What We Don't Know

The Daily Reckoning PRESENTS: There are plenty of things in this world of which we are fairly ignorant – global warming…peak oil…K-Fed and Britney – but then there are things of which we are fairly certain – specifically, the advantages of private investing over public investing. From New Orleans, Bill Bonner explains…


We were not at our best. Still, we managed to give a speech to the New Orleans Investment Conference. What follows is much of what we said:

We stand before you a profoundly ignorant man. (Actually, we felt no more ignorant than any of the other speakers. And in the back of our minds we wondered who was really ignorant – the man at the podium or the people who had paid to hear him. But we pressed on)…

What we don’t know is almost everything. We don’t know which investments will go up. We don’t know what will happen in the world. We don’t know if global warming is a farce or a fact. We don’t know if Peak Oil is something to worry about or something to ignore.

As Donald Rumsfeld put it, there are known unknowns; and there are unknown unknowns; and then there are things about which we don’t have a clue.

Still, that didn’t stop the Bush Administration from launching the biggest foreign policy blunder in U.S. history…nor does it stop us from having opinions and ideas about things. In fact, as we get older, the less sure we are that we know about anything. And there are people who think we already know nothing at all. But the less we know for sure…the more important it is to have rules and principles you can follow. So as we become more ignorant about what is going on, we become more stubborn in our opinions about things.

Now, imagine that there were no Barron’s…no Dow…no financial commentators…and no one writing books such as ‘Dow 36,000.’ If that happened, you’d have to rely only on your own eyes and ears…and your own ability to put two and two together. Investing would become a private matter.

The public spectacle of the whole thing – where you get Abby Cohen telling people how much ‘The Market’ is going up – would disappear…because there wouldn’t be any public market – just millions of private transactions, each one made on its own merits.

In our private lives, by the way, that is the way we tend to do things anyway. For example, if you were in the publishing business, as we are, you would look around to see how to invest your money without much thought to ‘The Market.’ You know you can get about 5% risk-free by buying U.S. Treasury obligations. And you know you can borrow at about 7% or 8%. So, in everything you do, you have to be sure that it will give you a return of more than that. Otherwise, it’s not worth doing…unless you’re doing it merely in an effort to learn something or to gain prestige…or to accomplish something else with a non-financial purpose.

But when we look for acquisitions in the publishing field that fit this objective we see that they are hard to find. We have to spend a lot of time talking to people, researching companies, studying bits and pieces, looking at a lot of publishing projects in order to find the one or two that make sense for us. And guess what, rarely are these investments available to the public. They tend not to be listed on the public markets. Out there in the public – where stocks are quoted on Wall Street – publishing businesses tend to be just too expensive.

In fact, in only one case did we find a publicly traded company that was cheap enough to consider. And that was the case of TheStreet.com…but only after it crashed. And even then it was only interesting to us and to a small handful of other investors from the industry who thought they knew what to do with it. In other words, even though it was available to the public, and even though it looked cheap enough to meet our criteria, a regular public-market investor probably still should have stayed away from it, because he wouldn’t have known what to do with it to make it profitable.

Well, as it turned out, TheStreet.com figured that out for themselves too, and their share price rose to the point where it was no longer a good investment for us.

But how could it be that a stock could be too expensive for those of us in the industry who best understand it? Why is it that public market investors believe they know more about our industry than we do and are willing to pay higher prices than we are? We’ve been in the business for thirty years. How does the casual, public-market investor think he can do better with this company than we can?

We just bring it up to be provocative. We all know there’s a big difference between what goes on in public and what goes on in private life. A guy can make a fool of himself…most do…but it takes a crowd to make a real public spectacle. Because in public…in a crowd…in a stock market, for example, a guy will do what he would never do on his own. This includes paying more for a company than it is really worth. In private, he looks at the situation as we do when we are making an acquisition; he figures out what it will cost and what it should be worth to him. But in public, he gets pushed along by slogans, headlines, collective fears and impossible dreams that he wouldn’t possibly take seriously in his private life.

So, we give you our first general rule: you will do better investing privately than you will investing along with the public. Why is that? Because, a private investor is more likely to know what he knows and what he doesn’t. And by getting close to his investments – by really knowing the industry and the business – he is able to eliminate some of the unknowns and make a better decision. Generally, that means he pays less for his investments and works harder to get them.

And now, another rule – the further you get from the facts and from the consequences of any action, the worse the results. This is true for individuals as it is for groups.

In politics it is obvious that a town meeting in New England is a long way from the U.S. Congress. Both are collective activities; both are, broadly speaking, forms of democracy. But the folks voting on where to put the new town dump are acting on information that is very close at hand. They know the area. And they don’t want to put the dump in the wrong place, because they are the ones who will have to live with it. If they put it upwind of the town, for example, the rest of the town will regard them as idiots and probably tell them so. And they will be very attentive to the costs, too, because they are the ones that will have to pay for it.

The U.S. Congress, on the other hand, is usually far removed from both facts and consequences. Members of Congress routinely vote on legislation that they haven’t even read. Not only do they readily vote to spend other people’s money, they often spend money that hasn’t even been earned yet by taxpayers who have not yet been born. And recently, they went along with a war in a country they’d never been to, for reasons they didn’t understand, paid for with money they didn’t have, and fought by soldiers who were not their own sons and daughters.

