An interesting list of favored stocks as of year end 1928 appears in Common Stocks and the Average Man by George Frederick, 1930.

Allis-Chalmers , American Can , Atlantic Refining , Fleishmann Co , General Motors , Liggett and Myers B , Montgomery Ward , Paramount , Famous Lasky , US Steel , Woolworth .

These were recommended for buy and hold, and the kind for George Baker, who made more in one day than all the gold miners in history, with his method of buying good stocks and holding them and living on interest. It is interesting to note, that as far as I can see, almost all of them went bankrupt or close to the same in the next 90 years.

The book by Frederick and the comparable one by Ralph Badger, a professor at Brown, (Badger on Investment Principles and Practices, 950 pages), although not 100 years old are both highly recommended as being much better and much more helpful than the average treatise of today, or 30 years ago, especially those like Graham and Dodd.

Steve Ellison adds: 

From the same era, I reviewed The Art of Speculation by Philip Carret on the dailyspec a few years ago. At the time I wrote the review, the phenomenon of "stocks carrying themselves" had not occurred in nearly 50 years, but that bullish condition did occur beginning in late 2008 and has been in effect ever since, as evidenced by the backwardation in S&P 500 futures. As Mr. Carret wrote, "Borrowed money is the lifeblood of speculation."

Jim Sogi writes:

I remember as a young kid my savings account at Seaman's Saving Bank paid 5%. I had a ceramic savings container for coins that was a merchant seaman in whites of the era. I vaguely recall that my stocks also normally yielded about a 5% dividend. My father's advice at the time was to use your rear not your head, and sit on the stocks. That must have been in the late 50's.

Funny thing is now, again, dividends seem almost attractive with SP yielding over 2%. Some utilities are yielding 4.5% and don't seem to have the volatility of bonds nor industrials.

Gary Rogan adds: 

It seems like the SP yield is way below its historical norms, so while
it has been rising it has a long way to go to make it all that

Of course given what "they" have done to the fixed yields they are
pretty attractive but sooner or later as we all can feel the fixed
yields will not stay low or negative even in Denmark and Switzerland
forever.  If they find a way to leave the dividend taxes alone, no doubt
sooner or later the yields will come back to historical averages, so I
don't think SP is attractive on that basis.  I do firmly believe in
sitting on stocks for a long time.  The point that was recently made
about all the old favorites having gone BK has a counterpoint: if you
diversify enough into high yield stocks, a small but noticeable
percentage of them will be bought out every year and that combined with
the stream of dividends will overcome the BK factor over the years.

As far as the bank savings accounts are concerned, I remember fondly how the banks and s & l's were engaged in a rhetorical war over, was it, 1/8th of a percent mandated difference? "You could spend that 1/8th of a point crossing town" was what one commercial said. It's pretty crazy how they "deregulated" the banks but left this one innocuous little Fed behind the scenes and now all savings yields are 0 and all the banks of note are TBTF. To me the moral of the story has always been: if you have FDIC in place all "deregulation" is a joke, but somehow the joke isn't funny to those guys and they don't like talking about moral hazards. You don't even get toasters these days.



 I am often asked what ten steps one should take to become a successful speculator.

I would start by reading the books of the 19th century speculators, 50 Years in Wall Street, The Reminiscences of a Stock Operator by Markman, and others.

Next I would read the papers of Alfred Cowles in the 1920s and try to compute similar statistics on runs and expectations for 5 or 10 markets.

Third I would get or write a program to pick out random dates from an array of prices, and see what regularities you find in it compared to picking out actual event or market based events.

Fourth, I would read Malkiel's book A Random Walk Down Wall Street and update his findings with the last 2 years of data.

Fifth, I would look at the work of Sam Eisenstadt of Value Line and see if you could replicate it in real life with updated results.

Sixth, I would start to keep daily prices, open, high, low, and close for 20 of so markets and individual stocks and go back a few years.

Seventh, I would go to a good business library and look at the old Investor Statistical Laboratory records of prices to see whether it gave you any insights.

Eighth, I would look for times when panic was in the air, and see if there were opportunities to bring out the canes on a systematic basis.

Ninth, I would apprentice myself to a good speculator and ask if I could be a helpful assistant without pay for a period.

Tenth, I would become adept at a field I knew and then try to apply some of the insights from that field into the market.

Eleventh, I would get a good book on Statistics like Snedecor or Anderson and be able to compute the usual measures of mean, variance, and regression in it.

