I’m throwing a little wine and cheese party tomorrow night so I stopped by Formaggio in West Cambridge for the first time in a couple of months. Prices had gone up 25 percent on almost everything. Imported cheeses are now $25-35/lb. Domestic cheese is $20-25/lb. A tuna sandwich has gone up 25 percent as well. Perhaps this is the solution to the obesity problem.
A good New Yorker magazine story about the Beijing airport, from the April 21, 2008 issue.
“The Beijing terminal cost $3.65 billion to build, which in China bought a structure bigger than all five terminals at Heathrow put together, for less than half the cost of the new Terminal 5. The project was conceived, designed, constructed, and opened in four years, whereas the Heathrow terminal, from conception to completion, took twenty years. … the public hearings over the Heathrow terminal took the same amount of time as the entire construction of the Beijing one.”
A few months ago, I wrote a posting about the insanity of anyone paying billions of dollars for Yahoo. The insanity seems to be spreading. Microsoft walked away finally. Yahoo shares are trading at $24.50. Journalists are talking seriously about how the company is somehow worth $37 per share. If they wanted to buy Yahoo shares at $37 today, it seems that they would have no shortage of sellers.
Thanks to the miracle of inflation, I think it is possible that a share of Yahoo will be worth $37 one day. And when you sell that share, you can buy yourself a 40 oz. Diet Coke (the obesity epidemic will render 20 oz. soda bottles obsolete).
Newspapers haven’t reported any new Wall Street crisis for at least a couple of weeks. Does that mean that financial markets are likely to be stable for a while? Let’s look at how we compensate money managers (old news) and how managers of blown up funds and companies are regarded (new news).
Most of the investment dollars in this world are managed by professionals. If you look at the way leverage is typically used in hedge funds, you could even argue that professionals manage more than 100 percent of our savings.
Most professional money managers are compensated with a percentage of the return on investment that they achieve, e.g., the famous “2 and 20″ of hedge funds (2 percent of the total just for showing up to work; 20 percent of any advance; 0 percent of any decline).
Let’s suppose that every 10 years the markets suffer a big stress, e.g., the Russian default of 1998, the dotcom implosion of 2000, or the subprime collapse of 2007. Let’s also suppose that every 50-100 years the markets suffer a catastrophic stress, e.g., the 1929 stock market crash and subsequent depression. An investment strategy that ignores these risks can yield a very high return for 5-15 years. Would you want to pursue such a strategy as an individual? Probably not. A high return for the next 5 years isn’t so great if you might be wiped out in the next crisis.
Consider the professional money manager. If a fund generates high returns for 5-10 years, he benefits handsomely. Then one day the fund blows up and the investors are wiped out. The old theory was that the fund manager would be sad and ashamed. Sure he had the beach house in the Hamptons, the coop in Manhattan, and gold bars under every mattress. But he would never work again and he would be forced to spend his remaining 50 years Gulfstreaming from golf course to golf course.
The entirely predictable subprime “crisis” and the way that it has been treated in the industry and in the media should embolden professional money managers to take even more risk in the future. The guys who blew up are mostly excused. They didn’t act irresponsibly with their customers money for personal gain. They were caught up in an industry-wide and worldwide “crisis” that was practically unavoidable. It seems that the very same folks who wiped out a lot of American dreams will be back on the job in a few months, collecting their 2 and 20 from the next round of investors. And what strategy will they pursue in their new job? The same one that you or I would if given the same incentives: maximize personal income by taking some risks that are unlikely to blow up the fund before the new jet is paid for.
[Exceptions to this rule are money managers like Warren Buffett who keep most of their own wealth in the fund that they manage.]
What do we get when we have tens of thousands of professional money managers worldwide operating with these same incentives? Unstable markets.
That leaves the question of what the next meltdown will be. We have had the dotcom meltdown. We have had meltdowns of debt from various countries that were obvious houses of cards, e.g., Argentina. We have had the U.S. “sold by criminals to deadbeats, rated by idiots, bought by fools” mortgage meltdown. We have had a substantial meltdown in the value of the dollar. My prediction is that the next collapse will be caused by a collapse in the prices of oil and gold, items that people currently believe can only go up and are making big bets based on those beliefs.
How could gold not go to $2000/ounce and oil to $200/barrel? The Earth contains an unlimited supply of gold if you’re willing to spend enough to extract it. That’s also what we were always told about energy, i.e., that if oil went to the seemingly ridiculous price of $50-80 per barrel, all kinds of alternatives would become viable. We would have geothermal systems pumping cold water down into hot dry rock. We would have all kinds of solar. We would be melting down shale into oil. Maybe folks in the U.S. won’t do any of these things since our government is investing all of its money in trying to make Iraqis love each other and our companies are investing all of their money in China and Mexico. But nothing stops the Canadians, Chinese, Indians, Europeans, et al., from pursuing technological innovation in energy and gold mining.
Here’s a video taken from a helicopter showing dogs and some of the colorful characters that make Florida such a great place to live.
The U.S. may be slipping in education, manufacturing, IQ (especially at credit rating agencies and among investors who bought mortgages), and economic growth. According to USA Today, however, we are doing great at creating jobs in local, state, and federal government: “Hiring leaps in public sector.”
“Governments added 76,800 jobs in the first three months of 2008, reports the Bureau of Labor Statistics.
“That’s the biggest jump in first-quarter hiring since a boom in 2002 that followed the terrorist attacks of Sept. 11, 2001. By contrast, private companies collectively shed 286,000 workers in the first three months of 2008.”
Let’s hope that the tax fairy doesn’t come around asking those handful of us who are still working to pay these folks’ salaries…
