The general discussion is in regards to systemic risk and how to think about extreme events.  My own biases are for the implementation of  Lo-Fi finance (low fidelity), the idea being a loosely coupled financial system is safer by design than any focus on strengthening individual components via micro-management.  

Lo-fi works on 2 levels, one is that it is the opposite of high fidelity a highly engineered system and it is based on individual units not trusting each other too much so they are more cautions.  Counter intuitively ratings agencies made things riskier.  After all nobody got fired early on for buying a AAA rated CDO tranche. 

Lower trust would have meant more independent thought.  Lo-Fi is safety at the expense of efficiency and innovation. The slow movement in finance if you will.

Instead of focusing on weak links in the chain such as specific instruments, participants or markets, I argue we should focus putting more space between the links via regulation.

If you want safer roads, don't put ever more airbags in the cars, make sure there is enough space between the cars, (more roads, fewer cars, slower speeds that sort of thing).  Yes this goes against most cultural values that push for ever greater speed and the role of the individual as independent unbounded actor. 

Glass-Steagall was an example of lo-fi finance, sub-optimal in terms of efficiency of scale but safer and thus more stable in the long run.  Lo fi would lead to more work on the analysis side of the business in smaller institutions and regulated boundaries to growth defined by either product or market niche.

The US debt outstanding is just under $12 Trillion dollars.

Roughly 43% of that debt has a maturity of less than one year according to The Economist. 

This equates to $5.16 trillion that needs to be rolled over or approximately $100 billion every week. 

If one assumes that the maturity of foreign holders is equivalent to the average maturity outstanding then the US and the world are playing a large game of chicken. 

The Treasury currently has the luxury of cheap money 3.5% on the 10 year and 4.40% on the 30 year, but can't be seen to go to far out on the curve in future issuance as it might kill the golden goose, but the rate of roll overs and amount of debt issuance is most likely to be stimulating in the next few quarters, pun intended. 

In case you are wondering about who plays the world largest game of chicken with us, here is the data from the Treasury of Foreign US Debt Holders.

I would recommend reading Nial Fergusson's The Cash Nexus to see how this game of Chicken has usually played out in the previous 300 years of debt and empire, then reach your own conclusions.

China or Japan doesn't have to sell debt to crash the price, the merely stop showing up at the auctions for a year and roughly half of the debt expires, with payments due.   As Japanese or Chinese populist it is a tough message to swallow, that you can't stimulate your own economy, because, there is some requirement to purchase more debt.

And yes Japan is in the same boat, just 20 years ahead of us.  It looks to be race to see whose bubble pops or melts first, the Japanese with a DEBT to GDP ratio of 190% or the US with a current debt to GDP ratio of roughly 80% but a legislated ratio almost 4 times that.  

He who pays the piper calls the tune and the music is starting to change.

Roubini syndrome involves being right once about a big thing and therefore attributing every utterance and opinion subject to that opinion and framework.  Having only a single mental hammer seems to have forced both men to see all problems before them as nails.   

The risk in Roubini syndrome is that of the one hit wonder pop star who slowly fades away.  Both men have more to contribute but seem bent on correcting the media with ever more shrill voices.  They have an analog version of SIWOTI syndrome which currently keeps them from more interesting and lasting contributions to thought on economics.

Take a look at Taleb's latest paper Oct 18,2009 entitled Common Errors in Interpreting the Ideas of The Black Swan and Associated Papers.

The paper's first pages are a tiresome tirade, but he has some solid points in the back end of the paper.  My own opinion is that his overly emotional rebuttals to prior rebuttals to his work cheapen his voice and muddle the waters. Don't feed the trolls.  A good idea stands the test of time and the best of ideas attract the strongest of criticisms early on before being accepted.

New paradigms are rarely acknowledged as such immediately, that is the role of fads masquarading as innovations.  History and ideas of historical note are only acknowledged correctly in the breech.

