Does the latest financial crisis signal the end of a golden age of stable growth?

[Moshe..]

The global economy

The turning point
Sep 20th 2007
From The Economist print edition


IF ECONOMICS were a children's tale, a long period of rising incomes and improving living standards would always be followed by a big, bad recession. Rising unemployment, falling spending and contracting output—such is the inevitable reckoning for the good times of plentiful jobs and abundant earnings that went before. The hangover needs to be commensurate with the party.

No country has had it quite so good as America. For the past 20 years or more its economy has managed an enviable combination of steady growth and low inflation. To add to its good fortune, spending has routinely exceeded its income—leading to a persistent current-account deficit—without any apparent ill effects on the economy. The occasional setbacks have been remarkably small by historical standards. At the start of 1991, for instance, America's GDP fell for a second successive quarter (a common definition of a recession). But output soon recovered and by the end of the year had surpassed its previous peak. The next downturn, in 2001, was shallower still, with GDP dipping by less than half a percent.

More recently, other rich countries have enjoyed a similar improvement in economic stability. The ups and downs of economic life, known as the business cycle, have provided a much smoother ride than they once did. That is partly why there has been such a clamour for financial and housing assets, and why firms and households have been more willing to take on debt. A lot is now riding on this golden age of stability continuing.

But perceptions about risk are shifting. America's economy, for so long seemingly impregnable, has been growing rather meekly for the past year, weighed down by a slump in housebuilding. The ongoing crisis in credit markets threatens it with recession. Some observers, long mystified by America's ability to live beyond its means and postpone what they see as an unavoidable downturn, think that the world's biggest economy might finally have run out of luck.

Competing views about what lies ahead are themselves cyclical. When growth is steady, the belief that the business cycle can be tamed is understandably high. When recession threatens, that confidence can quickly vanish. On a pessimistic view the “Great Moderation”—the sharp drop in economic instability in America and other rich countries—will prove illusory. But an optimist would counter that the vast improvement in economic stability has been so marked that it will not just disappear overnight.

The world economy has reached a decisive point. If that magical combination of growth and stability was just luck, it is now due a long-postponed and painful correction. But if it was thanks to changes in the way the world works, does that mean the golden age will endure?

Luck or judgment?
Much of the focus—in good times past, as well as bad times present—has been on America, where fluctuations in economic growth have fallen by around half since the early 1980s (see chart 1). In upswings the economy's growth rate has varied by less from one quarter of the year to the next and from year to year. Recessions have been rarer, shorter and shallower.



The most visible symptom of this smoother trajectory is in the jobs market. Since the mid-1980s, America's unemployment rate has fluctuated far less than it did in earlier generations. Between 1961 and 1983, America's annual unemployment rate varied from 3.5% to 9.7%. Since 1984, it has stayed within the tighter bounds of 4% to 7.5%.

Much of America's good fortune has been repeated elsewhere. A study published last year by Stephen Cecchetti, of Brandeis University, Alfonso Flores-Lagunes, of the University of Arizona, and Stefan Krause, of Emory University, found that 16 out of 25 OECD economies, including Britain, Germany, Spain and Australia, had also seen a marked improvement in economic stability.

What lay behind that change? The sceptical view is that improved stability has no cause: it is mostly down to luck. Economic shocks—abrupt shifts in business conditions—have by chance been less powerful. The economy is no better at taking a hit; it is just that since the two oil-supply shocks of the 1970s the punches have not been so hard.

Yet the global economy has taken some big blows during the golden age. In the last decade the rich world has weathered the Asian financial crisis, Russia's debt default, the dotcom boom and bust, terrorist attacks on America, sharp increases in oil prices and the uncertainty that came with wars in Afghanistan and Iraq. Still, economic volatility has not picked up. It is true that the abrupt curtailment of energy supplies to a world that was highly dependent on oil was a unique and traumatic event. But economies were more hidebound then: job markets were less flexible and producers more stymied by regulation. The painful results cannot wholly be put down to energy dependency.

The flexible economy
The more likely explanation is that economies have become far better at absorbing shocks, because they are more flexible. There are many structural shifts that might have contributed to this, from globalisation to the decline of manufacturing in the rich world. The academic literature keeps returning to three: improvements in managing stocks of goods, the financial innovation that expanded credit markets, and wiser monetary policy.

For such a tiny part of GDP, the content of warehouses has had a surprisingly big effect on its volatility. When industries cut or add stocks according to demand, that adjustment magnifies the effect of the initial change in sales. Stock levels were once much larger relative to the size of the economy, so a small slip in demand could easily blow up into a recession. But thanks to improvements in technology, firms now have timelier and better information about buyers. Speedier market intelligence and production in smaller batches allows firms to match supply to changing conditions. This makes huge stocks unnecessary and minimises the lurches in inventories that were once so destabilising. The entire inventory of some lean-running companies now consists of whatever FedEx or UPS is shipping on their account.

