Friday, June 26, 2009

Was Keynes really a savvy investor?

An excerpt from Scott Sumner's thought-provoking blog:
I got to thinking about this issue last night while reading The Lords of Finance (which by the way is a fine book so far, despite one little point I will nit pick.) See what you make of this:
“In early 1920, he [Keynes] set up a syndicate, with his brother, some of the Bloomsbury circle, and a financier friend from the City of London. By the end of April 1920, they had made a further $80,000. Then suddenly, in the space of 4 weeks, a spasm of optimism about Germany briefly drove the declining currencies back up, wiping out their entire capital. Keynes found himself on the verge of bankruptcy and had to be bailed out by his tolerant father. Nevertheless, propped up by his indulgent family and by a loan from the coolly acute financier Sir Ernest Cassel, he persevered in his speculation”

Translation, without help from his rich daddy and rich friends, this cocky, arrogant, smart-aleck would have fallen on his face, ended up digging ditches somewhere and we would never have heard of him. But he did have a rich daddy, who bailed him

Don’t anyone write in and tell me that Keynes made lots of other good investments, because if you’ve got a rich backstop, none of that matters.

Here’s what I’d do if Bill Gates was willing to lend me $3.57 billion dollars for a day: I’d go to Vegas and put $5 million on numbers 1 through 34 on the roulette wheel. The odds are roughly 90% I’d win. If I did so, I’d win $180 million on a bet of $170 million. I repay the $3.57 billion and pocket my $10 million dollars and be rich for the rest of my life, clipping coupons. If numbers 35, 36, 0, or 00 came up I’d bet again, this time $100 million on each number 1 through 34. If I won, I’d receive $3.6 billion, repay Gates, and have $30 million dollars to spend for the rest of my life. The odds are nearly 99% that I’d win one of these two bets. Of course if both failed, I’d be in big trouble. But that’s not very likely is it?

What’s the point? If you have a rich backstop it’s relatively easy to come up with investment strategies that will usually (not always) make you look like a genius. From now on I will never believe anyone who tells me that Keynes was a great investor.

Does this matter? It shouldn’t, but unfortunately it does. If his investment reputation was like Fisher’s (calling stocks fairly priced in 1929) nobody would take seriously his Chapter 12 in the General Theory where he tries to shoot down the efficient market hypothesis.


Update from Greg: Because of the formatting, some readers mistakenly thought I wrote part of what appears above. To be clear: It is all taken from Scott's blog. Sorry for the confusion.