On February 4, 1968, Martin Luther King, Jr. delivered a powerful sermon about the greatness-seeking impulses that are the source of many types of conflict, racism, bigotry and greed – impulses which are precisely those appealed to by social institutions in order to create the Long Now we all inhabit. He also delivered the antidote. The sermon is called “The Drum Major Instinct” and was delivered to the Ebenezer Baptist Church in Atlanta. (h/t to occasional ET reader Pastor Don for putting this one back on my mind)
If you’re looking for something to read in a time of reflection today, this would be my selection. I have excerpted what I think are especially meaningful – and for readers of this website, relevant – sections of his sermon. Parentheticals are transcribed exclamations from the church.
Alternatively, read the whole text from the Martin Luther King, Jr. Research and Education Institute here, or listen to the audio here.
James and John are making a specific request of the master. They had dreamed, as most of the Hebrews dreamed, of a coming king of Israel who would set Jerusalem free and establish his kingdom on Mount Zion, and in righteousness rule the world. And they thought of Jesus as this kind of king. And they were thinking of that day when Jesus would reign supreme as this new king of Israel. And they were saying, “Now when you establish your kingdom, let one of us sit on the right hand and the other on the left hand of your throne.”
Now very quickly, we would automatically condemn James and John, and we would say they were selfish. Why would they make such a selfish request? But before we condemn them too quickly, let us look calmly and honestly at ourselves, and we will discover that we too have those same basic desires for recognition, for importance. That same desire for attention, that same desire to be first. Of course, the other disciples got mad with James and John, and you could understand why, but we must understand that we have some of the same James and John qualities. And there is deep down within all of us an instinct. It’s a kind of drum major instinct—a desire to be out front, a desire to lead the parade, a desire to be first. And it is something that runs the whole gamut of life.
And so before we condemn them, let us see that we all have the drum major instinct. We all want to be important, to surpass others, to achieve distinction, to lead the parade. Alfred Adler, the great psychoanalyst, contends that this is the dominant impulse. Sigmund Freud used to contend that sex was the dominant impulse, and Adler came with a new argument saying that this quest for recognition, this desire for attention, this desire for distinction is the basic impulse, the basic drive of human life, this drum major instinct.
And you know, we begin early to ask life to put us first. Our first cry as a baby was a bid for attention. And all through childhood the drum major impulse or instinct is a major obsession. Children ask life to grant them first place. They are a little bundle of ego. And they have innately the drum major impulse or the drum major instinct.
Now in adult life, we still have it, and we really never get by it. We like to do something good. And you know, we like to be praised for it. Now if you don’t believe that, you just go on living life, and you will discover very soon that you like to be praised. Everybody likes it, as a matter of fact. And somehow this warm glow we feel when we are praised or when our name is in print is something of the vitamin A to our ego. Nobody is unhappy when they are praised, even if they know they don’t deserve it and even if they don’t believe it. The only unhappy people about praise is when that praise is going too much toward somebody else. (That’s right) But everybody likes to be praised because of this real drum major instinct.
But let me rush on to my conclusion, because I want you to see what Jesus was really saying. What was the answer that Jesus gave these men? It’s very interesting. One would have thought that Jesus would have condemned them. One would have thought that Jesus would have said, “You are out of your place. You are selfish. Why would you raise such a question?”
But that isn’t what Jesus did; he did something altogether different. He said in substance, “Oh, I see, you want to be first. You want to be great. You want to be important. You want to be significant. Well, you ought to be. If you’re going to be my disciple, you must be.” But he reordered priorities. And he said, “Yes, don’t give up this instinct. It’s a good instinct if you use it right. (Yes) It’s a good instinct if you don’t distort it and pervert it. Don’t give it up. Keep feeling the need for being important. Keep feeling the need for being first. But I want you to be first in love. (Amen) I want you to be first in moral excellence. I want you to be first in generosity. That is what I want you to do.”
And he transformed the situation by giving a new definition of greatness. And you know how he said it? He said, “Now brethren, I can’t give you greatness. And really, I can’t make you first.” This is what Jesus said to James and John. “You must earn it. True greatness comes not by favoritism, but by fitness. And the right hand and the left are not mine to give, they belong to those who are prepared.” (Amen)
And so Jesus gave us a new norm of greatness. If you want to be important—wonderful. If you want to be recognized—wonderful. If you want to be great—wonderful. But recognize that he who is greatest among you shall be your servant. (Amen) That’s a new definition of greatness.
And this morning, the thing that I like about it: by giving that definition of greatness, it means that everybody can be great, (Everybody) because everybody can serve. (Amen) You don’t have to have a college degree to serve. (All right) You don’t have to make your subject and your verb agree to serve. You don’t have to know about Plato and Aristotle to serve. You don’t have to know Einstein’s theory of relativity to serve. You don’t have to know the second theory of thermodynamics in physics to serve. (Amen) You only need a heart full of grace, (Yes, sir, Amen) a soul generated by love. (Yes) And you can be that servant.
Mark Zuckerberg launched Facebook when I was in college. I used it – everyone used it.
