Wrong thinking will be punished seems to be one of life’s truisms. It is a pity that we are so inept at sorting out which thinking is wrong.
I have recently seen several articles in name brand publications that actually make no sense. They are truthy nonetheless and that is a problem. They promote wrong thinking.
Is a corporation with $100,000,000,000 in sales a billion dollar corporation? It appears yes, but if their expenses are $110,000,0000,000, now what are they? Broke, unless they can fix it.
Net income and gross income are vastly different and people must understand how they are different before they invest. Amazon in 2014 had operating income of $178 million on sales of $89 billion. Microsoft sales were $87 billion, but they made nearly $28 billion. You cannot judge a business by its sales alone. Amazon is worth about two thirds of Microsoft. If sales told the story they would be the same. If net income told the story, Microsoft is worth 157 times more.
In 2008 the US Geological Survey decided there were 90 billion barrels of undiscovered oil in the Arctic. In 2000 they estimated there were 90 billion barrels of undiscovered oil in Saudi Arabia. Are Saudi’s 90 billion barrels the same? Maybe not. Those are gross reserves. You can extract the Saudi oil with not much cost. The Arctic oil is hard to find, harder still to recover and you might need to heat a pipeline for a couple of thousand miles to get it out. The “net” value of Arctic oil is a fraction of the Saudi oil. Not the same thing even though the gross number is identical.
And now we come to Chinese foreign currency reserves. As recently as June 2014, those seemed to be $4 trillion. By December 2015 they seem to be $3.3 trillion. They spent $513 billion defending their currency during 2015 and are presently trying to stabilize their stock market. Not cheap.
Can they do it for a long time or are they tapped out, or nearly so, now. The answer lies in understanding their currency reserves. Are the gross or net? Are the funds liquid? Are they committed elsewhere? Are some of the funds held for others? China won’t tell you, so it behooves us to ask, “What are their net reserves and what could happen when they run out of net reserves?”
I don’t know the answer to that and cannot even think about it usefully. My intuition is that if net reserves turn out to be very small Valium sales will increase.
N.N. Taleb has talked about black swans and how they may work in your favour. If there is a black swan developing in China, you will be wise to be on the right side of it. Learn more and pay attention to things that don’t make sense.
In the world, fairness is a bit uneven, so right thinking does not necessarily reward you, but that is the way to play the hand.
Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.