth of swaps; a 1% decline in the ABX earned Paulson a $250M profit, in a single morning he once netted $1.25B
  • By 2007, he was up 700% net of fees, $15B in profits and made himself $3-4B


I’m actually even more bored with this book having finished typing out my notes than I was when I finished the book the first time I read it. The book actually has some great quotes in it, from the insane delusions of grandeur of government officials and central bank functionaries, to wild facts and figures about the statistical trends of the hedge fund and financial industries over the last 60 years. I am too exhausted to go back and type some of it out right here even though I kind of wish I had some of the info here even without an idea of what I’d use it for anytime soon.

My biggest takeaway from MMTG is that most of these masters of the universe have such huge paydays because they use leverage, not necessarily because they’re really good at what they do. Many of their strategies actually involve teasing out extremely small anomalies between asset prices which aren’t meaningful without leverage. And they’re almost uniformly without a meaningful and logically consistent understanding of what risk is– though many are skeptics of EMH, they seem to all see risk as volatility because volatility implies margin calls for levered traders.

There were so many displays of childish superstition. Many of these guys are chart readers. The government intelligence backgrounds of many was creepy. And it was amazing how many relied on informational asymmetries which are 100% illegal for the average investor. These people really travel in an elite, secretive world where everyone is scratching each other’s backs. How many one on one conversations have you had with central bank presidents? How many trips to foreign countries have you been on where you were the invited guest of the head dignitary of the country? Are you starting to put the picture together like I am?

Overall, it seems so arbitrary. The best word that comes to mind to describe these titans and their success is– “marginalism”. We have lived in an inflationary economy for the last 60+ years and these players all seem to excel in such an environment. But inflationism promotes marginalism; the widespread malinvestment of perpetual inflation confuses people looking to engage in real, productive economic activity, and paper shuffling necessarily becomes a high value business.

The author himself is incredibly ignorant of economic fundamentals and the role monetary intervention plays in the economy. All of the various crises these hedgies profited from seem to come out of nowhere according to his narrative. The incredible growth in volumes of money managed by the hedge fund industry over time goes without notice, as if it was just a simple, unexceptional fact of life. Shouldn’t that be interesting? WHY ARE THERE HUNDREDS OF FIRMS MANAGING TENS OF BILLIONS OF DOLLARS EACH? Where did all this money come from?!

That makes the book pretty worthless as it’s key.

One thing that does strike me is that many of the most successful, most levered trades of Soros, Druckenmiller and others were related to currencies. These guys are all Keynesians but they probably don’t fully believe their own economic theories. However, they do understand them well enough to make huge plays against the dope money managers who DO put all their credence into what they learned at university. I should think an Austrian econ-informed large cap macro fund would have quite a time of it playing against not only the dopes, but the Soroses of the world– they’ll get their final comeuppance as this system of artificial fiat exchange finally unwinds over the next decade.

And, little surprise, the guy with the nearly perfect trading record for almost a decade (Farrallon) was involved in arbitrage trades.

Trend following is for slaves. It may have proven to be a profitable strategy (with gobs of leverage) for the contemporary crop of hedgies but I feel fairly confident in saying most of these guys will get hauled out behind the woodshed in due time if they keep it up, to the extent their strategies truly are reliant on mystic chart reading and nothing more.

Bon voyage!


Notes – Gary North On Inflation, Deflation And Japan (@DrGaryNorth, #inflation, #deflation, #japan, #money)

The following notes cover Austrian economist Gary North’s views on the chances of inflation and deflation in the US and Japanese monetary systems, derived from a 5-part article series on the subject found at

Why Deflation Is Not Inevitable (Sadly), Part 1: John Exeter’s Mistake

  • Fed will attempt to stabilize money supply before hyperinflation; “mass inflation, yes; hyperinflation, no. Then deflation.”
  • Deflation will not take place unless the CB stops making new money
  • When prices fall, you are richer, but you pay no income tax on your profits (deflation is good)
  • Not-money: if you pay a commission to exchange, the asset is not truly liquid
  • Gold is a mass inflation hedge, not a deflation hedge
  • According to Exter/deflationists, gold is supposedly both an inflation hedge and a deflation hedge– the only asset possessing this virtue
  • We have never been able to test Exter’s theory of gold as a hedge against price deflation because there has never been a single year in which CPI has fallen (Q: what did gold price of Yen do in 2009 Japanese CPI decrease?)
  • Consumer price indexes should be based upon goods and services that are rapidly consumed; not price of homes and other prices of “markets for dreams”
  • Central banks inflate, they do not deflate
  • “When housing is bought on the basis of ‘I’ll get rich,’ the market begins to resemble a stock market. When it is bought on the basis of ‘I can live here for what I can rent,’ it is more like the toilet paper market”
  • The skyrocketing price of housing under Greenspan was not reflected in the CPI; the collapsing price of housing under Bernanke was not reflected in the CPI
  • Consumer prices did not fall during the 2008-09 crisis because the money supply did not fall; if the money supply shrinks, there will be price deflation; watch the monetary statistics

