Two Books and Two Fish

Two Books and Two Fish
January 21, 2012
David R. Kotok

Admiring the untamed Chilean landscape and simultaneously using a wifi connection, I marvel at the interconnectedness that exists in this modern world.  We are heartened by the initial unemployment claims data and the somewhat benign inflation data.  We are watching markets and current world news.  We see Perry drop from the Presidential race; we see the Iowa caucus final count award Rick Santorum the victory.  Gingrich wins South Carolina.  The news is as current here as it is in our Florida office.  By my next trip, upgraded wifi speed and a Skype app will make the Alto Puelo Lodge a functioning mobile office. We return fully current on the news.

We thank many readers for the wonderful emails that came to us in response to our previous report from Chile.  The fly fishing comments from fellow fly fishermen from around the world were heartwarming and are most sincerely appreciated.  Even the questions about “photoshopping” the fish brought good laughs and the reward of sharing the experience with others.  The Alto Puelo Lodge is truly a wonderful place.

In particular, we enjoyed an email that came to us from Missoula, Montana.  Chris Squires, a mother, aged 60, with an 18-year-old daughter who wants to be a fishing guide, wrote eloquently about fly fishing and contemplating the world.  She captured the very essence of this annual ritual visit to the Patagonian valley when she wrote, at the conclusion of her letter, “Fishing is a good way to let thoughts settle.”  Chris is right, and so our second report from Chile will discuss two fish, two books, and their interconnection.  Our tale of two tails will commence shortly.  But first, let us discuss a book.

First book

Frank Knight’s seminal work Risk Uncertainty and Profit delves deeply into the differences and nuances between risk and uncertainty.  He suggests that risk is something that is examined and derived by measuring the past, using statistical analysis and other methods in order to assign probabilities of outcomes.  The presumption is that the past is prologue for the future; therefore, risk can be quantified with these methods.  Knight’s work introduces the notion of uncertainty framed in the context of human behavior.  Knight’s criticism of economists, forecasters, and those engaged in business operations is that they confuse risk and uncertainty. He goes on to discuss how various types of organizations function and how individuals collectively operate in circumstances of elevated risk or uncertainty.  His work is challenging and may be considered out of date by many who are caught up in quantitative processes.  He was an economist who went beyond mathematical equations and thought about economics in the terms of human behavior and social interaction.

“With the introduction of uncertainty, the fact of ignorance in necessity of acting upon opinion rather than knowledge into this Eden-like situation, its character is completely changed.  With uncertainty absent, man’s energies are devoted altogether to doing things; it is doubtful whether intelligence itself would exist in such a situation; in a world so built that perfect knowledge was theoretically possible, it seems likely that all organic readjustments would become mechanical, all organisms automata….

“With uncertainty present, doing things, the actual execution of activity, becomes in a real sense a secondary part of life; the primary problem or function is deciding what to do and how to do it….

“When uncertainty is present and the task of deciding what to do and how to do it takes ascendency over that of execution, the internal organization of productive groups is no longer a matter of indifference or a mechanical detail.”

Frank Knight has captured the essence of action when uncertainty is present.  The process by which one decides what to do and how to do it takes primacy over the mechanics of implementation.  Sitting on the Alto Puelo deck, we realize that this is what makes us human; this is what makes life interesting.  This is what makes economics a social science, not a quantitative, scientific, exact process.

Source: Frank Hyneman Knight, Risk Uncertainty and Profit (Memphis: General Books, LLC, 2010)

First Fish

The Rio Puelo drops down several sets of rapids below the Alto Puelo Lodge.  The runoff at the bottom of the second set makes a hard right turn.  The speed of the water and the ebb and flow of the seasons have carved out a large section of the bank.  As the river turns, it causes a back eddy to flow into a deep pool.  The back eddy circles around slowly, collecting flotsam from the river in a swirl about 50 feet across.  Insects come down the tumult of the rapids and get caught in the back eddy, along with everything else.  In the easy currents of this back eddy, rainbow trout glide in and wait for a nymph or a fly, and feed in this turquoise green, sunny environment.

A rainbow trout was feeding on a stream of insects that were floating through the back eddy of the pool.  We watched from a distance; she would rise and fall, come up for an insect, go back down into the mild current, and come up again.  We tied a small elk hair caddis imitation on the end of a 6-weight tippet, a very thin leader but necessary in order for it to be out of the vision of the trout.  In order to float the fly to the trout, I cast the fly upstream and place it so that it will float to the fish as a natural fly would do.  The cast was about 40 feet.  The fly was placed about 10 feet in front of the trout; and gradually, with some mending of the line, it floated naturally, the trout rose and took the fly, the hook was set, and the fight commenced.  Nano, our Chilean guide and an expert fisherman, got very excited when he realized that the trout was on a very light leader.  “Be careful!” he warned.  The result is here: Rainbow Trout.  The rainbow trout was released and gave a wonderful start to the morning, as it was the first cast.  Yes, it was going to be an extraordinary day.

Pools and feeding fish are assessable. In Frank Knight’s world, they are predictable.  Uncertainty is in the choice of the fly.  Skill involves decisions of presentation and execution, and so we connect the first book with the first fish, with the result that in this case we consider a combination of good execution and good luck.

Second Book

James Rickards’ Currency Wars: The Making of the Next Global Crisis is a good read from the deck of the Alto Puelo Lodge.  The afternoon breeze is soothing, and the air is deliciously sweet and pure.  The sun is bright on this summer day in Patagonia.  The morning fishing was marvelous, and lunch was exquisite.

