Berkshire Hathaway's
(NYSE: BRK.A)(NYSE:
BRK.B) Warren Buffett and Charlie Munger are undoubtedly the greatest
investment duo ever, so I think any sensible investor should try to learn as
much as possible about these two men and how they achieved their success. In
the case of Buffett, it's not hard -- there are many books about him, he's
published lengthy annual letters for decades (you can read the last 27 of
them for free on Berkshire's
website), and he gives speeches and makes public appearances regularly.
But Munger is more private; there are only
two
books about him, he is a far less prolific writer, and rarely gives
speeches.
Thus, my heart skipped a beat when a friend gave me a recording of a
speech Munger gave to the economics department at the University of
California, Santa Barbara last Oct. 3. It's 85 minutes long and entitled,
"Academic Economics: Strengths and Faults After Considering
Interdisciplinary Needs."
With that kind of title, it sounds like a real snoozer, eh? But it's not.
In this speech, Munger applies his famous mental models approach to
critiquing how economics is taught and practiced, and I think the lessons he
teaches are profound -- both for investors as well as anyone who seeks to be
a better, clearer thinker.
I transcribed the speech for my own benefit, but after making such an
effort (it took forever, as it's 21 single-spaced pages), I thought that
others might be interested in Munger's wisdom, so I sent him a copy and
asked if I could publish it. He asked me not to until he'd had a chance to
review it and make some edits. He has now done so, so I'm delighted to share
it with you:
Click here to read it.
In this column, I will share some of the highlights of the speech.
Berkshire's success
Munger started his speech by highlighting his credentials to talk about
economics -- namely the extraordinary success of Berkshire Hathaway over the
years he and Buffett have been running it (Buffett ran it for a few years
before Munger joined him):
When Warren took over Berkshire, the market capitalization was about
ten million dollars. And forty something years later, there are not many
more shares outstanding now than there were then, and the market
capitalization is about a hundred billion dollars, ten thousand for one.
And since that has happened, year after year, in kind of a grind-ahead
fashion, with very few failures, it eventually drew some attention,
indicating that maybe Warren and I knew something useful in
microeconomics.
Efficient market theory
Buffett and Munger have always heaped scorn upon the academics who cling to
the efficient market theory, unable to distinguish between an obvious
truth -- that the market is mostly efficient most of the time -- and obvious
nonsense -- that the market is always perfectly efficient all of the time:
Berkshire's whole record has been achieved without paying one ounce of
attention to the efficient market theory in its hard form. And not one
ounce of attention to the descendants of that idea, which came out of
academic economics and went into corporate finance and morphed into such
obscenities as the capital asset pricing model, which we also paid no
attention to. I think you'd have to believe in the tooth fairy to believe
that you could easily outperform the market by seven-percentage points per
annum just by investing in high volatility stocks. Yet…many people still
believe it. But Berkshire never paid any attention to it.
Multidisciplinary education and "man with a hammer syndrome"
Over the years, Munger has always preached the importance of learning -- and
then using -- all of the big disciplines, such as math, science, psychology,
etc. To him, this just came naturally:
For some odd reason, I had an early and extreme multidisciplinary cast
of mind. I couldn't stand reaching for a small idea in my own discipline
when there was a big idea right over the fence in somebody else's
discipline. So I just grabbed in all directions for the big ideas that
would really work. Nobody taught me to do that; I was just born with that
yen.
If one doesn't embrace all multidisciplinary thinking, Munger argues,
then one is likely to fall into the trap of:
"man with a hammer syndrome." And that's taken from the folk saying: To
the man with only a hammer, every problem looks pretty much like a nail.
And that works marvelously to gum up all professions, and all departments
of academia, and indeed most practical life. The only antidote for being
an absolute klutz due to the presence of a man with a hammer syndrome is
to have a full kit of tools. You don't have just a hammer. You've got all
the tools. And you've got to have one more trick. You've got to use those
tools checklist-style, because you'll miss a lot if you just hope that the
right tool is going to pop up unaided whenever you need it.
Problems to solve
During his speech, to illustrate the types of questions his ways of thinking
will help answer, Munger posed a number of problems to solve:
- There's an activity in America, with
one-on-one contests, and a national championship. The same person won the
championship on two occasions about 65 years apart. Name the activity.
