DAILY VIDEO COMMENTARIES

We must not forget who is responsible for the arms’ race. It’s not the little guys who want to join the big guys’ club but, rather: the United States as the largest arms producer and seller in the world; Britain, who may rank number two; France and Germany who are right in there in full competition; Russia, who needs to its arms’ industry to come back by selling to countries with aspirations.

The third world got hooked on arms when they were mostly given away during the cold war by the Soviet Union and the United States to their client states. Since then, we have maintained an active defense complex—which, you all remember, Dwight Eisenhower warned us against—in order to preserve employment and the profits and the influence that go with it. So we should not be surprised when India, Pakistan, Iran, Iraq, Israel and others want to join the nuclear club.

I doubt if we can stop it, but if we stop it at all, it has to start by a disarmament program that begins at the top, not after it’s all done, and not by telling the new people that they can’t have it.

I think we should bear a big responsibility for what has happened recently in India and Pakistan.

Investment people frequently confuse coincidence with causality. With any two sets of finite data we can find correlations which will satisfy a statistical test. Once we find those correlations, especially if they are plausible, we tend to enshrine them as causality, cause and effect, and assume that the very conditions which produced those circumstances, coincidences perhaps, in the past are projectable into the future where conditions can be entirely different. And even if they were the same, the result might not be the same in a complex adaptive system. And once we project into the future, we further attribute leads and lags that are quite predictable—or we think they are predictable—and ascribe those to the system that we have produced.

It is a tissue of assumptions, of implausibility, and produces a result that is highly prone to flaw, failure and excuses. We even go on to be prescriptive in the cause and effect, to say that if we do this, that will happen. For example, we say if interest rates are increased, that will make the stock market go down . . . not necessarily if the market interprets that move in entirely the opposite way, as being a very strong economy or as something else. But it is not a one-to-one relationship. There are new tools that are very infrequently used which do not promise as much—fuzzy data, high-frequency data, adaptive systems, simulations. We should look at those as being at least more honest than what we do now.

ADRs give the US investor a convenient way to buy shares in leading companies of emerging markets. This year, emerging markets have not been a very attractive place to be. Markets are down, probably 10% overall, and many a lot more. There have been notable, well-publicized collapses in Asia, more recently in Russia, and on the subcontinent in India and Pakistan. Investors in emerging markets are worried and reminded of the risks of being there.

I think this is quite properly so because the risks are in the form of nationalism this year—not necessarily reforms but rather how foreign investors are going to be treated. And since ADRs reflect a flow of funds into the larger companies, rather than into the smaller companies which are more broadly representative of the local markets, they are highly influenced by the flow of funds of foreign investors. I would thus expect this year that ADRs and the leading companies—the larger companies in emerging markets—for the first time in years, will underperform the broad local markets.

I would treat ADRs with care . . . and distance.

Let us examine the bull case for U.S. stocks. It is always worthwhile examining both bull and bear cases. Maybe now while the market is declining, at least in the short-term sense, let us look at the positive side. Of course we know there is no inflation. Virtually. We know the economy is good, surprisingly good. If you pick up the help wanted section in the newspaper, employment is at an all-time high. Money is freely available. You can finance almost any kind of business project. And the U.S. economy is dominant in the world, as the U.S. itself is dominant in the world.

Perhaps we should keep in mind that there is a very strong momentum buying into stocks. The public has learned over the past five or six years that every time there is a market decline you should go in and buy on a dip, even a minor dip, because things will go higher. That is now a conditioned response, as Pavlovian as anything we have ever seen. And of course many stocks are down a lot. Although the larger, more well-known stocks are only down four or five percent, the typical NASDAQ stock is down about 30 percent for the year. So stocks are off from their highs, which always makes them a little bit more attractive.

And finally, the most important thing of all, absolutely the most important. . . . we can’t forecast anyway, so if you have money to invest why bother to forecast?

That’s the bull case. What do you think?

