UBS trading floor above in 2008 and now in 2016
I have started to develop a set of generalizations along these lines by introducing the concept of reflexivity. Reflexivity can be interpreted as a two-way feedback mechanism between the participants’ expectations and the actual course of events. The feedback may be positive or negative. Negative feedback serves to correct the participants’ misjudgments and misconceptions and brings their views closer to the actual state of affairs until, in an extreme case, they actually correspond to each other. In a positive feedback a distortion in the participants’ view causes mispricing in financial markets, which in turn affects the so-called fundamentals in a self-reinforcing fashion, driving the participants’ views and the actual state of affairs ever further apart. What renders the outcome uncertain is that a positive feedback cannot go on forever, yet the exact point at which it turns negative is inherently unpredictable. Such initially self-reinforcing but eventually self-defeating, boom-bust processes are just as characteristic of financial markets as the tendency towards equilibrium.
Instead of a universal and timeless tendency towards equilibrium, equilibrium turns out to be an extreme case of negative feedback. At the other extreme, positive feedback produces bubbles. Bubbles have two components: a trend that prevails in reality and a misconception relating to that trend. The trend that most commonly causes a bubble is the easy availability of credit and the most common misconception is that the availability of credit does not affect the value of the collateral. Of course it does, as we have seen in the recent housing bubble. But that’s not sufficient to fully explain the course of events.
I have formulated a specific hypothesis for the crash of 2008 which holds that it was the result of a “super-bubble” that started forming in 1980 when Ronald Reagan became President of the United States and Margaret Thatcher was Prime Minister of the United Kingdom. The prevailing trend in the super-bubble was also the ever-increasing use of credit and leverage; but the misconception was different. It was the belief that markets correct their own excesses. Reagan called it the “magic of the marketplace”; I call it market fundamentalism. Since it was a misconception, it gave rise to bubbles.
After buying Apple during the depths of the Tech Bubble Bust in 2003 around $6.94, I recently had to sell about ten years later around $700 for a compound annual return over 10 years of 58.5%. Eat your heart out Munger, Buffett, Soros, Graham, Tudor Jones, etc., etc.
And now what?
Ok, Ok, I live in fantasy. A friend recently said that he wished he had sold his Apple after buying it last year. Coulda, shoulda, woulda doesn’t advance your skills as an investor. What can we learn A Priori (before the fact) to help us as investors in finding and or managing our investments? What lessons can be gleaned from Apple’s history? In Part 2: We will begin to prepare our case study file on Apple.
James Grant argued for a return to the classical gold standard at the New York Federal Reserve. Note Grant’s command of financial and economic history. He references several books which you might find of interest. The beauty and purpose of the gold standard is that it takes monetary policy out of the control of moneyed elites and allows the market to work. Critics will say that the nation had recurring booms and busts while on the classical gold standard, but they may be confusing the chaos of fractional reserve banking (being able to pyramid loans on top of deposits with fiduciary media) with the classical gold standard (the citizenry is able to convert currency into a fixed amount of gold).
Grant’s Speech to the New York Federal Reserve
My annotated copy is here:James Grant Speech on Gold and the FED April 2012
Another excellent critique of the Federal Reserve is Robert Wenzel’s speech on April 25th, 2012 http://www.mises.org/daily/6028/New-York-Fed-Leave-the-Building.
An excerpt: I simply do not understand most of the thinking that goes on here at the Fed, and I do not understand how this thinking can go on when in my view it smacks up against reality.
Please allow me to begin with methodology. I hold the view developed by such great economic thinkers as Ludwig von Mises, Friedrich Hayek, and Murray Rothbard that there are no constants in the science of economics similar to those in the physical sciences.
In the science of physics, we know that water freezes at 32 degrees. We can predict with immense accuracy exactly how far a rocket ship will travel filled with 500 gallons of fuel. There is preciseness because there are constants, which do not change and upon which equations can be constructed.
There are no such constants in the field of economics, because the science of economics deals with human action, which can change at any time. If potato prices remain the same for 10 weeks, it does not mean they will be the same the following day. I defy anyone in this room to provide me with a constant in the field of economics that has the same unchanging constancy that exists in the fields of physics or chemistry.
And yet, in paper after paper here at the Federal Reserve, I see equations built as though constants do exist. It is as if one were to assume a constant relationship existed between interest rates here and in Russia and throughout the world, and create equations based on this belief and then attempt to trade based on these equations. That was tried and the result was the blow up of the fund Long Term Capital Management — a blow up that resulted in high-level meetings in this very building.
