Dean LeBaron, techie,
quant, futurist, international investor, author. A full introduction of the
founder of Batterymarch Financial, would fill pages. Suffice it to say he’s
retired, but still very much at the top of his game. Dean splits his time
now between a lake home in Switzerland and one in New Hampshire, where I
caught up with him soon after Christmas, and only a couple weeks after his
return from Europe. Attitudes towards the U.S. there, and in the rest of
world were still very much on Dean’s agile mind. His analysis, sobering.
KMW
It must be hard to leave Switzerland, just as the skiing season begins—
Wow, it’s great weather there. I like Switzerland very much. I’ve been going
there for 15-20 years and I’m officially a Swiss resident—mostly because I’m
there six months a year and so should be paying for their services, which I
do. But you see the world differently, or at least I do, from Europe than
you do from here. And that’s always good. I try to read the European
newspapers even when I am here, which you can of course now do online.
Switzerland is a good place and it works.
You obviously started going there well before you “retired.” I’ll use quotes
because even a quick glance at www.deanlebaron.com provides ample evidence
that you are probably as busy now as you ever were at Batterymarch.
That’s right. But it is different now; all my time is my own. With so much
essentially unscheduled time, you can go wherever your mind takes you. It is
a tremendous luxury.
I’m envious. Your website indicates you’re still steeped in everything from
the future of finance to explorations of complexity—as well as the grandkids
and couple of fabulously scenic lakes.
The computer has evolved into a facility that makes so much knowledge
available at a click and a way for so many people to stay in touch. About
25,000 people come to my web site every week—and most of them are people
I’ve known. It’s not like—I remember when Nelson Rockefeller said he had
100,000 “closest friends.” That’s not the case. A lot of these people, I’ve
never seen or met with personally, but we’ve connected in one way or
another. It’s really very nice to be able to maintain contact with people in
far and distant places.
You’ve never lost your enthusiasm for computers—
Not at all. It’s wonderful that Google is formalizing this knowledge
exchange by putting a library online. Consider this: The goal of the new
Alexandria Bibliotheca in Egypt is to have 8 million volumes. But that
collection will pale in comparison to what is being contributed to Google.
The University of Michigan is contributing six million volumes of its own. I
think Google will have 80 million or more volumes online and available for
anyone at their home. That is fantastic. It’s as fantastic as the fact that
MIT has each of its courses available online for free.
It does? What a tuition deal.
It was a counterintuitive initiative of Charles West, MIT’s recently retired
president—and just such a tremendous resource for people in countries like
China , who otherwise would have no access to some of those courses.
It certainly melts away all sorts of distance and financial impediments to
learning. But I’m not sure how I’d feel if I were paying my son’s tuition
bills to MIT—
It’s nothing like the full experience. A student in Cambridge gets so much
more than course materials and an outline. And the thing this really does is
puts the instructors on notice that last year’s course and course outline is
a commodity. “You’ve got to come up with something new.” It’s almost the
reverse of tying something down with a patent or other proprietary lock. It
says that innovation and initiative come from open sourcing, rather than
from closed systems that promise of proprietary protection in advance. I
think that’s an important insight into innovation for the United States—not
to blow it up into too much of a big deal. But we are probably the world’s
greatest fans of patent and copyright protection, even though everybody
likes to claim we’re going for innovation. It may well be that innovation
comes more from opening things up and making them available, increasing the
pace of development, rather than closing down. As the fellow who founded
Sony, Akio Morita, said, “If we don’t compete with ourselves, somebody else
will.” He was always obsoleting his own products. So patent and copyright
protection, I think, is something we should revisit.
I detect that there are any number of issues on which you feel the U.S. is
losing its way.
Well, I noticed something during my most recent stay in Switzerland,
something so very substantially different that I commented on it in a video
on my website that I called “America’s Under Quarantine.” In some measure,
it was a reaction to the recent election. But even a year or two ago,
Europeans especially—but also others—were telling me, “We don’t understand
the American government. We were friendly and supportive of America after
9-11, and we tried to be helpful. But then America took such a high-handed
approach” (essentially referring to the Bush Administration), “that we sort
of pulled back and said, well, that will change after an election because
Americans are such good and compassionate and generous people. They will not
tolerate this degree of high-handedness.” So, after the election, Europeans
have been stunned. Some famously so. What was that headline in the The
Standard, of London? “How Can 53 Million Americans Be So Wrong To Have Vote
For This—” I think they called him a dummy or something.
Bush couldn’t get elected dogcatcher there—
But my point is that there has been a big change in Europe. Now, it is not
just the U.S. government that they don’t like. It’s the American people.
