Billionaire Economists

We all know that most economists are ivory tower academics whose ideas hold no practical value…but, as Mark Skousen recently pointed out in a speech – like it or not, they have made their mark…and are here to stay.

I teach personal economics at Columbia University and Rollins College, and we discuss the various financial problems people face. I often ask students, "What’s the financial solution to being heavily in debt and not earning enough money, or not having a good enough job and so forth?" The answer is always focused on one thing: making more money. Get a better job, get a higher income, or win the lottery. None of them ever say they should cut back on wasteful expenditures. Remember Andrew Carnegie’s statement, "The key to every successful company is to be cost-conscious." Not wasting money, is a very powerful concept, but one that’s often ignored.

While teaching my college courses, I tell the story of two finance professors, one that is older and tenured, and a younger professor who is still wet-behind-the-ears. The two are walking along on campus when they come across a $100 bill. Seeing the $100 bill, the young professor runs over and reaches down to pick it up. However, the old sage professor pulls him back and says, "No, no, young man, don’t bother. That’s not a $100 bill. It does not exist. If it did, someone would have picked it up a long time ago; therefore, let us continue on and ignore what you saw."

Now my question to you is this: Are there hundred dollar bills lying on the ground? Are there hundred dollars bills in your life that you can pick up and say here’s a $100 bill, look what I found?

There is a lot of money out there, but you can’t wait for it to come to you. You have to get up and go get it. You have to be aggressive, if you want to be successful in life. You can’t just sit back and expect people or money to come to you. There are no free lunches.

Theoretical and Practical Economics: Practical Economists on the Rise

Now, you know most economists are ivory tower academics who engage in abstract theorizing. Seldom are their ideas of any practical value. As Jean Baptiste-Say, the great French economists said, "They’re ideal dreamers who offer no practical value." But more and more, economists are offering practical skills and techniques. Some have done a lot of research on the ability to do well in the financial market, and have found some very interesting things in their studies. One of the most important fields is called behavioral economics. It’s a new area that’s been going on for twenty or thirty years. Several Nobel Prize winning economists have studied the performance of top money managers and individual investors. What they find is individual investors often have a far better record than professional money managers. Basically, they’re saying if you do your homework, and you go contrary to what the money managers and the establishment is doing you, have a better chance of beating the market.

The truth is if you forget about macroeconomics, you better believe you’re going to lose money. I don’t care what investment you’re in, if we have, for example, a terrorist who drops a nuclear bomb on New York City, and closes the stock market for who knows how long, the markets that do open are going to open up substantially lower. I’ll never forget 9/11 and the week after, and you shouldn’t either, because what happened there? That Monday, when the NYSE opened after a week of being closed, and the President of the United States, along with the President of the NYSE and all the major brokerage houses called their investors up and they said, "Please don’t sell." In fact, they encouraged us to buy stocks on that day.

What was amazing to me was all the stock markets outside the United States had all fallen ten to twenty percent, and the terrorists hadn’t even attacked their country. And I thought that was the stupidest advice; of course the markets are going to drop that day, and sure enough Wall Street fell. So you have to be alert to these kinds of things, there’s lot of events that could change the mindset of the market. Companies that are going well now may not do well in the future. I think you need to be alert to the signs of the time.

Theoretical and Practical Economics: David Ricardo

I would like to give you an example of a great, and more importantly, a practical economist. David Ricardo is probably one of the most brilliant economists who ever lived. He was born in the 18th century, and was noticeably present during the Napoleonic Wars in the early 19th century. Ricardo was from an old, London-based Jewish family and he was a stockjobber; he made a market in government bonds, known as the consol market in Britain. As you may know, England and France were at each other’s throats; constantly battling each other, and during the Napoleonic Wars the British government issued a lot of government debt.

Now, David Ricardo and his firm competed against the Goldsmids and the Rothschilds and other major government bond dealers. Ricardo was extremely successful in getting these government contracts and became a wealthy man as a result. His claim to fame was the amount money he made on June 15, 1815. What happened on that day? The Battle of Waterloo. British General Wellington won the battle.

