Essential Reading – Book Reviews

Intelligent Investor
the Black Swan
Irrational Exuberance
The Misbehavior of Markets
The Ascent of Money
The Arsenal of Money
Why the West Rules for Now
Animal Spirits
This Time is Different
The King of California

The Intelligent Investor
by Benjamin Graham

This book is the ultimate case for investing being a liberal art. And if one lives by the principles Graham articulates, then achieving a reasonable return from stocks is likely. That has been my experience and is why I read this book every 5 years, or so.

Insights include: obvious prospects for growth in a company do not translate into obvious profits for investors because a.) you may be wrong about the prospects, or b.) the market has already fully anticipated the growth.

The rate of return sought is not related to the risk taken, it’s dependent “on the amount of intelligent effort the investor is willing and able to bring to bear on his task.”

And the rate of return earned will be dependent upon the price you pay.

“Really good preferred stocks can and do exist, but they are good in spite of their investment form, which is inherently a bad one…In other words, they should be bought on a bargain basis or not at all.”

“…new issues have special salesmanship behind them, which calls for a special degree of sales resistance…”

The book is loaded with rule-of-thumb recommendations about buying individual stocks and gives a practical reason as to why book value is important in most cases:

“The investor with a stock portfolio having such book values behind it can take a much more independent and detached view of stock market fluctuations than those who have paid high multipliers of both earnings and tangible assets.”

Graham is a big believer that one must have the right temperament to deal with market fluctuations and that you should know yourself. If you are temperamentally not suited to investing, then delegate it. If you are well-suited, then decide if you are a defensive investor or an enterprising investor.

The following quote is very “au courant:”

“I have never seen dependable calculations made about common stock values, or related investment policies, that went beyond simple arithmetic or the most elementary algebra. Whenever calculus is brought in, or higher algebra, you could take it as a warning signal that the operator was trying to substitute theory for experience, and usually also to give to speculation the deceptive guise of investment.”

A nice summary of viewing the unknowable: “The future itself can be approached in two different ways, which may be called the way of prediction (or projection) and the way of protection.” He, of course, opts for protection and a margin of safety.

A quote that has always stayed with me: “…the chief loss to investors come from the purchase of low-quality securities at times of favorable business conditions.”

Finally: “To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.”

This book has rightly been called the investment bible. Combine this with Shiller’s “Irrational Exuberance” and Taleb’s “The Black Swan” and you’ll have a knowledge base powerful enough to enable you to keep your own counsel; and not make the common mistakes of others.

The Black Swan
by Nassim Taleb

In the end, this great book is a call to rigorous self-thinking, living life on your own terms and intellectual honesty.

For example, Taleb believes attempting to turn a social science into an exact science (most MBA programs) is an intellectual fraud.

Taleb gives a litany of why humans are so error-prone and the problems we face: our belief we can understand a world that is more random than we realize; our retrospective distortion of events after the fact and our overvaluation of facts.

As well, we commit the error of confirmation, generalizing from the seen to the unseen; we fool ourselves with stories that cater to our Platonic thirst for distinct patterns; we ignore the possibility of silent evidence; we tunnel only a few well-defined sources of uncertainty; and we behave as if the Black Swan doesn’t exist.

Some quotes:

“The casino is the only human venture I know where the probabilities are known, Gaussian (i.e., bell-curve), and almost computable…In real life you do not know the odds; you need to discover them, and the sources of uncertainty are not defined.”

“Our knowledge does grow, but it is threatened by greater increases in confidence.”

“We humans are victims of an asymmetry in the perception of random events. We attribute our success to our skills, and our failures to external events outside our control…This causes us to think that we are better than others at whatever we do for a living.”

“Randomness, in the end, is just unknowledge. The world is opaque and appearances fool us.”

“…it is contagion that determines the fate of a theory in social science, not its validity.”

“A theory is like medicine (or government): often useless, sometimes necessary, always self-serving, and on occasion lethal.”

And my favorite: “It is more difficult to be a loser in a game you set up yourself.”

Irrational Exuberance
by Robert Shiller

This book, revised in 2005, and written by the Yale Professor and House Index “guy,” outlines 12 factors that gave rise to the ’90s stock market boom and the more recent bubble in home prices. He shows how the effect of these booms is sometimes amplified by feedback loops and naturally occurring Ponzi schemes–all aided by the news media. Shiller explores the cultural components of exuberance and examines the basic psychological factors that tie it all together. He then challenges the efficient market theory and in doing so, gives us the crux of his common sense wisdom:

“…as a rule, and on average, years with low price-earnings ratios have been followed by high returns, and years with high price-earnings ratios have been followed by low or negative returns.” This is particularly true for investors with a 10 year time horizon and warns that with p/e ratios as of 2005 in the mid-20s, the next ten years look bleak.

