Berkshire Hathaway's Texas CEOs say Buffett manages by not managing

Thanks to Matt for passing this along.

Warren Buffett is one of the nation's most successful businessmen. So what's his key to managing Berkshire Hathaway, a corporation that operates 80 businesses with annual revenue of more than $140 billion?

Not managing, according to four Fort Worth executives who work for him.

The top executives at BNSF Railway, Justin Boots, Acme Brick and TTI came together Wednesday to share stories about the Oracle of Omaha before 550 people at a Fort Worth Chamber of Commerce breakfast.

New debt forecasts dash Greece hopes

The magnitude of Greece’s fiscal challenge was painted in sharp relief yesterday as Athens unveiled new budget projections exceeding the worst-case scenarios envisioned by international lenders when they agreed an €174bn rescue eight months ago.

Instead of Greece’s debt peaking at 167 per cent of economic output next year, as predicted in the March bailout agreement, it will hit 189 per cent and climb to 192 per cent in 2014, according to projections presented to the Greek parliament.

Even under an “alternate scenario” prepared by the International Monetary Fund in March, which attempted to project a pessimistic economic and fiscal picture, Greece’s debt was only predicted to peak at 171 per cent of gross domestic product.

The new projections all but dash hopes Greek debt would come down to 120 per cent of GDP by 2020 – once held out as the standard for a manageable debt load – and senior EU officials acknowledged they may have to give Athens more leeway to hit that target under a revised rescue currently being negotiated.

Howard Marks Interview

Found via the Corner of Berkshire & Fairfax.

What is your secret sauce?

No. 1, it's possible, especially in inefficient markets, to gain a knowledge advantage. By definition, an inefficient market is one where hard work and skill can pay off. We can also control our psyche and emotions so that we don't make the human mistakes that are so common. Of course the other thing is we have a philosophy of controlling risk. So that doesn't necessarily make us the winner rather than the loser in the transaction, but it increases the probability that we engage in transactions of the sort that we and our clients want.

Does that mean you're not always swinging for the fences?

We're rarely, if ever, swinging for the fences. We think a high batting average rather than home runs is more important, and the clients who come to us want that.

Charlie Rose Talks to Jeremy Grantham

So what will you do next year with all that money you manage?

I am going to be careful, particularly for the first half of next year. Great brands of blue chips are not so bad in the U.S. Emerging countries are about fair price. Beaten-down European stocks, particularly the so-called value stocks, are probably a little cheap, although risky. And resource stocks, once they reflect the weak economy—and we’ll get another whack-down—will be a wonderful long-term purchase. Farmland and forests, which should be the backbone of any long-term, serious portfolio. … It will also be a good time to buy in.

The Yield Hunt - By Michael Lewitt

Anyone who does not understand that the price of every stock and every bond is being artificially altered by the fact that interest rates are being manipulated by the Federal Reserve should not be risking any money in the markets.

Monetary policy has driven investors to search for yield in the riskiest assets. Both subprime mortgages and Greek bonds have rallied to some of their highest levels in years on the back of central bank policy. In the U.S., the Federal Reserve is taking a lot of mortgage paper out of the market, which is forcing investors into riskier subprime paper. At least there are signs that the housing market has stabilized and is beginning to recover. In Europe, the European Central Bank (ECB) has somehow convinced some investors that Greek bonds are worth buying. But the Greek economy is continuing to fall into the abyss, and another bailout would just be throwing (more) good money after bad. If Greek bondholders are not forced to take losses – even if they are German and French banks – there will be little chance of Europe solving its debt crisis. But just as investors who speculated on an upset in Venezuela’s election are licking their wounds if they didn’t sell fast enough, those who are betting on a payoff on Greek bonds are likely to be injured here (more on Venezuela below).

Charles Ferguson on Glenn Hubbard

Found via Chris Martenson. I haven't gone through all of Hubbard's CV, but as an example, it looks like he received total compensation from KKR of $301,125 last year, another $289,124 from Metlife, and another $205,000 from ADP. 

Mitt Romney has a credibility problem. He changes his beliefs like laundry (abortion, medical insurance, whether Bin Laden was worth killing, attacking Iran), refuses to disclose his tax returns, and won't explain how he could possibly pay for the tax cuts he proposes. But there is another scandal in Romney's campaign -- namely Glenn Hubbard, Romney's chief economic advisor, who was chairman of the Council of Economic Advisors under George W. Bush, and is now Dean of Columbia Business School.

I interviewed Hubbard for my documentary film Inside Job, and analyzed his record again for my book Predator Nation. The film interview became famous because Hubbard blew his cool after I interrogated him about his conflicts of interest: "This isn't a deposition, sir. I was polite enough to give you time, foolishly I now see, but you have three more minutes. Give it your best shot." But the really important thing about Hubbard isn't his personality; it's that as an economist and an advisor, he is a total, unmitigated disaster.