A lot of people don’t remember what Ricardo did during this time period. It was overshadowed by the more famous story of Baron Rothschild. The Rothschild family was famous because they engaged in a little bit of insider trading during Waterloo. What they did, since the Rothschild family had five brothers that were located throughout Europe, the French Rothschild, being at Waterloo with his agent, knew immediately who won that battle. Of course the outcome was a shock, as Britain was not expected to beat Napoleon at Waterloo, and the government bond market reflected that. The prices had dropped precipitously, and Ricardo himself had a very negative position because of his faith in the British Empire. His decision to make money was to go contrary to what everybody thought would be the outcome of this major battle.

Since the French Rothschild’s agent knew right away who won this battle, they sent the message via carrier pigeons across to Britain, and the Rothschilds were the very first ones to know who had won the battle. Then, Nathan Rothschild went into the trading area and gave a signal to sell bonds initially. He did this so that panic would sweep through the bond market. At first, Rothschild had everyone thinking Wellington had lost, and then he bought after everyone else had sold. Of course, they made a lot of money, and forever were known as the merchant princes of Europe.

Back to David Ricardo, who held on tenaciously and was the George Soros of his day. Ricardo became a very prosperous man – he made 1 million pounds sterling in one day. After he became wealthy, he decided he had an interest in economics and wanted to make great contributions. He discovered the law of competitive advantage, which is a subtly profound doctrine used in trade. But I like the idea that if you really believe in the fundamentals of your concept, and stick with it. You may have a short-term loss, but you may end up with a long-term win.

Theoretical and Practical Economics: Irving Fischer

Another economist I want to mention is Irving Fischer – the Milton Friedman of his day. In addition to being the premier monetarist economist of the 1920s, was he a Yale professor, and the only professor I know who had a chauffeured limousine taking him to and from class. He was an inventor, and he made one thing that is used every day in every business in America – the Rolodex. He sold his invention to Remington Rand and received stock that was worth $10 million at the peak of the stock market in 1929. He was known in the 1920’s as the oracle of Wall Street, and was always quoted on the front page of the New York Times. He was what we call a perma-bull; he was always optimistic. He was always optimistic, a perma-bull. He believed in the new era of the 1920’s, which was not unlike the 1990’s in many ways – all of these new inventions, the new technologies, and the new consumer products.

Where did he go wrong? This is where we have the name of a man who died in infamy, even though he was a great economist and contributed what was known as the quantity theory of money. There was a fatal flaw in his macroeconomics: he failed to see the coming debacle, the greatest collapse in capitalism in the 20th century in 1929 and 1930. He didn’t see the Great Depression coming. If you don’t foresee a major cataclysmic event in the world you’re going to pay dearly. On the other hand if, you anticipate it you can profit amazingly well. The 1920s and 1930s were no different. Most people lost tremendously, but there were others who made money and survived.

So Fischer was one of those who made a fatal mistake – he was too macroeconomic. He looked at prices and he noticed that they were very stable in the wholesale price index, and no problem in the consumer price index. He assumed that they were in a new era. Besides, he thought, we have a Federal Reserve, and how could the Federal Reserve blunder? They’re the lender of last resort. That’s why we set up the Federal Reserve. But it turned out very differently; the Federal Reserve didn’t know what they were doing. It was actually a reversal, and the Fed caused one-third of all the commercial banks in the United States to crash. Irving Fischer failed to see that, Keynes failed to see that. As a result, Irving Fischer lost his entire fortune. He was totally wiped out of his $10 million, and in the late 1940’s his financial situation was so dire that Yale University had to buy his home and rent it back to him for free. When he died, he died in poverty and disgrace.

He’s famous for having made a statement one week before the crash, on October 16th, 1929: "Stocks appear to have reached what appears to be a permanent plateau." He argued that stocks could not go down, and economists have had to live with that failure since. There are all kinds of jokes about economists and their inability to predict. That’s an important story of not understanding the macro situation.

Now, two of my favorite economists, who did predict, were Ludwig von Mises and Frederick Hayek. They worked together in the Austrian School at the University of Vienna. They both forecasted the Great Depression, but I should point out that Mises predicted the Great Depression starting in 1925, which means he missed the bull market too. We would like to be able to foresee the bull market, and get out at the right time, but of course, that’s difficult. Now there were the perma-bulls and the perma-bears. It’s an exceptional person who gets in right before the bear market starts. You can count on one hand the number of economists and financial advisors who fit in that category.