Today, like most people born after 1970, I only go to Facebook for two reasons: to ensure I don’t miss a single glorious specimen of my extended family’s boomer memes, and to post just enough pictures of my kids to stave off someone actually calling me on the phone. What can I say? I refuse to be labeled as a millennial, but I will cop to being an adult with millennial characteristics.
And the celebration of Roy Moore’s poetic stylings that an old family friend shared recently? It is exquisite, the kind of thing that really must be seen to be believed. More importantly, it is the kind of thing that simply cannot be missed.
If “our children wander aimlessly / poisoned by cocaine” isn’t up your aesthetic alley for some reason, Facebook will find something they think you might like in the oldest way possible: by letting someone pay for the right to put that thing in front of you. Today’s installment in my lovingly, artisanally curated feed? A sponsored post by a group of former students at Penn’s law school seeking signatures to a petition to dismiss the dean of the school.
This sort of thing having become de rigueur, I hope I can be forgiven for imagining that Dean Theodore Ruger must have done something truly horrifying and cancellable, like expressing admiration for Thomas Jefferson or fundamental freedoms or capitalism or something. As it happens, no! What Dean Ruger did was accept a $125 million gift from the W.P. Carey Foundation in exchange for renaming the school to the University of Pennsylvania Carey School of Law.
I suppose you can quibble about the process of doing something like that – or about the amount. I’m not sure what the going rate for a building at an elite university is, much less a program or the name of the school itself. Phil Knight sent $400 million to Stanford and got a fellowship program named after him. At Harvard that was roughly the price for John Paulson getting his name slapped on the engineering school. Prolific political advertiser and avowed Big Gulp hater Mike Bloomberg gave three times as much to Johns Hopkins, but it was apparently to expand need-blind admissions and eliminate debt as a means for providing financial aid rather than to slap his name on a school. Although – to be fair – he already had his name on one there.
All those quibbles aside, $125 million doesn’t seem out of whack with the going market rate for getting your name attached to a big name, elite professional school. So what was the nature of the complaint?
Well, you can read it for yourself here. Following the proper forms for Angry Letters, the group is upset ‘that current and former students weren’t consulted’ about the name change. As the university’s student-run newspaper reported it:
Of course, being ‘angry that you weren’t consulted’ is just the way that someone trying to be polite or formal says that they hated a decision and that they want to attach some moral judgment to it instead of just expressing their disagreement. The old Monty Python sketch in which a guy looking for an argument accidentally wanders into the room for abuse doesn’t work any more. When cooperative games are transformed into competition games, they’re the same room.
Indeed, the disgruntled group lays out the real problem they had in the petition, too. Why did the 3,121 current and former students who signed the petition (as of January 16, 2020) hate the decision? Because they felt it adversely impacted the brand awareness and reputational value of their degree, especially among employers.
And guess what? The alumni are absolutely right.
The Carey School of Law is not as good of a brand as Penn Law. I mean, not everyone can have a name as delicious-sounding as Salisbury State, but the name doesn’t jump off the resume. I mean, it’s a subjective sort of thing, but to my ear it sounds corporate and generic, and like the various Annenberg Schools scattered about, has begun to crop up as a school name at more than one university – even if the Carey namesake isn’t always the same person.
So I don’t blame the petitioners. I mean, it’s bad metagame, sure. It’s also an especially crappy way to treat a profoundly generous donor, and the subsequent petition to oust the dean is extremely stupid in the most insufferable way, but in the world of mutually pursued enlightened self-interest, the worst I suppose you can say about the petitioning current and former students is that they are technically accurate jerks. They paid for their school, and don’t have a duty to anything other than their own livelihoods. More power to ’em, I guess.
But here’s the thing: The university caved. Following community complaints, they changed the short name used on all materials back to Penn Law – at least for now.
The institution which purports – not least as part of its and other universities’ arguments in favor of non-profit treatment – to be an institution which exists for the primary purpose of research and education, elected to put this and future education and equality-enhancing philanthropy at risk for the purpose of protecting the brand value of the degree they confer among employers and the general public. OK, and maybe to get the students to shut up. But it is absolutely a case study for every indictment we published last year about the American university system as a guild system operating through the socially irresistible power of the meme of Yay, College!
In short, elite American universities and their associated professional schools are no longer selling an education. They are – like medieval guilds – institutions who operate in the interest of the members of the guild. Their priority is to protect and increase the value, prestige and perceived selectiveness of the license they confer – and to sell that increasingly scarce commodity at rapidly accelerating market rates that have been further bolstered by well-meaning government policy, like infinite debt for everyone. That means that if it comes to choosing between something that will actual help universities teach current students on the one hand, and maintaining the perceived credential value among graduates on the other, we know their preference, because they have showed it to us. Again.
Should we care? After all, these are nominally private institutions.
After all, we are collectively funding the investments and operations of these colleges today, both directly and indirectly. What’s more, if the student loan ‘crisis’, as media reportage has settled on calling it, is resolved through a full or partial forgiveness program with no consequences for the tuition-inflating credentialing guild, we will have effectively facilitated and cemented a generational transfer of wealth from nearly every American to elite private universities. (We’re already there on one side of the ledger, of course, we just haven’t fully socialized the losses yet).
