Wednesday, 13 June 2012

The Economic consequences of peace; Keynes and the Eurozone crisis

In 1919 John Maynard Keynes wrote the Economic consequences of peace, a tirade against overzealous yet political expedient WW1 repatriation claims on Germany which he argued would lead to;

 "the absolute falling off, for the time being in Europe's internal productivity, second, the breakdown of transport and exchange by means of which its products could be conveyed where they were most wanted; and third, the inability of Europe to purchase its usual supplies from overseas"

The only answer was to make repatriations far less harsh, and interest free; a cancellation of inter-ally indebtedness and passing over English debt claims to Belgium, Serbia and France.

"By fixing the repatriation payments well within Germany's ability to pay, we make possible the renewal of enterprise and hope in her territory"

Keynes argued that the future of European nations was entwined with one another, now was a time for politicians of creditor countries to realise this and aim for the prosperity of all nations.

Today, with a single currency, single market and open borders the European relationship is positively symbiotic.  Germany is far better off with a strong Greece, Italy and Spain (GIS) than a weak GIS. This is incredibly simple. So why do our leaders not act with this in mind?  

If this means jointly backed Eurobonds so be it. If this means debt forgiveness so be it, if this means a massive loan at 0% interest so be it.  This may be harmful in the short run economically and politically for creditors nations but it is the right thing to do in the long run for the good of every single European. If you have a blister, sometimes it is painful to take it out, but it is better than cutting your finger off.

The ability to believe that the way the world is now, is how it always will be, is one of the fundamental errors of humanity. It is possible such an inability to conceive of a future so very different from the present is what stops us from acting now.

We have an unerring belief that the problems of war, famine, instability, political extermism are behind us, but so did they in 1919. Then the First World War was known as "the war to end all wars". It is always worth remembering that there are far worse evils than cancelling a bit of paper, or earning slightly less interest.

There needs to be a shift into the argument. We need to talk about what we can do to help these countries in trouble. Not merely what we can do to help get our own money back.

Tuesday, 5 June 2012

Stop agreeing with yourself: Overcoming Confirmation Bias in Investing

In an experiment people are told that the following sequence; 2-4-6 conforms to a rule. Their job is to work out the rule by selecting sequences of three numbers which they are then told works or does not. Initially people see the rule as going up by 2. To test this they will select sequences like 8-10-12, or 50-52-54, once they are told that these fit the rule they will happily deduce the rule is sequences that go up by two. However, on this front they are wrong, the actual rule is any three ascending numbers so not only do the examples above conform but also 1-7-109 or 1-2-3 do too.

 The reason people rarely work this out is because they look to confirm their current theory instead of testing numbers that could falsify their theory. The confirmation bias.

So, we look for confirmation of already held beliefs. How does this affect our ability as investors?

Well, say you think apple may be a great buy so you are far more likely to dutifully type into google "is apple a great buy" or "reasons to buy apple" than "reasons not to buy apple" or "is apple a bad buy". Or, if you are an equity analyst poring over financial statements and industry data you are again in the vast swath of data likely to find evidence to support the position you already hold (buy, sell or hold) rather than counter it.

You are probably thinking that this is a very good way of understanding how other people behave, but not me. I'm far more impartial, I can let the evidence speak for itself. Sadly, this perspective is a deluded as the little boy jumping off his sofa, thinking if he can flap his arms fast enough, he may be the first human ever to fly. We are human which makes us both irrational and incapable of aidless flight. So, however hard we flap our metaphorical brain arms there is no getting around this fallibility. We do this, you do this, no one specially gifted with full rationality.

So, if you choose to accept your not a special case, what is the answer.

Well, it's impossible to overcome these biases in all areas. However, if we ingrain counter-intuitive thinking into our processes (and ensure we don't skip them) then it's possible to protect ourselves. Here is what I would suggest;

1.) Have a set procedures when making an investment and build into this the requirement to look at the dissenting view. (i.e force yourself to research and write down 5 possible negatives about the stock before purchasing)

2.) Carry out a pre-mortem.  This is done by imagining yourself 5 years in the future and the investment has gone badly. You generate ideas over what has caused this, possibly alerting you to weaknesses you may have overlooked.