An Honest Look at THE Most Important Thing Facing Investors

Over the last few years I’ve come to realize that understanding currency may be the most important challenge facing investors today. In order to build an informed and comprehensive view on what lies ahead, it is instructive to understand the history of money and currencies. Having read many narratives covering the same period, I was incredibly impressed with James Rickard’s ability to distill some of the more salient and often overlooked aspects of how our modern monetary arrangement came to be– and how the lessons of history can provide some insight into how our current system is changing yet again. Importantly, he is able to do so without slipping into some of the mental shortcuts that a less robust historical comparison invites, such as the role of the gold exchange standard during the Great Depression and what that may or many not mean for gold’s role as a monetary asset going forward.

[amazon_enhanced asin="1591844495" container="" container_class="" price="All" background_color="FFFFFF" link_color="000000" text_color="0000FF" /]By framing history as a series of “Currency Wars”, Rickards allows the reader to identify commonalities among various historical periods. The trade and budget imbalances, domestic and foreign policy challenges, and fiscal and monetary policy responses all seem to form a rhythmic melody which is layered over the fairly predictable and unsurprising beat of humans responding to incentives (greed) and focused on self-preservation (fear).

I found Rickard’s potentially disjointed discussion of complexity theory to be an unconventional and refreshing way of giving the reader another lens through which the currency system should be viewed– tools which have broad applications in understanding a variety of social, market, and economic forces.

I was disappointed by what I found to be limited use of the notes in providing references to assertions made by the author. But at the same time, unconventional ideas often lack academic support, and well supported assertions often carry similar bents and biases, so it is what it is.

In the end, Rickards arrives at a number of potential outcomes for various monetary relationships, some of which may sound outlandish to our modern mentality of relative currency and price stability, but surely are not radical in the context of the historical record and the many ways in which today’s challenges are larger in scale and more complex than those of the past.

Privilege Described, Opportunity Missed

Barry Eichengreen does an admirable job of describing the evolution of the global monetary system which has brought the US dollar to its presently tenuous role as the world’s reserve currency. It seems most people lack the historical perspective necessary to understand the present monetary arrangement and this book is an effective way to attain that base level of understanding. Though Exorbitant Privilege is certainly not unique in this regard and the task of educating readers on basic currency history does not require the advanced insight that Mr. Eichengreen is qualified to give, the Professor reaches his student-readers in a clear and concise fashion.

[amazon_enhanced asin="0199753784" container="" container_class="" price="All" background_color="FFFFFF" link_color="000000" text_color="0000FF" /]While my sense is that Mr. Eichengreen is somewhat progressive in his views that the dollar won’t (can’t!) maintain its status as sole reserve currency, I found myself disappointed that he didn’t ring louder alarm bells or entertain more extreme potential outcomes should the current imbalances persist. As an expert on money and currencies– the author shares with us many of the pieces needed to arrive at a few important conclusions. Yet he fails to combine the historical lessons learned (time and again) with some of the unprecedented current challenges to give proper weight to some truly alarming consequences.

Mr. Eichengreen gives many historical examples with modern day parallels of monetary policy makers “consciously choosing the stability of the banks over the stability” of their currencies, foreign currency agreements necessary for economic stability breaking down as the self-preservation of politicians overwhelms, and the tendency for markets to get out in front of policy makers, forcing change “not gradually, but abruptly.” The author details the important role gold has played throughout history, providing the carrot and stick for proper currency management. Yet at the end of the day, he seems to suggest a Goldilocks multi-reserve-currency, entirely fiat, Kumbaya type arrangement with no serious role for gold as a store of value is the most likely outcome.

He failed to convince this reader.

Professor Rappaport does a commendable job highlighting the common thread of many of the current deficiencies in our capitalist system: pervasive short-termism.

[amazon_link id="0071736360" target="_blank" container="" container_class="" ][/amazon_link]In “Saving Capitalism from Short-Termism” the author neatly threads the likely source of short-termism in capitalism today: the principal-agent problem and misaligned incentives. In short, we have become a society where corporate managers are hired to run businesses on behalf of shareholders who themselves are investment managers hired to run portfolios often hired by advisors or boards who themselves are agents entrusted to manage someone else’s money. Importantly, results in each area are measured by a set of accounting rules which often incentivize managers towards further favoring short-term decisions. Each of these agents is operating under a set of incentives that are often (and at best) misaligned and sometimes misappropriated.

