Page 1 of 2
Just staying alive
By Doug Wakefield with Ben Hill
The size and frequency of the United States government's interventions into the
markets, especially over the past month, has generated little coverage. Those
articles that have addressed this seem to ignore its implications, concluding
that the markets will chug along indefinitely.
The only real surprise is that these comments have more frequently come from
individuals who have written extensively of the morass in our financial system.
How is it that so many take such historically profound information in stride?
Why does most of the public not recognize the numerous warning signals the real
world is giving to prepare for significant changes?
I invite you to ask yourself the question I asked a few professional
traders recently: "What questions are we not asking that we should be?"
Historically speaking, inflation is a cunning enemy, creating the greatest
societal illusion of power and success, only to dash dreams as debts come
crashing down. And, history and science show that there are no easy solutions,
for debt - created out of thin air to bail out yesterday's failing debts - is a
sand pile that suddenly gives way in an avalanche.
Though science shows that earthquakes are often preceded by increasingly
frequent tremors, we are more prone to extrapolate our current circumstances
into the future than we are to look for cluster patterns. So when the dramatic
shift lower occurs, the vast majority are not prepared. Whether it was pride or
fear or the pace of the race we call life that prevented us, we failed to tear
through the flimsy facade of the just-so story presented to us and to look more
deeply into difficult information. So, famous people lose money; rich people
lose money; politicians lose money; and we can be sure that millions of couch
potato investors and advisors will lose money.
If our financial success has been built on inflation, or worse, runaway
inflation, and if we are told that our current credit expansion, the largest in
history, can continue, would it not make sense that we would want to dismiss
the rising fear and distrust around us as individuals becoming too negative or
too emotional? If given the choice between fear and overconfidence, from which
would we rather operate?
I recently talked with Dr Larry Parks, director of the Foundation for the
Advancement of Monetary Education. While some may be tempted to dismiss this
institution as heady or academic, Park's passion to communicate his message is
nothing short of patriotic. I asked him to tell me what he thought I might have
missed in my research. In response, Parks directed me to the Bank of
International Settlement's most recent OTC Derivatives Report, which states:
Notional
amounts outstanding of such instruments totaled US$516 trillion at the end of
June 2007, 135% higher than the level recorded in the 2004 survey. This
corresponds to an annualized compounded rate of growth of 33%, which is higher
than the roughly 20% average annual rate of increase since positions in OTC
derivatives were first surveyed by the BIS in 1995. Notional amounts
outstanding provide useful information on the structure of the OTC derivatives
market but should not be interpreted as a measure of riskiness of these
positions. While a single comprehensive measure of risk does not exist, a
useful concept is the cost of replacing all open contracts at the prevailing
market prices. [Triennial and semiannual surveys on positions in global
over-the-counter (OTC) derivatives markets at the end of June-2007, BIS,
released Nov. 2007]
The first thing to note about this data is
that it is in trillions of US dollars, which makes one thing clear: we have
reached a point in financial history that we have never seen before. That's
right, no one you are reading and no one commenting on our current financial
markets is an expert on where we are going.
So, successful navigation of these straits will require a great deal of
listening, frankness, and humility, things that have always been in short
supply within the financial system.
Too much to master
I am not the expert, and I have no problem with that. There is simply too much
to know to claim mastery of the subjects about which we write. I do love to
read brilliant thinkers, and I enjoy talking with those whose experience is so
vastly different from my own that I am bound to gain a broader perspective.
Mike Arnold's experience makes him keenly aware of the world of money and data
such as that given above. Arnold is a professional trader. He was a floor
trader and an off-floor trader on the Chicago and New York Exchanges. He
managed a group of off-floor traders in Chicago and New York and has taught
hundreds of people to trade stocks, futures and options. Those at the highest
levels in the world of money will tell you that the best way to gain an
understanding of how the world of money works is to become a floor trader.