One way or another, all this is exactly where the zeitgeist of class-based, identity-based conflict is taking us – and God, are the battlegrounds in the war between the merely rich and the super-rich ever weird and unsettling places. They’re the kind of places where extremely rich graduates of a professional program at an elite American university, in one breath, risk the loss of programs that would help underserved communities attend the school in order to protect the name value of the alumni’s credential, while in the next breath decrying the unseemliness of selling naming rights to a really rich person.
Get used to this kind of unsettling battle of competing memes between identity-driven groups, folks. This is the Long Now, where building a university system that serves America and Americans long-term interests is secondary to maximizing the present perceptions of the people with a real stake in it: the people who’ve already earned membership in the guild, whether through admission or philanthropy.
There is a chart I’ve been thinking about a lot lately, and I want to tell you about it.
Before I do, I also wanted to show it to you, along with a simple request: Tell me what you think that it is.
Put it in the comments if you’re a subscriber. If you’re not, send your guesses to firstname.lastname@example.org.
First one – if anyone can manage it – to guess remotely correctly gets a care package of Epsilon Theory swag. All other guesses will almost certainly make an appearance in an upcoming Epsilon Theory note, so mind your metagame here.
Sometimes we get enough good responses to a note from pack-members that we think it’s worth publishing them on their own. Our readers had some especially useful thoughts on our note about principal-agent problems and the meme of alignment! in the hiring of advisers, consultants and fund managers.
Thank you! This is one of the things that I have been trying to explain to clients and regulators ever since the Department of Labor released its Fiduciary Standard. There is no such thing as conflict free humans. There is no ideal compensation method. Every one of them has a conflict. Commissions are evil? Taken to excess, sure, but if you are a buy and hold investor it can be the cheapest way to pay for occasional advice. Advisory fees are perfect? Why does the SEC have a bulletin on reverse churning? (Charging Advisory fees, but not trading frequently enough to make the advisory fee cheaper than a commission model.) Advice only model? Who will help me execute the advice? I get a blueprint, but how do I pick a contractor to make it real?
Don’t even get me started on updating the regulations. Bernie Madoff, Ken Lay, and numerous others were fiduciaries for their investors. It did nothing to protect the investors. Governmental regulations are like a warranty. A warranty may force the manufacturer to repair their product, but it won’t prevent the hassle and other costs associated with a failure in the product. A strong warranty does not make up for a poor quality product. I would rather have a high quality product with no warranty. (Also, any car dealer will tell you that warranty repairs are the ultimate in misaligned incentives.) Technology will take an extremely long time to replace human interaction. (if it ever does.) No one cares about hurting a computer or robot’s “feelings.” We feel beholden to other people. How do I know? Look at physical fitness. How many people have lost weight, improved their diet and turned their life around because they bought a Fitbit or Apple Watch? How many have done it with a personal trainer and/or nutritionist? Investment analysis, portfolio design, portfolio management, financial planning, tax analysis, budgeting, really all of the math components of financial success will be automated. I’m sure there will be several different competing tools. None of them will take the place of a caring human financial advisor that will encourage you to use the tools, understand the differences between them, and provide personalized interpretation (wisdom) on using them to maximum advantage. I don’t work with institutions, I work with people. People want a caring guide to show them the ropes, identify the traps, and generally help them do better than they could do on their own. My clients are part of my packs. I use this part of my pack to help me do a better job for that part.
Pack Member TheCoeus
We believe in advice, too, a belief we have brought up a few times whenever the “everything in finance will be automated” crowd shows up after Vanguard or Blackrock enters a new segment.
Like TheCoeus,I am not, however, a believer in the Fiduciary Rule. I’m also not a believer in the application of the standard duties of care, loyalty, etc. to corporate and other board structures. Not because I don’t think that there are such duties we owe. Of course we do. But because “prudent man” standards are precisely what give us layers of consultants and bankers and lawyers to ensure that executives, boards, pension management teams, service providers and others have done enough to offload accountability for the decisions they’ve made. That is the problem with any good idea made into a meme, like alignment!: it auto-tunes our behavior to satisfy the parameters of the meme instead of embracing the underlying concept with a full heart.
The thing many fee-based clients don’t understand is this: they are subsidizing commission-based clients. My commission clients (usually older, buy-and-hold, low maintenance people) don’t do nearly enough trading to justify charging them a fee. But they still get phone calls, meetings, Christmas cards, and all the services they need. But maybe they make one or two trades a year. Without the fee-based people essentially paying the bills these commission clients would be passed off to someone else or sent online. And they don’t want that. A lot of them have been with my family for decades. We have relationships. So they get everything they need and it costs them very little. It’s a great deal for them.
Pack Member Desperate_Yuppie
A similar observation with some practical implicationsof it.
Because our industry is (often very rightfully) obsessed with process, we like to think that cutting off the possibility of the appearance of not having our clients’ interests at heart by eliminating structures with the potential for abuse is the right choice, somehow better than building a practice around valuesthat requires effort and discipline to achievewithout error.
