A Hint of Hype, A Taste of Illusion – By Leonard Mlodinow

Found via Simoleon Sense.

They pour, sip and, with passion and snobbery, glorify or doom wines. But studies say the wine-rating system is badly flawed. How the experts fare against a coin toss.

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Despite his studies, Mr. Hodgson is betting that, like the French, American consumers won't be easily converted to the idea that wine experts are fallible. His winery's Web site still boasts of his own many dozens of medals.

"Even though ratings of individual wines are meaningless, people think they are useful," Mr. Greene says. He adds, however, that one can look at the average ratings of a spectrum of wines from a certain producer, region or year to identify useful trends.

As a consumer, accepting that one taster's tobacco and leather is another's blueberries and currants, that a 91 and a 96 rating are interchangeable, or that a wine winning a gold medal in one competition is likely thrown in the pooper in others presents a challenge. If you ignore the web of medals and ratings, how do you decide where to spend your money?

One answer would be to do more experimenting, and to be more price-sensitive, refusing to pay for medals and ratings points. Another tack is to continue to rely on the medals and ratings, adopting an approach often attributed to physicist Neils Bohr, who was said to have had a horseshoe hanging over his office door for good luck. When asked how a physicist could believe in such things, he said, "I am told it works even if you don't believe in it." Or you could just shrug and embrace the attitude of Julia Child, who, when asked what was her favorite wine, replied "gin."

As for me, I have always believed in the advice given by famed food critic Waverly Root, who recommended that one simply "Drink wine every day, at lunch and dinner, and the rest will take care of itself."

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Related book: The Drunkard's Walk: How Randomness Rules Our Lives

Related previous post: Hollywood Success: Luck or Skill? - 2006 Article by Leonard Mlodinow

TESTING, TESTING - by Atul Gawande

Thanks to Farnam Street for passing Dr. Gawande’s latest piece along.

There are, in human affairs, two kinds of problems: those which are amenable to a technical solution and those which are not. Universal health-care coverage belongs to the first category: you can pick one of several possible solutions, pass a bill, and (allowing for some tinkering around the edges) it will happen. Problems of the second kind, by contrast, are never solved, exactly; they are managed. Reforming the agricultural system so that it serves the country’s needs has been a process, involving millions of farmers pursuing their individual interests. This could not happen by fiat. There was no one-time fix. The same goes for reforming the health-care system so that it serves the country’s needs. No nation has escaped the cost problem: the expenditure curves have outpaced inflation around the world. Nobody has found a master switch that you can flip to make the problem go away. If we want to start solving it, we first need to recognize that there is no technical solution.

Much like farming, medicine involves hundreds of thousands of local entities across the country—hospitals, clinics, pharmacies, home-health agencies, drug and device suppliers. They provide complex services for the thousands of diseases, conditions, and injuries that afflict us. They want to provide good care, but they also measure their success by the amount of revenue they take in, and, as each pursues its individual interests, the net result has been disastrous. Our fee-for-service system, doling out separate payments for everything and everyone involved in a patient’s care, has all the wrong incentives: it rewards doing more over doing right, it increases paperwork and the duplication of efforts, and it discourages clinicians from working together for the best possible results. Knowledge diffuses too slowly. Our information systems are primitive. The malpractice system is wasteful and counterproductive. And the best way to fix all this is—well, plenty of people have plenty of ideas. It’s just that nobody knows for sure.

The history of American agriculture suggests that you can have transformation without a master plan, without knowing all the answers up front. Government has a crucial role to play here—not running the system but guiding it, by looking for the best strategies and practices and finding ways to get them adopted, county by county. Transforming health care everywhere starts with transforming it somewhere. But how?

We have our models, to be sure. There are places like the Mayo Clinic, in Minnesota; Intermountain Healthcare, in Utah; the Kaiser Permanente health-care system in California; and Scott & White Healthcare, in Texas, that reliably deliver higher quality for lower costs than elsewhere. Yet they have had years to develop their organizations and institutional cultures. We don’t yet know how to replicate what they do. Even they have difficulties. Kaiser Permanente has struggled to bring California-calibre results to North Carolina, for instance. Each area has its own history and traditions, its own gaps in infrastructure, and its own distinctive patient population. To figure out how to transform medical communities, with all their diversity and complexity, is going to involve trial and error. And this will require pilot programs—a lot of them.