Dean LeBaron: Here is Rachel Perry, my granddaughter. She has come to visit with me. We have two dogs here with Blake (my son), as well as Stacy (my daughter and Rachel’s mother). And as we’ve been doing some work, we’ve also been having some fun. We have dogs here, but no cats. You have cats. Will you tell me about your cats, Rachel?

Rachel: Yes.

Dean: Please tell me about your cats. What are their names?

Rachel: Rusty. I can draw their names.

Dean: You can draw their names?

Rachel: Yes.

Dean: All right, here, let me give you a pen. All right, here’s the pen.

Rachel: I’ll draw the doggies’ names too. You draw the doggies’ names first. You do the doggies’ names.

Dean: All right. I’ll do them. But you have to tell me what their names are.

Rachel: Okay.

Dean: What are the names?

Rachel: Pawla and Barney.

Dean: Pawla and Barney. Okay, those are the dogs. What’s this letter?

Rachel: O.

Dean: And this letter right here?

Rachel: B

Dean: Okay, that’s right. Pawla and Barney. What are they doing now? What is Pawla doing?

Rachel: Sleeping.

Dean: Sleeping, yes, indeed. And are we going to take them out for a walk later?

Rachel: Yes, but they are very tired.

Dean: They’re very tired, yes. Are you tired?

Rachel: Uh-uh. I don’t go to sleep very much.

Dean: You don’t go to sleep very much—because you’re so active?

Rachel: Yes.

Dean: And life is exciting.

Rachel: Yes. You know you can draw my name first.

Dean: All right, I’ll draw your name. There it is. There’s your name.

Rachel: How about Mama’s?

Dean: I can draw your mother’s name too, yup. Well, this is the way we learn things. We learn things by doing, and we start learning them at a very, very early age. At this age, we learn faster and faster. I wanted to share that learning experience that we’re having, and fun, too, with you. Rachel, do you want to say goodbye to everybody?

Rachel: Yes.

Dean: Okay, why don’t you say goodbye, wave goodbye.

Rachel: Bye, everybody!

We live in an age of measurement. We want to measure everything . . . how high, how heavy, how much, the wind. We are trying desperately to improve our ability to have accurate measures. We need measures of course in order to be able to forecast because how can we tell anything about how much, how many, how heavy for the future unless we know the base from which we leave . . . the initial conditions. And yet as we improve our data (which we do) but do not improve anything to do with the measures—the models to which they move—in the end we come out with nothing that is any better.

I was part of a group, over ten years ago, that really started performance measurement for the Financial Analysts’ Society, as it was called then—AIMR, now—and we improved the data substantially by making it honest. But we didn’t improve anything on how the data was to be used. So, as a result, the data is no more forecastable than it was then, although it looks better, and can be used, seemingly, with higher degrees of confidence. Similarly in all other forms of data. We want to measure, but we’re still using the same old linear, Newtonian, archaic tools rather than tools that are adaptive, dynamic and which allow for multiple outcomes and options.

It’s too bad. We’re at the brink of being able to do it.

We are raised to think of time as absolutely immutable, a steady object. Time goes on. We were shocked to learn that time changes in its relationship to speed when Einstein came up with his very challenging theorem. However, those of us who are economists and investment people know that time is the X-axis, with equal units all the way across, and that time continuously flows. And we wear on our wrist a watch like this [holds up a wristwatch] that clicks at a steady rate.

But this is wrong. And this assumption builds errors into our system. Time comes in packets, quanta, bunches of information, at irregular rates. My friend Richard Olsen in Zürich has built a forecasting business in foreign exchange out of this for Olsen Associates. Similarly time means different things to different analysts. The late Roger Murray was in my office one day and said that there are some market events on particularly significant days that are more important than ten years of market data. That is something that has stayed with me.

We should look at time with great degrees of skepticism and look for new tools in dealing with time. High-frequency is one (and other methods as well) to take time away from the equation and look at time as a complete variable. We will make better forecasts if we treat time as discontinuous, not continuous.

