Can't do housegirls

Eliot Spitzer is the subject of this weekend's Lunch with the FT. In it, FT interviewer (and Spitzer biographer) Brooke Masters writes,

But the spectre of Ashley Dupré, the 22-year-old prostitute who became Spitzer’s downfall, hangs over the conversation. At one point we are comparing notes on skiing, and I make a pitch for how nice it was to have a catered chalet with what I refer to as a “houseboy or housegirl” to cook all the meals.

“Housegirls I can’t do,” he says bluntly.

Matthew Yglesias on John Meriwether's new Hedge Fund

Yglesias notes the Financial Times article about John Meriwether, of Long-Term Capital Management infamy, setting up his third hedge fund and writes,

I’m not a huge believer in human rationality, so I totally understand how this scam worked once. That he was able to get a second fund off the ground is pretty amazing. If he finds investors for a third spin around the wheel I’m going to propose confiscating all the rich peoples’ money and giving it to capuchin monkeys.

Rumors of the dollar's death: greatly exaggerated

So says Martin Wolf of the Financial Times in his most recent column. Excerpt:

It is the season of dollar panic. These panic-mongers are varied: gold bugs, fiscal hawks and many others agree that the dollar, the dominant currency since the first world war, is on its death bed. Hyperinflationary collapse is in store. Does this make sense? No. All the same, the dollar-based global monetary system is defective. It would be good to start building alternative arrangements.

It's worth reading Wolf's column in full, but he makes a point there similar to one David Merkel made on his Aleph blog¹ recently [Merkel]:

Whatever country of our world has the status of reserve currency must issue debt, and a lot of it, that other countries can invest in to park their idle cash balances.

Wolf sketches out the "Triffin dilemma" this leads to: an overhang of debt that eventually undermines confidence in the reserve currency. Wolf's proposed solution is to look for an alternative to the dollar as a reserve currency, but I wonder if a simpler alternative would make sense in the near-term: instead of having surplus countries buy up U.S. debt to satiate their demand for dollar-based assets, why doesn't the U.S. government offer them an equity-like investment instead? Specifically, why not offer shares in a sort of massive master limited partnership that would invest its assets in nuclear power plants and other infrastructure, and pay dividends out of the revenues generated from those infrastructure assets?

Unlike the proceeds from the sale of Treasuries, which can go to fund transfer payments and health care for retirees, or extended military expeditions, proceeds from the sale of shares in this master limited partnership would go toward increasing productive capacity, which would fuel future economic growth in the U.S. This idea is a similar to (but simpler than) one proposed by Professor Yu Qiao of the School of Public Policy and Management, Tsinghua University, Beijing, in the Financial Times last spring.

¹Speaking of Merkel's blog, last month he asked if any readers had any stock ideas to share. I mentioned three: USEG, AYSI.OB, and DSNY.OB. As of yesterday's close, they were up 26%, 390%, and 60%, respectively.

The Management Leisure Suit

The Yes Men are anti-capitalist provocateurs and pranksters (or, "culture jammers"). According to Wikipedia, their real names are Jacques Servin and Igor Vamos. Vamos is an associate professor at Rensselaer, and Servin is, I assume, independently wealthy. They can be pretty funny though. I was reminded of them by a review of their new movie in the Financial Times earlier this week. Here's an example of one of the Yes Men's pranks from a few years ago, while impersonating WTO officials at a conference in Finland. If you are impatient and want to skip the set-up, the management leisure suit makes its first appearance around 6:24. From there, well... you'll see.

"Yes we Khan"

The other day, when the local Barnes & Noble was sold out of Rolling Stone, it happened to have Monocle as its new, featured title. I'd been curious to see an issue of Monocle since reading its editor Tyler Brûlé's semi-ridiculous Saturday columns in the Financial Times, which generally focus more on the minutia of his globetrotting than on why he's traveling in the first place.

For example, one column described his early-morning routine at a Hyatt in Seoul: ordering a Mandarin orange juice and a cappuccino from room service, before running for an hour on a treadmill, then scrubbing himself with a brush while sitting on a chair in the hotel's fancy shower/sauna, etc. Another column detailed how he ordered a lackey to fly from London to some town in Switzerland to pick up the wallet Brûlé left there, and hop on a train to Paris to get Brûlé his wallet before his scheduled flight to Tokyo.

