Sunday, April 24, 2011
Saturday, April 23, 2011
Saturday, April 9, 2011
Do The Math......
The issue at the heart of all the explanations of boom-bust cycles is the unpredictability of the future. This is what makes finance different - and more unstable - than other economic activities. The primary purpose of any financial system is to link decisions made today with events many years or even decades ahead. Savers, investors, and businesses must resolve here and now how much to save or spend, whether to build new factories and which technologies to back, but all these decisions depend on views about the future - and those views, in most cases, can be based only on gut instincts, hope, and fears.
In non financial businesses, market prices may move more or less rationally in response to measurable changes in supply and demand, but in financial markets, prices respond mainly to subjective expectations about events in a distant future that is often unknowable, even in a probabilistic sense. Modern economists sometimes pretend to overcome this problem by assuming that financiers make decisions by calculating future probabilities in the same way that normal business, operating in the present, count current profits and losses. But substituting probability distributions for observable facts does not solve the problem of uncertainty. It merely covers up the true problem, like a con man playing the three-card trick. Calculating probabilities may work well enough in the insurance business or in everyday banking, but in many events, probability cannot be assessed. Recent events have offered Spectacular examples.
What was the probability that two planes would hit the New York twin towers within an hour? What was the probability that the Soviet Union would dissolve without a shot being fired? What was the probability that the US government would suddenly withdraw its backing for a systemically vital financial institution that everyone "knew" was "too important to fail"?
Business life consists largely of similarly incalculable, but more banal, questions about the future that simply cannot be answered, even in a probabilistic sense. What is the probability that someone in the next hundred years will invent a soft drink more popular than Coca-Cola? This probability must surely rate at almost 100 percent, yet that would also have been true in 1910. There is no rational way of making such an assessment.
It is unclear if Thomas J. Watson, the chairman of IBM in the early 1950's ever made his widely quoted remark that "there will be a worldwide market for maybe five computers." But what is certain is that even as late as 1980, no one would have put any significant probability on computer sales exceeding car sales by a factor of ten to one.
The role of inherent unpredictability in finance means that the most important prices set in financial markets - interest rates, exchange rates, stock market values, and property values - will almost never correctly reflect conditions in the economy of today and may not create the right investment and saving incentives to keep the economy in equilibrium. Most of the time, the errors tend to cancel each other out or correct themselves quickly through normal market competition. But every so often financial markets go haywire, succumbing to the alternating excesses of greed and fear that create boom-bust cycles. Does this mean that financial cycles are pathological and immoral? The alteration of greed and fear certainly causes losses and economic disruptions in the short term, as well as suffering among innocent bystanders who have no involvement in finance, but in a larger historical perspective, financial cycles can be seen to play a crucial part in the evolution of the capitalist system.
Greed and fear, after all, are not unnatural or dysfunctional conditions. Natural selection has hard-wired these emotions into the human brain for good reasons. The great insight of Adam Smith was that greed, euphemistically described as self-interest, is the creative force that constantly drives humanity to improve the material world. Greed is what gives impetus to the arrow of progress - and this is true not only of economics. In Chinese philosophy the creative principle of yang is associated with aggression and acquisition. In Politics, Machiavelli described the accumulation of worldly "glory" as the motivation principle that drives leaders to undertake "great enterprises" and do "great things" on behalf of their fellow citizens and not just themselves. But greed, whether for material possessions or for political glory, must be kept in check. Hence, the evolutionary value of fear. Fear also known as prudence, caution, or the Chinese yin, is just as important as ambition and greed for human success.
This is why the ring of repetitive financial cycles is needed as a countervailing mechanism to control the arrow of progress. In fact, the interplay between the arrow and the ring may be necessary for the capitalist system to evolve and improve itself, just as the balance between the greed for profits and the fear of bankruptcy is needed for business and industries to adapt and improve.