In the 1920s and 1930s there’s only one person who got out at the top and bought in at the bottom in 1932, and that was Joe Kennedy. He’s known for a famous statement; after he got out a little bit early in 1928, he came down and bought some real estate after the crash in the Florida market, and he feared that he got out too soon. He was thinking this when he was getting a shoeshine, and then the shoeshine boy gives him a stock tip. He decided right then and there that he was wise to be out, and he was right.

Say you’re at church and someone comes up to you and says, "Hey, I’m thinking about buying XYZ stock." That’s a sign we’ve reached the top. All the great investors in many ways are contrarians. It’s very difficult to be contrarians; you have to be in the minority. It’s very difficult.


Mark Skousen
for The Daily Reckoning

May 05, 2005

Boom time. Boom place. Boom. Boom. Ka-boom!

The FDIC says there are 55 areas in the United States in the middle of real estate booms – which it defines as places where residential property prices have risen more than 30% in the last three years. This is the biggest number of booms in 30 years, says FDIC, and twice the level of the ’80s.

If a bull market is what makes a genius, the real estate boom in the United States has created a whole nation of them. Thirty- and forty-somethings think they have noticed something their parents and grandparents missed – residential real estate prices go up. And since they go up faster than the inflation rate…and faster than the interest rate on borrowed money…the obvious thing to do is to borrow heavily to buy houses.

There was a time; believe it or not, when people thought the only way to make money was by producing things you could sell. The idea…and I’m reciting this from memory…was that you made things for $x and sold them for $x + 30%. It was pretty simple in theory, but hard to do in practice – especially when there always seemed to be someone in Asia willing to sell them for $x – 30%. The only way American manufacturers could possibly keep up was by investing massive amounts of money in research, new equipment and new training so that they could make things better and cheaper than they made them in Asia. But that involved all the old-fashioned virtues – thrift, saving, self-discipline, hard work, perseverance – who was going to put up with that? So manufacturing declined in the United States, and wages stagnated. Manufacturing made up more than half the U.S. economy in ’65. It fell to 39% in ’88. And by 2004, for every $1 of GDP in the United States only 9 cents came from making things. Per hour worked, in real terms, Americans barely earn more than they did 30 years ago. Last year, their earnings actually went down.

Thank God for the house price boom. Without it, Americans would be in a pickle. They wouldn’t be able to increase their standards of living. They wouldn’t be able to borrow so much money. The Chinese wouldn’t be able to build so many factories. Asian central banks wouldn’t have so much money. And there wouldn’t be so many geniuses in America.

The house price boom is natural thing, but not a normal one. It is not the happy consequence of millions of geniuses that suddenly discovered how to get rich. Instead, it the grotesque result of a central bank that looked into the future and tried to improve it before it happened. In 2001, Alan Greenspan and his team saw a Japanese-style slump coming. They decided to head it off with a little hocus-pocus – cutting lending rates to below the inflation rate. Americans were still basically bullish, so they took it.

We have harped on this so often we are getting tired of the sound of it. It is obvious to us that people who borrow and spend do not get richer, but poorer. But the insight seems lost on America’s race of geniuses, so we keep harping.

And today, we add a wrinkle…if not a pleat. We are beginning to think not of ourselves, but of our Asian neighbors. While we accumulate debts and gadgets, they accumulate dollars and credits. What are they going to do with them?

The Economist reports that Asian central banks, including Japan, have about $1.5 trillion in dollar reserves in their vaults. A relatively modest drop in the dollar’s value would mean huge losses to them. By way of comparison, the Nicaraguan central bank lost an amount equal to 13.8% of GDP in 1989. Argentina set something of a record, losing an amount equal to 23.5% of GDP that same year. These losses were not just "on paper." The standards of living in Argentina fell – and are still about 30% lower than they were before the boom exploded.