In ancient Rome, engineers were forced to stand under the arches they had designed when the scaffolding was removed. And in ancient Greece, not only did the sons of the assemblymen go out to fight, so did the leaders themselves. Not only that, the oldest veterans were put on the front lines!

If Americans wanted to make their government more responsible, they would force congressmen to put all their wealth in U.S. dollar bonds…and serve in every war they start. How long would American troops remain in Baghdad, we wonder, if each member of Congress were forced to serve a tour of duty there?

Our general rule works for investments too. The further you get away from them…and the less you suffer the consequences…the worse your investments will be. That’s why ‘collective’ investments are usually so bad. The investor himself does not take the responsibility for making decisions – removing him entirely from the facts – and managers do not suffer the consequences. These investments – index-linked funds, mutual funds, hedge funds – are just ways of being ‘in The Market,’ – not ways of making serious investments. And since the rate of returns you will get are always reduced by the managers’ fees, you’ll always – over time and on the average – get less than the market itself. And as we pointed out, getting ‘The Market’ is not getting much. Stocks go up and down. You go through a complete cycle – paying fees, taxes, commissions and adjusting for inflation – and you are usually about where you began.

Hedge-funds are a special case. Their ‘I win, You lose’ fee structures are so aggressive that the average hedge fund investor is almost bound to lose money. Even when the fund makes money, the manager takes a large chunk of the winnings. And, of course, when it loses money, he takes none of the losses. Since the average fund is likely to get average results, the average fund investor is likely to end up with less – not more – money.

Felix Dennis, publisher of Maxim magazine among other things, has a house on St. Barts. The luxury island is a playground for the rich and famous. Felix says that when he got to know his neighbors, he found that they were almost all hedge fund managers. ‘Where are the hedge fund customers?’ he wanted to know.”

Ater we made this speech, our old friend, John Mauldin came up and corrected us:

“You’re all wrong about hedge funds,” said he. “Some of them do make a lot of money. But they’re like stocks. The best ones are not available to you. And as you pointed out, you would have to work pretty hard to find the ones that will do well. The average hedge fund is no different from the average stock. On a good day, it will probably lose money for its owners. On a bad one, it will wipe them out.”

Bill Bonner
The Daily Reckoning
November 17, 2006

Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).

In Bonner and Wiggin’s follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is – an empire built on delusions. Daily Reckoning readers can buy their copy of Empire of Debt – now available in paperback – just click on the link below:

The Most Feared Book in Washington!

We were out of commission yesterday…partly because we were traveling…and partly because we were sick…partly because we were giving a speech in New Orleans. We begin today with a few thoughts from Addison Wiggin on the Crescent City; a city whose origins stem from one of the greatest financial bubbles of all time:

“At the height of “the bubble,” just when the wheels started to come off, Mississippi John Law came up with a brilliant plan to save his company and the Banque Royale. The year was 1720. Paris, over the previous three years and by virtue of Law’s financial innovations, had become the largest and richest city in Europe.

“Law’s “innovation” was paper money. Apart from a several-hundred-year stretch in China ending in 910, the world had never seen or used paper money. At the outset of The Mississippi Scheme, Law had demanded, on the pain of death, that his banker’s not print more money than could be redeemed in gold from their own reserves. The strict backing of the currency – what was essentially the world’s first gold standard – gave investors of the day such confidence that the currency actually traded at a premium.

“But there was a problem. Law’s bank existed by virtue of a deal with the Regent of France, the Duc d’Orleans. The finances of the government in France following the reign of Louis XIV, his wars and the building of Versaille, were a mess. Seeing how much value was being placed in the new bank notes of the Banque Royale, the Regent set another precedent modern readers will recognize: he decided to print his way out of debt. He suggested Law issue currency up to 80 times what the bank held in redeemable gold reserves. Law, being rather preoccupied with the power and prestige the scheme had bestowed on him, ignored his previous warnings, and let the printing begin.

“The new notes flooded into the market and for a while held the value they had gained with solid gold backing. So many people got rich, the Aristocracy of the time coined a new term to describe them: “millionaires.” Stories of commoners making so much money fired the imaginations of thousands and thousands more investors and the frenzy got out of hand.

“New Orleans, the site of this week’s investment conference, was founded at that time, named after the Regent, and meant to become the Paris of the New World – the jumping off point for those who would mine all the gold and silver soon to be discovered in Mississippi (sic).

“When people started getting wind of the fact that there was nothing backing Law’s currency but rumors of future profits to be reaped in the New World, they started losing confidence in the new currency. Law, trying to keep up appearances just a little longer, rounded up all the beggars, bums and thieves in Paris, furnished them with picks and shovels, and marched them through Paris ostensibly on their way to New Orleans…and the mines of Mississippi. The quiet hiss of air leaking out of the bubble accelerated into a screeching “whoosh!” when the same old dirty faces began appearing in the same old dirty doorways and alleys.

