This is my 250th Epsilon Theory post. Yow! While there’s no getting around some repetitiveness on the major themes of ET, like the Narrative Machine or the Common Knowledge Game or the Three-Body Problem, I do my best to keep the story arcs fresh by not repeating myself in the ephemera – the movie quotes and graphics and the like. But there’s one quote that I’ve used three separate times, and two graphics that pop up again and again. So for this 250th note I thought I’d call out these Hot Rocks of Epsilon Theory.
[And yes, one day I fully intend to rent out Swarkestone Pavilion and recreate this Stones pic with the Epsilon Theory band. It’ll be Rusty in the foreground … he is the drummer, after all. Jeremy and I are more the peacock-in-the-window type.]
Here’s the quote:
Shape clay into a vessel; It is the space within that makes it useful. Cut doors and windows for a room; It is the holes which make it useful. Therefore benefit comes from what is there; Usefulness from what is not there. – Lao Tzu (c. 530 BC)
I’ve used this quote in “The Tao of Portfolio Management“, “Who’s Being Naive, Kay?” and “The Arborist“, three notes that speak directly to portfolio construction. A portfolio is, after all, a vessel. It is a container for our financial investments, and what we leave OUT of that container is every bit as important as what we put IN.
But the wisdom of this quote goes way beyond investing. Our homes, our businesses, our friendships, our marriages, our children … our lives themselves … vessels all.
Not every empty space needs filling.
And here’s the first graphic that I’ve used repeatedly in Epsilon Theory notes, ad-man Harvey Ball’s 1963 smiley-face button, brilliantly adapted by Alan Moore and Dave Gibbon for their classic graphic novel, Watchmen:
Watchmen is one of those life-informing books, or at least it was for me. This button, worn by the Comedian, a villainous hero or heroic villain (it’s hard to tell), is my personal emblem of smiley-face authoritarianism, aka the Nudging State. It’s just so messy to stomp on someone’s face when you can cleanly accomplish the same ends with “choice architecture” and “communication policy”.
It’s all Fiat News all the time today, where opinion is presented as fact, and we are all shamed into compliance.
It’s an illustration of a wolf trap from Le Livre de la Chasse (c. 1407). It’s a pretty simple design, consisting of a blood trail set through a one-way door in a circular wicker fence built around a central pen with a scared, bleating sheep, but man, is it effective. The design has three crucial elements. First, the circular outer wall is hard for the wolf to escape if he gets wise to the trap, and the circular inner wall keeps the live bait … alive. Second, wolves expect to hunt and track their prey. By establishing a longer trail that must be navigated successfully the wolf becomes more committed to the trap the farther he goes. Third and most importantly, the design prevents the wolves from seeing each other until they get to the end of the blood trail, at which point it’s too late to escape what they now know is a trap.
I think the medieval wolf trap is an almost perfect metaphor for the way that the Nudging State and the Nudging Oligarchy operate. No one forces us to watch CNBC. No one forces us to use social media. No one forces us to nod sagely at the Fed’s every word. No one forces half of us to go into a berzerker rage over every Trump tweet and the other half to go into a MAGA apoplexy over every CNN segment. No, we’re much too smart and much too independent to ever fall for a trap like that.
I’ve said it before and I’ll say it again … I’m pretty sure this painting now hangs in Mark Zuckerberg’s office.
It’s true that once you become aware of these narrative machines, you see them everywhere.
I couldn’t stop thinking, while reading your note, about the current situation in Catalonia, a part of the world I know relatively well. The Spanish central government and the media are focusing entirely on the Catalan government breaking the law and on how an independence referendum is unconstitutional, and they will not debate the morality of such law or higher principles such as the right of self-determination. On the other hand, the independence movement has been able to use children and older folk during marches and protests. This has resulted in powerful images on newspapers and websites all over the world of the police beating old grandmothers in line to vote.
I am not entirely sure how all this will be resolved, but it is fascinating to see how this War of Narratives is developing and how it is very similar to other past wars. Thanks again for the work you are doing; I always have a feeling of growth and improvement after reading your notes.
– Ivan K.
