Summer reading list: Finance edition

I read six books during my working sabbatical last week. (OK, fine. Two of them I listened to.) Four were recommendations from Matt Levine — his top picks for books about finance, as shared on a recent podcast. One is from Ben Thompson — the best-ever book on Apple and one of the best-ever on China, he says. One is from me — a highly readable history of my favorite thing (money).

I found all of them page-turning enough (each in their own way) to qualify as summer reads. If you similarly think non-fiction finance is suitable for the beach, below are my short takes on each.

The Bond King: How One Man Made a Market, Built an Empire, and Lost It All

Journalist Mary Childs writes the story of Bill Gross, who invented active management for bond funds.

He was very good at it. Gross was among the first to invest in mortgage-backed securities. He also presciently predicted the demise of mortgage-backed securities well in advance of the 2008 crisis. He once made his investors a killing by cornering the market on a cheapest-to-deliver bond future. He had his traders scour the market for discounted odd lots of bonds to juice returns of an actively managed ETF.

He was not, however, an investing savant.

As depicted by Childs, Gross’s investment process seems pedestrian. He’d sell volatility because he thought the market wouldn’t move much, for example. He’d sell out of Treasuries because he thought the 2009 stimulus would be inflationary. Pretty standard stuff. But he traded in extraordinary size, putting hundreds of billions of dollars behind ideas he got just from thinking about things, basically.

It worked for about two decades. But shortly after his crowning triumph of being short mortgages going into the Great Financial Crisis, his long run of outperformance ended. 

The second half of Childs’ book is mostly a history of the infighting that then ensued at PIMCO.

It’s pretty entertaining. Levine summarizes Childs’ version of the story as Gross being kicked out of PIMCO because of the seating arrangements Gross made at meetings. The executives got so mad, Levine summarizes, they went back to their offices afterwards, said, “he has to go,” and fired him. “They make millions and millions of dollars a year and all they care about is where they sit,” Levine marvels.

That is oversimplified, of course, but it captures the essence of PIMCO after Gross started underperforming the market. 

Childs’ telling of that story gets a little inside-baseball. I’d argue we learn a little too much about Mohammed El-Erian’s ultimately meaningless tenure at PIMCO, for example. Still, Gross’s petty disputes with El-Erian are pretty entertaining. And there’s a lot to learn about asset management along the way.

Trading at the Speed of Light: How Ultrafast Algorithms Are Transforming Financial Markets

Donald MacKenzie’s history of high-speed trading is incredibly niche — a story of things like how financial data encoded in microwaves gets sent from Chicago to New York and back. 

But that turns out to be a surprisingly engaging subject.

MacKenzie begins with a history of pit trading in Chicago because so much of modern high-frequency trading emerges from the Chicago Mercantile Exchange.

He recounts the slow transition to electronic trading, which was impeded at every step by the vested interests of pit traders. Levine's favorite anecdote from the book is that it took eight months for CME pit traders to agree to an exchange rule requiring them to use pens instead of pencils to record trades.

My favorite anecdote is that the exchange once regulated the size of heels that pit traders were allowed to wear. Seeing over the crowd was such an advantage that some started wearing dangerously high-heeled shoes. To protect them from breaking their ankles, the exchange limited heels to two inches.

Most of the book is about the race among high-frequency traders jockeying for a micro-second advantage in sending information between cities.

Microwaves travel through air faster than light travels through fibre-optic cables, so trading firms built a series of microwave towers to send prices from New York to Chicago and orders from Chicago to New York.

(The towers were only necessary because the curve of the Earth stops microwaves from travelling in a straight line over long distances.)

MacKenzie notes that rain degrades microwaves, sometimes to the degree that high-frequency traders have to stop trading. On those days, knowing they wouldn’t be picked off by predatory HFTs, New York’s more traditional market makers felt safer posting bids and offers.

A thunderstorm in Pennsylvania would therefore tighten trading spreads in New York. Weird!

Another fun anecdote: an HFT trader that told MacKenzie his firm would turn its machines off for a few days when they were having an especially good month because they worried their prime broker would cut them off if they made too much money. 

They made a lot of money. So much so that HFT firms spent millions developing a material that bird droppings do not stick to.

They coated their microwave antennas with this proprietary material so birds wouldn’t interrupt their money making.  

Expected Returns: An Investor's Guide to Harvesting Market Rewards

This is the book I should have read before my trading career started, not after it was long over. I’m not sure there’s anything you need to know about either trading or investing other than what the financial theorist-practitioner Antti Ilmanen shares here.

Levine calls it “the best book about investing.”

I’d call it a textbook. Long and dense with information it’s definitely not one to buy on Audible.

