So how then do we invest? The problem we have as investors is that there is nothing we can do except invest in the global markets. That is where we get global growth. That’s it.
I had this conversation with Harry Markowitz (the Nobel laureate who developed Modern Portfolio Theory) two months ago. We talked for an hour and a half, discussing MPT and diversifying portfolios; and my argument was that in the future diversifying among asset classes will be futile, because correlations will be going to one in a world turned upside down. In order to actually see performance, I maintained, we have to diversify among the trading strategies that we use to trade the asset classes.
You cannot afford to be passive and be long this and short that. That won’t produce results you will be happy with. But if you diversify among smart traders, you have a chance to get your assets from here to the other side. Harry just pointed out that what I was suggesting is still consistent with Modern Portfolio Theory; it’s just a different way of trading diversified asset classes.
You really do want to get to the other side of what I see as the coming crisis, too, because on the other side will be one hellacious bull market. Technology is going to take us to places we have never dreamed of. Three billion people are coming into the emerging-market middle classes, even if later rather than sooner. It is going to be a phenomenal world. You have just got to figure out how to get your assets from here to there.
Look, the Fed models don’t work. Yet for whatever reason, we somehow continue to accept that the Fed is smart enough to manage the most important price in all the world, the price of money denominated in the world’s reserve currency. Which is to say, they manage interest rates, which is basically the price of money. They do this based upon the models they create, which have never been right. They get nothing else right, and we think they can get interest rates right? They are going to screw it up, which is precisely what they have been doing for the past six years. We are in the beginning stages of the most massive monetary policy mistake in the history of the world, with the possible exceptions of Weimer Germany and Zimbabwe. But the implications are far more global now.
I am afraid that the one thing we can count on is that whatever policy the Fed chooses will be the wrong policy. They believe they can set the price of money and thereby balance demand and supply. Can anybody name me one instance where fixed prices worked in the real world, creating a paradise where supply and demand were balanced? They have manipulated the system and set the wrong price of money. They have created a world where savers are penalized, companies are paid to buy their competition rather than compete, and only the participants on Wall Street are rewarded with appreciation of their assets. My Austrian and monetarist economics school friends, who predicted inflation from all the QE that we saw, have actually seen inflation – it has just been in asset prices that benefited Wall Street and not Main Street.
And it’s not just a US problem. It’s Europe and Japan and anywhere in the world where interest rates and savers have been repressed.
Unless we see the central bankers of the world reevaluate their religious convictions about how monetary policy should be run, we are going to enter yet another period when the unthinkable becomes reality. And to be ready for it, and to potentially profit from it, you need to begin to think the unthinkable today.
Some Quick Thoughts on Brexit
It is way too early to draw any conclusions about Brexit, other than to talk in terms of general concepts and feelings, which I will briefly offer, but I promise a later letter that will go into the implications of Brexit in far more detail, after my researchers and I have looked at the issues in depth.
First, my good friend and fellow writer/thinker Barry Ritholtz reminded me of the wisdom of screenwriter William Goldman, from a century ago, talking about the world in which he lived, that “Nobody knows nothing.” If you think you know how Brexit is going to turn out, you probably have a presupposition that is clouding your thinking. This is unknown territory. There be dragons out there, but we have no idea whether they are good dragons or bad dragons. It depends on which near-future science fiction novel you’re reading. Because economics is getting ready to turn into science fiction.
Cameron resigned. Big shock (note sarcasm). I would have done the same, because who on God’s green earth would be so insane as to want to go through the next two years of negotiations with the EU? Talk about a way to age 20 years in the next two – and that will be the new prime minister’s role. Whatever the outcome, nobody will appreciate the work. Cameron is young enough that he can make a comeback if Brexit ends up looking like a bad decision. If it turns out to be a good decision, well, his daddy is rich and his ma is good-lookin’, and he can make a lot of well-paid speeches, sit on a lot of boards, do a lot of consulting, and make a ton of money. There are worse gigs. Ask Tony Blair. Or Bill Clinton.
The next prime minister (if and when they can find somebody masochistic enough to take the job) will notify the EU of his or her intentions along about October or November, probably. Then they have two years to negotiate the exit strategy. This is a classic equilibrium-theory, prisoner’s-dilemma situation. The longer the British take to come to an agreement with the EU, the more the other EU members realize they need Britain and its market, not to mention its monetary and banking prowess. But the longer the British take, the more uncertainty there is in the market; so the more problematic the situation becomes for their economy, as businesses have to make a decision about whether to move to Ireland or to the mainland to have unfettered access to EU markets.