- You have studied supply and demand curves.
You have learned that when you raise the price, ordinarily the volume you
can sell goes down, and when you reduce the price, the volume you can sell
goes up. Now tell me several instances when, if you want the physical
volume to go up, the correct answer is to increase the price?
- You own a small casino in Las Vegas. It
has 50 standard slot machines. Identical in appearance, they're identical
in the function. They have exactly the same payout ratios. The things that
cause the payouts are exactly the same. They occur in the same
percentages. But there's one machine in this group of slot machines that,
no matter where you put it among the 50, in fairly short order, when you
go to the machines at the end of the day, there will be 25% more winnings
from this one machine than from any other machine. What is different about
that heavy-winning machine?
For the answers to these questions, you'll have to read the transcript.
Second- and third-order consequences and free trade
Munger gave a number of examples of how often people only look at immediate
consequences of certain actions and fail to consider second- and third-order
consequences. For example:
Everybody in economics understands that comparative advantage is a big
deal, when one considers first-order advantages in trade from the Ricardo
effect. But suppose you've got a very talented ethnic group, like the
Chinese, and they're very poor and backward, and you're an advanced
nation, and you create free trade with China, and it goes on for a long
time.
Now let's follow and second- and third-order consequences: You are more
prosperous than you would have been if you hadn't traded with China in
terms of average well-being in the U.S., right? Ricardo proved it. But
which nation is going to be growing faster in economic terms? It's
obviously China. They're absorbing all the modern technology of the world
through this great facilitator in free trade and, like the Asian Tigers
have proved, they will get ahead fast. Look at Hong Kong. Look at Taiwan.
Look at early Japan. So, you start in a place where you've got a weak
nation of backward peasants, a billion and a quarter of them, and in the
end they're going to be a much bigger, stronger nation than you are, maybe
even having more and better atomic bombs. Well, Ricardo did not prove that
that's a wonderful outcome for the former leading nation. He didn't try to
determine second-order and higher-order effects.
If you try and talk like this to an economics professor, and I've done
this three times, they shrink in horror and offense because they don't
like this kind of talk. It really gums up this nice discipline of theirs,
which is so much simpler when you ignore second- and third-order
consequences.
Open-mindedness
How many people do you know who actively seek out opinions contrary to their
own? Munger certainly does. For example, he said:
…take
Paul Krugman and read his essays, you will be impressed by his
fluency. I can't stand his politics; I'm on the other side. [Krugman
constantly bashes Republicans and the Bush administration on the Op Ed
page of The New York Times.] But I love this man's essays. I
think Paul Krugman is one of the best essayists alive.
Destroying your own best-loved ideas
Munger believes that it's absolutely critical not to "cling to failed
ideas." You must become good, he argues, "at destroying your own best-loved
and hardest-won ideas. If you can get really good at destroying your own
wrong ideas, that is a great gift."
How important this is when it comes to investing! Not long ago, I
publicly recommended a stock, yet a few weeks later, based on new
information, I came to the conclusion that it was no longer a good idea. A
natural tendency would have been to hold on to the stock and refuse to admit
to my readers that I might have been mistaken. Making it even harder to sell
was the fact that the stock had declined - why not wait until it rebounded
to the price at which I had bought it, right? (This is a deadly error, as
I've discussed in
previous columns.)
Fortunately, I did sell, refusing to "cling to failed ideas."
Chutzpah
I'll conclude this column with a bit of classic Munger humor: While Buffett
bends over backward to appear humble, Munger's the opposite -- he jokes
about his big ego. In his opening remarks, he said:
As I talk about strengths and weaknesses in academic economics, one
interesting fact you are entitled to know is that I never took a course in
economics. And with this striking lack of credentials, you may wonder why
I have the chutzpah to be up here giving this talk. The answer is I have a
black belt in chutzpah. I was born with it.
Contributor Whitney Tilson is a longtime guest columnist for The
Motley Fool. He owned shares of Berkshire Hathaway at press time, though
positions may change at any time. Under no circumstances does this
information represent a recommendation to buy, sell, or hold any security.
Mr. Tilson appreciates your
feedback. To read his previous columns for The Motley Fool and other
writings, visit
www.tilsonfunds.com. The Motley Fool is
investors
writing for investors.