He mentions a common sense corollary: times of low dividend yield are followed by price decreases over the long term.

According to his excellent and free website,, the current p/e ratio is 21.67 vs. long term average of 16. He uses the Graham/Dodd method of 10-year average of real earnings for the denominator. In the book he mentions that other expensive times were: 1901 when the p/e peaked at 25.2; in 1929 when it reached 32.6X; 1966 when it hit 24.1X; and famously, 10 years ago when it topped out at 47.2X.

By contrast, in 1982 the p/e was less than 7X.

In short, this is a classic investment book and puts the current environment in perspective.

The (Mis)behavior of Markets
by Benoit Mandelbrot

Mandelbrot argues convincingly that “Modern Finance” is based on flawed theories and we need a new foundation on which to build our global risk management system (utilizing the insights offered from the study of fractal geometry, a discipline he invented).

He’d been saying this for 40 years.

Despite the glaring flaws in Modern Financial Theory, academics are wedded to the current orthodoxy for numerous reasons: insufficient math skills by many economists and business professors; the politics of academia, habit & convenience, etc.

As a stock picker, the only practical information is his mention of a 1992 paper by Fama and French. It found that most of what differentiated the profitability of one stock from another is that companies with low p/e ratios and low price-to-book-value ratios will outperform. Mandelbrot calls it common sense. I say it proves that Ben Graham rules!

My favorite quote that sums up the lesson: “What matters is the particular, not the average.

The Ascent of Money
by Niall Ferguson

Ferguson, a professor of History at Harvard, among other things, reminds us that financial innovation is a driving force behind human progress, as vital as the advances of science.

Money is a matter of belief, of faith; and it seems to be that “breaking the link between money creation and a metallic anchor has led to an unprecedented monetary expansion–and with it a credit boom the like of which the world has never seen.”

There’s a great quote from Jonathan Swift regarding his experience of a stock market crash: “most people thought it would come but no man prepared for it; no man considered it would come like a thief in the night, exactly as it happens in the case of death.”

Ferguson discusses the history of emerging markets and suggests they should be called re-emerging markets and reminds us that we are not living in the first great age of globalism: in 1913, over a quarter of all securities held globally were non-domestic. It was a time when “the combination of global integration and financial innovation had made the world seem reassuringly safe to investors.”

He gives 3 reasons why financial history will remain a roller-coaster ride: first, so much of the future is uncertain and so much risk is not calculable; second, humans are too prone to emotionalism: not learning from history, skewed modes of thinking, etc.; and finally, evolutionary forces play a role–the creative destruction aspect of capitalism: institutional mutation and natural selection==> random drift and flow.

Something to ponder from Ferguson regarding the world today: “It may even be that we are living through the deflation of a multi-decade ‘super bubble.’

Arsenal of Democracy
by Julian Zelizer

This book refers to a FDR quote and is a history of the influence of domestic politics on foreign policy, especially since the establishment of the national security state some 60-70 years ago. Zelizer makes a compelling case that foreign policy is often shaped not in response to international events, but by domestic political debates.

The book traces the history of how we ended up with a permanent national security state and reminds us of the conflict between democracy and the demands of running a superpower.

The author, a Professor of History at Princeton, goes into great detail to explain the complicated political issues politicians have to deal with in response to foreign policy challenges: electoral pressures, ideological issues, partisanship, institutional rivalry considerations, budgetary conflict, and the impact of various scandals (think Watergate, Iran-contra, etc.).

Zelizer mentions four basic issues that have shaped our history since the establishment of the permanent national security state: the balance between congressional and executive power; the partisan advantage on national security; the size of government we are willing to tolerate in pursuit of peace and prosperity; and the benefits of a unilateral vs. multilateral approach to foreign affairs.

One intriguing premise of the book is that FDR’s liberal internationalism continued the Democratic party’s political dominance until the late 1960′s when many Democrats questioned our role in Vietnam, and thus splintered the party.

In the same way Reagan’s conservative internationalism has propelled the Republican ascendancy. (He views Clinton as a conservative internationalist in foreign policy.) He also reminds us that Reagan’s foreign policy was often not supported and roundly criticized by the Republican Right (as was the case for Eisenhower and Nixon).

So what is the difference between conservative internationalism and liberal internationalism?

Republicans talk tougher and are less nuanced on defense, prefer unilateral action to multilateral solutions, and, most importantly, require much less financially and physically of its citizens.

The apex of conservative internationalism is the “W” years where we “funded” with tax cuts two wars that cost more than Korea and Vietnam combined in real terms. A far cry from LBJ’s guns vs. butter debates.

Another intriguing thought: LBJ was such a hawk on communism because it gave him cover for his progressive domestic agenda. The Right couldn’t credibly accuse him of being a Socialist if he were an anti-commie warrior.