Both Russia and China are sliding into a crisis, although of quite different sorts. In the case of Russia, capital flight has been a problem ever since the Soviet Union broke up and it’s worse now. Flight capital has always been estimated at between $17 billion and $25 billion, and that’s probably on the high side. Yeltsin called the business people in who were perhaps responsible for much of it and told them to quit it, and they seem to have laid off for the moment. Economic deterioration—the economic condition has never been other than deterioration—is perhaps accelerating on the downside now, every place except Moscow, and even Moscow is not doing as well.

The government is uneconomic, largely because it can’t collect taxes. It can’t collect taxes because the money is not there. There is a new, very sophisticated tax collector, Boris Fyodorov, and that will help some, but it’s hard to tell how much actual muscle he’ll have. The situation in Russia is not correctable by foreign loans but it’s necessary to shore it up, because of the nuclear leakage that might occur otherwise. It’s a very bad situation, and I doubt if it’s correctable until General Lebed has a crack at the presidential election and brings about a stronger sense of nationalism in the year 2000 and on.

China is different. China is sliding into recession because the overcapacity there has not been taken up and it’s being aggravated by lower economic conditions in the rest of Asia. The Hong Kong dollar is at severe risk; it’s currently pegged to the dollar, and I don’t think that will hold. The renminbi may well be devalued next year and it has been a situation that will severely tax extraordinarily adept government people—the same people who are in charge of the economy are the people who corrected the inflation problem a few years ago, and they are very strong. For the year 2000 and on, China will be dominant in Asia but, until then, between now and then, it’s going to be tough.

Both Russia and China have their challenges and we should watch both of them very carefully but for quite different reasons.

Why are market innovations so slow in coming? We’ve known for a long time what to do . . . integrate global markets electronically; pay shares in decimals not fractions; open the specialist books and stock exchanges, like the New York Stock Exchange. Record and display publicly the questions and answers exchanged by companies and analysts. And if we want to go a little further, like I believe we should, to encourage insider trading; that is, to bring insiders’ wisdom into the market sooner, rather than hold it out waiting for culprits to take advantage of us. It could be done, merely by identifying insiders. Let them trade, and they would identify themselves when they trade.

All of these things and more could be done in a stroke, and yet we are slow, because we are constantly slow. And we’re afraid of being litigious. It just doesn’t make any sense. It could happen in a stroke, and it should.

The Web has changed language in ways which are permanent. The old will never come back. Capitals are going out of use as most computer programs are case-insensitive. We now put links in our writings, hot links, to other sites and other programs, somewhat like footnotes, but as an active part of our writing. Our writing is more conversational. It is quick, not necessarily following the old grammatical rules. And it incorporates multi-media devices, graphics—we’ve gone back to working with words and graphics together.

And we have new tools. Wonderful new tools. Not only do we have spell-check and grammar-check on programs in Word, we also have a secret weapon tucked in there called Auto Summary, which can condense our writing down to any size that we wish—to a few words or a summary of the total, or 95% of the total, or some point in between. It is a wonderful program and I use it extensively.

The tools also translate. Translations now make sense. I use extensively TranSurf and Babelfish, which is tucked into Altavista from Digital, and there are others. LanguageForce tries to cope with Cyrillic and Kanji, some of the more exotic languages, and it’s somewhat more primitive, but clearly they’ll get it right eventually and make sense of the whole thing. If we were to write, today, "The Art of Readable Writing," it would never be the same as that wonderful little book that we read in school days.

Temporary-ness is on the rise. Anything that feeds into a temporary satisfaction is quite likely to be successful. Those institutions, which we identify with permanence and solidity, are under attack. Brand loyalty is going down, not increasing, now that we can easily compare products and services, one to another, on the ‘Net. Similarly, fee for services is becoming more popular than salaries. Outsourcing is being done in order to provide efficiency for just-when-needed, just-in-time processes, and no more.

We are also producing businesses the same way that movie producers are producing movies—no longer do we manage for permanence, but we manage for change; we manage for flexibility; we manage for competence in our core areas; and we manage for high productivity and efficiency. This increases the ability to maximize profits in the short run. It also tends to increase the speed and rapidity of change.