Twelfth, I would read all the good financial papers on SSRN or Financial Analysts Journal to see what anomalies are still open.

Thirteenth, of course would be to read Bacon, Ben Green, and Atlas Shrugged.

I guess there are many other steps that should be taken that I have left out especially for the speculation in individual stocks. What additional steps would you recommend? Which of mine seem too narrow or specialized or wrong?

Rocky Humbert writes:

 All the activities mentioned are educational, however, notably missing is a precise definition of a "successful speculator." I think providing a clear, rigorous definition of both of these terms would be illuminating and a necessary first step — and the definition itself will reveal much truth.

Anatoly Veltman adds: 

I think with individual stocks: one would have to really understand the sector, the company's niche and be able to monitor inside activity for possible impropriety. Individual stocks can wipe out: Bear Stearns deflated from $60 to $2 in no time at all. In my opinion: there is no bullet-proof technical approach, applicable to an individual enterprise situation.

A widely-held index, currency cross or commodity is an entirely different arena. And where the instrument can freely move around the clock: there will be a lot of arbitrage opportunities arising out of the fact that a high percentage of participation is inefficient, limited in both the hours that they commit and the capital they commit between time-zone changes. Small inefficiencies can snowball into huge trends and turns; and given the leverage allowed in those markets - live or die financial opportunities are ever present. So technicals overpower fundamentals. So far so good.

Comes the tricky part: to adopt statistics to the fact of unprecedented centralized meddling and thievery around the very political tops. Some of the individual market decrees may be painfully random: after all, pols are just humans with their families, lovers, ills and foibles. No statistical precedent may duly incorporate such. Plus, I suspect most centralized economies of current decade may be guilty of dual-bookeeping. Those things may also blow up in more random fashion than many decades worth of statistics might dictate. Don't tell me that leveraged shorting and flexionic interventions existed even before the Great Depression. Today's globalization, money creation at a stroke of a keyboard key, abominable trends in income/education disparity and demographics, coupled with general new low in societal conscience and ethics - all combine to create a more volatile cocktail than historical market stats bear out. 2001 brought the first foreign act of war to the American soil in centuries. I know that chair and others were critical of any a money manager strategizing around such an event. But was it a fluke, or a clue: that a wrong trend in place for some time will invariably produce an unexpected event? Why can't an unprecedented event hit the world's financial domain? In the aftermath of DSK Sofitel set-up, some may begin imagining the coming bank headquarter bombing, banker shooting or other domestic terrorism. I for one envision a further off-beat scenario: that contrary to expectations, the current debt spiral will be stopped dead. Can you imagine next market moves without the printing press? Will you find statistical precedent of zooming from 2 trillion deficit to 14 trillion and suddenly stopping one day?

Craig Mee comments:

 Very generous post, thanks Victor…

I would add, in this day and age, learn tough typing and keyboard skills for execution and your way around a keyboard, so you don't wipe off a months profit in the heat of battle. I would also add, learn ways of speed reading and information absorption, though these two may be more "what to do before you start out". 

Gary Rogan writes: 

Anatoly, I don't think really understanding the sector and and the niche is all that useful unless one knows what's going on as well as the CEO of the company, which means that in general understanding quite a bit about the company isn't useful to anyone without access to enormous amount of information. It's the subtle, little, invisible things that often make all the difference. There are a lot of people who know a lot about pretty much any company, so to out-compete them based on knowledge is usually pretty hopeless. It is nevertheless sometimes possible to out-compete those with even better knowledge by sticking with longer horizons or by being a better processor of information, but it's rare.

That said, it has been shown repeatedly that some combination of buying stocks that are out of favor by some objective measure, possibly combined with some positive value-creation characteristics, such as return on invested capital, do result in market-beating return. Certainly, just about any equity can go to essentially zero, but that's what diversification is for.

Jeff Watson adds: 

 In the commodities markets it's essential to cultivate commercials who trade the same markets as you(especially in the grains.) One can glean much information from a commercial, information like who's buying. who's selling, who's bidding up the front month, who's spreading what, who's buying one commodity market and selling another, etc. When dealing with a commercial, be sure to not waste his time and have some valuable information to offer as a quid pro. Also, one necessary skill to develop is to determine how much of a particular commodity is for sale at any given time…. That skill takes a lot of experience to adequately gauge the market. Also, in addition to finding a good mentor, listen to your elders, the guys who have been successful speculators for decades, the guys who have seen and experienced it all. Avoid the clerks, brokers, backroom guys, analysts, touts, hoodoos etc. Learn to be cold blooded and be willing to take a hit, even if you think the market might turn around in the future. Learn to avoid hope, as hope will ultimately kill your bankroll. When engaged in speculation, find one on one games like sports, cards, chess, etc that pit you against another person. Play these games aggressively, and learn to find an edge. That edge might translate to the markets. Still, while being aggressive in the games, play a thinking man's game, play smart, and learn to play a strong defensive game……a respect for the defense will carry over to the way you approach the markets and defend your bankroll. Stay in good physical shape, get lots of exercise, eat well, avoid excesses.