A good book that will make you ponder what we, as a nation, are all about
and why we as a people do the things we’ve done.

Why the West Rules for Now
by Ian Morris

The scope and length of History covered by this book is truly impressive and interdisciplinary in its approach. Morris, an archaeologist by training and currently a Professor of History at Stamford, covers hundreds of thousands of years, taking us from pre-history to science-fiction in building his case as to why the West rules for now; and what will happen next.

His tale is the story of Homo sapiens and social development over the ages. He defines social development as societies’ ability to get things done: to shape the physical, economic, social and intellectual environment to satisfy its own end.

Morris uses a Social Development Index that begins around 14,000 B.C. He identifies four critical traits: Energy Capture, Organization, War-Making ability and Information Technology.

The history of social development is explained by three factors: biology, sociology and geography. Biology drives development up, sociology shapes how development rises or doesn’t, and geography decides where development rises or falls fastest.

Ultimately, biology and sociology explain global similarities and geography explains the regional differences. Morris spends considerable time arguing convincingly that people (in large groups) are all much the same; and shows that race-based theories about why the West rules are simply wrong.

Morris discusses the paradox of social development—the tendency for development to generate the very forces that undermine it—and how it has shaped history and what it might mean for the future

And the history of social development for both East and West is remarkably similar. It is a story of moving forward and going backward over cycles and centuries, until development hits against a “hard ceiling” and can progress no further.

In the West, a hard ceiling was reached during the Roman Empire. It would not be surpassed for 1,700 years: “Social development almost doubled in both East and West between 1000 and 100 BCE. Western development …was higher when Julius Caesar crossed the Rubicon than it would be when Columbus crossed the Atlantic.”

By the year 541, the East caught up with the West and by 1100, Eastern social development had risen as high as the peak reached in Ancient Rome. Then, as was the case in the West, China hit a hard ceiling and went into decline. It was a slow relative decline, and the East would remain ahead of the West for another six centuries.

The hard ceiling of social development has typically been due to society’s inability to make a breakthrough in energy capture. In other words, society did not get “the thought it needed” to move technology forwarded. These periods coincide with a visit by one or more of the 5 Horsemen of the Apocalypse: climate change, famine, state failure, migration and disease.

So why does the West rule for now?

Starting around 1750, Westerners were able to effectively tap into the stored energy of fossil fuels. This led to the Industrial Revolution, breaking through a hard ceiling that had existed for centuries.

The environment was ripe for this to happen—the West got the thought it needed partly thanks to the mindset of the great thinkers of the Renaissance, and, with the Atlantic Ocean opening up the world, the need for advances in technology followed. China, by contrast, went into steep decline after about 1800 due to civil wars and Western interference.

What will happen next? Morris believes we are once again hitting against a hard ceiling. “Either we will soon (perhaps before 2050) begin a transformation even more profound than the industrial revolution…or we will stagger into a collapse like no other.” The world will either look like Ray Kurzweil’s “Singularity,” or we’ll descend into nuclear war, into Nightfall.

To prevent Nightfall, the world needs to prevent nuclear war, slow down the acceleration of climate change (which he calls global “weirding”) and carry out a new revolution in energy capture. “Carrying on burning oil and coal like we did in the twentieth century will bring on Nightfall even before the hydrocarbons run out.”

In the end, our Age may get the thought we need and we will experience a profound transformation. There will no longer be a distinction between East and West, though America will likely continue its dominance because of DARPA, our lead in genetic research, nanotech, etc.

Or we may not get the thought we need and sometime in the next generation, China and the US will be at nuclear war over the world’s limited resources, and Homo Sapiens will once again be threatened with extinction.

Some quotes:

  • The entire course of history can be explained by “lazy, greedy, frightened people (who rarely know what they’re doing) looking for easier, more profitable, and safer ways of doing things.”
  • The great transformations in social development: “each was the result of desperate times calling for desperate measures.”

Some facts:

  • People of European and Asian descent share 1 to 4 percent of their genes with Neanderthals; only Africans did not interbreed with Neanderthals and therefore Modern Africans are pure Homo sapiens.
  • Depending on how you count, the world’s experienced between 40 and 50 Ice Ages.
  • It’s estimated that there were barely 20,000 Homo sapiens left alive 100,000 years ago.
  • During the apex of the last Ice Age, around 20,000 years ago, mile-thick glaciers locked-up so much water that the sea level was 300 feet lower than today.
  • The world slid back into an Ice Age period from 10,800—9,600 B.C. and Mankind was “expelled from the garden of Eden.”

Animal Spirits
by George Akerlof & Robert Shiller

This book reminds me of Tolstoy and his view of what caused the Napoleonic Wars: simply that the men of the West decided it was time to slay the men of the East. In the language of the great J.M. Keynes, Animal Spirits overtook them.

