As some of you may know, I’m a big fan of Gustave Le Bon’s books; in particular I like The Crowd: A Study of the Popular Mind. I reread it (again) last week and was delighted to uncover some insights that I had not recognized fully before. So I thought I’d share some of them with you because I think that a sound understanding of crowd psychology is really useful for constructing or refining your investment process.

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Most people look at debt-to-GDP ratios when thinking about sovereign debt. It’s a good measure, but there’s a better one that goes for the jugular; the ratio of public debt to government revenue. By changing the denominator in this way you get a direct feel for how increases in interest rates affect government accounts. For example, when public debt is 10X government revenue then a 1% increase in the average interest rate paid on public debt forces the government to use an additional 10% of its revenues for paying interest. In short, this metric gives you a clear idea of just how easily a government could reach the keynesian endpoint (i.e. the point at which all of government revenues are used to pay interest alone).

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[EDIT: For up-to-date real interest rate charts see here.]
 
One of the most important themes over recent years has been the presence of negative real interest rates in the developed world. Whether one likes it or not, it has a big impact on how institutional money is allocated. Professional investors, who are under constant pressure from clients to make money, feel compelled to chase market momentum, especially when their clients’ money is slowly withering away because of negative real rates of interest. As Jeremy Grantham puts it:

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Addogram.com have come up with a large graphic (an “addogram”) about the evolution of central banking in England and America going as far back as 1640. If you take a look at the zoomable image (click “Explore this addogram in high-resolution” once at the link above) you can see how UK & US central banks affected (and were affected by) equity, bond and gold prices since 1840. Present dynamics in central bank balance sheets and long & short-term yields looks eerily similar to 1930-1950. Interesting stuff.

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Sometimes it seems like the investment community operates on the assumption that the world started in 1929 – or at least that the financial booms, busts and speculators preceding the 1920s are irrelevant to the modern investor. We think this is misguided. Just consider that this common worldview ignores an age where speculators lived in sprawling mansions on Fifth Avenue (as opposed to apartments in the same place measuring about 1/100th the size)! We imagine that there’s a lot to learn from looking at the past 300 years as opposed to the past 80. With this in mind; here we present what we believe to be the best trades of all time:

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Several months ago we brought you a history of the Federal Reserve’s assets in charts — here we complete the story by presenting the evolution of its liabilities from 1915 to 2012.

 

As mentioned when we examined the assets side of the Fed’s balance sheet:

…the Fed has degenerated from a by and large passive institution (dealing only in high-quality self-liquidating commercial paper and gold) to an active pursuant of junk, an enabler of wars, a ‘benevolent’ combatant of the depressions of its own creation, a central planner of employment & prices and of course a forgiving friend to inconvenient market follies.

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Real Interest Rates

May 7, 2012

[EDIT: For up-to-date real interest rate charts see here.]
 
Here we present a consolidated view of real rates around the globe. As usual real interest rates in the perpetually-monetizing West are in deep negative territory (although be warned that they’re moving strongly higher at present). In contrast, real rates in Japan and the Czech. Republic are deteriorating rapidly.

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