I’m with Desperate_Yuppie here (Ed Note: Some of y’all’s handles…). Putting alignment over alignment! can accommodate a wide variety of fee structures.
Hi Rusty. Re your recommendations, how do you suggest calculating the beta hurdle, adjusted for long/short exposures?
Pack Member Bruce Winson
I have a few thoughts on principles here, but above all: simplicity.
I don’t think it’s every worth getting caught up in trying to create a hurdle from anything that starts to look like risk model beta, whether that’s holdings-based (e.g. Barra, etc.) or multi-factor regression based on historical returns. It is a recipe for an irreconcilable argument with your manager. Every time.
If you are dealing with a delta-1 long/short equity or credit manager, by which I mean one which almost always expresses exposure through vanilla long and short positions and only rarely options, I think you are best served by suggesting a hurdle based on 3-to-5 year average net exposure. Once you start getting into documentation of more complicated calculations or beta adjustments to that net exposure, the execution/completion risk becomes overwhelming. Don’t get cute and include an ongoing update to the calculation. Find the number. Hard code it in the document. Monitor it and re-open the issue if it’s no longer appropriate. I’ve been successful getting this kind of hurdle.
Once you start getting into more complicated strategies that have long effective net exposure but incorporate asymmetric securities to get it, you can either get in the game of incorporating delta measures into your hurdle (woof!) orbasing the hurdle on a single factor returns-based beta/slope calculation against the major beta benchmark (also woof, but less so). I’ve successfully negotiated the latter. Never the former.
If you’re dealing with managers who maintain that they have no beta bias – especially in global macro, managed futures, and market neutral strategies – good luck. I’ve had zero luck getting any of these funds to agree to any kind of hurdle like this. T-Bills or LIBOR-Plus hurdles, sure, but not any net exposure-based, returns-based, or other approach to calculating long-term beta biases.
No, not even when you show that their macro fund’s returns are just a steaming pile of negative alpha wrapped around mostly static rates beta and random rotation through different carry trades.
This a really important post. My experience as a manager has been that even the best efforts never get us to complete alignment and, as Rusty suggests, we need to accept this. I used to think the gold standard in alignment was for managers to have a large % of their net wealth invested in their own funds. I still think this helps, but following Rusty’s logic, it’s no more than that. What I came to realize as a manager with something like 80%+ of my wealth in my own fund was that my risk preference at certain times was likely to very different from my clients where our fund was one piece of a much larger portfolio. This really hit home in 2009/2010 after we had navigated the GFC with only a modest single digit drawdown which we recovered over the next 18 months. We could have recovered more but remained in somewhat of a defensive crouch with lower levels of leverage than pre-GFC. A client said he was disappointed in our results – we should have more aggressively re-levered post the crisis. At the time I honestly felt he was a bit crazy – wasn’t the crisis driven by excess leverage? But with time I’ve realized that part of it was a difference in our risk preferences. As managers with the vast majority of our wealth in the fund we were nervous about re-levering, even if we didn’t explicitly recognize this. As an outside investor, with distance and other investments they felt this was time to be greedy when everyone was else was scared. We ended up not being aligned at that moment and I think a big part of it was that having so much invested in the made if very difficult to asses the risk-taking environment objectively.
Pack Member Kevin Coldiron
I really hope people take the time to read what Kevin has to say here. He has run hundreds of millions in long/short and market neutral quant strategies really successfully, honestly and transparently, and his thoughts here are the thoughts that have been shared with me by many others many times. (Full disclosure: he was someone I was happily invested with in a prior asset owner’s seat.)
There’s a sub-meme within alignment! of skin-in-the-game! that is similarly based on very sound principles, and which gets quantized into a cartoon version of itself. I don’t have a problem with wanting managers to eat their own cooking – and I absolutely understand the underlying impulse behind the request. Still, as with all the other activities we mention in the piece itself, we must recognize something important about alignment and incentives. If something puts us in the same boat as someone else, but changes what that boat is to something the other person didn’t really want or need, we have not created alignment.
Once when Hyakujo delivered some Zen lectures an old man attended them, unseen by the monks. At the end of each talk when the monks left so did he. But one day he remained after they had gone, and Hyakujo asked him: `Who are you?’
The old man replied: `I am not a human being, but I was a human being when the Kashapa Buddha preached in this world. I was a Zen master and lived on this mountain. At that time one of my students asked me whether the enlightened man is subject to the law of causation. I answered him: “The enlightened man is not subject to the law of causation.” For this answer evidencing a clinging to absoluteness I became a fox for five hundred rebirths, and I am still a fox. Will you save me from this condition with your Zen words and let me get out of a fox’s body? Now may I ask you: Is the enlightened man subject to the law of causation?’
Hyakujo said: `The enlightened man is one with the law of causation.’
At the words of Hyakujo the old man was enlightened. `I am emancipated,’ he said, paying homage with a deep bow. `I am no more a fox, but I have to leave my body in my dwelling place behind this mountain. Please perform my funeral as a monk.’ Then he disappeared.
– Excerpt from the koan Hyakujo’s Fox
In Zen, a koan is a story or dialogue designed to trigger
and test understanding. It’s a fascinating literary form. Incredibly dense.
