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SS 69 – Learn What the Old Testament Can Teach Us About Risk with Jeremy Josse

Episode: 69

Guest: Jeremy Josse

iTunes: Stream Episode

In today’s discussion, Jason Hartman and Jeremy Josse talk about Jeremy’s latest book, Dinosaur Derivatives and Other Trades. Jeremy talks about some of the key lessons you can learn from the Old Testament as well as why financial innovation is not as bad as it might seem. Today’s topics mostly focus on economics, the value of money and other possessions, interest, and capitalism.

 

Key Takeaways:
1:45 – What are dinosaur derivatives?
3:40 – Jeremy talks about Joseph from the Old Testament.
7:40 – Joseph’s story shows us what happens if you take risk away from the economy.
14:08 – Corporations are legal fictions because they’re seen by law as a person when in reality they’re not.
19:10 – Jason asks if it’s bad to charge interest? Jeremy explains.
23:15 – Do corporations really operate on a capitalist system?
26:30 – Jeremy believes that neither socialism or capitalism is that helpful anymore.

 

Tweetables:
“Finance is fundamentally called speculation, because that’s always irreducible element of risk.”

“My advice to investors is don’t buy a new financial product. Wait until it’s been seasoned for 10 years.” 

“I strongly try to encourage people to step away from their ideology use and just judge economic issues on their merits.”

 

Mentioned In This Episode:
www.DinosaurDerivatives.com

 

Transcript

Jason Hartman:
It’s my pleasure to welcome Jeremy Josse to the show. He is author of Dinosaur Derivatives and Other Trades. Jeremy, welcome, how are you?

Jeremy Josse:
I’m very good. Thanks for having me on your show.

Jason:
Yeah, it’s a pleasure. This is a fascinating topic, fascinating book. What are dinosaur derivatives?

Jeremy:
Dinosaur derivatives is really just a metaphor. The book is not really about dinosaurs or derivatives, but the very first – the book is really a mixture of finance and philosophy and I try to put the two together in an entertaining and fun way and the very first chapter of the book is about an auction to sell a contract to buy a dinosaur, which may sound absurd given that dinosaurs are extinct, but the chapters really asking the question, you know, understand what circumstances could such a contract, could such a dinosaur option really have value. I do believe when you look at the financial markets today, we look at some of the strange dislocations between the market value facets and the real fundamental value. All sorts of bizarre things can turn out to be valued, but by the market. So, that’s the origin of Dinosaur Derivatives. It really is the reference to the very first story in the book, but the book covers many other sort of curious tales as well.

Jason:
Fantastic. So, you make a lot of scriptural reference or some, I don’t know if I want to say a lot, but some, you know, what can the old testament teach us about risk and uncertainty?

Jeremy:
Right, right. So, as I said, the book is always putting together philosophical ideas with financial ideas and I do it through these stories. Each story relates to a different concept in finance. Again, some of these stories are (#3:32?), but some are these are ancient stories evolve and one of the stories I pick up is this story of Joseph from the old testament and that story actually does – is a very, very profound story, never mind the religious meaning, but on a financial level, it’s a very profound story that tells us all sort of things about risk and uncertainty and, very briefly, I mean, obviously Joseph as your listeners will probably know, Joseph was given this prophecy by God that, according to the story, they’re going to be seven good years and then seven bad years.

For a starter, the story tell us recessions are as old as the world, right, but aside from that, Joseph, one of the interesting things about the story is actually if you look at the details of the scripture, Joseph later in the story during the bad years, he’s actually pretty aggressive with what he does economically. He’s built up this huge circle in the good yeas and in the bad years, he doesn’t sort of give it away, he actually sells all the stuff for some cash. Once there’s really no cash left in this system, he then sells his live stock and then the land and ultimately people’s labor. Effectively, he and the Pharoahs threw corners, a whole fertile crescent, the whole then-known world and it’s an interesting question. A lot of scholars are..

Jason:
So, it’s a diversification suggestion, isn’t it?

Jeremy:
Well, so a lot of scholar ask, you know, why does he actually do this at that period. In some ways, it sounds like he centralized the whole economy, you know, was he a communist? There are a lot of people who try to understand why he does it and what I try to say is that the best way to understand it, the stories are really giving you an inside into the nature of risk and if you think of modern financial theory, you see in many ways Joseph was given a tip. He was an insider dealer, but he wasn’t given a tip by the normal guy in the market, he was given the world of God.

So, if you believe the story, he knew the future. It wasn’t that there was any doubt about it, he was certain about the future and when you’re actually certain about the future, the whole risk/reward spectrum breaks down. If I am certain about a certain event, I can bet the whole world on that event and I will indeed be certain to win my bet and take over the whole world and that sort of effectively what he did. He took this long positioning call in the good years and then bet the whole thing to effectively in result in taking control of the whole then fertile crescent. It was a consequence of the fact that he had left the normal spectrum of risk return and gone into the world of certainty. So, summery, the story is actually giving a very fascinating insight into the very limiting case of risk and the nature of certainty itself.