Why Deflation Is Not Inevitable (Sadly), Part 2: The Deflationists’ Myth of Japan

  • The money supply shrank in the US 1930-33 (Q: Why did the Fed allow money supply to shrink? Does this weaken North’s argument that the Fed will always inflate rather than deflate going forward?)
  • The US and Japan had similar CB policies until late 2008, when the Fed “went berserk”
  • Japan’s M2 was mildly inflationary from 1992-2009; CPI was slightly deflationary over the same period of time but never worse than 1% in any 12mo period; prices rose 2% 1997 and 2008
  • There has been no systemic price deflation in Japan
  • Japan is more Chicago School than Austrian
  • Statistical conclusions about Japan:
    • CPI in Japan fell little 1992-2009, no more than 1% per annum
    • BoJ did not inflate the currency to overcome systemic price deflation, because it didn’t exist
    • Collapse of Japanese RE prices did not affect CPI
    • Collapse of Japanese stock market prices did not affect CPI

Why Deflation Is Not Inevitable (Sadly), Part 3: Why Currency Withdrawals Don’t Matter

  • The Japanese economy is starting to become price competitive; this will have ramifications higher up the corporate command chain
  • Estimates of US currency held outside the United States range from 50-70%
  • Rise of credit transactions such as credit cards have minimized the role paper currency plays in everyday transactions
  • Currency withdrawals from the banking system which are not later redeposited are deflationary due to the reserve ratio mechanism
  • Monetary deflation can occur as a result of deliberate Fed policy:
    • increase legal reserve requirement
    • sell assets
    • allow bank collapse to occur by not funding FDIC with new money to offset withdrawals

Why Deflation Is Not Inevitable (Sadly), Part 4: High Bid Wins

  • All economics systems are governed by principles of:
    • supply and demand
    • high bid wins
  • The increase in the Fed’s balance sheet (monetary base) has been offset by increase in excess reserves held at banks; thus, no price increases
  • Deflationists’ claim: “Commercial banks will not start lending until the recovery is clear. The recovery is a myth. So, banks will not start lending, no matter what the FED does. The largest banks remain over-leveraged. They will not be able to find borrowers at any rate of interest, so the capital markets will collapse (except gold), and then consumer prices will fall.”
  • North’s response: “the largest banks are making money hand over fist. It is the local banks that are failing. The FED has done what it was set up to do in 1913: protect the largest banks.”
  • Inflationists’ claim: “Commercial banks will start lending when the recovery is clear. The FED will probably not contract the monetary base all the way back to August 2008, because this would bring on another crisis comparable to September 2008. The FED will not risk bankrupting the still highly leveraged megabanks. It will therefore not fully offset the decrease in excess reserves. It will not “wind down” all the way, if at all. Bernanke fears 1930—33 more than anything else. So, the money supply will rise. Prices will follow.”
  • “The increase in excess reserves has been voluntary. The bankers are afraid to lend, even to the U.S. Treasury.” (Q: Why are bankers afraid to lend, even to the Treasury?)
  • “The FED is in complete control over excess reserves. It pays banks a pittance to maintain these reserves. It is legally authorized to impose fees.”
  • Why the Fed maintains its current policy:
    • doesn’t have to sell assets
    • doesn’t have to face rising long-term interest rates due to expanding money supply
    • doesn’t have to worry about collapsing housing market as interest rates go to 25-40%
    • doesn’t face a corporate bond market collapse
  • Monitoring money supply changes is key to predicting consumer price increases

Why Deflation Is Not Inevitable (Sadly), Part 5: Conclusion

  • J Irving Weiss and his son Martin, recommended 100% T-Bills since 1967; it takes $6400 to buy what $1000 bought in 1967
  • Deflationists confuse asset prices with consumer prices
  • Deflationists believe low interest rates lead to debt build up but lower ones won’t stabilize; cost of capital can fall to zero and no one will borrow
  • This is John Maynard Keynes theory, who therefore recommended the government should borrow and spend to avoid this fate
  • There is not a shortage of borrowers today, corporate bond rates are around 6%, not 0%, implying there are people looking to borrow at positive rates of interest
  • Capital markets — markets for dreams, priced accordingly
  • Consumer prices rise comparably to increases in M1 in the US and M2 in Japan
  • Deflationists confuse money (in a bank account) with dreams (imputed asset prices in capital markets)
  • At the supermarket, prices are slowly rising in the US and slowly falling in Japan