In any case, Monocle, as it turns out, is chock full of content (an inch thick) and an interesting read. In one feature, an analyst from Jane's Defense Weekly was asked what aircraft he'd buy if he had $15 billion and were tasked with building an air force from scratch for a mid-sized G-20 country. Another article reported on the nascent commodity- and energy-driven boom in Mongolia, "Yes we Khan". The online version of the article is restricted to subscribers, unfortunately, but it offered some color on the situation in Mongolia. There seem to be a lot of opportunities for natural resources companies there, given the amount of resources in Mongolia and its proximity to China, but how much of that money will filter down to ordinary Mongolians is a question the article raises.

The article also reminded me of the joint venture Alloy Steel International (OTC BB: AYSI.OB) was negotiating with Mongolian conglomerate Geomandel last year. Last I heard about this from Alloy Steel's CEO (this was last October, well before he took the "Run Silent, Run Deep" tack toward shareholder communications), he said,

We have shelved Mongolia for at least 6 Months till this madness subsides.

Maybe when the company releases its next quarterly filing in August it will provide an update on this.

The photo above, of the outskirts of Ulan Bator, accompanied the Monocle article and was credited to Andrew Rowat.

BRIC Versus CRIB

In an op/ed in yesterday's Financial Times, Michael Hudson, an economics professor at the University of Missouri, ventriloquized the thoughts of foreign opponents of the United States, while warning of ominous consequences from the summit in Russia this week of the BRIC countries (Brazil, Russia, India, and China) ("Washington Cannot Call all the Shots"):

Many foreigners see the US as a lawless nation. How else to characterise a country that holds out a set of laws for others – on war, debt repayment and the treatment of prisoners – but ignores them itself?

[...]

It is no mystery to other countries how the US remains above the law. Foreigners see a financial system backed by American military bases encircling the globe. The IMF, World Bank, World Trade Organisation and other Washington surrogates are seen as vestiges of a lost American empire no longer able to rule by economic strength, left only with military domination. They see this hegemony cannot continue without adequate revenues and are attempting to hasten the bankruptcy of the US financial-military world order.

[...]

US officials wanted to attend Yekaterinburg as observers. They were told no. It is a word that Americans will hear much more in the future.

Mark Chandler, Global Currency Strategist at Brown Brothers Harriman, had a slightly different take on this summit recently ("Bric or Crib?"):

Brazil, Russia, India and China, now collectively known as the BRICs, will hold a summit in Russia on June 16th. Besides the Goldman Sachs invented moniker, these countries have very little in common except for the fact that they believe, to seemingly varying degrees of intensity, that they deserve greater influence in the conduct of world affairs than they currently have. And given the enormity of US power, as hard-core realists, they know any increase in their power and influence will come at the expense of America’s.

[...]

One of the most important reasons why the BRICs do not have the economic clout that they would like is frankly they don’t deserve it. Goldman-Sachs had a story (and more) to sell with its BRICs concept, but those same letters spell a real word, CRIB. The point is that the countries, outside of China, are not among the largest.

According to Bloomberg data, at the end of last year, China was the fourth largest economy ($3.2 trillion), behind the US, Japan, and Germany. This of course takes the Chinese data at face value, and given the often large gaps between energy production and reported GDP growth, as well as the amazing consistency of the pace of growth, many often cast a suspicious eye on Chinese data.

With a GDP of $1.3 trillion in 2008, Brazil was the 10th largest economy, though it is roughly half the size of France, which is the 6th largest economy. Russia and India were neck-and-neck for 11th and 12th places with each having produced about $1.2 trillion of goods and services last year. Spain’s economy is nearly 20% bigger than Russia’s and India’s, and it is the 8th largest economy. Together the BRICs account for a little more than 12% of the world’s GDP, and China alone accounts for half of that.

An African Perspective on Economic Development

From an op/ed in Friday's Financial Times by Paul Kagame, the president of Rwanda ("Africa has to find its own road to prosperity"):

[A]s I tell our people, nobody owes Rwandans anything. Why should anyone in Rwanda feel comfortable that taxpayers in other countries are contributing money for our well­being or development? Rwanda is a nation with high goals and a sense of purpose. We are attempting to increase our gross domestic product by seven times over a generation, which increases per capita incomes fourfold. This will create the basis for further innovation and foster trust, civic-mindedness and tolerance, strengthening our society.

[...]

Entrepreneurship is the surest way for a nation to meet these goals. Government activities should focus on supporting entrepreneurship not just to meet these new goals, but because it unlocks people’s minds, fosters innovation and enables people to exercise their talents. If people are shielded from the forces of competition, it is like saying they are disabled.