I’m a little embarrassed that I didn’t mention the widespread prevalence of this “but it’s illegal” narrative in political and civil rights struggles across time and across geography. Ivan is absolutely right about what’s happening in Spain, and I would bet that every non-US Epsilon Theory reader can find examples of this State narrative in their own country.
I am just sitting down to this now, and noticed the picture on page 3 of the police officers and their dogs lunging at a young black boy in Birmingham. I can’t help but recommend Malcom Gladwell’s podcast about this exact image, if only to satisfy any curiosity you may have. The title of his podcast is “Revisionist History” (it has a website, and can be accessed on all the normal channels, including iTunes), and the relevant episode is from Season 2 and is called “The Foot Soldier of Birmingham.” It is truly fascinating. Of interest may be the one immediately prior, called “Miss Buchanan’s Period of Adjustment.” They are relevant to all of us, but it sounds like very much to you.
Lots of readers called the Malcolm Gladwell podcast to my attention, which I had not heard before. You can access it directly here. In a nutshell, this most famous picture of the Bull Connor era in Birmingham is not at all what it appears to be. The young man in the photo had nothing to do with the “Children’s Crusade”, as the intentional insertion of children into harm’s way in order to become a media cause celebre was called by the organizers of the march. He was just trying to get home. And the policeman in the photo was trying to restrain the dog and protect the young man, not sic the dog on him. But the photo was so evocative, so perfect for the narrative that civil rights organizers and journalists wanted to disseminate, that it didn’t matter. It’s a perfect example of the overwhelming power of Narrative, way more potent than the Truth with a capital T.
Longtime reader of your letter, and a native of Birmingham myself, born ~15 years after you were. I have to admit never having gone to the museum for the same reasons you mention. After reading your note that will change on my next trip home.
– Matt T.
Then my work here is done. Like I say, the Civil Rights Museum is a gut check.
Cheap shot against Trump with the Time Magazine cover and immigration reference.
Bull Connor was a lifelong segregationist democrat who used violence against blacks.
Republican Trump inherited Obama’s immigration policy, that included separating and caging children.
Trump used an executive order to change the policy and keep families together.
Not quite the impression you created.
Maybe you should move out of Connecticut. Or maybe do a little research and “think for yourself”.
– Mark V.
In the immortal words of Bill Simmons when he closes a Mailbag, “yep, those are my readers.” But it’s somehow funnier when Bill does it. This wasn’t the only email I got from readers determined to let me know that Donald Trump is actually reuniting families that were separated by Obama’s heartless decrees. We are well and truly broken.
Once upon a time in the dead of winter in the Dakota Territory, Theodore Roosevelt took off in a makeshift boat down the Little Missouri River in pursuit of a couple of thieves who had stolen his prized rowboat. After several days on the river, he caught up and got the draw on them with his trusty Winchester, at which point they surrendered. Then Roosevelt set off in a borrowed wagon to haul the thieves cross-country to justice. They headed across the snow-covered wastes of the Badlands to the railhead at Dickinson, and Roosevelt walked the whole way, the entire 40 miles. It was an astonishing feat, what might be called a defining moment in Roosevelt’s eventful life. But what makes it especially memorable is that during that time, he managed to read all of Anna Karenina. I often think of that when I hear people say they haven’t time to read.
One of the most formative works in science fiction history is finally being brought to the screen. After years of false starts, both at the movies and on TV, Isaac Asimov’s Foundation just got a 10-episode, direct-to-series order from Apple.
In 1942, fresh from reading Edward Gibbon’s History of the Decline and Fall of the Roman Empire, 22 year-old Isaac Asimov published the first short story in what would become the most famous and influential science fiction series of his or anyone else’s lifetime – the Foundation Trilogy. In these books, Asimov invented the fictional science of psychohistory, a combination of history, sociology and mathematics that could make accurate predictions about the behavior of crowds.
I was at a financial advisor conference the other week and the closing talk was by a guy from Singularity University (yes, that’s a thing) spreading the Futurist Gospel, a wondrous world of drones and blockchain and Elon Musk just as far as the eye can see.
How does one apportion the market effects of the three-body problem between the narrative effects of central bank purchases versus the direct capital flows of central bank activities? And does the distinction matter?