In non financial businesses, market prices may move more or less rationally in response to measurable changes in supply and demand, but in financial markets, prices respond mainly to subjective expectations about events in a distant future that is often unknowable, even in a probabilistic sense. Modern economists sometimes pretend to overcome this problem by assuming that financiers make decisions by calculating future probabilities in the same way that normal business, operating in the present, count current profits and losses. But substituting probability distributions for observable facts does not solve the problem of uncertainty. It merely covers up the true problem, like a con man playing the three-card trick. Calculating probabilities may work well enough in the insurance business or in everyday banking, but in many events, probability cannot be assessed. Recent events have offered Spectacular examples.
What was the probability that two planes would hit the New York twin towers within an hour? What was the probability that the Soviet Union would dissolve without a shot being fired? What was the probability that the US government would suddenly withdraw its backing for a systemically vital financial institution that everyone "knew" was "too important to fail"?
Business life consists largely of similarly incalculable, but more banal, questions about the future that simply cannot be answered, even in a probabilistic sense. What is the probability that someone in the next hundred years will invent a soft drink more popular than Coca-Cola? This probability must surely rate at almost 100 percent, yet that would also have been true in 1910. There is no rational way of making such an assessment.
It is unclear if Thomas J. Watson, the chairman of IBM in the early 1950's ever made his widely quoted remark that "there will be a worldwide market for maybe five computers." But what is certain is that even as late as 1980, no one would have put any significant probability on computer sales exceeding car sales by a factor of ten to one.
The role of inherent unpredictability in finance means that the most important prices set in financial markets - interest rates, exchange rates, stock market values, and property values - will almost never correctly reflect conditions in the economy of today and may not create the right investment and saving incentives to keep the economy in equilibrium. Most of the time, the errors tend to cancel each other out or correct themselves quickly through normal market competition. But every so often financial markets go haywire, succumbing to the alternating excesses of greed and fear that create boom-bust cycles. Does this mean that financial cycles are pathological and immoral? The alteration of greed and fear certainly causes losses and economic disruptions in the short term, as well as suffering among innocent bystanders who have no involvement in finance, but in a larger historical perspective, financial cycles can be seen to play a crucial part in the evolution of the capitalist system.
Greed and fear, after all, are not unnatural or dysfunctional conditions. Natural selection has hard-wired these emotions into the human brain for good reasons. The great insight of Adam Smith was that greed, euphemistically described as self-interest, is the creative force that constantly drives humanity to improve the material world. Greed is what gives impetus to the arrow of progress - and this is true not only of economics. In Chinese philosophy the creative principle of yang is associated with aggression and acquisition. In Politics, Machiavelli described the accumulation of worldly "glory" as the motivation principle that drives leaders to undertake "great enterprises" and do "great things" on behalf of their fellow citizens and not just themselves. But greed, whether for material possessions or for political glory, must be kept in check. Hence, the evolutionary value of fear. Fear also known as prudence, caution, or the Chinese yin, is just as important as ambition and greed for human success.
This is why the ring of repetitive financial cycles is needed as a countervailing mechanism to control the arrow of progress. In fact, the interplay between the arrow and the ring may be necessary for the capitalist system to evolve and improve itself, just as the balance between the greed for profits and the fear of bankruptcy is needed for business and industries to adapt and improve.
Sunday, April 3, 2011
Once You Have Moved Beyond GTD Products and Fixed Maturity/ Income Investing - You have Entered a New Realm
Anything beyond Guaranteed Returns and Principal is the Domain of Another Realm.
Banking 2.0 - Evolving from a commodity based Mentality
When a commodity based mentality is transferred to more complex products and services, bureaucrats can wind up creating more costs than they save.
Saturday, April 2, 2011
Friday, April 1, 2011
The MARKET is BETA - Excess Returns are Alpha....
Why pay Alpha Management fees for Beta Management... Money has been Flushed Confusing One with the Other
Once we go Alpha the Relationship Changes.......You and We are now part of the performance/result
Your Role in the Process is defined....
Once we go Alpha the Relationship Changes.......You and We are now part of the performance/result
Your Role in the Process is defined....
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