And the EU would like to immediately punish Britain so that nobody else will want to leave. But then the United Kingdom just stalls, so it really is pointless for the EU to bluster and try to take quick action. But waiting allows those who want to call for referenda in other EU countries to take heart and plunge ahead.
What we will end up with is a massive multiplayer Nash equilibrium-theory game, whereby all players try to make their least-bad decisions. I want to make it clear: There are no good decisions that will make everybody happy. This is a divorce, and it’s pretty rare to see both parties to a divorce walk away totally happy. This is not going to be one of those rare instances. This is going to be a very ugly, nasty, brutal, lawyer-riddled, expensive divorce.
Which is why I have to think more about the implications of the process before just offering a lot of off-the-top-of-my-head comments. This is a game changer. But it’s just not quite clear yet how the game will be changed.
Okay, I see you asking for my reactions. I’m already getting those phone calls and emails. So, my first reaction is that this is the first domino in a series of dominoes that will create more referenda and embolden numerous separatist movements. I saw a poll in which 90% of the Dutch questioned wanted to have their own referendum. I have no idea what that actually means. What happens when Italy decides to conduct a referendum? Polar political opposites like the Lega Norde and the Five-Star Movement (which just captured the Rome mayoralty) would both generally vote for leaving the EU. That might constitute a majority in Italy. God knows what the EU would look like afterwards. Seriously, Brexit might actually precipitate a breakup of the EU before the debt issue can even go critical again.
This European situation is actually becoming as interesting as Game of Thrones. Forget the Kardashians, this is Reality with a capital R. Fortunes will be lost and made; every country will have to actually weigh the costs of staying or going – no more kicking the can down the road. Will Germany decide to pick up the costs and debts of the rest of the EU? Will Italy willingly enter into a long-term, deflationary recession, as Greece has done? That is the price they may pay to stay. Do you release the Krakens, otherwise known as the ECB and Draghi, to go after individual country debts to the detriment of Germany and the other northern and more vested nations? Do you actually think the Dutch or the Finns, not to mention the Austrians, will go along with such behavior? And do you think the Belgians, who have been on the verge of breaking up for several decades, can keep their emotions in one piece, just for the kids? Europeans live in interesting times.
Finally, Brexit is going to take some time to play out. From my perspective, it is not at all clear what the actual financial implications are. I wanted duly noted that I’m on record as saying many years ago that the pound would go to parity. Ditto for the euro, which I talked about rising to $1.50 in 2003 and falling back to a dollar over a few decades. I think we are on track. Those calls have been better than my Japanese yen call – so far.
What does Scotland do? We are already seeing calls from authority figures in both Scotland and Northern Ireland to hold additional referenda on leaving the United Kingdom. I think it makes sense for Northern Ireland to join with their Irish compatriots, which would have them once again back in the EU and allied with the far more prosperous Ireland. Scotland, on the other hand, has to decide if it wants to hop from the frying pan into the fire. If I were a thinking Scot (and are there any other kind? – just ask any Scot you know), I think I might want to see how the dust settles before I decide which way to jump.
Those are my personal observations for now. As I think about it, they are fodder for multiple letters. I have to admit that being a writer on economics and finance today is more fun than I would’ve ever possibly imagined. Not that what we’re getting ready to experience is going to be fun, but there’s just so much great material sitting out there in front of you. The writer in me is just salivating.
Austin, Las Vegas, and Maine
This is a rather magical few days for me. My Brexit party was over the top, since the vote turned out to be a nail biter for the first few hours. Those of you who didn’t tune into the BBC (my daughter had to tell me to get BBC on DirecTV) probably never saw the vote swing back and forth, and every now and then it would be literally 50-50. The conversations were exhilarating with what turned out to be a fascinating party guest list. More on that later.
I am off now to Austin to spend a long afternoon, evening, and following day with George and Meredith Friedman. George is in book-writing mode, which means he is manic and isolated. Meredith has declared that he will take a weekend off and invite some odd friends down – and I qualify as odd, though Shane is nothing but middle-of-the-fairway nice, which works very well with Meredith; and the two of them spend the bulk of their time trying to keep George and me in the middle of the road. Not an easy task. But it is not a thankless task, in that George and I are both grateful. We will have a lot to talk about, as we are both deep into working on new books. He is writing about the future of the US; I’m writing about the future of the world. I think we will find a few topics to discuss late into the night. Not to mention our growing business partnership and future plans.