Notes – Dying Of Money (#hyperinflation, #crisis, #money, #economics)

Dying Of Money

by Jens O. Parsson, published 1974, 2011

The collapse of a monetary regime

The following note outline was rescued from my personal document archive. The outline consists of a summary of Jen O. Parsson’s classic tale of monetary woe, Dying Of Money. Parrson catalogued two mass inflation events in modern Western history– the German post-war hyperinflation and the US monetary boom of the 1960s and 70s which culminated in the abrogation of the gold-exchange mechanism by Nixon in 1971; both are instructive for different reasons.

Dying Of Money

  1. Prologue: The German Inflation of 1914-1923
    1. The Ascent
      1. “Disastrous prosperity”
        1. old mark had been worth 23 US cents; written off at 1T old marks to one new mark at end of inflation
        2. all the marks in the world in summer of 1922 (190 billion) were not enough to buy a newspaper or tram ticket in November 1923
        3. first 90% of Reichsmark’s real value had been lost before the middle of 1922
        4. inflation cycle: gestation of 8 years, collapse of 1 year
      2. The beginning
        1. summer of 1914, Germany leaves gold standard, runs up debt, prints money in anticipation of WWI
        2. war financed through issuance of new debt (war loans) paid for with newly printed currency
        3. domestic prices slightly more than doubled by the end of the war in 1918, even though money supply increased more than 9x
        4. 1919, Germany sees violent price increases of 17x prewar level
        5. other nations, including WWI victors, stop spending and suffer recession 1920-1921; Germany continues printing and experiences a boom while prices stabilize for fifteen months between 1920 and 1921, money supply doubles again
      3. Benefits of the inflationary boom
        1. Exports thriving
        2. Hordes of foreign tourists
        3. New fortunes minted overnight
        4. Berlin becomes one of the brightest capitals in the world
        5. Great mansions of the new rich in abundance
        6. City life took on a wanton, careless manner
        7. Frugality absent as no one took time to search for real value
      4. Losers of the inflationary boom
        1. Crime rate soared
        2. Unionized workers kept up with inflation while non-unionized fell behind
        3. Salaried and white-color workers lose purchasing power even as unemployment virtually disappears
        4. Total production rose
      5. Paradoxical wealth and poverty
        1. much employment in “spurious and unproductive” pursuits
        2. paperwork and paperworkers abounded
        3. government employment grew, heavy restraints against layoffs and discharges kept redundant employees on payroll
        4. incessant labor disputes and collective bargaining consumed time and effort
        5. business failures and bankruptcies were few
        6. almost any kind of business could make money
      6. Speculative fever
        1. speculation became one of the largest activities
        2. fever to buy and sell paper titles to wealth was enormous
        3. volumes on Berlin Bourse were so high that, even with bloated back-office staff, Bourse was closed several days a week to work off the backlog
        4. capital goods and industrial construction industry experience a boom, many new factories built all while neighboring countries continued using old equipment
        5. M&A, takeovers and proxy fights in vogue
        6. massive conglomerations of non-integrated businesses took place; these businesses and the “kings of inflation” disappeared after the collapse
    2. The Descent
      1. Price increases catch-up with money printing
        1. From July 1921, prices double in next four months and increase 10x through summer of 1922
        2. consumers put on “buyer’s strikes” that are fruitless
        3. interest rates soar as lenders attempt to anticipate inflation
        4. businessmen transact in gold or constant-value clauses or foreign currency
        5. government’s budget deficits close to balance; nonetheless, government is only able to refinance existing debt through money printing
      2. Final moments
        1. July 1922, prices rise 10x in four months, 200x in 11 months
        2. near end in 1923, prices nearly quadrupling each week
        3. prices raced so far ahead of printing that the total real value of all Reichsmarks in the world was smaller than ever
      3. The end of the inflation
        1. August 1923, government of Wilhelm Cuno falls; October 1923, Gustav Streseman made chancellor, given dictatorial powers, hires Dr. Hjalmar Schacht as commissioner of new Rentenmark (“investment mark”)
        2. Rentenmark placed in circulation beside mark with the avowal that Rentenmark’s would not be inflated
        3. Germans believed it, and Rentenmarks supply was held constant
        4. November 15, 1923: final exchange rate, 1T mark: 1 Rentenmark
        5. Government budget balanced by finance minister Dr. Hans Luther
      4. The fallout of the collapse
        1. Schacht orders end of credit from Reichsbank April 7, 1924; credit squeeze ensues; price increases halt
        2. Savings destroyed
        3. Inflationary boom businesses go bankrupt
        4. Credit nearly impossible to get
        5. Unemployment temporarily skyrockets
        6. Govt spending slashed, govt workers dismissed, taxes raised
        7. Working hours increase, wages cut
        8. Millions of voters join Communist and Nazi parties in the “inflation Reichstag” of May 1924
      5. Economic recovery
        1. New elections in December 1924 erase extremist party gains
        2. business recovery based upon foreign loans due to German credit tightening; world depression of 1929 knocks debtor Germany down
    3. Gains and Losses
      1. Debtors: winners
        1. every contract or debt fixed in marks was paid off in worthless marks
        2. Germany’s total prewar mortgage indebtedness, equal to 40 billion marks or 1/6th of total German wealth, worth less than one American cent after the inflation
        3. Savers and owners of mark wealth (bank accounts, savings, insurance, bonds, notes) lose out big
        4. those who borrowed up until the last minute to buy assets turned out to be winners
      2. German Govt: winner
        1. Largest debtor