When I asked Arnold to spend time thinking with me, he gave me some great
insights. In answering the same question I posed to Parks, he commented: "We've
built this monstrosity of a machine, and there are tons of architects always
working on it. The problem is no one knows what is going on in the entirety.
Nothing this complex has ever existed in history. I believe what we are
watching is an exercise in the folly of human ego."
What is most frightening about the BIS data and Arnold's comments is that,
whether we are bulls or bears, we do not want the system to fail, and we do not
want to see good people bear the increasing weight of trying to bail out the
system on their backs. And yet, we all know that ultimately this is the
decision we must make.
The more we ignore the human element in this giant quagmire, the worse it will
be when the major markets start reflecting the real world problems that
bailouts have only exacerbated. Whether we're hedge fund managers, with
billions under management, individual investors, with small IRAs, or somewhere
in between, I hope the following ideas will help each of us.
1: Do not look to be accepted. Surround yourself with individuals whose
business models have provided them with a great deal of latitude in the world
of money. If you respect great contrarian stories like Templeton, buying
heavily into Japan in the 1970s, and Warren Buffet, loading up as the markets
declined in 1973 and 1974, ask yourself, "As we headed into various equity
markets' tops last October and November, did my investments look like everyone
else's? If I were to go to a conference with thousands of people, would I feel
comfortable because my story is the same as theirs?"
If the answer is yes, the daily headlines are warning us to stop looking for
short-term emotional rewards and start looking at the hard facts of science and
human behavior throughout history. Because it is most often a classic sign that
everyone is wrong in the group and no one wants to be rejected for a contrary
view, we would all probably agree that when everyone is agreeing with us, we
should not trust ourselves too much. If no one ever criticizes our opinion,
then this may be an indicator to rethink our position.
To drive this point home even more, remember, at the end of a credit bubble, we
should not look for the advice that makes us feel comfortable. Rather, we
should ask a ton of questions about the real financial and social issues before
we are caught off guard. If you owned a large block of Bear Stearns, did you
take its decline in stride as just the "natural" forces of the "free markets?"
2: In financial markets, all men are not created equal. Realize that at the
highest levels, the true story of money is dirty. Think about it. When Bear
Stearns, one of the top five-brokerage houses in the US, collapsed recently,
did people start scrambling to get out of their buy-and-hold strategies? Did
they start to ask a lot of tough questions? No. Why? JP Morgan, a firm with a
long history of "rescuing" other banks, was going to bail Bear out.
Never mind the meetings with Treasury officials over the previous weekend to
talk about things too sophisticated for the masses to understand anyway. All we
know is that JP Morgan initially announced that they would only have to spend
$236 million to buy out the entire brokerage house. Of course, the Federal
Reserve loaned JP Morgan $30 billion to "stabilize" the situation. Did most
investors understand that in so doing, we were ultimately paying for the deal
through a decrease in the value of the US dollars currently in our pockets?
Uneven debt collection
When average Americans fall behind on their debts, banks begin charging us 31%,
and we are hounded by bill collectors. When major banks fall behind and lose
billions, the banking cartel creates money out of thin air and gives new loans
at 2.25% to its favored members. Does this sound sustainable to you? Does it
build confidence in the system?
3: Now is the time to do something different. Listen to people who have
different opinions than your own. Have respect for individuals whose experience
in the world of trading and managing money is vastly different from your own.
Bob Lang, of Lang Asset Management, is one such individual in the world of
money. He has managed money for nearly five decades. After four decades on the
long side of the markets and two years of practicing a short-selling platform
(without real money), in January of 2000, he went live with one of the few
short-only platforms in existence.
I ask him: "What percentage of people have you talked with over the last eight
years that you really think understand the benefits of short selling in
declining markets?"
Bob responded: "By the time a prospect comes to us, they are
Head Office: Unit B, 16/F, Li
Dong Building, No. 9 Li Yuen Street East, Central, Hong Kong Thailand Bureau: 11/13 Petchkasem Road, Hua
Hin, Prachuab Kirikhan, Thailand 77110