Often, koans convey multiple layers of meaning in less than a hundred words.
Sometimes just a few sentences.
The koan Hyakujo’s Fox, sometimes called the Wild Fox Koan,
is of particular interest to me because it touches on many of the themes near
and dear to us here at Epsilon Theory. Here a monk transforms himself
into a fox by “clinging to absoluteness.” While this is absurd on its face,
it’s really just a fancy way of arguing that perception is reality.
You are what you eat, the saying goes. More importantly: you
are what you think.
Recently, a friend and I were texting about the meaning of
life. (what? you and your friends don’t text regularly about the meaning of
life?) My friend wrote that in the end, all you can really do is carry your
cross to the finish line. I quite like this. It cuts right to the heart of the
issue. There are no Answers. There is only Process. I did suggest adding an inscrutable
Zen twist, however. My version:
In the end, all you can really do is carry your cross to
the finish line. Except there is no finish line, there is no cross, and there
is no you.
People sometimes ask me, if all the world is narrative and
meme, then how can we tell what’s real?
As far as social reality is concerned, it’s about as real as
any game or theatre production. There’s the White Collar Corporate Power Game,
for example. There’s Partisan Political Theatre. There’s the Social Status
Game. If you prefer more high-brow forms of entertainment, you can indulge in
Religious Theatre and Intellectual Theatre (I have a soft spot for the latter).
But let’s not kid ourselves. It’s theatre and games, all the way down.
This shouldn’t come as news to anyone. Heck, it’s been right
there in the Bible for over a thousand years. That bit about the camel passing
through the eye of the needle easier than the rich man making it to the Kingdom
of Heaven? That’s Jesus teaching that wealth and status are not inherently
meaningful or worthwhile. Accumulating wealth and power are just games we play.
I say this is a chaotic process because social reality is a three-body problem.
There’s no closed-form solution. And the process is extremely sensitive to
starting conditions. Everything else, as they say, is commentary.
I’m pretty sure the above is true. Yet it troubles me. First
and foremost, it induces many a dark night of existential dread—that thick,
dark curtain of despair that tends to descend whenever we contemplate our
inevitable end. It’s not really physical death that bothers us (if it were, we
wouldn’t find very much consolation in religion). No. What really bothers us is
ego-death. What really bothers us is the dissolution of the self.
After all, physical death is no biggie if your consciousness
(soul) transcends physical death. If that’s the case, then dying isn’t much
different from moving to another country. Ego-death, on the other hand, is true
death. Ego-death is non-existence. The void.
So what if there is no grand meaning to it all?
What if it all really does reduce down to nature + nurture +
randomness, and the entire arc of the history of our universe is just a single
run in some elaborate Monte Carlo simulation?
Frankly, you can take this to some pretty dark and
nihilistic places. Perhaps no one articulates it better than the Misfit, the
psychopathic antagonist of Flannery O’Connor’s short story, “A Good Man Is Hard
“Jesus was the only One that ever raised the dead,” the Misfit continued, “and He shouldn’t have done it. He thrown everything off balance. If He did what He said, then it’s nothing for you to do but throw away everything and follow Him, and if He didn’t, then it’s nothing for you to do but enjoy the few minutes you got left the best way you can—by killing somebody or burning down his house or doing some other meanness to him. No pleasure but meanness,” he said and his voice had become almost a snarl.
The Misfit is one of my favorite antagonists in literature.
You can read him almost any way you want. Maybe he’s nothing more than a
rambling, murderous redneck. Or maybe he’s the most coldly rational,
self-aware, introspective character in the story. The Misfit spent an awful lot
of time in prison, after all. He’s had plenty of time to meditate on The
Meaning of Life.
“Some fun!” exclaims his accomplice, Bobby Lee, after
their gang finishes killing the Grandmother and her family.
“Shut up Bobby Lee,” the Misfit said. “It’s no real
pleasure in life.”
(SPOILER) That’s the last line of the story. These days I
like to read the Misfit as a kind of anti-zen monk. He’s got it all twisted.
But he hasn’t necessarily got it wrong. He’s Hyakujo’s Fox. For clinging
to absoluteness, he has been sentenced to suffer 500 rebirths as a psychotic
So what the hell are we supposed to do about all this,
exactly? How does one cultivate a clear-eyed view of our world without
embracing murderous nihilism?
For starters, we quit looking for Answers. They don’t exist.
Self-actualization has no closed-form solution.
But there is a Process.
The three images above are all of ensōs. An ensō is just a
circle, drawn in a single stroke. Hitsuzendō is a form of zen practice where
one draws ensōs as a meditative practice. The process is simplicity itself. You
just draw a circle with a calligraphy brush. Maybe you close the circle. Maybe
you don’t. Maybe you’ve got a thick, continuous circle. Maybe not. It doesn’t
really matter what the circle looks like. Don’t overthink it. Just draw a
Here’s the trick: everything we do in life and investing is as simple as drawing an ensō. Every. Single. Thing. As Ben wrote in his Clear Eyes, Full Hearts, Can’t Lose manifesto:
“You want freedom? You want an autonomy of mind and spirit? You want that as an inalienable right? A right that is yours simply because you are a human being? Well, that comes at a price. And the Kantian price is this: everything you do, you must do for the right reasons.
