Mr. Klarman is president of the Baupost Group, an investment firm in Boston that manages $22 billion. His three private partnerships have returned an annual average of around 19% since inception in 1983—and nearly 17% annually over the past decade, as stocks went nowhere.
To measure Mr. Klarman's importance as an investor, you need only see the value his rivals place upon his words. You could have earned at least a 20% average annual return since 1991—better than twice the performance of the market—merely by buying and holding Mr. Klarman's book, "Margin of Safety": Published that year at a cover price of $25, hard copies now fetch up to $2,400.
But the professorial Mr. Klarman speaks in public about as often as the Himalayan yeti. He made an exception last Tuesday, when I interviewed him in front of a standing-room-only crowd of 1,600 financial analysts at the CFA Institute annual meeting in Boston. He then made another exception, speaking with me over the phone later to clarify points that he feared had been misconstrued.
Mr. Klarman specializes in buying securities that nauseate other investors. As the credit crisis exploded, he put more than a third of his assets into high-yield bonds and mortgage-related securities. I asked him what he had meant, in a recent letter to his clients, when he compared the financial markets to a Hostess Twinkie. "There is no nutritional value," he said. "There is nothing natural in the markets. Everything is being manipulated by the government." He added, "I'm skeptical that the European bailout will work."
Some members of the audience gasped audibly when Mr. Klarman said, "The government is now in the business of giving bad advice." Later, he got more specific: "By holding interest rates at zero, the government is basically tricking the population into going long on just about every kind of security except cash, at the price of almost certainly not getting an adequate return for the risks they are running. People can't stand earning 0% on their money, so the government is forcing everyone in the investing public to speculate."
"We didn't get the value out of this crisis that we should have," Mr. Klarman told the audience. "For our parents or grandparents, it was awful to have had a Great Depression. But it was in some ways helpful to carry a Depression mentality throughout their later lives, because it meant they were thrifty with their money and prudent in their investment decisions." He added: "All we got out of this crisis was a Really Bad Couple of Weeks mentality."
You could have heard a pin drop as Mr. Klarman proclaimed, "I am more worried about the world, more broadly, than I ever have been in my career." That's because you can make good investing decisions and still end up with bad results if you reap your profits in currencies that do not hold their purchasing power, he explained.
"Will money be worth anything," asked Mr. Klarman, "if governments keep intervening anytime there's a crisis to prop things up?"
To protect against that "tail risk," said Mr. Klarman, Baupost is buying "way out-of-the-money puts on bonds"—options that have no value unless Treasury bonds plummet. "It's cheap disaster insurance for five years out," he said.
Later, I asked Mr. Klarman what he would suggest for smaller investors who share his worries.
"All the obvious hedges"—commodities and foreign currencies, for example—"are already extremely expensive," he warned.
Especially gold. "Near its all-time high, it's a very hard moment to recommend gold," said Mr. Klarman.
Mr. Klarman pointed out that his own ideas "on bottom-up opportunities in undervalued securities are more likely to be accurate than my top-down views on what's going to happen in the world at large." In other words, while you might want to insure against a disaster scenario, you shouldn't bet the ranch on it.
And, said Mr. Klarman, one of the best ways to protect against a decline in purchasing power is to buy whatever is "out of favor, loathed and despised." So forget about gold or other trendy hedges. Instead, wait patiently for markets—European stocks, perhaps—to get so cheap that they turn most investors' stomachs. Then you can pounce.
As Mr. Klarman put it, "Sometimes, when you can't figure out a good defense, the best thing to do is to go on offense."
Pay attention as you watch the catchy new music video from the mega-star rapster Jay-Z, "Blue Magic", and see if you can't spot the product placement. It is not a fancy car that he is endorsing – although both his rides, a Rolls- Royce and soft-top Bentley, are plenty spiffy – but rather a currency – and it is not the dollar.