My recommendation is that the Black Swan should sink or swim in the sea of ideas.  The author needs to let it leave the nest to defend itself and fly on its own.  Ideas once submitted for consideration are no longer their author's property, but rather become a part of a useful collective consciousness or fade away.   Paradigms are a group phenomenon whether true or not.

The gifted Anish Kapoor creator of the Cloud Gate sculpture in Chicago long ago accepted that it would forever forward be known as "the bean", such it is with all creators and their creations in the public domain.

The truth while nice is not as grandiose.  Depending on whose database you follow, there are 8-12,000 hedge funds globally.  The term hedge fund itself is elastic enough to basically include anyone, who will place a bet on anything on someone else' behalf and charge 2 & 20 for the privilege.

Here is a little data.  Hedge funds success is like movie, sports etc. success in that a few do extremely well and most do fairly well.  The average (median hedgie) doesn't own or probably even lease a plane.   Note the data below most likely overstates incomes and returns due to survivorship and reporting bias which is significant in most hedge fund databases.  They are marketing tools after all.

Here is a break down using the Tass database over time.   One can see the evolution of a cottage industry paying white collar professional level salaries and then exploding.  More recent data would be interesting to see.  I have included the spreadsheet Download HedgeFund Data gogerty dot com I built for those interested in playing with assumptions behind the data.  Also note that some funds have a hurdle rate which may downplay the income more.

If anyone is interested in chatting about what makes a fund a more "successful business" drop me a line.  Getting more AUM (assets under management) is the goal of most funds. 

The magic threshold in this business is $100m AUM with +36 months of operations because these are the  levels where most institutions start looking at making allocations.   Instituional sales cycles for allocations are estimated at 9-12 months, while family offices are estimated at 12-18 months. Establishing trust takes time.

From an institutional perspective funds under the $100m AUM level are mostly noise.  As a hedge fund operator this means you chase high nets, feeders and those specialized in emerging managers etc.  which means lots of due diligence for smaller allocations. 

The business of a hedge fund is managing the investing process, managing the back office processes and sales in that order.  Growing and maintaining AUM is about establishing trust and faith in all the funds ongoing processes.  Hanging the shingle out with a sharpe ratio alone draws attention, but doesn't close the sale.

The back-office operations need to be stable and in place for real money to show up.

Return and Risk at the business level of hedge funds are as important as return and risk at the trading/allocation level of running the business.

Having top quartile risk adjusted returns is a good start.  Pros want to know about risk, ie. after verifying the apparent stability of the returns on the money, the need to verify the return of the money.  Fashions  come and go in various hedge fund sectors, but as a manager it is best to stick to your knitting.  Offering a 100/130 product for a long short value fund may work, but moving from value to convert arb is a stretch.

Mature back offices, SMA (separately managed accounts), operational stability and experience as well as lots of checks and balances are vital to the allocators due diligence process.

The more transparent all processes in a fund, the more successful it should be.  There are a few black box exceptions to this rule, but trust in process and people is vital to a funds survival.  Trust is built with more than logos with Greek columns and names that end in Capital.  Some of my favorite funds are the value based ones that put out newsletters or presentations extolling the thinking behind their positions.  Greenlight and Pershing Square are good examples of this.

Madoff was avoided by many banks who didn't understand the process he claimed to use. Acknowledging and then acting on ones ignorance is a powerful thing.  If you don't understand it move on.  "not getting it" may not be cool, but it is wise. Know thyself.

Another potential benefit of having investors understand about your funds operational and investment process is that they are more likely to stick around during tough times.  Many fund's revenue declined this year relative to previous years even though performance may have been extraordinary even adjusting for high water marks.  Redemptions reflect a lack of faith.  This lack of faith can be related to many of your funds aspects, don't make them your people or your processes.

Revenue adjusted for performance probably declined for hedges funds in 08-09 due to skittish investors who sold the "lows" of the fund.  Research into hedge funds and mutual funds shows the median investor under-performs the funds they invest in, due to buying high and selling low.

