Sticking The (Investment) Approach

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The investing world is full of colorful people and experiences.  You never know who you’re going to meet and what you can learn from it.  Take, for example, one of my more bizarre job interviews from earlier in my career.  I’ll spare the reader the details, but it was for a startup hedge fund and was conducted on a Saturday.  The following is a snippet of our conversation to the best of my recollection.  While the transcription may not be perfect, the spirit of the discussion is accurate.

Interviewer: “Do you have any interest?”
Me: “Well, I recently picked up golf.”
Interviewer: “Golf?!  I never understood golf.  What is the point of trying to hit a little white ball into a cup?”
Me: [Thoroughly confused.] “Well, it’s fun, there’s a self-improvement aspect to it, and you’re spending time outdoors in a picturesque environment.  Lots of people like it.  What do you do in your free time?”
Interviewer: “I don’t have any free time.  I work.”
Me: [Sigh.  Face slap.]

Needless to say, Mr. Interviewer and I parted our separate ways at the end of the meeting.  It was a good miss for both of us.

Every now and then I replay that interview in my head; not out of regret, but because of how sad I find such an existence to be.  To bury oneself behind a handful of screens and a keyboard all day, every day (true or exaggerated) is to completely miss the point of investing.  Investing is about the world “out there”, and life experiences can teach us many valuable lessons on the topic.  Golf contains many.  While my golfing career ended shortly after starting, a recent book I read reminded me of an important concept in the game: having a good approach.

In golf, an approach shot is one that’s intended to get the ball onto the putting green.  A good approach sets the golfer up for an easy putt, and can make up for earlier mistakes.  A bad one can leave him/her hacking through sand and hoping for the best.  The same holds true for investing.  While not crucial, a good approach in economics is helpful.  Unfortunately, there is much maligned thinking in the field.

In my view, the best economics thinkers and their seminal works are Frédéric Bastiat and his essay What Is Seen and What Is Not Seen, Henry Hazlitt’s Economics in One Lesson, and Ludwig von Mises’s Human Action.  Please note, that my list is not meant to be an exhaustive one, so my apologies to the other “greats.”  I consider the first two required reading for anyone interested in the field (they are quick reads); von  Mises’s magnum opus is an undertaking onto itself and only for the truly motivated.  These authors all have two things in common: 1) their approach, and; 2) they are deceased.  More on #1 in a moment.  With respect to #2, luckily for us there is a modern day torchbearer for the group: John Tamny.

Mr. Tamny is editor of RealClearMarkets, director of the Center for Economic Freedom at FreedomWorks, and the author of two books.  I recently read his latest, Who Needs The Fed.

I thoroughly enjoyed Who Needs The Fed.  I found that it not only challenged much of the conventional economic thought, but also my own in a profound way.  The title is somewhat of an unfortunate one though (possibly selected by his editors to be provocative), as the book is so much more than a “run of the mill” Fed-basher; in fact, if you’re looking to air your frustrations against our central planners, there are other books better suited for that purpose.  That said, Mr. Tamny, through the seemingly simplistic examples of Uber, Taylor Swift, NetJets, Jim Harbaugh, and others, illustrates to the reader why the Fed is not only harmful in Who Needs The Fed (though likely far less than we believe), but completely irrelevant.  Quoting von Mises, the author notes that “[n]o individual and no nation need fear at anytime to have have less money than it needs.”  How true for the truly productive.

What’s noteworthy about Mr. Tamny’s book is his approach towards economics; in this regard he walks among the aforementioned giants.  The common thread is their analytical starting point: the individual producer.  This is a key point of distinction from those of the more dominant Keynesian and Monetarism schools of thought which rule the halls of academia and the Eccles building.

Why the fuss over starting at production?  The acronym GIGO says it all.  Perhaps you’ve heard such statements as “the U.S. is a consumer driven economy,” or that “every transaction involves money, so of course money is fundamental.”  While both contain some elements truth to them, they are misguided.

There’s a reason why physicists build 27 kilometer long tunnels 175 meters underground only to smash microscopic particles into each other at the speed of light.  They are searching for the fundamental building blocks of matter.  By beginning their study of physics there, scientists are able to create more accurate theories of how the universe works.  The same holds true for economics.

Luckily for us, no smashing of human lives is required in order to gain a better grasp of the subject.  The simple recognition that economics starts at the individual will do.  Von Mise’s title Human Action was a perfect selection.  An economy is nothing more than a collection of individuals living their lives in an organized manner.  Thus, the individual should be the fundamental starting point for any such study.  Seemingly simple, oft ignored.

Let us conduct a thought experiment to illustrate this point.  It will go a long way towards correcting our approach to economics.  To be sure, the following could be actually observed via experimentation.  But as you will see, it is wholly unnecessary to do so; the conclusions will become that obvious, and supporting data permeate all of human history.

Imagine yourself instantaneously transported to a deserted island.  Poof!  Sure, your first thoughts might be to notice the pleasant warm sand rolling between your toes, detect the salinity in the humid air, and to take a step back to observe the spectacular view.  However, once the initial pleasantries wear off, you’re going to be faced with some seriously existential questions.  How will you survive?  What to do?!  The process of survival (and subsequently, thriving) is the fundamental question of economics.  All modern extrapolations are just that.