It’s really as simple – and as difficult – as that.
What are the right reasons? You don’t need me to tell you. You already know what they are, in every situation you’re in. You have a moral compass. But I’ll tell you anyway. Acting for the right reasons means acting in a way that reflects who you ARE as a moral human being. It means acting for your identity as a moral human being, not as a propitiation to some god or potentate, not as an exchange for some “greater good” that someone else has talked you into pursuing. Not even for gaining a Supreme Court seat. Not even for denying a Supreme Court seat.”
Note that I wrote this was simple above. I didn’t say
it was going to be easy.
Question: Is morality socially constructed through a process where biological systems are socially conditioned to respond in particular ways to particular stimuli, or is morality an innate moral compass manifested in Kantian ethics?
Two of the world’s major central banks – namely the Bank of Japan (BOJ) and the European Central Bank (ECB) – have created what is akin to a cycle of addiction to negative interest rates. Moreover, even those developed economies with positive rates appear addicted to near-zero rates. Without them, developed market economies seemingly begin to slip back into growth malaise.  Ben Bernanke’s 1999 critique of the Japanese central bank’s failure to act aggressively enough to stop their ‘lost decade’ is arguably one of the first seeds of the ‘do whatever it takes’ mantras now so common amongst global central bankers.  These mantras’ tools include quantitative easing (QE) – also known as Large Scale Asset Purchases (LSAPs) or Permanent Open Market Operations (POMOs) – which have ultimately forced long-rates negative in much of Europe and Japan. This suppression has far longer-lasting effects on capital allocation decisions and investor behavior than traditional rates policy using temporary open market operations (TOMOs). 
Step-by-step and slowly over time, the BoJ and ECB followed the Swedes and eventually arrived at negative interest rates policy (NIRP). This policy was not just limited to deposit rates but QE allowed its application to longer duration risk-free (as well as to risky) assets. Similarly, over the past 35-years, the Fed also has been on a march towards zero interest rate policy (ZIRP). However, the U.S. has the luxury of far better demographics than Europe and Japan. The U.S. also has the benefit of fiscal unity, which Europe lacks, and the U.S. has the benefit of possessing the world’s reserve currency. The structural impediments to growth in Japan and Europe have arguably necessitated more aggressive monetary policy. Not all within the central bank community agree with this approach. Former BOJ Governor Masaaki Shirakawa has identified what he calls the global ‘Japanification’ of monetary policy; importantly, he argues it has failed.  While Ben Bernanke has since recanted the severity of his 1999 critique, it has mattered little. Once socialized, central bankers seized upon it as an excuse to become even more active economic influencers.
Traditional monetary policy models are anachronistic. Despite aggressive policy measures, inflation has not met central bank targets in the U.S., Europe or Japan. The closed and static monetary policy models of the past fail to recognize that the Fed is no longer the only large policy actor. They generally assume economies are closed and not reflexively adaptive (i.e. – dynamic). To the contrary, rates markets are open systems subject to cross-border capital flows. For example, negative rates in Europe and Japan have important impacts on U.S. rates. Figure 1 shows how the U.S. 10-year regresses against the Bund (the German 10-year). The repression of long-rates in those geographies has anchored rates here.  Lastly, QE killed the traditional relationships between inflation and rates, and it also murdered the Philips curve. In fact, QE has created the unintended consequence of overinvestment, overcapacity and consequent lack of pricing power. Thus, the low rates QE produced have arguably caused the low inflation central banks intended it to cure.
The most extreme deployment of QE results in prolonged periods of negative long-rates, as we currently observe in Europe and Japan. The concept of negative real rates should not be offensive on its face. Negative real rates may occur when inflation exceeds the nominal interest rate. By the Fisher identity, nominal rates = real rates + inflation; thus, real rates = nominal rates – inflation. Real rates have gone negative in the past at various periods in time, and it is one reason why the Fed or other central banks have generally chosen to hike when inflation gets too high relative to the policy rate. Traditional theory holds that negative rates are inflationary. Proponents may argue that because negative real rates have historically required central banks to raise policy benchmarks to prevent inflation (as in the Volker era) that the converse is true. That is, they may argue that the use of negative rates now will create inflation later. We disagree. Currently, in Germany, real rates = [-.3% – .9%] = -1.1%. These deeply negative rates suggest that the ECB may be profoundly concerned about renewed deflation – ironically, we believe their prescription is producing precisely the opposite of the desired result.