I’m not so sure what it does on the other side, in terms of providing support in the event of a decline. However, it is what is taking place, and we have to learn to adapt to it in a major, structural-change way.

Boundaries, chasms, barriers are forming in American society which can produce very severe clashes in the future, maybe several years, maybe longer, but they are almost irreconcilable.

The first is wage inequities. Wage imbalance has been a problem commented on by economists for the last five years. The difference between real wages at the top and bottom areas of the American society continue to widen as they have widened for the past 20 years. And the forces are in place that will widen them even further. And it is an extreme circumstance.

Next is access to the financial system. Those people who have access to financial instruments, savings accounts, mutual funds, and the like, are doing much better than those who do not. And this is also widening even further although a little market decline may do a lot in that arena if that sets in for a few years.

And finally, access to computer skills, the ability to self-learn and have access to the world’s knowledge through the Internet helps a certain group of people educate themselves, adapt themselves to new skills and new climates . . . those without fall behind.

These three factors produce a circumstance in the future, which could produce very, very sharp, divided cleavages in the American economy. This is consistent with what might be called a fourth phase in systems dynamics, and it is unresolvable.

Precisely the same evidence may be used to support a good market tone or a bad market tone—a bull market or a bear market.

For example, prices are not rising as you would expect at this advanced stage of a business recovery. It could be good . . . or it could be bad because inflationary forces are building up and they are extremely destabilizing as we are learning from Asia.

Rates are attractive for borrowing and money is plentiful, and that is very good for business . . . or it may well be bad, because it means that a great deal of money is flowing in from overseas to the United States as the last fortress of capital. Similarly the public continues to buy on debt, almost every one. Is that good, because it means confidence? Or is it bad because it means that there is such a strong psychological undertone to the market that when it cracks nothing will bring it back? Further, we have the quality stocks doing much better for the past several years than the broad market averages. Good leadership? Or bad, meaning that there really is a low level of confidence, and this is just speculation in well-known names? Also we have continued concerns about what will happen in the year 2000 with our computer systems. Good, if nothing happens? Or bad because the year 2000 is only 18 months away?

Finally, earnings are good. Yes, they are. On the other hand, the majority of the surprises are on the down side, not just this quarter, but in preceding quarters as well. There appears to be a deterioration in terms of buildup of disappointments.

The same news. It can be seen as good . . . or bad.

Currency intervention . . . what a terrible idea. It has been the policy of this administration for the past six years to not intervene in all of the other cases. We have had some bailouts but not policy interventions.

And now we have changed that in the case of the Japanese yen. I wonder if this really is a Hobson’s choice. If we don’t intervene, it looks like we are not taking an active role. If we do intervene, we are actually just throwing some money away, but at least it indicates that we are serious players on the world scene, if anyone doubted that before. So, I guess we had to do that in advance of the latest round of talks that will take place in Japan. But it does indicate the flaws of our present free-market thinking.

When we espouse free markets and have managed trade in the automobile industry for sale of American goods in Japan, we are speaking with both sides of our mouth. Similarly in currencies. The good side of currency cooperation is that when things work well they work better. The bad side is that there is no place to hide when somebody gets into trouble. We seem to be in a worldwide pattern—deflation and depreciation of currencies. That encourages money to move to the United States as a fortress or a haven for all of the others.

I just hope that it actually works.

Baroness Thatcher must be pleased. When the American government has a Democratic president and an isolationist Republican Congress, nothing happens. No legislation can be passed, no compromises can be reached, and business and the economy are just wonderful. This is the feel-good era.

In the field of disarmament, the arms’ race is on again, signaled first by the failure of the Americans to participate in the land-mine resolution, and lately by the subcontinent blowing up nuclear bombs. The race is on. In many respects, it never stopped.