        2. Entirely relieved of crushing war debt, representing cost of war, reconstruction, reparations and deficit-financed boom
        3. beware being a creditor when the government is a huge debtor
      3. Farmers: winners
        1. always had food
        2. farms were constant values
        3. mortgages were forgiven outright
      4. Foreign owners of marks and other losers
        1. Germany made a profit of 15 billion gold marks, or 40% of annual national product, on sale of paper marks to foreigners, after deduction of reparation payments
        2. Trustees, forced by law to own fixed obligations, lost
        3. Wealthy Germans invested in marks lost
        4. Great charitable institutions wiped out
        5. Banks and insurance companies were weakened but not destroyed (they are both lenders and borrowers)
        6. Sound business survived, but in a weakened state, boom businesses wiped out
      5. Industrial stocks
        1. height of the boom, astronomical P/E ratios
        2. dividends cancelled
        3. stock prices increase 4x from February 1920-November 1921
        4. Stock market crash of December 1, 1921, in the middle of inflation
          1. prices fell by 25% and hovered for 6 mos while other prices were soaring
        5. real value of stocks decline because their prices lagged behind the price of tangible goods
          1. Entire stock of Mercedes-Benz valued at price of 327 cars
        6. near end of 1923, stocks skyrocket again as investors realize that stocks have value even when bonds do not and have a claim to underlying real value
    4. Roots of the inflation
      1. Prices contained by faith
        1. Germans and foreign investors, until 1922 and the brink of collapse, absorbed the Reichsmark
        2. faith was in the idea that an economic giant like Germany could not fail
        3. willingness to save marks kept them from being dumped immediately back into the markets
        4. realization that Germany would not back the money was the moment the dam let loose
      2. Balance of payments
        1. More cheap Reichs flowed out than hard money came in
        2. This despite constantly rising exports and constantly falling imports
        3. payment deficit actually muted price increases by keeping Reichs outside of German markets
        4. Reversal of payments deficits marked the proximity of the end
        5. in collapsing stages, Germany ran a huge payments surplus
      3. Foreign exchange rate
        1. unlike era after WWII, free and uncontrolled “float” of forex
        2. German mark almost always falling and almost always had a lower forex value than its purchasing power within Germany
        3. Thus, forex rate proved a quicker and more sensitive measure of inflation than internal prices
        4. German exports were abnormally competitive on world markets due to forex vs. internal purchasing power discrepancies
        5. Germany lost 10 billion gold marks, or 25% of a year’s national product, on underpriced exports due to inflation
    5. The Great Prosperity of 1920-1921
      1. March 1920-December 1921
        1. prices stable
        2. businesses and stock market booming
        3. exchange rate of mark against $ and other currencies rose for a time, was momentarily strongest in the world
        4. ROW enduring severe recession; Germany envy of the world
      2. Reign of finance minister Matthias Erzberger, June 1919
        1. Raised taxes on capital; real tax yield of 1920 highest of any year from beginning of war to end of inflation
        2. tight money induced for an extended period in late 1919; only time money supply stopped rising for more than a month or so
        3. March 1920, price level was 17x prices of 1914, roughly equal to increases in money supply, new equilibrium reached
        4. Price increases halted for nearly a year, real burden of war debt had been cut by 5/6ths as a result of price increases of 1919
        5. March 12, 1920, Erzeberger exits govt, disgraced after a libel suit, and his pro-inflationary rivals take over
        6. March 1920 is the month prices stop rising, but with Erzeberger’s exit, the boom prosperity begins
          1. prices remain passive
          2. exchange value of Reichsmark rises
          3. stock market rises 3x before crashing in December 1921
          4. Reichsbank doubles over next year into summer of 1921 when price increases catch up
    6. The Lessons
      1. Unrealized depreciation
        1. built upon faith in the German economy to recover
        2. built upon faith in German government to make good on debts
      2. Booms
        1. built upon increasing rates of inflation
      3. Hitler and extremists thrive in wild, inflationary conditions
        1. Hitler’s putsch was in the last and worst month of the inflation
        2. totally eclipsed when economic conditions improved
        3. took power through elections during another economic period of trouble
        4. middle class voters wiped out in the inflation moved to the extremes in polling, bolstering Hitler and others
  2. ACT ONE: The Rise of the great American Inflation
    1. The War
      1. Dollar lost 70% of its value from 1939-1973, prices rose 3.5x
      2. Seven years of WWII, Federal debt increased to $269B
        1. 1/4th greater than the annual gross product of the country at that time
        2. money supply grew by 3.5x between 1939 and 1947
        3. June of 1946, prices had increased by less than half from 1939
          1. price controls
          2. new money was absorbed by the issuance of war debt rather than bidding for consumer goods
          3. many saved money during the war for “safety” rather than spent it
          4. low money velocity resulted
        4. real value of dollar at the end of the war was 2/3rd what it had been at start of war
        5. government stopped inflating, allowed price increases to reach new equilibrium
      3. Prices controls end 1946
        1. prices double from levels in 1939 in two years
      4. Money supply held stable 1947-1950; prices remain stable as well
        1. economic recession 1949
      5. Comparisons: German war inflation vs. US war inflation
        1. American war debt of $269B, about 1.25x annual national product; Germany 153B marks, about 1.5x annual national product
        2. American monetary inflation, 3.5x; German 25x
        3. American price inflation 2x; German 17x
