I met up with on old friend of mine a few days ago. His name is Mr. Practical and if you don't know him (he tends to stay under the radar screen), he is quite a character, an enigma to most. He is truly a man of the world, traveling freely to any country, for he has access to some special sort of visa, spending from only a few weeks or months to several years in any one place (there is a particular reason for this that I will soon explain).
His resources are limited, although I hear that they have become quite substantial. He is known to take almost obsessive care in his finances. In fact, rumor has it that he inherited a small sum from an uncle at a young age and since hasn't worked a day in his life, earning all he needs from his investments. His opinions and methods in this area, although well respected, are quite unique, so I was quite interested in what he had to say about the current environment.
I found him in Madrid. I already knew why he was there. You see Mr. Practical travels to and lives in a country in which he believes the currency will strengthen against the other world currencies. Wherever he goes, because almost all of his assets are liquid, he transfers these assets into the currency of that country. This seemed silly to me at first, but once he explained the thought process it made perfect sense. Our assets, everything we own from our houses down to our socks, are priced in the currency of the country in which we live. That means the value of those assets continuously increases and decreases relative to those of other countries. We normal folk don't really notice this much because short term currency fluctuations tend to be diminutive. But when a country's currency declines in value relative to other currencies in a sustained and meaningful way, the people of that country begin to take notice, generally seeing rising prices for goods and services imported from other countries.
Mr. Practical told me that this process of continuously moving his assets into the currency that appreciates against other currencies has been the single largest contributor to the increase in his net worth. Being nearly one hundred years old, he has become extremely adept at this.
He has spent very little time over the last eighty years or so in the U.S., first leaving in the late 1920's. He once told me that since then the U.S. dollar has lost 90% of its purchasing power (I didn't believe this, but after looking it up it turns out that he is right). He recalls fondly how he used to be able to buy an apple for a dime then; now it costs a dollar.
His decision to leave the U.S. back then was predicated on the amount of debt relative to GDP that was being built up. He argued that although conventional wisdom dictates that strong economic growth drives currency valuation in the short run, the real long term driver is the level of debt. You see, he is not all that interested in weeks or months or really all that interested in short term returns either. He is focused on risk, first concerned with protecting his assets from deterioration.
He is not completely averse to debt and advocates the intelligent use of it. Debt can transfer future income and wealth to the present. Higher debt in the beginning of an expansion drives incomes higher, but at some point in the cycle it usually (because human beings ignore risk when they can) becomes unsustainable, and this is where he gets off the boat. Debt is very easy to accumulate, but very difficult to pay back.
He spent a good portion of the seventies in Japan where the yen has appreciated 67% against the dollar. He spent a little time in the U.S. in the mid-nineties on a lark and has since been in Europe. In his opinion the amount of liquidity injected by the Federal Reserve into the U.S. system has created debt levels not seen since the 1920's. Combine that with the fact that U.S. consumption is predicated on a relatively stable dollar since we borrow nearly $1.5 billion each day to finance this consumption, and you have a real potential problem. The key word is potential for the situation could last for years. But Mr. Practical looks at risk first, so when he sees potential, he walks the other way. In his way of thinking, why should the dollar remain stable given the fact that it has declined so substantially over long term anyway and there are currently forces that make matters even worse than usual? He told me to just look at the price of gold as a clue.
Mr. Practical doesn't normally like to talk about stocks, for he believes that in the short run the market is driven almost exclusively by psychology and in all his years he still hasn't really figured out human beings. He did offer one piece of advice on the subject, however. "To a long term investor, it doesn't matter a whit about picking stocks. There may be some individuals who can pick stocks successfully, although the preponderance of evidence suggests those people are very few: the average mutual fund has underperformed the SP500 by 100 to 200 basis points per year. What really matters is proper asset allocation. I am always invested in the stock market indexes, but I allocate a much smaller amount to them than conventional wisdom suggests, normally between 5% and 30% of my net worth. This allows me to stay in the market when it turns down and not sell. It is much more important not to sell at the wrong time than it is to buy at the right time."
Unfortunately, this was all the time he had to talk. I asked if he was running off to advise some head of state. He laughed. "They don't listen to me. They are much too short term oriented." I asked him where I could meet up with him next in case some Minyans had some specific questions. He said he was thinking about moving to Beijing.
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