Virtue Signaling, or … Why Clinton is in Trouble


Hillary Clinton would make a sober, smart and pragmatic president.

Donald Trump would be a catastrophe.

LA Times Editorial Board endorsement, September 23, 2016

Yep, gotta get me some of that pragmatism! It’s code for “typical lying politician”, and of course the LA Times knows it.

After opposing driver’s licenses for undocumented immigrants during the 2008 campaign, she now vows to push for comprehensive immigration legislation as president and to use executive power to protect law-abiding undocumented people from deportation and cruel detention. Some may dismiss her shift as opportunistic, but we credit her for arriving at the right position.

She helped promote the Trans-Pacific Partnership, an important trade counterweight to China and a key component of the Obama administration’s pivot to Asia. Her election-year reversal on that pact has confused some of her supporters, but her underlying commitment to bolstering trade along with workers’ rights is not in doubt.

New York Times Editorial Board endorsement, September 25, 2016. Italics mine.

With passive-aggressive friends like these …


As a result I am arguing for modest, gradual tightening now, out of concern that not doing so today will put the recovery’s duration and sustainability at greater risk, by generating the sorts of significant imbalances that historically have led to a recession.

Statement of Eric S. Rosengren, Commenting on Dissenting Vote at the Meeting of the Federal Open Market Committee, September 23, 2016

It’s not just the number of dissents on last week’s FOMC vote, it’s the argument. Rosengren says the Fed is causing the next recession.


Roger Mudd: Why do you want to be president?
Ted Kennedy: The reasons I would run are because I have great belief in this country, that is — there’s more natural resources than any nation in the world, there’s the greatest educated population in the world. It just seems to me that this nation can cope and deal with the problems in a way it has done in the past … and I would basically feel that it’s imperative for the country to either move forward, that it can’t stand still or otherwise it moves backwards.
CBS interview with Ted Kennedy, October 1979

And just like that, Kennedy was finished. My question for Yellen: why do you want to be Fed chair?


David Malki, “In which War is waged”, September 13, 2016

I was in Los Angeles last week, and the Clinton anti-Trump TV ads were in heavy rotation. It’s not because the Clinton campaign is worried about the California vote, because if they were then the election would already be irredeemably lost. No, the ads are being run in the metro LA area so that Clinton supporters (and donors!) can feel good about themselves. It’s like throwing a massively expensive dinner party to congratulate yourself for all the money you’ve raised to feed the poor.


Isaac: Has anybody read that Nazis are gonna march in New Jersey? Ya know? I read it in the newspaper. We should go down there, get some guys together, ya know, get some bricks and baseball bats, and really explain things to ’em.
Party Guest: There was this devastating satirical piece on that on the op-ed page of the Times, just devastating.
Isaac: Whoa, whoa. A satirical piece in the Times is one thing, but bricks and baseball bats really gets right to the point of it.
Helen: Oh, but really biting satire is always better than physical force.
Isaac: No, physical force is always better with Nazis.
Woody Allen, “Manhattan” (1979)

Epsilon Theory readers know where I stand on this. It’s just another instantiation of the Common Knowledge game, where everyone knows that everyone knows that John Oliver is funny, but no one actually thinks that he’s funny. Want to see effective (that is, subversive) political humor? Watch anything by Groucho Marx. Want to see ineffective (that is, status quo) political humor? Watch anything by these supercilious scolds. At least Samantha Bee gets the joke.

We do not place especial value on the possession of a virtue until we notice its total absence in our opponent.
― Friedrich Nietzsche (1844 – 1900)


PolitiFact, a Tampa Bay Times site that won a Pulitzer for its coverage of the 2008 election, has rated 70% of the Trump statements it has checked as mostly false, false or “pants on fire,” its lowest score. By contrast, 28% of Clinton’s statements earned those ratings.

Michael Finnegan, LA Times “Scope of Trump’s falsehoods unprecedented for a modern presidential candidate”, September 25, 2016

The fact-checker’s inspirational battle cry: “Lying only 28 percent of the time!”

The people complaining about “false balance” usually seem confident in having discovered the truth of things for themselves, despite the media’s supposed incompetence. They’re quite sure of whom to vote for and why. Their complaints are really about the impact that “false balance” coverage might have on other, lesser humans, with weaker minds than theirs. Which is not just snobbish, but laughably snobbish.

So, shut up.

Matt Taibbi, Rolling Stone “Stop Whining About ‘False Balance’”, September 16, 2016

Wait … Clinton apparatchiks are snobbish?  


As a lifelong Democratic voter, I’m dismayed by the radical left’s ever-growing list of dos and don’ts — by its impulse to control, to instill self-censorship as well as to promote real censorship, and to deploy sensitivity as an excuse to be brutally insensitive to any perceived enemy. There are many people who see these frenzies about cultural appropriation, trigger warnings, micro-aggressions and safe spaces as overtly crazy. The shrill tyranny of the left helps to push them toward Donald Trump.

Lionel Shriver, The New York Times “Will the Left Survive the Millennials?”, September 23, 2016

There are real bigots out there. Real misogynists. Real anti-Semites. Real alt-right “deplorables”. None of them are university professors. None of them are novelists. But if you want to see what the real thing looks like, just keep doing this sort of insanely misplaced virtue signaling.


I did not break up the Beatles. You can’t have it both ways. If you’re going to blame me for breaking the Beatles up, you should be thankful that I made them into myth rather than a crumbling group.

Yoko Ono (b. 1933)

Common Knowledge today: Donald Trump is the Yoko Ono of the Republican Party.

Common Knowledge tomorrow: Hillary Clinton is the Yoko Ono of the Democratic Party.

If you’ve ever played a team sport, you’ve experienced a game that was a mismatch on paper. Now usually that game goes according to form. The better team scores early and often, and the inferior team doesn’t sniff a win. But sometimes the game gets tight. Sometimes the better team makes a few unforced errors, and the inferior team capitalizes. Sometimes there’s a lucky bounce of the ball for the inferior team. And then another. And another.

There’s a moment in every game of this unexpected type — the upset in the making — when the individual players on the better team (call them the status quo team) begin to doubt. They feel the game slipping away, even though they know that they’re the better team. What happens to many players in that moment of doubt is, to use the game theoretic phrase, they decide to defect. It doesn’t mean that they quit. It doesn’t mean that they give up. In fact, without exception, they all believe that their team will still prevail. But they start to think about what a loss, however improbable, would mean for their personal, individual goals. They never even entertained those thoughts at the beginning of the game. It was all about the team, and a team victory would naturally go hand in hand with personal development and personal goals. But now … now that the unthinkable is suddenly thinkable … they start acting directly in favor of their own self-interest, not the team’s communal interest. They start signaling their virtue.

Virtue signaling is a behavior that visibly demonstrates the individual qualities of the player to some external audience, whether or not it improves the chances of the team to win. It’s not overtly detrimental to the team. In fact, for all outward appearances it’s rather supportive of the team. But it makes all the difference in the world if an offensive lineman is more concerned with making HIS block than protecting the quarterback no matter what. It makes all the difference in the world if a shooting guard is more concerned with meeting HIS scoring average than playing team defense. It makes all the difference in the world if a Democratic Party functionary is more concerned with tweeting HIS outrage at the latest nonsense that Trump is spouting than in volunteering for a get-out-the-vote effort in Greensboro, North Carolina.

Virtue signaling is an attempt to have your cake and eat it, too. If the team ends up winning … hey, I did my part. Didn’t you read that blistering anti-Trump op-ed piece I oh-so bravely penned in The New York Times? If the team ends up losing … hey, don’t look at me. Didn’t you read that blistering anti-Trump op-ed piece I oh-so bravely penned in The New York Times? It’s an entirely rational set of behaviors that seeks to insulate yourself from the inevitable blame game if things go wrong (the infamous circular firing squad of American party politics, particularly on the Democratic side) while still preserving your place in the victory parade if things go well.