I don’t have a strong methodology here, but my best guess is that the Narrative effect on markets is an order of magnitude greater than the direct capital flows impact. Certainly when it comes to the equity market I’m very comfortable saying that, with a slightly reduced Narrative share for the UST market and a more reduced Narrative share for the MBS market.
This article by Colin Woodard was published last November, and I have no idea why I haven’t seen it till now because it’s pretty darn interesting. While the defrocked political scientist in me has some misgivings about the, shall we say, lack of empirical rigor in drawing maps of regional US cultures and the “Eleven American Nations”, I think this is a very healthy corrective to the overwhelming and largely data-free assertion that our current political polarization maps onto some rural/urban divide. To the degree there is a rural/urban aspect to our bimodal electorate preferences, I think, as Woodard does, that it’s pure epiphenomenon. Yes, that’s a $10 word, but you can look it up.
We write about the Common Knowledge Game a lot in Epsilon Theory, because it’s the central game of crowds and narratives.
Common knowledge is something that we all believe everyone else believes.
We don’t have to believe it ourselves, and it doesn’t even have to be public knowledge. But whether or not you personally believe something to be true, if you believe that everyone else believes something to be true, then the rational behavior is for you to act AS IF you believe it, too. Or at least that’s the rational behavior if you want to make money.
Common knowledge is rarer than you think, at least for most investment theses. That is, there’s almost always a bear case and a bull case for a stock or a sector or a geography, and god knows there are plenty of forums for bulls and bears to argue their respective cases.
What can change this normal state of affairs … what can create common knowledge out of competing opinions … are the words of a Missionary. In game theory terms, the Missionary is someone who can speak to everyone AND who everyone takes seriously. Or at least each of us believes that everyone else hears the Missionary’s words and takes them seriously.
When a Missionary takes sides in a bull vs. bear argument, then depending on the unexpectedness of the words and the prestige of the Missionary, more or less powerful common knowledge is created. Sometimes the original Missionary’s words are talked down by a competing Missionary, and the common knowledge is dissipated. Often, however, the original Missionary’s words are repeated by other, lesser Missionaries, and the common knowledge is amplified.
When powerful common knowledge is created in favor of either the bull or bear story, then the other side’s story is broken. And broken stories take a looooong time to heal, if they ever do. Again, it’s not that the bulls or the bears on the wrong side of the common knowledge are convinced that they were wrong. It’s not that the bulls or the bears on the wrong side of the common knowledge necessarily believe the Missionary’s statements. But the bulls or the bears on the wrong side of the common knowledge believe that everyone ELSE believes the Missionary’s statements, including everyone who used to be on their side. And so the bulls or the bears on the wrong side of the common knowledge get out of their position. They sell if they’re long. They cover if they’re short.
Last Friday the SEC – a very high prestige Missionary due to their neutrality and sheer regulatory muscle – created VERY powerful common knowledge on Tesla. It wasn’t just that the SEC said they were investigating Elon Musk and the Board for the whole “funding secured” fiasco. No, what was unexpected – and thus extremely powerful from an information theory perspective – was that the SEC said they had been investigating Elon Musk and the Board for quite some time now, thank you very much, over more serious and widespread issues than “funding secured”. Boom!
And just like that the bull story on Tesla was broken. If you were long Tesla, you felt like you HAD to sell, whether or not it changed your personal beliefs or views about the stock.
I believe in American exceptionalism. Unironically. Still.
Millions of men and women over many centuries uprooted themselves from established lives of plenty and poverty alike. They bought passage or sold a portion of their futures for passage under indentures. They crossed the perilous Atlantic – and later, the Pacific – to start new lives as strangers in a strange land. Others were stripped of their freedom and sent here against their will. When they or their descendants were finally freed, a generation of millions were forced to start new lives among those who had enslaved them, who had thought them less than human.
Well, you know you’ve really made it in this business when Grant Williams shows up on your doorstep with his crew. What an honor to be part of Grant’s “In Conversation” video series, and what a blast we had making this film!