        4. Ratio of monetary to price increases about the same, 60%
    2. Grappling with Stability
      1. Korean War, 1950
        1. Federal budget did not run a deficit fighting the war
        2. money supply increases by 16%; prices increased 13%
      2. Eisenhower administration
        1. money supply increased 1% per year on average from 1953-1962; wholesale prices never vaired +/-1% from 1958-1964
        2. “monetary oscillations”
          1. 1953-1954, money growth <1%, recession
          2. 1954-1956, money growth 3.9%pa, boom and price inflation
          3. 1957, money supply contracts, followed by recession
          4. 1958-1959, inflation
          5. 1959-1960, contraction
          6. 1961, inflation
          7. 1962, contraction
    3. The Great Prosperity of 1962-1968
      1. intense monetary inflation beginning 1962
        1. 4.6% per annum for 43 months (through April 1966)
        2. 7.2% per annum for 27 months (January 1967-April 1969)
        3. total inflation over seven years was 38%, interrupted only by the 9month period of no expansion in 1966, accompanied by stock market collapse and economic recession by no effect on prices
        4. combined with an investment tax credit of 7% for businesses to spend on new capital assets, leading to exaggerated investment boom
        5. prices did not keep up, leading to “unrealized price inflation”, despite rising at nearly 5% per annum for the seven year period
    4. The Inflationary Syndrome
      1. economic effects from 1962-1968
        1. gross national product increased $360B, or 7% per annum, compared to 4.8% per annum during Eisenhower years of 1955-1960
        2. unemployment continually decreased
        3. stock market was almost constantly rising for more than 6 years
      2. speculative effects
        1. high stock market volumes, huge capital gains appreciation, large paper profit generation
        2. conglomeration and merger of big business
        3. most wage growth in the speculative class of paper-pushers
        4. overinvestment in capital goods
        5. IBM, Xerox (back-office service/goods companies) were the investment darlings of the era
        6. overproduction and stimulation of the growth of educational and legal industries
      3. foreign exchange and the balance of international payments
        1. current account deficits are a symptom of inflation
          1. when there is excess money in one country it flows out to other countries
          2. the currency in the inflationary country is overpriced relative to world markets, so it goes out and buys imports
        2. current account deficits reduce price inflation in the inflationary country because the currency bids up prices in foreign rather than domestic markets
        3. dollars held by foreigners returning to the US at the point that the current account turns to a surplus, would result in price inflation in the US
  3. INTERLUDE: The General Theory of Inflation
    1. Prices
      1. prices in aggregate are determined by total amount of money availble for spending in a given period of time, in relation to total supply of all values available for purchase with money in that period of time
      2. money supply defined as that which people use to buy things of value with, but which is not a thing of value itself (dollars, coins, checking account deposits)
      3. money available per unit of time, aka money velocity, also a factor, but it is hard to measure or determine
      4. price level = money quantity x money velocity / supply of all real values
      5. this is the quantity theory of money
    2. Real Values
      1. in an inflation, there are many “spurious values” which disguise and conceal the inflation of prices of real values
      2. real wealth consists of land, resources, productive plant, durable goods and people
      3. paper wealth is not real wealth; money wealth is debt, including money contracts such as bonds, mortgages, debentures, notes, loans, dposits, life insurance and pension obligations
      4. debt does not represent the direct ownership of any real assets but rather subdivision of interests in real assets with the direct owners of the assets
        1. for ex, a man is not part of the total supply of real capital as he can not be bought and sold
        2. however, if this man borrows money, he subdivides ownership of his future productive power and adds himself to the supply of capital assets
        3. if he borrowed from a bank which borrowed from a depositor, further subdivision has occured
        4. government debt represents a “lien” on the part of the productivity of all citizens
      5. this multiplication and stratification of paper wealth can be increased to many times the size of the real existing wealth
      6. paper wealth structure is all built on faith– issuance of new paper wealth does not result in an increase in real values by itself
    3. Government Debt
      1. issuance of government debt increases supply of paper wealth, meaning it is price deflationary
      2. when Fed wants to tighten money, sells govt debt into market, reducing prices
      3. large issues of government debt could not be marketed without a large increase in the supply of money beause they’d drive interest rates upward– precisely what govts don’t want; therefore, they’re almost always accompanied by money printing
      4. government surplus is price inflationary; if it is used to pay down debt, it reduces the supply of outstanding values and raises prices
      5. when faith in government debt fails, price inflationary effects will be amplified
    4. Interest
      1. lenders accepted negative real rates only because they didn’t realize what they were doing
      2. “the announced intention of Keynesian economics was to effect [the holder of money’s] extinction”
      3. the rich tend to be net debtors in an inflation
      4. inflation is paid for by the lower classes and the creditors
      5. an attack on interest results in a flight from debt to equity, from money wealth to equity/real values
    5. The Economics of Disaster
      1. occurs when the holders of money wealth revolt
      2. duller the holders of money are, the longer price inflation can be kept at bay by govt, though the greater will be the eventual breaking of the price dam
      3. desertion of money resembles a panic, sudden and unexpected