If someone doesn't have faith in your funds processes, then they are betting on your last month or quarter etc.  This isn't any way to build a stable business. 

I advocate transparency and openness wherever possible for a fund or fund of funds as it helps to retain clients.  The risk in transparency is that it shows a lot of these funds or FoF's for the smoke and mirrors marketing machines that many are.  Some black boxes in this business are black because they are full of junk, see Galleon, Madoff etc.

One could argue Buffet runs a hedge fund with an open structure that makes him immune to capital calls, this allows him to retain cash at the most interesting times and to compound returns, without having to change the rules of the game midstream such as putting up gates etc.

Running a small business, be it a hedge fund or dry cleaner is about trust and process building with employees, customers and anyone else who comes into contact with your firm.  Low trust or strong alpha male power based cultures should be avoided at all times.  Bullshit and bravado are often bedfellows that rarely build stable lasting enterprises.  As an investor I would seek funds with questioning & listening cultures rather than posing and posturing cultures.

About the charts above: my cost assumptions are for a small fund with 3 full-time employees, a basic  master feeder structure, no marketing payouts and outsourced legal, accounting and reporting functions in small office.  The incomes may be over stated by 20-40% due to high water marks, redemption flows, survivorship & reporting biases and start up costs.

In finance complex failure at the largest level is called systemic risk and it is what we are currently facing. 

How many items below relate to a recent  failure or proposed solution?  (real estate, CDS and AIG, US DEBT bubble, stimulus...) the comments in parenthesis are my opinions.  My own solution is a lo-fi finance approach.

1. Complex systems are intrinsically hazardous systems. The frequency of hazard exposure can sometimes be changed but the processes involved in the system are themselves intrinsically and irreducibly hazardous. It is the presence of these hazards that drives the creation of defenses against hazard that characterize these systems.

(Finance is nothing more than risk allocation)

2. Complex systems are heavily and successfully defended against failure. The high consequences of failure lead over time to the construction of multiple layers of defense against failure. The effect of these measures is to provide a series of shields that normally divert operations away from accidents.

(robust checks and balances need to be in place at all levels.  Innovation is frequently a form of subverting these for the sake of efficiencies (capital, tax or otherwise).   Risk eventually shows up.

3. Catastrophe requires multiple failures - single point failures are not enough. Overt catastrophic failure occurs when small, apparently innocuous failures join to create opportunity for a systemic accident. Each of these small failures is necessary to cause catastrophe but only the combination is sufficient to permit failure.

(The media reflecting audience desire seeks to identify point failures. There is rarely just a bad guy or broken part. )

4. Complex systems contain changing mixtures of failures latent within them. The complexity of these systems makes it impossible for them to run without multiple flaws being present. Because these are individually insufficient to cause failure they are regarded as minor factors during operations.

(people and organizations fail all the time.  All things fail eventually.  Systems need to allow for system failure.  To paraphrase someone else: Capitalism without failure is like religion without hell.  It doesn't really function as social tool.)

5. Complex systems run in degraded mode. A corollary to the preceding point is that complex systems run as broken systems. The system continues to function because it contains so many redundancies and because people can make it function, despite the presence

(Optimization comes at the expense of safety: 100:1 leverage or some other "innovation" may seem optimal, but may be unstable.)

6. Catastrophe is always just around the corner. The potential for catastrophic outcome is a hallmark of complex systems. It is impossible to eliminate the potential for such catastrophic failure; the potential for such failure is always present by the system’s own nature. of many flaws.

(Only the paranoid survive, find a culture or organization that is fat and happy and you will find un-acknowledged risks.)

7. Post-accident attribution accident to a ‘root cause’ is fundamentally wrong. Because overt failure requires multiple faults, there is no isolated ‘cause’ of an accident. There are multiple contributors to accidents. Each of these is necessary insufficient in itself to create an accident. Only jointly are these causes sufficient to create an accident.