It is as if traders assumed a given default rate was constant for subprime mortgage paper and traded on that belief. Only to see it blow up in their faces, as it did, again, with intense meetings being held in this very building.
Yet, the equations, assuming constants, continue to be published in papers throughout the Fed system. I scratch my head.
The Origins of the Federal Reserve by Murray N. Rothbard (128 pages) http://library.mises.org/books/Murray%20N%20Rothbard/The%20Origins%20of%20the%20Federal%20Reserve.pdf
If you read and understand the above articles and book, you will have a good inkling of why the rich become richer and the poor become poorer.
The three biggest achievements of the Cuban revolution are health, education, and low infant-mortality rates, and that its three biggest failures are breakfast, lunch, and dinner. — Government Worker, Habana, Cuba.
Last week, I promised the greatest business analysis ever done. See here: http://wp.me/p1PgpH-cs
A reader, Logan, gave a strong hint for the solution. Before I post the answer, let’s try another question.
Use Munger’s multidisciplinary thinking or Professor Greenwald’s strategic logic to find an answer to the following problem: The Cuban dictatorship collapses and property rights are restored. You have been given the job to develop a business in Cuba with barriers to entry. You must build a business with the strongest combination of competitive advantages. What business would you choose, why and how would you build barriers to entry? How many advantages can you design for development? If you come up with a sensible plan, you will be given $5 million to start.
Two hints: the business can not be involved in cigars or tourism (like hotels or restaurants). A reading of Cuban business history would lead you to an answer, but I presume many have little knowledge of that history.
Tip: A great way to learn about businesses is to read corporate history or the biographies of business leaders. You will sense how a business grows and develops advantages or loses them.
What are the markets telling us? Deflation has gold and commodities selling off? I don’t think so. Never predict, but here goes………The Fed and the ECB both have the ability to print money and exchange good collateral for bad collateral with banks. What do central banks know how to do? What motivates central bankers? What are the monetary aggregates telling us?
The dollar is weak: http://scottgrannis.blogspot.com/2011/12/dollar-is-still-very-weak.html#links
Keeping an eye on longer-term investors: Insiders are long-term bullish. http://www.marketwatch.com/story/those-bullish-corporate-insiders-2011-12-07
How do we place facts into context? A rap video of Hayek (Austrian Economist) vs. Keynes (An Interventionist)http://www.youtube.com/watch?v=d0nERTFo-Sk
Bernanke vs. the Austrians during the housing bubble:http://www.youtube.com/watch?feature=player_embedded&v=MnekzRuu8wo
What confidence do you have in Bernanke’s planning ability or in bureaucrats controlling our monetary system?
Note the unusual bond yields.http://scottgrannis.blogspot.com/2011/12/bond-yields-are-out-of-whack.html
MF Global is an example of our Ponzi financial system in action: http://lewrockwell.com/french/french143.html
Murray Rothbard wrote, “If no business firm can be insured, then an industry consisting of hundreds of insolvent (banks) firms is surely the last institution about which anyone can mention ‘insurance’ with a straight face. ‘Deposit insurance’ is simply a fraudulent racket, and a cruel one at that, since it may plunder the life savings and the money stock of the entire public.”
The videos below reinforce the need to read original documents or to speak to people who are actually involved in an industry or sent to war rather than believing our press. Excuse the political connotations.
A savage spoof of the media and our government that hits closer to the truth than I would like! Hitler reacts to Ron Paul’s Rise in the Polls: http://www.youtube.com/watch?src_vid=fFbc3sHl3Ic&annotation_id=annotation_162843&feature=iv&v=5ScPXDRcIfc
War and the importance of understanding history: http://www.youtube.com/watch?v=I8NhRPo0WAo&feature=youtu.be Note that many against war are the folks who actually have experienced it.
A podcast on finding opportunity: http://www.economicpolicyjournal.com/search/label/The%20Robert%20Wenzel%20Show Scroll down to the second or third show.
Adapt or Die: Be Creative and Sell your Skills http://www.lewrockwell.com/north/north1073.html
Old (2007) but detailed Longleaf Interview: http://www.palmerstongroup.com/articles/2007july/interview.html
Interesting Blog from a former Wall Streeter: Reading Fiction will Make You a Better Investor: http://interloping.com/
Have a great day and weekend.
Time off from the hurly-burly of the markets….
I am reading the abridged version (1250 pages) of The Decline and Fall of the Roman Empire by Edward Gibbon published in 1776 which is a long, sad commentary on the history of a nation that gave up political liberty to become a superpower. Gibbon’s work is considered one of the greatest works on history ever written in the English language.