Leo Jia comments:

Given that manipulation is still prevalent in some Asian markets, I would add that, for individual stocks in particular, one needs to  understand manipulators' tactics well and learn to survive and thrive under their toes.

Bruno Ombreux writes:

Just to support what Jeff said, you really have to define which market you are talking about. Because they are all different. On one hand you have stuff like S&P futures with robots trading by the nanosecond, in which algorithms and IT would be the main skill nowadays, I guess. On the other hand, you have more sedate markets with only a few big players. This article from zerohedge was really excellent. It describes the credit market, but some commodity markets are exactly the same. There the skill is more akin to high stake poker, figuring out each of your limited number of counterparts position, intentions and psychology.

Rocky Humbert adds:

I note that the Chair ignored my request to precisely define the term "successful speculator," perhaps because avoiding such rigorousness allows him to define success and speculation in a manner as to avoid acknowledging his own biases. I'd further suggest that his list of educational materials, although interesting and undoubtedly useful for all students of markets, seems biased towards an attempt to make people to be "like him."

If gold is up a gazillion percent over the past decade, and you're up 20%, are you a successful speculator?If the stock market is down 20% over a six month period, and you're down 2%, are you a successful speculator?If you have beaten the S&P by 20 basis points/year, ever year, for the past decade, without any meaningful drawdowns, are you a successful speculator?If you trade once every year or two, and every trade that you do makes some money, are you a successful speculator?

If you never trade, can you be a successful speculator?

If you dollar cost average, and are disciplined, are you a successful speculator?

If you compound at 50% per year for 10 years, and then lose everything in an afternoon, are you a successful speculator?

If you lose everything in an afternoon, and then learn from your mistake, and then compound at 50% for the next 10 years, are you a successful speculator?

If you compound at 6% per year for 10 years, and never have a meaningful drawdown, are you a successful speculator?

If the risk free rate is 6%, and you are making 12%, are you a more successful speculator then if the risk-free rate is 0% and you are making 6%?

If you think you are a successful speculator, can you really be a successful speculator?

If you think you are not a successful speculator, can you be a successful speculator?

Who are the most successful speculators of the past 100 years? Who are the least successful speculators of the past 100 years? 

An anonymous contributor adds:

 In conjunction with the chair's mention of valuable books and histories, I would append Fred Schwed's Where are the Customers' Yachts?.

While ostensibly written with a tongue-in-cheek hapless outsider view of 1920s and 1930s Wall Street, it has provided as many lessons and illustrations as anything by Henry Clews. In this case, I am reminded of the chapter in which Schwed wonders if such a thing as superior investment advice actually exists.

Pete Earle writes:

It is my opinion that the first thing that the would-be speculator should do, even before undertaking the courses of actions described by our Chair, is to open a small brokerage account and begin plunking around in small size, getting a feel for the market, the vagaries of execution quality, time delays, and the like. That may serve to either increase the appetite for such knowledge, or nip in the bud what could otherwise be a long and frustrating journey.

Kim Zussman adds: 

The obligatory Wikipedia* definition of speculation is investment with higher risk:

Speculating is the assumption of risk in anticipation of gain but recognizing a higher than average possibility of loss. The term speculation implies that a business or investment risk can be analyzed and measured, and its distinction from the term Investment is one of degree of risk. It differs from gambling, which is based on random outcomes.

There is nothing in the act of speculating or investing that suggests holding times have anything to do with the difference in the degree of risk separating speculation from investing

By this definition one must define risk and decide what comprises high and low risk — which may be simple in extreme cases but (as we have seen repeatedly) is not very straightforward in financial markets

*Chair is quoted in the link 

Alston Mabry writes in:

I'm successful when I achieve the goals I set for myself. And rather than a target in dollars or basis points or relative to any index or ex-post wish list, those goals may simply be to act with discipline in implementing a plan and then accepting the results, modifying the plan, etc.