First, Hubbard has an abysmal track record in economic policy, including the very issues that Romney has made the pillar of his presidential campaign. Second, like Romney, Hubbard refuses to disclose critical information about his income, conflicts of interest, and paid advocacy activities. Third, both in public statements and in my personal experience, Hubbard has been evasive, misleading, and even dishonest when discussing both policy issues and his own conflicts of interest. And last but not least, those conflicts of interest are huge: Hubbard has long advocated policies that Wall Street loves, often without disclosing that he is, in fact, highly paid by Wall Street.

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Related video clip from Inside Job:

Link

Steven Romick’s Q3 Letter

At the end of 2011, we believed that economists and Wall Street analysts were generally too optimistic with respect to 2012 expectations. Since then, we’ve been proven correct. United States (and EU) GDP is far lower than expected. The U.S. deficit (and thus our national debt) is larger than projected. And predictions of corporate earnings turned out to be too optimistic. In fact, analysts now expect third quarter earnings for the S&P 500 to come in below 2011 levels.

…..

We continue to be haunted by Mr. Bernanke’s admission that we “have been in the process of learning by doing.” One can always hope that academic work translates to the field, but we think it’s unlikely. Instead, we expect unintended consequences to create future dislocation, and with it, opportunity. We’re ready, and we’d prefer it occur sooner rather than later.

Sheila Bair: 5 Steps Obama or Romney Must Take to Fix Wall Street

Found via The Big Picture.

The former head of the FDIC warns that the financial system remains far from stable – and that regulations like the Volcker Rule may be too complex to be effective. These five steps, she suggests, could lead to more sensible reforms.

………

The five steps mentioned in the article, without the elaboration:

1. Break up the “too big to fail” banks
2. Publicly commit to end bailouts
3. Cap leverage at large financial institutions
4. End speculation in the credit derivatives market
5. End the revolving door between regulators and banks

Peter Cundill Protégé Tim McElvaine Discusses His Favorite Investments in Japan

Peter Cundill Protégé Tim McElvaine, President of McElvaine Investment Management, is one of twenty expert instructors at the fully online Japan Investing Summit 2012 (more information is available HERE).

Link

Economist touts radical idea for U.S. election rivals

When it comes to evaluating the economic and fiscal proposals of Democratic President Barack Obama and his Republican challenger, Mitt Romney, in the U.S. election battle, economist Richard Duncan takes a firm pox-on-both-their-houses view.

The Democrats “have no discernible ideas at all,” Mr. Duncan was saying the other day from his home in Bangkok. Which is not surprising coming from a bearish adviser and author of conservative bent who thinks the world went off the rails when it abandoned the gold standard. His latest book is called The New Depression. But he is even harder on the Republicans, who have been “kidnapped by this far-right fringe, the Tea Party. The Tea Party wants the government to cut the budget deficit right away. If they do that, we will immediately collapse into a new Great Depression.”

…

But he isn’t wandering the streets of Bangkok carrying a sign reading: The end is nigh.

Quite the contrary. “If I thought the world were doomed, then I’m not really sure I would write these books. I would just depress myself,” he says, sounding somewhat tired after nearly three months travelling the globe to promote his new book. “But I believe that we’re repeating exactly the same process that we went through in the Great Depression. … This time, we’ve got to do better. We have to learn from our mistakes.”

He comes armed with what seems a politically impossible solution that involves governments taking full advantage of record-low long-term interest rates to borrow vast sums and then funnel the cash on a massive scale into new industries such as solar energy and other cutting-edge technologies. Such investments, he argues, have the potential to transform economies, rebalance global trade and produce a high enough return on capital to bring public budgets back into balance.

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Related book: The New Depression

Related previous posts:

Jeff Glor interviews Richard Duncan (video)

Interview with Richard Duncan

Related link: Richard Duncan on Capital Account

Expert Enough Show Ep. 6 - 10,000 Hours of Golf with Dan McLaughlin

In this episode of The Expert Enough Show, Corbett Barr sits down with Dan McLaughlin of TheDanPlan.com to find out. Dan is testing the 10,000 hour rule by trying to become a professional golfer through 10,000 hours of deliberate practice. His goal is to make the PGA Tour. He’s already 3,300 hours of the way there and now has a 6 handicap (better than 93% of golfers), despite never playing a full 18 holes before he started the experiment.

Link

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Related previous posts:

The Dan Plan: Testing 10,000 Hours to Expert Performance

What it takes to be great

Related books:

Talent Is Overrated: What Really Separates World-Class Performers from Everybody Else

The Talent Code: Greatness Isn't Born. It's Grown. Here's How.

The Little Book of Talent: 52 Tips for Improving Your Skills

Outliers: The Story of Success

Hussman Weekly Market Comment: Distinction Without a Difference

The difficulty today is not only that valuations are rich, but that on our metrics, present market conditions cluster among those that have produced strikingly negative market outcomes on a blended horizon from 2-weeks to 18-months. Wall Street’s beloved forward-earnings multiples only seem reasonable here because profit margins are the highest in history (largely as a result of steep government deficits and depressed savings rates). Once we normalize for profit margins – which is necessary because stocks are very long-lived assets – valuations are elevated, and are coupled with a variety of historically hostile, overvalued, overbought indicator syndromes. Moreover, while our economic concerns do not significantly feed into our concerns about the equity market, we continue to view the U.S. economy as being in an unrecognized recession that started about mid-year.

