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Naomi Klein all for Shock Doctrine Now

We have followed the travails of Naomi Klein's implausible theories about "The Chicago School's" and neoconservative's penchant for creating or exploiting crisis to advance their ideological agenda.  (Ms. Klein thinks The Chicago School and neoconservatives are pretty much indistinguishable, which is kind of like saying that Brahms and Metallica are more or less the same because they are both music.)  According to her book, The Shock Doctrine, using or instigating chaos to foist their dastardly system on an unsuspecting and unwanting people is bad. 

Of course, what she means is it is bad when she disagrees with the philosophy itself.  If it is an ideology with which Ms Klein agrees, then hey, no problem, shock away!  From Johan Norberg.

"Do we want to save the pre-crisis system, get it back to where it was last September? Or do we want to use this crisis, and the electoral mandate for change delivered by the last election, to radically transform that system? We need to get clear on our answer now because we haven’t had the potent combination of a serious crisis and a clear progressive democratic mandate for change since the 1930s. We use this opportunity or we lose it."

Naomi Klein's The Shock Doctrine - The Liberal Chapter

We here at Running of the Bulls spend most of our time thinking about financial markets.  (We're boring people.)  Occasionally, we also like to ponder ideas in economics and geopolitics.

I quite like politics though I shy away from it on this blog as this is meant to be a forum on asset markets, particularly stocks.  However, economic policy greatly influences asset prices, and since we want to make a whole lot of money in the asset markets, we have to understand how economics and politics effect the world around us.

I tend to fall onto the center right of the political spectrum, at least on economic policy.  I consider myself to be a pragmatic classical liberal, or perhaps a quasi-libertarian.  If that sounds to you like a strange amalgam of competing philosophies, you would be correct.

My own belief is that markets create the most wealth for the most people most of the time.  Markets, however, do not create all the wealth for all the people all the time.  Markets usually work.  However, they do not always.  Markets fail on occasion. 

Markets are not the only force in wealth creation.  Government plays a critical role.  Nor is wealth creation the only goal of society, as it should not be.   Government is vital in both the creation of the wealth and the organization of civil society.

Thus, by "pragmatic classical liberal," I mean that the market should be allowed to work without government interference. But when markets break down, the government should be actively involved to get the market working again. Governments should also be involved in facilitating better functioning markets.

This is different from modern conservatism which says that market should take care of everything, and from modern liberalism which postulates that government should be a driving force in wealth creation through industrial policy and government intervention in the economy.

An example of good government intervention when the market fails - apart from the glaringly obvious example of the massive government involvement in the current financial collapse - is the government mandating increased information to consumers. 

In neoclassical economic theory, individuals are always attempting to maximize utility.  In theory, perfect equilibrium between supply and demand assumes that individuals have perfect knowledge.  However, individuals never have perfect knowledge, and at times have very little knowledge.  (Like when you take your car into the shop for example. - ed.)  Thus, government mandating producers to disclose information to consumers should increase utility for individuals since it allows them to make better choices.  It should also make markets more efficient since information asymmetry between producers and consumers is reduced.  Think SEC financial disclosures or the nutritional content now provided on packages of food.

So what has this all got to do with the title of this post?  Well, nothing really, other than to set the premise that I am not attacking liberals or the Democrats.  I supported Obama for President.  Heck I even predicted it at the beginning of the year!  (Yeah, you get one right. Big deal. - ed.) I consider myself to be an Independent the United States - neither Republican nor Democrat - tending to be more conservative on economic policy and more liberal on social policy.

Rather, I am attacking the basis for Naomi Klein's argument in her book, The Shock Doctrine, which I discuss here, here, here and here. 

Klein postulates that dastardly free marketeers such as Milton Friedman exploit crises to advance their agenda.  It seems that it ain't just the evil Chicago School fellows who exploit crises, as The Cato Institute points out (via Johan Norberg).

Paging Naomi Klein. In her book The Shock Doctrine, the left-wing polemicist claimed that right-wing governments — which she defined very broadly — take advantage of crises, or “shocks,” to implement their dastardly policies of free trade, privatization, and tax cuts. Well, one government has now announced its intention to take advantage of an economic crisis to implement “things you could not do before.” And since this government no doubt includes a lot of people who have read Naomi Klein, she may very well be able to take credit for giving them the idea.

According to the Wall Street Journal, President-elect Obama’s first and most central appointee is excited at the opportunities presented by the current economic shock:

Obama Chief of Staff Rahm Emanuel, speaking to a Wall Street Journal conclave of business leaders Tuesday, said the economic crisis facing the country is “an opportunity to do things you could not do before.”

“You never want a serious crisis to go to waste,” Mr. Emanuel said.

“You never want a serious crisis to go to waste.” Klein’s fans would be all over that if a Republican had said it. Instead, Paul Krugman praises that very line. Maybe he’s learned a few things from Naomi Klein, too.

In Crisis and Leviathan, Robert Higgs demonstrated that government growth in the United States has not been slow and steady, year in and year out. Rather, its scope and power tend to shoot up during wars and economic crises. Occasionally, around the world, there have been instances where a crisis led to free-market reforms. Generally, though, governments seek to expand their power, and they take advantage of crises to do so. But they rarely spell their intentions out as clearly as Rahm Emanuel did.

More Norberg v Klein

Johan Norberg takes Naomi Klein to task once again on Klein's rebuttals to claims of mistakes and misunderstandings of the topics she critiques in The Shock Doctrine.

An exert

Despite 74 pages of endnotes, Klein often omits notes and sources when there is a central and controversial claim about the horrors of markets that needs documentation. To show how Chicago policies failed, she often picks data from a particular year that suits her, and changes the yardstick when the old one yields results she doesn't like.

We can see this in her response as well when she claims that Chile is not a "free market success story," because poverty 20 years ago was almost as high as it was in the rest of Latin America. She does not mention that is has since been reduced from 45 to slightly more than 10 percent (according to the national poverty line — if we use the "extreme poverty" concept it is virtually abolished). Instead she changes the yardstick. When she writes about the situation today, she has suddenly forgotten all about poverty; now the problem is inequality, that is, the rich have become richer even faster than the poor have increased their living standards.

This is why one claim that is repeated in the book is so important: "that between 25 and 60 percent of the population is discarded or becomes a permanent underclass in countries that liberalize their economies." This is important because it is the only time when it seems like she provides the reader with data on problems from liberalisation over a longer period and worldwide, not just a short time-period in a country of her choosing, in the middle of a crisis. This in essence is her argument for why free markets and economic liberalisation are bad for mankind.

In my paper I wondered why she provided us with neither an explanation for what this means, nor a footnote or source. Now we know, because in her response she openly admits that this is just her own summary of different (and sometimes incomparable) statistics on poverty and unemployment from a brief period and sometimes only a year from no more than four countries — Bolivia in 1987, Russia in 1996, some areas of Poland in 1993 and so on. She doesn't even use data series, but newspaper articles and books with information on just that particular year.