Sure, we have some friends there, but Europeans in general really are afraid
of America. And they have decided, “We’d just better distance ourselves as
much as possible.” So they are forming a European Defense Union, which is
essentially NATO, without America. They are seriously discussing which
currency will be a reserve currency, other than the dollar. They’re
discussing trade relationships that do not depend on the World Trade
Organization, which they see as dominated by America, and so on. What I am
saying is that we are being sidelined, and it’s serious. There has been a
sharp drop in the number of foreign students applying to American
universities this year.
That’s a big worry for the schools, because exchange students by and large
pay full freight.
It is a big deal. And not just financially. At places like MIT, for example,
the students coming from Asia tend to be the best and the brightest. They’ve
been chosen to come, out of very large populations. I visited a Chinese
technical university last May, during what we would call spring break. Yet
most of the students and faculty were on campus. I didn’t ask them why they
weren’t boozing it up in the Chinese equivalent of Fort Lauderdale, but I
did ask why they weren’t home, visiting their families. I was told, “in the
first place it’s expensive to go home and, secondly, we’re here to study.”
So, the university actually adds extra courses for the holiday. That
just demonstrates extraordinary motivation. When you see that, you’re
getting a little glimpse of the future. But what I also realized while I was
there is that people in China today—just as in Europe—are less interested
than they were even a year or two ago in what America is doing. They have
just decided they want to distance themselves from the U.S. They want to
distance themselves from the language, from the currency, from military
alliances that are dominated by America. And they don’t need the U.S. for
trade. It’s a combination of circumstances. On a personal level, when I had
to get a visa to go to China, I was in Switzerland. No big deal. As a Swiss
resident, I went down to the Chinese consulate. A sign said Chinese visas
for foreigners, meaning non-Swiss, were 100 francs. I handed the fellow at
the counter 100 francs with my application. He looked at me and said, “No.
No. Not 100, 200 francs.” I’m thrifty, so asked, “Why 200?” He said, “You’re
American. Americans stick it to us. We stick it to them.” That attitude
isn’t unusual. Just fly back to the States from overseas. You’ll see all the
Swiss and all the other so-called foreigners being lined up to have their
retinas photographed and their fingerprints taken, while all the Americans
basically fly through immigration. It makes a bad impression. In any event,
we are withdrawing from the world—and the world is allowing us to, easily.
That’s a very serious thing, long-term.
You’ve written that America is becoming irrelevant. Isn’t that overstating
your case?
No. We can’t afford it. We need $2 billion a day of foreign money coming in.
We’re somewhat like a household pet, I fear. Somebody has to put a dish in
front of us every day with $2 billion in it, otherwise we don’t eat. We
don’t know how to make anything anymore. And it’s not a matter of tinkering
with the value of the euro. We can’t survive on our own. We’re like a bank,
I fear. The only thing we know how to do is financial services. We need
depositors—and most banks don’t thrive by insulting their depositors. But so
far, that’s what we have done. Our depositors are looking for alternative
institutions down the street.
Gee, just because we treat them like borrowers?
That’s true. Remember the financial cliché that says if you want to borrow
from a bank, make sure you borrow so much money that the bank becomes your
partner, rather than your lender?
Now you’re sharing Donald Trump’s secret.
Exactly. Don’t borrow $100. Borrow $100 million, then you “own” the bank.
That would imply we retain a lot of influence with our foreign creditors—
But it’s not the same. Our influence is very constrained. Our mutual friend,
Steve Leuthold is very good at looking at presidential cycles and market
cycles of three-four years or so. Which is great. But that’s not so much
what I’m worried about at the moment. Not even a five-year cycle. I’m
worried we are on some bigger cycle, almost a generational cycle or even two
generational cycle. I will admit to a secret interest in Kondratieff Waves.
It’s not so much that they’re exactly 57 years—and yes, I do remember that
they are commodities cycles. But there is something to the notion that
you’re likely to remember the lessons of your father, but not the lessons of
your grandfathers, so that over the span of a couple of generations, you
might have a big cycle. Some of the stuff going on at the moment looks big
cycle to me.
You’re sounding very European. Have you been surprised by attitudes here,
since you returned?
I’m clearly not in the majority here. But it is striking. Even my friends in
Switzerland and elsewhere in Europe who used to be very enthusiastic
supporters of the U.S., are not now. I’d say 95% or 98% of the Europeans I
know are people who have had favorable experiences with globalization. If
you asked them today, “Is America a good influence in the world or a bad
influence?” they’d say it’s bad. They would point out things like the fact
that, near as anyone can tell, nobody was considered to be selected as Time
Magazine’s “Man of the Year,” who wasn’t an American.