1: Bunds Regressed against U.S. 10-year
While exacerbated by the trade war, the slowdowns in Europe and Japan are largely structural. If negative rates in the developed world outside the U.S. – especially long-rates – remain pervasive, the bid for U.S. duration should continue. We think low growth and the potential for capital loss will require persistently low rates. Therefore, it is our view that long rates in Europe and Japan will continue to anchor U.S. long-rates, which will trend towards zero longer-term. Over the next three to six months, we forecast the U.S. 10-year yield will approach 1.25%. This likely coaxes the Fed to cut the funds rate more aggressively in 2020, as it will desire to prevent a prolonged yield curve inversion and its impact on banks. We doubt that nominal U.S. rates ever go negative as there appears to be resistance within the Fed, but we posit that real rates most certainly will. Indeed, it seems as if a Lagarde ECB might not be quite as committed to negative rates as a Draghi ECB, but she may have no choice but to force rates more negative given the capital loss that less negative rates will create. 
We believe QE has created an addiction to more QE (in both low-rate and negative-rate economies). Negative rates, in particular, necessitate yet more negative rates; they lock central banks and the economies they serve into a cycle of addiction to negative rate policies.  An addiction to low or negative rates can occur for several reasons. In order for a firm to invest in a new project, it must believe that low or negative rates will be persistent enough to limit refinancing risk. In the extreme example of negatively yielding debt, holders must also believe that rates will become more negative because they own these securities for capital appreciation rather than yield! Europe exemplifies this problem. These two behaviors are how the addiction to low rates forms.
Negative rates (whether real or nominal) are effectively a tax on
capital providers – i.e. on savers. Capital providers that should receive a
return for the privilege of a borrower providing stewardship of their capital
are instead charged for it. This tax creates unintended consequences and
incentives, just as fiscal tax policy often does. Indeed, we’d go a step
further and suggest that negative rates are social policy clothed in the guise
of monetary policy. Rates policy wasn’t always this way, but the world is here
now and the voting public ought to pay as much attention to it as it does to
fiscal policy. Democracies are based on the idea that a country’s citizens
should determine a government’s decisions to tax, spend and redistribute wealth.
Monetary policy has no such constraints, yet it has similar consequences for
the redistribution of wealth from savers to consumers.
The costs of persistently low or negative rates may ultimately be
far too high. For firms, they promote inefficient capital allocation decisions
– specifically, they lead to overinvestment. Importantly, QE distorts
perceptions about what rates of return an investment must produce over the
long-term. For context, TOMOs distorted (lowered) capital costs for only short
duration bonds. Therefore, the impact of lower short-rates was mostly to create
a pull forward in demand (i.e. – an intertemporal demand impact) with only
minimal impact on firms’ long-term investment decisions. As POMOs suppress term
premia, the impact is also to pull forward investment
(rather than just demand), as firms now have lower long-term hurdle rates.
This appears to have created global overcapacity and oversupply. When industries
have excess capacity, firms lose pricing power and inflation becomes difficult
Disinflation is not the only risk to low or negative rates. It is particularly important to understand risks to a system where negative yields are common. Currently, there are about $15 trillion in negatively yielding securities. Most of those are in Europe and the rest in Japan. First, bank profitability suffers. Eventually banks pass those costs through to the real economy in the form of potentially higher lending rates (relative to the negative benchmark) and less lending.  Figure 2 shows that negative deposit rates are not passed along to borrowers.  Market participants ought to be painfully aware that the costs of negative rates may ultimately be borne by European taxpayers when Europe’s banks need to recapitalize. Because the financial system is global, a European bank recapitulation would have important implications for global market liquidity (not unlike in 2011) and the global economy. 
The impact of negative rates extends far beyond the banks. Negative real deposit or other policy rates force investors, especially captive audiences like pension funds and insurance companies, to take unwarranted duration or credit risk. For investors like these funds, when purchasing negatively yielding securities, they must receive the benefit of price appreciation to make up for the negative yield. It is the only inducement for such a purchase. In order to induce the purchase, central banks must implicitly guarantee they are committed to such policies.  This creates a self-reinforcing cycle that pushes the neutral rate to zero across the entire curve. It becomes a trap from which the central bank can’t escape. This can be said of low rates, but it is particularly true of negative rates. Negative rates necessitate more of the same.
Figure 2: Policy rate in Sweden vs. rates to individuals and corporations
The distortions QE has created (especially where QE produced
negative rates) will be difficult to unwind. It is important to remember that the
balance sheet expansion needed to execute on QE policies ultimately works
through the suppression of term or risk premia. It is not through a quantity of
money mechanism. Little firepower is left in most of the developed world for QE
to have more impact, and we conclude more harm than good has already been done
through negative rates policy. Overall, there are few levers left for central
banks short of moving to purchases of equities (as in Japan). That leaves
fiscal policy, which is notoriously inefficient and has empirically
disappointed as a stimulant to growth when compared to good old fashioned
productivity gains. These gains are harder to achieve when low rates keep
zombie companies afloat. The seeds of aggressive rates policy and negative
rates were sown in the late 1990s, and they have sprung into large dogmatic
trees, which should soon be cut down.
The need for a quick policy reversal here in the U.S. when the Fed funds
effective rate hit 2.5% and the U.S. 10-year hit 3.25% is anecdotal evidence of
this. Now, we think 2% on UST 10-year yields is the new 3%.
The Swiss actually pioneered the practice back in the 1970s to keep their
safe-haven currency from over-appreciating.