(See earlier comment in regards to the media, this also applies to congressional committees, which are typically witch hunts.)

8. Hindsight biases post-accident assessments of human performance. Knowledge of the outcome makes it seem that events leading to the outcome should have appeared more salient to practitioners at the time than was actually the case. Hindsight bias remains the primary obstacle to accident investigation, especially when expert human performance is involved.

(This is the forehead slap effect, that accompanies after a bubble event.)

9. Human operators have dual roles: as producers & as defenders against failure. The system practitioners operate the system in order to produce its desired product and also work to forestall accidents. This dynamic quality of system operation, the balancing of demands for production against the possibility of incipient failure is unavoidable.

(Unfortunately positive feedback in the form of earnings, bonuses and industry recognition, amplifies this bias.  A fair assessment of skill rarely gets in the way of ego amplified by culture.  Cultures be they national, organizational or group that assume instant monetary reward directly equates to insight or skill almost always fail due to this bias.)

10. All practitioner actions are gambles. After accidents, the overt failure often appears to have been inevitable and the practitioner’s actions as blunders or deliberate willful disregard of certain impending failure. But all practitioner actions are actually gambles, that is, acts that take place in the face of uncertain outcomes. That practitioner actions are gambles appears clear after accidents; in general, post hoc analysis regards these gambles as poor ones. But the converse: that successful outcomes are also the result of gambles; is not widely appreciated.

( Few do post-mortems on successful outcomes that deviate from the norm.  These are better than post mortems on failures as  they paid for themselves.)

11. Actions at the sharp end resolve all ambiguity. Organizations are ambiguous, often intentionally, about the relationship between production targets, efficient use of resources, economy and costs of operations, and acceptable risks of low and high consequence accidents. All ambiguity is resolved by actions of practitioners at the sharp end of the system. After an accident, practitioner actions may be regarded as ‘errors’ or ‘violations’ but these evaluations are heavily biased by hindsight and ignore the other driving forces, especially production pressure.

(See CDO's, black boxes and any obfuscation.  Wall street is excellent at packaging and selling things, fairly mediocre at purchasing them.  See the mutual fund industry performance among others in these regards.)

12. Human practitioners are the adaptable element of complex systems. Practitioners and first line management actively adapt the system to maximize production and minimize accidents. These adaptations often occur on a moment by moment basis.

(wrong incentives, confusing short term motivations versus long term risks are part of the system. We need to design, organizations and regulations with this in mind.)

13. Human expertise in complex systems is constantly changing. Complex systems require substantial human expertise in their operation and management. Critical issues related to expertise arise from (1) the need to use scarce expertise as a resource for the most difficult or demanding production needs and (2) the need to develop expertise for future use.

(Expertise is a false notion in complex systems due to their changing nature.  For this reason anything seeking to "optimize a system can make it unstable.)

14. Change introduces new forms of failure. The low rate of overt accidents in reliable systems may encourage changes, especially the use of new technology, to decrease the number of low consequence but high frequency failures. These changes maybe actually create opportunities for new, low frequency but high consequence failures. Because these new, high consequence accidents occur at a low rate, multiple system changes may occur before an accident, making it hard to see the contribution of technology to the failure.

(see above and regulatory reform etc.  The law of unintended consequences runs deep in complex systems.  The ratings agencies offering stamps of approval to structured products is a classic case of this.)

15. Views of ‘cause’ limit the effectiveness of defenses against future events. Post-accident remedies for “human error” are usually predicated on obstructing activities that can “cause” accidents. These end-of-the-chain measures do little to reduce the likelihood of further accidents.

(Establishing boundary conditions etc. that assume point failure, human error (greed,stupidity and crowd blindness) need to be built in.)

16. Safety is a characteristic of systems and not of their components. Safety is an emergent property of systems; it does not reside in a person, device or department of an organization or system. Safety cannot be purchased or manufactured; it is not a feature that is separate from the other components of the system. The state of safety in any system is always dynamic; continuous systemic change insures that hazard and its management are constantly changing.