Mr Cecchetti and his colleagues calculate that, on average, more than half the improvement in the stability of economic growth in the countries they studied is accounted for by diminished inventory cycles. That something so workaday as supply-chain management could have so marked an effect might seem a dull conclusion. But dullness is a virtue, because technological improvement is irreversible. This means the greater stability it provides is likely to be permanent.

The Wall Street shuffle
If better logistics is an unalloyed plus for the economy, the benefits of financial innovation may seem more doubtful—at least just now. Complex derivatives, such as collateralised debt obligations (CDOs), have created a truly nasty mess (see article). But if credit has perhaps been too easy to come by, that was itself a novelty. Credit was strictly rationed until a wave of deregulation and innovation during the 1980s and 1990s led to an expansion. That, in turn, gave a wider range of firms and consumers the means to plug temporary gaps in spending power.

Credit scoring and securitisation have attracted plenty of scrutiny in recent weeks. But the use of techniques to assess the risk of default, together with the repackaging of loans into marketable securities suitable for savers, has broadened access to borrowed funds and broken the rigid link between income and spending. No longer are investment plans tied to the vagaries of a firm's cash flow. And consumers can better match their spending to lifetime incomes. A bigger credit pool means transient declines in earning power need not trigger a downward spiral of falling demand and falling income. These are all valuable advances that smooth out the business cycle.

The third explanation for the moderation is that central banks, in getting to grips with inflation, have fostered more stable economic growth too. Indeed, so widespread is this assumption that the power of central banks is sometimes exaggerated. The rally in the world's stockmarkets over the past month has probably been driven by “faith in the Fed”: the belief that America's central bank will cut interest rates by enough to prevent recession.

In principle, controlling inflation helps steady the economy. High inflation tends to be volatile and research has shown that erratic inflation and large fluctuations in GDP growth tend to go hand in hand. That statistical link might be more than chance. High and variable inflation interferes with the smooth functioning of economies. It obscures the changes in relative prices that tell producers about how customer tastes are always changing. It also leads to variations in real interest rates and volatile patterns in spending.

Though the theory is compelling, empirical studies have struggled to pin down a strong link between better monetary policy and tamer cycles. Ben Bernanke, head of the Federal Reserve, has argued that “the policy explanation for the Great Moderation deserves more credit than it has received in the literature.” At the very least, central banks have stopped adding to economic volatility, even if they have not done so much to actively reduce it.

The shock-absorber that shocked
Although it is perverse to argue the golden age has not been tested, it would be foolish to rule out a shock (or combination of shocks) that might break the economy's resilience. Combine the present discord in credit markets with the seeming vulnerability of housing markets and it is all too easy to imagine the rich-world economies in trouble.

What makes today's turmoil so disturbing is that one of the mechanisms which helped stabilise growth has suddenly become a threat to it. Financial innovation is central to the Great Moderation, but its most recent creations allowed credit to be extended on too easy terms. The fallout is now poisoning the markets for short-term funding that are so essential to the economy's smooth functioning.

Because of rising arrears and defaults on American subprime mortgages, investors have lost faith in the securities backed by them. The impact has broadened to a more general revulsion against assets in which the income depends on repayments of consumer debt. As funding dried up, the resulting squeeze has put upward pressure on the money-market interest rates that determine the cost of borrowing for households and small businesses.

As long as credit markets stay impaired, the economy's normal self-regulation cannot fully be relied upon. A channel that for so long has helped smooth economic growth might now threaten it. A shock-absorber could turn into a shock-amplifier.

Indeed, the very stability of growth may have encouraged people to take on a debt burden that could prove troublesome. Strong credit growth is both cause and consequence of the golden age.

Belief that the business cycle has been tamed for good helps explain why property prices in many rich countries have risen so high and why there has been such a willingness to take on debt at large multiples of income. A less volatile economy makes income streams more reliable and, goes the argument, justifies higher prices for all assets, including housing. A reduced fear of job losses means homebuyers in America, Britain and elsewhere have been content to take out huge home loans.

But like all booms, the housing rush is dependent on ever-more risky borrowers to prop it up. Once credit conditions tighten, the marginal homebuyer is frozen out of the market. That is one likely consequence of the trouble at Northern Rock, a mortgage bank that was rescued this week by the British government (see article). Northern Rock was responsible for a huge share of mortgage lending earlier this year. But after a run on the bank its ability to write new business has vanished.