Entrepreneurship gives people the feeling that they are valued and have meaning, that they are as capable, as competent and as gifted as anyone else.

The rest of Mr. Kagame's column is worth reading. In it, he refers to the ideas of an economist we've mentioned here before, Dambisa Moyo.

A quick check of Wikipedia suggests that Kagame had a long, eventful (and somewhat controversial) military career before entering politics. This year, Kagame was included in Time Magazine's list of the world's 100 most influential people. His entry was authored by the mega church pastor Rick Warren, who wrote (in part),

Kagame's leadership has a number of uncommon characteristics. One is his willingness to listen to and learn from those who oppose him. When journalist Stephen Kinzer was writing a biography of Kagame, the President gave him a list of his critics and suggested that Kinzer could discover what he was really like by interviewing them. Only a humble yet confident leader would do that. Then there is Kagame's zero tolerance for corruption. Rwanda is one of the few countries where I've never been asked for a bribe. Any government worker caught engaging in corruption is publicly exposed and dealt with. That is a model for the entire country — and the rest of the world too.

The photo above, of President Kagame shaking hands with President Bush in the White House in 2006, is from Wikipedia.

An Astronomer with a Sense of Humor

A humorous letter to the editor in today's Financial Times, "Buy me a massive telescope or pay the consequences":

From Dr Charles Beichman

Sir, “Give me a billion dollars for my accelerator or I’ll kill your economy.” These words should strike terror into the hearts of bureaucrats everywhere. And the next time they hear them, those responsible for funding big science should immediately just hand over the money.

As your article (“Of couples and copulas,” April 25) on David Li^[1] describes, the flood of theoretical physicists, aka the “quants”, coming into Wall Street after the cancellation of the SuperConducting Super Collider (SSC) created the financial weapons of mass destruction whose power to annihilate wealth is now obvious.

With the loss of trillions of dollars throughout the world economy, how much safer we all would have been if Congress had just paid the ransom over a decade ago and kept all those physicists safe in their laboratory at the Waxahachie, Texas, site of the SSC. So, please, listen carefully when I say that we have one or two major space telescopes that need funding. Otherwise I might consider moving to Wall Street.

Charles Beichman,
Executive Director,
Nasa ExoPlanet Science Institute,
California Institute Of Technology, US

The image above, of David Li's Gaussian copula function, comes from the Wired article by Felix Salmon linked to in the footnote below.

^[1]Creator of the Gaussian copula default function ("the formula that killed Wall Street").

How Not to Create Broad-Based Prosperity

I'd been meaning to comment on Matt Miller's op/ed column in last Monday's Financial Times ("Businesses must wake-up and take action") but haven't had a chance until now, so here goes. In his column, Miller, a management consultant and senior fellow at the liberal think tank Center for American Progress, suggests that, in order to keep the metaphorical pitchfork-wielding mobs at bay, business leaders need to,

[W]eigh in now on three subjects on which they have been notably absent: executive pay; the need for an updated “social contract” that fits 21st-century realities; and a strategy to make service jobs that cannot be offshored a path to the middle class.

On the first of those three subjects, Miller is on mostly solid ground; on the second two, not so much. On executive pay, he writes,

It is in the enlightened self-interest of business to acknowledge that it is both wrong and politically unsustainable to have chief executives routinely accumulating entrepreneurial-style wealth without taking entrepreneurial-style risk – or worse, while presiding over shoddy results or the actual demise of their companies.

Tough to argue with that, though I would have added that it's in the interests of society for entrepreneurial-style wealth to go to those who not only take entrepreneurial-style risk, but make entrepreneurial-style contributions (in terms of creating new products or services, creating new jobs, etc.). I'd also disagree with Miller's proposed solution, which relies on self-interested restraint on executive pay by corporate boards and CEOs. I think we'd be better off with more-empowered shareholders. Since mutual fund managers tend to vote their shares in lockstep with corporate boards, one way to strengthen the voice of retail shareholders might be to require mutual funds to aggregate the votes of their retail shareholders on, say, the funds' top 5 or 10 holdings, and then vote their proxies accordingly. Warren Buffett put his finger on the main cause of excessive executive pay in a Berkshire shareholder letter we excerpted in a recent post ("Revisiting Warren Buffett's Criteria for Selecting Corporate Directors"): directors who aren't "owner-oriented" or "truly independent". As Buffett wrote,

[M]any directors who are now deemed independent by various authorities and observers are far from that, relying heavily as they do on directors’ fees to maintain their standard of living. These payments, which come in many forms, often range between $150,000 and $250,000 annually, compensation that may approach or even exceed all other income of the “independent” director.

