Monday, May 26, 2008

Follow-up #3: You've heard of the Illuminati, right?

For one of my first blog entries I chose to assert that the mythological illuminati were real. I argued that it was not a group of overstuffed old European men swilling cognac as Hollywood would have it. Rather, it was a global group of investment houses which owned a surprising share of world assets. These were the New Illuminati who had replaced the original European aristocracy variety. It appears it's time to update that blog. We have a third generation on our hands.

At the time, I took the long-term view that the European variety was a relic, clawing for relevance in a more transparent modern world. From the days of monarchs and peasants controlling the known world, we've undertaken a 5-century march toward power decentralization. This has swept in a 4-century economic miracle of wealth democratization, compounded in a virtuous cycle by technological progress. I still hold that long-term view; tides that big don't just flip a U, but they also don't flow smoothly. They progress just like a wave on the beach: crashing forward and then receding back ... only to crash forward a teeny bit further the next time around. By analyzing the fluid dynamics of countless micro-forces partially reinforcing and partially countermanding each other, we can try to predict where the water will be at any future moment. Even with a supercomputer, our predictions are seldom accurate ... but even a whelk knows the water's rising.

I would suggest that we are entering a period of several such forces which will, on net, create a pause in the long march.

#1 - Sovereign Wealth Funds. The populists fear-monger with xenophobia, since many of these funds are not trusted allies of The West. To that, I say: grow up. The world is, indeed, too flat for that. Truly open markets are color-blind, and as such I'm all for letting SWFs join the party without a bunch of government intervention. The liquidity they provide will be a net benefit on the world economy.

At the same time, however, we must keep our eyes open to the unique risks SWFs present. These funds are notable first for their relative enormity. Sometime when you're bored, draw up a bar-chart of the assets under management for the largest mutual funds, hedge funds and retirement funds. Then add SWFs to the chart. I hope you're not afraid of heights because they will tower over the rest, and they're growing fast. These funds are notable second for the fact that as government entities, their motivation is at risk of being hijacked for political power, especially in less-than-democracies. SWFs might engage in economic warfare even if that means the fund loses some money. The same would never be done by a privately-owned, profit-motivated fund.

Put differently, SWFs amount to an concentration of economic power in the hands of a tiny group of governmental aristocrats. To wield influence in this context, one need not appeal to the masses democratically; just get a half dozen of new illuminati to collude and you can have a transfer of power the size of the 1970's oil shocks. True, market forces will eventually countermand these disruptions, but an adept strategist could ride the crest of the wave and then permanently lock in their gains at the high-water mark.

#2 - The Sage of Omaha. For a short stint in history, certain Americans have risen to a level of wealth that bought them influence similar to that of the illuminati. Unfortunately, all Yanks are ADD-afflicted cowboys. Generation after generation of Americans produce self-made men with no respect for precedent, lineage, continuity, or legacy. Canegie, Rockefeller, Getty, Hughes, Wilson, Gates, and many others have sat at the table, but few have stayed long. None of these men has been invited to participate in the control structures the illuminati use to protect and control European enterprise.

That's why it will be highly interesting to see if it will be any different this week as the Warren Buffett pays house calls on as many illuminati as he can find. Berkshire Hathaway's pitch is logical; they have one of the longest track records of investment success around. More importantly, he believes in the rare long-term value investing strategy (as do the SWFs BTW). This allows those thousand-year-old Euro dynasties to sleep at night knowing they won't wake up next to a wrinkly, hideous old cur like Icann, Ickes, or "Chainsaw" Al Dunlop ready to test out Schumpeter's creative destruction on their family empire.

Buffet has to convince the families of the hopeless future ahead for the stagnating Euro economy. He then has to sell the notion that the only way for their dynasties to survive the next 100 years is to introduce a teensy bit of his American youth and exuberance. They will fear that one cannot dip only the toe in the pool. They may be right. Buffet's number one goal, after all, is not to preserve European gentry. It is to continue market-beating returns on investment year after year after year. Loading up the Berkshire portfolio with a couple billion dollars of stagnant Euro businesses will not help in that regard unless change is on the horizon. The key question is How. Does Warren think he can break into this world of old money and introduce American business and finance models? Perhaps even unwind some of those share cross-holdings? Does he think he has enough political weight (and buddies with the same) to lean on national and EU governments to loosen the legislative straightjackets? Either would unlock tremendous value, but neither seems to me likely in the short-to-medium term.

I can only speculate that his objective is threefold:

  • Ensuring that, in the very long-term, he is well-positioned to take care of the European liberalization

  • Buying his way into the enormous and under-utilized pools of capital held by those families

  • Picking up some large shareholders in BH who share his stable, long-term view. He might even give them a few board seats to protect himself from the chance of an Icann or Ickes invasion.

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