Tuesday, February 05, 2013

Common Sense and Caution in Today's Investing Climate

In spite of the hesitant Consumer Confidence Index, the New Year is bringing us improved animal spirits. The various stock indices are reaching record levels. Is it time to plunge back into ordinary investments, as the retail sector seems to be doing? Should we dust off the Modern Portfolio Theory and put it back into action? How about taking those old Krugerrands and gold stocks out of the closet and turning them in?

caution
[Thanks to CreativeSafetySupply.com for the image.]

Not so fast. Let's use some common sense and look around us first. I do so regularly, and I wonder: Is it possible that today's high-flying economic and financial geniuses have lost their own common sense and become overly sure of themselves?

The loss of common sense seems to be a phenomenon that occurs frequently among our Ph.D. class, including the mathematics geniuses in our universities' economics departments. The more rational-observer economic science performed by their forefathers such as Adam Smith, John Stuart Mill, Alfred Marshall, Frederich Von Hayek, Ludwig Von Mises, John Neville Keynes, Edward C. Harwood, and even Milton Friedman (incidentally, all probably good or even excellent mathematicians) has been relegated to the back of the auditorium in favor of Dynamic Stochastic General Equilibrium and the like.

Over the past century the economic science has become a clique for high-level mathematicians who enjoy toying with complicated models and computers, probably very much like those used by NASA physicists. It is now a kind of private club where only those with a certain technocrat mindset can pass muster, get published, attain tenure in the best universities, and influence public policy.

Yet the overlooking of a common-sense piece of evidence by some very smart NASA experts actually became a fatal flaw. They failed to note that a piece of lightweight foam could pierce the shell of the Columbia space shuttle, resulting in the death of seven astronauts. (See information about the event here.)

Likewise, could economic folly be causing ruinous holes in our national economy? Although the damage may turn out to be less visually dramatic than the Columbia disaster, it could be more pervasive and therefore equally as devastating, once all is said and done.

Here are some examples of possible loose "foam" in the current application of economics: Does Bernanke really know how to solve the ballooning problem of the Fed balance sheet without making waves in the general marketplace? He says he does; his researchers seem to have the computer models that suggest he does; but does he really have the wherewithal? NASA's elite probably had models that said the Columbia's wing was impenetrable. When they noted the falling foam during the take-off, they were so sure of their models that they didn't hesitate to reassure the crew that the incident was insignificant. Subsequent examination of the evidence proved them wrong.

Is Bernanke correct when he states that the Fed's intervention in the lending markets is helpful, that it does no harm, and that it is, at the very least, the lesser of two evils? Is it possible this policy is doing more damage than its alternative? Intelligent people disagree, including some on the Fed's very own Board of Governors. This policy could very well be contributing to unemployment instead of solving the problem, according to an article today in the Wall Street Journal.

On the international front, do the Japanese prime minister and his cohort at the Japanese central bank (with the encouragement of Princeton's Paul Krugman) really think they can print the yen into oblivion without endangering the Japanese economy? The optimistic prime minister and his own common-sense central banker seem to disagree.

Can the European Union bureaucrats convince themselves and the rest of the world that Greece--and now Spain, Italy, Portugal, Ireland, and even France--can continue being "independent" and still remain a part of the Union in spite of their approaching unofficial bankruptcy status?

These are a few of the questions I am asking myself as a layperson. I hope that 2013 will be the year that reveals the answer to these questions. Will it end with a bang or a whimper? No one really knows, not even the elitist quants.

But what we do know is that in uncertain times people have always turned to gold and gold-related investments, the ultimate store of value, to protect their purchasing power from the folly of their misguided governors. This is certainly one of those times.  I'm not a professional advisor, but I wouldn't let go of your bullion, your ETFs, your gold mining stocks--and your common sense--just yet.

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