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The evolution of Capital Flow Analysis

I developed the methods of Capital Flow Analysis over the six years 1998-2004, based on experience in capital markets.

John Schroy

I received a degree in economics from Cornell University in 1954, but Federal Reserve flow of funds accounts (first published in 1952) were never mentioned by my professors, and, because I was working abroad after 1956, I was unaware that the Federal Reserve began quarterly publications of these accounts in 1965.

I first took notice of the flow of funds concept in 1967 from an annual report published by Bankers Trust Co. called “Summary of Sources and Uses of Funds” published in “The Investment Outlook”.

As managing partner of an investment research firm in Brazil during the 1960s, I was interested in the flow of funds idea, but application to the entire Brazilian economy seemed beyond the resources of a private firm.

A start in Rio de Janeiro

By 1971, our firm had developed a set of statistics pertaining to the Brazilian equity market and the incipient ideas of Capital Flow Analysis were put to a practical test by anticipating the crash of the Brazilian market in 1971.

Rio de Janeiro, where I worked for 23 years.

See “Case Study: Brazil 1971.

I subsequently moved away from investment research into banking, fund management, and advisory services on capital market policy.

However, I did not forget the lessons of the Brazilian crash of 1971.

A re-start in Jakarta

In 1998, I was advising the Indonesian government. In trying to explain the flow of funds concept to my client, I tried to find the Bankers Trust annual report that I remembered from thirty years earlier.

Jakarta, Indonesia where I worked for 10 years.

Fortunately, the Internet had just come to Indonesia.

In searching for flow of funds I came upon Release Z.1 of the Federal Reserve Bank.

This was a revelation, not only for the richness of the data, but for the fact that these useful accounts were rarely mentioned among investment practitioners and almost never in a way that suggested awareness of techniques that I had found useful in the Brazilian market of 1971.

The basis for Capital Flow Analysis

In 1998, I began writing a book to explain the concept of Capital Flow Analysis.

I was able to discuss these ideas with my good friend, the late John R. Evans, a former commissioner of the US. Securities and Exchange Commission (the second longest sitting commissioner) who had received training in economics from the University of Utah.

For over a year, John and I spent hours debating and discussing Capital Flow Analysis in depth.

In the process it became clear that the principles of Capital Flow Analysis were contrary to beliefs of many economists, especially with respect to the Efficient Market Hypothesis, the notion of Rational Man, and the supposed equivalence of savings and investments.

In the year 2000, I was able to again test Capital Flow Analysis by anticipating the peak of the Great Bubble, getting some funds that I controlled out of equities just before the crash.

For a discussion of what the signals were in 2000, see “Case Study: USA 2000.”.

Deciding on publication media

After 2000, I devoted full time to writing a book on Capital Flow Analysis. However, as the work progressed, it seemed that a linear format was not the way to explain this topic, since practical applications are more easily presented when related to current situations.

Capital Flow Analysis published as a free web tutorial in October 2004.

Furthermore, the techniques of Capital Flow Analysis require flipping back and forth between tables and cross-referencing concepts, a format more appropriate to a web site than to a book.

Consequently, I recast the book as a tutorial to explain the subject, with essays to present background examples, and color-coded flow sheets with technical annotations and web links for practical use.

Finally, by adding a web log, it was possible to keep the material fresh.

The framing of the two axioms and the presumption and a step-by-step method were designed to make the technique accessible to market practitioners.

See “The Motivation Axiom” and “The Irrationality Axiom“: and “Presumed Dominance“.