Anatoly Veltman adds: 

And don't forget Ed Seykota: "Everyone gets out of the market what they want". I find that everyone gets out of life what they want.

Plenty a market participant is not in it to make money. Fantastic news for those who are!

Bruno Ombreux writes:

This will actually bring me back to the question of what is a successful speculator.

In my opinion success in life is defined in having enough to eat, a roof, friendships and a happy family (as an aside, after near-death experiences, people tend to report family first). You can forget stuff like being famous, leaving a legacy or being remembered in history books. If you are interested in these things, you have chosen the wrong business. Nobody remembers traders or businessmen after their death except close family and friends. People who make history are military and political leaders, great artists, writers…

So you are limited to food, roof, friends and family. Therefore my definition of a successful speculator is a speculator that has enough of these, so that he doesn't feel he needs to speculate. I repeat, "a successful speculator does not need to speculate."

Paolo Pezzutti adds:

I simply think that a successful speculator is one who makes money trading. Among soccer players Messi, Ibrahimovic are considered very successful. They consistently score. They experience short periods without scoring. Similarly, traders should have an equity line which consistently prints new highs with low volatility and a short time between new highs. Like soccer players and other athletes it is their mental characteristics the main edge rather than knowledge of statistics. One can learn how to speculate but without talent cannot play the champions league of traders and will print an equity line with high drawdowns struggling losing too much when wrong and winning too little when right. Before dedicating time to find a statistical edge in markets one should assess his own talent and train psychologically. In this regard I like Dr Steenbarger work. In sports as in trading you very soon know yourself: your strengths and weakness. There is no mercy. You are exposed and naked. This is the greatness and cruelty of markets and competition. This is the area where one should really focus in my opinion.

Steve Ellison writes:

To elaborate a bit on Commander Pezzutti's definition, I would consider a successful speculator one who has outperformed a relevant benchmark for annual returns over a period of five years or more. Ideally, the outperformance should be statistically significant, but market returns can be so noisy that it might take much of a career to attain statistical significance.

Jeff Rollert writes:

I propose a successful speculator dies wealthy, with many friends. Wealth is not measured just in liquid terms.

Should a statistical method be preferred, I suggest he is the last speculator, with capital, from all the speculators of his college class.

In both cases, I suggest the Chair and Senator are deemed successful, each in their own way.

Leo Jia adds:

If I may wager my 2 cents here.

I would define a successful speculator as someone who has achieved a record that is substantially above the average record of all speculators in percentage terms during an extended period of time. The success here means more of a caliber that one has acquired which is manifested by the long-term record. Similarly regarded are the martial artists. One is considered successful when he has demonstrated the ability to beat substantially more than half of the people who practice martial arts, regardless of their styles, during an extended period of time. It doesn't mean that he should have encountered no failures during that time - everyone has failures. So, even if that successful one was beaten to death at one fight, he is still regarded as a successful martial artist because his past achievements are well revered.

With this view, I will try to answer Rocky's questions to illustrate.

Julian Rowberry writes:

An important step is to get some money. Preferably someone else's. [LOL ]



 It's amazing that in 60 years, a better product than white out to remove ink has not been found. Why is that? The white out smells, takes a long time to dry, is easy to spill and has thickness that requires a woman's touch to apply correctly. One recalls that the best experts on tree climbers were not the foresters or the scientists but the tree work companies themselves that taught everyone else how to climb.

In general the businesses know how to solve problems like this infinitely better than the academics as we see so often in our field. There are many companies that produce and dispense ink. What do they use to clean up spills and why can't this be applied. I am going to have Aubrey test if anything common works with his Kosmos chemistry set which I brought from Germany to the US. So I could use their great German sets to teach Galt since I couldn't understand their chemistry.

All the chemistry sets these days are in the form of games as kids apparently don't wish to read a manual and trial and error it. What other products needs a solution in the real world that industrial manufacturers have already solved for their continued profitability and ability to meet competition and provide proper conditions to their workers.



 As a first-time homebuyer a few years back, I am now working on becoming a first time homeseller. I was told by our realtrix that she recently had a closing that was held up by a house that failed to appraise at the selling price. Since she specializes in old houses (and ours is pushing 95) she told us that it was unlikely but possible that a sale of our house could be held up for the same reason, depending on how much we were able to get for it.