I know, I said I’m not planning to leave Dallas until I finish my book; but Mark Skousen talked me into coming to his big libertarian blowout in Vegas, called FreedomFest. Since I’m not really doing a vacation this summer, I thought I could go and moderate a few panels with old friends like Steve Forbes and Rob Arnott. I have tons of friends coming to the conference, and I’ll also do a breakout speech that I’ve have been wanting to do for quite some time but that I know nobody will pay me to do, entitled “The Invisible Hand, Evolution, and Why I Am an Economic Atheist.” It will be a short speech on a topic I have thought about a great deal and am passionate about.
Shane and I will catch a few shows (I will once again see the Cirque du Soleil show called “Love,” featuring the music of the Beatles) and spend time with friends. I will even catch some of the other conference speeches and panels. You can see the lengthy list of speakers and topics by going to freedomfest.com. It happens July 13–16 at the Planet Hollywood casino. It is actually a fairly inexpensive conference and venue. I think there will be something like 2,000 attendees, representing all wings of the libertarian world. Trump spoke there last year, and I think Gary Johnson is speaking this year. If you are at the conference, my speech is on a Saturday afternoon, and I would appreciate your dropping by. And if you see me wandering around, walk over and say hello.
Post-conference I’ll be back home until the first week of August, when I will head to our annual Maine fishing trip with a bunch of unruly economists. Afterward, I’ll show up in New York for a few days. Then my calendar is travel-free until the middle of September.
I talked Neil Howe into staying over one more night and then took him to a restaurant called Javier’s in Dallas. Javier is a good friend, and his restaurant is a staple in the local dining circuit. It is actually Mexican cuisine as opposed to Tex-Mex. On the weekends you can’t get a seat without a reservation unless you want to wait a few hours. Since Javier has somehow arranged to have the only legal cigar bar in all of Dallas, more than a few people have been known to come and wait. The place is usually packed with local celebrities. If you come to Dallas, you should check it out. Ask for Javier’s special margarita. And the panella they make tableside is awesome.
Neil and I spent hours chewing over a variety of topics. The breadth of his factual knowledge sometimes just astonishes me. How does someone learn, let alone remember, that much historical trivia?
I truly recognize that I am one of the luckiest guys in the world. For whatever reason, I get to hang out and talk with an amazing cast of characters day in and night out, always learning and maybe offering my own humble idea every now and then, just to keep up the pretense that it’s actually a conversation rather than their giving me a lecture. You have to keep up the image, you know?
I stayed up and watched the BBC for a few hours after all the guests left, not something I normally do. But I was fascinated by the reactions of the people they were interviewing. You could see the utter shock and dismay of those who were on the Remain side of the vote, and the general quiet determination to move forward on the part of those who were for Leave – well, except for Nigel Farage, who was his typical over-the-top self, declaring June 23 to be England’s new Independence Day.
I went to bed and woke up still thinking about the implications of Brexit. Over coffee, I thought about the potential future of the US and how unless we do something our debt will become so overwhelming that it will lead us straight to our own deflationary depression. I could imagine myself waking up on some future morning, walking out onto my balcony and stretching, and shouting to the world, “God, I love the smell of Texit in the morning!” Just saying…
And with that it is time to hit the send button. You have a great week. And if you want to make it really great, click on the next link and listen to a young rock group called the Shelters. My biotech junkie friend Patrick Cox introduced me to them. He is always sending me a link to a new group, most of which I don’t “get.” This group blows me away.
This is the song Patrick sent along. It’s called “Birdwatching.” Listen, and then sample some of their other songs. They are a new group, and most of their YouTube pages have only a few hundred views; but trust me, they are the real deal. First new group I’ve heard in decades that, immediately, everything they do goes on my playlist. It’s like listening to Paul McCartney and the Beatles, the Moody Blues, the Doors, and a few other bands from my youth; but the Shelters have combined all of that into their own unique sound and original music. Seems Tom Petty found them, gave them free run of his studio, and tried not to screw them up, offering a few ideas here and there. Not a bad way to while away a lazy Sunday afternoon. And you can really say you heard them here first…
John Mauldin is editor of Mauldin Economics' Outside The Box.
This article was originally published at Mauldin Economics.