Investment Bias Towards Optimism and Against Contrarian Thinking Investment Bias Against Contrarian Thinking : continued

Optimism Hides Structual Weakness

Common Blinders

Although every few years there is a financial crisis somewhere in the world, you might not witness a major turning point in your market more than two or three times in your working life.

Every few years there is a financial crisis somewhere in the world.

Although there is constant talk of market bubbles and busts, and short-term variations in business activity are common, a general institutional meltdown does not happen that often.

Every year there are books announcing a looming crisis or reckoning day.

Cassandras, contrarians, and doomsayers are a dime a dozen. After a while, like advertising, we learn to tune them out.

There is often not only a lack of consensus as to causes of past crises but also strong argumentation by market leaders and experts as to why the current market does not present special risks.

Don't expect that your conclusions will be ratified in the financial press:

Consequently, as a capital flow analyst you may be alone in your interpretation of the market.

For example, in 2004 it would have been clear to a capital flow analyst that the trade deficit was instrumental in driving long bond prices upwards and had been doing so for twenty years.

In 2004, most market pundits read the trade deficit the wrong way.

However, the trade deficit was almost universally decried as a negative factor that would drive bond prices downwards.

Nevertheless, the capital flow analyst would have been correct in predicting that an increase in the trade deficit would force long-bond prices upwards throughout 2004, while most market experts, including Federal Reserve Chairman Greenspan, were baffled or simply wrong.

Recognizing the lonely position of the capital flow analyst, the Capital Flows Forum offers a venue where analysts may exchange and check ideas with others familiar with this technique.

Summing Up

Capital Flow Analysis may make you aware of weaknesses in the financial system that others do not see.

Before jumping to conclusions and making dire predictions, make sure that:

Do not expect your analysis to be readily accepted by others.

However, you should be willing to express your views in a professional setting, even if not immediately accepted.

The analyst that predicted that long-bond prices would rise in 2004, giving cogent reasons based on Capital Flow Analysis, might not have been listened to in 2004, but would probably have been afforded more respect in 2005.


Before proceeding, check your progress:


Predictions of economic collapse are:
Choice 1 Readily accepted by the public.
Choice 3 Easily verified by historical precedent.
Choice 4 Generally supported by banks and brokers.
Choice 2 Frequently wrong.
Many investors make decisions based on:
Choice 2 Opinions of friends and colleagues.
Choice 1 Their own research of fundamentals.
Choice 3 Suggestions of brokers.
Choice 4 Articles in the financial media.
Capital flow analysts should expect:
Choice 2 Investors to know about flow of funds.
Choice 3 Respect when predictions are correct.
Choice 1 Immediate acceptance of their opinions.
Choice 4 To reach some contrarian conclusions.

Investment Tutorials: Capital Flow Analysis  learning module : continued >

Suggested Reading on structural weakness, investment bias, optimism, and contrarian thinking
"The March of Folly: From Troy to Vietnam", Paperback, Barbara W. Tuchmanstar

Examines the irrationalities of governments through analysis of four crises of history--the fall of Troy, the Renaissance popes' provocation of the Protestant Reformation, Britain's loss of the American colonies, and America's involvement in Vietnam.

"Indonesian Destinies", Hardcover, Theodore Friend

A labor of immense scholarship — the author takes on the last fifty years of Indonesian history, and includes in his sweep a magisterial treatment of the country's religion, politics, and cultural layers.

"Civil Islam", Paperback, Robert W. Hefner

The story of Islam and democratization in Indonesia, the world's largest Muslim nation. Challenging stereotypes of Islam as antagonistic to democracy, this study of courage and reformation in the face of state terror suggests possibilities for democracy in the Muslim world and beyond.

"The Politics of the Asian Economic Crisis (Cornell Studies in Political Economy)", Paperback, T. J. Pempel

A group of experts on the region focus on the political causes and implications of the crisis. The events of 1997-98 involved not just property values, financial flows, portfolio makeup, and debt ratios, but also the power relationships that shaped those economic indicators.

"The Chastening: Inside the Crisis that Rocked the Global Financial System and Humbled the IMF", Paperback, Paul Blustein

In the Asian Crisis of 1997, the IMF and Treasury Secretary Robert E. Rubin demonstrate monumental incompetence and misunderstanding of the world financial system.

"A Full Service Bank: How BCCI Stole Billions Around the World", Paperback, James Ring Adams, Douglas Frantz

Founded in 1972, the Bank of Credit and Commerce International (BCCI) started out as a small Third World banking operation and became in 20 years one of the world's largest privately owned banks with $20 billion in assets and four hundred branches spread across 73 countries at its zenith.

"The Failure of the Franklin National Bank: Challenge to the International Banking System", Hardcover, Joan E. Spero

The Franklin National Bank and the international banking crisis of 1974-1975 and how changes in banking regulations and practices contributed to Franklin's problems.

"Liquidity Black Holes: Understanding, Quantifying, and Managing Financial Liquidity Risk", Hardcover, Avinash Persaud

The clearest explanation yet of the impact on markets of volatility in liquidity and what happens when liquidity dries up

Far Eastern Economic Review
"A History of Modern Indonesia Since C. 1200", Paperback, M.C. Ricklefs

This standard work on the history of Indonesia has been thoroughly revised to incorporate the findings of recent research, and four new chapters have been added to bring the story up to date. This edition is the first to be illustrated, with the addition of 22 drawings and photographs.

"Strong Managers, Weak Owners: The Political Roots of American Corporate Finance", Paperback, Mark J. Roe

A comprehensive political history of the fragmentation of stock ownership and the critical role that this fragmentation has played in shaping the power of managers in the American business system.

"Derivatives, Regulation, and Banking", Hardcover, Barry Schacter

High quality academic research on the ongoing, and sometimes heated, public policy debate over the benefits of bank derivatives and trading activities.

"Understanding International Bank Risk", Hardcover, Andrew Fight

With globalization, syndicated lending and consolidation in the banking , virtually all industries will have international dealings, whether directly or indirectly, and will be exposed to consequential risks.

External Links with more on investment bias, contrarian thinking, and investors' optimism
Steve Hanke's Recommendation : "Testimony: U.S. House of Representatives, Committee on Banking and Financial Services", January 30, 2020. [Return]

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