Recession? The advance estimate for third-quarter GDP was released last week, showing a slow but above-consensus figure of 2% growth at an annual rate (paced by a 13% surge in defense spending). Surely, this is inconsistent with concerns about recession, isn’t it? No – not if we examine the historical pattern of data revisions early in previous recessions – a point that Lakshman Achuthan of ECRI also emphasized recently on Bloomberg.

Recall that in 2001, with the U.S. economy already in recession for months, Q1 GDP growth was initially reported at 1.2%. That figure was actually revised slightly higher a few months later, but based on final revision, Q1 2001 GDP is now reported at -1.3%. As a side-note, Q2 2001 GDP was positive, while Q3 2001 was negative. The 2001 recession did not contain two consecutive quarters of negative GDP growth. Contrary to what many analysts suggest, that is not how the National Bureau of Economic Research (the official arbiter) defines a recession in the first place.

The heavy revision of GDP figures is not the exception but the rule. In the first quarter of 2008, as another example, with the U.S. economy already in recession for three months, Q1 GDP was reported at 1% growth. That figure was later revised to -1.8%. Just like 2001, the following quarter was reported at positive growth. The economy then collapsed in the second half of 2008, but by the time that was evident in GDP figures, the stock market had already plunged. The upshot is that early GDP figures are often reported positive even after a recession is already well in progress, and waiting for two consecutive quarterly declines in GDP is a poor way of gauging recession risk, because that pattern sometimes doesn’t emerge until much later revision, if at all.

John Mauldin: The Quest for Certainty

The last two weeks we have been looking at the problems with models. First we touched on what I called the Economic Singularity. In physics a singularity is where the mathematical models no longer work. For example, models based on the physics of relativity no longer work if one gets too close to a black hole. If we think of too much debt as a black hole of sorts, we may understand why economic models no longer work. Last week, in “The Perils of Fiscal Cliff,” we looked at the use of fiscal multipliers by economists in order to argue for or against governmental economic policies. Do you argue for austerity, or against it? There is a model that will support your case, most likely using the same data that your adversary uses.

These letters have generated a great deal of positive response and conversation. While I very rarely suggest to readers to go back and read previous letters, but reading these may help you appreciate why it is so difficult to understand what is happening in the global economy today.

This week, in a somewhat shorter letter, we once again consider the vagaries of measurements and models. Growth of the US economy, we are told, was 2% last quarter. That number will of course be revised, but what is it we are measuring? Should we attach any importance to the measurement at all? The short answer to the last question is yes, but it is important to understand that there is no certainty in that number. Or at least not any certainty according to the generally accepted meaning of that word.

John Mauldin's Outside the Box: Memo to Central Banks: You’re debasing more than our currency – By Dylan Grice

I am more worried than I have ever been about the clouds gathering today (which may be the most wonderful contrary indicator you could hope for...). I hope they pass without breaking, but I fear the defining feature of coming decades will be a Great Disorder of the sort which has defined past epochs and scarred whole generations….

So I keep wondering to myself, do our money-printing central banks and their cheerleaders understand the full consequences of the monetary debasement they continue to engineer?

Seth Klarman Goes Nuts On The Fed In His Latest Investor Letter

Update: There are more excerpts HERE.

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Thanks to Will for passing this along. I haven’t seen a copy of the whole letter, but there is a very short excerpt in this article.

Seth Klarman, the legendary head of Boston based hedge fund Baupost Group, sent out his letter to investors this week.

He reports that his fund is up for the month, quarter, and year, but is sending out specifics in separate quarterly reports.

That said: The juicy part of this letter has nothing to do with specific investments or anything like that. What's interesting is that, like some of his industry peers (David Einhorn), Klarman has words for the Fed, and those words are all about QE3.

He said that like QE1 and QE2, QE3 is no lasting solution. He sees it, instead, as "attempted manipulation of Americans' behavior."

Alliance Bernstein whitepaper (April 2010): Deflating Inflation - Redefining the Inflation-Resistant Portfolio

Link to: Deflating Inflation - Redefining the Inflation-Resistant Portfolio

Billions in Hidden Riches for Family of Chinese Leader - By David Barboza

The mother of China’s prime minister was a schoolteacher in northern China. His father was ordered to tend pigs in one of Mao’s political campaigns. And during childhood, “my family was extremely poor,” the prime minister, Wen Jiabao, said in a speech last year. 

But now 90, the prime minister’s mother, Yang Zhiyun, not only left poverty behind — she became outright rich, at least on paper, according to corporate and regulatory records. Just one investment in her name, in a large Chinese financial services company, had a value of $120 million five years ago, the records show. 

The details of how Ms. Yang, a widow, accumulated such wealth are not known, or even if she was aware of the holdings in her name. But it happened after her son was elevated to China’s ruling elite, first in 1998 as vice prime minister and then five years later as prime minister. 

Many relatives of Wen Jiabao, including his son, daughter, younger brother and brother-in-law, have become extraordinarily wealthy during his leadership, an investigation by The New York Times shows. A review of corporate and regulatory records indicates that the prime minister’s relatives, some of whom have a knack for aggressive deal-making, including his wife, have controlled assets worth at least $2.7 billion.