Astonishingly, Naomi Klein calls this way of handling statistics and producing general conclusions on the effect of particular policies "standard practice." Well, it might be standard practice for some Canadian leftist fanzines, but at university we usually call it "rubbish." Not just because of the lack of data, but also of the biased choices — there is no explanation for the particular selections, it's not that they liberalised more than others, or that they are representative, and the years chosen are not the most recent ones, or from a particular period after liberalisation. It is that she found countries and years when things were really, really bad.

For example, I don't think that Klein just happened to pick the one year Bolivia's unemployment was 25-30 percent and just forgot to mention that it was soon reduced to less than 10 percent. And it is probably no coincidence that she looks at mass unemployment in Poland 15 years ago, and not today when it has been reduced to less than 10 percent. We don't have to mention that one of her statistics on Poland in 2006 comes from a 2005 article to see that something is very, very strange here.

If I took four other countries, other regions and/or other periods I would easily get the opposite result (for example if I looked at liberalisers like Estonia, Ireland, Iceland and Australia that Klein never writes about because they are too peaceful, democratic and successful).

The fact that Klein thinks that this is serious research is actually much more damaging for her than any of the conscious distortions that I have examined elsewhere.

If you want unbiased data you obviously can't cherry-pick countries and years, you have to look at longer periods and more countries. But if you do, you get the opposite results — the more liberal economy, the lower the unemployment and poverty rates, is the consistent result. And this is the reason why Klein never even tries.

As I write in my paper, in the freest fifth of countries, poverty according to the United Nations is 15.7 percent, and in the rest of the world it is 29.8 percent. Unemployment in the freest quintile is 5.2 percent, which is less than half of what it is in the rest of the world.

In the least economically free quintile, with the kinds of restrictions on private property, businesses, and trade that Klein claims are ways of helping the people, poverty is 37.4 percent and unemployment is 13 percent.

Criticism of Naomi Klein's Shock Doctrine From the Left

We have posted criticisms of the book Johann Norberg calls The Shlock Doctrine primarily from economists and the Right.  This criticism comes from the Left, written by Jonathan Chait at the New Republic.

Klein repeatedly implies that there is something immoral about using crises to advance the right-wing agenda without explaining why this is so. After all, Friedman wanted to overhaul the New Orleans public education system because he believed, rightly or wrongly, that vouchers would work better. If you thought your house was horribly designed, and a tornado flattened it, would you rebuild it exactly as before?

The notion that crises create fertile terrain for political change, far from being a ghoulish doctrine unique to free-market radicals, is a banal and ideologically universal fact. (Indeed, it began its dubious modern career in the orbit of Marxism, where it was known as "sharpening the contradictions.") Entrenched interests and public opinion tend to run against sweeping reform, good or bad, during times of peace and prosperity. Liberals could not have enacted the New Deal without the Great Depression. Communist revolutions have generally come about in the wake of wars. The liberal economist Victor R. Fuchs once wrote that "national health insurance will probably come to the United States in the wake of a major change in the political climate, the kind of change that often accompanies a war, a depression, or large-scale civil unrest."

Fuchs did not mean that the public would never accept universal health insurance unless they had been brutalized into doing so. Nor was his observation evidence that he longed for disaster to befall the United States. Most American liberals today would admit that the sorry state of the American economy, foreign policy, and political life has created a golden opportunity for progressive reform. There is nothing odious about this. Yet Klein takes analogous observations from conservatives as proof that the right "prays for crisis the way drought-stricken farmers pray for rain." ...

Most critics of the war believe the notion of exporting democracy to a hostile Arab country was doomed in its conception. Some war supporters counter that the occupation could have succeeded, but bungling and incompetence caused it to fail. Klein is staking out a third, esoteric, highly original position. She says that the occupation could have succeeded, but the Bush administration did not want it to succeed. She is explicit about this:

Had the Bush administration kept its promise to hand over power quickly to an elected Iraqi government, there is every chance that the resistance would have remained small and containable, rather than becoming a countrywide rebellion. But keeping that promise would have meant sacrificing the economic agenda behind the war, something that was never going to happen.

Never? Ten pages later Klein concedes that, starting in December 2006, the Pentagon pulled a "dramatic about-face" and decided to re-open Iraq's state factories. Her cheerful insouciance in the face of such inconvenient facts points to an odd, slightly endearing quality of hers: she is conscientious enough to provide readers with facts that blow her thesis to smithereens, yet at the same time she is deluded enough not to notice the rubble of her thinking on the floor. So Klein makes a big deal about the comic but stillborn efforts by some Republican ideologues to transform Iraq into a flat-tax paradise, but she also notes that very little privatization actually took place in Iraq, and indeed that the Coalition Provisional Authority (CPA) had just three staffers devoted to privatizing Iraqi state industries. You would think this latter fact would undermine her belief that privatizing Iraq's economy was the central goal of the war. Alas, no. She thinks it just goes to show that "the CPA itself was too privatized to privatize Iraq."

So Klein attributes the failure to privatize Iraq to the CPA's incompetence, but she deems every other apparent failure to be a deliberate plan to foster chaos. To make this case, Klein runs through every one of the administration's post-war mistakes and explains why it was no mistake at all. Paul Bremer, the director of reconstruction and humanitarian assistance, decided to purge Baathists from the Iraqi government not because they were Baathists but because they were government employees. De-Baathification, Klein writes, "had little to do with anti-Saddamism and everything to do with free-market fervor." She further insists that the widespread episodes of looting in early 2003 "cannot be dismissed as mere oversights," but were part of the American plan to dismantle the Iraqi state.

With the pseudo-clarity of a conspiracy theorist, Klein dismisses out of hand the possibility of incompetence. There were memos warning the Army of looting, she ominously notes--scanting the possibility that bureaucratic lethargy, rather than conscious intent, prevented the memos' warnings from being acted upon at ground level. That widespread bungling and mismanagement also followed Hurricane Katrina strikes Klein as proof of intentionality. "The fact that exactly the same errors as those made in Iraq were instantly repeated in New Orleans," she remarks, "should put to rest the claim that Iraq's occupation was merely a string of mishaps and mistakes marked by incompetence and lack of oversight."

Like every conspiracy theory, Klein's account of the fate of the world finally lacks internal logic. She points to one instance of American soldiers dismembering Iraqi passenger planes, inflicting "$100 million worth of damage to Iraq's national airline--which was one of the first assets to be put on the auction block in an early and contentious partial privatization." If the point of the war was to hand control of Iraq's state assets to American corporations, wouldn't American troops be protecting those assets instead of destroying them?

