A Gift to My Children Page 4

  CHAPTER 7

  Your Education, Part III:

  Learn History!

  A MACROSCOPIC VIEW OF THE WORLD

  IS WHAT YOU NEED.

  I want you to study history. I want you to understand the changes taking place in the world from a macroscopic perspective; by that, I mean that I want you to understand the big picture of how the world works and has always worked. You will learn that what is true today may not be true in twenty years, or even ten. In 1910 the British and German royal families were the fastest of friends and allies. Four years later their countries were embroiled in a totally senseless war. Examine the world at any one point, and you will find that ten to twenty years later much had changed.

  An interest in history, politics, and economics will help you see how occurrences in one country affect other nations as well, economically and in other ways. For instance, a single country's political turmoil can drive up commodity prices around the world; the price of gold in particular will usually rise. A full-scale war will drive up not only the price of gold but the price of most other commodities.

  WHICH HISTORY BOOK TELLS US THE TRUTH?

  History is multifaceted. There are historical studies in economics and politics; there is history as examined and understood from the viewpoint of the United States, from a European perspective, and from the outlook of various Asian, African, and South American nations. You will learn that most history is written by victors so has a clear view. As long as the historian has been rigorous, each perspective can fill in a piece of the historical puzzle. You really cannot say whose history is the more important. Imagine a four-dimensional puzzle of the world, and each of these different views of history is a piece of the puzzle. Before you can place them properly, though, you first must gather the pieces, and you do this by studying them all.

  CONNECT YOUR KNOWLEDGE OF HISTORY

  WITH YOUR TRAVEL.

  I urge you, before you take your first overseas trip, to study the history of your destinations. Without the historical context, you will not be able to fully understand much of what you observe. You can be a tourist and enjoy the scenic sites, but understanding is a far richer experience. It doesn't matter where you start. Choose a country, then go there to see the truth for yourself.

  HISTORY WILL SHOW YOU WHICH

  FORCES DRIVE MARKETS.

  By cross-referencing historical events with long-term trends in the market, you will identify those developments that affect stock and commodity prices. In my course “Bull and Bear” at Columbia University, I instructed students to research major bullish and bearish markets of the past, then figure out which historical events had contributed to their rise and fall. What was going on in the world when prices skyrocketed or plummeted? Why did those events serve as a catalyst? Looking back upon history is an invaluable way to learn how to analyze trends. And better still, it teaches you how to anticipate future changes.

  NOTHING IS REALLY NEW.

  History repeats itself in one way or another—or at least rhymes, as Mark Twain said. Human beings have pretty much always been the same. Headlines are constantly announcing the innovative, the radical, and the groundbreaking. When something is presented as novel or different, look to the past, and you will always find a precedent there. But remember the historical context; don't expect things to be identical. A general rule: What is happening now has happened before and will happen again.

  By way of illustration, take the Internet revolution. Many people reacted as though something entirely new had emerged. The Net is but one of many technological innovations to have presented themselves over history. Remember the “new economy” of the 1990s? Those with historical perspective can point to many such revolutions: the railroad, the clipper ship, airplanes, electricity, radio, telephone, television, the computer. Investments in all of those “new eras,” at one time or another, ended badly.

  As soon as I hear everyone making claims for something that supposedly is innovative and unprecedented, I check whether the market is overheated and often pull out my capital. Be extremely doubtful when you have people proclaiming, “It's different this time.” Historically, nothing emerges as so entirely different; such claims are indicative of a state of mass hysteria. I sold short shares in high technology between 1999 and 2000, and it was right around that time that the commodity index I created in 1998 started to rise.

  Again, study history very carefully. Learn precisely what happened and what did not. This will help you understand what is about to happen in the world.

  CHAPTER 8

  Your Education, Part IV: Learn Languages

  (and Make Sure That Mandarin

  Is One of Them!)

  MANDARIN WILL BE THE NEXT

  GLOBAL LANGUAGE.

  People who can speak or read other languages have a great advantage over those who don't. When it comes to investing, you can research primary sources and speak to people in their own language, increasing the likelihood of trust and candor. Just as important, there will be times in your life when you will be in social and professional situations with people from other cultures. Your life will be enriched immeasurably if you can defy the stereotype that Americans don't learn other languages and put yourself in a position to learn from your new friends.

  To help you succeed in life as well as investing, we gave you a head start. You have a Chinese governess who communicates with you in the official language of China. And as you learn Mandarin from her, you will learn English from us. (You must master English to speak to your father; about the only expression he knows in Chinese is “cold beer.”) We moved to Asia so that both of you could attend Chinese schools and use Mandarin in everyday life while experiencing both Asian and Western cultures.