If you follow football closely, you’ll hear a phrase that players and position coaches use in an entirely positive light: selling out. They don’t mean a sell-out in the way the phrase is generally used, either as a full house inepsilon-theory-virtue-signaling-september-30-2016-cutler terms of ticket sales or, pejoratively, as a person who’s chosen money over authenticity. No, they mean it as a compliment. When you sell out on a play or a coach’s game plan, it means that you commit fully. It means that you are prepared to embarrass yourself by your single-minded pursuit of a team victory. It’s the absolute opposite of virtue signaling, and there is no higher praise for a teammate than to say he “sold out” in a game. I see no one willing to “sell out” for Clinton, and that tells me that, in a close game, she’s in a lot of trouble. If Clinton were an NFL quarterback, she’d be Jay Cutler of the Chicago Bears, a player who is infamously difficult for his teammates to support or rally around. No one has ever sold out for Jay Cutler. Now in his 11th season, Cutler’s teams have made the playoffs once. Once.

What I DO see for Clinton is virtue signaling galore among her supporters, including her own campaign staff. It’s the fact checking fetish. It’s the TV ad spend in safe states. It’s the damned-with-faint-praise and passive-aggressive endorsements. It’s the passion reserved exclusively for “outrage” over Trump’s intentionally outrageous statements and utterly absent for anything Clinton says. It’s all designed to signal to your tribe that you’re a good person because you’re against Trump. It’s not completely uncorrelated with getting Clinton elected … it’s not counter-productive, per se … but it’s not very productive, either. Why not? Because this is a turn-out election. The winner of this election will be whoever can get more of their tribe to the polls in swing states: Colorado, North Carolina … maybe Nevada … maybe one or two others. Period. This is not an election that will be decided by influencing undecided or “lightly decided” voters one way or another, because all of these voters are staying home on November 8th anyway. It’s an election that will be decided by motivating your base. Can fear of Trump motivate? Sure it can. But if Brexit taught us anything, it’s the limitations of a fear-based campaign, at least when the fear-mongers are the same smarter-than-thou elites who tsk-tsk their deep and abiding concern for the benighted masses from Davos or Jackson Hole. Status quo candidates don’t win on fear alone. They’re not the anti-party. There has to be a reason … a why … an anthem for rallying the troops. And that’s what’s missing from the Clinton campaign, in exactly the same way it was missing for Teddy Kennedy in 1980 and Michael Dukakis in 1988.

Look, I get it. The Democratic candidate isn’t Clinton, it’s Clinton™. Having chosen (or more accurately, anointed) a profoundly hypocritical and opportunistic pragmatic candidate, Democratic mouthpieces are now in the uncomfortable position of manufacturing enthusiasm rather than channeling enthusiasm. Enthusiasm is something you can easily fake when you’re winning big. But when the game gets tight … when it looks like (gulp!) the game might go the other way … well, that’s when thoughts of self-preservation and virtue signaling start to creep into the most adamant Democratic partisan. In fact, particularly the most adamant Democratic partisans. They WANT to believe. But Clinton™ is just so hard to sell out FOR.

The concepts of cooperation and defection are at the core of game theory. Whether it’s a game of Chicken or Prisoner’s Dilemma or (below) Stag Hunt, the standard depiction of strategic decision-making is always a choice between cooperation and defection.


But it’s so important, I think, to recognize that defection isn’t always (in fact, usually isn’t) some grand gesture of rejection. Defection is a state of mind. Sure, when Never Trump Republicans come out and jump ship over to the Clinton camp, that’s an obvious defection. But it’s also a defection when Clinton advocates use all of their precious media time to rail and rail about how Trump is a more prolific liar than Clinton, because the subtext here is “my candidate is a liar, too”, and there’s nothing motivating about that. Here’s the big kicker: the virtue signaling “soft defector” is more damaging to the Clinton campaign than the turncoat “hard defector” is to the Trump campaign. Why? Because virtue signalers are rewarded by their own tribe, while turncoats are blasted. Virtue signaling is infectious. It spreads like the common cold. And because the psychic rewards from virtue signaling are so immediate and so powerful, it’s really, really hard to shake this disease from an organization. It’s impossible to overemphasize the importance of psychic rewards in the decision-making of staffers and candidates alike.

epsilon-theory-virtue-signaling-september-30-2016-cruzDitto for psychic punishment. It’s impossible to overstate the human animal’s ability to rationalize an abdication of principle when his tribe showers him with disdain. It’s impossible to overestimate a political animal’s love of winning over anything else, including integrity. I mean, it’s amazing how Ted Cruz was delighted to be the standard bearer of the in-party opposition so long as it looked like Trump was going to be trounced. But then the polls turned up for Trump, and Cruz falls all over himself doing his best Chris Christie imitation. Just goes to show, there’s no mockery like self-mockery.epsilon-theory-virtue-signaling-september-30-2016-christie

Two final points. First, everything I’ve written about the soft defection that’s endemic within the Clinton campaign can be written about the Yellen Fed, too. God knows I’ve been railing about the Fed a lot in recent notes, though, so I’ll save that for another day.

Second, there’s always the risk that a note like this will be misinterpreted, that in critiquing the Clinton campaign I’ll be perceived as supporting Trump. Nothing could be farther from the truth.

Don’t get me wrong. I’m thoroughly despondent about the calcification, mendacity, and venal corruption that I think four years of Clinton™ will impose. I think as a candidate she’s a bizarre combination of Michael Dukakis and Teddy Kennedy, and I think as a president she’ll be an equally bizarre combination of Ulysses Grant and Warren Harding, both of whom presided over a fin de siècle global economic collapse. Gag. But I don’t think she can break us, not as a society, anyway.


Trump, on the other hand … I think he breaks us. Maybe he already has. He breaks us because he transforms every game we play as a country — from our domestic social games to our international security games — from a Coordination Game to a Competition Game.

The hallmark of a Coordination Game is that there are two equilibrium outcomes possible, two balancing points where the game is stable. Yes, one of those stable outcomes is mutual defection, where everyone pursues their individual goals and everyone is worse off. But a stable outcome of mutual cooperation is at least possible in a Coordination Game, and that’s worth a lot. Here’s a graphical representation of a Coordination Game, using Rousseau’s famous example of “the stag hunt”.

Fig. 1 Coordination Game (Stag Hunt)


The basic idea here is that each player can choose to either cooperate (hunt together for a stag, in Rousseau’s example) or defect (hunt independently for a rabbit, in Rousseau’s example), but neither player knows what the other player is going to choose. If you defect, you’re guaranteed to bag a rabbit (so, for example, if the Row Player chooses Defect, he gets 1 point regardless of Column Player’s choice), but if you cooperate, you get a big deer if the other player also cooperates (worth 2 points to both players) and nothing if the other player defects. There are two Nash equilibria for the Coordination Game, marked by the blue ovals in the figure above. A Nash equilibrium is a stable equilibrium because once both players get to that outcome, neither player has any incentive to change his strategy. If both players are defecting, both will get rabbits (bottom right quadrant), and neither player will change to a Cooperate strategy. But if both players are cooperating, both will share a stag (top left quadrant), and neither player will change to a Defect strategy, as you’d be worse off by only getting a rabbit instead of sharing a stag (the other player would be even more worse off if you switched to Defect, but you don’t care about that).

The point of the Coordination Game is that mutual cooperation is a stable outcome based solely on self-interest, so long as the payoffs from defecting are always less than the payoff of mutual cooperation. If that happens, however, you get a game like this:

Fig. 2 Competition Game (Prisoner’s Dilemma)


Here, the payoff from defecting while everyone else continues to cooperate is no longer a mere 1 point rabbit, but is a truly extraordinary payoff where you get the “free rider” benefits of everyone else’s deer hunting AND you go out to get a rabbit on your own. This extraordinary payoff is what Trump is saying is possible when he talks about America “winning” again. But it’s not possible. Not for more than a nanosecond, at least, because there’s no equilibrium there, no stability in either the upper right or bottom left quadrant. You want to pass a modern version of the 1930 Smoot-Hawley Tariff Act to “win” a trade deal? Knock yourself out. As in 1930, you’ll enjoy those benefits for about two months before every other country does the same thing against you. And in about 12 months, as in 1931, every bank that’s levered to global trade finance goes bust. Whee! There’s one and only one equilibrium in a competition game — the “everyone defect” outcome of the bottom right quadrant — meaning that once you get to this point (and you will) you can’t get out. The stability of the Competition Game is the stability of permanent conflict.