That’s pretty petty. Why should they care about Time?
Their point is that America is obsessed with itself—and not with its role in
the world—although I guess Bush would disagree.
Isn’t it more that they don’t like the role it is playing?
Yes. They are all very much against America. Now, Americans are puzzled.
They tend to ask how Europe can fail to understand that this country is
generous and compassionate?” But if you listen to Jeffrey Sachs (Director of
The Earth Institute, Quetelet Professor of Sustainable Development, and
Professor of Health Policy and Management at Columbia University) talk about
America’s role in development spending, he points out that we spend less in
per unit of GDP than any other developed country. Furthermore, that a lot of
it is politically tied or military aid, or that at best it tends to pay for
expensive consultants staying in high-priced hotels. Very little American
aid is development aid that helps people. I’m surprised, in fact, that he
hasn’t been in the headlines yet, talking about the disaster in Southeast
Asia, where this country’s first move was to announce that it was giving
$100,000 in total aid to the government of India. Jeff has done a lot of
work sorting out how much of our foreign aid goes to governments who vote
with us at the U.N. and how very little actually goes to help grassroots
people in Africa, for instance, where it has no political impact. It was
interesting too, to see it pointed out in this morning’s paper, that federal
aid to Florida, which was having an election, after the hurricanes was
around $13 billion. (At least, that’s what was announced; we’re not very
good at actually following through and paying.) But total announced aid for
the governments in Southeast Asia stands at $35 million. Do we see ourselves
as persons in the world or do we see ourselves as Americans? Other people
look at us and say we’re thinking of America first, even when we think we’re
acting globally. It is a different viewpoint. Things look different from
here.
You have the advantage of dual vantage points
And I’m afraid I agree with theirs. Somebody gave me a little joke gift for
my son for Christmas. It includes a Canadian flag and a guide for Americans
on how to sound Canadian. Someone, tellingly, has turned that into a
commercial product. I don’t mean to get into political stuff with you. But I
must admit that I find the glaring absence of Democratic voices in
post-election discussions of any issue I can think of just extraordinary. I
mean, John Kerry and Tom Daschle may have lost, but they should still have
views on the policies and appointments that are emerging. But if they are
commenting, they’re not being picked up in anything I am reading. My
suggestion is that America deserves a shadow government, somewhat like the
British system, where the party out of power creates shadow cabinet offices
and such to demonstrate they’re engaged and worthy of being returned to
power.
There was a time–in my memory—when the leaders of the opposition party
wielded real power in Washington.
I hear the reason that they don’t now may well be that the Executive branch
has figured out ways to usurp the power of the purse—actually pay out or
withhold money, whether in accord with legislation or not. I can’t cite
chapter and verse, but there are some programs that have been passed, which
tend to be environmental and the like– for which money just has not been
expended. It just sits there. Meanwhile, bridges get built from nowhere to
nowhere in Alaska. Then again, in the most recent congressional elections,
something like 96% of the incumbents were re-elected.
And half of the 4% who weren’t, didn’t run again.
Yes. This suggests that we have learned how to provide pork to the
representatives of both parties. There’s an implicit deal made: Tow the
line, stay out of the way, and your district can have all the bridges or
whatever you want. I remember seeing this sort of government first-hand,
back when I had three plantations in Papua, New Guinea, and tried to learn
about agriculture in developing countries. I also got a lesson in how people
got elected. Including my partner there. The legislature, of which he was a
member, gave itself an appropriation of money to be handed out at the
discretion of the legislator in each district. I sat there and watched as
the chiefs of the various villages came in to see my partner. He’d sit there
with a pile of cash in front of him, and hand money out to each. Those
chiefs knew exactly where the largess was coming from, so when it came time
for an election, they’d deliver their votes and my partner was re-elected
resoundingly each time, as were all the other legislators. Those were real
elections, and it was a political process. But was anything actually taking
place? I’m not sure.
At least there’s a refreshing honestly and simplicity about that, compared
with the special interest funding that greases Washington's wheels.
Shouldn’t we be horrified when the Chairman of the House Committee that just
wrote a major piece of drug regulation retires to becomes the chief lobbyist
for the drug industry ? But nobody raises an eyebrow. The sort of general
mood of the public that this reflects is another indication to me that we
may be caught up in market cycles of more importance that a typical business
cycle. Kerry talked about a global test for America, but I would argue that
we already have one, our currency. It’s a way that people globally can
“vote” on whether they see America in a favorable light. Where the dollar
has gone, down 7% since the election, suggests to me that we’re flunking the
global test.