In order to survive on a deserted island (and in general), one must take certain actions.  We humans can’t just kick back and expect to prosper, it’s a metaphysical impossibility.  Take eating, for example.  It is an obvious necessity for life.  However, food does not simply present itself or fall from the sky.  Rather, one must find it.  Even this, the simplest process of gathering, is an active one.  It is, in fact, the most primitive form of production.  One could not consume food without first producing it.

(Just let that sink in for a moment.)

Now, let us further evolve the food production process to the point of agriculture.  Farming requires resources.  Land, seeds, equipment, tools, etc. are perquisites.  The farmer demands such items for his craft, which he will consume in the process of food production.  The farmer might also want to trade his grain with his neighbors the butcher and the tailor to satisfy those wants he cannot produce himself.  He might barter directly or use some kind of intermediary good as money.  However, money is really just the farmer’s output in a different form.

I hope the reader gets my point.  Without production there is no consumption, there is no credit, there is no money.  That’s not to say that studying these topics are illegitimate endeavors – in fact, many important economic discoveries have come from just that.  Rather, that grounding one’s theories at these points in the economic process can lead to faulty conclusions when extrapolating them to a wider context.  Mr. Tamny notes that even Milton Friedman openly questioned the validity of his theories towards the end of his career.  Perhaps it is no accident that economics is so openly mocked today, most practitioners start mid-stream.

When one begins the analytical process with the individual producer, all kinds of behavior and phenomena come into better focus.  Not only does it help validate Mr. Tamny’s assertion that the Fed is a wholly irrelevant and unnecessary institution, but also exposes the flaws in many of the post-financial crisis policies that confounds many market observers today.  The elevation of aggregate spending and the money supply as primary issues has created a bizarre suite of policies and national debate.  As we have just seen, spending and money growth are outcrops of production.  It would be easier and more effective to direct our efforts towards freeing up the barriers to such.

Sure, negative interest rates and quantitative easing (QE) policies might have “worked” in that they forestalled the collapse of existing financial system.  But, as Mr. Tamny illustrates, they likely did more harm than good by perpetuating a broken one rather than provide for a cleansing event and brighter future (as painful as it might have been in the short term).  Isn’t it odd that something as innocuous as inflated home prices could bring the entire developed world to a screeching halt?  How is that so?  Banker greed?  Come on.  Busts of all kinds are mere signals of underlying problems, and the bigger the former, the bigger the later.  Believing that these post-financial crisis policies stabilized the financial system is akin to thinking that Tylenol can cure a virus-induced cold because it reduces a fever.  It illustrates an ignorance of the nature of the problem one is trying to solve.  (For anyone interested in a plausible explanation for why the financial system is broken, see Jeffrey Snider’s Eurodollar University podcast series on MacroVoices.) 

Who Needs The Fed is chock full of seemingly simple examples that profoundly challenge the conventional thinking on such fundamental concepts as money, credit, economic growth, and the Fed’s importance.  Mr. Tamny even disarms the fear mongering surrounding artificial intelligence that seems to be gaining in popularity.  While it may be tempting to dismiss his arguments as oversimplifications and hence incomplete, nothing could be further from the truth.   The truth should be obvious once the context is properly set.  It is the setting of the context wherein the genius lies.  Take Sir Isaac Newton’s “discovery” of gravity.  Gravity was self-evident to even the most primitive of cavemen (otherwise our ancestors would have literally wandered off cliffs and into extinction).  It took the genius of Newton to turn this implicitly known phenomena into an explicitly useful concept.  It takes a brilliant mind to make the complex seem simple.  Mr. Tamny, like his forebearers, does just this with economics.

“Simplicity is the ultimate sophistication.” 

— Leonardo da Vinci

All of this is not to say that the Fed (and its ilk) does not matter with respect to the prices of financial assets.  It is my opinion that it does via QE, as all participants in a market impact price (as argued here, here, and even here).  I will concede though, that in which markets and by how much the distortion is occurring is an open debate.  This exercise should provide us with a greater understanding of just how misguided their actions have been in the long run, and potentially some insight into how various investment prices might respond in the future.

The lesson of having a great approach extends beyond economics.  It’s a universal principle that can be applied to the pursuit of knowledge in all fields.  The best golfers tirelessly work on theirs, practicing different shots from all over the course and adjusting their strokes.  Regardless of whether or not you agree with Messieurs Bastiat, Hazlitt, von Mises, and Tamny, consider their radical views.  By challenging our deeply held premises from different angles, we can fine tune our thinking and ensure that we are building the best integrations possible.  Our approach shots will improve and hopefully we’ll find ourselves two-putting a little less when investing.

On a personal note, my motivation for creating The Integrating Investor was to do just this.  I wanted a forum where I could test the boundaries of conventional wisdom and either strengthen my own previously held beliefs or dispel them in favor of better ones.  The pursuit of truth is hard, but is bound to be both intellectually and financially rewarding.

For those who are interested in Mr. Tamny’s work, you can follow him here at Forbes and here at RealClearMarkets, and find his first book here.

In the interest of full disclosure: our articles can be found on RealClearMarkets.com.