Each time I visit a yearly financial asset management gathering (no press allowed) with some of the largest financiers in the country (and the world) interspersed with ambassadors, members of Congress and White House representatives (thanks for the tour Meg), I am reminded how fundamentally different finance behaves from production.
The people at the top in finance are kind, well-groomed, approachable, and appear willing to help each other in any way they can. They are out to build lasting relationships with their peers in the industry, to share investment strategies, foster deal flow, and secure new career opportunities.
At first glance, no one appears to be selling anything to anyone. Instead, the esteemed financiers mingle, meet, and greet to prepare to talk shop at some other time or location, hidden from view. No one shakes the (money) tree with tough questions for the star-studded panel, afraid of becoming collegially disbarred.
Everyone seems to share, and float comfortably in midair, unfazed by the economic threats that keep knocking on our door. Undeterred, these financiers proceed to feed their respective firms with investment returns wherever they emerge globally and deploy escapism with cunning precision when the easy ones dissipate.
Void of explicit recognition of their fiduciary role and responsibility in our nation’s health and prosperity, even when tickled by a probing ambassador.
Despite finance’s ethereal behavior, it has a lot to lose.
The United States (and many other countries that copied our financial model) is in trouble because over many decennia – so do not get partisan on me now – it has amassed a financial system eleven times the size of production.
We gained self-induced economic instability as a result of valuing the ballooning gamble on production (with its many derivatives) higher than the creation of products that yield socioeconomic value. A giant financial bubble, more significant than we have ever seen before, is starting to deflate. And no new air blown into it by the sub-optimizations from the Fed or other government institutions will prevent it from collapsing further.
Fundamental financial reform is the cure needed to resurrect our economy.
Mark my words; nothing will improve in the economic outlook of our country until we improve the economic imbalance between finance and production.
Production in the more modern definition, that is, the intellectual capacity to produce innovation that may yield physical manufacturing, wherever that is best produced (think iPhone: designed in California, assembled in China).
Our economic instability is caused by the extreme imbalance between production and finance, and thus any new legislation that does not deploy an appropriate rebalance will be futile. Regulations that implement more restrictions on structural in-market deficiencies will have minimal impact on the health of our economy, as they are sure to be circumvented by more in-depth and even less transparent financial constructs.
Simply put, we need to reduce the size and dependency on finance and improve the size and role of production to ensure economic prosperity and stability. Finance needs to be redirected to trace the opportunity for production more accurately by removing the ability to make continued investments in itself.
We need to remove pancake economics.
At the heart of our economic engine are financiers, the aforementioned asset managers, who supported by the free-for-all of an aging laissez-faire economic model – that we have allowed them to deploy – have a convoluted, uninformed and thus unrealistic assessment of risk associated with the underlying assets (production). Yes, I just said that.
To put it more entrepreneurial:
No company in my portfolio or that I would start would be allowed to deploy the endless diversification of risk and responsibility as it exists in the asset management playbook today.
My point is that financiers are supposed to be the ultimate experts in assessing risk, and yet by my discovery of how money is deployed and following the trail, few have a clue. I support that assessment by asking some of the top financiers in the country the following simple question:
Why do you expect to generate sustainable outlier returns from the deployment of no less than ten levels of bottom-heavy diversification (in each asset class) ?
A question these top financiers all – without exception – fail to answer decisively, instead of stumbling and stuttering with a sometimes “what do you mean?” or “that can’t be true” or “I’ll ask my managers” deferred answer. It is a question that does not require knowledge of the workings of finance nor deep domain expertise in a particular asset class. But a question that challenges their understanding of the full value-chain of risk that determines the support of the underlying production.
By playing the telephone-game (or Chinese whispers) in class, a story you say to the first person that they then need to tell forward to the next, will yield a completely different story (and facts) after it has traversed ten people. And thus an asset management strategy that is supposed to empower production, that is predicated on the deployment of ten levels of (bottom-heavy) diversification will be invalidated by people as smart as elementary scholars.
The discovery from my analysis yields a more complete and systemic fix of our economy is steeped in fundamentals and does not require the fuzzy logic deployed by hindsight laden economists endlessly tweaking the economic dials and feverishly applying a plethora of stimuli that cost us even more money.
The starting point to rebalancing production with finance starts with a straightforward exercise I have deployed so many times in my life; if we were to invent a financial system from scratch today, would we invent it the way it works today? The answer to that question based on my findings is: absolutely not.