Although few here paid much attention as the dollar fell even more than that
earlier last year
Right. The trend is not new. It’s just a little bit more precipitous and a
little more visible. Which would suggest that there should be a pause. The
contrarian in me says that if this is just a normal trend, the dollar is due
to bounce. But I fear that it’s not just an ordinary cycle and in the long
run Americans—investors, especially—will have to become accustomed to
investing money the way Swiss do, across a broad range of currencies. And
the dollar will be just one of many, not the sole one. That’s the new way of
thinking in America.
True enough. But couldn’t the dollar’s decline, especially against the euro,
go a long way towards explaining the sour attitude about the U.S. you’ve
been describing there?
I mean, I don’t know which is a lead or which is a lag or whether it’s
coincident. My hunch is it’s coincident. I don’t think the dollar’s decline
has necessarily soured attitudes. I’ve seen the dollar go down before. The
kinds of people I’m talking to, if they didn’t have these attitudes, would
be looking to take advantage of these market moves. In fact, my hunch is
that their attitudes are leading indicators, but I have no data to support
that whatsoever, just anecdotal conversations.
So what should America be doing to win back old friends?
A series of things. The first, of course, is ending our misadventure in
Iraq. Europeans believe it has nothing to do with terrorist threats against
the United States—except perhaps to promote them. They feel that the world
is less safe now, and that their own countries are less safe, than before
the U.S. invaded Iraq. They say that the Administration publicly seems to be
making decisions on the basis of information that everything is fine and
dandy and generally going well in Iraq, which is very much at odds with what
they are seeing and hearing. They say they have seen the U.S. inviting other
countries into Iraq as partners —but not treating them as partners, even
Britain. Their impression is that they’re invited to follow, and to sign
blank checks that will probably be sent to Halliburton, solely at the U.S.’s
discretion. That is intolerably insulting to the Europeans. Not so much the
money, but the attitude and the style. Beyond Iraq, they sense that the U.S.
is attempting to dominate the world. In fact, Rumsfeld in his near-soliloquy
to the troops at Christmastime sounded this same note, saying that America
is in Iraq to bring democracy to the world. He added, “This is the same as
putting down Hitler’s fascism.”
And Saddam, while awful, wasn’t Hitler?
Well, I am old enough to remember Hitler. I was alive then. What Hitler
talked about was bringing the glories of German efficiency, the 1,000-year
Reich, to the rest of the world under his leadership. What the Soviet Union
was trying to do was bring the glories of communism to the word. We opposed
the Soviet Union, not because the Russian people were exploited under the
yoke of communism, but because it was exporting communism to a variety of
other countries, including Cuba, Vietnam, and others. Well, it seems to
me—and to many Europeans—that we are doing much the same thing. Hitler tried
to forcibly export national socialism. We are we are trying to forcibly
export democracy. Justifying it by saying, “Of course, the world wants
democracy and freedom.” But what much of the world may really want more is
clean water, sewers and electricity. Instead, in Iraq, they have less of
those basics than they had before, but we’re telling the Iraqis they don’t
want them. That we’re going to give them democracy and freedom—as long as
they don’t vote for mullahs friendly to Iran. Rumsfeld made that clear. To
European ears, he sounded just like he could have been standing in Nuremberg
in 1938.
He certainly didn’t raise those kind of hackles on this side of the pond.
Europeans are much more sensitive to those kinds of stylistic nuances—and
history. It so often is not what we do, but how we go about it. Look at our
response to this disaster in Asia. How much better it would have been to
simply come out quickly with a pledge of money and troops and airlift
capability—to be provided under the leadership of someone like Australia, if
not the UN. That would have gone over so well. I worry about these kinds of
things because they can have a big influence on how people think. But my
biggest, sort of bedrock , concern is that—after the bubble of the late
1990s—we have not completed the cycle of pain and recovery that typically
should occur after a bubble. It surprises me that the financial services
industry is as strong as it is. That speculation is rampant. That hedge
funds, your subscribers, are growing. There’s a lot of money around and
willing to speculate in a short-term sense and at high prices. That is not
what usually occurs after a bubble. It may mean that the pain is still in
front of us now. I tend to think that’s true.
Why? Maybe we’ve just gotten smarter—
Well, I’ve noticed around Lake Sunapee, for example—this is a local
thing—that most of the people who are buying houses on the lake (where real
estate taxes have just gone up by about 300%) are involved with the
financial industry in some way. That’s troubling. We can’t all be providing
financial services to each other. Some of us have to be bending metal.
Very few, evidently. You say we haven’t had enough pain. Surely, 2002
counted for something.