      4. people’s ability to discern real and spurious values suddenly becomes acute
      5. people flee paper assets and goods and services for known value like food and land
      6. no government causes collapse, “when at least it sees the choice, it has no choice”
  4. THE LAST ACTS: The American Prognosis
    1. Act Two, Scene One: President Nixon Begins
  1. Treasury reduces expenditures and attempts to balance budget, July 1969- June 1970
  2. Fed drops inflation rate in May of 1969 from 8%, 1yr later approx 3.8%
  3. Stock market prices fall by 14% within two months of May 1969, another year later down 31 percent; interest rates rise into spring 1970 credit crunch
  4. Approaching two year mark to next election, government begins pumping money again
    1. August 1970, budget deficit plungs to new peacetime lows
    2. money inflation of 6.5%
    3. interest rates plunge, stock market soars
  • Act Two, Scene Two: Price Controls and Other Follies
    1. worst inflation since the end of WW2 and before 1967
    2. economic boom into Nixon’s re-election in 1972
    3. boom quickly wears off
      1. stock market falls
      2. interest rates rise to surpass peaks of 1970
      3. price inflation worse than ever, around 4%
      4. cheap dollar floods world markets
    4. Nixon announces Phase I of price controls, August 15, 1971
      1. detaches dollar from gold
      2. 10% import surcharge
      3. excise taxes on automobiles removed
      4. wage and price controls
  • Self-Defense
    1. No sure safety, safety will change fluidly through an inflation
    2. Best hope is to lose as little as possible
    3. fixed money wealth/debt is the absolute worst investment in an inflation
    4. foreign money can be safe refuge only if the foreign government inflates less wildly than the domestic government
    5. the author shits on gold, but with no reason other than an arbitrary one because he is a Keynesian– gold may be overvalued during and even before and inflation but so long as people continue to think it is money, it can hold some value
    6. real estate provides a shelter for REAL value (useability/liveability/productivty of land) but could be harmed in terms of investment value in an inflation
      1. real estate held in high esteem by inflationary prosperity (luxury dwellings, overblown commercial developments) may lose more real value than other investments as they started out overpriced in the inflation
    7. farmland is a special category of real estate
      1. produces what people must have, inflation or no
      2. farmers thrive and farmland excels in dying throes of every inflation
      3. less prosperous in early stages of an inflation
    8. hoarding of useful goods is a possibility, but has large storage, distribution and opportunity costs prior to an inflation
  • Self-Defense Continued: The Stock Market
    1. stock shares are pieces of paper, but they are claims on real assets and real wealth
    2. stock market is incredibly liquid
    3. common stocks provide returns in first madness of an inflation, then fall into disrepute in middle stages of an inflation
    4. a booming stock market is not necessarily part of an economically healthy nation
      1. the opposite is truer: booming stock market is a signal of inflation
      2. falling stock market is a sign of returning to reality
    5. the stock market as a whole rises due to inflation and nothing more
    6. the stock market declines on a weakening of inflation
    7. general business conditions and price inflation operate on a lag; when money is first printed it has nowhere to “work” and goes into investment markets
      1. markets rise while business is still bad
      2. later, as money moves out of the market and into businesses, the market falls
      3. when business is worst, stock markets rise; when business is best, stock markets fall
      4. rising stock market signals nothing but fresh money inflation– it is the earliest and most sensitive signal
    8. stocks bought at any price above their real-value bottom are not a hedge against loss but a guaranteed loss
    9. conversely, stocks bought at real-value bottoms have a good chance of holding their values through an inflation
    10. American stock market’s deflated bottom in 1970 was 43% higher than deflated bottom in 1962, just as money supply in 1970 was about 43% higher than in 1962
    11. as other prices outpace stock market rises (or even stock market decreases), fear can take over that the businesses will not be worth anything; but faith will pay off with real value nearly the same at the end of an inflation
    12. stock markets can enjoy inflated gains if there are laws in place forbidding the inflationary money to bid up prices elsewhere or in foreign markets
    13. the stock market represents real value, but not every stock does
    14. inflationary times tend to reward the most valueless stocks; use a “post-inflationary eye” to have a look around at what might actually survive the inflation in terms of real value
    15. “Attempting to make profits from the stock market, or even to make sense of it, without completely understanding the universal determinant of inflation was like being at sea among uncharted rocks and shoals without so much as a tide table.”
  • A World of Nations
    1. Virtually all of the entire growth of Federal debt after 1967, $55B, was involuntarily financed and acquired by foreigners
    2. by 1973, foreigners’ holdings of liquid dollar debt had risen to $90B from $31B in 1966
    3. America exported inflation; other nations imported it– this is the balance of payments deficit
    4. natural consequence of an inflation, surplus money must flow outward looking for “cheap” items to buy abroad
    5. 100% beneficial to the deficit country
      1. import real value from abroad while exporting worthless paper
      2. price inflation domestically is partially contained
    6. central bankers began a game of printing up new local currency to exchange with the inflowing dollars, sending the dollars back to the US where they would be recycled and re-exported
    7. exchange rates operate on a time lag
      1. first, the internal price level is too low, so the new currency flows out to the rest of the world
      2. then, the internal price level rises, drawing in currency from the rest of the world
    8. the best defense against another country’s inflation, is inflation

