Eric's Beijing Diary

Listening to the BBC this morning...special on the Bernie Madoff scandal, because he has just been sentenced to 150 years in prison. I certainly had sympathy with the victims of this appalling scam. But what is hardly mentioned is that these folks all violated time-honored principles of investment. I heard one of them say, "We did nothing wrong." Not true. Now there may be an investor here or there who put a little money into this scam unwittingly as a means of providing balance to funds invested elsewhere. But if that is true, it would be the exception. I didn't hear any cases like that. The people I heard were all suffering because they had departed from sound principle in their investment practices. I am not referring to anything complicated. Something as simple as "Don't put all your eggs in one basket." And a few more subtle principles, like, "He that hasteth to be rich hath an evil eye, and considereth not that poverty shall come upon him." The wisdom of the ages has escaped these people, and now they are acting like victims. I am really stepping into dangerous territory, now, because I don't know anything about finance. I have never worried about losing everything on the stock market, because I have never had much to invest. Had a tax sheltered annuity once; I think that's about it. Oh, I did buy a $25 savings bond when I was in high school. My investment history is sketchy. But I have read the Book of Proverbs a few times, and I try to pay attention to what's going on, viewing it in that light, even though I am not a participant in the game. To me, the bottom line is that people are trying to get money without working for it, setting themselves up to be cheated. It's a big problem in China. If I pay 700,000 RMB today for an apartment, what do I care that the thing is clearly overpriced? The real estate market is booming, so chances are good I can sell it for 800,000 a year from now. I'm not planning to live in it, so I don't care. But this is a dangerous game. I can never be sure that I won't be caught holding it when the price drops. Many neophyte Chinese investors (and American investors, it seems) do not know the difference between speculation and investment. But Warren Buffet sure does:The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities -- that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future -- will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There's a problem, though: They are dancing in a room in which the clocks have no hands.Well said. For this reason, I believe the recent downturn has been very good for China. You see, China does not have a stock market crash to look back to. China has experienced extraordinary growth for close to thirty years, so young people seem to thing that the economy always goes up. This encourages speculation, because people think they can safely assume that they will be able to recover their "investment" at any point in the future. Warren Buffet has invested successfully for many years. Up until the recent economic crisis, his investment gains were the equivalent of putting money in the bank at 22% interest. That's because Warren Buffet has always been stubborn about buying value. When asked to share his secret of wealth, he said he could sum it up in two basic rules:Rule #1. Never lose money. Rule #2. Don't forget Rule #1.You see, this is the problem with speculators (gamblers). They expect to lose money. They are just hoping they win more than they lose. They put money into something based on what they hope to eventually recoup from it, without paying any attention to the real value of that "investment." Bernie Madoff's victims would say that their case is different, because they were not merely the victims of unwise investment; their money wasn't even being traded. They were pouring money into a massive Ponzi scheme. But in my opinion, any time you put money into something with a market valuation far in excess of real value, your are essentially being taken in the same way, even if it does not involve direct fraud. A bubble is not the same as a Ponzi scheme, but it's not that much different, and it seems to me that the same kinds of people lose their shirts. They are looking for quick money. So how do we protect ourselves from such abuses? Read the book, folks. The principles are there, and have been throughout the centuries. Solomon said it best: "Wealth gotten by vanity shall be diminished: but he that gathereth by labour shall increase."