Yes, we got a bad bear market when the bubble finally popped. But the
recovery rally that we had in 2003 and that managed to keep its act together
basically in 2004 was pretty dramatic. In fact, I tend to like cheap prices,
to really invest. And there aren’t any now. At best, there are some
reasonable values, and those are pretty hard to find. But there are also
some outrageous ones, because there’s so much money around, seemingly.
Seemingly?
Yes. We’re all part of a very long chain of obligations and money creation.
A break in that chain quickly becomes very serious and that risk—thus far,
typically brings a fairly quick federal response. The collapse of Long Term
Capital Management was the last thing that seemed to threaten that chain,
and the crisis brought everybody out quickly. Most people–I was not one—but
most others had not even heard of that firm. Yet all of a sudden, it looked
like it had the potential to bring down the entire financial structure
because it was so much a part of the chain of obligations and money creation
that runs through the system. If that really was the case, we’re probably
even more vulnerable now, than we were before. The discussion now revolves
around to what extent the troubles at Fannie Mae could distress the housing
market. My guess is not much, because there are so many private companies
ready to step into that particular role, if there’s enough money around.
What’s more worrisome is that if the Europeans, Japanese and Chinese weren’t
supplying us with our $2 billion a day of kibbles, there might not be enough
money around to keep that chain going.
Isn’t that the essence of the problem the incredible mountain of debt we’ve
built up? All the leverage that’s been employed to prime the world’s pumps?
Yes. My financial education began long enough ago that I remember textbook
admonitions that you issued bonds only to pay for specific projects that
would generate sufficient revenue to pay off the bonds. You didn’t —
How perfectly quaint!
It is extremely quaint. That was back when the sign on my office door said,
“Statistical Department,” not “Financial Analyst.” Now, of course, bonds are
considered a perpetual part of a capital structure—and their quality is
determined by their ability to be refinanced. It’s a totally different type
of instrument than the one that used to be related to particular projects.
Still, I remember “credit risk” from time to time, because bonds on the
downside tend to bite you in some very unfortunate ways, when you can’t
refinance them—as whole industries of junk bond credits and the junk bond
financing market attest. They grew up out of the need to recapitalize
companies that were unable to be refinanced. If that happens on a broad
scale, it could be very troublesome. And now the decision as to whether that
happens on a broad scale is no longer an American decision. It is a foreign
decision.
In other words, without our huge foreign inflows, bond prices collapse?
We’re dependent on our kibble. And as I pointed out in one of my recent
video commentaries, I suspect that China has made a very quiet, but major
policy decision to move economically into areas that previously had been
considered off-limits, because they are within the traditional American
sphere of influence.
Why is that?
The fact that China bought up 45% of Cuba’s nickel production would have
been unimaginable two years ago. Likewise, China coming in and buying oil
production in Canada, in Venezuela, as well as buying businesses in Brazil
and Argentina. [Not to mention IBM’s PC business. Or talk of a Chinese bid
for Unocal.] This goes back to old Monroe Doctrine stuff, where no country
would have inflamed the United States by threatening in its economic sphere;
by coming in and saying I’m going to go in business, or even China saying,
“Well, I’m going to buy IBM’s PC unit.” If that doesn’t ring a bell to
anyone else, it sure rings a bell with me. The economic world we have
entered is far different than the one we have left. Bond market decisions
are not going to be made by us in New York but will be made by Chinese in
Shanghai.
The typical Wall Street response is that it makes no difference. The Chinese
have to keep buying our bonds—in effect, keep providing vendor financing—or
they won’t be able to sell their exports.
So far, the Street has been right about that. But I think the Chinese are
less and less concerned about their export markets. This is more my
impression, more anecdotal evidence from my visit there in May, than
anything else. But they seemed less concerned with the U.S. market as an
export market than they were with their own market as a domestic market.
And, curiously enough, they’ve moved up the line very rapidly in terms of
technology and consumer products. They’re not just providing us with cheap
textile goods anymore. If you look at them, all of the DVD players and other
consumer electronics like that have Chinese manufacturers’ labels. This
isn’t junk. It’s good stuff, and it is well-designed. I went to a Chinese
auto show while I was there, for example. And what they can turn out for
$7,000 or $8,0000—I’ve even forgotten the name of the car—but I could
visualize it having a good export market. It wasn’t just a Volkswagen copy.
It was a Italian-style product that looked pretty good, although I didn’t
drive it. I can’t say that technologically it came anywhere close to a
hybrid, like Toyota’s, but it wasn’t bad. There’ll be a market for it. China
isn’t selling stuff merely on price anymore. They have good technology. And
their domestic market interests them more than their export market to the
U.S.