As many of you know, Grant is a co-founder of RealVision, which provides all sorts of dynamite video content for investors, and RealVision has graciously given Epsilon Theory readers complete and free-of-charge access to both the six-minute trailer (above) and the ONE HOUR AND FORTY-FIVE MINUTE full interview (below). I know, I know … that’s a longer running time than The Hangover. What can I say? An Alabama drawl takes its sweet time to get a point across. But seriously, the magic of Grant Williams is his ability to make long-form content as engaging as it is informative. It’s what we try to do here at Epsilon Theory, as well, and I think you’ll agree that when we combine forces it turns out pretty darn well.
Little Carmine: So, the reason I’m here you could probably guess.
Tony Soprano: What happened at Coco’s restaurant.
Little Carmine: This alteration you had with him. You’re at the precipice, Tony, of an enormous crossroad.
― The Sopranos, “The Second Coming” (2007)
Turning and turning in the widening gyre The falcon cannot hear the falconer; Things fall apart; the centre cannot hold; Mere anarchy is loosed upon the world, The blood-dimmed tide is loosed, and everywhere The ceremony of innocence is drowned; The best lack all conviction, while the worst Are full of passionate intensity. ― W.B. Yeats, “The Second Coming” (1919)
Ogbuef Ezedudu, who was the oldest man in the village, was telling two other men when they came to visit him that the punishment for breaking the Peace of Ani had become very mild in their clan.
“It has not always been so,” he said. “My father told me that he had been told that in the past a man who broke the peace was dragged on the ground through the village until he died. but after a while this custom was stopped because it spoiled the peace which it was meant to preserve.”
― Chinua Achebe, “Things Fall Apart” (1958)
Things Fall Apart is the best-selling book of any African author, with more than 20 million copies sold. Chinua Achebe got involved directly in politics when his native Biafra declared its independence from Nigeria in 1967. Nigeria won that civil war by imposing a blockade and starving as many as 2 million Biafran civilians to death. This is the least disturbing photograph of the Biafran War that I could find.
Revenge is profitable, gratitude is expensive.
― Edward Gibbon, “The Decline and Fall of the Roman Empire” (1776)
We are all Tony Soprano today. We’ve tried to reason with Phil Leotardo. We’ve tried to compromise. We’ve tried to maintain the cooperative institutions of Our Thing. But the guy won’t take “yes” for an answer. He wants it ALL. So when one of his crew insults our daughter, we lose our mind. We overreact. We suffer Phil Leotardo Derangement Syndrome and we kick the lieutenant’s teeth in. Now we’ve got a choice. Do we settle with the guy we hate? Do we voluntarily pay the heavy price for breaking the “norms” of conflict with a guy who we suspect wouldn’t hesitate to break any norm at all? Little Carmine’s comic relief notwithstanding, we all believe that we are at the precipice of an enormous crossroad in American politics.
But what if it’s not a choice at all? What if the choice has already been made for us? What if we are immersed in a competitive equilibrium of a competitive game, where the onlyrationalchoice is to go to the mattresses? To do unto others as they would do unto you … but to do it first. What then?
I don’t want to overstate the case. It bugs me to no end when people say that something is “another Pearl Harbor” or that we’re talking about a “civil war”. You know what’s like Pearl Harbor? Pearl Harbor was like Pearl Harbor. You know what’s like a civil war? Go to Wikipedia and look up Biafra, and then get back to me about how awful it is that Democrats and Republicans are figuratively at each others’ throats, not literally.
How did we get here? We got soft. I don’t mean that in a macho sort of way. I don’t even mean that as a bad thing. I mean that, just like the Romans of Gibbon’s history and just like the Africans of Achebe’s novel and just like the mobsters of the Sopranos, we have long forgotten the horrors of literal war and why we constructed these cooperatively-oriented institutions in the first place. We are content instead to trust that the Peace of Ani or the Peace of the Five Families or the Pax Romana or the Pax Americana is a stable peace – a stable equilibrium – where we can all just focus on living our best lives and eking out a liiiiitle bit of relative advantage. We are content to become creatures of the flock, intently other-observing animals, consumed by concerns of relative positioning to graze on more grass than the sheep next to us. Besides, it’s so wearying to maintain the actual intent of the old institutions, to mean it when you swear an oath to a Constitution or a god or a chief, and not just see it as an empty ritual that must be observed before getting the keys to the car.
This has all happened before.
