I am not going to discuss inflation in this month’s article. Why? Because it is predictable. Inflation was a popular topic during my formative years before FIM Group was founded. I was in my mid-20s when President Ronald Reagan had Federal Reserve Chairman Paul Volcker save us from inflation. For those of us old enough to remember, Volcker initially appeared to nearly kill our economy as he raised interest rates to the stratosphere in his quest to "Whip Inflation Now."

Rather than discussing inflation, I want you to think about the fact that no one believed Volcker could rid the economy of high inflation. Volcker tightened the monetary policy and dropped the inflation rate by 8.7% in two years, even with the major tax cut of 1981. Unfortunately, many believed his efforts would have a negative impact. This lack of trust drove purchases of gold and real estate, all often bought with debt and borrowed at high rates. These folks felt that, based on historical trends of everincreasing inflation/interest rates, it was rational to pay more today because tomorrow will be even worse, and Volcker’s rhetoric was not going to convince them otherwise.

During our FIM Group Currency Webinar, recorded on May 4th, we discussed gold, inflation, the U.S. dollar and other related topics. But for now I’d like to discuss how the human brain works and, more important, why billions of dollars will be made by those who realize that their beliefs can get them into trouble, especially when it comes to money.

It Ain’t that Simple

Everything is connected, and everything happens for more than one reason. Our brains are wired to oversimplify everything. Our world is complex, and everything changes. We think we are learning, but often we only look to our immediate surroundings.

To clarify the complexity theme of this article, let’s look to Japan. If we lived in Japan, a democracy that can "print money" and whose economic characteristics are similar to ours, we would be concerned about a lost decade of burgeoning government debts, stagnating wages, unemployment and gridlocked leadership. Our perspective would be that of a "Cold War-seasoned Russian," and we would be concerned about our own war spending and the way military spending is crowding out investing and spending in other areas. The U.S. has increased its military spending by 81% since 2001, and now accounts for 43% of the global total, six times its nearest rival China (source: Stockholm International Research Institute). Our next ten years will be different than Japan’s (and Russia’s for that matter), but there also will be similarities.

Emergent Systems and Path Momentum

Emergent systems are both top-down and bottom-up – they try to help us see the whole, but they need to be studied differently. For example, understanding emergence and the importance of analyzing a complex system requires us to think differently than we were taught. We want to take things apart and put them back together to understand them. To fully learn how a human being works requires both observing ourselves in action, in different environments, and also dissecting ourselves – literally and analytically.

Economists who deal with all this complexity want to simplify it into statistics, because to stare into a bucket full of stats is much easier than to analyze people in motion. Economists started us down a path based on a reaction to rising government spending. The politicians and economists wondered if, "Our economy is becoming too dependent on government spending – what if we constrained the government’s income – then it would have less to spend, and the growth in spending will slow." Seems logical, if I personally have less income, I spend less. So let’s go down that path, and assuming we are a U.S. government adviser we could say, "Don’t raise taxes. If we do we will only accelerate spending. So to control our big growth in government, let’s not raise our income (i.e., tax more) and that will constrain the rise in spending." From what I can see, that was the path we took as a country in 2000-2001.

In 1970 total Federal spending was $890 billion, in 2009 it increased by 299% to $3,551 billion. The average median income has risen only 27%, which creates a larger burden on taxpayers to fund government spending. Washington now spends around $30,000 per U.S. household – more than ever before. The logic of "don’t raise spending because it will slow growth in government spending" seems a bit unhinged based on the evidence. Perhaps if we had raised taxes (and thus revenue) we would have just spent more. But the point is that the path (i.e., revenues will constrain spending) gained momentum, and now we find ourselves in a $1.6 trillion pickle. Had economists used complexity-emergentinterconnected analysis in their presentation, most likely they would have gotten lost in the river of complexity, and the U.S. would have used common sense and stayed on the path that kept us out of trouble for more than 200 years. What a concept to have spending and income match.


In April, Jeff Lokken, Barry Hyman and I conducted a webinar titled "Kicking the Bricks" about how we research companies, make investments, and assess management. Someone asked what we thought was the most important thing to think about as an investor. My instant response was to realize that everything is connected. We then talked about complexity and emergent systems. At FIM Group we don’t oversimplify our process. It is important to have a disciplined approach that is rooted in a belief in emergent systems, the importance of humble scientific enquiry and common sense. All that takes time, and the real time is not just the enquiry into an investment’s merits. It is the time it takes to nurture your education with experience. Luckily, however, there is a way to measure if all our analyses, work and experience have paid off – and that is results. Unlike most other investment firms, FIM Group publishes our actual performance statistics, not someone else’s. We say, "This is what our actual clients have earned," and we provide you with your portfolio’s unobscured performance data. Our goal with our monthly newsletters is to help you have a better understanding of not only what, but why we do things here at FIM Group. We believe our performance comes because we humbly do a lot of little things right … and they add up to respectable performance. Humans are wired to want to oversimplify things that are inherently complex, but to oversimplify as an investor is to throw common sense out the door. The world is moving fast, and our webinars help us keep you informed in real-time, answering today’s questions, so I invite you to participate in them whenever you can.

Note to FIM Group clients: What follows is my reaction to news that came across my Bloomberg wire about two hours after I finished the above article.

Democracies Are Reactive Systems

On April 18, Standard & Poor’s put a "negative" outlook on the United States’ AAA credit rating, citing a "material risk" if the nation’s leaders fail to deal with rising budget deficits and debt. According to Bloomberg, S&P said in a report, "We believe there is a material risk that U.S. policy-makers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013." They went on to say that, "If an agreement is not reached, and meaningful implementation does not begin by then, this would in our view render the U.S. fiscal profile meaningfully weaker than that of peer ‘AAA’ sovereigns."

Where will the "safe" money go with the U.S. looking shaky? Certainly not into U.S. CDs or fixed annuities. Rather, we think it will migrate to countries that run their affairs with a bit more common sense. AAA sovereign debt in countries like Norway, Australia, Switzerland, Singapore and the United Kingdom, for example, could benefit from the possible U.S. downgrade. Is this "credit watch" a big deal? I think that the U.S. will use it as a rally cry to get our House, Senate and Oval Office to convince citizens that we need to fix the spending and revenue side of our fiscal budget. Democracies tend to be reactive systems – they wait until things get worse before they get on corrective course. Just ask Paul Volcker.

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