Britain has been growing steadily in the last year, but it has the same fault lines as America—an overvalued housing market, high consumer debt (see chart 2) and a huge trade deficit. Unlike other European countries, it has a big non-prime mortgage market too. Though less than 10% of recent loan growth has been in subprime, this rises to around 25% if you count borrowers who never had to prove how much they earn, according to David Miles, at Morgan Stanley.

Just as the germ carried from America's subprime mortgage market is now infecting money markets elsewhere, so the housing downturn itself could spread globally. As Alan Greenspan, the former Fed chief, reminded everyone this week, there have been housing booms in at least 40 different countries and “the US is by no means above the median”. If global house prices are as correlated on the way down as they were on the way up, the pain will not be confined to America. The cracks that have spread with the credit crisis could be the network through which the housing malaise travels.

As central banks try to mitigate these risks to growth, the danger is that they become complacent about inflation. There is a sorry story of how monetary laxity once undermined hopes for a more stable economy. In 1959 Arthur Burns, then chairman of the National Bureau of Economic Research (NBER), made a famous prediction that “the business cycle is unlikely to be as disturbing or troublesome to our children as it once was to our fathers.” For a decade that optimism seemed justified. But in the 1970s, on Burns's watch as Fed chairman, unemployment rose, inflation took off and a growing sense of economic crisis made a mockery of the idea that governments could control the business cycle. Attempts to fine-tune the economy through cheap money instead led to higher inflation and increased economic instability.

In his new book (see article), Mr Greenspan delivers a timely warning that progress in policymaking is always vulnerable to reversal. Looking to 2030, he fears that the burdens of an ageing population will eventually lead to upward pressure on inflation. And future Fed chairmen cannot rely on the deflationary effects of globalisation to tame prices, as Mr Greenspan could, as over time that impulse will fade.

Mr Greenspan questions the political will to enforce price stability. “Whether the Fed will be allowed to apply the hard-earned monetary policy lessons of the past four decades is a critical unknown. But the dysfunctional state of American politics does not give me great confidence in the short run.”

Once people sense inflation is slipping out of control, changes in expectations can quickly become self-fulfilling. Firms price higher and employees demand wages to match. If inflation expectations slip anchor, central banks will have to ratchet up real interest rates (or bond markets will do the job for them). Policy might again become the source of economic shocks.

Today the stakes are arguably higher. Highly leveraged economies rely on low nominal interest rates to keep debt-service costs manageable. A spike in bond yields would probably cause huge instability as interest costs ate into available spending. If wiser central bankers have indeed played a big role in the Great Moderation, it is sobering to think how easily the dangers of lax monetary policy might be forgotten.

Revising downwards
The prospect of a co-ordinated global housing slump is a very frightening one. For the moment, it remains a plausible risk. If house prices hold up, the credit-market disruption is still likely to harm growth in 2008. Even if money markets settle down—and there are the first signs of this happening (see article)—the loans that banks have been unable to sell as securities will instead sit on balance sheets, crimping their ability to lend. A more careful approach to credit means businesses and households will find it harder to borrow. That will hurt the world economy.

Banking on the Fed
Private-sector forecasts for developed-world growth are understandably being revised down. Revealingly, the biggest changes have been to expectations about interest rates. The likelihood of rate increases in Europe has been largely written off. And many projections for the Fed funds rate were decisively reduced ahead of the decision this week to cut (see article). In essence, the markets are betting the Fed can save the day. Stockmarkets, at least, do not appear to be priced for a recession—or anything like it.

On this they may be simply following the form book. If central bank actions are credited with mitigating previous downturns, then why not this one? The global economy has proved to be far more resilient than had often seemed likely. And it showed very few signs of trouble before the credit-market dislocations, mostly because growth outside the rich world has been strong.

In July the IMF revised down its projections for economic growth in America for this year, but still upgraded its global economic forecasts because of the strength of the emerging markets. These economies—a source of a big shock only a decade ago—could now prove to be a stabilising force for the world economy. Thanks to their handsomely cushioned foreign-exchange reserves, the fast-growing economies of Asia and the Middle East are now less dependent on capital markets to fuel their growth.

America remains the biggest risk. Even here, where the outlook is gloomiest, recession is not a forgone conclusion. Perhaps the best that can be hoped for—and maybe what policymakers are trying to engineer—is a continuation of the muddle-through growth of the past year or so. That would help contain pressures on inflation without causing excessive dislocation in the economy. But the risks to even this outcome are on the downside.