Clearly, a director who gets more money from her director fees than from her day job isn't going to rock the boat on behalf of shareholders to try to rein in executive pay -- why risk losing her high-paying directorship? It's worth noting, though, that this sort of thing is mostly just an issue at the very largest companies. There are thousands of small publicly-traded companies where executive comp isn't excessive, and directors don't face such big conflicts of interest (mainly because director fees are so much lower, and also because fewer directors are selected for non-business reasons).

On to Matt Miller's other two subjects. On the need for a new social contract, he writes,

A visionary business agenda would make sure average workers feel more secure in an era of accelerating change; this is the only way to avoid a backlash against trade and economic dynamism altogether.

A fair point, though Miller seems to have no idea of how to do this. He gestures vaguely in the direction of universal health care, arguing that,

American business must rethink its odd, outsized role in the provision of health coverage, which may have made sense 50 years ago but which today leaves millions of families falling though the cracks...

It's worth noting here, since Miller didn't, that American business's "odd, outsized role" in health coverage was a direct response to a government policy, specifically FDR's wartime wage controls, which led companies to increase forms of non-cash contribution (such as health care coverage) to attract workers in a tight labor market. That said, there's nothing original about wanting to sever the link between employers and health insurance -- Milton Friedman advocated that, as did even John McCain's advisers during the general election campaign.

Miller is most off-base on his third subject, making service jobs that cannot be offshored a path to the middle class. On this, he writes,

[G]rowing numbers of jobs in the US face effective wage caps because they can be done for less, and often better, overseas. Yet in-person service jobs – such as teaching, home health services or hospice care, for example – cannot be offshored. How can the US turn this kind of work into jobs that can sustain a family?

Where to begin with this one? First, teaching is already a job that can sustain a family. Teachers tend to be paid solid, middle class wages with excellent benefits and job security. This is true as well of many skilled jobs in health care, such as nursing, physical therapy, etc. (though it may become less true if we transition to fully-socialized medicine). Second, although these jobs can't be outsourced, they can be performed by immigrant laborers, and in fact are. My guess is that Matt Miller is a smart fellow, but is relatively young and has little life experience related to the health care of senior citizens. Otherwise, he'd know that many nursing home, hospice, and home health care aids are female immigrants from the Caribbean or the Philippines. If Miller knew this, would he advocate restricting immigration? Somehow, I doubt that.

More broadly, the idea that a broad-based prosperity and a strong middle class can be built on teaching, home health care and the like seems daft. These are important jobs, to be sure, but ultimately the private sector has to earn the money to pay the taxes to support public sector jobs such as those of public school teachers. As for home health aids, in the private sector, the salaries of workers ultimately come from the sale of some product or service; a home health care agency that pays its unskilled health aids as if they were registered nurses won't be able to sell its home health care services at a competitive price. This isn't the way to create high-paying blue collar jobs. The way to do that is to facilitate industries that have high enough margins that they can pay their blue collar employees well -- industries such as natural resources and manufacturing.

The problem is that liberal think tanks such as the Center for American Progress -- although they support the goal of a strong middle class in the abstract -- advocate policies that work against this goal in reality. They oppose most manufacturing and natural resource industries out of concerns about carbon and global warming; they advocate policies that will make energy (and thus energy-intensive industries such as manufacturing) more expensive, for similar reasons; they oppose the vocational tracking that would support a strong manufacturing base, out of egalitarian educational ideals; and they support unskilled immigration, which lowers the wages of blue collar workers in industries such as construction.

The photo above, of oil industry worker who I'm sure earns enough to support a family, comes from the Department of Labor, courtesy of Exxon Mobil.

Goldman Sachs 666

Another Goldman-related item in today's FT is this blog post by Tracy Alloway, "The Devil and www.goldmansachs666.com", which mentions the existence of an anti-Goldman Sachs website, GoldmanSachs666.com, run by a fellow named Mike Morgan. Here's Mr. Morgan's disclosure note from his site:

Disclosure: Yes, I am short Goldman Sachs stock. I believe this company is evil and should not exist. We need to begin to break up companies that have as much control over world finances as Goldman Sachs.

