There are other physical commodities, however, which have an equally compelling attraction. Commodities such as wheat, rice, oil, copper, and other metals are supported by the most remorseless of all current trends: a swelling world population and powerful growth in the emerging market giants. These commodities offer huge potential for profit—but you do need to invest with caution. You need to research an opportunity hard before you invest, and be prepared to walk away if the prices turn against you. You do need to think strategically as an investor, but you can’t afford to neglect tactics. In the long term, these are markets with wonderful upside potential; but a great opportunity at the wrong price is a deal you need to turn down.
By this point on our ladder of risk, we’re a heck of a lot higher than we were when we started. The truth is that ordinary investors should avoid futures, options, and other complexities, but I do believe that all investors should have direct exposure to physical commodities. The best way to do this is via a managed fund (such as a mutual fund) which invests directly in such things on your behalf. There are ETFs that theoretically offer the same thing, but I personally would avoid them. Commodities are traditionally seen as high risk and indeed they do bring some volatility into a portfolio. I personally regard them as a lower-risk long-term investment, in the sense that a rising world population and strong growth in the emerging markets will over time force the price of physical commodities (including food) ever higher, especially as currency values erode due to debasement, inflation, and excessive debt (which ultimately will be have to be monetized).
If you fancy treading still higher on the risk–reward ladder, there are additional steps which may appeal to a minority of confident investors. If you’re inclined to explore these upper steps, go ahead and do so—but always bearing in mind that as the opportunity for reward increases, so the risk of loss increases too. You need to evaluate your investments against your own risk tolerance—very low, low, medium, high, or very high. In general, younger folk can afford to invest a small proportion of their assets in well-researched medium- to high-risk opportunities; but no matter who you are, if you are attracted to high-risk opportunities, make sure you never invest money you can’t afford to lose.
I’d say there will be three major themes between now and the end of 2013, or thereabouts. The first will be acute trouble in the eurozone. Thus far, the damage done to the currency itself has been limited. The real damage has been to various specific risks within the currency zone, notably certain sovereign bond markets and the market for bank debt. In time, I’m confident that the region’s debt problems will cause the currency itself problems as investors rush to get out of the euro. They will most likely buy US dollars, the traditional safe haven, as they exit. In the longer run, however, the debt problems, inflation, and monetary expansion in the US are going to accumulate to a point where that currency no longer feels safe either. So while I wouldn’t want to be in the dollar for the long term, I personally am short the euro and long the US dollar for the time being. I’d expect to expand my position whenever attractive opportunities arise. If you don’t know what shorting means, and if you’re not sure how you’d go about shorting a currency—well, you may not be sufficiently expert to dabble in these things. The golden rule of investing is never to invest in an opportunity where you don’t fully understand the full range of risks and the full range of possible outcomes.
The second major theme will be problems in the banking sector. As it happens, for technical reasons, most bank stocks are at such low levels today that there is no great upside in shorting them. Nevertheless, if there is any sustained rally in the banking sector and if that rally is not firmly based on solid capital increases and honest accounting for losses, I’ll be looking to short the stock of individual banks. There is potentially a huge amount of money to be made here, but it’s an area where you need some real depth of expertise if you’re not to be burned.
Finally, the equity market is likely to go through a period of sustained volatility. On the one hand, investors are still stuck in Ponzi-ish thinking. They’ve spent twenty or thirty years relying on policymakers to support the markets whenever those markets have hit a roadblock. Investors want to believe that the current efforts of central banks and political leaders will make a difference, and we’ve already seen some huge (and unrealistic) ‘relief rallies’ at various stages since 2008. It still amazes me how gullible certain investors can be. Markets are meant to act according to reason and evidence, yet when a central banker comes out like a cheerleader, claiming that everything is getting better, the markets often trade up massively without any solid reason to do so. Experience shows that the only solid improvement will come from quantifiable deleveraging and solidly based growth, yet markets frequently ignore that knowledge in a lather of forgetting and false hope.
At the same time, professional investors aren’t completely dumb, and when the cold, hard evidence points to a mounting crisis in both the financial markets and the real economy, the market will react. Emotions sway a market, but facts will end up determining it.
Those conflicting feelings will make for a turbulent ride in the equity markets. If you’re adept at timing your entry and exit from the market, you should be able to make plenty of cash by riding the relief wave up and selling again for the surge down. The relief rally may well be substantial and it may well be prolonged, but that doesn’t mean it’s sustainable. Indeed, the current trading pattern in the markets—abrupt, exaggerated movements in both directions—strongly suggests an unhealthy trading pattern and one where the underlying demand is weak rather than steady.