But her most explosive charge is that Bush and his cabal are not merely the puppets of war profiteers, but war profiteers themselves. "Key Bush officials have maintained their interests in the disaster capitalism complex," thereby "allowing them to simultaneously profit from the disasters they help unleash." Klein provides two examples of such conflicts of interest. The first is that Donald Rumsfeld maintained his stock in Gilead Sciences, which holds the patent for Tamiflu, even while serving as defense secretary. Get it? Rumsfeld would stand to profit from a flu pandemic. But surely you don't have to be an admirer of Rumsfeld to doubt that he would engineer an outbreak of a deadly virus in order to fatten his stock portfolio. (Indeed, one suspects that even if Rumsfeld tried to pull off such a dastardly scheme, he would probably wind up creating a cure for the flu by mistake and render Tamiflu worthless.)

The other piece of data that Klein cites to support her charge that Bush administration officials profit from the disasters that they cause is Vice President Cheney's holdings in Halliburton. "When he leaves office in 2009 and is able to cash in his Halliburton holdings," she charges, "Cheney will have the opportunity to profit extravagantly from the stunning improvement in Halliburton's fortunes." This is a spectacular accusation--that the driving force behind the Iraq war stands to gain millions of dollars from it. You might wonder why John Kerry did not make this an issue in 2004, or why liberal pundits have not crusaded against Cheney's blatant self-dealing. The answer, of course, is that it is completely untrue. Cheney has signed a legally binding agreement to donate to charity any increase in his Halliburton stock. (Honest-- you can look this up on factcheck.org.) Lord knows Rumsfeld and Cheney have committed enough actual misdeeds not to need indicting with imaginary ones. ...

[Klein] pays shockingly (but, given her premises, unsurprisingly) little attention to right-wing ideas. She recognizes that neoconservatism sits at the heart of the Iraq war project, but she does not seem to know what neoconservatism is; and she makes no effort to find out. Her ignorance of the American right is on bright display in one breathtaking sentence:

Only since the mid-nineties has the intellectual movement, led by the right-wing think-tanks with which [Milton] Friedman had long associations--Heritage Foundation, Cato Institute and the American Enterprise Institute--called itself "neoconservative," a worldview that has harnessed the full force of the U.S. military machine in the service of a corporate agenda.

Where to begin? First, neoconservative ideology dates not from the 1990s but from the 1960s, and the label came into widespread use in the 1970s. Second, while neoconservatism is highly congenial to corporate interests, it is distinctly less so than other forms of conservatism. The original neocons, unlike traditional conservatives, did not reject the New Deal. They favor what they now call "national greatness" over small government. And their foreign policy often collides head-on with corporate interests: neoconservatives favor saber-rattling in places such as China or the Middle East, where American corporations frown on political risk, and favor open relations and increased trade. Moreover, the Heritage Foundation has always had an uneasy relationship with neoconservatism. (Russell Kirk delivered a famous speech at the Heritage Foundation in which he declared that "not seldom has it seemed as if some eminent neoconservatives mistook Tel Aviv for the capital of the United States.") And the Cato Institute is not neoconservative at all. It was virulently opposed to the Iraq war in particular, and it opposes interventionism in foreign policy in general.

Finally, there is the central role that Klein imputes to her villain Friedman, both in this one glorious passage and throughout her book. In her telling, he is the intellectual guru of the shock doctrine, whose minions have carried out his corporatist agenda from Santiago to Baghdad. Klein calls the neocon movement "Friedmanite to the core," and identifies the Iraq war as a "careful and faithful application of unrestrained Chicago School ideology" over which Friedman presided. What she does not mention--not once, not anywhere, in her book--is that Friedman argued against the Iraq war from the beginning, calling it an act of "aggression."

It ought to be morbidly embarrassing for a writer to discover that the central character of her narrative turns out to oppose what she identifies as the apotheosis of his own movement. And Klein's mistake exposes the deeper flaw of her thesis. Friedman opposed the war because he was a libertarian, and libertarian conservatism is not the same thing as neoconservatism. Nor are the interests of corporations always, or even usually, served by war.

What makes Klein's thesis so odd, and so awful, is that in fact there is an unlimited supply of raw material, an abundant basis in reality, for the sorts of arguments that she wants to make. The last two decades certainly have seen the global spread of absolutist free-market ideology. Many of the newest adherents of this creed are dictators who have learned that they can harness the riches of capitalism without permitting the freedoms once thought to flow automatically from it. In the United States, the power of labor unions has withered, and prosperity has increasingly come to be defined as gross domestic product or the rise of the stock market, with the actual living standards of the great mass of the population an afterthought. Corporations, which can relocate nearly anywhere around the world, have used their flexibility as a cudgel against workers, who do not enjoy the privileges of mobility. Domestic policy has aggressively sharpened income inequalities, and corporations have enjoyed unfettered influence to a degree not seen in a hundred years. And the president did start a war without paying the slightest bit of attention to the country that he would be left occupying or how its people would react.

All these things are true. And all these things are enormous outrages and significant problems. It's just that they are not the same outrage or the same problem. And Naomi Klein's relentless lumping together of all her ideological adversaries in the service of a monocausal theory of the world ultimately renders her analysis perfect nonsense.

Just One Thing

The idea behind the book Just One Thing is that 12 of the supposedly "World's Best Investors" proffer the one piece of investment wisdom they have found most useful in their investing careers.  The advice offered ranges from the profound to the irrelevant, and was usually more than one thing. 

Andy Kessler's lesson was one of the most interesting.  Kessler sites two principles around which he has constructed his investment success - 1.) lower cost creates its own huge networks when demand is highly price elastic, and 2.) intelligence migrates the edge of the network.

Dennis Gartman explains his 13 trading rules, which, if you aren't paying attention, is 12 more than the title suggests.  That's fine, since Gartman is one of my favourite investment commentators, and writes the fabulous Gartman Letter.  The most important rule?  Never, ever, under any circumstance, should one add to a losing position ... not EVER!  Actually, Gartman repeats that rule again, so he really only had 12 trading rules.

Mark Finn, formerly Chairman of the Virginia Retirement System and Chairman of the Vantage Consulting Group, and his son Jonathan admonish investors not to rely mainly on historical performance to assess investment skill, since strong returns are often followed by poor returns.  The recent performance of the legendary Bill Miller is strong evidence of this truism.

Gary Shilling explains the wonders of trading in boring old Treasury bonds.  T-bonds boring?  Nonsense, says Shilling, and proves it by demonstrating that investing in zero coupon Treasury bonds can generate higher returns than investing in stocks.  Shilling called the top of the interest rate cycle in the early 1980s, and became financially secure by buying long-dated zero coupon bonds, which can be purchased on 5% margin.  By rolling over 25-year strips each year - buying a 25-year zero, selling it a year later and using the proceeds to buy another 25-year strip - one outperformed stocks throughout the 1980s and 1990s.  A book is worth its cover price many times over if it reveals one unknown and surprising fact to the reader.  This was such a revelation to me.

Ed Easterling argues that risk is not a knob that can be dialed up and down at will to generate higher or lower returns (amen. - ed.). Easterling discusses how volatility can dramatically skew returns over time, and how the measurement of returns can distort results.  For example, the average annual capital gain from the stock market since 1900 has been 7.3%.  However, the compounded return has been 5.0%, an enormous difference.  Compounded, not average return is what matters.  Returns are driven by valuations, particularly the price/earnings ratio of stocks.  The lower the valuation, the higher the prospective return of the market and vice-versa. 

