Christmas is a great time to sit down in a comfy chair, undo the belt buckle, let your turkey-stuffed belly hang out and read a worthy book or two.
So at this festive time of the year, I’ll make a couple of recommendations of markets-themed books that may not be as light, crumbly and delicious as the shortbread my wife is busily baking in our kitchen this week, but may usher you into the new year a bit wiser and better informed.
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The first worthy work is This Time is Different, by Carmen Reinhart and Kenneth Rogoff. As the subtitle says, it’s a study of eight hundred years of financial crises and their cause, and obviously very topical a subject these days. Lots of books have been written recently about economic catastrophes, but none with this combination of academic rigor and readability. It’s by two internationally recognized experts in finance and the perils of public and private debts, both of whom have been involved in institutions like the International Monetary Fund and seen crises from the inside.
Their basic point is that large increases in debt levels almost invariably precede financial crises – without the debt a problem stays a problem, debt creates a collapse – and that most analyses of past crises have noted debt as a primary culprit, whether it’s government debt defaulting, as with Edward the Third of England in the 14th century and the Italian moneylenders he bankrupted, or private debt defaulting, as with the present crisis as millions of American homeowners default on their mortgages and bankrupt banks and impoverish bondholders. However, eventually the market almost always lurches on to the next crisis, ignoring the wisdom it gained in the last crisis, because of the “This Time Is Different” mentality. Sure, everyone knows that leverage and crippling debt loads of some sector of society propelled the last slump, but we always get back to thinking we’ve solved the economic puzzle this time, so as debt levels spiral again, we laugh off the dangers and say: “This time is different.”
Combined with this problem is our misperception that crises and defaults occur only rarely. As Reinhart and Rogoff show again and again, debt defaults and crises occur regularly, and any period in which they don’t – like the mid-2000s – should be feared as an aberration and that a reversion to the mean is coming.
This book is not a story book, in that it does not tell a string of stories. Don’t pick it up if you want a string of pithy stories about financial pratfalls through the ages, with colourful details about characters like Edward III. This book is an academic study of crises and debt issues, so it jumps back and forth through the centuries picking out common themes, and the situations it explores are explored statistically and with charts. (There’s a neat two pages on how crippling debt pushed Newfoundland into Canada.) If you want the story form of this subject, you should get the book I recommended last year at this time: The Ascent of Money, by Niall Ferguson. Fabulous book by a fellow who was one of that small crew of folks who spotted the subprime meltdown coming. But Reinhart and Rogoff’s book provides massive backing to Ferguson’s main points, while developing their thesis far more profoundly than Ferguson attempted in his, so the two books work as a perfect pairing. And funnily enough, look at who recommended Reinhart and Rogoff’s book:
Well, that’s either a good sign or a bad one. If you like Ferguson, you’re likely to like this book. If you don’t like him, you’ll suspect that this book is just part of the groupthink of a certain breed of thinkers who just happen to seem right right now because they were lucky. I’m on their side, so the arguments seem reasonable to me, but check it out for yourself.
The second book is one that I’ve just managed to skim so far, but seems a perfect development of themes that have interested me and occupied a number of sage Wall Street contrarian investors for the past few years. (Their contrariness means that they and their companies generally didn’t go broke and some made a pile of dough in the meltdown.) I’ve talked a bit about Nassim Nicolas Taleb’s The Black Swan in the space a few times before. He pushes the idea that tumultuous events that send the market spinning one way or the next happen both more frequently and more catastrophically than we accept, and that because we seem to be hardwired to look at the short term rather than the long term, we tend to stumble into disasters more disastrously than we would if we understood probabilities better and banked on the unexpected rather than the expected.
Michael Mauboussin’s Think Twice: Harnessing the Power of Counterintuition may sound like a flaky self help book, but it’s anything but. (Anything but useless, actually, because it’s the kind of self help that may help you not blow all your money in the market, not get killed in avoidable traffic accidents, not make silly choices that have big consequences.) Mauboussin is an investment manager who, like Taleb, thinks humans commonly and generally make major mistakes in their thinking that lead to unnecessary calamities. It’s a bit of a spin, perhaps a counter-spin, on Malcolm Gladwell’s Blink, which is about how split second judgements are often better than carefully considered decisions due to our evolution from bipedal monkeys that needed to run away from sabre-toothed tigers. Mauboussin’s book is a fun and entertaining demonstration of common flaws in basic thinking, which is an uncommon beast. He provides games and puzzles with which to confound your brain and reveal the hidden internal flaws that are our human plight.
These are not unsubstantial revelations Mauboussin provides through his games and puzzles, but reveal what he thinks is the source of so much wrong-thinking that causes us not just personal woe, but also tends to lead to market catastrophes. Anyone catch a common theme between Reinhart and Rogoff, Ferguson, Taleb, Gladwell and Mauboussin? All feel that we appear, as a species, to be wired for certain wrong ways of thinking that lead us into trouble. But all feel that by understanding these problematic ways of thinking we can circumvent them and suffer less than we otherwise would if we just stumbled along blindly. They focus on failings, but with the hope that they can be minimized through understanding and lead us into a profitable and fruitful future. But they’ll never be caught saying “This time is different.”
So with that I’ll wish you a joyous Christmas (my second daughter is being baptized Christmas Eve, so it’ll be especially joyous for our household) and Happy Holidays to all!