NARRATOR: And so it came to pass that in the late days of empire, both Rome and America waged remote control wars through vassal states and provincial “citizens”, wars that were no longer debated by the Senate but were announced by administrative fiat alongside a schedule of entertaining games and pleasing economic distributions, wars that could last for decades in farther and farther flung corners of the empire, wars that were all about naked commercial interest even as they were gussied up with strong words of patriotism.
Sure, tell me again how much we’ve advanced over the past 2,000 years, how much smarter we are, how much more self-aware and woke we are. What’s the difference between a President Trump and an Emperor Commodus? Commodus didn’t have cruise missiles for his Syrian theatrics. That’s really about the extent of it.
And it’s not Trump per se, although Trump – like Phil Leotardo or Commodus – is the apotheosis of what I’m talking about. If it weren’t Trump, it would be someone just as ridiculous. It WILL be someone just as ridiculous in the future, probably someone on the other side of the political spectrum, someone like Elizabeth Warren or Kamala Harris. See, I am an equal opportunity connoisseur of ridiculous politicians. I’d say don’t @me, all you Trumpkins and Good Leftie Soldiers alike, but it won’t do me any good. Ah, well. That’s the thing about an equilibrium. That’s the thing about a widening gyre. The times make the man. Or the woman.
Here’s what a widening gyre looks like.
The Pew Research Center does consistently excellent work on U.S. voting patterns. In this long-running research series, they tend to focus on the distance between the median Democrat voter and the median Republican voter, and that’s all well and good. What I’m focused on however, is the shape of the Democrat and Republican electorate distributions, such that the overall distribution in 2017 is no longer a single-peaked something-akin-to-a-bell-curve as it was in 2004, but is instead a double-peaked or (to use a $10 word) bimodal distribution.
So what’s the problem with a bimodal distribution? The easiest way to think about it is to compare the size of the purple area (where both the Republican and the Democrat electorate overlap) with the pure blue area (Democrat with zero Republican overlap) and the pure red area (Republican with zero Democrat overlap). When the purple area is smaller than both the blue area AND the red area, a centrist politician (someone between the median Democrat and the median Republican) can win neither a national nomination nor a national election in a two-party system. For any centrist candidate or policy, there exists a winning majority of voters on both the left AND the right who will favor a competing candidate or policy on both the left AND the right. This is what it means to say that the center cannot hold.
This chart is why incumbent Republicans who speak up against Trump or Trump policies lose their primaries to 9-11 Truthers and that incel-in-training kid in 10th grade history class who proclaimed that the Civil War wasn’t really about slavery. This chart is why incumbent Democrats who aren’t outright Socialists lose their primaries to latte-sipping, fashion-forward young things who honest-to-god believe that Fidel Castro and Yasser Arafat had some pretty good ideas if you just stop and think about it.
This chart is why mainstream and relatively centrist political candidates like Hillary Clinton lost. This chart is why mainstream and relatively centrist politicians like Paul Ryan are quitting. And yes, this chart is why I will get angry emails saying, “how dare you call that devil incarnate [Hillary Clinton/Paul Ryan] mainstream and relatively centrist!” AND emails saying, “good riddance to that mainstream and relatively centrist [Hillary Clinton/Paul Ryan]!”. Good times.
If you’re an incumbent centrist politician, somewhere to the left of your median voter if you’re a Republican and somewhere to the right of your median voter if you’re a Democrat, you have exactly two choices.
You remain silent and just go with the party flow, clinging on for dear life against primary challengers, holding your nose at the party excesses, apologizing to your donors and your spouse in private, and hoping that one day the party comes back to you. You tell yourself “apres moi, le deluge.” Or in English, “sweet Jesus, have you seen the racist moron / lunatic communist who would take my place if I quit?”, and you’ve got a big enough ego to believe that sort of excuse as you slowly sell your soul.
That’s it. Those are your options. I guess there are variations on #2, where you can either rage-quit (Jeff Flake) if your constituency is an eternal Trumpland desert or slink-quit (Paul Ryan) if your moderate constituency at least gives you a chance for a political comeback one day. But those are your only options.