I nodded my head at the time, but thinking on it later in the day, I was more and more baffled the more I considered it. In the financial markets, if you value infrequently traded securities, then you know that the absolute holy grail of a security's valuation is an arms length trade, in size, viewable on the "tape" (stock exchange, TRACE, MSRB, etc.). Even if you have no trade, an appropriately sized offering on the security sets a ceiling on the price, while a live, executable bid sets a floor price beneath which there's no justification to value the piece. The terminology varies from sector to sector, but fair valuing, marking to model, etc., should be avoided whenever possible.

I guess people for a while have been saying the appraisal system for houses was a contributor to the housing crisis, but most claim it was improperly performed appraisals which led to the problem. To me, the whole structure of the system is wrong. Right now, it works like this: customer pulls a price less than selling price out of the air, and probably after some negotiations, a price is settled upon by the buyer and seller. At this point, it is probably a written, binding offer, contingent upon inspection and appraisal at or above selling price . THEN, an appraiser is brought in to determine "market value." But the market price has already been set! If the appraiser can't take the live, accepted bid on the very property in question as the house's value, then what can he possibly go on?

The answer, incredibly, is that the appraiser is marking to market. He is marking to a model, based on comps, accouterments, neighborhood, lot size, rebuild cost, etc., but it is undeniably a model. If the system made any sense, it wouldn't go offer -> negotiate -> agree -> appraise -> close. The appraisal would be conducted prior to the offer and negotiation as a bidding tool to the buyer… or even as justification by the seller for the offering price. As it is, the appraisal serves two purposes. One, it gives the buyer a false sense of security that he paid the right price, and it gives the bank a false sense of security that sufficient equity will be coupled with the down payment to motivate the mortgagor to perform, and/or that a sale under duress could make the bank sufficiently whole to take the loan risk. I know that theoretically appraisers don't try to "hit the number" but it seems like the knobs on the appraisal are probably turned a little bit at least to get in the right ballpark. I know that it's supposedly a science and they are professionals, etc., but still…

The structural problem, of course, is that the buyer and the lender are trusting an appraiser's mark-to-model to protect their long-term interests. It allows lenders to be more impersonal and buyers the sense they are delegating responsibility. To me, it's yet another example of unintended consequences of regulation: a process that was intended well but ultimately creates an environment where a buyer's biggest purchase in a lifetime and the financier facilitating the trade are entrusting huge sums of money to the model and signature of an interested (but probably not interested enough) third party. A signature counts more today than it ever, in a time when it probably means less than ever.

But I sure hope my house appraises right when I accept an offer!

Jim Sogi comments:

The appraisers' methods have been well tested in the courts, and recently not so well in the markets. There are 3 ways to value property:

1. Comparable Sales

2. Income

3. Replacement Cost.

Marginal price in liquid markets are set by comparable sales of that security. But we know that they can be wrong also. Comparing the appraisal methods to see if there is undue variance give some back up to each method. If one or more are way off, perhaps something is not right. Chair's Fed Model looks at the income for stocks. Replacement cost is rarely used and does not account for things like location or in the stock market, goodwill. Over reliance on comparable sales, which are set at the margin, resulted in the boom and crash of real estate and derivatives of the mortgages.There is quite a bit of play in the range of price that an appraiser can defend, and it plays out regularly in court with the IRS in estate tax cases so the method has been well tested.
They key is getting a good appraiser.

Sam Humbert explains:

The prospective buyer of your home isn’t the young couple with the cute kids and Labrador retriever you’ve been “negotiating” with. It’s their bank. The bank takes all the risk, aside from the small haircut the down payment represents. And appraisals are how banks roll. If you don’t like it, sell to an all-cash buyer instead, so there’s no bank in the picture.

Jonathan Bower writes:

Appraisers are part of the vig in a real estate transaction. As recent first time homesellers (about a year ago) who "scratched" the house, we discovered the long line of people with their hands out to help facilitate my transaction…

City (Sales and Stamp Tax)

County (Sales and Stamp Tax)


2 Brokers (on the market less than 2 weeks…)






Municipal Service Fee

Document Preparation Fee

Closing Fee

Wire Fee

Overnight Fee et al

This is when I realized why the gov't is so interested in stimulating the housing market…

Ken Drees writes:

In general, during the housing boom there was no restraint on the appraisal part of the transaction. The appraisal price was matched to or above the agreed upon sale price in order for the loan to go through. The appraisal person often asked the real estate agent what number they needed. Once again, this is not true in all cases–but obviously lax rules and lax ethics swirled around this function during the boom. Now there is a lot of heat and scrutiny on the appraisal part of the process. These people can and will be held liable and responsible for any questionable values. So naturally they are over reacting and sharpening their pencils to the point of overkill on the low end of ranges. It really is a buyers market–and only now the appraisal needs to be at or below the selling price for the loan to go through.