Because these things move so fast, I’ll maintain a running update via my blog (planetponzi.com), but you can do a lot simply by making sure you have the right mindset to profit from markets in this state. The fundamental requirement for successful investing is that you keep a rigorous eye on the fundamentals, while also staying in touch with the market mood. In particular, you need to be aware that many individual investors end up feeling pressured by both the upswing and the downswing. At the top of the market, you’ll read a lot of material in the mainstream media about the glorious prospects for equities, the strong upsurge, the great growth prospects, and so forth. Talking heads—usually with an undeclared buy-side interest—will try to talk the markets up. Inevitably, you may feel you need to be in the market to benefit from all these things. But remember that professional investors are always ahead of you. The mood reflected in the mainstream media is already dated, and by this point professional investors will be thinking about taking profits and protecting against a fall. If you do invest then, you risk finding that you’ve bought in at the very top of the market.
Likewise, when the market is low, it’ll be that way because of a torrent of bad news, media bias, and grim prognostications for the future. You may well feel, if you do hold equities, that you were dumb for not selling them before but that you should at least cut your losses by getting out when you can. Again, that’s precisely the wrong way to think. Just as you need to sell when the market mood is euphoric, you need to buy when the market mood is dire. You also need to be realistic about your own limitations. Investing your money can be scary. The pressure of negative headlines can be overwhelming and nudge you into making poor financial choices. If you do want to invest your money actively, you need to be confident that you have the right emotional makeup to do so calmly and rationally—even when the markets around you are at their most volatile and the news headlines are at their most frightening. But for those who do have the confidence to do this, the opportunities for profit will be very considerable. And as I say, do watch the website, as we’ll maintain a running commentary on events there.
A final word about what not to invest in. You should certainly treat the entire area of exchange traded funds (ETFs) with suspicion. There are some very good and reliable ETFs, but there are far too many very poor ones. The simple test is only to invest in somet
hing you completely understand and feel comfortable with. If you are faced with a 1,000-page prospectus packed with legal terms that you don’t understand, you should avoid the damn thing. That’s not you being stupid, it’s you being smart.
For the same reason, if an opportunity looks too good to be true—a great bank interest rate, some kind of structured product with apparently excellent returns—it is too good to be true. In successful investing, plain vanilla is the best flavor, for almost everybody, for almost all the time. And in times of uncertainty, you should prioritize safety and the preservation of capital above everything else. That’s prudent investing. It’s how you’ll create and preserve your wealth.
26
Mr Smith goes to Planet Ponzi
This book has not been optimistic in tone, but I remain an optimist. Not in the short term, admittedly—the short term is going to be horrendous—but in the longer term.
The simple fact is that there is only one proven model for long-term wealth creation. That model requires free markets, competition, democracy, free speech, and an openness to trade, innovation, entrepreneurship and a lot of hard work. It’s a model based on enterprise and on calling authority to account. Those things aren’t merely embedded in American DNA, they pretty much are American DNA. Although the economic model looks a little different in Europe and Japan—a little more government intervention, a little less entrepreneurship—the same basic recipe has fueled a dramatic increase in living standards right across the Western world. The froth created by Planet Ponzi is merely the foam on top of the wave—temporary, dazzling, but fundamentally irrelevant. The collapse of Planet Ponzi will simply restore our focus on the things that have mattered the most all along: strong companies competing fiercely.
What’s more, countries can beat even the nastiest of financial crises. Sweden did so during the 1990s. Britain is taking some of the right steps (albeit under far less propitious circumstances) today. The Latin American debt crisis of the 1980s and the Asian and Russian financial crises of the late 1990s also passed away, leaving relatively little trace behind.
And once a crisis is fixed, it doesn’t need to recur. Sweden again is something of a poster-child for sound economic management, but so too is Canada. Australia (except for its crazy property market) is also well managed. So is New Zealand. Germany, though it’s surrounded by profligacy and economic turbulence, nevertheless pumps out strong economic results with remarkable consistency.
So these things are possible. In a way, it’s a mistake to get over-focused on all the bad things that have happened over the past few years. Although it’s absolutely essential to understand those mistakes and their origins, it’s easy to end up believing that Ponzi-ish thinking is so ingrained in our culture as to be effectively unavoidable. And that’s simply not true. Planet Ponzi has been a twenty- or thirty-year aberration. The damage from the period of financial realignment that will follow its collapse will be severe enough to teach a lesson to everyone: politicians, regulators, and—most important of all—taxpayers and voters. If voters refuse to accept fiscally incontinent government, we will never again have fiscally incontinent government. If voters refuse government-by-lobbyist, we will have government-by-voters instead. If voters refuse to accept a Wall Street of vast political influence, minimal regulatory oversight, and lethal economic impact, Wall Street too will be tamed. That’s how it used to be. That’s how it can be again.