Ms. Alloway takes something of a cheeky tone in her post on GoldmanSachs666.com, but what Mike Morgan is calling for above isn't too far off from what Alloway's FT colleague John Gapper called for in his column on Goldman today¹:

More fundamentally, we now know unambiguously that Goldman is a “systemically important financial firm”. In other words, Goldman is too big to fail and would be bailed out by the US government if its balance sheet failed. That privilege should come with weighty conditions.

Note that Goldman’s status is a choice, not a tag it has unwillingly been given. It could avoid this by shrinking itself into an institution like a private equity group or a merchant bank, which can take all the risks it desires because its partners lose everything if it fails.

¹The same column we mentioned in the previous post, "John Gapper Brings the Crazy".

"John Gapper Brings the Crazy"

Add the FT's John Gapper to Megan McCardle's crazy contingent¹ for questioning the political influence Goldman Sachs wields via its alumni in government. In his column today ("Don’t set Goldman Sachs free, Mr Geithner") Gapper writes:

Goldman wants to escape the burdens of political control while retaining the benefits of public backing. That does not seem like a good deal for the taxpayer.

There are obvious political risks in letting Goldman roam free while other banks remain bound by the troubled asset relief programme (Tarp). It would exacerbate suspicions that Goldman, with its long history of producing Treasury secretaries, gets special treatment. These were not soothed by the decision to pay off all Goldman’s credit default swaps with American International Group, now controlled by the state.

The bigger danger is the long-term precedent it would set. Goldman wants to bolt before Congress or Mr Geithner, who still operates as a one-man band while the nomination process for his senior staff meanders along, has the chance to change fundamentally how it operates.

So far, it has faced mildly irritating limits on how much it can pay staff but nothing on the scale of the 1933 Glass-Steagall Act, which imposed structural reforms on Wall Street after the excesses of the Jazz Age. It would never acknowledge it, but its political campaign is going just fine.

[...]

[Goldman CEO Lloyd] Blankfein criticised Wall Street’s past pay practices as “self-serving and greedy” but Goldman is still putting aside 50 per cent of revenues – $4.7bn in the first quarter – for the bonus pool. Inside, it may feel “humbled”, as Mr Blankfein said, but it looks like the same old bank.

The same, that is, except for one thing – Goldman is now backed by the US government. That is why Mr Blankfein wants to repay the Tarp money. Once it has repaid the $10bn, Goldman hopes to go back to paying employees what it wants, buying and selling more or less what it fancies and operating as before.

He is peddling an illusion. Even if Goldman repays the equity, the world has changed irrevocably because it is a government-backed enterprise.

The illustration above accompanied Gapper's column in the FT.



¹New readers can see this previous post for an explanation: "David Weidner Brings the Crazy".

The Undertaxed American Middle Class

In the Forbes column we quoted in the previous post ("Undertaxed America"), Bruce Bartlett referred to OECD data in making his case. Clive Crook referred to OECD data as well in a post on taxes in his Atlantic blog earlier this week ("America's widening fiscal gap"):

Mr Obama intends to squeeze the rich, but the scope for this may be more limited than US liberals would wish. Few Americans seem aware that the US income tax code, as a recent Organisation for Economic Co-operation and Development study showed, is already one of the most progressive.* Even before the rise in top marginal rates promised by Mr Obama, the US income tax collects 45 per cent of its revenues from the highest-income decile. Compare that with Britain at 39 per cent, Canada at 36 per cent, France at 28 per cent, Sweden at 27 per cent and an OECD average of 32 per cent.

This difference is only partly explained by the less-equal US income distribution. The fact that the US has no broadly based national sales tax - value added taxes make Europe's overall tax codes less progressive still - only underlines the point. The US tax system raises comparatively little revenue; what little it raises already comes disproportionately, by international standards, from the rich.

I have previously argued that the US will need a VAT [value added tax]. Even before Mr Obama unveiled his ambitions for healthcare reform, wage subsidies to help the working poor, better education and the rest, the US middle class was seriously undertaxed. The government's promises, on present plans, will be unaffordable. If they are honoured regardless, the only question is which comes first: broadly based tax increases or fiscal collapse.

I have wondered if there might be a simpler way to tax Americans' consumption than to implement a value added tax. Since income taxes in the U.S. are highly progressive, and IRAs and 401(k)s don't offer deductions for payroll taxes, there is little incentive for Americans in lower income quintiles to save instead of consume. For example, according to CBO data, effective income tax rates for Americans in the bottom two income quintiles were negative in 2005 (i.e., these Americans received more in transfer payments than they paid in income taxes). So why not just increase the payroll tax by some amount and then allow workers to deduct up to that entire additional amount if they make an equivalent contribution to an IRA or 401(k)? Those who contribute less than that additional payroll tax amount to their retirement accounts will be paying a de facto consumption tax.