I’m no Pollyanna about the world. Not only do I think that the world is, in fact, described best as a Clash of Civilizations, but I also think that many of the cooperative international games we play as a country are inevitably heading toward a competitive dynamic, and this is at the heart of what I’ve described as the transformation of the Golden Age of the Central Banker to the Silver Age of the Central Banker. I get that. But it is insane to throw away the stable cooperative equilibrium we have with Japan and Europe and China in the international security game or the international trade game. Insane. If I’m China and Trump is elected, I don’t wait for him to fire the first shots in a trade war. I fire first, by floating my currency. That’s the Golden Rule of any competitive game: do unto others as they would do unto you … but do it first.

More importantly than what happens in any of these international games, however, is what happens in our domestic games. Blowing up our international trade and security games with Europe, Japan, and China for the sheer hell of it, turning them into full-blown Competition Games … that’s really stupid. But we have a nasty recession and maybe a nasty war. Maybe it would have happened anyway. We get over it. Blowing up our American political game with citizens, institutions, and identities for the sheer hell of it, turning it into a full-blown Competition Game … that’s a historic tragedy. We don’t get over that.

But that’s exactly what’s happening. I look at Charlotte. I look at Dallas. I look at Milwaukee. And I no longer recognize us.

I don’t think people realize the underlying fragility of the Constitution — the written rules to our American political game. It’s just a piece of paper. Its only strength in theory is our communal determination to infuse it with meaning through our embrace of not only its explicit rules, but also and more crucially its unwritten rules of small-l liberal values like tolerance, liberty, and equality under the law. Its only strength in practice is that whoever runs our Executive branch, whoever is our Commander-in-Chief, whoever is in charge of “law and order”, whoever runs our massive spy bureaucracy national intelligence service, whoever controls the legitimate use of deadly force and incarceration … that he or she believes in those unwritten rules of small-l liberal values like tolerance, liberty, and equality under the law. When you hear Trump talk about “loosening the law” on torture, or “loosening the law” on libel prosecutions of anyone who criticizes HIM, or the impossibility of a federal judge being able to rule fairly because his parents were born in Mexico … well, there’s no way he believes in those small-l liberal virtues. No way.

And yeah, I know what the supporters say, that he “really doesn’t mean what he says”, or that “once he’s elected he’ll listen to the right people and his views will evolve”, or — my personal fave — “it’s only 4 years, how bad can it be?” Answer: pretty damn bad. And yeah, I understand the argument on the Supreme Court. But what I’m talking about is bigger than the Supreme Court. A lot bigger.

I’m going to close this note with two pages from Friedrich Hayek’s The Road to Serfdom (in Cartoons), originally published in Look magazine in 1945. If you’ve never read The Road to Serfdom … that’s okay, most people haven’t. But do yourself a favor and at least read the Classics Comic Book version I’m copying from here. I’m not saying that Hayek was some Nostradamus and I’m not saying that history is repeating itself. But I am saying that Hayek was a really smart guy who believed with all his heart in small-l liberal virtues and keenly observed the politics of the world the last time we got into such a global mess. I am saying that history rhymes.

We’re in the middle of Cartoon #9 today. Our confidence in “the planners” — the central bankers of the world — has plunged over the last few months as the popular Narrative around negative rates and other extraordinary monetary policies is now more negatively skewed than the popular Narrative around Brexit.

epsilon-theory-virtue-signaling-september-30-2016-confidence-in-planners-fades epsilon-theory-virtue-signaling-september-30-2016-road-to-serfdom

epsilon-theory-virtue-signaling-september-30-2016-trump-speechOver the next nine months we’re going to have national elections in three of the largest, most powerful countries in the world: the U.S., Germany, and France. We’ll have the equivalent of a national election in Italy, as well. Hayek believed that the inevitable result of those elections is Cartoon #10 — the coming to power of the strong man.

epsilon-theory-virtue-signaling-september-30-2016-happy-faceYeah, Ben, or the strong woman. You’re railing about Trump and his anti-liberal pseudo-fascist tendencies, but you’re giving Clinton a pass? Seriously? Doesn’t Hayek’s work apply to smiley-face authoritarians as well as Brown Shirts? Aren’t you just virtue signaling?


But here’s the biggest difference. I know how to resist Clinton. It won’t be a fun four years, but — thank you, gridlock! — I don’t think she can mess things up so horribly that we can’t undo it, or at least prepare for the political battles to come. I don’t know how to resist Trump, and neither does anyone else, because we haven’t experienced this reactionary populist strain in American politics since … I dunno … the Know Nothing Party of the 1850s?

So what’s to be done? In investing, I’m just looking to survive the next four years, regardless of who’s in office. I’ve written a lot on what that means, most recently in “Cat’s Cradle”. In politics, I’m selling out for the Scottish Enlightenment and the small-l liberal values of tolerance, liberty, and equality under law. I’ve got some ideas on how to bring those political values into a world of Google, spy satellites, and PlayStation 4, so that’s what I’m going to write about. If there’s no home for these political values in the Republican or Democratic parties — and who in their right mind thinks there is — then I’ll find another home, another political party. I don’t think the Republican Party or the Democratic Party will be recognizable in four years, anyway — both of these bands are now structurally unstable, I just don’t know if the break-up is going to be like the Beatles or like Oasis — so I’ll be working with a new political landscape. But it’s time for a third party based on IDEAS, not on a billionaire’s personality. Imagine that.

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Essence of Decision


The essence of ultimate decision remains impenetrable to the observer — often, indeed, to the decider himself.

John F. Kennedy (1917 – 1963)


“The Manhattan Projects” by Jonathan Hickman and Nick Pitarra (©Image Comics)

I have found that the best way to give advice to your children is to find out what they want and then advise them to do it.
―Harry Truman (1884 – 1972)

As far as I was concerned, his decision was one of non-interference ­— basically, a decision not to upset the existing plans.
―Lt. Gen. Leslie Groves (1896 – 1970), commanding officer of the Manhattan Project, discussing Truman’s okay to drop atomic weapons on both Hiroshima and Nagasaki.


“Ah,” she cried, “you look so cool!”

Their eyes met, and they stared together at each other, alone in space. With an effort she glanced down at the table.

“You always look so cool,” she repeated.

She had told him that she loved him, and Tom Buchanan saw.

 ― F. Scott Fitzgerald, “The Great Gatsby” (1925)

And that was the end of the party. When Tom Buchanan saw.

Lear: Create her child of spleen, that it may live
And be a thwart disnatur’d torment to her!
Let it stamp wrinkles in her brow of youth,
With cadent tears fret channels in her cheeks,
Turn all her mother’s pains and benefits
To laughter and contempt, that she may feel
How sharper than a serpent’s tooth it is
To have a thankless child!
― William Shakespeare, “King Lear” Act 1 Scene 4 (1606)

Once-revered central bank failed to foresee the crisis and has struggled in its aftermath, fostering the rise of populism and distrust of institutions.

Jon Hilsenrath, “The Great Unraveling: Years of Missteps Fueled Disillusion with the Economy and Washington” (August 26, 2016)


John Hale: Theology, sir, is a fortress; no crack in a fortress may be accounted small.
  Arthur Miller, “The Crucible” (1953)

Few of us can easily surrender our belief that society must somehow make sense. The thought that the State has lost its mind and is punishing so many innocent people is intolerable. And so the evidence has to be internally denied.

The structure of a play is always the story of how the birds came home to roost.

That’s a very good question. I don’t know the answer. But can you tell me the name of a classical Greek shoemaker?

Arthur Miller (1915 – 2005)

That last, one of my all-time favorite quotes, was in response to a shoe manufacturer who asked why Miller’s job should be subsidized while his was not. Miller’s finest accomplishment: when McCarthy and crew forced him to testify in their Communist witch hunt, he refused to name names. Miller was a leftie and a huge ego. And a freedom lover. Imagine that.


Yet each man kills the thing he loves

By each let this be heard

Some do it with a bitter look

Some with a flattering word

The coward does it with a kiss

The brave man with a sword

 ― Oscar Wilde, “The Ballad of Reading Gaol” (1898)

We’ll get the kiss, not the sword. Don’t know when, but it’s going to kill this market that the Fed loves.