James Montier discusses the nascent field of neuroeconomics and how the brain is hardwired to separate ourselves from our money in the market.  This is a fascinating field, and the subject of Montier's chapter is too broad to summarize here, other than to say that we all have cognitive biases and irrationalities that impede our investment success.  Identifying and understanding these biases and irrationalities is crucial if one is to become a great investor.

Bill Bonner wrote a polemic rant better suited for a book on the philosophies of Ayn Rand or Ludwig von Mises.  Whether or not one agree's with Bonner, the dogma was irrelevant to the subject at hand.  Skip this chapter.

Rob Arnot postulates that capitalization weighted indices such as the S&P 500 or the Russell 1000 are inefficient. Market cap indices are top-weighted with the biggest companies based on equity values.  Since probabilistically the largest cap stocks will underperform all other stocks, indices based on other factors will do better.  From 1975 to 1999, indices that were constructed using book value, cash flow, revenues, dividends and employment levels outperformed the S&P 500 by 2% per year.

George Gilder has a chapter in this book. Gilder is definitely NOT someone whom I would identify as one of the "world's greatest investors" since he was a True Believer during the Technology Bubble, and led his followers off the cliff when the Tech Bubble imploded.  I do not consider anyone who is unable to identify an investment bubble as a good investor, let alone a great one.  One would think that the ability to identify a crazy mania would be one of the first prerequisites of being a competent investor.  Having said that, I have to give Gilder his due.  He makes a very cogent argument that Regulation FD - where corporations must release all material public information at the same time and not advantage one group of investors over another - has had the perverse effect of allowing insiders to capture wealth at the expense of the public.  Before Reg FD, a company might disseminate information selectively, allowing the lucky few on the receiving end to invest in the company's stock before the information became widely known.  The effect of this selective information disclosure on the price of the stock was that it would rise in smoother fashion.  With Red FD, the market is deprived of this outlet.  Now, when information is released, the change in the price of the stock is more violent.  This allows insiders to benefit more since they capture the delta between the price change of the stock before and after the information is released.  I do not know if Gilder is correct, but I had never thought of this before.

Michael Masterson talks about building a successful business.  His advice is to be nice to people.  Do not screw someone over the last penny in business, which he says is the dominant ethos of many businessmen and women today.  Instead, make sure everybody wins from the transaction.  Over time, you will become much wealthier as people will want to do business with you.

The legendary Richard Russell offers what he considers four axioms of the market.  First, compounding works.  You will get rich, or at least wealthier than you are, if you let your money compound.  Second, don't lose money.  Third, wealthy people don't need markets.  If you feel pressured to make money in the market, you are less likely to do so.  Since the wealthy do not need to make money in the market, they tend to take a longer view and do better.  Finally, look for values.

The editor of Just One Thing, John Mauldin, finishes up the book.  His central message is to not underestimate the power of innovation.  New innovations you could never imagine are on the horizon.  Being able to identify the effects of the innovations will make you very wealthy.

Out of five, I rate Just One Thing

1/2

and place it on my investment book log.

Greater Fool

I was in the Calgary airport a few weeks ago on my way to the west coast when I wandered into a bookstore and picked up Garth Turner's book Greater Fool, a critique of the current Canadian housing market. A little ironic, I thought, given that the bookstore looked out onto the open rolling hills at the edge of one of Canada's hottest real estate markets, unencumbered by any natural barriers which might put a halt to the ever-expanding building.

Turner is a Member of the Canadian Parliament and noted author and commentator on financial issues. This is a timely book, given that the real estate market may already be peaking in Canada.

Turner argues - and I would concur, given my experience talking to people when I return to Canada - that many Canadians believe their housing market is different from the US housing market, which is in the midst of the worst collapse in prices since The Depression over 70 years ago. Prodded on by highly conflicted real estate and banking industries, too many Canadians believe that home prices cannot go down.

Canadians rationalize their beliefs based on faulty logic and Turner demolishes the rationalizations one by one. Canada does not have a subprime mortgage market. Wrong, Turner notes. Banks offer "below prime" loans. Canadians are not able to take out loans with little no equity down. Nope. Canadians have been able to do so for some time, though the Canadian Mortgage and Housing Corporation recently said it would no longer insure mortgages with less than 5% down (as if 5% down means much). Canadians aren't stretching to meet mortgage payments like they are in America. Then why have 35 and 40 year loans been created, replacing the traditional 25 year loan? The economy is healthier in Canada. Perhaps, but that does not mean it is healthy, nor will it remain so when your trading partner that accounts for 40% of your economic output is in a recession. Rising commodity prices have increased incomes. A bit, perhaps, but not by much, and certainly not by the amount home prices have increased. In fact, by almost any measure, house prices are as expensive relative to incomes and rents in Canada as they have ever been.

In fact, Canada looks remarkably similar to the US. Canadians are just as indebted as Americans, mortgage debt has skyrocketed by 70% over the past 7 years, and speculators have flooded hot markets, with speculators accounting for as many as 40% of condos sold in Toronto in 2007.

Turner excoriates the financial industry, the homebuilders and the real estate agents that have encouraged the mania in Canada. He laments the "all now" attitude of many younger buyers who believe they are entitled to granite counters and stainless steel appliances, and are willing to plunge deep into debt to attain such luxury items.

The only place where Turner falls down is in his argument that global warming will lead people buying smaller homes. It appears that Turner feels passionately about global warming. However, he assumes that global warming will alter consumer behavior and dramatically alter peoples' lifestyles. There is little evidence to support this. For most Canadians, environmentalism is a feel-good issue they support as long as it does not significantly impede their lifestyles. Yes, people may recycle more and halt the use of pesticides on their lawn, but where has it ever occurred that individuals did not want to live a better, more comfortable and wealthier lives than their parents? In fact, Turner seems to contradict himself when he argues that global warming will lead to the migration of millions. However, millions of immigrants coming into Canada would increase demand for housing and be supportive of home prices. Turner practices what he preaches, however, having purchased a smaller, less energy-consuming and more self-sufficient homestead.

Also, some of the book is repetitive, with Turner making the same or similar points about the collapsing American market over and over. It had the feel that information was being repeated to add to the volume of the book.

But I shan't quibble. Every Canadian involved in real estate or who is thinking about buying or selling a house should read this book. Unfortunately, it will almost certainly be out of date in two or three years when Canadians are living their own housing melt-down nightmare. However, it will be good to keep on the bookshelves until a new generation of real estate speculators bid up prices to insane levels in 15 or 20 years.

Out of five, I rate Greater Fools

1/2

and place it on my investment book log.

Greenspan's Bubbles

Much of the public who are aware of Alan Greenspan have only heard positive things about the former governor of the Federal Reserve board.  Political pundits, when commenting on Greenspan, offer nothing but effusive praise.  Wall Street has deified the ex-jazz musician.

