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Views from the Prairie

November 10

What are the real risks?

Jeff Ma was one of the members of the MIT blackjack team that took millions from casinos. He is also a successful entrepreneur and has written an interesting book combining his experiences with business philosophy. He is also training people for the gambling tables. One challenge he runs into is that most people do not understand the real risks they are taking and how risks change over time. This is true also for business.

In management, that lack of understanding of how risks change over time can be a critical or even fatal mistake. Recently, Pontiac rolled their last car off the line and the brand is now dead. At one time, it was one of the liveliest brands in America. What happened? While individual decisions may be criticized, the crucial aspect was when the brand was put in the hands of people who avoided many small risks. They avoided small risks but took the huge risk of turning off the customer. They didn't recognize the various risks they were taking.

Human beings discount the risks after we take the risk and win. Most times, we will not re-evaluate what the risks are since time has passed and simply follow the same path as before. However, often the risks change significantly over time.

Jeff Ma points to a case where someone dropped thousands on the roulette wheel. The person saw that the last eleven spins had returned red and thought that the probability was a sure thing to have a black. He didn't realize that the risks changed with each spin. Instead of a sure thing to win, he lost it all. (Technically, the probability was the same for each spin. The risks of a sequence start low, but change with every spin.)

Some people claim that taking on debt is taking on risk. Technically, that is incorrect. Taking on debt reduces how well you can react to risks happening in the future. For example, after the 1906 San Francisco earthquake, the Federal government pumped the equivalent of $100 Billion in today's money into recovery efforts. If a major earthquake hit Los Angeles today, it would take about $3 Trillion to give the same level of support per person. The US government would be hard pressed to provide that kind of money because of all the debt we have. Yet, every year, the probability of a major earthquake increases.

One point Jeff Ma makes is to look for the numbers. Walt Disney did that before opening his famous parks. Harrison Price, the person who evaluated the locations for Disneyland and Disneyworld, stated that "Guessing is dysfunctional. Ignoring prior experience is denial. Using valid numbers to project performance is rational."

Repeatedly, people use their impressions of what the numbers should be instead of researching the numbers. This causes all sorts of losses at the gambling tables as well as in industry.

Gaining Wealth or Importing Money?

Over the last year, the Federal Reserve has been pumping money into the system to try to prevent deflation and restore inflation. The policy has been a roaring success. In the last year, prices and wages have gone up by 30%. Where? In China.

This inflation points to a human tendency. Over and over again, countries have imported gold, silver, and other forms of money thinking that they were gaining wealth. Instead, what they got was major inflation. Spain had the fleets bringing silver and gold from the Americas. People expected that they would be wealthy. Instead, prices soared. Spain actually declared bankrupcy three times in the late 1500's. Most of that money wound up in the hands of bankers in other countries. The gold and silver from the Spanish colonies were the basis of the banking fortunes elsewhere.

China has been trying to gain economic strength by holding its currency low. The result has been a flood of money into the country. Instead of wealth, they have inflation. To have wealth requires that a majority of people share in the benefits of trade. A similar problem happened in Turkey in the early 1970's and in Somalia more recently. The Irish economy was bubbling along on easy credit (which was another form of importing money) until recently when it has had to start cutting services. In the long run, importing money does not help a country.

The next few years are going to have major challenges. People quickly adjust to having more money. We do not quickly adjust to not having money. Thus, winners of the lottery generally go bankrupt quickly. After having spent that much money, they can not dial their lifestyles back to the new reality after the loss.

Risky World

The day that the Dallas cowboys fired their head coach, they also lost their web site. They had not paid the fee for maintaining their domain name. If they had not taken quick action to recover it, they could have lost their domain to someone else. Yet, it took a while before they had fully recovered their web presence.


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Prior Years

  1. 2008
  2. 2009