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Wednesday, Dec. 26, 2012

A time to reflect on pressing economic challenges


Special to The Japan Times

HONG KONG — Sir John Templeton was a legend in his own lifetime who made billions of dollars from the sensible and wise way he invested money. In these difficult times it is apposite to quote Rule No. 12 of Templeton's legendary golden rules for investment success: "Begin with a prayer," he advised.

Templeton was a committed Christian. But his reason for advocating prayer was not so much to ask an almighty power to deliver miracles for the investor. As Templeton explained, "If you begin with a prayer, you can think more clearly and make fewer mistakes."

In the holiday lull around the New Year holidays it would be a good idea for politicians, economists and investors everywhere to offer a prayer and then enjoy some cool reflection on how to tackle the myriad and various issues facing them.

These are evidently perilous times economically and financially. Leading dogmatic American politicians are determined to drive their country over the fiscal cliff, even at the risk of tipping their own country and the rest of the ailing western world into renewed recession with potentially devastating consequences for the rest of the world.

In Asia, a new government in Japan is preparing to print and spend its way out of recession as the lesser evil in spite of already horrendous government indebtedness. In response, the Tokyo stock market rose to 10-month highs, although it is still at 26 percent of its December 1989 record levels.

In China, the new government seems wedded to yearly growth rates of at least 7.5 percent, even though a wiser course would be to rebalance the economy toward consumption and the common man.

One mountain-high obstacle is that our time horizons have been foreshortened by the era of instant communications to be far too short for clear thinking, let alone for considered action or proper planning of policies. Politicians are constrained by the next election, which is never more than a few months away. Economists think in terms of the economic cycle. Corporate CEOs have to be alive to the next quarter's results or even tomorrow's market response to a new discovery or reaction to a fresh scandal, however little it may have to do with the underlying soundness or performance of the company.

As for leading stock market "investors" with billions to play with, they and their computer programs are preoccupied with what will happen in the next microsecond, and even a millisecond is too long to wait.

Templeton recognized that successful investing cannot be done in a day or week or year. His first two rules make this plain. "Invest for maximum total real return," he advised. "This means the return on invested dollars after taxes and after inflation." His second rule was: "Invest — don't trade or speculate. The stock market is not a casino, but if you move in and out of stocks, every time they move a point or two, or if you continually sell short ... or deal only in options ... or trade in futures ... the market will be your casino. And, like most gamblers, you may lose eventually — or frequently."

Whether investors win or lose, make fortunes or are wiped out, matters to them, their families and newspaper reporters who entertain us with the deeds and misdeeds of the high and mighty.

It is sadly evident in today's America — witness the fiscal cliff shenanigans — that politicians have become captivated and captured by dogma. In addition, few politicians think problems through to their conclusions or understand how the repercussions of policies may be more harmful than at first inspiration.

Blogger and investor Barry Ritholtz draws attention to this in his Washington Post column, "Why don't bad ideas ever die?" He quotes Cambridge economist Joan Robinson, who said, "The purpose of studying economics is not to acquire a set of ready made answers to economic questions, but to learn how to avoid being deceived by economists."

Some of Ritholtz's pet peeves concern investing. He attacks the idea of "shareholder value", claiming that concentration on increasing share prices leads to a decline in long-term research and development and in a company's long-term prospects, as well as fostering short-termism that has "led to earnings 'management', accounting fraud and a raft of management scandals." In his typically robust style, he also attacks gurus, shamans and prognosticators, greed and sloth, institutional mandates, the status quo, incompetency, bias and good stories that ignore data, all of which lead to bad investing decisions.

But Ritholtz also draws attention to flaws in economic thinking that affect not only investing but economic policy. Belief in homo economicus, the lazy principle behind classical economics — that human beings are rational and constantly make objective, intelligent judgments — is dangerous. So is the arrogance that economics is a science that responds to economists' models.

Austerity, the puritanical idea that peoples must do penance for their sins of past bubbles in the form of spending cuts and tax increases to produce balanced budgets, is also a dangerously misguided idea. Supply-side economics and the belief that tax cuts will pay for themselves may work when tax rates are at confiscatory high levels of 75 percent plus, but can only lead to trouble at today's more modest tax levels. Having said that, a country like Japan must beware of spending its way to the same mistakes that caused the original mess.

Two other dogmatic tenets are also leading financial authorities and politicians dangerously astray. One is the efficient market hypothesis, the idea that markets are "informationally efficient," which Ritholtz terms "the mother of all academic zombie ideas." The other is that markets can regulate themselves and government intervention is costly and damaging.

These errors are important when the 0.1 percent of the richest people in the United States — and the super rich in China and India — gobble up the gains of economic growth, leaving the poor with crumbs when they can find anything.

The increasing domination of the rich threatens the heart of Keynes claims for capitalism, which he described as "the astounding belief that the most wickedest of men will do the most wickedest of things for the greatest good of everyone."

For politicians in a globalizing world, narrow nationalism is another perilous dogma that feeds into the constant demand for leaders to stay on top of the opinion polls or vultures in their own camps will tear them down.

Of course, countries must defend their own interests, but they must take care that the demand for a quick public opinion fix does not lead them to beggar-thy-neighbor policies that damage everyone. An example is the nationalism of both China and Japan driving both to the brink over disputed barren islands in the East China Sea.

As 2012 closes, there is a crying need for refreshed global institutions that can offer better economic advice for precarious times. The Group of Seven/Group of Eight is past its sell-by date. The Group of 20 and BRICS are both cumbersome and driven in conflicting directions. The International Monetary Fund and World Bank are the playthings of the big powers. The United Nations is more querulous and disunited than ever. Let us pray for 2013.

Kevin Rafferty is editor in chief of PlainWords Media.


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