Hugh Hendry and David Einhorn at The Buttonwood Gathering 2012

Hugh Hendry is the first segment. The David Einhorn segment begins at the 55:48 mark.

theeconomist on livestream.com. Broadcast Live Free

Link to video: The Buttonwood Gathering 2012 Part 5

Richard Oldfield on Japan

This excerpt is presented by ValueConferences.com and The Manual of Ideas as part of the Japan Investing Summit (more information is available HERE).

Leading British value investor Richard Oldfield, chairman of the investment committee of Oxford University, sat down with us in a wide-ranging exclusive interview. Here are his views on Japanese equities.

Link

James Montier on 2008/2009...

James Montier’s answer to a follow-up question at the European Investing Summit 2012 (for those interested, the next Investing Summit is on Japan and will take place November 7-8....more information can be found HERE).

Question: Going back to the lowest point of the markets in late 2008/2009, what was going through your mind? How did you retain the courage and confidence to carry on?

James Montier: In late 2008 and early 2009 I was getting very excited because I was seeing a large number of stocks appearing on my value screens, and seeing cheap valuation at the market level. So whilst a lot of people were focusing on the things that could go wrong (and there was no shortage of them back then), because I was focused on valuations I was getting buy signals. The key point is to have a good process and to stick to it. This cuts down on the amount of decision making under duress that you are forced to conduct. Sir John Templeton used to talk about doing his analysis on quiet days in the market and placing limit orders with brokers, he knew when the stock was down 50% he wouldn’t want to buy it (emotionally) but his pre-commitment strategy forced him to do so.

Seth Klarman puts it this way “One of our strategies for maintaining rational thinking at all times is to attempt to avoid the extreme stresses that lead to poor decision making. We have often described our techniques for accomplishing this: willingness to hold cash in the absence of compelling investment opportunity, a strong sell discipline, significant hedging activity and avoidance of recourse leverage, among others.”

Meredith Whitney on CNBC

Link

Warren Buffett on buying a house in today’s environment

From one of the segments from earlier today (HERE, starting at the 2:50 mark):

Warren Buffett: …so I think that anybody that knows where they're going to want to live, has a reasonably assured income…I think they're making a terrible mistake if they don't buy a single family home now and get mortgages at these rates, and they should get a 30-year mortgage. It’s really a golden opportunity. It was a little bit better six months ago, but it’s still wonderful now. You’re not going to see a chance like this five years from now. I’ll guarantee you that.

Becky Quick: Five years from now, it's going to be a different picture?

Warren Buffett: Rates will be higher and all kinds of things. This is the time to buy, if you know where you want to live. You've got to want to live there. A home's a wonderful thing, but I wouldn't buy one if I was going to move in six months or something of the sort. And I wouldn't buy one if I was terribly nervous about my job.

Baupost Co-Portfolio Manager Wagner to Start His Own Firm

Herb Wagner, the Baupost Group LLC executive appointed as Seth Klarman’s co-portfolio manager two years ago, will leave the firm at the end of 2012 to start his own investment company, according to a letter sent to the hedge fund’s clients yesterday.

Wagner, who has worked at Baupost for 13 years, plans to manage his own wealth initially and eventually take in money from outsiders, according to the letter, portions of which were obtained by Bloomberg News.

East Coast Asset Management's Q3 Letter

Found via Market Folly.

Valuation is the primary driver that informs our investment strategy. Over time the market is meritocratic and rewards investors when they have purchased a stream of future cash flows at a discount. Conversely, the market will tend to punish market participants who have overpaid. Every investment has an expected rate of return from its quoted price over a given time horizon, it is our primary objective to determine what that expected return is and allocate capital accordingly.

Since early 2009, there has been a secondary driver informing our investment strategy – the developed world’s central bank monetary policy. As noted in earlier letters, central banks have three exit strategies to mitigate their debt burdens: increase taxes, reduce spending, and print money. We expect them to employ a combination of all three strategies but history shows that the printing of money will be the most politically and economically viable. These actions potentially have critical implications for accumulated wealth, future interest rates, and inflation.

Greenlight Capital Q3 2012 Letter

Via ValueWalk.

Link to: Greenlight Capital Q3 2012 Letter

The thin cow…

I mentioned Gene Hoots’ book Pay Attention to the Thin Cow a few weeks ago. Below is excerpt from the book, explaining the title.

“My grandfather once asked my uncle Ken, “Why do you pay so little attention to the advice of others?” Kenneth answered, “Because I am the only one that I’m certain is working for me ALL the time.” He was skeptical about advice, experts of every ilk, and especially politicians. No one was more widely liked than my uncle.