Granted, China’s domestic market—eventually—should be huge. But a whole lot
of development still has to take place before many Chinese have paved roads
where they live, much less the means to buy an $8,000 car.
Yes, that’s true. China is not there yet. But I’m reminded of two things.
One is the old story about the shoe salesmen assigned to Brazil. The first
shoe salesman goes there and he reports back to headquarters, “This is a
terrible place. Nobody’s wearing shoes. I can’t sell a thing.” So they bring
him back. The second guy goes out to the same place and reports back, “This
is wonderful. Nobody’s wearing shoes. I can sell shoes to everybody.”
“Opportunity is where you find it”–
Sure, and just as American companies are finding it attractive to
manufacture and sell their goods in China, Chinese manufacturers are also
finding their own domestic market attractive. They agree. The other thing
is, as an aside, let me share with you something a Chinese official told me,
semi-seriously, I think, while I was there: “By the year 2050, the average
Chinese family will have an American houseboy!”
A Chinese official said that?
Yes, I’ve forgotten his name. That’s probably just as well, to protect the
innocent. But it’s obviously stuck in my mind.
Small wonder you’re preaching about the balance of payments deficit.
Yes. And I don’t know any painless way to fix it. I was very disappointed in
the campaign. John Kerry talked about protecting American production, which
which sounded protectionist—and it may well have been. That would be
obviously the wrong course. Certainly, if Kerry doesn’t know that, his
adviser, Bob Rubin does—and should have told him so, no matter how
superficially attractive it sounded politically in the Midwest. But even
there they know that you can’t get away with putting on tariffs.
What should have been proposed?
I don’t know. There are no attractive ways of coming out of the balance of
payments deficit. It involves repaying someone. Probably one of the easiest
places to start, or what should be, would be with American farm policy,
which is highly protective. We have a subsidy program that–depending on how
you count it—amounts to $40 to $80 billion a year. But we’re obviously not
going to change that policy, since the farm states voted so overwhelmingly
for the Administration. Nobody even proposes changing it. Still, it would be
a good place to start, eliminating the subsidies to make American farm
products competitive in the world market, as they should be. Even though
that would mean a lot of farmers would go out of business.
You want to destroy “the American family farm?” Talk about a political
non-starter.
I was an American farmer for a while. I had 12 farms—and I received
substantial farm subsidies. I couldn’t not take them, because the farmers I
had actually farming the properties insisted on being able to use the
subsidies and farm price support programs. Once they get hooked on that
welfare system, they can’t say no. What amused me, as another aside, was
that these same farmers I had working farms around the country were all
very much against urban welfare programs. And, again, what amused me, just
as an aside, was that these same farmers were very much against urban
welfare programs.
On which we spend a lot less than we do on farm subsidies, no?
Exactly. I found it appalling. So I quit farming.
These are all complex and many-sided issues. But you’re on the board of the
Santa Fe Institute. Complexity should be right up your alley.
What I’ve learned is that sometimes, a simple solution to a complex problem
is best. Frequently, when we look at a complex problem like Social Security
or debt management, we think it is intractable and study it to death. We
could learn something from China’s efficiency on that score. When they come
up against a problem like that, they appoint a small team to study it for a
about six weeks, then they have to come back with a recommendation. Which is
implemented, if they’re going to do anything at all, within a few weeks. In
that spirit, I do have some simple solutions to propose for complex problems
that threaten to be intractable.
Go on—
The first is to get out of Iraq immediately. Meaning, turn it over to the
U.N. and promise to pay whatever they tell us it costs. That way, the pain
of getting out of there will be humiliation, more than anything else. Which
is what the world wants to see. So the more humiliation we absorb, and the
sooner we admit our mistake, the less it will cost us. It doesn’t have to be
20 years and 500,000 lives. But we have to get out. We’re not on the side of
the angels there. We have to turn it over to some form of leadership that
doesn’t look American. Even the UN may be too Western for people in the
Middle East. We’ve already inflamed the whole region. Iraq’s neighbors have
far greater vested interests there than we do. Let them sort it out.
The second thing we have to do is find a way to be productive in the few
industries we have left. Which probably involves promoting research. Yet at
the moment, the National Science Foundation budget is being cut. Our
universities are being cut off from the foreign graduate students who are
the heart of American academic research. We’ve got to find those ways to get
those people back. People with skills have to be encouraged to come into
this country. Economically, I don’t think you put up protection for
industry. Essentially, you have to do the reverse, open doors. I think you
make it possible for Americans to invest in production facilities wherever
it makes the most sense, to keep them on the leading edge of information and
competition.
Doesn’t that amount to exporting our increasingly scarce capital?