Jason:
Yeah, very interesting, but I mean, we are never certainty about anything. No one can be certain, right? So..

Jeremy:
You’ve hit the nail on the end, so of course, you know, most of us don’t have a line through to God and most of us are not Joseph. So, most of us, of course, have got to struggle through life with the ordinary necessities and the ordinary risks involved in life and that’s why finance is fundamentally called speculation, because that’s always irreducible element of risk, but the Joseph story sort of tries to show us what would really happen if you ultimately extract the risk from the system entirely and that’s why it’s fascinating.

Jason:
Yeah, really interesting. Okay, alright. Is there anything you want to share with the listeners that can teach us about monetary policy?

Jeremy:
I think part of the purpose of the book, I mean, I studied a lot of philosophy and economics both as a undergraduate in Oxford university and then later as a graduate (#8:06?) from England, but spent my career in finance, but I do think that sometimes, you know, with finance there’s this inherent power dogs and I sort of summarize it in the acknowledgment of the book, which is that, you know, on the one hand it’s a very important business, but on the other hand, it can be very venial and it’s fundamentally parasitic on the underline economy. You’re not really doing with an actual industry. It is dependent on the risk of the economy.

So, on the one hand, finance can be somewhat venial, but on the other hand it is fundamental to our system and when it really goes wrong are the brains and blood of the system. Everything goes wrong, we saw that in the credit prices, and that’s sort of the paradox I wanted to bring out throughout the whole book that finance is a fundamental, but don’t take it too serious and don’t get too wrapped up in the inherent materialism in the industry.

Jason:
Out of curiosity, do you believe there’s a big derivatives bubble? People have been on my show talking about the 700 trillion dollar estimate of derivatives out there and what I’ve never been able to make of that, you know, for every transaction there’s a counter party, so can that really ruin the world and the global economy or is it just going to move things around? For example, I know this may be a little off track, but we’ll get back on track here, but the day after the finance crisis, everyone work up and the world had this same amount of wealth. The oil didn’t suddenly disappear, the gold didn’t suddenly disappear, you know, the real estate didn’t suddenly disappear, all of it was still there.

Jeremy:
Well, so you’ve raised a lot of interesting questions. I mean, actually going into reverse. Whether people have the same wealth or not is not clear, because one of the things, again, the book discusses is the nature of value and as I say, there’s often a dislocation between market value and fundamental value. So, one day an asset can be worth x, the next day it can be worth a lot less than x, so yes, the total amount of goods in the world stays the same as a result o the credit crisis, whether the value of those goods are the same is a different question, but to your first point, I think the book also has a whole chapter and a whole set of stories about financial innovation and there’s no doubt that derivatives were a huge piece of financial innovation over the last 30 years, 40 years whether you’ve even seen a Black Scholes’s work on derivatives and one of the problems with financial evasion is that we don’t really have a social laboratory when we innovate new financial products.

I mean, when we innovate a drug or when we innovate a hammer or a car, all these things can be tested before they’re put on to the market, but you don’t have that same facility with financial innovation and so, we are all the guinea pigs when a new financial product comes under the market, the first time it’s tested is when it has hit the market. What’s certainty has periodically happened with derivatives is that they also had the consequences which we didn’t necessarily envisioned and hence the history of some of the Orange County debacle, hence undoubtedly some of the problems lending up to the credit crisis.

Jason:
You’re referring to Bob Citron in the 1995 area, yeah.

Jeremy:
Exactly, so there was that. There have been all sort of times when people thought they were actually hedging themselves to a derivative, but were actually leveraging themselves, actually increasing risk. That clearly was part of the problem leading up to the credit crisis and the Lehman bankruptcy is full of derivative positions, but having said that, they’ve been around for awhile now and I do think post-credit crisis we have a much better understanding of how to use them and how to use them in moderation when they’re really hedging and when they’re doing the opposite. So, I am more confident today that we use derivatives in a prudent and a structured way compared to say 10-20 years ago.

Jason:
Back to the book, you know, maybe I’ll just ask you about some of these chapter heads, you know, we talked about the uncertainty and Joseph’s dream and so forth, direct line to God, you mentioned financial innovation several times and, gosh, I tell ya, if any word should scare people it’s financial innovation, because you know what that always means. It means that the Wall Street crooks are going to be enriched and the general population is going to be screwed.

Jeremy:
Well, I wouldn’t go that far, but you’ve got a point.

Jason:
Okay, devastated, not screwed. How’s that? But, what is a financial instrument? Is that just a legal fiction? Tell us what you mean by that.

