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Safeguarding Your Money in Uncertain Times by Simon Mikhailovich (Transcript)

Simon Mikhailovich at TEDxWilmington

Full text of contrarian investor Simon Mikhailovich’s talk: Safeguarding Your Money in Uncertain Times at TEDxWilmington event.

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Simon Mikhailovich – Contrarian investor

Famous American journalist H. L. Mencken once said:

Whenever you hear somebody say, it’s not about the money, it’s about the money.

So my topic today is definitely about the money. And it’s about how to protect your money during these uncertain times.

Now, why do I say these are uncertain times? The last 35 years, I’ve seen tremendous innovations in many areas. We’ve seen technological revolution in technology, in computer science, in health sciences, in telecommunications, we’ve also seen a technological revolution in finance.

But unlike those other areas where I think the technological advances have been extremely positive, a lot of technological innovations in finance have been pretty dangerous, and I think pose catastrophic risks.

Now humans have been dealing with catastrophic risks since the dawn of civilization. 2500 years ago, Pericles, who was an Athenian politician, and a general said that the key was not to predict the future, but to prepare for it.

But clearly, if you were to prepare for the future, you have to have some understanding as to what kind of risks you’re trying to manage. Let me give you an example.

Everybody intuitively understands that tangible assets are subject to catastrophic risks, and the way… fires, thefts, floods, and so forth. And the way we deal with those risks is through insurance. So we insure our homes, we insure our cars, we insure our furniture.

Now you may be interested to know that tangible assets only represent 25% of household net worth in the United States. 75% is in financial assets. But nobody seems to have an idea to insure financial assets against loss, which they cannot afford to lose, of course.

SO WHY IS THAT? Well, if there’s one thing we learn from history is that people don’t learn anything from history. People learn from personal experience.

Well, first of all, let me tell you a little bit of my personal experience, so you have some ideas as to where I’m coming from with this.

I grew up in the Soviet Union. I emigrated with my family when I was 19. One of the reasons we immigrated was because we saw the facts for what they were and we realized that the Soviet economic and political systems were unsustainable. It was a very expensive decision.

We came to the United States as stateless refugees, we had to abandon or give up our citizenship. And we were allowed to take $100 a person in a suitcase. And so that’s how we arrived there. That was my first brush with catastrophic financial risks.

I worked my way through college, I worked my way through business school, and I became an investor and I’ve been doing it for the past 32 years. 15 of those 32 years I’ve been involved in credit derivatives, structured credit, a lot of the new technologies that were squarely behind the crisis of 2008.

So fortunately, my partners and I were able to see that being in the business we saw this coming and we profited from that crisis. But unfortunately, I’m seeing a lot of the same problems.

And in fact, I think the problems that I see now in the same areas that were problems before, are much greater. So before I share some of these facts that I’m referring to, let’s just do a little bit of financial math. You don’t need to know anything other than what I’m about to tell you.

All financial assets are valued based on something called discounted cash flow model, DCF, discounted cash flow formula. And this formula operates in a way where one of the major inputs is interest rate. And the way it works is when the interest rates go down, asset prices go up. Asset prices, meaning cash flow producing assets: stocks, bonds, commercial real estate, go up. So rates down, values up, rates up, values go down.

So just keep that in mind as we continue to talk.

So what has been the personal experience of investors in the west for the past 35 years? This is a picture of U.S. interest rates, it’s been a one way ride. Interest rates have gone from 20% to virtually zero. And the asset prices, of course, because when rates go down, asset prices go up. And the asset prices have continued to go up.

Yes, there have been crisis along the way. But over time, prices keep going up. So you can see that this has been a one way street.

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If we take a step back for a minute, and look at a broader historical perspective, you will see, this has been an incredibly unusual period of time. This is that less steep decline in the dark area, all the way at the edge of the chart.

You can also see the red line which shows that the rates today are lower than they have ever been in history. And go back to the formula I just gave you: If the rates are as low as they’ve ever been in history, that means that the values of financial assets are as high as they’ve ever been in history.

Now that’s interesting, because when I went to business school and when they were teaching me how to be a good investor, the first thing they told me is you’re supposed to buy low and sell high.

Well, it seems like what we’re doing here is the other way around. We’re buying high and hoping that it’s going to go much higher. Well, that in history… historical record of that kind of thing is that’s how you go broke. That’s not how you become wealthy.

Now, you can also see that low interest rates have spurred the growth in debt. And these two lines that you’re looking at is the growth of debt and the growth of stock prices, S&P 500. And you can see they’re perfectly matched. As debt increased, as leverage increased, so have the prices. It’s clear why: cheap debt, people borrow money, they buy securities, demand for securities increases, and the prices go up.