In 1969, Graham Allison published an academic paper about the Cuban Missile Crisis, which he turned into a 1971 book called Essence of Decision. That book made Allison’s career. More than that, the book provided a raison d’être for the Kennedy School of Government at Harvard, which — combined with Allison’s fundraising prowess — transformed a sleepy research institute into the most prominent public policy school in the world.


The central idea of Essence of Decision is this: the dominant academic theory to explain the world’s events is a high-level, rational expectations model based on formal economics, a theory that ignores the impact of bureaucratic imperatives and institutional politics. If you look at the Cuban Missile Crisis through all three lenses, however, you get a much better picture of what actually happened in October 1962. In fact, the more you dig into the Cuban Missile Crisis, the more it seems that the actual people involved (on both sides … Allison wrote a follow-up edition in 1999 when Russian archives opened up post-Gorbachev) made their actual decisions based on where they sat (bureaucracy) and where they stood (internal politics), not on some bloodless economic model. Publicly and after the fact, JFK and RFK and all the others mouthed the right words about geopolitical this and macroeconomic that, but when you look at the transcripts of the meetings (Nixon wasn’t the first to tape Oval Office conversations), it’s a totally different story.

Allison’s conclusion: the economic Rational Actor model is a tautology — meaning it is impossible to disprove — but that’s exactly why it doesn’t do you much good if you want to explain what happened or predict what’s next. It’s not that the formal economic models are wrong. By definition and by design, they can never be wrong! It’s that the models are used principally as ex-post rationalizations for decisions that are actually made under far more human, far more social inputs. Any big policy decision — whether it’s to order a naval blockade or an air strike on Cuba, or whether it’s to drop atomic bombs on Hiroshima AND Nagasaki, or whether it’s to raise interest rates in September or December or not at all — is a combination of all three of these perspectives. But for Allison’s money, we’d do better if we focused more on the bureaucratic and political perspectives, less on the rational expectations perspective.

Allison is writing this in 1969! And here we are, almost 50 years later, still consumed by a theology of formal economic models, still convinced that Fed decision-making can be explained or predicted by our armchair analysis of Taylor Rule inputs. From an anthropological perspective, it’s pretty impressive how the high priests of academic economics have expanded their rule. From a human perspective, it’s awfully depressing.

What follows is my analysis of the Fed’s forthcoming decision on interest rates from a bureaucratic and an internal politics perspective. Seen through these lenses, I think they hike. Maybe I’m wrong. These things are always probabilistic shades of gray, never black and white. But what I’m certain about is that the bureaucratic and internal politics perspectives give a different, higher probability of hiking than the rational expectations/modeling perspective. So heads up.

First the bureaucratic perspective.


What I’m calling the bureaucratic perspective, Allison calls the “Organizational Behavior” perspective. His phrase is better. It’s better because entities like the Federal Reserve are, of course, large bureaucracies, but what we’re trying to analyze here is not the level of do-nothing inertia that we usually associate with the word “bureaucracy”. What we’re trying to analyze is the spirit or culture of the organization in question. What is the institutional memory of the Fed? What do personnel, not just the Fed governors but also the rank-and-file staffers, believe is the proper role of the institution? Most importantly, how do these personnel seek to protect their organization and grow its influence within the jungle of other organizations seeking to grow their influence?

The spirit, culture, and personnel composition of the modern Federal Reserve is almost identical to that of a large research university. That’s not a novel observation on my part, but a 30-year evolution commonly noted by Fed watchers. Why is this important? It’s important because it means that the current marriage between Fed and markets is a marriage of convenience. As an organization, the Fed doesn’t really care whether or not markets go up or down, and as an institution it’s not motivated by making money (or whether or not anyone else makes money). Like all research universities, the Fed at the organizational level is motivated almost entirely by reputation. Not results. Reputation. A choice between “markets up but reputation fraying” and “markets down but reputation preserved” is no choice at all. The Fed will choose the latter 100% of the time. I can’t emphasize this point strongly enough. From a bureaucratic perspective, the Fed absolutely Does. Not. Care. whether or not the market goes up, down, or sideways. When they talk about “risk” associated with their policy choices, they mean risk to their institutional reputation, not risk to financial asset prices. And today, after more than two years of a “tightening bias” and “data dependency”, there’s more reputational risk associated with staying pat than with raising rates in a one-and-done manner.

Why? Because the public Narrative around extraordinary monetary policy and quantitative easing has steadily become more and more negative over the past three years, and the public Narrative around negative rates in particular is now overwhelmingly in opposition. When I did my Narrative analysis of financial press sentiment surrounding Brexit prior to that vote, I always thought that would be the most hated thing I’d ever see. Nope. I’ll append the Quid maps and analysis at the end of this note for those who are interested in digging in, but here’s the skinny: the negative sentiment around negative rates is now greater than the negative sentiment around Brexit. The public Narrative around ever more accommodative monetary policy has completely turned against the Fed. And they know it.

It’s not only the overall Narrative network that has turned with a vengeance against the Fed, but also some of the most prominent Missionaries, to use the game theoretic term. Over the last few weeks we’ve seen Larry Summers take Janet Yellen directly to task, as the runner-up in the Obama Administration Fed Chair sweepstakes has apparently taken to heart the old adage that revenge is a dish best served cold. More cuttingly, if you’re Yellen, is the heel turn by Fed confidante and WSJ writer Jon Hilsenrath. His August 26thhit piece on the Yellen Fed feature article — “The Great Unraveling: Years of Missteps Fueled Disillusion with the Economy and Washington” — is the unkindest cut of them all.

I think that Summers has been emboldened and Hilsenrath has been turned because they’re picking up on the same sea change in public opinion that the Quid analysis is identifying with more precision. For Hilsenrath, here’s the centerpiece of his j’accuse: a long-running Gallup poll asking Americans to rate the relative competence of federal agencies. Yep, that’s right, the Fed — which used to have a better reputation than the FBI and NASA — is now at the absolute bottom of the heap, dragging behind (by a significant margin) even the IRS! It’s one thing to bring up the rear in 2009 polls, what with the immediate aftermath of the deepest recession in 70+ years. But to still be at the bottom in 2014 after a stock market triples (!) and The Longest Expansion In Modern American History™? Incredible. And the most recent poll was in 2014. If anything, the Fed’s reputation is even lower today. I mean … this is really striking, and I can promise you that none of this is lost on the current custodians of the Fed’s prestige and reputation. Or, like Summers, the wannabe custodians. If you’re a professional academic politician like Summers, you can smell the blood in the water.

How Americans Rate Federal Agencies
Share of respondents who said each agency was doing either a ‘good’ or ‘excellent’ job, for the eight agencies for which consistent numbers were available.


Source: Gallup telephone polls, most recently 1,020 U.S. adults conducted Nov. 11—12, 2014, with a margin of error of +/-4 percentage points. As reported by the Wall Street Journal.

So what does all this mean for the September FOMC meeting?

Look … does “the market” want more and more supportive policy? Of course it does. We’re addicts. But if the Fed takes a dovish stance now — and anything less than a hike is going to be perceived as a dovish stance — from an organizational perspective the Fed is risking a lot more than a market sell-off from a rate hike. It risks being blamed for anything bad that happens in the economy going forward. This is the risk of being an unpopular political actor. This is the risk of losing your reputation for competence. The Golden Rule of organizational behavior is quite simple: there must ALWAYS be plausible deniability for culpability if something goes wrong. There must ALWAYS be some other political actor to blame. Unless the Fed takes steps now to stem the erosion in their reputation and their position in the public Narrative, they will own this economy and the downturn that everyone (including the Fed) suspects is coming.


By raising rates now, on the other hand, the Fed can declare victory. We achieved our dual mandates of price stability and full employment! Mission accomplished! And unlike George Bush and his infamously premature declaration of same, the Fed has someone to blame when the “mission” unravels (which of course it will) — those dastardly fiscal policymakers who didn’t follow up with structural reforms or pro-growth policies or whatever when they were elected this November. While the consensus view is that the Fed loathes to do anything to rock the market boat before the November election, in truth this meeting is the perfect time to act if your political goal is to declare victory and pass the buck. Hey, we did our part, says the Fed. Prudent stewards of monetary policy and all that. Now, about that consulting gig at Citadel …

That’s the bureaucratic or organizational perspective. Here’s the internal political dynamic as I see it.

