Designing better futures

Don't trust your senses they can make things disappear: the Troxler effect and change blindness.

Stare at the red dot in the center of the figure for a minute or two. Before long, the green ring will disappear--it simply seems to fade into the white background. There are no tricks: This is a simple, static image file. The effect has been known for more than two centuries and is named for its discoverer, Ignaz Paul Vital Troxler (1780-1866), a Swiss physician and philosopher. "Troxler fading" is actually related to what you experience when you get "dizzy": You become so habituated to a phenomenon (spinning in a circle or seeing a green ring in your peripheral vision) that you stop noticing it's there.

Or, rather, you don't realize that your perceptual system has begun actively ignoring it. It's only when your circumstances change that you see what the phenomenon has done to your perceptual system. When you stop spinning, the world seems to continue, in reverse. When you look away from the green ring, you see a red ring in the same part of your visual field.  From the excellent blog Cognitive Daily.

Something similar to this happens in Media, if we don't hear about it is assumed to have gone away.  In many areas of risk, there are risks, I refer to as Oxygen risks, ie things that are so common and pervasive in the environment that we only notice their absence.  Liquidity and the efficacy of a Triple AAA rating used to be like that.  Flawed or un-considered assumptions due to unchanging environmental factors.

If that green circle doesn't mess with you check out the Change Blindness video. again Courtesy of Cognitive Daily.

Good Senate Risk Commentary you may have missed

Nassim in some more focused presesntations before congress. Comments on Stimulus and free markets: Ht: Rocky Chen

Here is Rick Bookstabers Testimony on VaR, which is a very good introductory read.

My own opinion is that the best way to measure financial risk is to assume it is a function of concentration of opinion or belief. The more people, models, institutions etc. all believe the same thing to be true the greater the risk.

There is no "truth" in finance it is a social phenomenon, not a physical reality like physics, the laws of economics are plastic. Homogeneity in opinion leads to homogeneity in action and reaction.

It isn't the models, ratings agencies, regulators, traders or banks that cause financial catastrophes it is the fact that sometimes their opinions through mania, legislation or fate all converge leading to mania, panics and crashes.

Concentrations of opinion/belief are a form of collective myopia that is part of the human condition. We are social, we group, agree, act and propagate risk. The bubbles, actors and rationalizations change, but the ultimate causes of risk don't, we are all too human.

My own opinion is that the greatest current systemic risks outstanding are:

The dollar as safe currency, example last years lesson via the flight to quality leads to the maginot line behavior of today as the USD is now the darling of the carry trade.

Basel II implementations leading to a "unified" framework for global banking risk.

A nutritious way to learn about economics & politics.

The best way to invest is to arm oneself with information and perspective. Sadly many make the mistake of developing the wrong taste for financial information, preferring junk food to more quality fare.  True financial acumen comes from cultivating a proper palate for economic information.

Being a financial information connoisseur isn’t about being a snob or an effete aesthete as many contemporary observers would have you believe, rather it is about having cultivated a sensibility and taste for only the best information in the appropriate doses and from the appropriate sources, judiciously applied at the right time providing the ability to act uniquely and effectively.

Life is too short and precious to spend consuming the junk food swill that is mostly on offer from CNBC which has qualities associated with an all you can eat Vegas buffet. 

CNBC and FoxBusiness are currently fighting a losing battle to the bottom for TV market share.  The weapons of choice are female eye candy, gaudy graphics and sophomoric shouting matches strongly advocating buying low and selling high.  These tactics endear CNBC and FoxBusiness to neither serious money managers nor the public according to the latest ratings. 

One can only guess that the latest policy initiatives must have the producers rubbing their hands with glee, for without them, there is little to kick and scream about in the world of business. 

Pete and Bob from Nebraska don’t heat up the broker’s phone upon learning that the TED spread has returned to 2004 levels as has recently happened.  They wait for Cramer to hit a buzzer or yell "back up the truck", for that is surely the time for action.

One could argue that real actionable business news and or thoughtful journalism is truly a limited market and that when the current financial storm blows over the ratings and associated networks will wash out with the tide like so much flotsam and jetsam.   

FoxBusiness latest reported viewership was around 21k and CNBC’s was around 250k.  As media business models go this looks like the weak chasing the sickly in a rather sad affair akin two carnies fighting over cigarette butts.

Many investors and money managers are certain that an “edge” is to be had by literally being milliseconds ahead of the competition.  Unless you are a high frequency algorithmic trader or former Flash Trader/thug this is most likely untrue.