I’m trying to say we’d import ideas, but we may well export capital in the
process. We have to be prepared to accept the fact that the dollar has
already ceased to be the principle store of value for the rest of the world.
English is probably gone as the sole language of commerce, to be replaced by
computer translations. In the short run it’s extremely painful. In the long
run, as a free trader, I hope that it stimulates what’s left of America’s
inventiveness. But anything that you do to put up barriers makes it worse.
Free trade sounds good. But can it work when our trading partners are
playing by different rules? The Chinese aren’t really free trade
advocates—or capitalists.
No one knows yet, do they? But then, while the U.S. espouses free trade, to
most of the world we appear very hypocritical in that. What I am suggesting
is that we know protectionism doesn’t work, so let’s try free trade. I am a
believer that if everyone finds their specialty the invisible economic hand
will let the African countries grow things because farming happens to be one
of the easiest ways to convert unskilled labor into a product. Here, I have
no grand magic solutions, except education and job retraining. It’ll be a
long process. We are so far out of manufacturing that it’s hard to imagine
getting back in easily. It will take a lot of time.
What about your old bailiwick, Wall Street?
I think it’s wonderful that the industry is doing well. We’re all, in
various ways, beneficiaries . However, I think the financial industry has
become decoupled. It’s operating quite separate from the underlying economy.
Normally, I think, the financial industry should be reflective of the
economy—though, again, I recognize that’s a quaint idea. Still, I find it
disturbing that the financial industry has morphed into a sort of
speculative numbers game that has nothing to do with how the economy does,
or how companies do. It’s a zero sum game of I’ll speculate against you and
you’ll speculate against me and one of us will win. This degree of
separation—and mind you, I’m investing in a company that’s very directly
involved in this separation—will ultimately come apart. Eventually, someone
will look back and realize there is nothing underneath it. What should be
underneath it—this is the quaint part—is companies that make money and whose
shares sell on the basis of those profits from what they do—and not on the
basis of whether someone has designed them into a new hedged or unhedged
instrument someone will buy. And that’s true, even though, as I said, I’m an
investor in a company that is engaged in so-called event markets, InTrade.
What’s its attraction?
I like new markets a lot. But this one has little to do with the underlying
companies. It allows somebody to express a bet on whether or not they think
interest rates will go up or down or whether the Republicans or the
Democrats will win or Osama bin Laden will be caught . This market has
nothing to do with the events themselves. It only has only to do with one
person on one side of the market and another person on another side of the
market disagreeing about some event—and transferring money based upon that
disagreement. Which is fine as a small market in a free economy. But in the
economy in general, ultimately, I think these decoupled money flows have a
way of influencing economic activity. Originally, it was the other way
around. Again, when I started in this business, if a company did well, then
coincidentally or even subsequently its securities would do well. But more
recently we have had the dominance of financial flows. If you could raise
money very cheaply, you could influence your company’s fortunes by making
more capital investments and so forth. So, finance actually led economic
activity. Now, we’re in a new phase, where financial flows are becoming
separated. They have nothing to do with what companies do. The price of
Google is as good an example as any. Google is a wonderful company doing
great things, but that has rather little to do with whether people want
Google in their portfolios at $185 or $190 or whatever it is today.
Only with whether they’re willing to wager someone will pay more. It strikes
me that you were very much present at the creation of financial phenomena
like indexing, which put us on the path to this unhinged financial economy—
Yes. And it’s been a progression in some sense. Tremendous changes have
taken place, even in the 30 years I’ve been watching the markets in terms of
the growth of these things.
But is there a tipping point? Have we passed it?
A tipping point ? I don’t know. Indexing was something that we were always
doing anyway. The only thing that Batterymarch did was to make something
that was implicit explicit. Many of us were investing in the same kinds of
portfolios other people had in other firms; were very concerned with things
that were overweighted or new. We weren’t being very precise about it. But
the result was that we all had pretty similar portfolios. At Batterymarch
all we did was say, why not explicitly call it indexing? Cut expenses
expenses across the portfolio and be clear that you’re not going to be
adding any value by picking one steel company versus another; just index the
major part of your portfolio. Then, if you want, with a minor part of your
portfolio, you can play with high alpha stocks. That’s really what we did.
