I had the pleasure recently of visiting the wonderfully named Library of Mistakes in Edinburgh. It’s essentially a financial history library, and it’s funded by a charity dedicated to improving financial education. While I was there I conducted an in-depth interview with the Keeper of the library, RUSSELL NAPIER.
A respected financial author and academic, Russell’s day job is advising institutional investors about asset allocation. For almost 20 years he was a Consultant Global Macro Strategist with CLSA Asia-Pacific Markets. In 2013 he was elected as a fellow of the CFA Institute of the UK. He is a non-executive director of the Scottish Investment Trust and the Mid Wynd International Investment Trust, and he also serves on the Investment Committee of the National Trust for Scotland.
The interview is in two parts. In Part 1, Russell explains how the library came into being and what its purpose is. He also explains why, in his view, most academic finance courses today totally disregard important and relevant subjects. Finally, he gives some suggestions for books that curious investors should try to read, as well as books to avoid.
Russell, how did the Library of Mistakes come about?
The library is a follow-on from something that we started in 2004. I say “we”, but I mean a charity called the Didasko Education Company. What that charity saw was a need for a course on financial history. That was because so many people teaching finance were throwing away things that we thought were important, such as an understanding of psychology, politics, even philosophy. All the things that play a key role in determining the price of financial assets seemed to be left out.
So we started a course called Practical History of Financial Markets to add those elements back again. And in due course, ten years later, it seemed to us that we also needed a library. It’s actually a resource that increasingly doesn’t exist. These books on financial history had been stripped out of university libraries, and we all know that public libraries are not exactly growing and thriving at the minute. So we built up this resource to back up the course. But it’s a public library, and it’s open to any member of the public who registers.
So, for those who are interested in financial history, how do they get to use the Library of Mistakes?
You can go to our website and register as a reader. And once you register you can then arrange a visit on the website as well. This library opens Monday to Friday, 9-5. We also have guest lectures here. It’s not a large space, but we can take up to 35 people. We run about nine of those a year, and they’re all on financial history, but with a focus on what financial history has to teach us about the future. If you happen to live in Pune, India, there is a library there you can visit. And we’re also opening one in Lausanne, Switzerland.
Talk me through the range of books you have in the library.
I’d like to make it wider. It’s almost exclusively focused at the moment on business and financial history. But the reason I’d like to make it wider is that what we’re really studying here is human decision-making when faced with uncertainty.
Daniel Kahneman won the Nobel Prize for Economics, or what is commonly know is that the Nobel Prize for Economics, for his work on that subject. But he’s not an economist; he’s a psychologist. What we are doing is using the tools of an historian to study exactly the same phenomenon — human decision-making under uncertainty.
Business people and finance people get a lot of flak because of the mistakes they make. But that’s because they live in the future more than most people. Doctors and surgeons tend to live in the moment, but financiers have to live in the future.
So mistakes, in the sense of the Library of Mistakes, are not just mistakes we make in finance. It’s about what goes on in our minds, and how we as human beings are prone to make certain systemic errors when we deal with uncertainty. That’s the core work of Kahneman, and it’s changing economics. So we look forward to expanding way beyond the field of business and finance. That’s just our current fixation, but we will move on from that.
What you’re talking about seems to have more to do with social science than financial history.
Finance is about human beings. If you look up the Oxford English Dictionary’s definition of market, it’s a place where people come together to set a price. We can force that into a purely mathematical and measurable objective outcome, but in doing so, I think we throw many other things away. And therefore we often come up with wrong answers.
Now, obviously, all of this is much more in focus post the great financial crisis than it was before the crisis. But all the things we are throwing away, when we reduce everything to an equation, or numbers, are the things that make us human beings. There are issues of psychology, philosophy and politics, and issues of general human behaviour. And I think we don’t yet properly account for those when we estimate the future price of financial assets. We used to, and it used to be the way we taught it. Financial history and economic history used to be part of syllabus for people studying finance, but it isn’t anymore. So this is a small step to add back in some of the ingredients that we stripped out. We are quite good at distillation in Scotland, but you can take things to an extreme. Sometimes you throw away some of the better bits.
It’s not just books you keep in the library, is it? There are exhibits too.