Indeed, although this book has presented a large number of uncomfortable data, I see it as a fundamentally positive book. A motivational one. Although the political and financial situation around the world is dire, the power of change lies in our hands: yours and mine. And that change is starting to happen. The Western world has seen a surge in peaceful, popular protest movements, unparalleled for a generation or more. It’s perfectly true that those movements often lack coherence, but movements do. The protesters in Egypt’s Tahrir Square didn’t present a closely argued set of political demands, nor did they need to. They gathered to express their rage at Mubarak’s rotten regime and that regime duly crumbled, to be replaced, let’s hope, by something better. We need our Tahrir Squares: the rage, the protest, and, in due course, the regime change too.
What’s more, all the building blocks for a revived American economy are already in place. Leave aside the financial system for a moment. The US is still the richest, most innovative, most entrepreneurial nation on earth. We have the best universities, the best scientists, the strongest companies, and lavish natural resources. These are assets that will endure far beyond any financial crisis. They are assets which, even during the supremacy of Planet Ponzi, led to the success of Microsoft, Intel, Google, Apple, Amazon, eBay, Facebook, and countless others—to name only companies from a single economic sector.
And crises can be positive. Rahm Emanuel, President Obama’s chief of staff, once commented: ‘You never let a serious crisis go to waste. And what I mean by that is it’s an opportunity to do things you think you could not do before.’ He’s right. The toxic political atmosphere in Washington has inhibited change for far too long. It’s been impossible to secure real tax reform, real reform of Medicare or social security, a fundamental rethink of defense spending. Yet these things are essential. They’ve been essential for a long while, and it’s taken a once-in-a-century crisis to force these issues on to the agenda. Naturally, it’s not enough for these items to figure on a Washington agenda—we actually need to see change. That means legislators passing laws which their primary voters won’t like. It means an administration taking actions that are right for the country, not just right for the next day’s news headlines. It means voters acting wisely too: voters willing to use the opportunity brought by the elections of 2012 to enforce changes of the right sort.
The same goes for Wall Street. It was always going to be impossible to force through a fundamental reform of investment banking while those banks appeared to be highly successful at creating wealth. So it’s entirely positive that circumstances have altered so abruptly. As banks tremble again on the verge of collapse, and as ordinary voters can see what wreckage Wall Street has inflicted on the economy, change becomes not merely possible, but imperative.
The same goes for Europe. The pain currently being inflicted on southern Europe is awful, but it ought to have the effect of compressing into a few violent years the economic reforms that should have been put in place over the past two decades or more. If the rage of people on the streets sweeps out one rotten set of politicians, there’s no reason to think that set should not be replaced by a better, more truthful, more responsible set. Nor is there any reason why the economies of the south can’t be as vibrant as those of the north. Italy, remember, had thirty extraordinary years of postwar growth, and that was despite its governments not because of them.
These things aren’t idle hopes. The British government—the same one which is slashing spending, raising taxes, and being tough with banks—is, broadly speaking, not unpopular. Still more bizarrely yet (to an American observer at least), the left-wing Labour opposition party isn’t calling for anything so very different. The Labour leaders call for the austerity program to run a little more slowly, but even they explicitly support the need for entitlement cuts and tax increases. As a matter of fact, there isn’t a single political party in the UK that does not support these things.
The Brits are a stoic sort of people, but it’s not some weird ingredient in the British character which makes them willing to endure this kind of pain. It’s simply that their politicians risked being truthful. They explained the facts and explained why the pain was necessary. That’s all there was to it. That’s all it would take in the United States, all it would take anywhere else in the world: truthful politicians, willing to take a risk. It’s not much to ask—and as the gaudy palaces of Planet Ponzi collapse around us, it’s going to be harder and harder to shy away from a return to truth-telling.
&n
bsp; There’s yet another positive aspect to all this. Our culture has become gradually poisoned by Ponzi-ish falsehoods. We’ve raised a generation of children to believe in a get-rich-quick culture, to believe that material success simply floats down from the sky, that it doesn’t have to be earned by effort, risk-taking, and hard work. The super-materialists of Planet Ponzi—all those bankers who seemed to have a huge amount of wealth without having done anything tangible to deserve it—were terrible role models for our children, and at the same time so prominent that their example was hard to avoid. Yet as one set of role models collapses, another one endures: the older American one founded on a belief in hard work, invention, thrift, and excellence. The destruction of one culture will mean the return of the other. It can’t happen too soon.
Finally, I don’t believe at all in the idea that China is going to rise up and overshadow America and the Western way of life. The collapse of Planet Ponzi will be debilitating in the short term, but strengthening in the longer term: a tactical reverse that imposes a better strategy on the generals. Inevitably, of course, the Chinese economy will soon be larger than the American one. It won’t be so many years before the same is true of India too. But these are dumb wins, not smart ones. In 2011, in the midst of our financial crisis, per capita GDP in the United States was $48,666. In the same year, Chinese per capita GDP stood at $4,833. The reason why the Chinese economy is going to exceed the American one has everything to do with sheer mass of population and almost nothing to do with its technological or economic sophistication.
Planet Ponzi Page 32