We also developed a capacity to mechanically replicate almost any investment
strategy you could define in terms of financial characteristics, P/E,
financial riskiness, market cap or whatever, which in most cases we could do
very cheaply. Obviously, you weren’t paying for investment insights, and the
competition to reduce trading costs helped us tremendously. We got trading
costs down to zero in some cases below zero, on some portfolios. Today, a
large proportion of portfolios are indexed, passively run, while most in the
other sphere are very aggressively run, with high turnover. And I think
segregating the two strategies is a step forward in asset management. It
puts the decision in terms of I’m going to index 80% of my assets and play
with 20% or whatever. I think the contribution that Batterymarch made here,
along with Wells Fargo and a few others, was—I don’t want to say stop the
hypocrisy—but we redefined the chores. Still, I admit I was surprised that
indexing became such a short-term thing. As the industry grew, we needed
some way to measure the quality of one indexer versus another. I remember
when there were 75 of us indexers in one issue of P&I–and who was the “best”
indexer was determined by how many basis points you were above or below the
index in one month. That was when I said, “This is getting to be
ridiculous,” and we left indexing. It wasn’t as much fun as it had been. It
had become a marketing game. There’s nothing wrong with that, except it
wasn’t what we were good at doing. I always thought of Batterymarch as an
engineering shop. If we could make something that was superior from an
engineering standpoint, at a lower cost, it was a good idea. But if we had
to compete just on a marketing basis, we generally didn’t do a good job at
it and would quit it.
The ascendancy of marketing played no small role in some of the recent
financial and corporate scandals—
I probably should have commented on them earlier. What’s very strange to me
is that in all these corporate scandals, [except, now, WorldCom] none of the
independent directors have been held responsible for their lack of
diligence. But they shouldn’t get off. They’re the ones charged with
fiduciary duty, given responsibility for financial and management oversight.
Certainly more directly than research analysts. But they don’t seem to be
taking much heat for not doing their jobs, even though they often were
getting very large salaries and insurance to indemnify them in case of
problems.
They were bought off with the crack cocaine of the corporate set, options
compensation. But blasé acceptance of the notion that directors are mere
window dressing seems to be the norm.
I think so. And that really does trouble me. Nobody picks up on the fact
they weren’t doing their jobs. I’m a fan of transparency. I think
transparency solves almost everything. You participate in the process of
transparency by publishing. I’ve tried to be as open as I can, to the point
of obnoxiousness sometimes. But I’ve never heard of a directors’ vote that
was other than unanimous. If that’s true, what a waste of time. Companies
never have directors stand for election individually or make claims as to
what they’re in favor or what they’re against. You get a list and are asked
to vote for a group, not really knowing anything about what they’re doing.
That seems to be pretty stupid. The process—without transparency—is broken.
And it looks to me like it’s not getting fixed.
A lot of institutional investors even refuse to do anything but vote with
managements, arguing that they “vote” by buying or selling the stock.
Isn’t that silly? The curious thing was that even my good friend, Jack Bogle,
who is as vocal on the need for transparency as anyone, had his own company
embarrass him by refusing to disclose their votes. Way back when,
Batterymarch publicly announced its proxy votes 10 days before every
balloting date. In addition, if any company announced that its directors had
voted unanimously and adopted shark repellants, we voted against those
directors, including when they were nominated as directors at other
companies. This did not exactly win friends or influence a lot of people in
the corporate world— although I can’t tie the loss of any specific piece of
business to this policy, we did coincidentally happen to lose some business
about the same time we instituted it. So it was not conducive to commercial
success, but it was a position I felt very strongly about—and still do.
But that the crux of it, isn’t it? What portfolio manager, whose performance
is measured virtually by the nanosecond, is going to cast a vote that might,
even for a moment, cast the management of a portfolio holding in less than
sterling light?
Yes, that’s true. I had some very interesting, challenging conversations
with clients of Batterymarch when we were voting against some of their
directors. More transparency and a little boardroom democracy would go a
long way toward eliminating unethical practices.
I know, market forecasts aren’t your thing. But it is the new year. Care to
try?
I’ve been gloomier than I should have been for the past couple of years,
more than a couple, and really haven’t done much. So I don’t really have any
market forecasts. Other than that we’re due for a bad bump sometime. Whether
this year or next year, I don’t know. My former colleague, good friend and a
fellow I admire, Jeremy Grantham, thinks a really rough patch begins this
year. That’s as good a forecast as any.
Thanks, Dean.
W@W Interviewee Research Disclosure: The
opinions expressed by Dean LeBaron are his own, and subject to change.
Factual information is taken from sources believed to be correct, but memory
does play tricks. Dean LeBaron’s personal portfolio holdings are subject to
change without notice; he does not provide investment advice and no part of
this interview constitutes an offer to sell or a solicitation of an offer to
buy a security, or any interest in any fund. All discussions of portfolio
management, investment theories or possible holdings are intended as
illustrations of investment strategy, not as specific securities
recommendations or investment advice. For further information, see:
www.deanlebaron.com. |
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Illustration by Ann Field |