Well, I don’t believe Ralph Waldo Emerson when he said that if you build a better mousetrap, the world will beat a way to to your door, I don’t think “build it and they’ll come” is a reasonable way to do things. We have to make this a place that people want to come to. We have to make it fun, we have to make it interesting. If it was called the Edinburgh Business and Financial History Library, and had no exhibits, just books, I suspect we wouldn’t be doing this interview.
Briefly, then, why should investors take time to read financial history? What can they learn of relevance today from events that happened many decades, or even centuries, ago?
I’d say primarily it’s about mechanisms. There is a famous line by Mark Twain, when he said, “History doesn’t repeat itself, but it rhymes.” I think it would be foolish simply to look at the patterns and charts, for instance, and say these things will repeat themselves. Some people think that’s why financial history is useless, because it’s a form of extrapolation. That’s not what it’s about; it’s about understanding mechanisms.
In the case of the investor, that means mechanisms for price determination. Those mechanisms are not set through an equation, as I said; they are set through human interaction, through things like changing inflationary expectations and the level of money supply growth. They are set through who is in political power and what their ultimate goals are, and they’re also set through movements in exchange rates.
One of the better ways to understand the mechanism of price determination is to study financial history. So we are not looking at it and saying, “This will repeat.” We are looking at it to understand how it works, in the same way you might lift the bonnet of a car. You are looking at the engine to see how it works, because if you know how it works, there’s a better chance that you will be able to keep it running.
Of course, most people who want to learn about investing read what I would call “self-help” books. And these books aren’t actually new. You’ve been involved in a study on that subject, haven’t you?
Yes, that’s a fascinating project and it’s run by academics. The library has just been involved in that tangentially. It’s really an academic study of that particular form of literature — not self-help in general, but self-help in relation to finance. These books have been around for a very very long period of time. A good example is a book called Every Man His Own Broker, which is about 150 years old now. And the reason academics are interested in it is not really to do with finance at all; it’s about what it tells them about us. That’s why these books are really fascinating — they tell us about how we see ourselves.
Are there are any general rules for investors in there as well? The first is, don’t read books that tell you how to invest in the stock market. These kinds of books are usually more to do with marketing than anything else.
There’s an interesting phenomenon of the sort of people who read these books and get a little bit carried away with their level of self-knowledge. I’m not saying ignorance is a bad thing. I’m here to recommend that everybody reads financial history and tries to understand mechanisms. But I do think that’s better than reading some of the advice books on how to invest, how to be a better investor, how to make a million dollars and so on.
So you’ve told us about the sorts of books that investors shouldn’t read. So what should they read?
It’s an awfully difficult problem given the scope of the whole subject. There’s Triumph of the Optimists by Dimson, Marsh and Staunton, which simply looks at the history of returns. If you read it you can calibrate yourself. I think this is really important for the retail investor. It’s very easy for me to get calibrated if I buy a car, a 20-year-old Skoda, for instance. And if they tell me that it will do 150 miles a gallon, and it’s capable of 0-60 in three seconds, I know they are lying. I know from my personal experience that that is a lie, that this cannot be true.
People are not calibrated on what returns to expect from financial assets, and it’s all in Triumph of the Optimists. So you know that if someone comes to you and says, “I’ve got a product that’s going to produce a 20% return, ad infinitum,” you know that person is either taking too much risk or lying, almost certainly. There is a chance that they are the one-in-a-million genius, but it’s very unlikely. So Triumph of the Optimists is a key one.
I like everything written by a man called Jim Grant. He has written a great series of books on financial history and how it relate to asset prices, The Trouble With Prosperity being a very good one. But he has written many others.
I personally believe that there’s an important link between money and asset prices. Everything that you invest in is denominated in money, but how many people really understand how money is made, and the linkages between credit and money? So for anybody who’s really feeling up to it, there’s the fantastic Monetary History of the United States by Friedman and Schwartz. I’ve read it, cover to cover, three times, and I think I understand 95% of it. I’m maybe flattering myself; it’s not an easy read. But I think getting through to understanding that mechanism is really important.
There’s a really good book by the famous Charles Kindleberger, Manias, Panics and Crashes. Most people don’t know he also wrote a fantastic book called A Financial History of Western Europe.
So there are lots of great books to read. And I should finally say, that on the website for the Library of Mistakes, we have a book search. So if you wanted, say, to read about inflation, you could put the word inflation in there, and it will bring up every book we have in this library on inflation. You can then either come here or buy the book you need online.