Submitted by JM
Apocalypse Trades: Neither Things Nor Bureaucracy
Given the utter implosion of the American consumer and Hurricane Irene, it is fashionable to be apocalyptic these days. One should be disinclined to acquiesce to such visions.
One should not be blamed for being seduced: a Federal Reserve apparatchik dictates the path of every asset class by his whim. Regrettably, there is no reliability in predicting such whims of fate. There is, of course, value in speculating to the end of anticipating probable decisions. But it is sometimes best to ignore these perturbations as best one can and undertake reasonable, empirical explorations that buy what is cheap and sell what is dear. Remember the words of the wise: “there is nothing new under the sun.”
One should stick with time-honored traditions that ignore credit ratings and do one’s own diligent investigation of companies. This obtains bonds that will be money good in a wide class of evil or jolly circumstances. One should buy shares of companies with prudent managers who understand the best way to be black swan proof is to avoid excesses in both debt and austerity. One should follow the general but not too rigid proviso that said managers respect their investors enough to return a healthy portion of their capital back via dividends in reasonable time. If the prevailing opinion of the market is such that they trade below book value, then one should be doubly pleased to acquire them. It can be more painful to carry on this way undismayed, but there is nothing like pain for feeling alive.
It is commonly held that financial markets are “gamed” against retail investors. Fair enough assessment of some dreadful practices. But for the enterprising, this rigging itself creates opportunity through market volatility. One can game the game by buying into volatility spikes, that is, when all are pressing the sell switch. This takes patience and discipline. One should not condescend to buy shares of a mature business so disrespectful of its owners that it offers no dividend: tosh on these. One should not nurture delusions that an established company with a multiple reflective of 200x earnings is capable of growing into it: insufferable presumption.
Above all, one should trust in people and their businesses to navigate uncertain waters, and view with distrust things and bureaucracies. It is prudent to hold small tangible stores of wealth as a counterpoint to ever-increasing financial complexity, but only in small quantities purchased at fair prices. This not said to be injurious. It is said because bargain investments in people are most desirable. People are creative, pliant, and resilient in ways that metals, commodities, or bureaucracies can never approach. Firms and concerns of that sort are options on people, bounded by their limitations and fueled by unlimited desires. In contrast, bureaucracies are condensates of other institutions, deadening instruments with negative carry on the human soul. Some exceptions will arise.
The Scourge of Bureaucracy
The “bread and circuses” theatrical in the United States Congress last month ended with a stop-gap, thoroughly provisional approach to resolving the debt ceiling. It led to some relief at the front end of the treasury CDS curve, which was ominously inverted. This inversion is a measure of the childish depravity politicians now represent.
While the steepening of the curve seemed to provide a favorable wind in the sails, there is something disagreeable afoot. It is the extent of the steepening at the long end which says all is not well. Irresponsible kicking the can down the road is being priced into the protection premium on treasuries.
Notably, these curves are illiquid. At the 5Y mid, the most liquid point on the curve, there has been a 7% increase in premium in the month following the debt ceiling deal. This is nothing short of dramatic.
The CDS market is simply the prevailing view of a given crowd regarding the credit worthiness of a referenced entity. The crowd in question here comprises tier 1 banks, bond market dealers and a few other agents at the margin. It is their view that prevails here. The short-term resolution, if it can be called that, is more than offset by the long-term deterioration in credit-worthiness by their estimation.
There are no easy remedies for this state of affairs. But provocation that aggravates the situation serves no good. The United States can borrow virtually unlimited sums for 10 years at 2% interest. This capacity should not be spoiled due to the whims of the Crassus’ and Brutus’ in Washington D.C. Drastic cuts in public expenditure will surely contribute to greater unemployment. But without earnest action that aligns expenses closer to revenues, the problem of credit-worthiness reflected in CDS will invariably lead to limits on borrowing at precisely the worst time. Neither austerity, nor total avoidance of painful responsibility is the right course Aristotle was right: the mean course is virtue. The mean is anathema to apocalypse.
The Superfluity of Things
Tangible stores of wealth are indeed seductive, and apocalyptic overtones add to their allure. But what is tangible can be taken. Trading in apocalyptic settings has minimal gain and even the most tangible things carry risk: there is no profit in an unshakable faith in them. The only unshakable faith should be in one’s capacity to foster a world worthy of wonderful and useful ideas, avoiding religious matters.
It is here that the rules themselves change in unpredictable ways. Bureaucracies collapse: the largest predators in the food chain become extinct. The best hope is to rise out of it and rise quickly and the smaller, nimbler, and more cunning can live to see brighter days. There is no science to living in such circumstances. But perhaps there is an art in it. If the world does melt under the unlaboring stars, one should not despair of it.