In the past year, America has become less central to global growth. But it is a big importer and a hard landing would affect other countries. Its fortunes over the next year will still have huge significance for other reasons too. America has been at the leading edge of the Great Moderation and has arguably pushed the boundaries of risk-taking furthest. If America falls hard now, it will be a harbinger for the rest of the rich world.

http://www.economist.com/finance/dis...ory_id=9831159

Another good article: http://www.economist.com/finance/eco...FTOKEN=8677363

[Moshe..]

I wonder if any of the americans here are players. I've been obsessively worrying & stressing out this month about what to do with my (admittedly very modest!) american assets. The american economy is a bit scary right now. I moved out my nasdaq and dow-jones index-funds last month - thankfully it was on the day after the markets rallied due to that beautifully timed interest-slash announcement following the credit-crunch. I barely got burned (about 0.8-9% to the bad). I've temporarily put everything into silver commodities (but that's obviously not a long-term solution for my small but important high-risk portion of assets). Currently, the silver demand from china and india is accelerating away nicely (the hunger for silver being a result of the vast capacity expansions of the electronics industry). Unfortunately, the EU, Japanese and American governments have been matching that demand by selling off their silver stockpiles, thus keeping the price gains relatively modest. I am nonetheless going to keep most of my funds there for safety (85% I think! However, if inflationary expectations start to pick up, I'll have to move most of it into the bond-markets in order to catch the inevitable spike in bond yields), but I want to do something moderately high-risk with my remaining 15%.

I am thinking american energy-futures now (Alaskan oil reserves? Also, oil-futures speculations in the gulf of mexico?). The basis for my (original) masterplan is the american government's strategic stockpiling policies. The huge expansion of the american strategic petroleum reserve (it will be doubled in the next few years according to the whitehouse) will guarantee american demand is higher than it should be. Moreover, the american domestic oil industry is going to be continuously subsidised (and given regulatory breaks) during this expansion for obvious geo-political reasons (reduced reliance on the middle-east + russian). Finally, even if the forthcoming situation changes radically (i.e. stability in iraq; iranians behave themselves and act nice; russians cheer up and stop drinking illicit industrial chemicals), the stockpiles will only be happily drained off to private american oil companies at discount rates (very very profitable for chevron stock ect!). And, basic macro-economist that I am, I know that this lucrative discount selling will be far more likely to happen in a few years if we have an economic slow-down (due to the political desperation caused by otherwise decreased government revenue flows). (So far as I know nobody else in finance has thought this stuff through yet!).

The alternative is to move it out of america altogether. This is what my brother's doing. He's putting his high risk portion (never more than 15%) into some very risky emerging markets. The remaining 85% is split: 45% super safe bonds, 40% medium-safe hard-commodities. He has some ridiculous mathematical justification for spreading his risk across the extremes. I believe too much in economic fundamentals to dare play the chinese and russian markets (and gov bonds, safe as they, are not very much better than a goldman-sachs savings-account). Foreign capital investors into russia were completely decimated less than a decade ago. And the chinese 'free-market style' institutions are built on quick sand. Of course, some kids would argue that this is still a mathematically acceptable level of risk so long as you keep moving that 15% in and out very quickly (almost like you do when playing the forex markets - which is, at least, good entertainment and divertissement!).

[MSFixR]

I saw your post a couple of days ago but due to its length have not gotten around to read it until now.

One word: diversify. (Of course you already know this, Moshe, but for anyone else reading this diversification is your insurance policy toward loosing your shirt.)

The last month or so has been rather scary. Personnal I lost a few bucks but decided to stay put in diversified blue chips and real estate. Things have not quite returned to "normal" but they are headed in the right direction. This is a self-healing correction and no credit to Bernanke & Co. whom Wall Street does not have anywhere near the confidence in as his predecessor Greenspan. When the second most powerful man in the world sneezed, everyone grabbed a bottle of cold medicine.

Personally, I'm not much of a gambler so I stick primarily with US investments with less than 5% in foreign equities. I would consider any investment in Russia or China very high risk. Also I suspect you are a bit younger than I, so your investment strategy can be a bit more risky. Good luck.

[Moshe..]

I saw your post a couple of days ago but due to its length have not gotten around to read it until now.

One word: diversify. (Of course you already know this, Moshe, but for anyone else reading this diversification is your insurance policy toward loosing your shirt.)

The last month or so has been rather scary. Personnal I lost a few bucks but decided to stay put in diversified blue chips and real estate. Things have not quite returned to "normal" but they are headed in the right direction. This is a self-healing correction and no credit to Bernanke & Co. whom Wall Street does not have anywhere near the confidence in as his predecessor Greenspan. When the second most powerful man in the world sneezed, everyone grabbed a bottle of cold medicine.