Perspective and sound judgment are more important than the latest information hit or tip.  The big money doesn’t move in milliseconds its movements are measured in weeks, months and years. 

One’s information diet should be proportionately adjusted to the task at hand.  An investor ie. someone with a horizon longer than a thinly sliced twitter tip should consider a well rounded diet of information for perspective. 

If you are investing for the next 20 years you may wish to look back over 100 years to understand what is going on, for there is a 1:5 chance you will be up against a 100 year storm.

Many investor diets are sadly deficient in historical, political and international perspective.  Assumptions about equities or debt based on 30 years of history or a single countries returns are hardly akin to an understanding of how political economy or market forces truly work. 

Listening to such people and their homilies is akin to seeking restaurant suggestions from someone who lives on Cheez whiz and Wonderbread sandwiches.  Sadly, most retail brokers and other  financial “professionals” exemplify this condition.

I am not advocating a more robust financial diet to help one predict the market, but rather to avoid panicking or over allocating to it in the first place.  A well fed/read investor acknowledges and appreciates the foolishness of market predictions and other off handed punditry.  They also eschew those who offer such morsels of advice.

The Cash Nexus by Niall Ferguson is a fantastic baseline with which gain to perspective and makes an excellent pairing with Kindelberger’s Mania’s, Panics & Crashes. 

You may not think what happened to the Ottoman or Hapsburg Empires or their debt levels is relevant to you, but it is.  You live and act in a political and economic machine. Its fiscal health could determine your own physical health going forward. 

This political economic machine (country) you live in is mostly similar to others that have gone before it. Over the centuries  the roles of politics, economics, debt, taxes and war are the same, only the actors names have changed. 

Almost every person in every period has thought they were exceptional and unique. History has a way of showing these assumption to be mostly wrong.  Ethnocentrism and an inflated sense of one’s self or one’s cultural period’s importance appears to be a part of the human condition.

Imagine someone claiming to be a biologist who had studied a single specimen for a portion of its life.  Now imagine that specimen was his/her own pet.  That person might be considered to have a rather limited expertise and some narrowly biased opinions.

Most economic journalists are just such persons, who are somewhat aware of 10-25 years of their own economies ups and downs.  This isn’t significant as most real reportage does not require depth of knowledge, merely the reporting of fact. But once journalism slips from reporting into punditry, analysis or debate, one requires a bit of expertise and depth. 

This is where most of today’s video business journalism falls apart.  Serious lack of depth during the commentary is made up for with sophomoric emotional zeal and cheap video effects in an effort to sell more cars, Viagra and hope to the mostly older white male clientele who watch.

My suggestion for those seeking to become investors is to remove the junk video from your diet and replace it with a few carefully selected books or blogs.  As a fellow who hasn’t owned a TV in 20 years here is the book suggestion,The Cash Nexus by Niall Ferguson.

The Cash Nexus is broken into 4 sections covering, “Money and Power in the Modern World 1700-2000”

1. Spending and Taxation
2. Promises to Pay  “i.e.public debt”
3. Economic Politics
4. Global Power

If one is serious about investing, then one should study and understand the game that is economic politics.  Money/economy is a useful collectively shared political fiction, i.e.  a created social convention, not a physical reality or science. 

Studying money/economy  as a cultural behavioural belief system with many historical precedents allows one to see how others have built and lost empires with the tools of politics, central banks, war, taxes and debt.  The Cash Nexus is an excellent introduction and provides deep  sampling of many economic issues, bubbles and behaviors which were all “different this time” to their participants, but strikingly similar in retrospect.

If this book were a wine it would be heavy and complicated, not as dry as an academic paper, but rather robust and hearty, best consumed over a few meals and then revisited from time to time for further appreciation. 

If you wish to become an economic information connoisseur you may find you have to make time by giving up CNBC etc. Most TV information sources are the sommeliers equivalent of a sickeningly sweet White Zinfandel, best suited for clueless relatives, teenagers or unwanted house guests.

A few samples from The Cash Nexus:

Major Western country bond yields from 1700-1999 have averaged 5-6% with one of the more interesting spikes occurring in the early 1970’s.  This includes the US only back to 1804.  The biggest decline in yields since 1700 for the UK was in 1998. Pg  177

Interestingly the relationship between debt markets is more related to politics than economics.  The rise of the Napoleonic empire is quite interesting when seen through the eyes of the French bond market, whether it be the Crimean, Prussian or other wars.  This may seem pedantic, but interesting to know the next time a blaring “war/terror” event hits the news.  The debt investor needs to know the difference between panic as a considered and wise allocation move and “a panic” which could be a buying opportunity in sovereign debts.