Wall Street Mesmerized, Perplexed By “400% Man”, But Why? (#investing)

Two separate friends sent me links to an investor profile in SmartMoney magazine entitled “The 400% Man“, about a college dropout in Salt Lake City who appears to have made a killing over the last ten years following the principles of value investing.

Allan Mecham, had been posting mind-bogglingly high returns for a decade at a tiny private-investment fund called Arlington Value Management, and the Wall Streeters were considering jumping on board. For nearly two hours, they peppered him with questions. Where did he get his business background? I read a lot, he replied. Did he have an MBA? No. I dropped out of college. Did he have a clever computer model or algorithm? No, he replied. I don’t use spreadsheets much. Could the group look at some of his investment analyses? I don’t have any of those either, he said. It’s all in my head. The investors were baffled. Well, could he at least tell them where he thought the stock market was headed? “I don’t know,” Mecham replied.

When the meeting broke up, “most people left the room mystified,” says Brendan O’Brien, a New York City money manager who was there. “They were expecting to see this very sharp-dressed, fast-talking guy. They were saying, I don’t get it, I don’t understand why he wouldn’t have a view on the market, because money managers get paid to have a view on the market.” Mecham has faced this kind of befuddlement before — which is one reason he meets only rarely with potential investors. It’s tough to sell his product to an industry that’s used to something very different. After all, according to their rules, he shouldn’t even be in the business to begin with.