Then there are a small band of critics who charge that Greenspan has been recklessly incompetent and has imperiled the US economy.

One of those critics is short seller and hedge fund manager Bill Fleckenstein.  "Fleck," as he is known, has been an unrelenting critic of Greenspan since I first stumbled across his writings over a decade ago. A witty writer, Fleck has penned a short book entitled Greenspan's Bubbles where he lays out the case against The Maestro. 

According to Fleckenstein, much of the prosperity of the past 20 years has been due to Greenspan's penchant for bailing out financial markets when they have gotten into trouble.  Rather than allowing markets to clear naturally, Greenspan sought to cut interest rates and increase the money supply whenever asset markets fell hard.  This encouraged risk taking and the development of the "Greenspan put" whereby investors felt they could take on more risk than they otherwise would have had they not believed that Greenspan would bail them out.  Each crisis was met with more action by the central bank, which meant more stimulus and more problems down the road as problems where pushed into the future.  The excess monetary creation fed its way into the real economy, artificially inflating economic growth and encouraging the misallocation of resources and excess supply - think tech stocks and homes.  Eventually, Fleckenstein argues, we will have an enormous bill to pay, one that we may be paying right now.

Greenspan's claim that bubbles could only be identified in hindsight and the proper duty of the central bank was only to deal with the after-math of the popped bubble contributed to the creation of bubbles.  If an asset bubble was being fed by the central bank, yet the central bank was unable to recognize the results of its actions, then used the power of the printing press to flood the system with money to ease the asset market's descent, the seed's of the next bubble were being sown if the bank did not embark on a policy of cleaning out the excess monetary creation.  This, Fleckenstein argues, occurred under Greenspan.

Fleckenstein argues that many adjustments to the economic statistics (not necessarily the fault of the Federal Reserve or Greenspan) have skewed the true health of the economy, leading to poor policy decisions.  For example, hedonic adjustments to the calculation of inflation have understated inflation.  Adjustments have always lowered the official rate of inflation because of quality improvements - think computers - but never once have inflation rates been adjusted upwards because of deteriorating products and services - think airline flights. 

Fleck also takes issue with the notion that productivity rapidly improved during the latter half of the 1990s, which Greenspan inferred through the increase of investments in technology, even though official growth rates in productivity had not yet shown a dramatic increase.  Greenspan believed that productivity was being understated by official figures since all the investments in computers and servers and software must have lead to an acceleration in productivity, even though there was little empirical evidence that this was so.

A former protege of Ayn Rand, Greenspan had an enduring faith in markets.  By buying into the notion that markets were almost always efficient, there was no reason for the central bank to intervene when asset markets went nuts, valuing companies in the billions of dollars when a company barely had $10 million in sales.  If the collective action of millions of investors valued such a Talking Sock Puppet company at that level, who was the central bank to doubt them? 

Today, nearly a half a trillion dollars worth of losses have been recorded by banks as home prices have fallen nearly 20% from their peak according to the Case-Shiller home price index, all on top of the collapse of the Tech Bubble, which erased $7 trillion of shareholders' wealth. 

I generally agree with the central premise of the book - Greenspan was complicit in the creation of the never-ending asset bubbles.  I would also concur that Greenspan's stock, like the stocks of the Talking Sock Puppet companies of The Tech Bubble, is vastly over-rated.  Whether or not he is the worst central banker of all time, I have no idea for I don't even know the name of the Fed governor in 1929 and am too lazy to google it. 

Fleckenstein acknowledges that Greenspan is not solely to blame for the asset bubbles.  However, I think that though Greenspan may be the single greatest contributor to the bubbles, I tend to believe that he is not as responsible as his arch critics and the perma-bears contend.  The support to keep the party going was intense, not only from the politicians in Washington, but from Wall Street and investors themselves.  Remember, the emotions were so incredible, analysts who downgraded stocks would sometimes receive death threats.  And my guess is that it wasn't Alan Greenspan making them. 

Greenspan's faith in technology investments driving an acceleration in productivity gains is almost certainly over-done.  However, the lesson I take away is that so much power should not be in the hands of one man.  Greenspan was the overwhelming force on the Federal Open Market Committee.  It was he who determined the setting of the interest rates, not the FOMC.  Greenspan used the committee primarily to legitimize his decisions on the rate that should be set.  If Greenspan - that one man - was wrong, for example, about the productivity gains arising from technology investments, then the fall-out from the Fed's policies could be disastrous.  Thus, Ben Bernanke's decision to democratize the FOMC is a very welcome decision.

Fleckenstein wrote the book with Fred Sheehan.  Greenspan's Bubbles is short.  It does not take long to read.  In an interview with Kate Welling, the authors said that the length of the book was due to the tight deadline set by the publishers.  Sheehan will publish a more extensive volume in the future.

On a scale of 5, I rate the book

1/2

and place it on my investment book log.

Johan Norberg's Critique of Naomi Klein's The Shock Doctrine

Johan Norberg answers Naomi Klein's claims in her book, The Shock Doctrine. 

Exerts.

Naomi Klein's The Shock Doctrine purports to be an exposé of the ruthless nature of free-market capitalism and its chief recent exponent, Milton Friedman. Klein argues that capitalism goes hand in hand with dictatorship and brutality and that dictators and other unscrupulous political figures take advantage of "shocks"—catastrophes real or manufactured—to consolidate their power and implement unpopular market reforms. Klein cites Chile under General Augusto Pinochet, Britain under Margaret Thatcher, China during the Tiananmen Square crisis, and the ongoing war in Iraq as examples of this process.

Klein's analysis is hopelessly flawed at virtually every level. Friedman's own words reveal him to be an advocate of peace, democracy, and individual rights. He argued that gradual economic reforms were often preferable to swift ones and that the public should be fully informed about them, the better to prepare themselves in advance. Further, Friedman condemned the Pinochet regime and opposed the war in Iraq.

Klein's historical examples also fall apart under scrutiny. For example, Klein alleges that the Tiananmen Square crackdown was intended to crush opposition to pro-market reforms, when in fact it caused liberalization to stall for years. She also argues that Thatcher used the Falklands War as cover for her unpopular economic policies, when actually those economic policies and their results enjoyed strong public support.

Klein's broader empirical claims fare no better. Surveys of political and economic freedom reveal that the less politically free regimes tend to resist market liberalization, while those states with greater political freedom tend to pursue economic freedom as well.  ...

The chief villain in Klein’s story is Milton Friedman, the Chicago economist who did more than anyone in the 20th century to popularize free-market economics. To make her case, Klein exaggerates the freemarket reforms that take place in times of crisis, often by ignoring central events and rewriting chronologies. She uses loose metaphors and wild distortions to claim that free markets are a form of violence. She confuses libertarianism with corporatism and neoconservatism and blames Milton Friedman for encouraging reform by stealth. To do so, she engages in one of the most malevolent distortions of a thinker that has been done in a major work in recent years. ...