An internal politics perspective is similarly driven by questions of reputation, but at the individual level rather than the organizational level. In an academic organization like the modern Fed, your internal reputation is based entirely on how smart you are, as evidenced by the research you do and the papers you write and the talks you give, not on how effective you are in any practical implementation of organizational aims. It’s not that the Fed or major research universities are intentionally ignoring or trying to put down practical implementations like teaching or outreach to commercial bank staffers, but every hour you spend doing that is an hour you’re not spending impressing your colleagues and bosses with how smart you are. It’s just how the internal political game is played, and anyone who has achieved any measure of success in an organization like this knows exactly what I’m talking about.

What this means in practice is that FOMC meetings are driven by a desire to form a consensus with the other smart people around the table, so that each of you is recognized by the other members of the consensus as being smart enough to be a member of the consensus. It’s the precise opposite of the old Groucho Marx joke: “I don’t want to be a member of any club that would have me as a member.” Every FOMC member desperately wants to be a member of the club that would have him or her as a member, because it means that you’ve been recognized as one of the smart kids. The internal political dynamic of academic cultures like the Fed, at least at the highest levels of Governor to Governor interaction, is NOT antagonistic or divisive. On the contrary, it’s cooperative and consensus-forming.

Not sure what I’m talking about? Read this Jon Hilsenrath interview of St. Louis Fed Governor Jim Bullard again (I say again because I published it for other reasons in the last Epsilon Theory note, Magical Thinking), where Bullard describes this consensus building dynamic.


Mr. Hilsenrath: What kind of compromise would it take to get the FOMC to move in September? I mean, so the tradition is there’s some kind of — like you say, some kind of agreement. What would it take to get them there?
Mr. Bullard: Well, I have no idea, so — and it’s really — it’s really the chair’s job to fashion that. But I will say that — I’ll talk historically about the FOMC, the kinds of things that the FOMC would do. You would trade off. You would say, OK, we could hike today, but then we’ll not plan to do anything in the future. That would be one way to — one way to go about a consensus. So that often happens on the FOMC. Or vice versa. If you read the Greenspan-era transcripts, he’ll do things like, OK, we won’t go today, but we’ll kind of hint that we’re pretty sure we’re going to go next time.
Mr. Hilsenrath: Right.
Mr. Bullard: And so you get this inter-tempo kind of trade-off, and that often — that often is enough to get people to sign up.
Mr. Hilsenrath: So, hike today and then delay.
Mr. Bullard: Yeah. (Laughs.)
Mr. Hilsenrath: Or, no hike today and then no more delay.
Mr. Bullard: Yeah, yeah.
Mr. Hilsenrath: Something like that.
Mr. Bullard: Yeah, those kinds of trade-offs are, historically speaking — I’m not saying I know what Janet’s doing, because I don’t. But, historically speaking, those are the kinds of things that the FOMC has done.
Mr. Hilsenrath: I came up with my catchphrase for the — for the month. (Laughter.)
Mr. Bullard: Those are great. That’s worthy of a T-shirt. (Laughs, laughter.) You could have one on the front and one on the back.
Ms. Torry: Or a headline.
Mr. Hilsenrath: Well, that’s the St. Louis framework now, right?
Mr. Bullard: Yeah.
Mr. Hilsenrath: Hike today and then delay.
Mr. Bullard: Yeah. That’s what it would be, yeah.
― Wall Street Journal, “Transcript: St. Louis Fed’s James Bullard’s Interview from Jackson Hole, Wyo.” (August 27, 2016)

What Bullard is describing from a game theoretic perspective is a dual-equilibrium coordination game. Either it’s “Hike today and then delay” (Bullard’s preferred equilibrium outcome) or “No hike today and then no more delay”. Those are the two possible consensus outcomes. Both are stable equilibria, meaning that once you get a consensus at either phrase, there is no incentive for anyone to change his or her mind and leave the consensus. Importantly, both are robust equilibria in their gameplay, meaning that it only takes one or two high-reputation players in the group to commit to one outcome or the other in order to start attracting more and more reputation-seeking players to that same outcome. You can think of individual reputation as a gravitational pull, so that even a proto-consensus of a few will start to draw others into their orbit.

It’s always really tough to predict one equilibrium over another as the outcome in a multi-equilibrium game, because the decision-making dynamic is solely driven by characteristics internal to the group, meaning that there is ZERO predictive value in our evaluations of external characteristics like Taylor Rule inputs in 2016 or US/Soviet nuclear arsenals in 1962. (I wrote about this at length in the context of games of Chicken, like Germany vs. Greece or the Fed vs. the PBOC, in the note Inherent Vice). But my sense — and it’s only a sense — is that the “Hike today and then delay” equilibrium is a more likely outcome of the September meeting than “No hike today and then no more delay”. Why? Because it’s the position both a hawk like Fischer and a dove like Bullard, both of whom are high-reputation members, would clearly prefer. If one of these guys stakes out this position early in the meeting, such that “Hike today and then delay” is the first mover in establishing a “gravitational pull” on other members, I think it sticks. Or at least that’s how I would play the game, if I were Fischer or Bullard.

Okay, Ben, fair enough. If you’re right, though, what do we do about it? How are markets likely to react to the shock of a largely unanticipated rate hike?

In the short term, I don’t think there’s much doubt that it would be a negative shock, because as I write this the implied “market odds” of a rate hike here in September are not even 20%. My analysis suggests that the true odds are about three times that, as I give a slight edge to the “Hike today and then delay” equilibrium over “No hike today and then no more delay”. Do I think it’s a sure thing that they hike next week? Give me a break. Of course I don’t. But if I can be dealt enough hands where the true odds of something occurring are three times the market odds of something occurring …

The medium-to-long term market reaction to whatever the Fed decides next week is going to be driven less by the hike-or-no-hike decision and more by the Fed-directed Narrative that accompanies that rates decision. That is, if they hike next week and start talking about how this is the next step of a “normalization” process where the Fed will try to get rates back up to 3% or 4% in a couple of years … well, that’s a disaster for markets. That’s a repeat of the December rate hike fiasco, and you’ll see a repeat of the January-February horror show, where the dollar is way up, commodities and emerging markets are way down, and everyone starts freaking out over China and systemic risk again. But if they hike next week and start talking about how they’re rethinking the whole idea of normalization, that maybe rates will be super-low on a semi-permanent basis, or at least until productivity magically starts to improve … well, that’s maybe not such a disaster for markets. Ditto if they don’t hike next week. If the jawboning associated with a no-hike in September sets up a yes-hike in December as a foregone conclusion, that’s probably just as bad (if not worse) for markets than a shock today.

Of course, the Fed is well aware of the power of their “communication policy” and the control it exerts over market behavior. Which means that whenever the Fed hikes — whether it’s next week or next month or next meeting or next year — they’re going to sugarcoat the decision for markets. They’re going to fall all over themselves saying that they’re still oh-so supportive of markets. They’re going to proclaim their undying love for markets even as they take actions to distance themselves.


But here’s the thing. The Fed is now revealing its one True Love — its own reputation and its own political standing — and that’s going to be a bombshell revelation to investors who think that the Fed loves them. Investors are like Tom Buchanan in The Great Gatsby. We’re married to this really swell girl, and we get invited to these really great parties, but then we see that Daisy is truly in love with Jay Gatsby, not us. And everything changes. Maybe not on the surface, but deep down, where it really matters. I’m not saying that the Fed abandons the markets. After all, Daisy stays married to Tom. But everything changes in that moment of realization that she truly loves someone else, not you, and that’s what the next Fed hike will mean to markets.

That’s when the party stops.

Appendix: Quid Narrative Analysis

For a recap of how I’m using the Quid tool kit to analyze financial media narrative formation and evolution, please refer to the Epsilon Theory note The Narrative Machine. Below are two slides from Quid providing a quick background on the process.