No wonder that money supply is high at the base level and crashing in terms of reaching the people. Where is the lending?

Rocky Humbert comments:

If a lender isn't involved, there's no need for an appraiser, and there's no bank closing fees. If one has engineering expertise, an inspector is optional. A knowledgeable buyer can also conduct his own title search from public records and (bravely) skip the Title insurance, and can also (in most states) represent themselves "Pro Se," and not retain an attorney. You can also buy and sell without a broker. All of these people are providing risk-reduction or other services for the parties.

The real "vig" in a real estate transaction is not only the stamp tax and bid/ask spread, but also new drapes for all of the windows, and the discovery that there's no way to fit your 9-foot Steinway Concert Grand Piano through the front door.

Real estate markets have one unique peculiarity: In what other market is the seller's identity and cost-basis a matter of public legal record, but the buyer can remain anonymous prior to the closing?

Phil McDonnell adds:

In a market with fungible items the fair market value is the gold standard. The reason is that the previous transaction is a good measure of value given that all items traded are identical. But in Real Estate every property is unique. Even in cookie cutter developments the locations are unique.

Real Estate also differs in financing because the margins are only about 10% or so. Your broker can and will sell you out if your stock falls in value below maintenance margin even momentarily. The bank cannot do that to a homeowner. In effect a mortgage is a loan and a put option. This is because the homeowner can put the house back to the bank if it falls underwater via a foreclosure or short sale.

In California during the boom an immigrant gardener was able to buy something like 10 houses from his friend for inflated prices because of lax mortgage appraisal standards. In scams like that the friend walks away with fast cash from the overpayment. Appraisals are really designed to weed out the risk of less than arms length transactions for the banks.

Stefan Jovanovich writes:

Around here (Contra Costa, Alameda Counties) in California the appraisers were usually in on the deal and their justification for the absurd valuations was the "fair market value" of the lots on which the houses were built. The primary fallacy was– and is– the idea that the dirt itself could be adequate security for the loan. That has been a recurring delusion throughout American history– that land alone could support debt. In the bad old days when money was itself the gold standard, bankers refused to lend against land; they limited their risk to the earnings power of the improvements - i.e. the buildings or the prepared soil. Rents and reliable crop yields were seen as the only reasonable estimate for comparable value; and, since those were expressed in dollars, properties were not considered unique. That was, of course, one of the limits of the gold standard that the newer, more flexible currency was going to solve. And it did in one sense; imagine what dirt prices would be without FHLBs, FNM, FRE and the AAA of 1938.

Rock Humbert replies:

Maslow's hierarchy of needsOuch. Maslow's Hammer just came down on my head, as Stefan once again suggests that society's ills would be cured by the gold standard.There is an important difference between saying "appraisers were usually in on the deal" (which suggests fraudulent intent), and saying the justification was "fair market value.""Fair Market Value" (FMV) is a defined term: the "price" where a willing buyer and a willing seller complete a transaction. This concept is applicable to all assets (including land, copper, gold, horses, equities, etc.), and the price can be stated in any agreed medium of exchange (dollars, gold, salt, seashells). Although it wasn't called FMV, the FMV concept dates back to at least King Solomon and the Talmud.

If a third party (e.g. a bank) provides capital for an asset purchase/investment (debt, equity or barter), and the third party is falsely induced to provide capital, this is fraud. And the existence of fraud also pre-dates modern history. Hardly an argument for the gold standard.

If the third party provides capital based on assumptions (including FMV) regarding the asset purchase that turn out to be wrong, this can be called a bad business decision. And bad business decisions are not a recent development either. Again, hardly an argument for the gold standard.

However, if the bank makes an investment because it plans to flip the loan to Fannie & Freddie– that's a completely different story. And much of the recent mess can be attributed to this phenomenon.(Yet I don't understand why a gold standard and the existence of a gold-rich Fannie & Freddie are necessarily mutually exclusive.

Perhaps Stefan will explain…. 