(see above large stable systems are the results of small stable systems. Consider the role of audit integrity and other sub functions of the financial system.)

17. People continuously create safety. Failure free operations are the result of activities of people who work to keep the system within the boundaries of tolerable performance. These activities are, for the most part, part of normal operations and superficially straightforward. But because system operations are never trouble free, human practitioner adaptations to changing conditions actually create safety from moment to moment.

(System participants need to look out for changes, be they over or under performance of a system normal behaviour.  Keeping an eye out for "innovation" in finance is highly recommended.)

18. Failure free operations require experience with failure. Recognizing hazard and successfully manipulating system operations to remain inside the tolerable performance boundaries requires intimate contact with failure. More robust system performance is likely to arise in systems where operators can discern the “edge of the envelope”. It also depends on providing calibration about how their actions move system performance towards or away from the edge of the envelope.

(More work needs to be done discussing multiple points of failure in a system, including the hubris or collective myopia that lead to the failure.  My own belief is that a culture or group which reflects hubris, is obsessed with over optimizing or believes that today's profit means they are "right", are the things to watch for. For quants out there: beware of geeks baring gifts.)

One of my favorite relationships is house price values relative to median income.  Houses when viewed in an ecological framework are physically constrained to a given catchment area.  The resources that keep them strong (value wise) are the available incomes in that catchment area.

Rental income to home price ratios are just a sloppy proxy for this relationship.  House value isn't a function of replacement value etc.  Detroit with its average home price of <$10,000 should make this point.  The relationship is between median incomes in an area and the price of the available homes. 

This ratio has historically been about 3:1 in the US.  Here is a video showing the US relationship over time.  The ratio was temporarily distorted by the magic of securitization, govt programs etc. but has now resorted back to its original relationship of 3:1.  Beware of unquestionable financial beliefs. The chart below came from a very useful blog called Sober Look who lifted if from Credit Suisse, who lifted it from DataStream.  

The bad news is that median income recently reported a 3.3% decline albeit looking backwards.  If this level were sustained it would indicate a further 10% decline in house values fair value. 

Another important factor to consider is that the median figure hides a likely increase in the variance of incomes and regions.  This affect the economic and value impacts on 2 axis. 

The likelihood of extreme pockets being created with continuing downward spirals such as Detroit on the geographic data axis. On the time axis the potential for the mean or median to hold over time at 3:1 would statistically indicate potential for overshoot on the downside.  In the long run things will stabilize, but a 7 year debt/asset bubble is rarely rectified in a few quarters.

The process known as the great depression had a false dawn about 2 years after the equity market decline. 

Given the consumer debt load and new found interest in a saving behavior a net contraction of 12-17% in US GDP would not be surprising to me over the next 3-5 years.

The potential for, consumer consumption declines or falling to normal (sans housing wealth effect) followed by more fiscal stimulus at the federal level still leads me to speculate we are in a dollar/ US debt bubble of significant size. 

The recent California bond auction is not a dead canary in the coal mine, but certainly a bird with labored breathing. 

The ever shortening US govt. duration (about 4 years now) is worrying. A debt maturity which needs be to rolled over at a faster pace will one day lead to ever increasing auctions.  One of those auctions will be an egg, maybe not a latvian sized egg, but an egg none the less and that failed auction will be yet another prick in yet another financial bubble.  que sera sera.

Interestingly enough the symbols of an old man and young baby are still used in western tradition with the Jan 1 New Year and we still make loud noises out of celebration.

Here is the wikipedia entry on Halloween for fellow pedants, and for those truly interested in the origins and cultural shifts in the holiday, here is a book on it Halloween: From Pagan Ritual to Party Night.

.I am going to go as a Moody's ratings Zombie (employee) walking around with a AAA stamp putting it on everything that moves :) Still have to convince my wife to follow me around dressed as a CDO dealer trying to buy everything I stamp AAA.

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.

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.

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.