Like so many in the hip-hop genre, the song is a celebration of ostentatious wealth. But capturing the attention of commentators in this clip, shot in the glimmering, neon-lit canyons of New York City, are the repeated glimpses of flickering wads of €500 notes. Jay-Z has thus performed a currency defection: the dollar is not just down, it is out. The euro is the new bling.
A VAT is no panacea; deficit reduction can't be painless. We'll need both spending cuts and tax increases. A VAT might be the least bad tax, though my preference is for energy taxes. But what's wrong with the simplistic VAT advocacy is that it deemphasizes spending cuts. The consequences would be unnecessarily high taxes that would weaken the economy and discriminate against the young. It would become harder for families to raise children. VAT enthusiasts need to answer two questions: What government spending would you cut first? And how high would your VAT rates go?
Robert Samuelson is also the author of The Great Inflation and Its Aftermath: The Past and Future of American Affluence and Untruth: Why the Conventional Wisdom Is (Almost Always) Wrong."
The Post has owned NEWSWEEK since 1961, when Ben Bradlee, then the magazine's Washington bureau chief, helped persuade Philip Graham, the publisher of The Washington Post, to buy us. I say "us" quite consciously: there has long been a sense of tradition as well as journalistic mission here. For half a century, the Graham family has been a faithful steward of NEWSWEEK, allowing us, in Phil Graham's phrase, to write the first rough draft of history.
The problem this time is bigger. It is not only about banks, it is about the essence of the eurozone, and the political survival of all the public figures responsible. If Mr. Trichet and Mr. Strauss-Kahn were honest, they would admit to Ms. Merkel “we messed up – more than a decade ago, when we were governor of the Banque de France and French finance minister, respectively”. These two founders of the European unity dream helped set rules for the eurozone which, by their nature, have caused small flaws to turn into great dangers.
The underlying problem is the rule for printing money: in the eurozone, any government can finance itself by issuing bonds directly (or indirectly) to commercial banks, and then having those banks “repo” them (i.e., borrow using these bonds as collateral) at the ECB in return for fresh euros. The commercial banks make a profit because the ECB charges them very little for those loans, while the governments get the money – and can thus finance larger budget deficits. The problem is that eventually that government has to pay back its debt or, more modestly, at least stabilize its public debt levels.
This same structure directly distorts the incentives of commercial banks: they have a backstop at the ECB, which is the “lender of last resort”; and the ECB and European Union (EU) put a great deal of pressure on each nation to bail out commercial banks in trouble. When a country joins the eurozone, its banks win access to a large amount of cheap financing, along with the expectation they will be bailed out when they make mistakes. This, in turn, enables the banks to greatly expand their balance sheets, ploughing into domestic real estate, overseas expansion, or crazy junk products issued by Goldman Sachs. Just think of Ireland and Spain, where the banks took on massive loans that are now sinking the country.
Given the eurozone provides easy access to cheap money, it is no wonder that many more nations want to join. No wonder also that it blew up. Nations with profligate governments or weak financial systems had a bonanza. They essentially borrowed funds from the less profligate elsewhere in the eurozone, backed by the ECB. The Germans were relatively austere; the periphery enjoyed the boom. But now we have moved past the boom, and someone in Greece, Portugal, Spain, Ireland and perhaps Italy has to repay something – or at least stop borrowing without constraint. So Mr. Trichet and Mr. Strauss-Kahn go, cap in hand, to ask Germany for further assistance."
The current generation of leaders experienced a cultural revolution. They know what a mess China can be if it is mismanaged and how important it is for China to grow and improve the lives of its people. The next, or maybe the next-next group of leaders will be post-cultural-revolution. They will have grown up in 30 years of reform and opening up. They will have lived in a China that is connected through the Internet with people who are much better informed about what's going on in the world. And they will have to run this whole system not as a central system but with a market economy and a coherent political framework on top of that. I think they will have a big challenge.
What worries Chinese leaders?
Instability.
They've seen Tiananmen, and they saw the Falun Gong.