Source: Quid


Source: Quid

Here’s the network of all 941 Bloomberg articles over the past year mentioning negative rates, colored by topic cluster:


Source: Quid

This is a prototypical focused narrative network, indicative of articles that are truly “about” negative rates, as opposed to articles about something else that provides the clustering characteristics and only mention negative rates in passing. So now let’s look at the same network, but colored by sentiment rather than by topic clustering.


Source: Quid

Fully 50% of the articles are negative, 42% neutral, and only 7% are positive in their sentiment.

How does this compare to other Bloomberg networks and other sentiment scores? Horribly. The only subject issue that even comes close is Brexit, with 47% negative, 42% neutral, and 10% positive in the weeks leading up to the vote. Post-vote, the negative sentiment around Brexit drops to the mid-twenties.

To be sure, few topics associated with monetary policy have an overtly positive sentiment distribution, at least in recent years. For example, here’s a chart of the Quid sentiment scores for all Bloomberg articles mentioning Quantitative Easing (QE), by year over the past three years. The Narrative is steadily deteriorating, but we’re still not close to negative articles taking the lead over neutral articles.

Sentiment Scores for Bloomberg Articles Mentioning QE, by Year

9/13 – 9/14 9/14 – 9/15 9/15 – 9/16
Neutral 58% 52% 48%
Negative 24% 31% 38%
Positive 17% 16% 13%

Source: Quid

One final network observation. Of the positively-oriented Bloomberg articles, they tend to cluster in the topic circled below. That topic? Gold. The articles have a positive sentiment because negative rates are great for gold prices. Of course, that’s a very negative thing from the Fed’s reputational perspective, which means that many of the articles that speak positively about negative rates are actually intimating something negative about central bankers! Bottom line: there is no more hated policy initiative in the world than negative rates.


Source: Quid

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Magical Thinking


Duane Hall: Can I confess something? I tell you this as an artist, I think you’ll understand. Sometimes when I’m driving … on the road at night … I see two headlights coming toward me. Fast. I have this sudden impulse to turn the wheel quickly, head-on into the oncoming car. I can anticipate the explosion. The sound of shattering glass. The … flames rising out of the flowing gasoline.
Alvy Singer: Right. Well, I have to — I have to go now, Duane, because I … I’m due back on planet Earth.
“Annie Hall” (1977)

One of my all-time top-ten movie scenes. Of course, Duane ends up driving Alvy and Annie back to the airport that night. No one does crazy better than Christopher Walken. Except maybe the Fed’s #2, Stanley Fischer. We’re all just passengers in the backseat of the Fed-driven car.



Alvy Singer: This guy goes to a psychiatrist and says, “Doc, my brother’s crazy; he thinks he’s a chicken.” And the doctor says, “Well, why don’t you turn him in?” The guy says, “I would, but I need the eggs.” Well, I guess that’s pretty much how I feel about relationships; y’know, they’re totally irrational, and crazy, and absurd … but, I guess we keep going through it because most of us … need the eggs.
“Annie Hall” (1977)

We’re all passengers in the backseat of the Fed-driven car, and we all suspect that our drivers might be high-functioning lunatics, and we’re all terrified about what they might do next.

But we need the eggs.


“What are the stars?” said O’Brien indifferently. “They are bits of fire a few kilometres away. We could reach them if we wanted to. Or we could blot them out. The earth is the centre of the universe. The sun and the stars go round it.”

“For certain purposes, of course, that is not true. When we navigate the ocean, or when we predict an eclipse, we often find it convenient to assume that the earth goes round the sun and that the stars are millions upon millions of kilometres away. But what of it? Do you suppose it is beyond us to produce a dual system of astronomy? The stars can be near or distant, according as we need them. Do you suppose our mathematicians are unequal to that? Have you forgotten doublethink?”

Winston shrank back upon the bed. Whatever he said, the swift answer crushed him like a bludgeon. And yet he knew, he knew, that he was in the right. The belief that nothing exists outside your own mind — surely there must be some way of demonstrating that it was false? Had it not been exposed long ago as a fallacy? There was even a name for it, which he had forgotten. A faint smile twitched the corners of O’Brien’s mouth as he looked down at him.

“I told you, Winston,” he said, ‘”that metaphysics is not your strong point. The word you are trying to think of is solipsism. But you are mistaken. This is not solipsism. Collective solipsism, if you like. But that is a different thing: in fact, the opposite thing.”

George Orwell, “1984” (1949)

As O’Brien patiently explains to Winston between torture sessions, or what we would call today “FOMC meetings”, Collective Solipsism is the voluntary abdication of empirical and independent thought. But it’s not ordinary solipsism — a pathological egocentrism where reality is entirely defined by one’s own thoughts. Instead, Collective Solipsism annihilates one’s own thoughts and replaces them with state-sponsored thoughts. Your reality is just as fake. But you’re living someone else’s fantasy.

epsilon-theory-magical-thinking-september-1-2016-joan-didionGrief turns out to be a place none of us know until we reach it. … We might expect that we will be prostrate, inconsolable, crazy with loss. We do not expect to be literally crazy, cool customers who believe that their husband is about to return and need his shoes.

In the version of grief we imagine, the model will be “healing.” A certain forward movement will prevail. The worst days will be the earliest days. We imagine that the moment to most severely test us will be the funeral, after which this hypothetical healing will take place. … We have no way of knowing that this will not be the issue.

There was a level on which I believed that what had happened was reversible.

 ― Joan Didion, “The Year of Magical Thinking” (2005)

The best book I’ve ever read on the emotion of grief. Central bankers today are grieving the death of the so-called Great Moderation, and they are expressing their grief in the same way that Didion expressed hers — through magical thinking, through the pathological belief that if only the right words are said and the right thoughts are thought, then the dearly departed might walk through the front door and ask for his shoes.


 Mr. Hilsenrath: What kind of compromise would it take to get the FOMC to move in September? I mean, so the tradition is there’s some kind of — like you say, some kind of agreement. What would it take to get them there?
 Mr. Bullard: Well, I have no idea, so — and it’s really — it’s really the chair’s job to fashion that. But I will say that — I’ll talk historically about the FOMC, the kinds of things that the FOMC would do. You would trade off. You would say, OK, we could hike today, but then we’ll not plan to do anything in the future. That would be one way to — one way to go about a consensus. So that often happens on the FOMC. Or vice versa. If you read the Greenspan-era transcripts, he’ll do things like, OK, we won’t go today, but we’ll kind of hint that we’re pretty sure we’re going to go next time.
 Mr. Hilsenrath: Right.
 Mr. Bullard: And so you get this inter-tempo kind of trade-off, and that often — that often is enough to get people to sign up.
 Mr. Hilsenrath: So, hike today and then delay.
 Mr. Bullard: Yeah. (Laughs.)
 Mr. Hilsenrath: Or, no hike today and then no more delay.
 Mr. Bullard: Yeah, yeah.
 Mr. Hilsenrath: Something like that.
Mr. Bullard: Yeah, those kinds of trade-offs are, historically speaking — I’m not saying I know what Janet’s doing, because I don’t. But, historically speaking, those are the kinds of things that the FOMC has done.
Mr. Hilsenrath: I came up with my catchphrase for the — for the month. (Laughter.)
Mr. Bullard: Those are great. That’s worthy of a T-shirt. (Laughs, laughter.) You could have one on the front and one on the back.
Ms. Torry: Or a headline.
Mr. Hilsenrath: Well, that’s the St. Louis framework now, right?
Mr. Bullard: Yeah.
Mr. Hilsenrath: Hike today and then delay.
Mr. Bullard: Yeah. That’s what it would be, yeah.
Mr. Hilsenrath: But if you decide to use that, maybe you can credit — you know, include a little footnote to the Wall Street Journal.
Mr. Bullard: OK. (Laughs.)
― Wall Street Journal, “Transcript: St. Louis Fed’s James Bullard’s Interview from Jackson Hole, Wyo.” (August 27, 2016)

Reading this transcript made me throw up in my mouth a little bit. And Bullard is the best of the lot. At least he’s honest about the intellectual poverty about the whole FOMC interest rate-setting exercise. They’re just making it up as they go along, a hallmark of magical thinking.