As an investor, I particularly enjoyed the chapter pointing out the benefits of determining what expectations are priced into stocks (based on the estimating the present value of future cash flows), and making decisions based on a company’s likelihood of meeting or exceeding those expectations. [amazon_link id="159139127X" target="_blank" container="" container_class="" ][/amazon_link] Rappaport co-authored another book with one of my favorite investment thinkers, Michael Mauboussin, on the the same topic. However, I would have like to see a more lengthy discussion of other ways in which short-termism is reinforced in the investment management business, including Maverick Risk and the undesired side effects of many of the core principles of modern portfolio theory.

Rappaport takes the reader through each of the players highlighting the presence of short-termism driving decisions large and small and making some useful suggestions on ways each can change the incentives at play in order to re-orient decisions towards favorable long-term outcomes. Readers from all walks of business and life will find these suggestions thought provoking. The concept of customer equity was new to me and a compelling way for business managers to shift their thinking.

I received a copy of this book because I asked for it.

[amazon_enhanced asin="0470932937" container="" container_class="" price="All" background_color="FFFFFF" link_color="000000" text_color="0000FF" /]The Little Book of Sideways Markets: How to Make Money in Markets that Go Nowhere by Vitaliy N. Katsenelson is both a concise summary and updated version of Active Value Investing: Making Money in Range-Bound Markets.

The Little Book begins with a reminder that markets do not generate consistently average returns even over time horizons as long as 10 or 20 years, but rather are marked by secular cycles.  Bull, Bear, and Sideways. Where sideways markets are defined by periods when earnings grow but valuations contract resulting in low real returns and bear markets are defined as periods when both earnings and valuations contract driving returns decidedly negative. This way of looking at secular markets is described in much greater detail by the likes of Ed Easterling in Unexpected Returns and Probable Outcomes, John Mauldin in Bull’s Eye Investing and others. However in his Little Book, Vitaliy provides good foundational groundwork for the different approach all investors must take in secular bull or sideways, range-bound markets. Importantly, the author reminds us that strategies  need to differ– “Think Long-term, Act Short-term in Sideways Market.”

[amazon_enhanced asin="0470053151" container="" container_class="" price="All" background_color="FFFFFF" link_color="000000" text_color="0000FF" /]The Little book does an excellent job describing the three characteristics of potential equity investments Quality, Value, Growth and what to look for. Again, this book is a summary appropriate for students, new investors, and the like– for details one needs to revisit Katsenelson’s original book, Active Value Investing.

The updated commentary comes in the form of a concise, lucid summary of the macro issues facing Japan and China and should be required reading for anybody who has not given full consideration to the imbalances that exist. Lastly, the biggest “AHA” idea in the book came from the foreword by John Mauldin which relates that research shows that people need to be hit with at least three negative events to be persuaded that things have changed. With two dramatic declines in the US equity markets in the last 10 years, one is advised to head the advice of Vitaliy in his Little Book to avoid needing the third negative shock to make changes to the way one invests.

Disclosure: I received a copy of the book because I asked for it.

Having listened to Chris Whalen’s analysis and commentary over the last several years, I expected Inflated: How Money and Debt Built the American Dream to be a critique of the use of debt over the last 20- 30 years to drive economic growth via consumption. I was expecting a story that while underreported, under-appreciated, and not widely understood by the public, was one that I, like many other investors, am ultimately aware of.Instead, the book was a 200 year tour of American monetary history, an invaluable story which ultimately even fewer of today’s citizens and investors are aware of.

The author meticulously covers what seems to be every critical political development in America’s monetary history. From the period of free banking, private (non-government issued), gold-based money prior to the Civil war to Lincoln’s establishment of a national currency printing press to the multi-stage 20th century de-linking of the value of the dollar to gold, we learn of our elected officials ongoing struggle to limit the role of government and the issuance of debt to fund national priorities. These priorities shifted over time from war efforts and subsequent rebuilding requirements to imperialism, the suppression of communism and ultimately the protection of the interests of Americas banking elite and the continued growth of a consumption-addicted economy. Interestingly, the one constant was the presence of special interests pushing politicians towards economic and monetary policies that benefit the few at the expense of the many.I don’t think it is myopic to suggest that we are hitting all time lows in the collusion of politicians and the special interests that keep them in office at the expense of the economic well-being of current and future citizens.