He made a living for over sixty years as a farmer and cattle trader. He was a true contrarian. He told me that at cattle auctions, most people buy the fat, slick cattle – they look healthy and prosperous, and they are priced accordingly. He always bought sickly looking, thin cows. He said there was nothing he could do to improve the fat ones, but he had a fair chance of improving the prospects of the thin ones and selling them for a profit. Investors would be well advised to use his approach in searching for stocks.” –Gene Hoots, Pay Attention to the Thin Cow

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Related previous posts:

Pay Attention to the Thin Cow – By Gene A. Hoots

Don't Enlist In the 7th Cavalry - by Gene Hoots

Japan Investing Summit 2012

John Mihaljevic and company have once again put together a great lineup for this online conference (click on the link below for more details). I attended the European Investing Summit earlier this month and was very glad I did. Mohnish Pabrai and Guy Spier will doing a joint keynote Q&A session on November 7th at 11:30am EST, though attendees that can't attend the live session will have access to the replay and transcript as well.

Japan Investing Summit 2012 is a collaboration of ValueConferences and The Manual of Ideas with the sole objective of bringing you the most compelling investment ideas in Japan. As this is a fully online conference, there is no need to travel or incur thousands of dollars in attendance fees. Our flexible online schedule gives you access from the comfort of your own home or office to all event content on November 7-8, as well as for an additional two weeks.

Warren Buffett on CNBC

Link to videos:

Buffett: Us Residential Housing Starting to Pick Up

Buffett: Instincts Go Against QE3

Buffett: 'We Mostly Buy Stocks For Future Earnings'

Buffett: 'We'll Add 8,000 Jobs Organically'

Buffett: 'We Buy on an All Equity Basis'

GE's Immelt: 'General Trend is Still Positive With Volatility'

Buffett: Procter & Gamble Earnings Disappointing

Buffett: Election Comes Down to Who Has Better Ground Game

Buffett: Euro Zone Banking Problem Clouds Recovery

Buffett's Final Word: Hold

Nigel Farage's latest rant

Link

Incredibly Small: Best Microscope Photos of the Year

Link to: Incredibly Small: Best Microscope Photos of the Year

Doom Heralded at Hayman by Widening Trade Deficit: Japan Credit

Thanks to Will for passing this along.

Going back and reviewing an investor letter from Kyle Bass dated November 30, 2011, Bass wrote “We believe that Japan would have a bond crisis of its own within the next two years without the current European debt crisis. The European debt crisis will simply act as an accelerant to the Japanese situation as it will most likely change the qualitative thoughts of JGB investors. We believe that this sequence of events is set to begin in the next few months (beginning with defaults in Europe).”

So maybe central bank intervention delayed the “next few months” part, but it appears their thesis (of which there is more detail HERE) remains intact. 

Japan’s worsening trade gap will make it harder to service the world’s largest debt, fulfilling part of the doomsday scenario that Hayman Capital Management LP is betting on.

The nation’s 10-year note yield may rise toward 10 percent from the world’s third-lowest of 0.79 percent, while the yen weakens, said Richard Howard, who oversees Dallas, Texas-based Hayman’s Japan-focused fund with J. Kyle Bass. That would represent the developed world’s second-highest borrowing costs after Greece, and a surge to that level by the end of 2013 would cause losses of 42 percent for investors purchasing the securities now, data compiled by Bloomberg show.

Data yesterday showed Japan had its biggest half-year trade deficit on record. Hayman, which manages about $1 billion, made $500 million by predicting the U.S. housing market collapse, and Bass has said since at least 2010 that Japan’s $12 trillion bond market is heading for a crash. So far, the debt has returned 3.1 percent in the past two years, Bank of America Merrill Lynch data show, while yields touched nine-year lows.

“It all came down to this idea that there was an internal self-funding mechanism in Japan, that essentially the Japanese economy and interest-rate environment could exist separate to the rest of the world,” Howard, 32, said in an Oct. 18 interview in Singapore. “It wasn’t going to last forever, and in fact it is rapidly approaching a turning point.”

Jeff Bezos on the value of changing one's mind

Found via World Beta.

He said people who were right a lot of the time were people who often changed their minds. He doesn’t think consistency of thought is a particularly positive trait. It’s perfectly healthy — encouraged, even — to have an idea tomorrow that contradicted your idea today.

He’s observed that the smartest people are constantly revising their understanding, reconsidering a problem they thought they’d already solved. They’re open to new points of view, new information, new ideas, contradictions, and challenges to their own way of thinking.

This doesn’t mean you shouldn’t have a well formed point of view, but it means you should consider your point of view as temporary.

What trait signified someone who was wrong a lot of the time? Someone obsessed with details that only support one point of view. If someone can’t climb out of the details, and see the bigger picture from multiple angles, they’re often wrong most of the time.

Be the Disruptor

Found via Farnam Street. There is also an interview with the co-authors HERE. 

Harvard Business School professor Clayton M. Christensen’s theory of disruptive innovation provides a framework to understand how businesses grow, become successful, and falter as nimble start-ups muscle in on their customers. It’s a familiar story, one that has played out in the steel and auto industries, among others. Now Christensen, in collaboration with 2012 Martin Wise Goodman Canadian Nieman Fellow David Skok, has applied his analysis to the news industry. Their goal in “Breaking News” is to encourage news executives to apply the lessons of disruption to the media industry as a means of charting new paths to survival and success.