Tom Freidman aside, Globalisation is modern in the sense that it has been going on for hundreds of years. 

In 1890 British foreign investment was 9.3% of GNP  a level not surpassed until the 1990’s. On the eve of the first world war 1/4^th of the World’s population 444m people lived under some form of British rule. Pg 278.

Merchandise exports were 27% of GDP in the UK in 1870. Pg 294

The Ottoman Empire got into trouble when debt went from 130% of GNP to 1,500% of GNP leading to Turkish bankruptcy in 1874.  Pg 280.

Current US debt estimated at $11 Trillion (dis-regarding future liabilities) would be about 78% of GNP, serious concern and action is in order but not outright panic.  Getting into the Euro required a governments debt to be below 60% of GDP.  Current global debt is 64% of Gross World Product.

There is a great table on bond risk premiums for (Brazil, Chile, Mexico, Egypt, Japan, Argentina)  on page 284.  The dates range from 1850-1993, the concept of debt and risk isn’t new and neither are global capital flows.

The US was a net creditor from 1914-1918 (9% of GNP) and by some measures represented the peak of international lending and capital outflows.  Pg.288

In terms of globalization and contagion, 1931 saw national defaults by Turkey, China, most of Eastern Europe and all of Latin America. Pg 289

Global Merchandise exports as a function of GDP were 9% in 1913. In 1990 they were 13% of global GDP.  Foreign assets were 18% of world GDP in 1913. Pg 291  This is in contrast to an era in 1997 when 144 countries had capital controls according to the IMF. 

We were so much more global then in some ways.

Net Emigration from the UK between 1881-1890 was 7% of the entire population. 

The decade from 1900-1910 saw US immigration peak at 10% of population a level not matched since. In 1990 it was 2.2% Pg 292-294 The equivalent today would be about 30m people showing up in 10 years.

A great chart showing the UK equity risk premium vs. bonds from 1700-1999 shows it ranging from -5% to 10% with an average of about 1%. Pg 303.

There is a great discussion about the rise of government debt markets in Venice and the Netherlands in the period from 1600-1800 and how this allowed for growth in war and trade. Pg 305-312

The famous South Sea and Mississippi Bubbles and the remarkable story of John Law is briefly introduced.  This is the bubble that suckered Sir Isaac Newton in twice. Pg 312-315.   I wish they would make a movie about this as it is a truly incredible story, something along the lines of Stanley Kubrick’s masterpiece Barry Lyndon(youtube)  would be good.

For those who believe Goldman Sachs owns the treasury, consider the following.

The bank of England was owned by the Whig Party in 1694 and the South Sea company was owned by the Tory party in 1711. That is some great crony capitalism and amazing intrigue. 

In 1720 the South Sea Company offered to take over the Entire UK National Debt.  Pg. 316.  And we think we live in interesting times.  Perhaps America should put all its debt on a credit card and then take a vacation with the air miles earned, or perhaps one of the esteemed political parties would like to take on the national debt, it would provide an interesting degree of accountability.

A brilliant quote from Financial journalist Anatole Kaletsky  in 1999 “The entire US economy has in effect become a sort of gigantic investment fund, borrowing money cheaply from financially unsophisticated foreigners (especially the Japanese) and then reaping the profits for investing it more imaginatively in riskier ventures at home and abroad.”   The 18^th century suggests that a shift in sentiment of foreign investors could have dire consequences.  Pg. 318

A great table showing average global inflation defined as the annual mean of the GDP deflator between 1871-1938 as 0.2-1.2%.  Under Bretton Woods (1946-1970) it was 7.3%. Under floating regimes the global average of inflation from 1974-1990 was 19%. Pg 330.

 This presentation of data as averages is suspect but interesting to me nonetheless.

The book is The Cash Nexus by Niall Ferguson. I don't want to tout the book more but rather the experience that may come from digesting and appreciating it.

On a personal note I consider gold an interesting place for cash allocation right now with a 3 year time horizon and an estimated 2:1 risk reward ratio $600 sell, $1,800 upside.  Gold is a horrible investment as it has a long term negative real yield, but as a hiding place from a weakened dollar it may work well. 

Knowing history means I don’t consider gold as a serious long term investment. Knowing history also means I trust politicians with urgent fiscal problems, a willing market and a printing press even less.