What Argentina was doing was little different from what America is doing now – spending more than it could afford. It made up the difference by printing money – precisely what Ben Bernanke, who may be destined to replace Alan Greenspan as Fed chief next year, proposes to do. In Argentina, the printing presses literally broke down under the strain of printing up new money. In America’s case, it may be the entire world economy that breaks down. So far, the inflation is being absorbed by Asian central banks – which take dollars onto their ledgers at par – and by the geniuses that buy houses in America for more than they are worth. How long this can go on is anybody’s guess.

More news, from our team at The Rude Awakening…


Eric Fry, reporting from Manhattan:

"Warning: A virulent epidemic is sweeping the nation. How many more victims the epidemic might claim is anyone’s guess. But suffice to say that the rapid spread of this contagion is a serious national problem, which may produce several dire consequences…"


Bill Bonner, back in London…

*** "I continue to be struck by the eerie similarities between post-bubble patterns in Japan and America," said Stephen Roach.

"Five years after the bursting of the U.S. equity bubble, the NASDAQ continues to track the post-bubble Nikkei very closely. Is this merely a coincidence or, in fact, a visible manifestation of the long and drawn out perils of a post-bubble shakeout? I fully realize the indelicate nature of this question. Everyone – from investors and recovering dotcomers to policymakers and politicians – seems united in their conviction to dismiss this possibility as nothing short of blasphemy."

Three years ago, the parallels between America’s then-current markets and those of Japan 10 years before struck us as so alarming we couldn’t stop talking about it. We bored Daily Reckoning readers with it…and then put our thoughts in a book to bore thousands more.

It seemed like something worth worrying about back then. It still does. Our guess remains the same: that the U.S. economy is following Japan into a long, slow, soft slump. But unlike the Japanese, Americans won’t be able to afford it. The Fed has lured too many Americans too close to their own destruction. When the credit expansion stops – and it must, someday – Americans will go bust. Their mortgages will be foreclosed. Then, they will howl so loud the feds will panic. Ben "Printing Press" Bernanke will point toward Argentina. "There…that is our only way out," he will say.

*** Merryn Somerset-Webb came back from Omaha even more cynical than when she left.

"Warren Buffett is a fraud," said she. "I watched him. He barely drank any Coke. And I can’t believe he lives in Omaha. There’s nothing there. Everyone in town swears he lives there…and that he goes into the coffee shop and so forth. The cab driver took me by to see his house, which looked like a decent place. And so I asked him, and everyone else I met, ‘Have you ever actually seen Warren Buffett in town?’ ‘Well, no,’ they all answered. The whole thing is an elaborate fraud. He lives in Laguna Beach. He probably only holds a Coke can in public.

"And from the point of view of a European investor, you’d have to be crazy to buy the stock. Buffett himself wouldn’t buy it. He says the dollar is falling. And Berkshire is not cheap. Where’s the value?"

Buffett is a hero to many investors. Merryn reports that during the question and answer session, one shareholder after another go up to praise the man. "Thank you for your wisdom," they would say.

But is Buffett really wise…or lucky? Both, is our guess. He is wise enough not to do anything particularly stupid. He buys good companies at decent prices. He doesn’t allow himself to get caught up in manias. He avoided tech stocks in the late ’90s…and he has no particular truck with the real estate bubble. He’s not flipping condos or building monumental hotels in Las Vegas. He’s also recognized the bubble in U.S. credit and tried to protect himself by getting out of the dollar.

On the other hand, there are a lot of investors who’ve studied Benjamin Graham’s principles. There are many who are just as smart. There are some who have better track records – though on a smaller scale.

"Yes," said Merryn, "But if you’re going to go to all that trouble to make a lot of money the least you can do is have the good grace to spend it in good style."

*** Here’s an interesting item. The Chinese can knock off anything. According to The Daily Mail, they are copying European cars…and producing them at half the price. They’re even making a Chinese version of the Rolls Royce Phantom; they call their version the Red Flag. From the photo, it actually looks better than the original. But it sells for only about $200,000 compared to $450,000 for the real thing.

Prefer a Mercedes? Try the Ssang Yong Chairman. It looks just like a Mercedes…but it sells for just $45,000.

The Daily Reckoning