But there’s a bit of a problem. And the problem is that the lower line there in blue is the growth of American economy. And the red line is the growth of American debts.

Now in mathematics, whenever you see a line that goes like this, it’s called exponential function and the historical and mathematical record for exponential functions is that they always end in a bust. Now, maybe this time is different. But history is pretty clear. It’s a 100% certainty in the past that those types of events always end badly.

What you’re looking now are the global debts for this century since 2000. So if 2000 crisis was about there being way too much debt, we have 50% more debt in the world today… 50%, over $200 trillion of debt.

In the United States, government debt has doubled since the last crisis. Corporate debt has doubled since the last crisis, and personal debt which declined because of the mortgage defaults after the crisis has just… I just read in the paper that it has reached a new all-time high. So we have fully recovered and we’re off to the races again.

Now, before I go further, everybody hears about trillions, their eyes glaze over and people don’t have a sense for how much that is. Let me give you a little bit of example of what we’re talking about here.

Let’s talk about time first. Million seconds. Million seconds ago was August 5, that’s 11 days ago. Well, we can get it, we understand that.

Billion seconds ago was 32 years ago, 1985. Some of us still remember 1985. So that’s still relatable. A trillion seconds ago was Stone Age; 32,000 years ago. And that clearly is not relatable. And that’s actually so when you add three zeros in other thousand times, that’s what exponential function is. It just goes stratospheric, and goes completely out of the realm of people’s understanding. How is it possible?


That’s what I was mentioning in the first part, it’s the breakthroughs in technology, digitization, the ability to create unlimited money has enabled us to accumulate these kinds of debts. And there’re some other technologies that I will mention.

What you’re looking at now is the money printing by, or I should say not money printing, pushing a key and creating electronic money by the global central banks. So even as we’re sitting today and the global markets are making new highs, you ought to know that this year alone… so far this year, global central banks have injected another $2 trillion into the global markets through something called QE. Many of you have heard what that is. Some of you may not know what it is. It’s quantitative easing.

So let me translate that into English. It’s conjuring money out of air and taking that money and going to buy stocks and bonds and drive up the prices of stocks and bonds. And that’s essentially what’s been going on.

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Now, the by-product of being too much money is that the money gets debased. In 1906, there’s a picture of a hotdog cart. And if the picture were a little bigger, you could see that the hotdog in 1906 cost three cents apiece, so US dollar used to buy 33 hotdogs. Today, New York hotdogs are $2 apiece, so $1 buys half a hotdog.

I’ll do the math for you. It means that the US dollar has depreciated that the purchasing power of the dollar has depreciated by 98.5% in 100 years. Well, you may think that’s a very long period of time, it’s a little bit beyond my horizon. It will help you to know that more than half of that depreciation happened in a few years during the 1970s.

During the 1970s, alone, the US dollar has lost 60% of its purchasing power; 60%, just in several years, and at the rate we’re going, I think that’s going to happen again.

The other technology that’s enabled creation of debt is credit derivatives or derivatives in general. Derivatives purport to redistribute risk in a way that it disappears. But risk is like energy, energy doesn’t disappear. We know that from the laws of physics, it just goes from one place to another, it just changes its form. It’s the same with derivatives.

What the chart shows is Deutsche Bank, which is one of the largest European banks is in the center of the chart, and all of these are the dots are the too big to fail banks, who have relationships with Deutsche Bank and owe each other money, based on these derivatives contracts.


Well, it’s a problem, because when you look at how many derivatives Deutsche Bank has, it has $42 trillion worth of derivatives on its books. $42 trillion, just to give you a scale is 14 times the size of the German economy. It’s three times the size of the economy of the European Union. It’s an unconscionable amount of money.

And the ability to carry this type of amount of derivatives without risk relies on all of these institutions, being able to meet their obligations as and when they come due.

And as we know what happened in 2008, it was impossible for AIG and for Lehman to meet their obligations. And that brought down the entire financial system requiring massive bailouts.

Now, don’t take my word for it. Warren Buffett recently said something very cogent, and I think, better than I can say, derivatives of financial weapons of mass destruction, carrying dangers that while now latent, meaning not seen, are potentially lethal. And he’s absolutely right.

The other problem that this money printing has created is the loss of the purchasing power has hidden; people make more money, they have more money, and they feel good about it.