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Related book: The Innovator's Dilemma

Related previous posts:

Clayton Christensen Presentation: Reinventing IT

Clayton M. Christensen on Disruptive Innovation in Health Care

Related videos:

Disruptive Innovation - Clayton Christensen (Part 1)

Disruptive Innovation - Clayton Christensen (Part 2)

Disruptive Innovation - Clayton Christensen (Part 3)

Disruptive Innovation - Clayton Christensen (Part 4)

The myth of the money multiplier - by Steve Keen

Three Business Spectator readers contacted me directly about one topic last week – bank money creation, and how bank reserves work. Following an old journalism adage that three direct enquiries about a topic from the public means that everybody’s interested in it, I’m diving into wonkdom to answer their queries in detail here. Ignore this post if the adage isn’t true for you, but if it is and you haven’t yet had your morning Java, now’s the time for that stroll to the barista.

OK, caffeinated? Here we go.

The standard story about how banks create money, and how reserves work, is the “Money Multiplier Model”. Money creation starts with the government injecting “fiat money” into the economy – say by giving a welfare recipient $100 in cash. That recipient then deposits the cash in a bank, which hangs on to a government-mandated fraction of it (the “Reserve Requirement”) – say 10 per cent or $10 – and lends out the rest to a borrower. The borrower then deposits that $90 in another bank, which does the same thing – hangs onto 10 per cent of the $90 or $9, and lends out another $81 to another borrower.

The process repeats ad infinitum, and in the end a total of $1,000 is brought into existence: the original $100 in cash, plus $900 in credit money created by the private banking sector (matched, of course, by $900 in debt).

This alleged system, known as Fractional Reserve Banking, is seen as “fraud” by Austrian economists, and by many in the public. To inflationists, because Bernanke has hit the printing presses, dramatically increasing Base Money, and therefore money in circulation will soon explode, leading to hyperinflation.

To Neoclassical economists, it’s just the way banking works: bank lending is controlled by the Fed because, “even if banks hold no reserves”, Fed control over the currency means that private banks must do what the Fed wants.

And to anyone who’s done empirical research, it’s a myth.

Hussman Weekly Market Comment: The Data-Generating Process

For anyone who works to infer information from a broad range of evidence, one of the important aspects of the job is to think carefully about the structure of the data – what is sometimes called the “data-generating process.” Data doesn’t just drop from the sky or out of a computer. It is generated by some process, and for any sort of data, it is critical to understand how that process works.

For example, one of the moments of market excitement last week was the reported jump in new housing starts for September. But later in the week, investors learned that there was a slump in existing home sales as well. If we just take those two data points at face value, it’s not clear exactly what we should conclude about housing. But the story is clearer once we consider the process that generates that data.

Weschler Rise From Grace Leads to Role Advising Buffett

Ted Weschler’s first job after college was at chemical maker W.R. Grace & Co. (GRA) In 2007, six years after the company filed for bankruptcy, his hedge fund held 15 percent of the shares. That’s when he called Joe Rice.

Rice, a South Carolina lawyer, represented workers who claimed asbestos products manufactured by Grace had caused cancer and other illnesses. The 158-year-old company, which once owned shipping lines and restaurants, declared bankruptcy in 2001 under the weight of those lawsuits. Rice was at an impasse with the firm when Weschler suggested they meet.

Over a three-hour dinner at Charleston’s Oak Steakhouse, the men started a conversation about resolving the case in a manner that would be fair to workers and shareholders. Weschler picked up the check. His initiative paved the way for a settlement a year later that helped Grace’s stock climb 40-fold since the bankruptcy and an investing record that earned him a job at Warren Buffett’s Berkshire Hathaway Inc. (BRK/B)

“He understood the issues for my clients weren’t all dollars and cents,” Rice said. “He was a catalyst.”

That ability to find value in distressed companies and cut deals helped Weschler, 51, carve out a role at Omaha, Nebraska- based Berkshire that goes beyond the stock-picking job he was hired for. Since joining Buffett’s firm in January, he has made a bid for a bankrupt mortgage business, negotiated a transaction that pushed Berkshire deeper into newspaper publishing and consulted with the heads of the company’s operating units.

Levy, Harkins Q3 Letter

In the middle of last month in response to desultory growth, Federal Reserve Chairman Benjamin Bernanke announced Quantitative Easing III, a program most notable for its claims to “unlimited” size.  By the calculation of Martin Feldstein in the Financial Times last week, “unlimited” might come to $1.5 trillion of new money created in three years.  To put such a sum in perspective, the Fed’s assets totaled all of $825 billion at the beginning of the financial crisis in late 2007.  America’s leading economic light, Professor Paul Krugman of Princeton, says that not only is there nothing alarming about this, but that those of us who express concern are like bullies who would scare small children around a campfire for our own amusement.  Inflation is dead, now and forever, says the twice a week New York Times Columnist.  His assertion will look odd to you if you have been in a grocery store lately, but it grows positively loopy if you’re currently paying for a Princeton undergraduate.  Nothing on that campus is going up at a 2% annual rate, least of all tuition.  Which might remind all of us how often in politics things look different if you are signing the front of the check or the back.