My brief synopsis
Plenty of lessons to be learned by America in the 21st century. Giving up your liberties for security brings neither.
If you study history or companies, always seek to read original documents. Read the actual speeches, the annual reports, the proxies rather than rely on what a reporter, analyst or your history teacher says about a historical event or company. Read for yourself. Note in a prior post, http://csinvesting.org/2011/09/21/learning-the-importance-of-studying-history/ Buffett studied the Great Depression by sitting in the Columbia Business School library reading through the newspapers of that period including the ads!
I learned in ninth-grade American history class that the American Civil
War (1861-1865) was started over the issue of slavery. As a good little boy, I
regurgitated back the facts and received an A in history. Twenty years later, I became a fanatical Civil War buff and perused everything I could on that period. What I learned shocked me; I was bamboozled as a kid. I was not taught the true reason for the start of the Civil War which led to about 650,000 killed and millions more maimed. The Civil War was one of the defining historical events in U.S. history and its effects linger to this day.
Read Lincoln’s First Inaugural Address at the link below:
If you were living in any of the southern states in 1861 and you read or
heard Lincoln’s speech, what would you think and feel? Remember that the Southern states were primarily exporters of cotton and other agricultural goods to the Northern states and Europe. What then started the Civil War? As history teaches over and over again, once war erupts, ending war is difficult.
I place my interpretation below along with historical context, but do not
read it until you form your own opinions based on the document you have read. Where do you disagree with my interpretations?
Defense of Slavery
The first point President Lincoln made was to defy anyone to find any evidence in any of his speeches or statements that he ever had any intention at all to disturb Southern slavery. He pledged his undying support for the protection of southern slavery, and said that it would be criminal
of him to not do so. In his own words, he quoted from an old speech of his: “I
have no purpose, directly or indirectly, to interfere with the institution of
slavery in the States where it exists. I believe I have no lawful right to do
so, and I have no inclination to do so.”
Furthermore, he said, the Republican Party was certainly aware that he did not favor interfering with Southern slavery when it nominated him. “Those who nominated and elected me did so with full knowledge that I had made this and many similar declarations and had never recanted them.”
To make the point even more forcefully, Lincoln quoted the Republican Party Platform plank which pledged the defense of southern slavery: “Resolved, That the maintenance inviolate of the rights of the States, and especially the right of each State to order and control its own domestic institutions according to its own judgment exclusively, is essential . . . and we do denounce the lawless invasion by armed force of the soil of any State or Territory, no matter what pretext,
as among the gravest of crimes” (emphasis added). “Domestic
institutions,” of course, meant slavery.
“I now reiterate these statements,” Lincoln then announced to the world. He next pledged his “cheerful” enforcement of the constitutional protection of slavery, including the Fugitive Slave Act. He mentioned that all members of Congress swore an oath to obey the Constitution, which included the Fugitive Slave Clause, and proposed that a law be passed to further codify the responsibility of the federal government to see to it that runaway slaves were “delivered up” to their owners, as he put it. Such a law, he said, would command
unanimous support. (Keep in mind that, on the day of Lincoln’s first
inauguration, the seven states of the lower south had seceded and their
senators and representatives had left Washington). The overwhelming majority of Congress was composed of northerners who, Lincoln was sure, would unanimously support the stronger enforcement of the Fugitive Slave Clause.
Indeed, just two days earlier the Northern-dominated U.S. Senate passed a proposed constitutional amendment that would have forbidden the federal government from ever interfering with Southern slavery. This “first thirteenth amendment” read: “No amendment shall be made to the Constitution which will authorize or give to Congress the power to abolish or interfere, within any State, with the domestic institutions thereof, including that of persons held to labor or service by the laws of said State’ (U.S. House of Representatives, 106th Congress,
2nd Session, The Constitution of the United States of America: Unratified Amendments, Document No. 106-214, presented by Congressman Henry Hyde (Washington, D.C.: U.S. Government Printing Office, January 31, 2000).
This amendment had passed the Northern-dominated House of Representatives on February 28, 1861. Two days after the amendment passed the Senate; Lincoln pledged his support for it in his first inaugural address: “I understand a proposed amendment to the Constitution . . . has passed Congress, to the effect that the Federal Government shall never interfere with the domestic institutions of the States, including that of persons held to service. To avoid misconstruction of what I have said, I depart from my purpose, not to speak of particular amendments, so far as to say that, holding such a provision to now be implied constitutional law, I have no objection to its being made express and irrevocable” (emphasis added). Coming from the president of the
United States, this was a much stronger defense of slavery than was ever made by John C. Calhoun or any other southerner.