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None of this is as satisfying as a master plan. But there can’t be a master plan. That’s a crucial lesson of our agricultural experience. And there’s another: with problems that don’t have technical solutions, the struggle never ends.

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Related previous posts:

Dr. Atul Gawande - 2009 Commencement Speeches

A Lifesaving Checklist - By Atul Gawande

THE CHECKLIST - by Atul Gawande

Related link: The New Yorker: Video of Atul Gawande

Other recommended articles written by Dr. Gawande:

The Cost Conundrum

The Cost Conundrum Redux

Hussman Weekly Market Comment: Credit Crises Generally Require Multi-Year Adjustments

There are some good graphs and quotes from Ken Rogoff and Carmen Reinhart’s book in the latest Hussman piece linked below. Some things in this piece reminded me of something Howard Marks wrote in his memo entitled The Long View: “In my opinion, there are two key concepts that investors must master: value and cycles.” As you may have noticed, I’ve posted more things this year on the blog that relate to the cycle side of investing than I have in the past – and much of that has to do with the insight in that quote from Mr. Marks, along with some holes I noticed in my own philosophy as things unfolded during the current financial/credit crisis.

Aside from the likelihood of further credit losses, my primary macroeconomic concern at present is the likelihood of far larger deficits and eventually, inflation, than investors appear to anticipate. As I've noted before, the inflation issue is most likely several years out, because over the shorter run, fresh credit difficulties are likely to boost “safe haven” demand for default-free U.S. government liabilities, which will allow the huge new float of these liabilities to be absorbed without an immediate deterioration in their value. From a longer-term perspective, particularly after we work through the adjustments of the next two or three years, it appears very unlikely that the enormous collapse in “monetary velocity” that we've seen during this crisis will be sustained. Over time, the increased supply of U.S. government liabilities (whether in the form of monetary base or Treasury securities) is likely to be met by a similar depreciation in their value. I continue to expect that we will observe an approximate doubling of the U.S. consumer price index over the next decade.

Reviewing some recent comments from Rogoff (who used to be head of the International Monetary Fund) and Reinhart, it's notable that they share these same concerns:

“Assuming the U.S. continues going down the tracks of past financial crises, perhaps the scariest prospect is the likely evolution of public debt, which tends to soar in the aftermath of a crisis. A base-line forecast, using the benchmark of recent past crises, suggests that U.S. national debt will rise by $8.5 trillion over the next three years. Debt rises for a variety of reasons, including bailout costs and fiscal stimulus. But the No. 1 factor is the collapse in tax revenues that inevitably accompanies a deep recession. Financial crises don't last forever. But this one could last a lot longer if policymakers don't start basing their actions on more realistic assessments of where we are and what is likely still to come.”

“The marketplace is suggesting that there's not going to be a lot of inflation in the near term. During the height of the crisis the alternatives to dollar assets were not there. It wasn't irrational, but it was lack of alternatives. What concerns me most about inflation is not something that is imminent. The inflation question becomes more pressing in a 5-10 year time horizon—and it's not 5 years from now, it's 5 years from where the crisis started, which was two years ago. If we had a history of defaults, like in South America, that horizon would be compressed. For other cases, you have more time.”

Miguel Barbosa Interviews Joseph Calandro, Jr.

Link to:

Miguel Barbosa’s Interview with Joseph Calandro, Jr.,

Author of Applied Value Investing

Will Big Business Save the Earth? – By Jared Diamond

Found via Simoleon Sense.

THERE is a widespread view, particularly among environmentalists and liberals, that big businesses are environmentally destructive, greedy, evil and driven by short-term profits. I know — because I used to share that view.

But today I have more nuanced feelings. Over the years I’ve joined the boards of two environmental groups, the World Wildlife Fund and Conservation International, serving alongside many business executives.

As part of my board work, I have been asked to assess the environments in oil fields, and have had frank discussions with oil company employees at all levels. I’ve also worked with executives of mining, retail, logging and financial services companies. I’ve discovered that while some businesses are indeed as destructive as many suspect, others are among the world’s strongest positive forces for environmental sustainability.