There is a complete failure to address the health care issue, and we have the rather ludicrous examples of politicians running around holding benefit dinners while decrying the problems of election finance. We have huge mergers taking place with the Justice Department doing nothing. The latest one between Travelers and Citicorp is, perhaps, the most ludicrous of all because it is illegal until the Glass-Steagall Act is repealed. And finally, we have Goldman Sachs’ partners willing to share their largesse with the public in an IPO.

It surely is the feel-good time.

In times of volatility in so many factors it is worthwhile to stand back, gain perspective, and then, on issues, one by one, dig deeper to get your hands dirty with the data, and come back up. This used to be referred to sometimes as a pattern of inference reading for news. It is rather difficult to do when you are involved in day-to-day affairs, but it is essential to do when you want perspective.

Today, the mantras of the past fifty years are being broken one by one. Currencies are dropping one after another, the Japanese currency being the latest, but probably not the last. The mantra of the Japanese miracle which drove so much of the post-World War II period is broken and probably won’t return until China takes over as the leader of Greater Asia and Greater China well into the next century. The mantra of "small is good" is broken. Now companies are rushing to merge, to get bigger and bigger in order to build up liquidity and in order to cash in on the market’s favor now for larger companies.

Business, presumably, should be thinking long-term, but most of the proposals I see are extremely short-term and extremely equity-driven. We used to hold that capital was good to be poured into emerging market countries. Now the evidence is fairly strong that that has helped those people within the countries who had access to the financial system but has not done much for anybody else. Russia is an example of this, and the early moves of capitalism have exacerbated the split in income inequity around the world.

Globalization is giving way to nationalism which is putting at risk a whole variety of institutions set on the global model . . . the UN, the IMF (which probably is out of money) and NATO, are just among the few of many at risk. Finally, of course, we have labor unrest over work rules, not over pay. We’re facing the prospect of substantial trade deficits next year, and we will see some real union militancy coming up in the United States in the next few years.

So these mantras are being broken, one after another. What does that mean? It means we should go down into each one, get our hands dirty in the data and see what implications those have for our investment decision-making in this rather extraordinary era of volatility, change, and questions.

It would be a mistake to underestimate the importance of sports in world politics. Sports reaches the broad mass of people in many countries, many of them developing countries. The recent loss of a game by the United States to Iran may actually be a good thing, improving the chances of relations between these two countries, which wish to reconcile with each other. It tends to give some pride to the Iranians in their dealings with the American superpower, the American giant. And that is going to be extremely important in having them feel comfortable about making concessions, perhaps concessions involving some loss of pride.

I am also reminded that cricket was the first pathway to acceptance of South Africa back into the community of nations. And soccer was the way Brazil made itself known as a powerhouse in Latin America. We have opportunities now, perhaps with baseball in Cuba. Perhaps playing in Florida in the southern leagues during spring training.

Sports is important. I can remember the time at which a friend from China called to say there was some terrible, terrible news, a little more than a year ago. And I didn’t know what happened. The news was that China lost its bid to hold the Olympic Games in Shanghai.

Sports counts for a lot. And we should watch it very carefully, because it means so much to so many nations.

Agency issues tend to be forgotten about in bull markets. Essentially this is where people engaged in generally high-priced services—like investment managers, brokers, consultants—behave in their own interests and not in the interests of those fiduciaries they should be serving.

Usually, the mistakes, or things avoided, are fairly minor—things like high expenses; a limousine when a subway would do; wasted meetings; soft dollars, where institutions tolerate higher commission charges than do the more tight-fisted retail customers using electronic brokerage for their own accounts. And slow innovation, because it is so much fun making money the old-fashioned ways.

This is really the edge of ethics. It is not out-and-out dishonesty, but rather it is the avoidance of putting somebody else’s interests ahead of your own. It is a field of academic study, which should be pushed more than it is by the various industry groups who hold out their standards of high ethics.

Clinton’s visit to China is perhaps the most important presidential visit in recent memories, perhaps maybe even since World War II, when we had the massive visits of leaders to decide what the world would be. This visit is also deciding what the world will be, but we’ve got it wrong.