Higher Tariffs Imposed
On the same day that the U.S. Senate passed this “first thirteenth amendment,” President James Buchanan signed into law the Morrill Tariff, which more than doubled the average tariff rate. The U.S. House of Representatives had passed the bill during the 1859—60 session, long before Lincoln’s election or the secession of any southern state. It received only one vote from a congressman from one of the states that would eventually secede (Tennessee).
Lincoln was a protectionist for all of his political life; he owed his nomination to Pennsylvania protectionists; told a Pittsburgh audience two weeks before his inaugural that no issue — none — is more important to Congress than raising the tariff rate; and would further raise the tariff rate ten times during his administration. He was also aware that the last time the Whigs — which by then had been politically morphed into Republicans — attempted to double the average tariff rates, South Carolinians nullified the tariff, refused to collect it, and forced President Andrew Jackson to compromise and lower the hated 1828 “Tariff of Abominations.” Lincoln, however, was not about to back down as Andrew Jackson had done. On the issue of slavery, he was one hundred percent accommodating, even going so far as to support the enshrinement of southern slavery explicitly in the Constitution. But on the issue of tax collection he was one hundred percent uncompromising. “Pay up or die,” he essentially told the South. Not in these exact words, but any Southerner might have taken that meaning.
Here’s what he actually said: “[T]here needs to be no bloodshed or
violence, and there shall be none unless it be forced upon the national authority.” And how might it be “forced”? Failure on the part of any state to collect the newly doubled tariff, that’s how. After stating that he assumed the power to “possess the property and places belonging to the Government,” he said he was also obligated “to collect the duties and imposts; but beyond what may be necessary for these objects, there will be no invasion, no using force against or among the people anywhere.”
The Confederates had offered to pay for any federal property on southern soil (federal forts were there for their protection anyway), as well as their share of the federal debt. Lincoln refused to even discuss this with them. Fully 95 percent of all federal revenue came from tariffs in 1860, and with the southern states seceding a large portion of that amount would go uncollected. The seceded states were not about to send any checks to Washington, D.C. Fail to pay the doubled tariff tax, Lincoln said, and there will be an invasion. He would not back down to the South Carolina tax resisters, as Andrew Jackson did. (Two weeks after Fort Sumter, where no one was wounded or killed, Lincoln announced a naval blockade of the southern ports and gave only one reason for it: tariff collection).
Compared to Today
This would be the equivalent of President Obama saying, “My fellow Americans, we have decided to double everyone’s federal income tax rate. And if you refuse to pay, federal soldiers will be sent en mass to make you pay, burning out your homes and destroying your cities, towns, business and farms if necessary.” The south refused to pay, and Lincoln kept his word, launching a full-scale invasion of all the southern states and waging total war on them for four years, eventually killing 300,000 of them out of a population of approximately 9 million. This was three percent of the southern population. Standardizing for today’s population of
roughly 300 million that would be the equivalent of 8,800,000 American deaths.
States Joined the Union Voluntarily, But Forced to be in Perpetual Union?
Lincoln proclaimed that the Union, which he always spelled with capital letters, was “mystic.” This was a surprise to most Americans at the time, who believed that the union was voluntary and not mystical and perpetual. Indeed, when the Constitution replaced the Articles of Confederation and Perpetual Union the words “perpetual union” were dropped and appear nowhere in the Constitution. This sudden insistence on keeping the union, which was in reality a compact of the free, independent, and sovereign states, intact at any price, only makes sense in light of Lincoln’s statements and actions regarding the tariff. Slavery was
more secure in the union than out of it, as both the abolitionist William Lloyd
Garrison and Confederate Vice President Alexander Stephens publicly admitted.
But the union needed to be kept intact if sufficient taxes were to be collected for success of the Republican Party in fulfilling is 1860 Platform promise of massive corporate welfare spending on the railroad corporations and road-building companies (“internal improvements”). Without southern tariff collection this
could not be accomplished. Worse yet, the Confederate Constitution had outlawed protectionist tariffs altogether, creating a free-trade zone in the South. Much of the commerce of the world would have been diverted from Northern to Southern ports, which is why Republican Party-affiliated newspapers were calling for the bombardment of southern ports before Fort Sumter. Abraham Lincoln’s political career would have been ruined, and that was just unacceptable.
Is Lincoln’s legacy drenched in blood?