Jeremy:
Again, a couple of things. In terms of what is a financial instrument, I mean, look, financial instrument are really just contracts, types of contracts and there are often complex constructs of contracts. The reality is that actually many of them turn out to be what we call legal fictions over the centuries and by which I mean the following. If you think of a corporation, a corporation is really a legal fiction. It’s deemed to be a person, a legal person, when in fact it’s not a person.

Jason:
Yeah, I’m so glad you mentioned that, because just as a side, I mean, if corporations are people, then they should be able to go to prison just like people, you know?

Jeremy:
Right. So, they’re not people and what they are really is devices for risk management, because they allow people, they allow risk to be spread so that multiple people can own a corporation and those people can only be liable for the purchase price of their securities. Actually, many financial instruments are like that and one of the things I discuss in the book is the ancient prohibition on usury. You know, there was back (#15:03?) Jewish days, there was this prohibition on interest.

This thing go manifested in medieval times into the Christian doctrine also into Islamic doctrine and an incredible thing is that many, many that prohibition itself actually created a lot of financial innovations. Many, many financial products developed as a way to get around the prohibition. To give you an example, a lease is really a way to get around the prohibition. Instead of lending cash and charging interest, you lend an asset and charge a rent. So, it is a legal fiction. It is a mirror image of lending, but it’s not technically called interest. Indeed understand Sharia law it is a typical mechanism to getting around the prohibition and usury.

Jason:
The interest, yeah, exact. It’s interesting how the Muslims do that, they do leases rather than purchases with financing.

Jeremy:
There are many other structures, which you will find that the actual development of a financial product was as I say a legal fixture. It was a way of getting around a legal prohibition. So, that’s what I’m really talking about there and I think you touched on financial innovation is dangerous. That gets back to my point when I say there’s so no such thing as a social laboratory. I think, we must have financial innovation, right, I mean, credit used to always flow and the economy is complicated, but financial is dangerous and my general advice to investors is don’t buy a new financial product. Wait until it’s been seasoned for 10 years and that we actually seen how it can function and what its limitations are. So, I mean, I think your point about finance innovation is spot on. It is dangerous, but is also required.

Jason:
Good point. So, railroads and the credit crisis.

Jeremy:
So, that actually as also a part of the analysis on financial innovation. The railroad revolution in America in the middle of 19 century, many people don’t realize that it was during the railroad boom that the convertible bond was invented and it was invented to solve a very specific problem. What tended to happen with railroads was they were built for certain lengths and then the builder of the railroad tended to go bust and then they needed more capital and what they found was that you couldn’t get either equity or debt investors into these railroads, but they realized if you offered someone a bit of debt with a limited coupon which could be paid from the part of the railway already built, but then with the kicker of an equity ownership when the railway was finished, that could act as a nice solution. They could be an attractive product for investors and genuine convertible bonds were invented to solve this financial problem in terms of American railways and it worked and many railways were finished because of convertible bonds and convertible bonds then became an established part of the financial architecture, So, just a nice example of the nature of financial innovation.

Jason:
You know, going back to some of the biblical references, I mean, should it not be okay to charge interest? Isn’t there a time value of money? Usury is just a perception and a relative concept, isn’t it?

Jeremy:
I think you’ve hit the nail on the head. The whole problem with the original – we can sort of understand where original scholars came from in terms of the prohibition and usury. They felt that if someone was short of money, you shouldn’t exploit that situation, right? If someone needed money you should give them money to get them back on their feet and there weren’t back then this sort of advance capital markets we have today, but the problem with the prohibition is exactly the one you said, which is that all money has a time value so that if I don’t charge, if I lend money and I don’t charge interest, the interest hasn’t actually gone away.

The cost of the money is still there it’s just by not charging interest, I am effectively baring the cost myself. I’m actually giving the borrower charity and obviously as economy advance particularly with the renaissance it just wasn’t possible for lenders to go around providing capital on a charitable basis. So, that was really the point where scholars had to find ways of providing lending on interest without it appearing to be lending on interest and that’s exactly the sort of legal fictions that I’m talking about. There was a great period of financial innovation in the renaissance precisely to solve this problem.

Jason:
Where are going from here? I mean, you talk about what is money? What is ownership? I mean, this are pretty big philosophical concepts. We have to have ownership. I mean, private property rights seem to, although I’m definitely bias, seem to have really improve a lot in life of most people, right?

Jeremy:
Of course. No, I’m just trying to explain the nature of what really are ownership rights and I try to explain them in a slightly whimsical way by reference to the story of (#21:16?), which I don’t need to go into the details of, but yeah, ownership rights are an absolutely fundamental part of any functional economy, but one of the messages also of the book is, you know, I do think that – I no longer believe that I the socialist or capitalist solutions to many of our economic problems are particularly helpful anymore. I think socialism and capitalism were really the product of the industrial revolution.