Stefan Jovanovich explains:

No Fannie or Freddie could possibly be or want to be "gold-rich"; if you can exchange your paper with the central bank why would you want to endure the vicious discounts that 19th century merchants imposed because they insisted on valuing their inventory by what it would sell for in cash, not what it could be appraised for or securitized into? No one here has disagreed that the state has a monopoly of legal tender. What the medium of exchange folks have said is that the government monopoly (and the potential for abuse inherent in any legal monopoly) does not matter because you can always trade your horses, copper, land for money whenever you want and the government's self-regulation will prevent abuse. Or, as Rocky put it, the tax man will take property instead of cash in payment of taxes. Alas that part is simply not true: the tax liability remains even after the taxpayer's property is seized; it is only discharged when and if the property is sold. (One of the interesting interactions of the present tyranny is how the drug laws have revived debtors prison.) Perfect liquidity, like FMV, is a notion that works better on paper than it ever does on the barrel head where - even now - legal tender (Fed reserve balances and notes) remains in limited supply. Because legal tender is in limited supply, there is the unavoidable temptation for the holders of the government to make more money available whenever Congress and the President want a war - whether against poverty or Iraq. That was what the Founders properly feared. They wanted the unavoidable monopolies of our central government - the powers to make Money and War - to be constrained by the requirement that both be approved by an actual vote of the Congress. Since they knew that no unpopular war could be waged without a debasement of the currency, they imposed the further restraint of insisting in our Constitution that the Money be Coined to a Standard Weight and Measure. Credit would regulate itself, even in a world of mark to model and foreign military/aid adventures, as long as the government monopoly could not create legal tender as needed. Money exchangeable on demand into specie was the ballast for republic itself; it might seem useless to waste all that precious cargo space carrying heavy weights that were only hoarded– until you found yourself caught in a storm– and then the ballast would be the only thing that would give the ship of state's righting arms the weight with which to do their work.

David Hillman writes:

Speaking of real estate, more particularly of having the ranch foreclosed upon, TCM [Turner Classic Movies] will air this evening at 10 EDT/9 CDT, a chair and list favorite, the original 1970 version of the classic 'demise of the old west' tale, "Monte Walsh" starring Lee Marvin. Thought some might like a heads up. Enjoy. 

Stefan Jovanovich adds:

And now for a brief jab at Maslow: anyone who would compare being the lonely Jew in a New York school full of gentiles in 1920 to being "the first Negro enrolled in an all-white children" had a sense of self-importance that would have made even our country's original hammer head (aka George Washington) blush. Talk about a hierarchy of needs!



a penny beginning to meltWhy would people hold hard currency when they can get interest on it or melt it down? Why would governments continue to issue coins with metal content values higher than the denomination values? What is the theoretical probability of that? Yet it occurs in the real world where a penny has twice it value in copper and recent dimes are worth slightly more than their denomination.

The other interesting aspect of this is when numismatic value is increased by melt down events. An increase in scarcity of certain lower mintage dates that would be discovered only as collectors figure out that not so many coins from a certain date still exist.

From a paper by Drs. Espen Gaarder Haug and John Stevenson:

All physical monies with face values contain embedded options. By being aware of these options, more precise valuations of coins and paper money can be made. Some of the most commonly circulating coins in the USA (and also in the UK) have gone from having their embedded option deep-in-the-money to at-the-money, then to deep-out-of-the-money, and then returning to deep-in- the-money. The value of the optionality has been high. Because the central banks and commercial banks are selling such coins at a xed price, equal to the face value, the price and face value of such coins will only be the same when the option element is deep-in-the-money. When the option element moves towards at-the-money or out-of-the-money, arbitrage opportunities arise. Since governments are not adjusting the face values, they have to reduce the value of the coin for example, by stopping the circulation of such coins by other means or by taking legal action against the exporting and melting of coins.

Gene Gard replies:

a nickelI have thought about this a lot, and there is a little more to the interesting optionality of pennies and nickels…

Of course, the theoretical floor to a coin's value is max (face, metal value). In great inflationary times, the metal value will greatly exceed the face value of the coin. But here's the interesting part– if holding the coin in deflationary times, the face value increases, its purchasing power even as the metal value plummets in nominal terms.

Two implications– first, even though you don't get interest payments on your money, if you bought with the metal value "at the money" you are some earning real return in all cases unless the purchasing power of the dollar remains absolutely stagnant. Second, because of the previous point, you're not just getting a free call option on the metal value, you're really getting a free straddle– or in other words, a free "inflation vol call option." The worse inflation or deflation gets, the better off you are. And it's the same investment– no adjustment is required for inflation or deflation. Look back at what happened to TIPS breakevens toward the end of '08 beginning of '09 when the deflation bulls were winning!