Personally, I'm not much of a gambler so I stick primarily with US investments with less than 5% in foreign equities. I would consider any investment in Russia or China very high risk. Also I suspect you are a bit younger than I, so your investment strategy can be a bit more risky. Good luck.

I like your post. However, unlike you, I am sure that the american markets are at least going to stay scary/uncertain for a while (and that there is a quite small but still very real possibility they will crash a bit - we simply don't know how likely this is).

I was only in nasdaq and dow-jones tracking index-funds (because I'm a follower of the random walk hypothesis - i.e. "you can't beat the market, my boy!") so obviously it was really easy for me to make the decision to move everything out. I don't know what you have, or the state of the particular american industries you're playing, but I think any kind of stock whatsoever should count as moderately-high-risk stuff from now onwards (since there is a small but nonetheless significant possibility of a recession, or even [although I think really unlikely] full-on-depression, which will hit everything stock-related).

The essential principle of the game (I was taught) is that you always keep at least 85% safe. Combining the principle with what I said above, 85% of your investments should be out of the american-stock-market as we speak.

But I'm also thinking hard about how to play (since I've pulled all my index-funds now) my remaining 'high-risk' 15%.

1. Real-estate or at least real-estate derivatives? I don't know anything about american real-estate (but if you're doing it, please be careful. Look at the weather forecast for the credit markets [upon which most of the demand is derivative] - it's not pretty!).

Given the credit-crunch, and probable future interest increases, I'd love (in my dreams!) to get into the super-high-end residential market of London. This sounds contradictory. However, I think it is a safe bet whatever the state of the other markets, including the credit market and general housing market - and not just because we have a massive under-supply of nice houses. The special thing about the super-high-end market in London is that the consumers are so rich (the russian/arab/american super-rich) that their demand is therefore entirely underivative on, or even positively-correlated with (due to their ownership of huge savings accounts), the rate of interest. Unfortunately, I'm currently far too poor to get into the racket (unless a lot of beneficient relatives kindly decide to die very soon!).

2. Energy company stock or derivatives, or energy commodities, or even energy-commodity futures. I know this is definitely in the quite high-risk [i.e. no more than 15%] category. The reason I'd like to try the sector out, although I don't know nearly enough yet, is the fact that, while energy demand is quite resilient regardless of (or inelastic relative to) the state of the business cycle, supply is (or at least predictions about future supply are) to a significant extent dependent on, in very simple mechanical ways, the international political/diplomatic situation (especially regarding the forecasts of external-supply-shocks - which are absurdly profitable!). And, luckily, I am comparatively good at understanding, analysing and predicting political/diplomatic events/machinations and thinking through their deeper implications (i.e. 'comparatively' meaning compared to the average financier who is usually the hermetical mathematician type. I have an advantage over the Quants in this department.).

3. Bond markets. This is obviously only for a part of the safe 85%. But given the current turbulence, and the potential for a yield-spike if continued interest cuts and inflationary expectations should pick up, our safe 85% might at least become reasonably profitable in this possible scenario. But if interests start looking like going up again, we move out of bonds!

4. Commodities. Obviously the commodity to do in the above inflationary-scenario is silver (but it may be bit over-valued at the moment - after tripling in six years). Of course, this is only relevant for your safe 85% portion (the average long-term price-growth in the commodity isn't comparable to an index-fund). However, silver is looking particularly good at the moment because of the emerging asian electronics industry which is thankfully no longer all that dependent on the whims of the American consumer (and therefore increasingly resistant to external-demand-shocks).


5. Emerging markets. Yeah I think we should probably wait a bit and see how these respond to any possible american crisis (if it ever happens - let's hope not!) before making a move (and then you have to be in and out as slowly as you dare).

6. Forex - I only play currencies if I'm really desperate! I've done it quite a few times before - and if you don't mind sitting in front of the computer all day long while thinking seriously hard about swiss-franc fluctuations, it's quite profitable (I once made well over $2000 in a day [using a $150,000 trading loan I borrowed from the Deutsche Bank currency accounts at about $90 interest per day]. But it is intellectually strenuous & stressful work. And it felt truly scary & risky being that over-leveraged!). Deutsche Bank allow you borrow over 20 times your deposit -- if you dare.

[open32]

The essential principle of the game (I was taught) is that you always keep at least 85% safe. Combining the principle with what I said above, 85% of your investments should be out of the American-stock-market as we speak.

I was taught 100-your age until 65 or 68 should go into the market with high to moderate risk. Which I pretty much follow right now.

I had real estate and got out of it, bad move since everything I had did pretty good. Now I have mostly international and emerging markets; a mutual fund as its difficult and expensive to buy foreign stocks. And Utilities and telecommunications. Its mostly funds, few stocks, no bonds or commodities.


