The Market Monarchs
DRAPER, ROGER
THE MARKET MONARCHS BY ROGER DRAPER For more than a generation, the most common academic model for Wall Street investment has been the "efficient market" (or "random walk") theory. EMT holds that...
...The drama of "stateless" money—so-called because no single state can possibly direct its movements around the globe?and the efforts of monetary authorities to contain it are the subject of The Confidence Game: How Unelected Central Bankers Are Governing the Changed Global Economy (Simon & Schuster, 606 pp., $30.00) by Steven Solomon, formerly a reporter at Forbes...
...In time, said Graham, it is fairly likely that the undervalued shares will rise to their "intrinsic value," but this is not necessarily embodied in the market price...
...No new information caused the crash of October 19,1987...
...markets...
...The Bretton Woods agreement (1944), stabilizing the relative values of currencies in terms of the dollar, and the dollar's value in terms of gold, made our currency the medium of world trade...
...Lowenstein succeeds not only in telling a very readable tale about an important man but also in stimulating the reader to think seriously about investments...
...Unlike Buffett, too, most contemporary investors aim to build up a broad, countercyclical portfolio of risks, rather than concentrate on a few they really understand...
...In addition, only the central bankers had a common mindset—hostility to inflation and skepticism about the ascendant gospel of deregulation—as well as effective transnational institutions, notably the Bank for International Settlements (Basel...
...All certificates of a given class issued by a company are exactly alike...
...EMT holds that all important information is continually factored into the price of a company's shares...
...But the problem, as the author admits elsewhere in the book, is more serious: "For lengthy periods"—not just "occasionally"—the trends of stateless money have been "divorced from the underlying fundamentals of the real economy, producing the unprecedented exchange rate misalignments, economic imbalances, and financial booms and crashes that have marked the era...
...Thereafter, governments chose to blame 29-year-old traders for whatever happened, though there is still a good deal of covert intervention...
...In 1973, fixed exchange rates were abandoned...
...Few transactions fully conform to this pattern, but its defenders say it has very considerable predictive value even if it is only partially accurate...
...If you had given Warren Buffett $ 10,000 in 1956, at the start of his career, you would now be a millionaire 80 times over...
...When money managers in Japan buy T-bills, yen must be exchanged for dollars...
...if they are selling low, the market has rationally judged that the company's future earnings will be lower than those of businesses whose equities trade at higher levels...
...This was no random walk...
...rate of inflation undermined the Bretton Woods ratios, and by the early 1970s the authorities could no longer maintain them by intervening in foreign exchange markets...
...Indeed, EMT would appear to be further undermined by the success of Graham and his disciples, especially Buffett...
...it responds to Japanese as well as American economic cues by very actively trading on U.S...
...Solomon, who shares the currency-oriented viewpoint of Paul H. Volcker, Alan Greenspan and their foreign counterparts makes much of an observation attributed to Lenin by John Maynard Keynes: "The best way to destroy the capitalist system was to debauch the currency...
...The concept of a market is based on the metaphor of a commodity auction, where buyers and sellers meet face-to-face, all participants are guided entirely by the hope of gain, and the products for sale are pretty much identical...
...Starting in the late 1960s, the surging U.S...
...The author and central bankers will need better evidence for the importance they invariably attach to low inflation than his opinion could ever provide...
...By finding undervalued stocks and waiting patiently, investors could hope to realize a substantial capital gain at some point...
...This Japanese money is mostly new, and therefore nervous...
...Japan became the principal source of stateless loot because it depends so heavily on its exports to the U.S...
...They made it possible for Washington to raise the loans it needed to function...
...More and more of this speculative capital crosses national boundaries, chiefly from Japan to the United States...
...Berkshire Hathaway, Buffett's investment vehicle since the early 1970s, was once a major textile producer...
...Yet stock markets do not behave as EMT leads us to think they should, so the force of the auction metaphor at the heart of market theory is substantially weakened: As Lowenstein notes, share prices have been "far more volatile than the expected cash flows of the underlying companies of which they were in theory a mirror...
...since EMT, the dominant point of view, questions the possibility of long-term investments with unusually high returns, most investors in the U.S., Western Europe and Japan place short-term bets on the direction of various markets and of such indicators as interest and exchange rates...