Nickels are better than pennies from a storability perspective — nickels are 1 cent/gram and pennies are .4 cents per gram, though pennies are much more in the money right now according to coinflation.com. I haven't decided if I'm buying a truckload of pennies or nickels at this point.



ReactorWhile nuclear power gets bad press, it's really a pretty nifty way to make electricity.  Modern Pressurized Water Reactors are safer than outsiders could ever imagine. In addition to numerous automatic safety shutdown mechanisms, they possess a very reassuring design property known as a "negative temperature coefficient of reactivity." Basically, it means that as the neutron-absorbing control rods are pulled out of the core of an operating reactor (in other words "reactivity is added"),  more fission takes place, and the water that removes heat from the core heats up and expands. This causes fewer neutrons to be slowed down by the water to a speed at which they can cause fission, and therefore, the higher temperature ultimately lowers reactivity. It's a true negative feedback loop that mitigates problems from a heavy-handed reactor operator and partially keeps the rate of change of reactor power manageable by a human.  It is difficult to cause a nuclear accident these days, due to the safety of the design and the many interlocks and safety features available to the operator. It takes a comedy of major maintenance errors and poor judgment (Three Mile Island) or a bad design and overriding of safety features on purpose (Chernobyl) to damage a reactor at power.

However, that is not true at all during a reactor startup. When a reactor is starting up, the level of reactor power is so low that only a negligible amount of heat is produced. Reactor power when fully shut down is very low– say 1×10^-10% of the reactor's full power design limit. What this means is that when pulling rods out to start up the reactor, an operator must be extremely careful! There is no negative temperature coefficient of reactivity to mitigate the power rise, and if you pull rods out too quickly, you can be raising reactor power at such a rate– maybe even as high as a factor of 100,000 every minute (aka a "start up rate" of 5 "decades per minute")– that you can go from not even creating any heat at all to a meltdown in a matter of seconds. There are safety features designed to prevent this scenario, but you're never supposed to test safety features. Besides, if you get the power rising too quickly during a startup, you can possibly cause problems more quickly than the automatic protection system can solve them, if you know what I mean.

See any connections to the markets?

I read and watch a great deal of the financial press, and every time I hear pundits talking about interest rates and inflation I think of a reactor's control rods and reactivity. People act as though the Fed's reactor operator is carefully watching the dials, and will be able to deftly move the rods back into the core (remove liquidity) just at the right moment to pull us from the precipice but maintain an absolutely stable price level. What they're missing is that the reactor of the economy was truly shut down for a while at the end of last year. We were no longer operating at power, and they were probably right to recognize that things like the Taylor rule don't apply when it hit the fan. Right or wrong, the Fed pulled all the control rods out of the core as fast as they could. Now, rods are at the top, and the economy's "reactor power" is probably screaming up at an incredible "startup rate" right now, but it's not moving the needles that anyone can see– yet. I'm afraid that once the economy starts moving the needle, by means of rising lagging economic indicators (all indicators are lagging, by definition, by the way) it will be too late for the human operators at the Fed to take away the punch bowl by putting rods back to the "normal" levels. Plus, the Fed's reactor operators won't even be able to take action when the needles start to twitch, because there will be congressional supervisors straight out of the plot of an Ayn Rand novel standing over the Fed's shoulders whispering that more is better for the little people– until it's too late, at which time Congress will blame those that they pressured only a short time ago. Heck, I think it's already too late. It's hard to find signs of strong American deflationary pressure that can't be explained mainly by falling gas prices in the last year (which were elevated to begin with by those darn speculators, right?). Plus, most of the official indicators are bogus anyway, and will be exposed as a scandal du jour sometime down the road when it's obvious in retrospect what all the problems were with them.

I have questions, but no answers. It's a tough situation, because on one hand, instead of a negative temperature coefficient of reactivity, the economy has a positive liquidity coefficient of reactivity– the more you add, the more the economy heats up, and it may be getting ready to heat up quicker than anyone thinks. On the other hand, if you stop pulling rods too early, before the reactor is "self-sustaining," reactor power will fall back down to near zero– a depression. I have no idea where we are in all this, but I would be surprised if inflation doesn't come back to the forefront of the American psyche in the next few months or years. All I know is that as an unstable, discontinuous market system with demand cliffs and greed and fear it's absolutely certain that the Fed will take away the liquidity either too soon or too late. I think it's unlikely they'll do it too soon.


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