What got us to shake our heads even harder at QE3 was the simultaneous announcement that 0% interest rates at the short term would be extended through mid-2015.  Beyond bridling at the clairvoyance that this would require from an institution that was wholly impercipient through the worst of the crisis, it also goes a year and a half beyond the term of Chairman Bernanke, set to expire January 31, 2014.  Bernanke was confirmed by the Senate last time by the smallest majority ever, and aren’t the country’s savers, who will have gone without interest for about 7 ½  years by the end of this program, ever to be heard from, ever to have their rights restored?

In thinking about what comes after QE3, consider this.  It currently costs America comparatively little to service our debt , a little over $200 billion a year, because interest rates are so low.  But that number will leap by something on the order of $500 billion the next time interest rates revert to anything like historical low norms.  And it will be worsened still more by the losses that the Fed will have on its mortgage and long bond holdings.  The Fed and the Treasury came to an agreement that those losses would not be borne by the Fed, but would instead flow through Treasury’s current year deficit.  This was reported in January 2011 by Grant’s Interest Rate Observer, and to our knowledge no place else.  It is a disturbing agreement, partly because it has the whiff of someone preparing to leave the scene of an accident.  But even more, it means the next Fed Chairman, if he only normalizes monetary policy, will be handing the political system an incredible bill, wholly unexpected, about the size of the Simpson-Bowles fix all by itself.  And we did not have the courage to implement that fix a year ago.  Paul Volker is 6`7”; the next fellow is going to have to be a lot bigger when inflation has to be tamed again.

Steven Romick on WealthTrack

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Garrett Hardin quote

This quote can probably apply to the economic world as well.

"The natural world is organized into a web of life more complex than we know. We have only a limited ability to predict what will happen in time as the result of any intervention, however well meant, in the natural order of things. Caution and humility are the hallmarks of the ecolate attitude toward the world." -Garrett Hardin, Filters Against Folly

Human Accomplishment By Charles Murray and Black Swan by Nassim Taleb (2007)

Found via Farnam Street. This took place in July of 2007.


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Believe the hype in hyperinflation - By Tim Harford

First, hyperinflation is a phenomenon of the modern era: with a single exception, every hyperinflation has occurred since the end of the first world war. The outlier is revolutionary France, where monthly inflation passed 300 per cent in the summer of 1796. 

Second, three-quarters of these hyperinflations – 43 out of 56 – occurred in one of three clear historical clusters. The first cluster is central European states after the first world war. It provides the most famous hyperinflation in history: Weimar Germany. The second cluster is during or immediately after the second world war, and it includes history’s worst: Hungary in 1946. Those inflation rates defy comprehension – 41,900,000,000,000,000 per cent a month, compounded, is (I believe) an annual inflation rate with 178 digits. It makes more sense as 207 per cent a day. 

The third cluster is that of Eastern bloc countries as the Soviet Union disintegrated, and it comprises over half of all the 20th century’s hyperinflations. These are all examples of hyperinflation going hand in hand with an extremely stressed political and social system. Most of the remaining examples, from Zimbabwe to late revolutionary France, exhibit that same stress. 

There’s a lesson here: regardless of the fears of some US Republicans and German hard-money fans, hyperinflation is not produced by central bankers. It is the result of a total failure of the political system. 

There are a few people who are simultaneously buying gold in expectation of hyperinflation in western economies and stockpiling bullets in anticipation of a calamity for western civilisation. I will give the survivalists this much credit: the scenarios are consistent. But calamity arrives first, and hyperinflation follows.

Coelacanth: The Fish That Time Forgot

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Beautiful Minds: Richard Dawkins

Link to video: Beautiful Minds: Richard Dawkins

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Related link: Growing Up in the Universe

Related books: 

The Greatest Show on Earth

The Selfish Gene

The Blind Watchmaker

Chanticleer Q3 2012 Letter

Below are a couple of sections (slightly edited for public viewing) from a letter just sent to the investors of the fund I help manage. 

Disclosure: I am a portfolio manager at Chanticleer Advisors ("CA") and Chanticleer Investment Partners ("CIP") and the fund managed by Chanticleer Advisors owns shares in High Arctic Energy Services Inc. (TSX: HWO), which is mentioned in the letter below.  We may in the future buy or sell shares in the fund or other accounts managed by either CA or CIP and are under no obligation to update our activities. This is not a recommendation to buy or sell a security. Please do your own research before making an investment decision.

Chanticleer - Q3 2012 Letter to Investors - Edited for Public Viewing 

Hoisington Q3 2012 Letter

Growth Recession

Entering the final quarter of the year, domestic and global economic conditions are extremely fragile. Across the globe, countries are in outright recession, and in some instances where aggregate growth is holding above the zero line, manufacturing sectors are contracting. The only issue left to determine is the degree of the downturn underway. International trade is declining, so weaknesses in different parts of the world are reinforcing domestic deteriorations in economies continents away. With this global slump at hand, a highly relevant question is whether the U.S. can escape a severe recession in light of the following:

a) the U.S. manufacturing sector that paced domestic economic growth over the past three years has lapsed into recession;

b) real income and the personal saving rate have been slumping in the face of an interim upturn in inflation, and

c) aggregate over-indebtedness, which is the dominant negative force in the economy, has continued to move upward in concert with flagging economic activity.