The image above accompanied the Financial Times column from which Clive Crook quoted himself in his Atlantic post.

Lula: "White People with Blue Eyes" Caused Financial Crisis

From today's Financial Times ("Brazil president blames white people for crisis"):

Brazil's President Luiz Inácio Lula da Silva yesterday blamed the global economic crisis on "white people with blue eyes" and said it was wrong that black and indigenous people should pay for white people's mistakes, writes Jonathan Wheatley .

Speaking in Brasília at a joint press conference with Gordon Brown, the UK prime minister, Mr Lula da Silva told reporters: "This crisis was caused by the irrational behaviour of white people with blue eyes, who before the crisis appeared to know everything and now demonstrate that they know nothing."

He added: "I do not know any black or indigenous bankers so I can only say [it is wrong] that this part of mankind which is victimised more than any other should pay for the crisis."

Lula ought to know about the victimization of black and indigenous people. After all, Brazil was the last country in the Western Hemisphere to abolish black slavery, and as recently as five years ago, Brazil acknowledged that tens of thousands of its indigenous citizens were working as slave laborers. It's interesting that Lula says he doesn't know of any black or indigenous bankers though. Perhaps all the bankers in Brazil are white, but this isn't the case in the United States. We've had African Americans at the highest levels of the financial industry -- for example, Stan O'Neal as CEO of Merrill Lynch, and Don Parsons as a director (and soon to be chairman) of Citigroup. We've also had people of all races and backgrounds involved in originating toxic mortgages -- including Brazilians. In fact, two years ago, the Wall Street Journal reported on a "mostly Brazilian ring that allegedly conspired to defraud people by persuading them to buy homes they couldn't afford" ("How the Subprime Mess Hit Poor Immigrant Groups"). Here's an excerpt from that article:

SOUTH SAN FRANCISCO, Calif. -- Naira Costa, a 27-year-old housekeeper, met her husband at Message of Peace, an evangelical church that is a spiritual and social haven for Brazilians in the Bay Area. When the couple considered buying a house a few years ago, the church's head deacon, Soario Santos, ministered to that need, too.

Mr. Santos, a fellow Brazilian, served the Pentecostal church on nights and weekends. During the day, he worked as a loan officer at a mortgage brokerage owned by a Brazilian immigrant. Mr. Santos and other church officers also working at the same real-estate business routinely approached churchgoers to encourage them to buy homes.

Weak credit and low wages weren't barriers, Ms. Costa recalls. "He told us that a house easily would appreciate $100,000 in a year," enabling the owner to refinance, says Ms. Costa. "We trusted him implicitly. Everyone at the church was buying houses from him."

Today, Ms. Costa and other former Message of Peace parishioners claim that Mr. Santos was a key part of a mostly Brazilian ring that allegedly conspired to defraud people by persuading them to buy homes they couldn't afford. Ms. Costa, the housekeeper, secured a $713,000 sub-prime mortgage. In another instance, a Brazilian baby sitter borrowed $495,000. Now, the home buyers are beset by foreclosures and additional stains on their already-tainted credit.

The graphic above, from a Knight-Ridder article on modern slavery in Brazil, comes from a website called Mongabay.com

Stocks for the (Very) Long Run

From John Authers's column in today's Financial Times ("Long View: Why baby boomers will put their faith in bonds"):

US stocks have now underperformed Treasury bonds since 1969. Very few savers actively putting money away today started much before 1969. Most of them did so during a period when the cult of the equity held sway. For this whole generation, that belief in equities has proved badly misplaced. Various long-term surveys show that there have been very long periods of underperformance by equities in the past.

But we can say that the current sell-off is almost without precedent for its speed. [Research Affiliates' Rob] Arnott’s figures show that as Wall Street opened on Friday it was already dealing with the second biggest six-month decline in its history. The only bigger six-month drop was barely larger, at 51 per cent, at the end of the crash of 1932.

The good news is that 1932 marked the bottom of the great bear market of the 1930s, and that stocks rallied more than 100 per cent in a matter of weeks.

The bad news is that there were still 22 years to go before stocks regained their highs in nominal terms, and 26 years before they regained their highs in real terms, an event that did not happen until 1958.

[...]

All of this could shatter our confidence in stocks as the vehicle for the long run. While the evidence is still unequivocal that they do perform best over the very long term, the periods may be so long that they do not help some people during their lifetimes.