  Probably the best advice I can give to anyone, anywhere in the world, is to have your children and grandchildren learn Mandarin. For their generation, Mandarin and English will be the most important languages in the world.

  CHAPTER 9

  It Is the Century of China

  PAY ATTENTION TO THE MAJOR CHANGES

  TAKING PLACE IN THE WORLD NOW.

  The reason that you are learning Mandarin is because China is gaining economic, political, and cultural strength, and will become an even more significant player internationally. You must be aware of such developments, not only as an investor but as a world citizen. When we look back upon history, we know that Spain dominated the sixteenth century, while France was the more prosperous country two hundred years later. The nineteenth century was the century of Great Britain. In the twentieth century, the United States rose to prominence. Well, the twenty-first century belongs to China. This development is under way now, right before our eyes. China has had recurring periods of greatness. Egypt was great once, Rome was great once, Great Britain was great once. China has done it a few times and has weathered disasters a few times. Now it is on the rise again after three hundred years of decline.

  The Chinese are generally considered Communists, not capitalists, but how accurate is this? Historically, the Chinese people have been among the best capitalists in the world. Many remember the form of capitalism that existed in China prior to Mao Tse-tung's revolution in 1949, which culminated in the founding of the People's Republic of China. Those who would not give up on capitalism during the revolution fled to Hong Kong, Taiwan, America, and elsewhere, and cultivated their own economic prosperity. These overseas ethnic Chinese have always been a valuable asset to China. They know the language and pass it down to later generations as well as retain ties to other Chinese on the mainland and around the world. They are always ready with capital and expertise to invest back in China as opportunities arise. The bond has always been so great that China gives passports to those of Chinese descent even if they have been away for a few generations.

  There is a remarkable difference between the China that I saw in my first four visits between 1984 and 1990 and the China that I saw when I traveled there in 1999. The effort that the country has put into increas
ing its productivity has paid off. China's production levels in home electrical appliances, cellular phones, and motorcycles have surpassed those of the United States. In fact, China's cell phone production is now tops in the world. These are developments that an investor cannot dismiss.

  BUY CHINESE STOCKS, AND BUY THE

  FUTURE OF THIS COUNTRY!

  I own a couple of dozen or so Chinese stocks, but I did not make my first purchase until 1988. This happened in a rundown building, then the home of the Shanghai Stock Exchange. The bank-stock certificate representing that initial purchase hangs framed on a wall in our house. I don't know by how much its value has increased, but I have no intention of selling it because of its sentimental value.

  When I revisited Shanghai in 1999, the shabby building had been replaced by a brand-new structure. I opened up an account and continued to invest more. At present, China's gross national product (GNP) is growing in excess of 9 percent, and there is plenty of potential for further growth.

  Many famous American investors who rarely, if ever, invested abroad or invested in China have done so in this decade because of the enormous growth. But if you want to buy Chinese stocks, be prepared for the normal setbacks in the Chinese economy. The United States underwent many consolidations as it rose to power and glory, and China will too. When is the best time to sell? Probably not until after my lifetime, because the Chinese economy will continue to grow. So my shares in China may be my gift to you.

  A HARD LANDING CANNOT BE AVOIDED!

  Both the Chinese economy and Chinese real estate are becoming overheated, with an inflation rate somewhere between 7 percent and 8 percent, according to independent banks. Perhaps Chinese banks have made too many loans. Excessive investment has resulted in a higher than normal default rate, which usually happens in periods like this. I think that a hard landing in some sectors, such as real estate, is inevitable.

  The Chinese government and the International Monetary Fund (IMF) insist that a soft landing is possible, and the Chinese government restricted bank loans for awhile and restrained the money supply, rightly to cool things off. Low interest rates have led to overinvestment in real estate and certain manufacturing industries. These sectors are taking a nosedive. Other fields, however, will probably be unaffected.

  A Japanese investor once asked me when China was going to experience its hard landing. I explained that there is no telling exactly when that will be or how severe it will be. I am not a trader with a superior sense of timing. It could happen soon, or it may not happen at all. It is more likely to occur in specific sectors such as real estate, while some sectors will not be affected. But who knows? As soon as you hear in the news about a hard landing in the Chinese economy similar to those in 1989 and 1994, consider it the best opportunity to buy into Chinese stocks or commodities. I began buying Chinese shares again at the end of 2005 and into 2006, and again in 2008 for the first time since 1999.

  CHINA EQUALS COMMODITIES.

  The rise of China brings with it a rise in demand for commodities. China, with its 1.3 billion people, consumes steel, iron ore, and soy; it is the largest consumer of copper in the world and the second leading consumer of energy, including oil. Furthermore, the demand is increasing yearly—monthly, even. It will take at least another ten years before supply meets demand; in the interim, this imbalance will continue to drive up the price of commodities despite the normal, periodic corrections to prices.