The embrace of environmental concerns by chief executives has accelerated recently for several reasons. Lower consumption of environmental resources saves money in the short run. Maintaining sustainable resource levels and not polluting saves money in the long run. And a clean image — one attained by, say, avoiding oil spills and other environmental disasters — reduces criticism from employees, consumers and government.

What’s my evidence for this? Here are a few examples involving three corporations — Wal-Mart, Coca-Cola and Chevron — that many critics of business love to hate, in my opinion, unjustly.

1991 Moneychanger Interview with John Exter

Thanks to Will for passing this along after seeing John Exter quoted in the Op-Ed piece from Jim Grant.

MONEYCHANGER You recognised very early that one major problem with Keynesianism was its reliance on debt.

EXTER That’s what my upside-down debt pyramid is all about. The debt burden at some point becomes unsustainable because too many debtors borrow short term & lend long term, or, worse yet, borrow short term & put the money into bricks & mortar. [Exactly the crisis that erupted in Asia in 1997 – Ed.]

MONEYCHANGER Exactly. Because most people thinking about inflation back in the ‘70s were looking at the models of John Law or Revolutionary France or even Germany after WW I, they saw our inflation ending in a hyperinflation. You have steadily insisted that our inflation would end in a deflation & a debt collapse.

EXTER Yes, that’s very important. I’m sure the collapse that I’m talking about will start in the dollar. (My debt pyramids are always in single currencies: there’s a dollar debt pyramid, a deutsche Mark debt pyramid, a Yen pyramid, & so on.)

This will be a deflationary collapse rather than an inflationary blow-off because creditors in the debt pyramid will move down the pyramid [See pyramid chart -- Ed.] out of the most illiquid debtors at the top of the pyramid -- junk bonds, failing banks, S&Ls & insurance companies, Donald Trump, & Campeau. [Trump has survived until now, 1998, but Long Term Capital Management & other ailing hedge funds fit the same bill. – Ed.] Creditors will try to get out of those weak debtors & go down the debt pyramid, to the very bottom: currency (dollar bills), even though they pay no interest. Next above currency are Treasury bills, issued by the government & backed by the Federal Reserve, which supports the market through its open market operations. They are by far the largest component of Reserve Bank credit, so are really as safe as currency notes, plus they pay interest. Still, you can’t buy anything with Treasury bills; you have to liquidate the bills to get money of some sort to buy something. [The very flight to quality that we are seeing in 1998. – Ed.]

The higher debtors sit in the pyramid, the less liquid they are. At the top are all the least liquid debtors that I’ve already mentioned. This explains why we are headed for deflation. Creditors will move out of debtors high in the debt pyramid as many of those debtors fail through defaults & bankruptcies. That is very deflationary.

Requiem for the Dollar – By James Grant

Ben S. Bernanke doesn't know how lucky he is. Tongue-lashings from Bernie Sanders, the populist senator from Vermont, are one thing. The hangman's noose is another. Section 19 of this country's founding monetary legislation, the Coinage Act of 1792, prescribed the death penalty for any official who fraudulently debased the people's money. Was the massive printing of dollar bills to lift Wall Street (and the rest of us, too) off the rocks last year a kind of fraud? If the U.S. Senate so determines, it may send Mr. Bernanke back home to Princeton. But not even Ron Paul, the Texas Republican sponsor of a bill to subject the Fed to periodic congressional audits, is calling for the Federal Reserve chairman's head.

I wonder, though, just how far we have really come in the past 200-odd years. To give modernity its due, the dollar has cut a swath in the world. There's no greater success story in the long history of money than the common greenback. Of no intrinsic value, collateralized by nothing, it passes from hand to trusting hand the world over. More than half of the $923 billion's worth of currency in circulation is in the possession of foreigners.

In ancient times, the solidus circulated far and wide. But it was a tangible thing, a gold coin struck by the Byzantine Empire. Between Waterloo and the Great Depression, the pound sterling ruled the roost. But it was convertible into gold—slip your bank notes through a teller's window and the Bank of England would return the appropriate number of gold sovereigns. The dollar is faith-based. There's nothing behind it but Congress.