Klein cites the influence of Milton Friedman’s economic views on Augusto Pinochet’s military dictatorship in Chile in the 1970s as evidence that free markets rely on tyranny and torture. She writes that Friedman acted as “adviser to the Chilean dictator.” This is wrong. Friedman never worked as an adviser and never accepted a penny from the Chilean regime. He even turned down two honorary degrees from Chilean universities that received government funding because he thought it could be interpreted as a support for the regime.

However, he was in Chile for six days in March 1975 to give public lectures, invited by a private foundation. When he was there he also met once with Pinochet for around 45 minutes, and wrote him one letter afterwards, arguing for a plan to end hyperinflation and liberalize the economy. That was the same kind of advice Friedman gave to communist dictatorships like the Soviet Union, China, and Yugoslavia, yet nobody would claim he was a communist. ...

Klein writes that the Chilean coup in 1973 was a neoliberal coup, executed so that Chilean liberal economists (“the Chicago Boys”) could reform the economy. She has to do that to give the impression that neoliberals have blood on their hands, because the most violent period was shortly after the coup. To do that she has to invent a new chronology and claim that the liberalization began on the first day the junta took power. This creates a big problem for her. If liberalization began on day one, then it is impossible for her to claim that Friedman’s visit was of such a tremendous importance and started the real transformation, because that visit didn’t take place until late March 1975. Yet she tries to have her cake and eat it too.

The reality was that military officials were in charge of the economy at first. They were often corporatist and paternalist and opposed the Chicago Boys’ ideas about radical reforms. ...

It was only after the economic crisis of 1973-74 that Pinochet turned to reform the economy.  Until then, he was just like the other economically-illiterate right-wing strongmen that ruled Latin America at the time who brought triple and quadruple-digit inflation to their economies.

Klein claims that Friedman’s definition of freedom meant that “political freedoms were incidental, even unnecessary, compared with the freedom of unrestricted commerce.” That was not Friedman’s view. He thought that they really are related, and that it would be easy for dictators to rule impoverished people fighting for their survival, whereas richer people in a growing economy would begin to demand political rights. As late as in his last interview, Milton Friedman warned that he was much more pessimistic about China than India, because of China’s authoritarian political system. According to him, China “is heading for a clash, because economic freedom and political collectivism are not compatible.” From Friedman’s perspective, one of the main reasons to try to get both communists and military regimes to accept liberal economic policies was that it would increase the chance that they would become democratic. As he wrote in 1975:

I approve of none of these authoritarian regimes—neither the Communist regimes of Russia and Yugoslavia nor the military juntas of Chile and Brazil. . . . I do not regard visiting any of themas an endorsement. . . . I do not regard giving advice on economic policy as immoral if the conditions seem to me to be such that economic improvement would contribute both to the well-being of the ordinary people and to the chance of movement toward a politically free society...

She claims that Friedman was a “neoconservative”  and thus in favor of an aggressive American foreign policy, and she argues that Iraq was invaded so that Chicago-style policies could be implemented there. Klein even goes so far as to suggest that Bush administration officials disbanded the Iraqi army and de-Baathified the government because they are neoliberals who dislike the public sector, but nowhere does she mention Friedman’s actual views about the war. Friedman himself said: “I was opposed to going into Iraq from the beginning. I think it was a mistake, for the simple reason that I do not believe the United States of America ought to be involved in aggression.” And this was not just one war that he happened to oppose. In 1995, he described his foreign policy position as “antiinterventionist.” Speaking of the Gulf War, he said it was “more nearly justified than other recent foreign interventions,” but concluded that the arguments for it were “fallacious.”

In other words, the person whom Klein accuses of welcoming wars and coups could not even bring himself to support a war to stop the direct aggression of Iraq against Kuwait, much less other American interventions. She also never mentions that he considered ending the draft his biggest political achievement.

This misrepresentation is hardly unique. Klein also blames Friedman and Chicago economics for the actions of the International Monetary Fund during the Asian financial crisis and the Sri Lankan government’s confiscation of the land of fishing families to build luxury hotels after the tsunami. Yet the fact is that Friedman thought that the IMF shouldn’t be involved in Asia, and he held that governments should be forbidden from expropriating property to give it to private developers. Of course, Klein could argue that Friedman was in some sense a source of inspiration for those policies, even though he was opposed to them. But she doesn’t do that. She pretends that he agreed with them, and that that is what he and other Chicago economists wanted all along. ...

Hidden in Klein’s word games is a real argument—the fact that several dictatorships have liberalized their economies in recent years and that some of these have also tortured their opponents. But how strong is this connection? If we look at the Fraser Institute’s Economic Freedom of the World statistics (EFW), we find only four economies about which we have data that haven’t liberalized at all since 1980. All the others have. Obviously this also means that we will see economic liberalization even in brutal dictatorships, just as in peaceful democracies.

Klein relies on her personal interpretation of anecdotes and examples and never tries to supply broad, statistical evidence for her case. It’s an understandable omission, because the data don’t support her argument. There is a very strong correlation between economic freedom on the one hand and political rights and civil liberties on the other. The quarter of countries with the most economic freedom score 1.8 on average in Freedom House’s measure of political rights (1 = most free, 7 = least); the second freest quarter gets 2.0; the third; 3.4, and the least economically free quarter of countries gets 4.4. On average, the economically freest quarter is more democratic than Taiwan, and the least economically free quarter is less democratic than Nigeria.

A 2007 survey from the Pew Research Center shows that there is a plurality in 41 of 46 polled countries who think that most people are better off in a free-market economy. In most countries, an overwhelming majority thinks so. Klein never provides us with any countervailing surveys to prove her point that free markets are unpopular. ...

[S]he does deal with Britain under Margaret Thatcher, and argues that she also relied on shocks and violence to reform. Thatcher won the election in 1983 because of the boost she got from the Falklands War—which does nothing to prove “disaster capitalism” as a deliberate strategy, because it was a war she did not start. Klein never mentions that another reason for Thatcher’s growing popularity was that the British economy improved rapidly at the same time, which would not fit the argument that liberalization hurts people. (One study even looked in detail at the timing of events and the voters’ perception of them and made the case that the Tories only gained three percentage points from the war, and the rest from improved economic prospects.) ...

In another instance she misrepresents the ideas of the economist John Williamson, who coined the term “Washington Consensus,” by inserting an “all” before his recommendation that “state enterprises should be privatized.” In fact, however, Williamson has opposed general privatization. Instead, he has recommended that governments hold on to enterprises when it is difficult to create competition (he mentions public transport) or when there are externalities (for example, water supply).

But it is important for Klein to portray Williamson as a radical for two reasons. The first reason is that this helps to make the institutions of the Washington Consensus (the U.S. government, the IMF, the World Bank) seem like radical Friedmanite organizations and part of a global Chicago crusade. The second reason is that Williamson is the only economist from whom she has actually found a quote asking whether it might be good to provoke a smaller crisis (inflation) to get acceptance for reforms. Granted, it was just a question at a conference in 1993 to provoke a discussion, but that alone was enough for Klein to write on the next page that this was now “part of a global strategy” and through the rest of the book write as if it was what all liberal economists now believed. ...