But thanks to Ilmanen's accessible writing style, it’s as close as academic finance will get to being a page turner. Helpfully, Ilmanen also structures it to give you the basic idea on each topic before he dives into the minutiae. (Full disclosure: I skipped a lot of the minutiae.)

One of the basic ideas he elucidates is “time-varying risk premia” — the idea that the return investors demand for bearing risk changes over time.

Previously, people assumed this was constant: equities investors always expected annual returns of, say, 4% above Treasuries, corporate bond investors expected 1%, etc. (Hence the book’s title.)

Now, however, academics recognize that expected returns vary — which means that investors, against all received wisdom, probably should try to time the market.

I don’t recommend it without reading Ilmanen’s book first.

Diary of a Very Bad Year: Confessions of an Anonymous Hedge Fund Trader

This is everything we learned from the Great Financial Crisis in the form of a Platonic dialogue between an anonymous hedge fund trader and journalist Keith Gessen.

Gessen was reporting for the literary magazine he co-founded, n+1, which gives the interviews a very different feel from what you’d find in a finance book or the Wall Street Journal.

Despite the book’s subtitle, there are no confessions here. But the book is all the better for it: HFM proves to be an excellent guide to both the Great Financial Crisis and finance more generally.

Levine particularly liked his description of investing as a game of “writing call options on your time.” In HFM’s speciality of private-credit investing, the basic assumption is that investments are not perfectly correlated, so they won’t require attention all at the same time. But in financial crises, correlations shoot toward 100%. In 2008, HFM found all his investments blowing up at nearly the same time, which made it impossible for him to fully realize their fundamental value.

The lesson, Levine says, is that investing is “not just about your portfolio. It’s about your time management.”

Diary of a Very Bad Year is a quick read, so probably worth the time you’d have to invest. 

Apple in China: The Capture of the World’s Greatest Company 

Patrick McGee writes the definitive history of Apple’s supply chains and China’s ascendance in advanced manufacturing. But that undersells his accomplishment. 

Ben Thompson of Stratechery says Apple in China is “the best book about Apple ever written, one of the best books about China ever written, and an immediate addition to the tech canon of must-reads.”

McGee’s reporting shows that Apple wouldn't be Apple without China — which isn’t too surprising. But he also makes a convincing case that China wouldn't be China without Apple.

When China’s economy overtakes America’s, people will ask how they did it, McGee says. “Some portion of the disquieting answer is that Apple taught them. Year in, year out, Apple took the most cutting-edge designs, processes, and technical expertise from around the world and scaled them in China.”

McGee coins the phrase “the Apple Squeeze” to describe how the company routinely got Chinese manufacturers to build iPhones effectively at cost.  

Suppliers agreed to these draconian terms because they knew Apple’s engineers would teach them how to manufacture at scale while maintaining the highest quality standards.

McGee depicts this as a Promethean act: Apple handing China the gift of fire.

It didn’t take long for that fire to burn them. Just a decade later, the tables had turned: Apple had to fly engineers in from China to teach its staff in Texas how to manufacture MacBooks.

It was around that same time that Tim Cook realized Apple had trained its suppliers so well that China was making phones that were better — and cheaper — than the iPhone.

More consequentially, Apple is a large part of the reason China is now on its way to becoming self-sufficient in advanced electronics, robotics, and chip manufacturing, McGee says. “From there, it will be a short leap to Xi Jinping’s goal of bringing about the ultimate demise of capitalism, as he pledged in 2013.”

That is speculative (I hope). But McGee’s telling of Apple’s story makes clear that Apple is a Chinese company now. And that the iPhone has made China a far more formidable country.

Money: The Unauthorized Biography — From Coinage to Cryptocurrencies

Felix Martin’s book is a highly readable argument debunking “the mistaken view of money as a thing.”

Ancient Chinese, Greeks, and Mesopotamians knew otherwise, Martin writes: they all recognized money as a social technology — a system invented to help large groups coordinate social relationships.

Few still think of it that way. We now typically imagine money as a representation of real value. Martin blames this “monetary naturalism” on the philosopher John Locke, who mistakenly argued that economic value is a state of nature. Locke convinced classical economists that the role of money is simply to represent that value.

This, Martin says, has been the source of much confusion about both money and monetary policy ever since.

He proposes some radical solutions, some of which will be familiar to crypto enthusiasts. “The specious claim of ‘liquidity transformation’ has become camouflage for a one-way bet, and should be forbidden,” Martin writes — an argument for narrow banking (like stablecoins). 

He also believes that governments should revoke the independence they’ve granted central banks.

As radical as that sounds, Martin makes a convincing case that the history of money supports taking radical action.

“It’s not experimenting with the alternative understanding of money that risks a revolution,” Martin concludes, “it’s sticking to the conventional one.”

— Byron Gilliam

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