“In 1971, our own currency, the almighty dollar, was the last modern currency to be officially removed from the gold standard. Ironically, or not, the move was precipitated by the French government.

“At the time, de Gaulle realized that the United States had built up immense debts to governments around the world. If the United States wanted to pay the debts back, all we had to do was fire up the printing press, and the world was forced to accept our paper in lieu of these debts. De Gaulle thought he’d redeem his paper for gold…a move that was still legal at the time.

“Nixon thought better of it, said no way, and closed the “gold window.” Since that day, no one – not you, or me or the president of France – can redeem his paper money for gold. And the value of the dollar is largely determined by the confidence investors around the world foresee in future success of the U.S. economy.”

And just how is investor confidence holding up for the U.S. dollar? Let’s check in with our currency counselor:


Chuck Butler, also at the conference in New Orleans…

The data yesterday left us wanting for more because it didn’t satisfy our needs to drive the dollar lower. First of all, the government reports through CPI that we’re not experiencing any additional inflation in our lives (HAHAHAHAHA!), and that the annualized number is only 2.8%… The thing that is strange here is that the dollar got all kinds of support as inflation was rising per this report, and now that it looks like it is backing off, the dollar isn’t getting sold…hmmmm.

For the rest of this story, and for more insights into the currency markets, see today’s issue of The Daily Pfennig


More thoughts from Bill Bonner and crew…

*** Addison continues: “Word came this morning, too, that the economist Milton Friedman has died. Friedman often addressed the crowd in New Orleans, in person for years, then later via satellite when his health prohibited travel.

“One thing that is not commonly known about Milton Friedman: It was he – not Ben Bernanke – who was the architect of the strategy Bernanke referred to in his now infamous ‘Helicopter Theory’ speech of November 2002. Bernanke suggested at the time that through a recipe of tax cuts and low interest rates the government could simulate the effect of throwing dollars out of a helicopter and into the waiting bosom of the panting American consumer below. Unfortunately, traders around the globe did not react kindly to the comments: the dollar fell nearly 50% against the euro in the ensuing four months.

“With ideas like these, good ones and bad, Friedman revolutionized American economics. In 1961 he and his wife Anna publicized their view of what went wrong in the Great Depression. He believed that had the Federal Reserve acted more quickly slashing interests rates in response to the crash in ’29, the Great Depression could have been avoided altogether. Today, the most famous student and practitioner of this view is Ben Bernanke. It’s no coincidence that Bernanke was ripped from his chair at Princeton and rapidly gained influence at the Fed following the tech wreck of 2000.”

*** “As I sip my steaming hot chicory flavored coffee and gobble down the warm powder sugarcoated beignet, I have to say life is good,” reports our commodities guru, Kevin Kerr from the Big Easy.

“I spent all day yesterday giving my general presentations and workshops to over 1,000 attendees and it was fantastic to meet so many investors and to share ideas. Then, during one of the breaks, I flipped open my laptop to look at the markets and was stunned to see our OJ up $5 and by the end of the day up $8.55…it made my day to say the least to catch one of the biggest bull moves for any market this year.

“I will report back next week before Turkey Day…in the meantime, I plan to have some fresh oysters and enjoy this great city.”

*** At an airport bar in Atlanta…

A man bought a sandwich and sat down at the bar to eat it. He was a youngish fellow, who looked like he might be a representative for IBM or something, dressed in a business suit. It was early in the morning…there were just a few people there, spread out among the wooden tables; no one tending the bar itself. Instead, if you wanted a cup of coffee, you had to go to a counter on the other side of the restaurant.

Along came a big man, unshaven and vaguely uncouth in his attire and comportment. He walked behind the bar.

“You can’t sit here,” said he. “You have to move over to one of those tables.”

“Why not? I’m just eating the sandwich that I just bought here.”

“Sorry, you have to move…it’s the law.”

The man moved.

“When did Americans become so docile?” we wondered – so ready to listen to anyone who pushes them around…and calls it the law?

*** Later, on the plane to New Orleans…

We noticed a soldier, dressed in desert fatigues, who had just come back from Baghdad. The on-board team found a place in business class and brought him up.

One of the older stewardesses engaged him in conversation.

“How was it over there?”

“Not too bad, but I’m glad to be home.”

“How long were you there?”

“A year…and I’m just coming home for two weeks. It’s my wife’s birthday, so I’m going to surprise her by coming home for Christmas.”

“Wow…what a surprise that will be!”

Then, as the plane was preparing to land came an announcement.

“Ladies and gentlemen, we have with us a young man who has just come from Baghdad. He’s in the army and is coming home for Thanksgiving. His wife doesn’t know he’s coming. He’s been defending his country in Iraq for a year…and I’m sure he’s anxious to get home to his family. So, I’m sure you’ll all want to do this man a favor and let him off the airplane first.”

When the plane landed, the soldier grabbed his kit, almost a bit embarrassed, and made his way to head of the line…and was off the plane as soon as the door opened.

“That’s touching, isn’t it?” said one stewardess to the other. “Surprising his wife like that?”

“Yeah…I only hope his wife is at home when he gets there.”

The Daily Reckoning