Klein’s suggestion that crises benefit free markets and limited government is controversial to say the least. In fact, politicians and government officials often use crises as an opportunity to increase their budgets and powers. World War I led to communism in Russia, and hyperinflation and depression led to National Socialism in Germany. War and disasters are rarely friends of freedom. Economic historian Robert Higgs showed in his now classic work Crisis and Leviathan that the growth of the American government took place during crises like the Depression and the world wars. When the crisis is over, the government does not return to its previous state, instead keeping some of the power and money it grabbed to meet the crisis. The state, not the market, grows on crises.

“War is a friend of the state. . . . In time of war, government will take powers and do things that it would not ordinarily do,” said a famous economist explaining why he opposed the Iraq War. That economist was Milton Friedman—the person Klein claims longed for war and disasters to ram through laissez-faire. Friedman was right when it came to the Iraq War. The Bush administration used the war to expand the federal government’s powers dramatically, and Bush has increased federal spending more than any other president since Lyndon Johnson (another war president), even excluding spending on the military and national security. ...

One would think that Klein should find it difficult to explain this major exception to her thesis. But she doesn’t. Instead she uses the United States after 9/11 as a major example for her thesis. She claims that the terrorist attacks gave the Bush administration the opportunity to implement Friedman’s ideas, by benefiting friends in the defense and security industries with new contracts and unprecedented sums of money. Klein never clearly explains why this is Friedmanite. In the real world, Friedman “had always emphasized waste in defense spending and the danger to political freedom posed by militarism,” in the words of his biographer, Lanny Ebenstein. It is possible for Klein to make this connection for one reason only—that Klein never clearly defines what Friedman’s ideas are and what they aren’t, and she gives no indication that she understands them. So she confuses Friedman’s limited-government liberalism with both neoconservatism and outright corporatism—the granting of special privileges to corporations beyond what they could earn without government help.

As Klein sees it, in Bush’s America “you have corporatism: big business and big government combining their formidable power to regulate and control the citizenry.” This sounds, improbably enough, like a healthy libertarian critique of the administration. The only problem is that Klein thinks that this is the “pinnacle of the counterrevolution launched by Friedman” and that the Bush team that implemented it is “Friedmanite to the core.” ...

Klein repeatedly identifies libertarianism (or “neoliberalism”) with neoconservatism. She seems to think that they are the same ...

It is obvious that Klein does not know what neoconservatism is and has not bothered to find out. She writes in passing that Friedman was neoconservative and suggests that neoconservatives long for “the elimination of the public sphere, total liberation for corporations and skeletal social spending.” The founder of American neoconservatism, Irving Kristol, defines the movement’s ideas quite differently. Back in 1979, he explained: “Neoconservatives are not libertarian in any sense. A conservative welfare state is perfectly consistent with the neoconservative perspective.” He reiterated that viewpoint in a recent manifesto: “Neo-cons do not feel that kind of alarm or anxiety about the growth of the state in the past century, seeing it as natural, indeed inevitable.” And if neoconservatives and libertarians have important differences on domestic policy, their differences on foreign policy are even starker. ...

Klein also confuses libertarianism with corporatism, arguing that tax-funded corporate welfare is the zenith of Chicago’s free-market revolution. Klein accepts that corporate welfare is not what the Chicago liberals originally promoted: “But it’s not an aberration; it is where the entire Chicago School crusade—with its triple obsession—privatization, deregulation and union-busting—has been leading.” But she doesn’t explain why this separation of government and the economy would lead to more cronyism and corporate welfare. ...

[T]he follower who says nice things about dictators is Naomi Klein herself, who has nothing but praise for Cuba, Che Guevara, and Hezbollah when she mentions them in her book, and who defended the Iraqi radical leader Muqtada al-Sadr as representing the mainstream of Iraq and as fighting only in self-defense. And the leaders who implement the “economic nationalism” Klein asks for are people like Vladimir Putin, Hugo Chavéz, and Mahmoud Ahmedinejad, who do it while dismantling independent and democratic institutions. In other words, Klein does not seem to mind dictators, fascists, and murderers, as long as they don’t lower taxes and trade barriers. ...

Nothing in The Shock Doctrine suggests that Klein thinks that there is something wrong with using crises to promote your ideas. This tactic, it seems, is only wrong if it advances the wrong ideas. Klein herself has never hesitated to suggest her own solutions to the problems after Katrina or the Iraq War, and she would never dream of considering it as a cynical way to take advantage of suffering people—she would say that it was a way of helping others. Her only reason for thinking it cynical and evil when libertarians do exactly the same thing is that she thinks that those ideas are evil and produce horrible consequences. But that is a claim that she doesn’t provide any arguments for. One must take all this for granted to see anything of value in Klein’s criticism of “disaster capitalism.” ...

A look at the EFW data shows that Klein has it backwards. Poverty and unemployment are lowest in countries with the most economic freedom. In the freest fifth of countries, poverty according to the United Nations is 15.7 percent, and in the rest of the world it is 29.8 percent. Unemployment in the freest quintile is 5.2 percent, which is less than half of what it is in the rest of the world. In the least economically free quintile, filled with the kinds of restrictions on private property, businesses, and trade that Klein claims are ways of helping the people against the powerful, poverty is 37.4 percent and unemployment is 13 percent.

Klein writes that global capitalism has lapsed into “its most savage form” since 1990. If she is right about the connection between free markets and deprivation, poverty should have increased at a dramatic speed since then. The opposite has happened. Between 1990 and 2004, extreme poverty in developing countries was reduced from 29 to 18 percent, according to the World Bank. This means that extreme poverty has been reduced by 54,000 people every day under “savage” capitalism.  And the proportion of people in slums, which is another result of liberalization according to Klein, has been reduced from 47 to 37 percent during the same time. Averages don’t tell the whole story, so it’s important to point out that the biggest improvements took place in the parts of the world that liberalized the most, whereas there have been setbacks in less liberalized countries.

If Klein is right about the connection between free markets and political violence, we should also have seen more war and dictatorships in the era of “savage” capitalism. Klein insists that “the world is becoming less peaceful” without documenting it. She is wrong. According to the Human Security Centre at the University of British Columbia, the number number of military conflicts involving at least one state declined from almost 50 in 1990 to 31 in 2005. The number of war deaths in 2005 was the lowest in half a century. In 1990 there were nine ongoing genocides around the world. In 2005, there was only one, in Darfur. Despite a few conspicuous exceptions, the world is becoming more peaceful in the era of “savage” capitalism.

