Where Taleb is wrong (happens rarely!)
Nassim Taleb is a man who I respect very much, and I believe he is one of the most intelligent people in the world. He is right most of the time-but is wrong on one important count wrt financial markets.
Taleb is an options buyer. He is a believer in financial markets making crazy long tail moves, and says that options sellers underpredict the probability of these large moves in the markets (individual stocks). His strategy is to hold a large amount of cash-and buy cheap options counting on big moves once in a while. Sounds like a winning strategy. He also is very wary of buying stocks, but is quite happy keeping cash. That's where the problem is.
What is cash? At heart you are talking about your excess capital. You can either loan it to the Government, or loan it to private companies (diversified portfolio of stocks).
When you loan your money to the Government-which Government do you choose? I live in Chile-should cash be buying US Dollars or Chilean Pesos? In other words-cash depends on where u live-and an Australian who listened to Taleb and was holding lots of Australian Dollars last year actually lost of a lot of money, when measured in USD, for example. He thought he was "all cash" all the time-but his real buying power in the developed world went down (The AUD collapsed against the Yen, Dollar and Euro--the major developed world currencies)
In a world of multiple currencies-or multiple loans to multiple Governments worldwide, it is difficult to say what is cash. That the US dollar and the Japanese Yens have been the currencies in vogue lately is obvious-but we don't know what the future "safe/flight to safety" currency will be in the next crisis. Cash loses its meaning for a currency trader, and that's where Taleb's idea runs into problems. Holding cash becomes a trade-because depends on whether you held cash in AUD, JPY, etc. you can make or lose large amounts of money-measured in another currency.
I am more towards loaning money to private companies than Governments. In both cases we dont know the people who we loan our money to-and if you really are scared loan it to only the friends and family you know with massive legal contracts-but if you are going to loan it to unknown people, I would rather give it to private companies listed on a stock exchange than some silly Government.
An example is the 2001 crisis of Argentina. People who held money in Argentine Pesos actually saw a massive reduction in their buying power after the devaluation against the USD. But people who held stocks didn't lose that much-even though it was very volatile! The Argentine stock market went way down, but recovered all of it in the coming months. Someone in Argentine who held a bunch of Argentine stocks would have come out much ahead. See chart here-focus on the years 2000-2004 to see what I mean.
The same holds for the Russian Rouble collapse of 1998-a Russian investor would have done better holding a bunch of Russian stocks than holding roubles.
More fundamentally-since a Government really is not a big generator of profits, it only takes profits generated by the private sector in the form of taxes and redistributes them-it makes sense that the private sector will outperform Government bonds or cash. This also goes directly against the stupidity taught in Economics and Finance departments-that Government bonds are the safest investments in the world. It is MORE LIKELY that a Government will default than a diversified portfolio of Corporate bonds. If you are going to trust someone unknown ---trust the private sector and not the Government with your money.
It follows therefore, that Taleb's cash in US Dollar will turn out to be a really bad investment if the USD collapses against all currencies in the next 10 years. He will say that his account didn't go down, because in USD measure it won't-it won't be volatile; but the real buying power of that account will be down considerably in that time. Or put another way-if he starts measuring his wealth in Brazilian Real, and in 10 years Brazilian Real really goes up against the USD, then he would have lost a large amount of money on his trade to keep cash in USD.
And therefore, a world portfolio of stocks will be a better bet than a portfolio of Government bonds of different countries.
Sanjay
Taleb is an options buyer. He is a believer in financial markets making crazy long tail moves, and says that options sellers underpredict the probability of these large moves in the markets (individual stocks). His strategy is to hold a large amount of cash-and buy cheap options counting on big moves once in a while. Sounds like a winning strategy. He also is very wary of buying stocks, but is quite happy keeping cash. That's where the problem is.
What is cash? At heart you are talking about your excess capital. You can either loan it to the Government, or loan it to private companies (diversified portfolio of stocks).
When you loan your money to the Government-which Government do you choose? I live in Chile-should cash be buying US Dollars or Chilean Pesos? In other words-cash depends on where u live-and an Australian who listened to Taleb and was holding lots of Australian Dollars last year actually lost of a lot of money, when measured in USD, for example. He thought he was "all cash" all the time-but his real buying power in the developed world went down (The AUD collapsed against the Yen, Dollar and Euro--the major developed world currencies)
In a world of multiple currencies-or multiple loans to multiple Governments worldwide, it is difficult to say what is cash. That the US dollar and the Japanese Yens have been the currencies in vogue lately is obvious-but we don't know what the future "safe/flight to safety" currency will be in the next crisis. Cash loses its meaning for a currency trader, and that's where Taleb's idea runs into problems. Holding cash becomes a trade-because depends on whether you held cash in AUD, JPY, etc. you can make or lose large amounts of money-measured in another currency.
I am more towards loaning money to private companies than Governments. In both cases we dont know the people who we loan our money to-and if you really are scared loan it to only the friends and family you know with massive legal contracts-but if you are going to loan it to unknown people, I would rather give it to private companies listed on a stock exchange than some silly Government.
An example is the 2001 crisis of Argentina. People who held money in Argentine Pesos actually saw a massive reduction in their buying power after the devaluation against the USD. But people who held stocks didn't lose that much-even though it was very volatile! The Argentine stock market went way down, but recovered all of it in the coming months. Someone in Argentine who held a bunch of Argentine stocks would have come out much ahead. See chart here-focus on the years 2000-2004 to see what I mean.
The same holds for the Russian Rouble collapse of 1998-a Russian investor would have done better holding a bunch of Russian stocks than holding roubles.
More fundamentally-since a Government really is not a big generator of profits, it only takes profits generated by the private sector in the form of taxes and redistributes them-it makes sense that the private sector will outperform Government bonds or cash. This also goes directly against the stupidity taught in Economics and Finance departments-that Government bonds are the safest investments in the world. It is MORE LIKELY that a Government will default than a diversified portfolio of Corporate bonds. If you are going to trust someone unknown ---trust the private sector and not the Government with your money.
It follows therefore, that Taleb's cash in US Dollar will turn out to be a really bad investment if the USD collapses against all currencies in the next 10 years. He will say that his account didn't go down, because in USD measure it won't-it won't be volatile; but the real buying power of that account will be down considerably in that time. Or put another way-if he starts measuring his wealth in Brazilian Real, and in 10 years Brazilian Real really goes up against the USD, then he would have lost a large amount of money on his trade to keep cash in USD.
And therefore, a world portfolio of stocks will be a better bet than a portfolio of Government bonds of different countries.
Sanjay
Labels: general commentary
posted by Sanjay "John" Gandhi at 8:47 AM
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