But what’s been hidden is that the purchasing power of their money is not what it should be. So this flat line that you see in the bottom is the real income of the American families. And you can see that over 50 years, American families have not had a raise, whereas the upper line, which slopes very nicely upwards is the nominal income.

So you’re getting more dollars, but these dollars are not buying anymore. And that’s why we’re seeing political change. We’re seeing political turmoil, and there are all kinds of negative implications that can happen from that.

The point I’m making here is that this financialization, the advent of these technologies has been beautifully good for very few people, but it’s not been good for the vast majority of the people. And that is what’s behind a lot of the problems that we’re seeing.

So what is Warren Buffett’s advice? Be fearful when others are greedy and greedy when others are fearful. That’s just another way of saying buy low and sell high.

Well, in order to buy low when nobody has money, you have to have access to purchasing power. How do you do that? Well, let’s look at what the competition is doing.

Now, we’ve accused Chinese and Russians of a lot of things, but nobody has accused them of being stupid. What are they doing? They’re building Gold reserves. Why are they building Gold reserves? Why gold of all things? Because in the world that’s flooded with financial paper, with paper claims and paper assets, Gold possesses three qualities that no financial asset and not even cryptocurrencies have.

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One is scarcity. There’s only one kind of gold and nobody can create or print any more of it. The second is permanence. All the gold that’s ever mined still exists. And because it’s scarce and still exists, it protects its purchasing power. That example I gave you with hotdogs. Well guess what… an ounce of gold 100 years ago, bought somewhere between 600 and 700 hotdogs, and an ounce of gold at today’s price still buys between 600 and 700 hotdogs.

That may not be exciting. It didn’t make any money, but it’s preserved its purchasing power. And so scarcity, permanence and independence, because gold is just a brick. It’s not anybody’s obligation. It’s a thing. It can’t restructure. It doesn’t default on its promise. And it’s completely independent from the financial system and financial institution.

And to the extent that you don’t put all your eggs in one basket, it’s in a different basket.

So what have we been doing? Where are they getting all these gold, the Russians and the Chinese and the Indians and the Turks? But we’re selling it to them, we’re giving them the gold and they’re giving us the paper? Well, guess what? In any trade, both sides cannot be right. Somebody is on the right side of this trade, somebody is on the wrong side of this trade.

And it’s not just the Russians and the Chinese, it’s the central banks too. The chart you’re looking at shows that between 2000 and the crisis of 2008, the global central banks have been selling gold. They believed in the technologies, and in the promise of these technologies to solve all the financial problems.

But after they saw what happened in 2008, there have been big buyers and they’ve rebuilt all of their reserves. And in fact, on average, global central banks hold 10% of their reserves in gold.

I think everybody should have their own central bank, be your own central bank, 5% to 10% of assets should be in gold because we don’t know what’s going to happen.

Now, remember, buy low sell high. Throughout the 20th century, gold enjoyed a place in investment portfolios, and the value of gold accounted for about 20% of the value of financial assets. Today, it’s only 3.5%. Either gold is undervalued, or the financial assets are overvalued. It’s probably a combination of both.

But I personally like when somebody hates something. There are no bad assets, there are only bad prices. So if people hate gold, I think that’s probably a better bet than a lot of other things that people love.

So why is it with all these facts that I’ve just shared with you, just a few facts, obviously, that’s a bunch bigger subject. Why is everybody so calm? Why is everybody so confident? Well, because the experience of the 35 years has been that everything always works out. Interest rates have gone from 20% to zero, but I would suggest to you that they can go from zero to minus 20%.

So the next 35 years are not going to be like the previous 35 years. And to the extent that people are very certain about what they think is going to happen, they should be careful, because as Mark Twain said:

It ain’t what you don’t know that gets you into trouble. It’s that what you know for sure that just ain’t so.

So guess what? Everybody who thinks everything is fine can afford to be right. The question is, can they afford to be wrong? So I suggest that everybody needs to step back, needs to think about how to de-financialize their savings. Gold is not the only solution. There are other real assets, starting your own business that you can control, having property, income producing property and other things.

But the most important thing is to examine the facts, take a step back and do something about it. As long as you do something about it, you’re not going to end up like that guy.

Thank you.


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Resources for Further Reading: 

The Real Truth About The 2008 Financial Crisis: Brian S. Wesbury at TEDxCountyLineRoad (Full Transcript)

How Does The Stock Market Work? By Oliver Elfenbaum (Transcript)

The Dirty Secret of Capitalism – And a New Way Forward: Nick Hanauer (Transcript)

10 Things I Learned After Losing a Lot of Money: Dorothée Loorbach (Transcript)