The world has also become more democratic, contrary to the implications of Klein’s thesis. In fact, while markets have been opened, the world has simultaneously undergone a democratic revolution. Between 1990 and 2007 the number of electoral democracies increased from 76 to 121. In 1990 there were more countries defined as “not free” by Freedom House than were ranked as “free.” In 2007 there were twice as many “free” countries as there were “not free” countries.

So in the absence of serious arguments against the consequences of free markets, we are left with Klein’s reasonable critique of torture, dictatorships, government corruption, and corporate welfare. In the final analysis, The Shock Doctrine boils down to the curious claim that Milton Friedman and free markets are bad because governments are incompetent, corrupt, and cruel. It is probably not a coincidence that there are blurbs from four fiction writers on the back of the book.

Invest Like a Shark

I am a subscriber to RealMoney.  And on RealMoney, there are two columnists that are must reads for me.  One is Helene Meisler.  The other is James "RevShark" DePorre.

DePorre's story, encapsulated in his book Invest Like a Shark, is a fascinating and inspirational one.  A lawyer by trade, DePorre went deaf and lost his practice, his livelihood and his marriage.  Going broke, he began searching for a way to make a living. 

He eventually made his way to investing.  At first, he listened to the recommendations of a broker, but after buying a stock, the broker did not want DePorre to sell.  "Hold for the long-run" was the response from his broker when DePorre wanted to dump a losing position.

Being poor, as DePorre was, has a unique effect that most investors probably do not share.  If one is attempting to make a living from one's profits in the market, one must profit. A falling stock does not put food on one's table.  It may over a year or two, but between then and now, one must eat. 

Frustrated with his broker, DePorre struck out on his own and developed a system that not only put food on his table, but lots of it.  It was also expensive food as DePorre became wealthy in a relatively short period of time.

DePorre's system is one of trend-following and preserving one's capital.  DePorre argues that such a system is an edge the small trader has relative to Wall Street.

Trend-following - also known as "momentum investing" - is often looked down upon by the investment community, though that is changing with the astonishing success of some hedge fund managers such as Jim Simons and John Henry.  "Proper" investing, according to what is taught in MBA schools, is deep fundamental research and financial analysis, and is the dominant methodology of Wall Street.

But what edge, DePorre asks, does the small trader have doing deep fundamental analysis when giant firms such as Fidelity, T Rowe Price, Wellington, Capital Research, etc. have hundreds of analysts eating, breathing and sleeping the 20 stocks they cover?

They do not.  The edge the small trader has derives from the structure of Wall Street in that the firms above are so massive and have so many resources, they have to do in-depth fundamental analysis.  They have no choice.  They cannot follow charts because they are the charts.  Their actions draw the charts.  Recognizing this, the small trader can hop on board or sell quickly based on the charts the big whales draw.

Selling quickly is another facet DePorre emphasizes.  Wall Street is loathe to tell its retail clients to sell.   Why?  As DePorre states, if a client sells, he may take his money elsewhere.  Best that it stays with the broker so the assets can generate future commissions or profits for the broker who invests the clients' cash balances.   

Many investors themselves do not like selling stocks because they see it is an admission of failure.  This is wrong, says DePorre.  You can always buy it back later, even if the stock is higher.  DePorre argues that rather than looking at selling as an admission of failure, investors should view it as insurance.  If you think the stock is going to fall, and you sell it, then if it goes up instead, you can buy it back. The difference between the sale price and the higher purchase prices is the investor's insurance premium against a loss.  And loss of capital is anathema to small traders because if you lose your capital, you are out of the game.

I have deliberately been using the term “small trader” as opposed to “small investor” because this book is best for small traders who make a living trading stocks as opposed to investors who spend no more than an hour or two a week on their portfolio.  DePorre is derisive of the buy-and-hold methodology of many investors, but for those who do not have the time nor the resources to trade full-time, buy-and-hold is often the best option because the option for many passive investors is not between market returns and outstanding returns, it is between market returns and cash returns generated in a bank deposit.  And over the long-run, most investors will be better served in a buy-and-hold market strategy than earning less than the rate of inflation on a time deposit.

This book will not take you long to read.  One of the disappointments is that it is long on very useful generalities and short on specifics.  I believe that DePorre may have done this deliberately as the book is more of a framework on approaching the market as opposed to specific trading strategies, which is really too bad because I would have loved to have read many more examples of DePorre's successful trades and his rationales since the reader wants to be rich like him too!

Invest Like a Shark goes on my Investment Book Log, and I rate it out of five,

A Demon of Our Own Design

How prescient that Richard Bookstaber's A Demon of Our Own Design was released a few months before a derivatives induced melt-down nearly KO-ed global financial markets.  If Bookstaber's writings our correct, it won't be the last either. 

Part autobiographical and part contemporary financial market history, Bookstaber borrows analogies from biology and human failures in nuclear power and airline disasters to demonstrate how complexities of system design increases the odds of failure in financial markets.  The first half of the book is Bookstaber's career as a risk manager, giving the reader a front row seat to two market implosions - the crash of 1987 and the collapse of Long Term Capital Management.  (It also gives shareholders in Citigroup - of which I am one - pause on why we're invested in the stock!)  The second half of the book details the complexities of financial markets, how those complexities leads to failure, and Bookstaber's prescriptions for dealing with financial convulsions.  Unfortunately, his prescriptions will go unheeded as "less complexity" is certainly the way financial markets are not headed.

There were three general ideas that were either re-emphasized or struck me about A Demon of Our Own Design.  The first was Bookstaber's description of system complexity within financial markets.  Bookstaber argues that the more complex the system, the more difficult it is to remedy shocks to the system.  Anyone dealing with structured products over the past few months - where it is still difficult getting prices - is certainly aware of the outcomes of system complexity.  Bookstaber shows that the more complex the system, the smaller the error needed to derail or destroy the system.  Also, the more complex the system, the less adaptive the system is to foreign or unknown elements, and the more prone the system is to collapse with the introduction of foreign elements.

Bookstaber argues that increasing regulation is not necessarily the answer to increasing complexity.  Like the Heisenberg Principle, increasing  scrutiny of market players alters investors' behaviour that will have unintended consequences and make the financial system even more unstable.   For example, Wall Street, knowing LTCM's positions when the hedge fund was in trouble, sold what LTCM owned and bought was LTCM was short, causing losses to widen at LTCM which eventually led to the collapse of the fund.  Had Wall Street not known LTCM's positions, trading desks would not have known to take the opposite side of the collapsing hedge fund.  Increasing transparency, according to Bookstaber, makes such events more likely.

Finally, Bookstaber argues that liquidity is a prime, if not the main determinant of equity prices, at least in the near term.  This should be obvious to equity market participants.  However, teachings on stocks usually emphasize characteristics such as value, growth, quality, etc., as deterministic factors in equity pricing, not liquidity.  Liquidity, or the lack of it, can at least partially explain, amongst other things, why value stocks get and/or stay cheap for a period of time and why bubbles occur.

I thoroughly enjoyed this book.  I put Demon of Our OwnDesign on my recommended investment reading list, and out of 5 give it