...Federal Reserve Board and its equivalents elsewhere have saved financial markets from what Solomon calls "their inherent tendency to destabilize occasionally...
...But Lenin failed to overthrow a single truly capitalist state, and it is absurd to suppose that he knew "the best way" of doing so...
...This focuses on the fact that the shares of many enterprises are undervalued in the light of their assets and potential ability to generate future earnings...
...For reasons that are obvious if not sufficient, the central bankers who cope with these excesses are the author's heroes...
...Tightness and the resulting higher interest rates send currencies flying, and vice versa...
...They were better placed than any other officials to influence exchange rates, both through direct intervention in currency markets and their largely independent power over the domestic money supply...
...Profit is the sole object...
...They prevented a recession after October 19,1987, and limited the recession of the early 1990s...
...Except for a jet (the Indefensible) charged to Berkshire, he seems to live on the $ 100,000 salary he pays himself as chairman of the company, which as recently as the late 1980s had a corporate staff of 11 people...
...the debtors have rescheduled their payments and continued to gain access to funds...
...In short, for 20 years the U.S...
...By contrast, finance ministers in the 1980s were often ideologues hostile to government intervention, or politicians who wanted low interest rates in virtually all situations...
...For if Wall Street and its overseas counterparts are not rational, what on earth is...
...He himself claims to be guided by an earlier investment model: the "value theory" of Benjamin Graham...
...Thus, when a country's interest rates go up, overseas money managers purchase its debt instruments, and its currency soars...
...There is one place, however, that completely satisfies the theoretical conditions of a true market: the stock exchange...
...that it must finance them itself...
...In the long run, therefore, no stock can yield an exceptional rate of return...
...In the main Japan's "frenzied domestic financial speculators," as Solomon calls them, must know even less about the events they are gambling their cash on than American investors do...
...This explosion reflected equally spectacular long-term increases in the value of Berkshire's investments and the earnings accruing from them...
...Consider the achievement of perhaps the most successful investor of our time, whose life story is presented in Buffett (Random, 473 pp., $27.50) by Roger Lowenstein, a Wall Street Journal reporter...
...The advocates of EMT suggest that Buffett trades on inside information...
...Investors, say the proponents of EMT, are betting on the ticker tape's overall direction, not on their own holdings, so they might as well choose their portfolios by taking a random walk through the floor of the exchange...
...For the first time in history, as Solomon notes, capital is "free to pursue its innate profit-expansive logic regardless of geographic boundary...
...Shares are bought and sold in a series of ongoing auctions...
...They cut the rate of inflation in the early 1980s...
...the same soon happens somewhere else...
...In a global context such behavior makes even less sense than it does domestically...
...He himself is worth $9.7 billion...
...But in the 1980s, that ceased to be the case...
...Stock markets resemble crowds, he maintained, not calculating machines...
...Why, then, do some people do so much better than the general run...
...This is precisely the sort of divination Buffett avoids...
...they are rational solely over the long run...
...Foreign exchange markets primarily used to supply the monetary needs of international trade in goods...
...Buffett, curiously enough, is a liberal Democrat who would "tax the hell out of personal consumption—at progressively higher rates—and impose an 'enormous' inheritance tax...
...Stateless money emerged by installments...
...Instead, as the United States came to depend on huge loans to finance its budget deficit and its investment requirements, foreigners hastened to supply them...
...Berkshire itself pays no dividends...
...Banks that had lent imprudently to the Third World survived their follies...
...EMT appeals to those who desire a better, purer kind of market economy...
...and to restrict competition among domestic financial institutions, Tokyo has discouraged internal investment opportunities...
...Since 1962, when he first started buying its shares, their price has gone from $7.60 to $29,900—the highest on the New York Stock Exchange—following his decision (in late 1995) to sell a fifth of Berkshire's stake in Salomon Brothers...
...Buffett differs from his mentor Graham in his partiality to firms, like Coca-Cola, that basically take advantage of their place in the national psyche rather than hard assets...
...Such transactions now drive foreign exchange markets...
...The central bankers who have presided over this evolution?especially those of the United States, Japan, the nations of the European Community, and Switzerland—had the unique ability to essay bringing this flood tide under control...
Vol. 78 • December 1995 • No. 9
