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Leithner Letter Nos. 87-89
26 March - May 2007

I was duped ... by the Secretary of the Treasury, and made a tool for forwarding his schemes, not then sufficiently understood by me; and of all the errors of my political life, this one has occasioned me the greatest regret.

Thomas Jefferson
Letter to George Washington (9 September 1792)

I wish it were possible to obtain a single amendment to our Constitution. I would be willing to depend on that alone for the reduction of the administration of our government; I mean an additional article, taking from the federal government the power of borrowing. I [also] deny them power of making paper money or anything else a legal tender. I know that to pay all proper expenses within the year, would, in the case of war, be hard on us. But not so hard as ten wars instead of one.

Thomas Jefferson
Letter to John Taylor of Caroline (26 November 1798)

To preserve the independence of the people, we must not let our rulers load us with perpetual debt. We must make our election between economy and liberty, or profusion and servitude.

Thomas Jefferson
Letter to Samuel Kercheval (12 July 1816)

Avoid the Rush: Prepare Now for America’s Bankruptcy

Grahamite investors analyse companies and securities. They focus upon businesses and their operations rather than markets’ and economies’ fluctuations. Hence their decision to purchase a given security stems from an analysis of the underlying company’s past and present. This decision does not hinge upon any specific prediction about the security’s future price; still less does it include detailed assumptions about the overall market’s or economy’s prospects.

These points are widely misunderstood – even among people who purport to be value investors. Grahamites do not, as is often asserted, ignore market and economic conditions; nor do they exclude these considerations from their analyses. Instead, they ask questions such as: “how unusual are the results (profits, dividends, etc.) that X Ltd has generated over the past 5-10 years? Have monetary and overall economic conditions given these results an artificial or unusually favourable boost? Given general corporate ‘base rates’ and those for similar companies, how likely is it that these results can continue? Are there grounds to believe that X’s results in the future will regress towards some long-term mean? If so, does a purchase at today’s price provide a margin of safety that sufficiently offsets the risk that X’s future operations might not match those of the present and recent past?”

Precisely because they draw conclusions about the prices of many securities, Grahamites also hold views, which are rough and prone to error, about market indices today and several years hence. And because they form judgments about the normality or otherwise of today’s economic conditions, they also develop opinions about booms and busts down the road.

Graham, for example, famously warned in the late 1950s about unduly and perhaps dangerously high asset prices (see, for example, his articles “The New Speculation in Common Stocks” and “Stock Market Warning: Danger Ahead!”). Conversely, he rejoiced when in the mid-1970s he detected attractively cheap prices (see “The Renaissance of Value” and “The Future of Common Stocks,” all of which appear in Janet Lowe, ed., The Rediscovered Benjamin Graham: Selected Writings of the Wall Street Legend, John Wiley & Sons, 1999). Similarly, citing implausibly high prices and correspondingly meagre prospects, in 1969 Warren Buffett closed his investment partnership. And at several points since the late 1990s he has warned investors to temper their expectations about the results they might reasonably expect during the years and decades to come (for examples, see the references on Leithner & Co.’s links page).

Grahamites’ views about markets, interest rates, overall profitability, etc. thus play a distinctly second fiddle to their analyses of individual companies and securities. They incorporate these views into their individual analyses; but within these analyses, company-specific factors and figures always predominate. Their approach resembles that of Lawrence Sloan, who in Every Man and His Common Stocks (McGraw-Hill, 1931) posed three questions about the funk then gripping the U.S. (and most other countries). First, was the country in the midst of a severe and possibly prolonged slump? The answer, he believed, was “yes.” Second, could astute observers have discerned signs of trouble ahead of time? Sloan thought that they could have; and one economist, Ludwig von Mises, certainly did (see in particular Percy Greaves, ed., The Causes of the Economic Crisis and Other Essays Before and After the Great Depression, Ludwig von Mises Institute, 2006).

Sloan’s third question is perhaps the most important. Could investors have protected their portfolios from the Depression’s worst effects? Maybe – but only if they were prepared to ignore the crowd and think for themselves. The problem was that during the boom, signs of bust were apparent only to those who sought them. And as the Depression unfolded, mixed and positive signs remained numerous enough to persuade investors with optimistic and even neutral views of the world, such as Graham, that all would soon be well. Then and now, the most sensible stance – particularly when one’s analysis of the past yields the conclusion that today’s prices and profits are improbably high, and that tomorrow’s harvest might be rather thin – is to expect reductions, adopt a rather dour attitude and incorporate cautious macro possibilities into one’s micro analyses. Mind the downside, in short, and the upside will mind itself.

How to apply this mindset to the conditions prevailing early in 2007? First, disregard high and possibly rising international tensions. They are real, but have been caused mostly by Western governments. Accordingly, these governments could, if they chose, reduce these tensions; and at any rate, they are much less severe and their consequences less pressing than they were during most of the 20th century. Most notably, the risk of terrorism in Oz is trivial. Also, forget about the bird flu scare. As Jeffrey Tucker shows in Bush’s Fowl Play, it is largely the concoction of budget-maximising bureaucrats. Finally, ignore global warming. It’s a possibility; but so too, as Lawrence Solomon shows (The Deniers), is global cooling. And perhaps warming is a good thing. Whatever it is, it’s not a hard fact. It is, rather, an accelerating bandwagon energetically pushed by (a) scientists whose status and income depend upon the state rather than a sober application of the scientific method and (b) politicians and other zealots eagerly grasping the latest opportunity to aggrandise themselves and plunder everybody else (see, for example, Climate Chaos? Don’t Believe It by Christopher Monckton and The Stern Review: A Dual Critique). Accordingly, even if global warming exists, says Bjorn Lomborg in The Sceptical Environmentalist, the interventions demanded to combat it – like all government interventions – will produce more harm than good.

Put out of your mind, in short, the exotic and hypothetical risks that are stirring ever more people into a collectivist frenzy. Instead, focus upon a danger that is much more pedestrian, whose evidence is much firmer and whose consequences politicians are doing their best to ignore. Why wait? Be the first on your block to recognise that the U.S. Government likely is – or before long will probably become – bankrupt.

To read the entire Newsletter (PDF), click here.

Chris Leithner


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