A couple of thoughts on this:

1) The shattering of confidence Authers mentions above, and the associated revulsion toward stocks, explains the multiple compression that Vitaliy Katsenelson wrote occurs during secular range-bound (or bear) markets (see his graphic above, or this post for elaboration on Katsenelson's thesis).

2) This column wouldn't have been a revelation to Benjamin Graham. Unlike the advocates of buy & hold indexing in recent years, Graham was well aware that stocks, broadly speaking, could under-perform for painfully long periods. Graham wrote this on p.12 of the third edition of his Security Analysis, which was published in 1951:

"Prior to 1929, one could say with some logic that the course of common stock prices appeared to be so determinedly upward that the intending holder of high-grade stocks for investment could afford to buy them at any time and to ignore their fluctuations. In the past 20 years there is no longer any clear-cut evidence of an underlying and persistent upward trend in common stocks taken as a whole."

Hence, Graham focused on investment strategies that didn't rely on a secular bull market lifting most stocks¹. Incidentally, he didn't know it when he wrote the quote above, but a new secular bull market had already begun when the third edition of Security Analysis was published -- one that would continue for about another 15 years.

The graphic above is from Katsenelson's website.

¹Worth remembering though that even Graham took a beating during the Great Crash: According to James Grant, in his introduction to the latest edition of Security Analysis, Graham lost 70% of his money (The Dow dropped 89.5% over the same 1929-1932 period).

More on Japan

In yesterday's Financial Times, David Pilling wrote that many Japanese are pining for Japan's pre-industrial days, "Japan harks back to an age of innocence":

On a visit to Tokyo this week, on more than one occasion when I asked how Japan should tackle the economic crisis, my interlocutor turned with ninja-like alacrity to the topic of pre-Meiji Japan. The period before American warships forced the country open in the mid-19th century was regularly invoked as a prelapsarian idyll, a time when Japan did not have to deal with the grubby business of earning its crust in the world.

Eisuke Sakakibara, the former vice-finance minister indelibly branded Mr Yen, describes a country that was peaceful, orderly, unspoilt and friendly. “That was what pre-Meiji Japan was like. We should go back to that,” he says.

His invocation of a more innocent, pre-industrial age could easily be dismissed as idle chatter were it not for the fact that it keeps coming up.

[...]

There is now much talk of putting more emphasis on agriculture and de-emphasising the manufacturing industries on which postwar wealth was built. “Japan, having major strength in manufacturing, will probably suffer most,” says Mr Sakakibara, who argues that, even after this economic crisis subsides, the world will never return to previous levels of material consumption.

Japan’s farm industry is commonly regarded as heavily protected, but the Japanese worry that they only produce 40 per cent of their calorific requirements. Mr Sakakibara supports the DPJ’s proposals massively to increase subsidies to agriculture and to industrialise the family-run farming industry. He has been trying to persuade Toyota that cars are a dying industry and that it should turn its engineers on to farming efficiency instead. The era of just-in-time carrots could soon be upon us.

A Historical Perspective on China and Japan

Interesting letter to the editor in Wednesday's Financial Times:

Japan has been in the cold before, by the same rationale

Published: March 4 2009 02:00 | Last updated: March 4 2009 02:00

From Prof Arthur Waldron.

Sir, Japan’s allies have left it in the cold before (“A diplomatic feint that looks set to leave Japan in the cold”, Philip Stephens February 27), most notably after the Washington Conference of 1921-22, which saw the security treaty with Britain, fundamental to Japan, discarded, with a fine-sounding set of multilateral guarantees as substitute. The rationale then, as now, was the need to yield before the inevitable rise of China.

What happened? China entered an unexpected period of turbulence that threatened Japanese interests. Tokyo drifted for a while trying to work within the multilateral framework, but when it proved useless found a new compass in dictatorship at home and pre-emptive attack abroad, against China and eventually the US.

History does not repeat itself but it has lessons. One is never to sell short Japan, least of all as a power. Another is that all long positions on China should be carefully hedged.

Arthur Waldron,
Bryn Mawr, PA, US
Lauder Professor of International Relations,
University of Pennsylvania

The image above, of one of the Kongo Rikishi guardian statues at the Kofukuji temple in Nara, Japan, was pilfered from a Geocities site of what appears to be (judging by the flag) an Argentinian karate club.