But now the world is losing faith, as well it might. It's not that the dollar is overvalued—economists at Deutsche Bank estimate it's 20% too cheap against the euro. The problem lies with its management. The greenback is a glorious old brand that's looking more and more like General Motors.

You get the strong impression that Mr. Bernanke fails to appreciate the tenuousness of the situation—fails to understand that the pure paper dollar is a contrivance only 38 years old, brand new, really, and that the experiment may yet come to naught. Indeed, history and mathematics agree that it will certainly come to naught. Paper currencies are wasting assets. In time, they lose all their value. Persistent inflation at even seemingly trifling amounts adds up over the course of half a century. Before you know it, that bill in your wallet won't buy a pack of gum.

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Related link: 1991 Interview with John Exter

Related book: Mr. Market Miscalculates

The Greatest Deception in the History of Finance - By Kent Thune

So, if wanting more is a natural human behavior and we are deluged daily with enticing messages that encourage and support this behavior, what can be done, if anything, to manage this challenge? To help make my point, I will defer to an anecdote delivered to MBA graduates of Georgetown University, back in 2007, by Jack Bogle, founder of Vanguard:

“At a party given by a billionaire on Shelter Island, the late Kurt Vonnegut informs his pal, the author Joseph Heller, that their host, a hedge fund manager, had made more money in a single day than Heller had earned from his wildly popular novel, Catch-22, over its whole history. Heller responds, ‘Yes, but I have something he will never have: Enough.’ “

In summary, the best way to “get rich quick” is to be content with “enough.” What greater tragedy can there be than to chase something for one-half to two-thirds of a lifetime that may not be actually acquired by the means for which you have sacrificed?

“If thou wilt make a man happy, add not unto his riches but take away from his desires.” ~ Epicurus

To conclude, there is no such thing as financial freedom, at least not in the conventional sense of the term, which is the great deception. Paradoxically, the pursuit of financial freedom is closer to slavery than it is liberating. Furthermore, and in my humble opinion, freedom cannot be procured by financial means — freedom most likely lies at the point at which the utility for money begins to diminish — the point at which the basic sources of physical well-being — food, shelter and clothing — have been met. Beyond this point, freedom cannot be procured by financial means, yet millions continue pursuing the idea of financial freedom. This is the deceit. This is the illusion.

True freedom begins by learning contentment — by the realization that you already have “enough” — where the search for pleasure can be replaced by the search for meaning.

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I would add the quote below to the list of great quotes in the article linked above:

"What difference does it make how much there is laid away in a man's safe or in his barns, how many head of stock he grazes or how much capital he puts out at interest, if he is always after what is another's and only counts what he has yet to get, never what he has already. You ask what is the proper limit to a person's wealth? First, having what is essential, and second, having what is enough." -Seneca

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Related book: Enough: True Measures of Money, Business, and Life

What Ben Franklin can teach execs

A 2006 Fortune article from Justin Fox.

Let others take the credit, set goals for the workday, and don't drink rum all day. And when your time-management fails, you're still better off for the attempt.

You'll never catch me reading a Stephen Covey book or attending one of David Allen's "Getting Things Done" seminars.

Why not? It's a combination of misplaced snobbery, an allergy to inspirational messages, and the fear that, once I've started on somebody's failsafe program for time-management success, I'll inevitably fall off the wagon and hate myself for it.

Now, however, I have found an acceptable alternative. It is the Autobiography of Benjamin Franklin. It's history! It's literature! It's Franklin! And yeah, it is also something of a self-help/time-management bible.

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The book is mostly, as advertised, an autobiography -- sprinkled as most good autobiographies are with the occasional life lesson. One is astounded by all that Franklin manages to do (he teaches himself French, Spanish, and Italian in the evenings after full days of running a print shop, publishing a newspaper, and busying himself with Pennsylvania politics).

There is a steady stream of advice about interpersonal relations, the common thread of which is this: You can get a lot more accomplished if you let others take the credit. Franklin also argues that you can be more productive at work if you don't drink rum or beer all day, apparently a revolutionary concept in the 18th century.

