Beta Beats Alpha

The Daily Reckoning, May 16, 2008
Bill Bonner

Real investment gains come from being in the right place at the right time.

The most reliable and entertaining trait of humankind is vanity. Despite much evidence to the contrary, men see themselves at the very centre of the universe…the alpha of all creation. Without man, nothing happens…trees fall in the forest, but who cares?

Primitive people imagine that they are to blame for whatever goes wrong – floods…earthquakes…volcanic eruptions; they appease the gods by tossing nubile virgins into volcanoes and building huge monuments of granite in their honour.

Modern people imagine that they are to thank for whatever goes right. Did they not write the Treaty of Versailles…and invent both Long Range Ballistic Missiles as well as Long Term Capital Management? Didn’t they build Las Vegas? And hasn’t Ben Bernanke finally taken the crunch out of the credit cycle?

What follows is basically a lament…a wail…a whining reflection on how we flatter ourselves…and why the most flattered are the best short sale candidates. The short version is that “alpha” is a windy fraud. In broader terms, the moral of the story is simply that whenever you feel proud enough to offer advice to others, you should prepare to get it yourself. Good and hard.

What brought this to mind is a news item from the New York Times. America’s president seems to have an insight. The reason food prices were going up, he guessed, was because people in India had more money in their pockets and now they wanted to eat more. This remark might have gone unnoticed, but for the fact that it was true. The foreigners are getting richer…and uppity. “Asian Age,” of New Delhi, whose name gives you an idea of the way the Indians think things are going, said the US president wouldn’t “get away…with passing the buck on to India.” Others threw biofuels and agricultural subsidies in America’s face. Then, striking low, they said Americans ate too much; if they just slimmed down to the weight of middle-class Indians, said Pradeep S. Mehta, “many hungry people in sub-Saharan Africa would find food on their plates.”

What a revolting development! For four generations, America has been the world’s alpha nation – the country with the money, the power, and the answers. Generations of Americans have offered advice to the rest of the planet, confident that they knew best what was good for everyone. Wilson showed up in Le Havre with his “14 Points” in 1918. Clemenceau remarked sourly that “God only needed 10.” From then until six months ago, the world’s unfortunates had to put up with American know-it-alls. “Tear down this wall,” said Ronald Reagan and the neo-cons. “Dollarise” said Jeffrey Sachs and the Chicago boys. US military “advisors” showed foreign armies and terrorist groups how to kill more efficiently. US businessmen explained how to set up factories and operate them more profitably. (F. W. Taylor introduced ‘scientific management’ …Stalin loved his ideas, which still are known as ‘Taylorism’ in much of the world.)

A long stream of professors handed out trade secrets like chewing gum, confident that the ideas would never stick; foreigners would never really get the hang of it. They urged free-market policies, monetary reforms, and market regulations. Agricultural engineers introduced peasants to pesticides and DDT. And just as 17 th century priests showed the heathen how to copulate correctly, our own world improvers demonstrated to couples all over the world how to copulate without begetting. There was no vanity too absurd…no pretension too embarrassing. By the 1960s, Americans were even sending their children – who hadn’t yet learned a trade or earned a living – in the belief that their callow bodies, in the Peace Corps, might lift the fuzzy wuzzies out of poverty like Pharaoh’s wife plucking Moses up out of the bulrushes.

And then, wouldn’t you know it? The little Moses all over the world took the advice, set up their own shops…and now they’re back-sassing America’s president and stealing its best customers.

And here, for further elaboration, we return to the world of money. While Americans offered advice gratuitously, Wall Street offered its own advice, for a price. The financial industry hotshots said that they, too, had some special magic. Yet, a colleague recently handed us a chart of the London stock market over the last 107 years. What is remarkable about it is that it shows a flattish line beginning over the far left and running right along the bottom for ¾ of the page. Then, after lying in the dirt for ¾ of a century, the chart suddenly springs to life like a locust, in the early ‘80s. In the next 20 years, it shot up more than 1000%.

This same phenomenon is visible in almost any market you choose to look at. There are small gains…and small losses…all the time. But the big gains come all at once. In the gold market, for example, except for occasional war spikes, the price barely budged from the defeat of the Spanish Armada until the 1970s. Then, an investor who bought the stuff in 1972 would have seen his money multiplied 21 times in the next eight years. Following this exertion, gold went back to sleep…and didn’t wake up for another two decades.

The pretence of America is the pretence of Wall Street. It is pretence of alpha itself and the vanity of the species. While Wall Street promised investors elusive, above-market gains – alpha – the real gains came from merely being in the right place at the right time. Beta, in other words. Likewise, it was no special genius that put Americans on top of the world; it was simply being in the right place at the right time. Too bad they can’t stay there.

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