The fact that people were mystified by this young man’s performance should be embarrassing to Wall Street. And, not to rain on Mecham’s parade, but it really doesn’t speak to the greatness of Mecham so much as it speaks to the “mysticism” of Wall Street.

Benjamin Graham’s lessons on value investing have been available to the general public for over 70 years. Graham’s greatest disciple, Warren Buffett, is also the greatest investor of all time and one of the wealthiest individuals in the world. The story of his success has been told in countless biographies (of which little old me has managed to read two), all of which make it abundantly clear that Buffett’s time at an Ivy League graduate program likely had little to do with his destiny in the financial world. In fact, the man has railed against the Wall Street paradigm for decades himself and has explained to anyone who will listen — and they are legion! — why you can’t make money playing Wall Street’s game.

So, why is this all such a big surprise to these people?

It’s a big surprise because Wall Street isn’t broken. Wall Street is a mystical financial priesthood, just as the Federal Reserve and other central banks infesting the globe are mystical monetary priesthoods.

Wall Street doesn’t “get” value investing and is “surprised” to learn of its existence, and successful practitioners, because if Wall Street ever acknowledged that such a school of thinking existed, they’d be admitting their own inefficacy and the whole jig would be up. This is just the same as how the members of the Fed remain ignorant of the teachings of Austrian economics– to acknowledge and seek to understand them would be the beginning of the end of their nefarious charade.

The Wall Street business model is a volume-based, sales operation. It isn’t any different from television sales, automobile sales, pharmaceutical sales or insurance sales in terms of mechanics and objectives. All that’s different is the sales people are better “educated”, wear fancier clothes and work out of taller, shinier buildings. It’s a fee-based business, and the fees are generated by controlling assets and repeatedly churning them– the more you manage and the more often you turn it over, the more fees you generate and the richer you get.

Because Wall Street lives off of hyperactivity, the philosophy of patient inactivity (Buffet’s “waiting for a fat pitch”) and concentrated portfolios is, literally, blasphemous. Under such a model, your only chance at earning a return for your services is… to generate real returns for your clients! With the Wall Street model, you can get rich even as you lose your clients money. In fact, if you’re a brokerage or investment bank, you might even be able to accelerate the pace at which you enrich yourself as your client loses simply by trading more losing positions more often!

This is not an indictment of capitalism, free markets or financial exchanges, all of which are socio-economic goods with real value. This is an indictment of the Wall Street money management paradigm in relation to the tenets of value investing, a paradigm which doesn’t “work” at generating real returns for investors because it can’t– it wasn’t designed to do that!

Again, to draw comparisons to the Federal Reserve and the nature of central banking, the Fed can’t “fight inflation” and “lower unemployment” because that is not what the Fed was designed to do. The Federal Reserve CREATES inflation by issuing new fiduciary media into the economy and, with the assistance of the fractional reserve banking system, expanding the monetary base. It does this because the purpose of the Federal Reserve is to provide an alternative, “silent” tax system for the political class while easing the built-in, we-all-fall-down tensions within the fractional reserve banking system, which is the whole reason such a system requires a “lender of last resort.”

Wall Street, as a moniker for the fee-based, AUM-central “financial services” industry, delivers precisely what it was designed to deliver– lucrative pay plans and an unearned sense of superiority compared to everyone else in the economy for the specially-entitled club members and graduates of the connected institutions who populate it. It, like the banking industry and the global central bank system, operates via the herd mentality simply because those who thieve together, hang together. If you want to avoid hanging together, you must be committed to thieving together.

Defining risk as volatility, as Wall Street does, practically ensures that you’ll repeatedly expose your clients to real risk (that is, the risk of permanent capital loss) while naively trying to juggle the impossible task of managing ex post facto-determined volatility risk. Operating off of an asset accumulation/inventory churn model guarantees that your incentive structure will never be aligned with your clients, no matter how well-intentioned you might be. Government coercion in the form of mutual fund industry regulation and others provides the necessary legal muscle to prevent anyone who can think for themselves from attempting to do so.

Mecham’s closing comment is prescient:

Where does Arlington head next? Mecham says he won’t compromise his strategy to play the Wall Street game. That leaves Ben Raybould battling to market a fund, and a manager, that many other money managers can’t even understand. Mecham is bemused that so many people expect him to hold a broad basket of stocks and follow a benchmark, such as the S&P 500. “It’s laughable to think that in this competitive world, you’re going to find brilliant ideas every day,” he says. “The world’s just not set up that way.”

Exactly. And Wall Street will never manage to successfully manage risk and generate real returns for its clients– it’s just not set up that way.