It was during a sea voyage home from London in 1726 that Franklin had time to think more deeply about what constituted effectiveness, and how to achieve it. He refined his ideas over the following couple of years into a list of virtues (temperance, silence, order, resolution, frugality, industry, sincerity, justice, moderation, cleanliness, tranquility, chastity, humility), after which he drew up a scorecard to keep track of how he was doing on each of them. Achieving order was a particular struggle, so he devised a template for his workdays that he consulted regularly:

"THE MORNING," it began. "Question: What good shall I do this day?" Then he was to spend 5 through 7 a.m. rising, washing, and eating. More importantly, he was to "Contrive day's business, and take the resolution of the day..." In the evening, after his day's work, he was, among other things, to ask himself, "What good have I done today?"

This emphasis on setting goals for the day ahead and taking stock afterward remains a staple of time-management advice. (At least, so I'm told.) There's clearly something to it: I know that I'm far more likely to accomplish something when I have a well-defined to-do list for the day. But in a work world where conflicting, competing priorities are the norm, it's really hard to stick to such a list. Which is why most of us seldom get around to devising one.

Ben Franklin certainly didn't. As a small-businessman he had to jump at the whims of his customers. Also, his interests were so many that he struggled to keep track them all. "I found myself incorrigible with respect to Order," he admitted in the Autobiography. "But on the whole, tho' I never arrived at the perfection I had been so ambitious of attaining, but fell far short of it, yet I was, by the endeavour, a better and happier man ..."

This is perhaps the most appealing aspect of Franklin's time-management advice: He was an admitted failure at it, and yet that was ... okay. Which is just about the most inspirational message conceivable.

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Related previous post:

Ben Franklin's 13 Virtues

Related book:

The Autobiography of Benjamin Franklin

Hussman Weekly Market Comment: Reckless Myopia

I should have assumed that Wall Street's tendency toward reckless myopia – ingrained over the past decade – would return at the first sign of even temporary stability. The eagerness of investors to chase prevailing trends, and their unwillingness to concern themselves with predictable longer-term risks, drove a successive series of speculative advances and crashes during the past decade – the dot-com bubble, the tech bubble, the mortgage bubble, the private-equity bubble, and the commodities bubble. And here we are again.

We face two possible states of the world. One is a world in which our economic problems are largely solved, profits are on the mend, and things will soon be back to normal, except for a lot of unemployed people whose fate is, let's face it, of no concern to Wall Street. The other is a world that has enjoyed a brief intermission prior to a terrific second act in which an even larger share of credit losses will be taken, and in which the range of policy choices will be more restricted because we've already issued more government liabilities than a banana republic, and will steeply debase our currency if we do it again. It is not at all clear that the recent data have removed any uncertainty as to which world we are in.

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Frankly, I've come to believe that the markets are no longer reliable or sound discounting mechanisms. The repeated cycle of bubbles and predictable crashes over the recent decade makes that clear. Rather, investors appear to respond to emerging risks no more than about three months ahead of time. Worse, far too many analysts and strategists appear to discount the future only in the most pedestrian way, by taking year-ahead earnings estimates at face value, and mindlessly applying some arbitrary and historically inconsistent multiple to them.

This is utterly different from true discounting – which does not rely on multiples, but instead carefully traces out the likely path of future revenues, profit margins, cash flows and earnings over time, and explicitly discounts expected payouts and probable terminal values back at an appropriate rate of return. That's what we actually do here. Talking in terms of multiples can make the process easier to explain, and can be a reasonable approach to the market as a whole if earnings are normalized properly, but ultimately, an investment security is a claim to a long-term stream of cash flows. It is not simply a blind multiple to the latest analyst estimate.

Fortunately, the evidence suggests that the long-term returns to a careful discounting approach tend to be strong even if investors repeatedly behave in speculative and short-sighted ways. This is because long-term returns are fully determined by the stream of cash flows actually received by investors over time, and because inappropriate valuations ultimately tend to mean-revert. In the face of speculative noise, the long-term returns from a proper discounting approach may not capture as much speculative return as might be possible, but over time, many of those speculative swings tend to wash out anyway.