While “sound-money,” limited government, and fiscal restraint are certainly advocated for by Whalen, he makes no effort to sugar-coat these virtues as panaceas to todays financial vices. He does a good job of describing the cycles of speculation, market manipulation, asset bubbles, and resulting deflationary depressions that litter America’s history. While it seems that Whalen attempted to hide his obvious contempt for liberal, Keynesian economic policy, he nonetheless seems to lose some impartiality in his review of history. Perhaps a bit of anger and contempt is what is needed to get people to understand what is happening to the value of their currency.

Most citizens today do not understand what money is beyond a medium of exchange used to acquire goods. Unlike our ancestors, we do not understand its important role as a store of value or know what it is like to see abrupt declines in the purchasing power of the money in our wallets. Instead we have been lulled into a false sense of security through the veils of a false prosperity and a sometimes slow, but always steady decline in the purchasing power of ‘the almighty dollar’. Perhaps growing awareness of our current debt woes, income inequality, and general economic discontent, will be enough to spur a call to action. However, we will need more books like Inflated to remind us where we have been and where we are headed.

The history of money and debt in American provides context for the current generation of savers and investors and an essential component to understanding today’s economic imbalances and tomorrow’s solutions. Inflated does a commendable job of delivering such a message.

Disclosure: I was sent a copy of this book to review because I asked for it.

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In Working Together, Michael Eisner uses the stories of several successful partnerships (including his own) to find commonalities and perhaps offer the reader a formula for identifying or creating the same.

The stories are great and every reader will find a different partnership that he or she identifies most with, but the overriding lesson is that the best two person teams have partners who have very different personalities and skill sets, but shared values, beliefs, ethics, and ultimately goals.

As an investor, I particularly liked the chapters on Warren Buffett and Charlie Munger and John Angelo and Michael Gordon, which remind us that most great partnerships have at least one optimist and one skeptic. The trust that Warren and Charlie have developed in one another was a key feature of several other partnerships including Joe Torre and Don Zimmer of the New York Yankees who also discovered that trust fostered loyalty and an ability for partners to benefit from each other’s strengths, without feeling compromised by their own vulnerabilities.

Several notable stories emerged from Eisner’s interviews like Bernie Marcus asking Arthur Blank to just keep bumping the revenue projections up on the first Home Depot store until the projections showed profitability. While this obviously worked out for them, I imagine there are more than a few entrepreneurs where that wasn’t the case. I also enjoyed learning about Brian Grazer’s networking techniques at Warner Brothers which ultimately led him to his partner, Ron Howard.

Ultimately, Eisner draws a set of conclusions about successful partnerships that lead to the whole being greater than the sum of the parts which can be measured in both financial and emotional terms. Eisner’s book is a relatively quick read with enjoyable stories and relevant lessons for anyone interested in how to identify or create the next great partnership.

[amazon_enhanced asin="1604190086" price="All" background_color="FFFFFF" link_color="000000" text_color="0000FF" /]Mr. Market Miscalculates was my first sustained introduction to the writings of James Grant. I became an immediate fan-boy and was ultimately inspired to start writing the Value Restoration Project.

The book is a collection of essays that originally appeared in the pages of Grant’s Interest Rate Observer, a must-read research publication for serious investors. The book however is organized in such a way that both professional and novice market observers will gain from. Grant’s style is sophisticated and somewhat verbose, yet elegantly, if not effortlessly, weaves both history and current cultural phenomenons into his prose.

Grant takes the reader on a journey through two of the most amazing bull market turned bubble manias in history: The late 1990s Tech-Media-Telecom led boom in US stocks and the follow on act in the Housing and eventually Mortgage-backed Securities markets. The insights come mostly in “real-time” which allows us to appreciate the insanity of the times without the benefit of Monday Morning Quarterbacking. One can’t help but think, had he or she been reading Grant at the time (and headed his advice) then there would have been plenty of opportunity to not only avoid some of the largest losses of the decade, but actually prosper.

The other top level topics covered by Grant include two of his favorite: Monetary policy and the consequences for bond markets and currencies, including gold; Value investing and the immortal advantage of knowing what something is worth.

Mr. Market Miscalculates is an excellent collection of Grant’s unmatched combination of style and substance. Be warned however, if you get hooked on Grant as I have, you will be forced into becoming a subscriber of his paid newsletter/research service and it will cost you. It’s worth every penny.