We forget very easily that, in China, the things that count are pride and pragmatism. We forgot it in the case of the Soviet Union in dealing with Gorbachev and we are left now with a mess and the turmoil of dangerous, destructive elements groping towards the future. Similarly we may do so in China. China is important to us but we don’t know the difference between their pride and what they do for pride, and their pragmatism and what they are doing for that. With Taiwan coming along towards independence, with Hong Kong in a state of turmoil, if not finding itself between East and West, again, we are missing the opportunities.

There are things that Clinton can do. He can contract his visit and make it smaller in response to the initiatives to belittle the positions that the United States is taking because China is playing to an internal audience. It does govern by the consent of the governed rather than by an autocracy—although it looks like an autocracy—and we forget that. We can—we have to—have some response to show that America feels that China is important, but that America is not a pushover. And we are not doing that.

I think China is taking its place as the leading nation in Asia and may become the leading nation, but it is doing so at the expense of the United States and we don’t understand enough about the Chinese to be able to manage this relationship correctly.

It is too bad. We could do it right.

The U.S. considers itself the model of disclosure in financial affairs. But there is much, much more that can be done. Particularly in this climate of mergers and acquisitions of one form or another, information known by insiders is kept out of the market by our archaic rules. We should try to capture the information that insiders know by encouraging insiders to trade, meaning, by identifying themselves, to trade whichever way they wish, to buy or sell, and capture their information on time.

Secondly, directors’ votes as reported in prospectuses and annual reports always seem to be unanimous . . . that is nonsense. Directors should not be unanimous if indeed they are functioning as directors. We do not have information as to what their true feelings are. Also, we do not track and disclose the payment of all resources by companies, by investment managers and brokers. But the flow of payments of all varieties, soft and hard, should be disclosed. And finally, we should use the press for reporting purposes rather than waiting for the awkward SEC reporting process. In Britain they use the press very aggressively, in India also. I don’t necessarily mean that these are models in everything, but using the financial press for disclosure purposes in a legal sense.

Safety valves are essential for governments, companies, perhaps even individuals. I was reminded when watching the pictures of Tiananmen Square how useful it would have been to have a section there entirely for dissidents, officially sanctioned by the Chinese government. If dissidents wanted to go and demonstrate and put up placards they could. Essentially that is what Speaker’s Corner is in Hyde Park in London.

Similarly, countries often have an extraterritorial safety valve for their finance system. Hong Kong is such a safety valve for the Chinese finance system, a little bit more liberal, a little bit of a way-station between East and West. Bermuda is such for the United States and Canada, the Channel Islands for the U.K., Uruguay for Brazil and Argentina, Mauritius for India. Almost every country has its extraterritorial place.

Companies do the same thing, perhaps, with casual days, or even company outings where things can come along and people can behave differently. So the safety valve is useful and could have been used so effectively by the Chinese government if they had thought to have a section of Tiananmen Square named "Dissident Section."

It is impossible to overestimate the importance of Taiwan to China. Clinton has handed China a triumph by reaffirming America’s decades-old "one-China" policy. But when America put this policy in, it was that there would be one China under the nationalist government. Now, we and everyone else know that the one China is under the PRC government, whether that is arrived at peaceably or otherwise.

I remember, when I first went to China with one of the earliest tourist groups in the mid-80s, I went to a Chinese movie theater at Lushan up in the hills. And my translator was telling me about the meaning of the story, a romance that I was seeing, of a beautiful, young Taiwanese woman who visited China with her family. She fell in love with a young officer in the PRC army and they were married, uniting around the mission of bringing the Chinas together. This story was so important and so wonderful, people in the theater were crying at how wonderful it would be to have the two Chinas together.

And I though of that at this occasion when I saw the one-China policy come to the fore again. The importance of that movie and the importance of almost everything that has happened, for the movement of Taiwan in the direction of China, are extremely helpful. The chance that it might occur peaceably is another issue. I fear, perhaps not.