New government initiatives have been announced, particularly by central banks, in an attempt to counteract deteriorating economic conditions. These latest programs in the U.S. and Europe are similar to previous efforts. While prices for risk assets have improved, governments have not been able to address underlying debt imbalances. Thus, nothing suggests that these latest actions do anything to change the extreme over-indebtedness of major global economies.

To avoid recession in the U.S., the Federal Reserve embarked on open-ended quantitative easing (QE3). Importantly, the enactment of QE3 is a tacit admission by the Fed that earlier efforts failed, but this action will also fail to bring about stronger economic growth.

Don't Enlist In the 7th Cavalry - by Gene Hoots

Listening to a Park Ranger lecture about Little Bighorn, it struck me that Custer had a lot in common with the investment industry.   His story can teach us a lot about the effects of hubris and the myth of “beating the odds.”

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Related previous post: Pay Attention to the Thin Cow – By Gene A. Hoots

Related article (and a really great story): Barbarians at MY Gate

Nigel Farage on the UK's Tax Probe Into Starbucks (CNBC)

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CornerCap Special Report: THE AFTERMATH OF 2008 - A Look at the Lasting Impact of the Credit Crisis

The panic of 2008 is still among us, judging from investor behavior. Most investors are putting a premium on safety at almost any price. This article looks at the lasting impact of the credit crisis: Does it mean we are in a different investment era? Are defensive portfolios that seek extra yield the only prudent strategy in this difficult time?

Key Messages

Market volatility and the fallout of the credit crisis have had a profound negative impact on expectations and investment strategy. Nevertheless, we’ll argue that while we are in a new economic era, we are not in a new era for investing, as investor behavior since 2008 reveals.

Excessive emphasis on defense exposes long-term portfolios to two key risks: 1) not growing enough to meet longer term objectives and 2) actually losing value (the opposite of the intended goal) if inflation materializes.

Recognizing investment extremes, which requires running against the grain, is key to success. We continue to see long term risk to bonds, so we keep maturities short; we find larger high-dividend stocks and US REITs to be expensive; and we see better opportunity in US value stocks, international stocks, and select higher-yielding investments.

While no one can predict the future, we build broad portfolios that align investment tools with probable outcomes to help you achieve your long term goals. In this commentary, we review our method for doing so.

Beating inflation…

Via notes from Berkshire Hathaway’s 2010 Annual Meeting:

Question: What are key metrics you look for on inflation, and catalysts for a future rise?

Warren Buffett: You give me credit for more brainpower than I actually bring to the question. You can’t look at any metric. If it gets going, it creates own dynamic and is very hard to stop. We saw it in 1970s until Volcker came in with a sledge hammer. Prime rate was at 21% and governments up to 15%. We had a demonstration project 30 yrs ago. If we continue today’s policies, something like that could be possible. Trend is not destiny. We have power to control our future. We do it through elected representatives. I will go back, with what I see, currencies are [a] poorer bet and [I’m] not sure what it means for inflation. If inflation gets into saddle, faith in institutions could break down.

Charlie Munger: Contribute the most to civilization and counter the effects of inflation. To outsmart others isn’t the best way to do it. If you are best painter or best brain surgeon, you will always command your share of the economy around you. Talent is terrific asset to deal with it.

The strange new world of Nanoscience

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Dividends...

A great post with some great charts, via the The Reformed Broker blog:

Link to: 5 Things I Learned About Dividends From PIMCO

Dylan Grice on QE3

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Santangel's Review: Transcript of Charlie Munger's 2010 Talk at Harvard-Westlake School

One of the things that really stood out to me when I watched this a couple of years ago was the comment from Munger about how well he knew Howard Marks. I hadn't previously realized they were as close as they might be. 

Munger Talk at Harvard-Westlake

Abraham Lincoln: The Great Campaigner

Some consider politics a dirty word. But the 16th president was a master of political ruthlessness—for the sake of the highest ideals.

FiveBooks Interviews: PJ O’Rourke on Political Satire

Link to: FiveBooks Interviews: PJ O’Rourke on Political Satire

Jean-Marie Eveillard on King World News

Link to: Jean-Marie Eveillard on King World News

Chris Mayer on Capital Account

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BOSS RAIL: The disaster that exposed the underside of the boom. (China) – By Evan Osnos

Evan Osnos was also on Charlie Rose discussing this article and other China topics HERE.

On the morning of July 23, 2011, passengers hurried across Beijing South Station at the final call to board bullet train D301, heading south on the world’s largest, fastest, and newest high-speed railway, the Harmony Express. It was bound for Fuzhou, fourteen hundred miles away.

Beijing South Station is shaped like a flying saucer, its silvery vaulted ceiling illuminated by skylights. It contains as much steel as the Empire State Building and can handle two hundred and forty million people a year, thirty per cent more than New York’s Penn Station, the busiest stop in America. When Beijing South opened, in 2008, it was the largest station in Asia; then Shanghai stole the crown. In all, some three hundred new stations have been built or revitalized by China’s Railway Ministry, which has nearly as many employees as the civilian workforce of the United States government.