I didn’t think that in medieval days or in ancient days people thought necessarily in socialist or capitalist terms and we don’t really live in – we live in a post-industrial economy today and I think one of the problems in America is people are still very intrenched in these either left or right wing views and actually economics is much more nuance than that and I strongly try to encourage people in the book to sort of step away from their ideology use and just judge economic issues on their merits and the same goes with ownership. Ownership is of course absolutely fundamental, but that doesn’t mean to say that sometimes we have gross wealth inequalities, which are also not right and need to be dealt with. It’s that sort of balance that I’m trying to encourage.

Jason:
Let me give you a proposition. I want to see if you agree with this, because that’s a fascinating comment you just made, Jeremy, and that is – well, it’s a question, do you believe at the level of large, you know, fortune 1000 sized corporations and banks and Wall Street, which is usually the same group in most cases, not always, do you believe they operate on a capitalist system?

Jeremy:
There is no such thing as pure capitalism and pure capitalism is not necessarily a good thing. It tends to destroy itself. There’s no such thing as pure socialism or communism. We know that destroys itself also. So, to give the example, to answer your specif question about the big corporation, they’re functioning within a relatively capitalist systems, but you’re right. Many of these big corporation are oligopolies – they’re rent seekers. They’ve become established..

Jason:
I only asked a question, don’t say I’m right.

Jeremy:
I think you are partly right. Many big…

Jason:
You know where I’m going with this is why you say that.

Jeremy:
I do and again, it’s a theme in the book. Many of these big corporation have become sort of oligopoly rent seekers and that itself actually undermines the capitalist market.

Jason:
Why do you say rent seeker, though? What do you mean by that?

Jeremy:
Well, the rent seeker is really someone who has an established position in a market; is virtually a monopolist and therefor all he’s doing is just collecting an income just becomes of his established position in the market and those dominant players in the market, they actually don’t want innovation, that’s the last thing they want is innovation, because..

Jason:
Innovation means competition.

Jeremy:
Right, they want status quo and look, that’s why we have anti-trust laws, because capitalism destroys itself a certain point. A monopolist emerges and he doesn’t actually want capitalism, so those monopolies have got to be broken down. So, again, to answer your question, yes, I think we do function broadly in a capitalist system, but there’s no doubt that some of the big corporations abuse their position within that capitalist.

Jason:
I think small businesses operating in a capitalist system unless of course they’re underwritten by the government through the SPA or through, you know, some sort of minority advantage, you know, those kinds of things, but the big companies on Wall Street, that’s not even close to capitalism, you know? It’s corporate socialism.

Jeremy:
I wouldn’t say it’s not close to capitalism, because there is ruthless competition between these organizations, but there is clearly distortion. There are real distortions.

Jason:
Okay, that’s a little more fair. I know we’ve go to wrap up here, but why do you say taxation is better than thief?

Jeremy:
The taxation chapter, again, is another fun story where I actually try to analysis the political economics of the lost city of Atlantis, so again, it’s sort of totally apocryphal story, which again, I mean, I don’t need to go into, but what I try to bring out is that we do need taxation, right, and we do need an appropriate level of taxation to solve – partly because our governments need money to solve certain wealth and equality is used, but I also believe that taxation is a very suboptimal form of wealth-free distribution and this gets back to my point about neither socialism or capitalism being that helpful anymore.

I think, if you think of hunter gatherers, if you think of man back in tribal days, you know, they were self-sufficient, but they had these tribal bonds, they have these communal bonds and they’re supporting each other through these communal bonds. What they didn’t need was taxation, right, the communal bonds was strong enough just to allow the system to work, so I’m sort of saying, you know, look, clearly taxation is better than, you know, people just receiving money in the system, but on the other hand it doesn’t replicate those ancient communal bonds that we used to have in tribal times and I think we sort of lost in the relatively modern atomized world.

Jason:
Very good points. Give out your website if you would, tell people where they can learn more about you and the book.

Jeremy:
Sure it’s, www.DinosaurDerivatives.com or of course you can just Google Dinosaur Derivatives and you can get the book from Amazon. Wiley are the publisher, so it’s widely available.

Jason:
Fantastic. Jeremy Josse. Thank you so much for joining us. Do you want to mention any closing thought before you ?

Jeremy:
Just to thank you for a really interesting discussion. Much appreciated.

Jason:
Good having you on the show. Thanks.

Announcer:
This show is produced by the Hartman Media Company, all rights reserved. For distribution or publication rights and media interviews, please visit www.hartmanmedia.com or email [email protected] Nothing on this show should be considered specific personal or professional advice. Please consult an appropriate tax, legal, real estate or business professional for individualized advice. Opinions of guests are their own and the host is acting on behalf of Platinum Properties Investor Network Inc. exclusively.