  CHAPTER 10

  Know Thyself by Understanding

  Your Weaknesses and Acknowledging

  Your Mistakes

  KNOW WHO YOU ARE.

  Of course you need to be aware of the circumstances that surround you, you need to be knowledgeable about the world, you need to know history. But even more important, you need to know yourself. Look at yourself in the mirror and ask what drives you. If you can understand these things up front, you are more likely to be able to keep your head in a crisis. Also observe how you react to mistakes, so that you can respond more constructively the next time things go wrong.

  For example, I know now that I often see things well before others and therefore act much too soon. So I have tried to discipline myself to wait. When I was younger, I nearly always got swept away when stocks were rising amid mass hysteria or when people were dumping in panic. I often joined in too. I have learned that when I am frantic to join a trend, I must steel myself to do the opposite. It is extremely difficult to say “buy” when everyone else is selling and I am desperate to join in, but I have learned a bit about my own emotions over the years.

  Granted, we all make mistakes. The important thing about making errors in judgment is the ability to admit those errors. If you grow into adulthood unable to acknowledge your mistakes—in life, as well as in investing—you will learn your lessons the hard way. Only when you recognize your mistakes will you be able to make the corrections necessary to put yourself on the right path.

  PEOPLE ARE EASILY CARRIED AWAY

  BY MOB PSYCHOLOGY.

  Even those who call themselves professionals are at times persuaded by the mob. I remember when I started full-time on Wall Street in 1968, during another period of mania, I shared an office with an older analyst because things were growing so fast that companies could not even get more office space (a sign of trouble, I now know). I was diligently working out some numbers on a spreadsheet when an executive rushed into the office to see the analyst. When he saw what I was doing, he exclaimed, “Do people still waste time on things like that?!” I was mortified, of course, but that executive was out of the business just a few months later when that little bubble popped.

  More recently, a number of “experts” lost a lot of money in the dot-com debacle. You can imagine how hard it was for people who saw a bubble coming to pick up the paper every day and realize that people were getting rich (at least on paper) all around them. Maybe this really was a New Era, and the old rules did not apply. Whenever we enter a so-called new era, folks start to ignore decades-old standards of valuations for investments because they believe the growth will be so dazzling that stocks will trade at unbelievable prices and then will triple and quadruple again. Classic measures like book value, earnings per share, and dividends will be ignored and even ridiculed.

  The Wall Street Journal began referring to the New Economy in the late 1990s because, it claimed, “things have changed so much.” Companies with no history, low sales, and no earnings went public on the stock exchanges and shot up in price. Thousands of multimillionaires were created overnight. People projected huge growth in earnings for years into the future. In the end, of course, the old rules did apply, and many folks learned this the hard way. The Wall Street Journal went back to using lowercase letters the few times it mentioned the (ahem) new economy. Many companies collapsed and disappeared—just as always has happened after all the “new eras” in history.

  For another example, look at Japan. In 2002 and 2003, most analysts and economists discouraged investment in Japanese stocks, some going so far as to claim that investors should sell every Japanese stock they owned and some even suggested that Japanese leave Japan altogether. Such misguided advice was born of mob psychology; the gloom had become so deep-rooted that not even the professionals could see the changes taking place before them.

  Japan had enjoyed a huge bubble in the 1980s. When it burst, in 1990, prices collapsed, sending the economy tumbling. Regrettably, the government and the Bank of Japan kept trying to halt the natural, cleansing effects of this recession by propping up many of the companies in trouble. Just as a forest fire serves to clear out deadwood and underbrush so that the forest can renew itself, recessions help to ensure healthy future growth. In Japan, businesses that should have been liquidated became “zombie companies,” surviving, albeit barely, on the government's artificial support. Everything was Band-Aided with quick fixes. While this delayed a decline, it also postponed the economy's recovery. A country can actually spend more money trying to stave off a recession than t
he recession itself might cost. Moreover, most developed nations now have safety nets in place to limit the damage from a recession.

  Japan still talks of the 1990s as “the lost decade,” characterized by no washout, but no recovery, either. (By the way, America followed the same route in the 1970s, and endured a miserable decade until a new policy helped the country finally start over. One would think that central bankers would learn their lessons from history, but, unfortunately, the United States is again repeating the same mistakes, and America may be in for an extended period of difficult economic times.) Now, bear in mind that lifetime employment with the same company had been a longstanding foundation of Japanese society. When companies had to lay off workers in the nineties, an unprecedented development, the country practically fell into a national depression—reflected in low birth rates and a disturbingly high suicide rate.

  It took thirteen years of stagnation, but finally, around 2003, the Japanese economy started to rebound. Since then, the stock market there has doubled.