In point of fact magicians appear to have often developed into chiefs and kings.

 ― James George Frazer, “The Golden Bough” (1890)

Frazer’s book on the history and anthropological foundations of magic was a revelation to me when I first read it, as it was to as disparate a group of writers and poets as Yeats, TS Elliot, Freud, Hemingway, Joyce, and … Jim Morrison.


Courtier T.L. — Amid all the people starving, missionaries and nurses clamoring, students rioting, and police cracking heads, His Serene Majesty went to Eritrea, where he was received by his grandson, Fleet Commander Eskinder Desta, with whom he intended to make an official cruise on the flagship Ethiopia. They could only manage to start one engine, however, and the cruise had to be called off. His Highness then moved to the French ship Protet, where he was received on board by Hiele, the well-known admiral from Marseille. The next day, in the port of Massawa, His Most Ineffable Highness raised himself for the occasion to the rank of Grand Admiral of the Imperial Fleet, and made seven cadets officers, thereby increasing our naval power. Also he summoned the wretched notables from the north who had been accused by the missionaries and nurses of speculation and stealing from the starving, and he conferred high distinctions on them to prove that they were innocent and to curb the foreign gossip and slander.

 ― Ryszard Kapuscinski, “The Emperor” (1978)

If you can only read one book on the end of an ancien regime and the magical thinking that ALWAYS takes place in its wake, this is it. Kapuscinski chronicles the final years of Haile Selassie’s reign in Ethiopia from the inside out, interviewing dozens of courtiers to paint a first-hand portrait of an entire society lost in the fantasy world of Collective Solipsism.

Selassie and his Inner Party maintained the fantasy for years after it lost all connection with reality, so that a mighty fleet consisted of a single ship with a malfunctioning engine, promotions and medals were conflated with real-world power and influence, and bad people and bad ideas were constantly lauded and rewarded to keep hard questions from being asked.

Spoiler alert: it doesn’t end well for Selassie or for Ethiopia. In the words of another famous solipsist, Louis XV, “après moi, le deluge.” After Selassie came The Dergue. Think Pol Pot in committee form.

The last years of Selassie’s rule are more than a parable for our times … they ARE our times.

Magical thinking is a term of art in both clinical psychology and cultural anthropology, and it refers to the common belief among both children and “primitive” societies (yes, intentional quotation marks there to show my arched eyebrow at the word) that thinking the right thoughts or saying the right words can control the invisible forces that shape our world.

For example, as Jean Piaget (the father of developmental psychology) noted, children from the ages of 2 to 7 tend to have very little conception of real-world causality. Tell your four-year-old son that the family dog has died, and he is likely to a) blame himself for something he did or didn’t do for “causing” the death, and b) believe that there is some combination of proper words and proper thoughts and proper actions that can make the dog come back to life. That’s magical thinking. It’s a profoundly ego-centric conception of the world, and if you’re a parent you know exactly what Piaget is talking about. Every four-year-old child is an egomaniac, in the clinical, non-judgmental sense of the word.

It’s the same thing with what cultural anthropologist Claude Lévi-Strauss called “The Savage Mind” in his groundbreaking 1962 book. Societies without a causal explanation for, say, the weather will always construct some sort of combination of words and thoughts and actions to be performed by privileged caste members like priests or kings, through which the entire society convinces itself that humans exercise some sort of control over these incredibly powerful real-world forces and that they aren’t just buffeted this way and that by the inexorable might of a big bad world that really couldn’t care less about them. In fact, that’s the literal origin of the word “inexorable”, from the Latin in (not), ex (away), orare (to pray) — something that cannot be prayed away.


In early days of any human society, this sort of magic usually emphasizes some form of sympathetic or like-for-like object … for example, you might rub a banana-shaped crocodile tooth against a banana plant to make it bear fruit (I’m not making this up). Over time, however, the spellcasting caste and society at large convince themselves that you don’t really need actual crocodile teeth, but you can instead invoke the power of a crocodile tooth by calling it by its secret name. Maybe you need to write down that secret name using the secret language of the priests in order to make the spell work, but you definitely don’t need to go out and hunt down a real-world crocodile. It’s at this point that hunter/soldier-kings are replaced by academic/priest-kings … the pen is truly mightier than the sword, or at least writing “crocodile” carries a longer life expectancy than hunting crocodiles. Over still more time, the secret names and the secret language of the priest-kings become a vast edifice of magical thinking, an edifice that provides great comfort and stability to the entire society. Because there is nothing more important to societal stability than the belief that nature is under control. That the invisible forces of nature can, in fact, be prayed away.

Until they can’t. Until all the banana plants die because of some rare nematode infestation in the roots, and all the secret words and secret languages and even the “old magic” of the actual crocodile teeth are useless. They were useless all along, of course, as the banana plants would have borne fruit for the past 50 years with or without the spells, but hey … until this year there was a 98% correlation between the spells and a healthy banana crop! And my VAR was really quite negligible!

Okay, Ben, we see what you’ve done here. Yes, yes … quite droll, really … you’ve found a clever metaphor for railing against our central banker ruling class. Again. Thanks for the diversion, but now we need to get back to planet Earth. Important work to be done, and all that. Love your quotes, by the way.

Wait! This is not a metaphor. This is not an anthropological parable for our times. This IS our times. Want to see what a magic spell looks like? Here you go:


This is the Gaussian Copula spell. It’s what you write down to make sure that your AAA-rated slice of a massive bunch of mortgages pays you 6% a year with only an infinitesimal risk of default. It’s not a metaphor for a spell. It is an actual magic spell, exactly the same in form and function as the talismanic scripts written on, say, Egyptian funerary urns in 1000 BC to make sure that your body and soul get to the afterlife with only an infinitesimal risk of default.

Secret language no one can read or understand? Check. Not really comprehensible even by most magicians? Check. Administered by a privileged caste with appropriate pomp and ceremony? Check. Reflective of an innate human desire to control invisible forces that are, in fact, uncontrollable and inexorable, like death and business cycles? Check. Highly effective in motivating human behavior and supporting status quo political institutions? Check. And mate.

The Gaussian Copula spell wishes away the possibility of a nationwide decline in U.S. home prices (if you haven’t already, please read Felix Salmon’s 2009 Wired magazine article on the Gaussian Copula — “The Formula That Broke Wall Street” — my all-time favorite piece of financial market journalism). The magical thinking embedded in this spell is that a nationwide decline in U.S. home prices is not just unlikely, it is — literally — unthinkable. It is an incantation that generated enormous societal stability and wealth, creating out of whole cloth a belief that a $10 trillion (yes, that’s trillion with a T) asset class in residential mortgage-backed securities (RMBS) was a solid thing, a triumph of Science (why, just look at all those Greek letters and the mathematical stuff!), an example of man’s mastery over the invisible vagaries of nature.

And then we had a nationwide decline in U.S. home prices. Which broke our world.

Here’s another spell:


This is the Taylor Rule spell. It’s what you write down to make sure that the inflation rate in your economy goes up or down the way you want it to go up or down. There are lots of other spells that go along with the Taylor Rule spell for “controlling” inflation, but it’s the main one, I’d say. This is the spell that has created a $12 trillion asset class in negative yielding sovereign debt. Because, you know, the lower interest rates go, the more you’re going to borrow and spend, and the higher inflation goes. Right? Right?

If the Gaussian Copula is like a funerary spell, trying to assure investors that they will get to investor heaven like dead Egyptian Pharaohs were assured of getting to dead Egyptian Pharaoh heaven, the Taylor Rule is like a weather spell. When I read this from James Frazer’s The Golden Bough:

epsilon-theory-magical-thinking-september-1-2016-scotland-witches So in Scotland witches used to raise the wind by dipping a rag in water and beating it thrice on a stone, saying:

I knok this rag upone this stane
To raise the wind in the divellis name,
It sall not lye till I please againe.

I can’t help but think of Stanley Fischer, vice-warlock of the Fed coven, saying in Jackson Hole that we need thrice interest rate raises (one last December, two more this year) to quell the inflationary winds. Or raise them. Or whatever sort of weather that Fischer is trying to manufacture. It’s really hard to tell.