"Dutchman who turned Nazi Debris into a dialysis machine"

From this weekend's Financial Times obituary for Willem 'Pim' Kolff, written by Phil Davison ("Dutchman who turned Nazi debris into a dialysis machine"):

There were parts from a downed Luftwaffe fighter aircraft and from the radiator of an abandoned Ford car. There were orange juice tins, an enamel bathtub, a wooden drum and thin, artificial sausage skins.

The strange prototype would one day save the lives of millions. Kolff himself, an inventive genius who has died at the age of 97, would go on to become the driving force behind the first artificial heart as well as a man-made eye, an artificial ear and one of the first sophisticated prosthetic arms. He never patented any of his inventions because he believed they should benefit all mankind, not one individual.

His early dialysis machines failed and 16 patients died. The 17th, just weeks after the end of the second world war in 1945, was 67-year-old Sophia Schafstadt, a Nazi collaborator.

“Most people wanted to wring her neck,” said Kolff later. He himself had supported the Dutch resistance. He had helped save 800 of his countrymen from Nazi labour camps by hiding them – he concealed one 10-year-old Jewish boy in his own home – or by helping them fake the symptoms of disease. Yet he still used his machine to bring Schafstadt, the dying Nazi sympathiser, out of a coma and she lived for another seven years.

“The moral is that we have to treat patients when they need help even if we don’t like them,” he said.

[...]

Kolff recalled later that her first words as she came out of the coma were: “I’m going to divorce my husband.” Her husband had opposed the Nazis – and she did divorce him.

The article also notes that Kolff led the team at the University of Utah that implanted the first artificial heart in a human (Barney Clark): Robert Jarvik, after whom that artificial heart was named, was one of Kolff's students. Jarvik, of course, is also the former star of Pfizer's Lipitor commercials.

FT Letter Writer Seconds Commenter J.K.

In the comment thread of a recent post ("Singularity U."), commenter J.K. took the editors of the Financial Times to task for their dismissive editorial about Ray Kurzweil’s "Singularity" concept. In today's FT, letter writer David Crooks offers similar sentiments:

From Mr David Crookes.

Sir, You say: “And even if researchers do endow machines with real intelligence ... why should it suddenly grow exponentially ... ?” (“Singular fantasies”, editorial, February 7).

You’ve not been paying attention in class, since this is Ray Kurzweil’s key point (and that of others, for example Vernor Vinge).

The substrate of future machine intelligence is expected to be computation, which is increasing in power exponentially thanks to Moore’s Law. The year we get a silicon FT editor for the price of a laptop, the next year we get two for the price of one. How long before the entire FT staff can be replaced by one laptop?

David Crookes,
Inverness, UK

The FT Editors Echo Jim Rogers on India

Jim Rogers has mentioned his doubts about India as a destination for investment on various occasions (for example, in this unfortunately undated article on his website). Friday's Financial Times included a bearish editorial on India, prompted by the accounting scandal at outsourcer Satyam Computer Services ("Satyam Scandalises"). Below are a couple of excerpts from the editorial.

India is rarely as shiny as its fans insist. The $1bn fraud perpetrated by Satyam Computer Services will not only throw the $40bn software and outsourcing industry into a tailspin, it will also raise disturbing questions about the risks of doing business in India - and even the sustainability of the country's much-vaunted growth miracle.

Only a few months ago, India saw itself as relatively immune from the global credit crisis. Some officials patted themselves on the back for going slow on liberalising capital markets, crediting their prudence as yet further evidence of the country's inexorable rise. But India now has a credit crunch of its own. Exporters are hurting and threatening to lay off 10m workers. Terror attacks on Mumbai have cast into doubt the competence of the security apparatus and shaken business and consumer confidence.

[...]

In spite of its poverty, it has sold itself as a country to which Fortune 500 companies can entrust sensitive data, banks their back offices and even patients the production of medicines. Its extraordinary success in IT over the past decade was based on the trust and credibility it established with globalised companies; the Satyam scandal has now put that at risk.

Outsourcing companies, furthermore, are keen to move up the value chain; to outsource some of their own functions and even to start acquiring the western companies whose businesses they help run. These ambitions are laudable. But like India itself, whose economic success story is built on extremely rickety social and infrastructural foundations, such grand designs can also smack of hubris.

John Paulson Gets Ready to Go Long

John Paulson of Paulson & Co., whose hedge funds posted huge returns last year by betting against sub prime mortgages, is starting a new fund on October 1st to invest in mortgage backed securities and selected financial institutions, according to today's Financial Times ("Paulson moves into Recovery Mode").