And when I say that those are your only options, let me pour some cold water on the idea that there are centrist candidates who could carry votes from both parties in a general election, or that the time is somehow ripe for a third political party. Hahahahahahahahaha. No, gentle reader, the idea that Ben Sasse or Joe Biden can ride a purple wave to victory in 2020 is completely and utterly wrongheaded. Look again at that chart. Look again at the size of that purple area today versus its size in the past. In 1994 or 2004, that purple area is where Bill Clinton and George Bush lived and thrived. Today, that purple area is where political candidates go to die.
The idea of a third party is somewhat more interesting, but only somewhat. The interesting part is that most liberal democracies have had bimodal electorate distributions for a long time. We call this Europe. And if, like European democracies, the United States had a proportional representation system, where getting 20% of the national vote would give you 20% of the seats in Congress, well then, centrists would no longer be the sad sacks of American politics. On the contrary, they’d be the swing partner in any conceivable coalition and would wield enormously outsized political power. But we don’t have proportional representation, and until that happy day of a Constitutional convention and a complete reconfiguration of American democracy … fuhgeddaboutit, as Tony Soprano would say.
The bottom line is this. In a two-party system with high-peaked bimodal electorate preferences:
There is no winning centrist politician.
There are no stable centrist policies.
One of the big points of Epsilon Theory is to call things by their proper names, to speak clearly about what IS. And what America IS today is a two-party political system with high-peaked bimodal electorate preferences. So long as that is the case, we will be whipsawed between extremist candidates of the Right and the Left. Our choices for president in 2020 will be The Mule and Madame Defarge. Enjoy.
I say “enjoy” because I can’t help but use snark in my despair. But the truth is … and again, this is what a bimodal electorate preference distribution means … a significant majority of Americans will enjoy very much, thank you, a choice between The Mule and Madame Defarge. Or as all the pundits will say on TV, “the base sure is excited”, and that will be true for both Democrats and Republicans.
So why do I despair? Primarily because I think that the policy agendas on both extremist sides are an absolute dumpster fire, and that lurching from stem to stern on fiscal policy and social policy and national defense is a really crappy way to run a country. All I can hope for is gridlock.
But secondarily I despair because, as much as a significant majority of Americans will want and will enjoy a contest of extremists in 2020, an even larger majority of Americans will be veryunhappy with whoever wins. A bimodal electorate preference distribution doesn’t just go away on its own. It doesn’t just get better over time. It is a widening gyre. It gets worse over time, as more and more extremist candidates, full of passionate intensity, strut and fret their hour upon the stage. That’s a mixed poetic metaphor, but you get my point. The widening gyre, as Yeats put it so perfectly, is a period of mere anarchy, not special or momentous anarchy. It is a tale told by, if not idiots, then ridiculous people, full of sound and fury and ultimately accomplishing nothing.
Has all this happened before? Sure. Time to dust off your copy of Gibbon’s Decline and Fall. Time to reread Will and Ariel Durant. Just be forewarned, the widening gyre can go on for a loooong time, particularly in the case of a major empire like Rome or America. It took the Romans about four centuries to officially exhaust themselves, at least in the West, with a few headfakes of resurgence along the way. Four centuries of mostly ridiculousness. Four centuries of profitable revenge and costly gratitude. Four centuries of a competitive equilibrium in a competitive game.
Has this happened before in American history? Hard to say for sure (how dare the Pew Research Center not be active in the 1850s!), but I think yes, first in the decade-plus lead-up to the Civil War over the bimodally distributed issue of slavery, and again in the decade-plus lead-up to World War II over the bimodally distributed issue of the Great Depression. I really don’t think it was an accident that both of these widening gyres in American politics ended in a big war.
I think that’s how this widening gyre ultimately resolves itself, too. In a big war. Not another Civil War, because the issues at stake today in the aftermath of the Great Recession aren’t existential and foundational like slavery, but are echoes of exactly the same issues we wrestled with in the aftermath of the Great Depression. No, we’ll need a big war with an Other to get out of this.
So one way or another, that’s what we’re gonna get.
This is Part 1 of a three-part series. Next, what’s the market/investing corollary to all this? Because there is one. And finally, what do we DO about this, as both investors and as citizens? Spoiler Alert: you may not like the answer.