But here’s the kicker. When a spell doesn’t work, no one in the magically thinking society believes it’s because spell-casting itself doesn’t work. It means that the spell wasn’t performed properly. Either the priest-kings said the words wrong or they didn’t think the right thoughts or there’s some other invisible force that we need to propitiate first. So what always happens, and I mean “always” in the sense of This. Is. Human. Nature. and has been happening in a rhyming sense for tens of thousands of years across every human society that ever lived, is this:

In phase 1, the priest-kings try harder. They seek out purer ingredients for their spells. They speak more loudly, more convincingly, more stridently. If two crocodile teeth were used in the past, now they use four. Or eight. It’s not just “more”, it’s “MOAR!”. Often there’s an internal purge near the end of phase 1.

In phase 2, the priest-kings regroup and tweak the spell. Maybe instead of “targeting” (another word for “praying for”) a 2% inflation rate, we need to “target” a 4% inflation rate. Maybe we should change the magic word “inflation” to “nominal GDP growth” and see if that works any better. Sure, why not? This tweaking process has happened, it is happening now, and it will happen all the way to the bitter end. What will never happen is that the priest-kings quit. There’s always another tweak, always another word choice, always another order in which the words can be said.

In phase 3 — and this is where we are now in the historical process, somewhere near the end of phase 2 and the beginning of phase 3 — the priest-kings are challenged by a rogue priest in their midst (rare) or an alt-priest coming out of nowhere (common). By “nowhere” I mean that the alt-priest is an Other, whether that’s a foreign religion or a foreign geography or a foreign (i.e., non-priestly) caste. The alt-priest isn’t about tweaking the spell or casting it louder. He’s about doing an entirely different spell, and he’s about accusing the incumbent priests of incompetence or worse. The alt-priest is always a populist, and populism comes easy when the incumbent spells have been failing … and failing … and failing.

So what happens? It depends on reality. It depends on whether the banana plants get better on their own or if they die. If they get better on their own (and this happens more often than you might think), then the incumbent priest-kings remain. If the banana plants give up the ghost, then the incumbents are swept away. For future reference, this is what dead banana plants look like.


Interestingly — and this was Frazer’s big point in The Golden Bough — even if the incumbent mode of magical thinking survives, it’s necessary for societal stability to perform a public human sacrifice of the primary incumbent priest-king. The king is dead. Long live the king. Fortunately for all involved, human sacrifice today is a lot less literal than it was during, I dunno, the heyday of the Etruscans. A little public shaming, a tearful interview with Anderson Cooper, a quiet hermitage in the form of a deanship at a small New England college … yeah, that should do the trick.


The way this all plays out also depends on how deeply the incumbent priest-kings retreat into their fantasy world of tweaking spells and magical thinking, and that’s where I’m most concerned. The fact is that the global economy — particularly the U.S. economy and the Chinese economy — is more robust than the alt-priests tend to let on. Amazingly enough, the U.S. can still grow its way out of the massive debt we’ve taken on. I know … hard to believe. But it’s true. The power of compounding is truly inexorable, and it’s amazing what a steady 3.5% growth rate on a huge economic base can do to make manageable even trillions of dollars in debt. The rest of the developed world? Impossible to grow their way out of debt. They’re finished. Or rather, to use the lingo of my distressed debt friends, Japan and Europe ex-Germany are now “work-out situations”. But if the U.S. could just get out of its own way … if we could stop arguing about who gets to use what bathroom and start arguing about how to increase productivity (i.e., how to make technology a tool for humans doing more stuff rather than a replacement for humans doing stuff at all) … then we could actually come out of this okay.

I know, I know … I’m a dreamer. And for all the political fragmentation and polarization reasons that I write about ad nauseam, or at least here, here, here, and here, the politics of identity are unlikely to be replaced by the politics of growth anytime soon. Not in the West, anyway. But that’s why I want to pull my hair out when I watch the Jackson Hole theatre. Guys, you’re not helping!

I was dumbfounded by the stultifying, excruciating more-of-the-sameness that came out of Jackson Hole. Oh my god, are we really saying that the entire FOMC decision-making process comes down to whether there’s a good jobs report on Friday? Why don’t we just inspect the entrails of a goat? Are we really still arguing about one-raise-or-two when LIBOR is now pushing 90 basis points? Was there any mention — any mention at all — of LIBOR during the entire Jackson Hole meeting? Do these people, and it’s not just the central bankers themselves but all the courtiers — the journalists, the academics, the hangers-on — do they even recognize that a world exists outside of their imaginations and theories? Answer: NO.

Yep, at first I was disappointed in them. But on reflection I became more and more disappointed in us.

See, the problem isn’t with the Fed. They’re going to do what solipsistic, magical thinking priest-kings have done for ten thousand years … more of THAT. More solipsism. More magical thinking. More 4 year old egomaniacal determination that their spell casting efforts are the ONLY thing that stand between us and utter ruin.

No, the bigger problem is with us. The bigger problem is that we cannot imagine a solution for our current economic and political problems that does not rely on greater and greater state-directed spell casting. Monetary policy spells not working? Well, golly, I guess our ONLY alternative is to try some fiscal policy spells. Really? That’s the best we can come up with? I understand that this is what the courtiers are going to say. But I expect more from the rest of us. I expect more from myself.

Look, I get it. To riff on Woody Allen’s famous joke, we need the eggs. We need a stock market that goes up, not down. We need financial asset price inflation. We need the eggs so badly that we’re willing to support the magical thinking crew and smile at their courtiers even though we think they’re totally out of touch with reality. We’ve become so used to getting our eggs delivered on time and without fail that our first, second, and third responses are to ask for more magical thinking from the incumbent priest-kings, not less.


This is a dangerous, myopic game. Because we will get what we ask for. We will get more magical thinking. Only it won’t come just from the status quo magicians. It will also come from the alt-priests, some of whom will represent the absolute worst impulses of humanity. There are really bad ideas lurking on the wings today — there always are — but these really bad ideas about how human society should be organized always resurface and grow more powerful at times like this. Because it’s the old magic, an old magic that the human animal is hard-wired to respond to.

Maybe we’ll get lucky. Maybe the banana plants of global growth will turn green again, and we can have a grand celebration of the particular variant of the policy spell that was coincidentally cast at the same time. That could happen. As Otto von Bismarck, the Iron Chancellor of 19th century Europe supposedly said, “there is a special providence for children, fools, and the United States of America.” Any portfolio manager with long enough tenure knows what it’s like to be bailed out by the market, and it’s a beautiful thing. Now we just need that to happen on a much larger scale.

But we should do better than just trust to luck. I’m not saying that we have to deny our human nature and stop believing in the act of spell-casting itself. I’m not (that) delusional. What I’m saying is that the more we embrace and encourage state-directed magical thinking, whether it’s of the monetary or fiscal policy sort, what we are actually doing is opening the city gates to the old evil magic and the alt-priests of fascism and totalitarianism. We don’t need the eggs that badly. What I’m saying is that we need to think less about Scottish witchcraft, a la Macbeth and James Frazer and Stanley Fischer, and more about the Scottish Enlightenment, a la David Hume and Adam Smith and Alexander Hamilton. What I’m saying is that we need to focus on empiricism and on what works in the real world, not theory and what “works” as an equation. What I’m saying is that usually the better course of state-directed action is to do less, not more, and the better course of individually-directed action is to do more, not less. What I’m saying is that the old good magic of small-l liberalism and technological innovation in the service of man rather than the replacement of man is pretty darn powerful itself, and the stories still inspire. Let’s embrace and encourage THAT as we make our way through what is still a largely inexorable world.


It matters whether or not we call things by their proper names, because the words and the spells motivate human behavior like nothing else. It matters whether or not we sleepwalk our way through our own fin de siècle, because the really bad people and the really bad ideas that periodically wreck our world can’t be wished away. It matters whether or not we become courtiers ourselves, because the courtiers always fall the farthest. The problem with magical thinking run amok and its perpetuation of a fantasy world is that sooner or later the dream of the delusional king becomes a real world nightmare for real world people. It’s time to wake up.

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