The scariest thing is the credit problem, which isnt really balancing itself out and this strategy of continuing to lower rates to make more credit available isnt going to work forever.

Energy stocks are the riskiest thing to get into because of all the variables that play a role like weather, wars, politics, and new technology. With the push towards go green in America (though surprising the hell out of me, the US ethanol industry is in free fall) and a possible Demarcate as president long term plans might change for oil or at least speculation might change. Plus with all the high prices of oil, big oil company stocks are at a premium. You have to bet that most people will think oil prices will continue to rise for the next several years.

[MSFixR]

By Shula Neuman (Washington University Record)

The stock market might be nervous due to the subprime loan mess, but Stuart Greenbaum, Ph.D., former dean and Bank of America Professor Emeritus of Managerial Leadership for the Olin Business School, is bullish on the situation.
"Banks that don't have a lot of bad paper in their portfolios are going to see the credit spreads widen out, and they're going to end up making money as a result," Greenbaum said. "The situation has created a buying opportunity, and we're already seeing the reaction in the price of financial stocks, such as banks and insurance."

Greenbaum said that the subprime loan problem is a bit of toxicity that has entered the food chain.

Although the toxicity is widespread and expansive at this point, the market is built to absorb a certain amount of default.

The reaction to the subprime loan issue is compounded by several factors: First, the market was at a historically high level; second, interest rates were low; and third, the yield curve was flat and credit spreads have been very narrow, reflecting historically low volatility.

"So the market is reacting to a somewhat exaggerated situation to begin with, and it has a particular vulnerability because credit spreads were narrow," he said. "Volatility has been very low, which has been driving the compressed interest margins. As a result, banks have been having trouble making money."

Despite the circumstances, this is not a time to panic, Greenbaum said.

In fact, he anticipates interest margins to return to their historic levels.

[open32]

The sub prime loan thing is minimal and short term, a bubble bust and some people got caught and the market may take a small hit which it can handle.

The issue is credit in general, US public debt. It continues to go up with nothing to balance it out. When there is a credit crunch (higher rates) it drives the market down so fed lowers interest rates to inflate the economy.

[Moshe..]

I was taught 100-your age until 65 or 68 should go into the market with high to moderate risk. Which I pretty much follow right now.

We play 85% safe because this is how you beat the house over the long-haul. Exposure to risk is a bad thing. Over the long haul, it is a very bad thing - a guaranteed bad thing, as the law of large numbers will ensure. We have to keep risk exposure in check. We don’t want to gamble; we want a guaranteed victory. If I wished to play roulette, I’d go to Monte Carlo and do it in style.

Bear in mind the lack of a necessary connection between risk and potential profitability (you should expose yourself to risk when necessary; but it is so often superfluous). There were zero-risk investments (which everyone at the time knew were safe – i.e. would at least never drop) that gained more than any stock in history. My granddad lost fortunes on stock many times over (a terrible gambler). He thankfully also collected super safe paintings (e.g. by klimt, egon schiele, redon, kokoshka, max beckmann, kirchner) which were already so well established they were never in risk of dropping off. Despite their safety, they’ve made 10, 000% gains since he collected in the early 1950s. He bought property and art that was completely safe (because it was so good, he correctly thought it would always be in demand), yet despite the safety of the investments, they returned more than anything risky could. This is just one little example so it doesn’t mean very much! – what it does at least illustrate is the lack of a necessary connection between risk and your potential returns.

For better discussions, listen to Taleb
http://www.econtalk.org/archives/200..._on_black.html

(also about indexing: http://www.econtalk.org/archives/200...on_invest.html -- a very good idea, but not right now in my opinion!)

I had real estate and got out of it, bad move since everything I had did pretty good. Now I have mostly international and emerging markets; a mutual fund as its difficult and expensive to buy foreign stocks. And Utilities and telecommunications. Its mostly funds, few stocks, no bonds or commodities.

I’ve decided to move just a little ten thousand into a famous american-managed emerging market fund, via their London office ( PRMSX - if you want to join me). It’s super diversified so should do well as long as most of the world’s emerging markets stay all right – i.e. don’t get too badly external-shocked by any possible american crisis. And I’ll be watching the world markets very carefully now, so should be vigilant enough to move out instantly if I start getting burned.

Energy stocks are the riskiest thing to get into because of all the variables that play a role like weather, wars, politics, and new technology. With the push towards go green in America (though surprising the hell out of me, the US ethanol industry is in free fall) and a possible Demarcate as president long term plans might change for oil or at least speculation might change. Plus with all the high prices of oil, big oil company stocks are at a premium. You have to bet that most people will think oil prices will continue to rise for the next several years.

