Preface

My first teaching experience was a disaster. The year was 1977, and the venue was the University of Southern California in Los Angeles. It was an important time for me. I had just left the University of Chicago with a doctorate in economics, along with a full head of ideas and plenty of energy. Economics wasn't only my vocation; it was my passion. I was about to jump into action at USC's graduate school of business. What could be better?

A root canal, perhaps.

My initial feeling was one of awkwardness. It turned out that most of my students were older than me. They also were a much different sort than my colleagues back in Chicago—people who could consume large portions of economic theory at a sitting. My students at USC worked during the day and went to school at night. They went to business school to learn how to make money, how to get a better job, how to succeed. They were practical people, and they wanted little more than the action points they could apply to their business lives. Theory? Theory didn't stand a chance with this crowd. At the time, the late 1970s, residential real estate prices were climbing about 1 to 2 percent a month in the Los Angeles area. This had my business students ravenous for knowledge about real estate finance—and finance in general—and turned off by even a whiff of macro- or microeconomics. My impression was that some of my students viewed economics as a minor inconvenience, at best, while most found it a major nuisance—a requirement that had to be satisfied before they could pursue their fortunes.

My youthful penchant toward showing off probably didn't help matters any. From the outset, I overemphasized the analytical aspects of economics, which I thought to be my forte, and quickly found that most of my students did not share my enthusiasm. The stark differences between teacher and student were reflected in the poor evaluations I received at the end of the semester. I was devastated at the time. Worse, analytics aside, I simply could not understand why my students were not as passionate as I was about economics in general. Doesn't everyone interested in success in life carry around a pair of economic viewing glasses through which they study their surroundings, calculate, and plan for the future? Many of my students commented in their evaluations that they failed to see how the textbook, or even the subject, would help their careers. After all, many of them already were working. And outside of perhaps the finer points of real estate and the letters MBA after their names, many figured they already possessed what they needed to get ahead.

I knew then, as now, that no one ever knows everything he or she needs to get ahead, that life and experience instruct and challenge us each and every day. But my students were certain that economics need not be part of their life programs. Teaching economics to MBA students seemed like a daunting task at the time. But I would recover.

The next semester, I told my students that even if they did not accept how economic theory could aid their careers, they could benefit from its study in at least one way: Economics, I revealed, was an excellent conversation piece. If grasped even to a nominal degree, it could elevate their status in all manner of social situations, from the cocktail party, to the business luncheon, to the client dinner. Wouldn't it be nice, I asked, if they could discuss with confidence the important political and economic issues of the day? (I note here and do throughout this book that political and economic issues forever are intertwined.) At the very least, they should know what the economic and political issues are, and if they wanted to show off a little, their opinions should be informed because the person with an informed opinion best articulates a position.

I suggested that we try this approach for a while, calling it cocktail economics. By definition, we would apply economic theory to the everyday events that might be discussed over, well, cocktails. For my part, I hoped the approach would spark a fire of interest in the subject. If it didn't, we could fall back on the course outline. The students agreed, and cocktail economics was a go.

Most of my MBA students subscribed to The Wall Street Journal, so I suggested at the outset that we go over the paper's editorial page each class. (In all honesty, I suspect that most of my students agreed to this as a way of reducing the time spent on the textbook. But one has to start somewhere.) A few rules were in play: First, if an editorial discussed some policy action in Washington, the students needed to figure out the breadth of the initial impact of that action. Would the policy affect the economy as a whole or just a region or an industry? To answer this, they needed to identify the nature of economic "shocks," those disruptions to the economic trajectory that are either natural or manmade. Would the shock in question affect the demand or supply side of the market? The succeeding step was to determine how the economy would return to a state of equilibrium in the wake of a shock. Would this occur through a change in price or a change in output? I argued that if consumers and/or suppliers exhibited a degree of flexibility, the bulk of the adjustment back toward equilibrium would occur in the form of quantity changes (or the shift in the amount of a product or good in the economic pipeline), with little or no change in price. On the other hand, if inflexible factors were at work—for instance if there was little give in a supplier's production capacity—prices would have to change to clear the market and restore equilibrium.

This last analysis, it turns out, was dear to the hearts of my students. Because they were businesspeople, I asked them simply to think of who would benefit and who would lose in the aftermath of each shock we studied. My students all wanted to be on the side of the "winners" in life, so at the very least, they were intrigued.

With cocktail economics set in motion, my classes initially became livelier—even entertaining. And to the extent that my students were able to correctly answer each question related to the editorials we surveyed, I reminded them that they could now carry these informed opinions to the office, bar, or restaurant—anywhere they met with clients, colleagues, or even friends. Their skills at arguing and debating would only improve across this process. Finally, I told them that, if nothing else, cocktail economics would teach them how to better tell a story and maybe even enhance their ability to identify good investments.

This scheme soon took on a life of its own, with frowns turning to smiles and nodding-off being replaced with straightened backs and wider eyes. Correspondingly, my ratings as a teacher improved, and I felt very satisfied: I had found a way to both motivate my students and engage them in economic thought.

It has been more than 25 years since I began using this method, but I still find it gratifying when my former students mention it. The chance meetings are few and far between, but nearly every time, the conversation starts the same way: "Professor Canto, I'll always remember cocktail economics." Sometimes they mention that they still use this approach, that they return to it every time they have a big decision to make.

In this book, I have applied the cocktail-economics approach to my theories on investing. I have attempted to be conversational and to employ guiding anecdotes to help reduce what can be complex economic theories to the common-sense basics. But these are powerful basics. Whereas some of my former students might apply cocktail economics to their big life decisions, you will be encouraged to apply it to your investment portfolio—a place where the right decisions can usher in true prosperity.

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