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It is early yet, but today promises to be a bit on the weird side – as I was taking my morning constitutional up the Hunters Ridge Trail, I came across Earl sitting on top of a big flat rock out in the middle of a small mountain meadow.

Now this in itself was unusual, because Earl does not get around so well anymore. He lost a good chunk of his left foot in a warehouse accident (his foot got caught between a dolly on the central chain and a metal pole and basically was pulped – ugh!) and he is built along the general lines of a refrigerator. So running into Earl on the trail was a surprise.

But there was an added element today, because Earl was sitting there with his head inside a huge cardboard box.

Me: “Say, Earl, is Madge punishing you for something?”
Earl (pulling box off of head): “No, Daisy, this here is what they call a pinhole camera! I am watching the sun!”

Now I am a big fan of pinhole cameras for watching eclipses and such, and I recommend them to everyone:

But in the absence of an eclipse or a Venus transit, looking at the sun with a pinhole camera can be a bit on the dull side, since all you see is a bright circular spot that just sits there. So I asked Earl why he was watching the sun, and he explained that he was hoping to catch it just as it reversed polarity:

I thought about commenting further – along the lines of pointing out that there would be no visible signs of a polarity reversal -- but in the end it seemed better for Earl to be out in the fresh air than in his usual spot in front of the TV watching daytime soaps, so I just walked on, leaving behind the strange apparition of Earl with his head inside the huge box.

Which in a way might be symbolic of our macroeconomic situation, if you think about it . . . .

Anyway, we are a bit in danger of perambulating off into a divagation here, so let me jump right into the important macroeconomic content of this post.

Jeremy Grantham’s house, GMO, is famous for employing the very best and brightest economic thinkers in the private sector. For example, there is a guy named James Montier who looks like he might have played O-line for Slippery Rock University, but who wrote an appendix entitled “Wicksell’s Red Surströmming,” which most likely is fascinating reading.

But maybe the brightest guy at GMO, other than Grantham himself, is a chap (that is how I imagine they talk at GMO) named Ben Inker. And Ben Inker recently wrote a concise, luminous explanation of our current macroeconomic situation, at least that part of it that pertains to asset markets.

As a service to the community (and required reading for my children), I will now proceed to reproduce key excerpts from Ben’s article (in italics) with commentary where necessary. The entire article should be read, and can be accessed here (with free registration):

What the *&%! Just Happened?
Ben Inker
GMO 7/13 Quarterly Letter

Let me apologize right at the outset, because Ben’s title contains a wink and a nod at a very bad word. There is no reason for him to dart off in this direction, other than perhaps a deep internal need to show that at heart he is just like the rest of us.

While we are dodging around a very bad word, let me point out that my investing philosophy can be summed up by the refrain of the following, which has become my informal theme song (again, bad word alert, with careful dodging being largely unsuccessful):

Back to Bold Ben Inker

. . . growth shocks and inflation shocks . . . are two of the basic ways investors can lose significant amounts of money in otherwise diversified portfolios . . . .

In the grand fashion of Hussman and, as it turns out, Inker, let me help the lay reader understand these concepts by commonplace allegorical examples:

Imagine Cletus coming down from the hills to visit his sister Alma, who lives in a big city – say, Wheeling. Cletus is sitting in the naugahyde chair when his young nephew Purdy walks in.

Growth Shock:

Cletus: Heavens to Murgatroyd, boy, look at you! You must have growed a foot since I seen you last!”

Inflation Shock:

Cletus: Well butter my butt and call me a biscuit, boy, they’ve been feeding you well! You look full as a tick! If you was an inch taller you’d be round!”

But there is a third way to lose money, and it was what bit the financial markets in May and June . . . . it is the risk associated with the discount rate on an investment rising.

By pulling down both today’s cash rate and the market expectation of future cash rates, the Fed has increased the relative attractiveness of pretty much all assets other than cash and, as a consequence, their prices have risen . . . . And this gives today’s markets a vulnerability that has not existed through most of history. Today’s valuations only make sense in light of low expected cash rates. Remove that expectation, and pretty much every asset across the board is vulnerable to a fall in price . . . .

. . . the trouble is that there is no easy way to resolve this problem. . . . there is unlikely to be a safe harbor from the fallout, other than cash itself.