Akerlof and Shiller assert: “Just as Adam Smith’s invisible hand is the keynote of classical economics, Keynes’ animal spirits are the keynote to a different view of the economy–a view that explains the underlying instabilities of capitalism…”

A surprise for me was learning that most economists do not incorporate Animal Spirits into their analysis. “In their attempt to clean up macroeconomics and make it more scientific, the standard macroeconomists have imposed research structure and discipline by focusing on how the economy would behave if people only had economic motives and if they were also fully rational.”

The authors say the Animal Spirits ignored are confidence, fairness, corruption, money illusion and stories. “These are real motivations for real people. They are ubiquitous. The presumption of mainstream macroeconomics that they have no important role strikes us as absurd.”

The first part of the book gives a detailed explanation of each animal spirit. The second half answers economic questions using animal spirits as a guide. For example: most economic ups and downs are caused by “overconfidence followed by under confidence.” True but not exactly an earth shattering insight.

A nice quote that is related to the question of fairness: “We have shown that a great deal of what makes people happy is living up to what they think they should be doing.”

I’m glad I read this book but it’s not in the same league as Shiller’s masterpiece, Irrational Exuberance.

This Time is Different–Eight Centuries of Financial Folly
by Carmen Reinhart & Kenneth Rogoff

This book concentrates mostly on the history of financial crises but delves into theory at appropriate times. It is straight-forward, easy to read and chock full of data/evidence. The lessons taught are important and profound. But the real fun is in the plethora of “boxes”and “tables” scattered throughout the book and at the end section, Data Appendixes.

The main message of the book is: we’ve been here before and history can teach us warning signals as well as how the economy will likely look as a financial crisis unfolds. That every generation creates justifications for why the old rules don’t apply, why this time it’s different. And the ‘this-time-is-different’ syndrome is caused by a failure to recognize the precariousness and fickleness of confidence.

The book explains the different types of crises, most of which have their roots in too much debt fueling a boom.

These crises include sovereign debt crises in which investors lose faith in the ability or willingness of governments to fulfill their obligations.

Inflationary crises involve debasing the currency to inflate away the value of debts.

Banking crises in which people lose faith in private-sector promises essential to a market economy. And these crises in tandem often results in a currency crises.

The authors make the point that nations have been able to graduate from being serial defaulters of their sovereign debt, but no country has been able to graduate from bank crises.

Sovereign default, by the way, is much more common than most think: indeed, it’s the norm; not the exception for just about all countries.

What caused the recent financial crisis? “The U.S. conceit that its financial and regulatory system could withstand massive capital inflows on a sustained basis without any problems arguably laid the foundation for the global financial crisis of the late 2000s. The thinking that this time is different…”

The antecedents of a banking crisis in rich countries and in emerging markets have much in common. In the U.S. specific signs in 2007 were: 1. asset price inflation, particularly housing prices had doubled in five years; 2. rising leverage; 3. large sustained current account deficits; 4. slowing trajectory of economic growth.

So what happens in the aftermath? First, deep and prolonged asset market collapses: real housing prices drop 35% over 5-6 years and equities decline an average of 56% over a 3 1/2 year downturn. Second, the unemployment rate jumps 7 percentage points over 4 years and output drops 9% over a couple of years. Lastly, government debt increases by 86% on average. The main cause of this explosion is not the cost of bank bailouts, it’s the collapse in tax revenues due to the bad economy. This explosion of debt sets off rounds of sovereign defaults.

The authors try to end their discussion on a positive note by saying authorities now have more flexible monetary frameworks as well as other tools, but then: “…we would be wise not to push too far the conceit that we are smarter than our predecessors.”

A nice quote: “V-shaped recoveries in equity prices are far more common than V-shaped recoveries in real housing prices or employment.”

Looking back over 800 years: “Technology has changed, the height of humans has changed, and fashions have changed. Yet the ability of governments and investors to delude themselves, giving rise to periodic bouts of euphoria that usually ends in tears, seems to have remained a constant.”

I learned a new concept: the Lucas critique says that it is naive to try to predict the effects of a change in economic policy entirely on the basis of relationships observed in historical data, especially highly aggregated historical data. Clearly Rogoff and Reinhardt beg to differ.

Terrific book!

The King of California
by Mark Arax & Rick Wartzman

This is a fascinating and fast paced historical narrative about the taming of the West, exploitation of the environment on a massive level, the development of water rights, murder for land and the migration of the peoples who settled California. It’s also a tale about how government bureaucrats break the law to help friends.

But most of all it’s about two Boswells, an Uncle from the “Old South” and later, his nephew, who built one of the country’s largest Agricultural Empires through cleverness, connections, and obsession. There’s much to admire about these two men and much about their legacy to criticize. In other words, it’s a thought-provoking book.

My favorite quote by Jim Boswell: I’m not going to tell you how to run your life except to get it right.”