Don’t worry, I ‘m just putting a little bit into an american energy hedge fund, via a London-based subsidiary. I think this is a sure winner. Fingers crossed for a war with iran (I joke).

By Shula Neuman (Washington University Record)

The stock market might be nervous due to the subprime loan mess, but Stuart Greenbaum, Ph.D., former dean and Bank of America Professor Emeritus of Managerial Leadership for the Olin Business School, is bullish on the situation.
"Banks that don't have a lot of bad paper in their portfolios are going to see the credit spreads widen out, and they're going to end up making money as a result," Greenbaum said. "The situation has created a buying opportunity, and we're already seeing the reaction in the price of financial stocks, such as banks and insurance."

Greenbaum said that the subprime loan problem is a bit of toxicity that has entered the food chain.

Although the toxicity is widespread and expansive at this point, the market is built to absorb a certain amount of default.

The reaction to the subprime loan issue is compounded by several factors: First, the market was at a historically high level; second, interest rates were low; and third, the yield curve was flat and credit spreads have been very narrow, reflecting historically low volatility.

"So the market is reacting to a somewhat exaggerated situation to begin with, and it has a particular vulnerability because credit spreads were narrow," he said. "Volatility has been very low, which has been driving the compressed interest margins. As a result, banks have been having trouble making money."

Despite the circumstances, this is not a time to panic, Greenbaum said.

In fact, he anticipates interest margins to return to their historic levels

The sub prime loan thing is minimal and short term, a bubble bust and some people got caught and the market may take a small hit which it can handle.

The issue is credit in general, US public debt. It continues to go up with nothing to balance it out. When there is a credit crunch (higher rates) it drives the market down so fed lowers interest rates to inflate the economy.

Yes. The sub-prime business was a silly bubble (but god what a bad idea). It is not causally very interesting (it is probably a causal epiphenomena). It is interesting as an indication/sign (i.e. for epistemological not ontological reasons) of deeper troubles at work - particularly, as you say, in the american money markets. We have had a regular business cycle for all of industrial history – will this continue, or have we magically beaten it? We’re due a recession – will it come, or have we cheated it? The grand science of economics reduced by me to a simple parlour game!

[Moshe..]

Originally Posted by Moshe..

I’ve decided to move just a little ten thousand into a famous american-managed emerging market fund, via their London office ( PRMSX - if you want to join me). It’s super diversified so should do well as long as most of the world’s emerging markets stay all right – i.e. don’t get too badly external-shocked by any possible american crisis. And I’ll be watching the world markets very carefully now, so should be vigilant enough to move out instantly if I start getting burned.

Already up over 1% at the end of my first day.

[open32]

Exposure to risk is a bad thing. Over the long haul, it is a very bad thing - a guaranteed bad thing, as the law of large numbers will ensure.

I dont mean all risky stock, I just mean 100-age in the market, things that arnt savings, Treasury Bonds, or CD accounts; FDIC insured stuff. Sill following the ideas of a diversified portfolio, just changing the risk allotment of that portfolio with age.

I’ve decided to move just a little ten thousand into a famous american-managed emerging market fund, via their

London office ( PRMSX - if you want to join me). It’s super diversified so should do well as long as most of the world’s emerging markets stay all right – i.e. don’t get too badly external-shocked by any possible american crisis. And I’ll be watching the world markets very carefully now, so should be vigilant enough to move out instantly if I start getting burned.

Looks good, they usually do better when American Markets go down. I have something similar, American Century's AIOIX.

[Captain Beefheart]

I am a strong supporter of making a sound investment in the drugs & whores market. I'll probably grow and diversify, spend the money on good times, women, and Irish Whiskey. The other ten percent I'll probably waste.

I'm not extremely educated on the markets, but there are a few things I do know.

Anybody who thinks they can predict whats going to happen is lying(unless you're a time traveler wearing a bunny suit). It's crazy bordering paranoia how heavily the stock market relies on peoples feeling and perceptions. If enough people get spooked and pull their money out the market will crash, even if there were not any incidents that would have caused a crash on their own. Pretty scary that all your money can just vanish like that isn't it?

What's been going on in real estate for the last twenty years isn't good and you're already in trouble, the media just isn't telling you about it, because their major sponsor is the mortgage companys.

What's been going onoverseas with hostile takeovers in emerging markets isn't sustainable either.

China had a settling of their markets and the last time there was a shift like this in Asia, it sent Brazil in a tailspin, one that Alan Greenspan barely got all of you out.

If just a couple of countrys default on their debt we all start circling the drain. This lifestyle America enjoys right now is a *potemkin village of lies and deciet. Impression is huge in American economics. You are a consumer based society. If the impression is that bad times are ahead and you all spend less, well that guarentees the bad times.