. . . and . . . cash offers no return today, while other asset classes are priced to give positive returns, even if lower than their historical averages. . . . investors are getting paid to move away from cash if things revert to normal over 7 years. If things are going to revert over 2 years instead, cash suddenly becomes a pretty appealing asset by comparison . . . .

So either we time the market – i.e., guess when interest rates will go up, which is basically impossible -- or we recognize that we are at the mercy of vast economic forces and just take our lumps.

To be honest, this pretty much sums up the entire life of the average person in West Virginia, so I am not particularly bothered by it. As far as I can tell, we are all crouched in canoes, paddles lost, sweeping down the Cheat River and listening to the deep bass rumble of the gorge up ahead. Why should investing be any different?

BTW, without preening, I would like to say that the above is a pretty good example of a canoe analogy created by an Earthling who has actually seen a canoe. Which leads me to the concluding paragraph of Ben Inker’s essay . . . .

Apparently They Teach Clunky Metaphors In Economics Graduate School.

We have all enjoyed John Hussman’s long string of tortured anecdotes, where he attempts to cast economic ideas in contexts that he hopes normal people can understand. His efforts at imagining the situations that non-economists encounter have led to speculation that he is actually an inter-galactic alien posing as a human.

Well, apparently Ben Inker is from the same star system as Dr. Hussman. After giving the clearest explanation one can imagine of our current macroeconomic situation, he decides that he will try to make this explanation accessible to his less . . . alien/sophisticated . . . readers by comparing it to his peculiar, Greater-Magellanic-Cloud view of a canoe race in the face of an oncoming storm.

Mr. Inker begins:

. . . I’d like to put our current positioning in terms of a summer camp metaphor. We’re in a canoe race to the other side of the lake. We know all of the canoes are old and a bit leaky in the best of times, and there’s a storm coming.

Well, end of story, right? Here is how the ensuing conversation goes here in WV:

Bo: “Say guys, hurry up! The canoes are all leaky and old, and a storm is coming, so let’s have a canoe race!
Arky: “You’re kidding, right?”
Five-Finger Frankie: “Quiet guys, ‘Wheel of Fortune’ is on!”
Gib: “Look at Vanna! I don’t think she’s wearing a . . . “
Bo: “But what about the canoe race?”
Arky “Mañana, man.”

But Ben Inker sees a different story arc:

If we knew the storm were going to break now, we’d just stay in the cabin and laugh at everyone else as they were forced to turn around and trudge back to the cabin, sopping wet and half drowned.

Which is, of course, both (i) kind of sadistic and (ii) exactly what the average Earthling would do regardless of when the storm was going to break.

But we don’t know when the storm will break or even if it might miss us altogether, so we’ve stuck an extra guy in the middle of our boat with a bucket instead of a paddle. We know it will slow us down, but it will go a long way to help ensure we don’t sink along the way, even if we’re resigned to the likelihood of a long slow paddle in the rain, sitting in water up to our ankles.


Bo: “I know, guys. Let’s stick an extra guy in the middle of the canoe with a big bucket, so he can bail as we get rained on and start sinking.”
Arky: “Great idea, Bo – why don’t you go get a bucket and let us know when you have found one? Fill it with ice to keep it nice and cold. And bring back some beer while you are at it.”
Gib: “And see if you can find Flipper anywhere. He could tag along with us and save us when we go under.”
Five-Finger Frankie “Remember how he used to tow the boat with a rope around his nose?”
Gib: “I don’t think dolphins have noses. It’s a snout.”
Arky: “No, I think it’s a beak, like a bird.”
Bo [completely forgetting the canoe race]: “Well, it can’t be a beak, because fish don’t have beaks.”

And so on . . . .

So, although I am very impressed by Ben’s clarity in describing our current dilemma as investors contemplating the macroeconomic situation,* I worry that his Stan-from-Planet-Zan understanding of canoe racing in a storm may signal a deep lack of understanding of Earthling behavior. And, after all, what is macroeconomics other than a description of the aggregate behavior of a whole bunch of Earthlings?


A Drumlin Daisy

An Earthling from that small corner of the globe known as the Greater St. Albans Area . . . .

*My hope is that if I use the word “macroeconomic” often enough, people will believe that I am actually discussing macroeconomics.
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