Chapter ten, entitled “Currencies, Capital and Complexity,” describes the risk of strategies of devaluation of a currency.  In the earlier sections of his book, Rickards recites history, from Roman times to modern times, and how devaluation in many instances led to tragic outcomes.  He argues that the central banks of the world are now engaged in competitive devaluations, and that devaluations lead to a modern form of war.  He discusses the thinking that goes into devaluations.  He is harshly critical of some of our present leaders who have represented themselves as favoring devaluation, either through implication or public expression.

Rickards adds the issue of behavioral economics to complexity, and he discusses how these interactions elevate risk, because increased complexity makes economic processes more dangerous when they fail, just as they are more beneficial to society when they succeed.  He writes, “What Bernanke, Geithner, and like-minded behavioralists in policy positions fail to see is something Merton might have easily grasped – the positive feedback effect that arises from framing without substance.  If the economy is actually doing well, the message requires no framing and the facts will speak for themselves, albeit with a lag.  Conversely, when reality consists of collapsing currencies, failed banks and insolvent sovereigns, talk about green shoots has at best a limited, temporary effect.  The longer term effect is a complete loss of trust by the public.”

Rickards is warning about impending difficulties.  His concluding chapter outlines options and how they might unfold, and it is a thought-provoking read.

Chapter 11, entitled “End Game: Paper, Gold or Chaos?”, outlines processes at work in the International Monetary Fund and in the interconnected central banking systems of the world that are leading to increasing devaluation of currencies.  He traces the origins of the IMF and the collapse after Bretton Woods; and the results show that the US dollar comprises “over 61% of identified reserves, while the next largest component, the euro, weighs in at just over 26%.”  He notes how the IMF is attempting to gradually institutionalize special drawing rights (SDR), and he notes how the development of the SDR as a world monetary substitute on an institutional level is currently underway as a new process.  He talks about the risk to this approach in the 2012 election and what would happen with a Congress and a President in 2013 if some contributions were made or limits on contributions to the IMF were created by Congress.  SDR borrowing capacity is a huge issue now.  He points out some of the work done by Geithner to assemble larger entities into informal groups, in which decisions are made without direct consultation with political constituencies and certainly without consultation with the taxpayers who support those constituencies.

Rickards also sponsors the notion that a gold standard is necessary.  He rejects the attack on gold as a “barbarous relic.”  Rickards notes clearly in his arguments that “gold is not a commodity.  Gold is not an investment.  Gold is money par excellence.”  He notes that gold is “truly scarce.”

I am not sure whether gold is the answer to the current woes in our economic circumstances, and I am not sure that the current expansion of central bank balance sheets will lead to an immediate inflation.  In fact, that has been a warning we have heard the last four years, and we at Cumberland have rejected it in the near term.  By doing so, we were able to take advantage of the tremendous decline in interest rates, and our bond portfolios were rewarded for that decision.

However, we are approaching levels of interest rates that are creating concern.  How long will they remain this low?  How much more expansion of central bank balance sheets will occur?  What are the multipliers attendant to the monetary-base calculations for various currency blocks around the world?  Readers may look at the Cumberland website for updated graphic depictions on central bank balance sheets and on interest-rate spreads.  Look at the two chart stacks at for details.

Frank Knight described the difference between risk and uncertainty and developed the concept of organizational structure in which the process of deciding what to do and how to do it becomes the critical element in dealing with uncertainty.  James Rickards talks about that process in the context of central bank policy and the monetary dynamics involving the euro, the British pound, the Japanese yen, and the US dollar.  He focuses on possible outcomes of that decision-making process.  He talks about the uncertainty that awaits us and about the various scenarios that could befall us.  Currency Wars, with its last two chapters, is an exciting book to read and ponder on the Rio Puelo.  Frank Knight’s classic work provides the framework for such thought, and Chris Squires’ quote from her email frames the connection between contemplative reading, thinking and digesting of ideas, and a fly rod.

Source: James Rickards, Currency Wars: The Making of the Next Global Crisis (New York: Penguin Group, 2011)

Second Fish

When you take the Rio Puelo down below the first rapids and before the second rapids with the big rainbow pool, there is a feeder stream that flows in from the left side.  It brings food from the mountains down into the river, and joins the larger flow.  In the abundance of swirling water, trout can easily find a meal.  The place to take the boat is below the location where the feeder stream comes in, and then bring the boat back, positioning and anchoring it so that the cast can be executed so that the fly will float into position where the two streams meet.  Trout will hold in that water searching for a meal.  In this case, the meal was a “matuka.”  The matuka is the name for a fly with a gold bead head, a green and black feathered tail, and a reddish-orange thorax.  I guess the insect it most closely resembles is an oddly shaped caterpillar or worm.  In any case, the trout like it.

In order to cast in this environment you have to throw the fly as far as you can across the fastest-moving water.  You have to use sinking line; in this case, it was an Orvis 250 Depth Charge.  You also need a heavyweight rod; in this case, it was an 8-weight.  In order to shoot the weighted line out as far as possible, you make one false cast, taking a stack of line off the reel; and then you attempt to fling the line across the river and allow it to swing so that the fly floats naturally into the desired space.  A monster brown trout lay in waiting.  The fight was twenty minutes in length, the tippet was 4x, several runs went to the backing, and the proof is here:  Brown Trout.  Nano, our fishing guide, again demonstrated his knowledge of the river and provided expert consulting.

Two books.  Two fish.  A great week at the Alto Puelo Lodge on the Rio Puelo.  For more information, please visit patagonia-flyfishinglodge or email ericschoenauer -at-  With this, I am on my way back to my desk.


David R. Kotok, Chairman and Chief Investment Officer

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