[Moshe..]

I dont mean all risky stock, I just mean 100-age in the market, things that arnt savings, Treasury Bonds, or CD accounts; FDIC insured stuff. Sill following the ideas of a diversified portfolio, just changing the risk allotment of that portfolio with age.

We don’t just want to protect ourselves from the large probabilities of small losses (which is the traditional purpose of ‘diversification’ as the mundane professional financiers mean it). We want to protect ourselves from the small probabilities of very large losses. The marginal probabilities of a very large loss appear insignificant to us (they are insignificant when viewed from the marginal perspective). However, what we forget when we reason using marginality calculations is that the large losses are not accumulative - they put you out of the game at a stroke. Therefore, while the marginal distributions are relevant for analysing the large probabilities of small losses, they are irrelevant for analysing the small probabilities of very large losses. Unfortunately, the cumulative probabilities of such, marginally improbable events, are not insignificant (and it is the cumulative distribution which is relevant)! The type of confusion is a typical blind spot for humans. You have to remember to manage the smaller risks of super large losses from the cumulative distribution perspective.

Looks good, they usually do better when American Markets go down. I have something similar, American Century's AIOIX.

PRMSX made a 52% gain last year (with 1% off the top to pay the Quants) -- so I presume they must be gambling like mad. But just imagine if they could keep up a compound figure like 52%! -- we would doubtless be multi-billionaires by forty.

I'm not extremely educated on the markets, but there are a few things I do know.

Anybody who thinks they can predict whats going to happen is lying(unless you're a time traveler wearing a bunny suit). It's crazy bordering paranoia how heavily the stock market relies on peoples feeling and perceptions. If enough people get spooked and pull their money out the market will crash, even if there were not any incidents that would have caused a crash on their own. Pretty scary that all your money can just vanish like that isn't it?

What's been going on in real estate for the last twenty years isn't good and you're already in trouble, the media just isn't telling you about it, because their major sponsor is the mortgage companys.

What's been going onoverseas with hostile takeovers in emerging markets isn't sustainable either.

China had a settling of their markets and the last time there was a shift like this in Asia, it sent Brazil in a tailspin, one that Alan Greenspan barely got all of you out.

If just a couple of countrys default on their debt we all start circling the drain. This lifestyle America enjoys right now is a *potemkin village of lies and deciet. Impression is huge in American economics. You are a consumer based society. If the impression is that bad times are ahead and you all spend less, well that guarentees the bad times

You state the obvious and trivial in a recklessly incoherent fashion. You then manage to squeeze in another rant about america. My dear friend, credibility plummets -- sharply.

Of course, in order to co-ordinate our future behaviour with the future behaviour of others, we have to be able to both read their minds and know that they are able to read our minds (i.e. our intentions to act must be epistemically accessible to the third-person). When we make an investment, we speculate about how other people will behave in the future. Those other people must equally model their future behaviour on speculation about how other people will behave, including ourselves. We therefore speculate about their speculations, and they speculate about our speculations about their speculations, and we speculate about their speculations about our speculations about their speculations ect.

A precondition for the co-ordination of future behaviour between a set of individuals is a shared portfolio of predictions about the future behaviour of the other members of the set. When we see that others do not share our predictions (predictions are inconsistent between a set of individuals) or that their own predictions form an inconsistent set (predictions are inconsistent within a single individual) then the co-ordination of behaviour becomes inefficient because our predictions (and therefore our intentions to future behaviour) become epistemically opaque. Now you understand why you always hear investors and economists talking about ‘confidence’ and ‘stability’.

Your use of this very plain fact about animal behaviour for the purpose of anti-american ranting is not just silly, but also ignorant. The innovations in our communal-prediction-systems which have so complexified and refined the possible co-ordination of future human behaviours are not only a good thing, but a very non-American thing! As every schoolboy knows, the modern securities market was opened in medieval Venice. Joint-stock corporations were created in 17th century Flanders. Capital markets and risk-management has been formally trading, albeit in primitive fashion, since the days of croesus.

[open32]

The marginal probabilities of a very large loss appear insignificant to us (they are insignificant when viewed from the marginal perspective). However, what we forget when we reason using marginality calculations is that the large losses are not accumulative - they put you out of the game at a stroke. Therefore, while the marginal distributions are relevant for analysing the large probabilities of small losses, they are irrelevant for analysing the small probabilities of very large losses.

Ya, it does protect only the small losses usually of a specific stock or industry. Of course if there is such a large loss all across the board, then there isnt really anything safe anyway, unless you have a pile of gold in the closet.