There will always be ways to support something good in this world. And with all respect for wise words, there are new things under the sun. There are always opportunities to bring something new and vibrant into this world in spite of surrounding gloom.
Here is one example to consider. A man carried coal during World War II. During one night bombing attack, some 80,000 people where he lived were killed. While his family was spared death, this fire-bombing destroyed his home. His family effectively collapsed. This man’s father was a successful lawyer before the rules changed on him. But during the war he was injured and could not work anymore. His father’s accumulated wealth evaporated during a sharp devaluation of the currency, by a factor of 100. The family could not live on past savings and investments, and this young man nearly starved to death. Anyone with family or friends in the countryside was supposed to move there. But this man had no relatives or friends in the countryside.
There was an admirable resiliency in his society, in some sense enduring to this day. Desperate, homeless young men and women formed close-knit groups led by their teachers. These teachers held great honor and did more than impart knowledge of subjects. They imparted knowledge of living, shared food and clothing, and gave encouragement. This young man was lucky to have this teacher. He was rather timid and not talkative at all, a bonchan, but his teacher always encouraged him and pushed him to learn. The teacher imparted that learning was not a game at all. It was something very serious that imparts what is genuinely wonderful onto the coldness of the world. If there are such things as guardian angels, then the connection between this teacher and this student is an example of such divine work. Perhaps it was simple inexplicable luck.
During this time, life became harder and harder, but the young man went deeper and deeper into study as a response. He describes this obsession for knowledge as similar to an alcoholic’s thirst. After the war, he wanted to continue his studies and become a professor. Finances and circumstances forced him to accept being an elementary school teacher instead. But he never lost his thirst for knowing, reading Sugaku on his way to and from work in a country rapid being rebuilt from nearly absolute devastation. He learned a spectrum of general topics like sheaves, algebras, and categories. In his mind he came to see remarkable relationships between analysis, geometry, and algebra and he had a desire to unify them.
He came across a problem that shocked the mathematical world of the 1950s: there were linear partial differential equations with variable coefficients that had no solutions in the space of distributions, not even local ones! He developed a solution to this problem and in the process created a framework to convert functional analysis into a coherent whole instead of scattered fragments united only by common techniques. He saw that a manifold is the geometric analogue of an algebraic commutative ring. In an amazing step, he saw that going to the non-commutative case led to a powerful treatment of partial differential equations. These ideas were radical indeed. Gradually the novelty and just plain weirdness of them wore off and some people began using these ideas in a garden variety kind of way. Algebraic analysis still remains somewhat unexplored by the mainstream to this day, save the French. The French above all others have an impeccable feeling for the truly profound.
The man was Mikio Sato, and few living mathematicians exceed him. What is most fascinating is the extent to which his world collapsed around him, and how swiftly it was rebuilt. In less than a generation, equity markets were destroyed then booming again and personal wealth exploded upward. Opportunity returned in spite of radiation, physical destruction, political and economic collapse. So it was, so it will be.
Japan’s rebuilding is more than a copy of its former state. One can argue that the solar panels on virtually every roof and the integration of robotics and the virtual world intertwine with the time-honored tea ceremony in ways that front-run the rest of the world. Mikio Sato was a part of this rebirth, enriching it, making the world more interesting and full of new vistas, simply by pursuing his own personal need to understand.
People’s needs transcend things. There are always material needs like food, shelter, and clothing: satisfying these alone makes one no better than an animal. There are social needs that make some men rise to be little lower than angels and some men descend into nothing more than demons. These are best understood as thirsts: sometimes twisted into a thirst for dominance and power, sometimes is a simple longing for closeness and belonging. But there is a thirst much nobler in man. He creates ideas to nurture and cherish. These rebuild and give something to all.
“They can take land and money and all your things, but they can never steal what is in your mind.” A friend told me these words. They were told to a son from a father living in 1930s China to explain why all of a possible inheritance did not leave land or silver for an only son. Instead his father poured the inheritance into a physics degree from Peking University. He told his son those words, which he in turn passed on to his own daughter. I passed them on to my sons.
I have no illusion of being extraordinary or that what I do changes the world: I use mathematical methods, but I am no great mathematician. What I do simply supports both the beauty and the ugliness in the world. At my best, I can make the world better by my actions. Anyone can. Should new things under the sun realize the worst of men’s fears, should epic fail overtake me because I honor the time-honored, I shall be open and receptive. I shall still support the world in ways that will never fail to unfold.