While alternate causes for the move in U.S. long rates may be a lack of above
trend growth and inflation in the U.S., the move in 10-year yields versus the
Bund and 10-year JGB is observable.
 It remains our view that European and Japanese
negative yields will persist for at least the next eighteen months
(and likely for much longer) because global growth will fail to turn. After the
recent backup in yields, we foresee Bund yields once again below -50bps by
year-end. The secular challenges to growth in Europe and Japan simply will not
The Philips Curve at the ECB.
Those cataclysmic results include massive capital loss at pension funds and insurance
companies that have purchased negatively yielding securities.
withdrawal from these policies is likely to be a painful process for
which few policy makers have the stomach. Perhaps, with a new ECB chief at the
helm, a policy ‘mistake’ that allows European rates to become less
negative too quickly will be the undoing of global risk-on.
impact of negative rates on banks may be summarized as follows:
negative interest rates
upon dipping below the ZLB
(zero lower bound), banks no longer pass through negative yield to borrowers
but in fact increase lending rates as a way to offset the cost of paying
Central Banks for safely storing currency, and
loan volumes may actually
decline as rates rise because of the pass-through the costs.
Every now and then we come across an article or blog post that’s directly relevant to what we’re trying to say on Epsilon Theory, but is too big and thoughtful to be carved up for a Mailbag note or Zeitgeist post. Steve Soukup has been writing for The Political Forum for many years now (@thepolforum), and I always enjoy reading his weekly emails (email@example.com). This note hit home for Rusty and me (in different ways!), and Steve was kind enough to let us publish it in its entirety. – Ben
Make / Protect / Teach is a Big Tent.
The great line of demarcation in modern politics, Eric Voegelin used to point out, is not a division between liberals on one side and totalitarians on the other. No, on one side of that line are all those men and women who fancy that the temporal order is the only order, and that material needs are their only needs, and that they may do as they like with the human patrimony. On the other side of that line are all those people who recognize an enduring moral order in the universe, a constant human nature, and high duties toward the order spiritual and the order temporal.
“Ten Conservative Principles,” Russell Kirk, Adapted from The Politics of Prudence, 1993.
AND REBIRTH As you may (or
may not) recall, we ended last week’s Politics, Et Cetera on a seemingly
pessimistic note. “Foreign observers of
American politics often wonder at the pervasiveness and divisiveness of the
abortion issue in this country,” we wrote.
“They are right to do so. It
didn’t need to be this way. And now that
it is, there’s no political way to rectify it.”
The emphasis on the word “political” was in the original
and was added purposefully. This is a
largely inarguable assertion. There is
no political solution to the abortion issue and there never will be. It is beyond politics. And so, for that matter, are a great many of
the most serious issues facing the nation and indeed our civilization. This may sound strange for “political”
analysts to say, but it’s the God’s honest truth. There is a definite and incontrovertible
limit to the effectiveness of “politics” as we know it.
Longtime readers will undoubtedly know that this is an
idea around which we’ve tap-danced for years.
Now is the time to make it explicit.
For decades, we have insisted – categorically, in print and in speeches
– that Washington is not the place where the big decisions about the fate of
this nation are made. Washington, we’ve
said, is merely the place where the score is kept.
Unfortunately, we’re not entirely sure that this is the
case any longer. The ruling class has
been trying, for at least the last fifty years to change that, to reverse the
balance of power in our federal republic. And almost without interruption, it has been
winning, slowly but surely usurping the rights and prerogatives of the
people. The Ninth and the Tenth
Amendments are considered by the ruling class to be relics, quaint reminders of
days gone by that serve no practical purpose and are embraced only by cranks
The people have done their best to resist. As we have noted in these pages over the last
several weeks, both Barack Obama and Donald Trump were manifestations of the
country class’s resistance to the ruling class’s perfidy. Both promised “hope” and “change,” albeit of
differing varieties. But neither
delivered on those promises. And while
our knowledge of the specific reasons for their failures may be fragmentary, it
is nevertheless clear that the larger problem is that this is NOT, strictly
speaking, a fight that can be won through political means.
You could, we suppose, call this a “come to Gramsci”
moment on our part. (We’ll call it
something else, but more on that in a minute).
It is the recognition that the century-long effort on the part of
statists to infiltrate and command the institutions of the transmission of
culture has been so thorough and so remorseless that it is simply impossible to
fight the good fight any longer, by politics alone. Gramsci was right, of course, and victory in
the “War of Position” – i.e. the war within society to control the culture – is
a necessary precondition to victory in the longer, more eternal struggle. The statists – Left, Right, and otherwise –
fought that war, at Gramsci’s insistence, and now control the culture. And as a result, they control the state and
are able to impose their will upon the people, almost without the people even
noticing. “Free” healthcare, you
say? Sign me up!
For a long time, we – and countless other “anti-statists”
– believed that the response to this victory in the War of Position by the
statists should be met in kind. In order
to win back the country from its now-ensconced ruling-class, the country class
would, we believed, have to reverse engineer the statists’ strategy and wage
its own war to take BACK the institutions and thereby take back the
culture. Just as they took over
education, entertainment, and the media, we would have to do the same, taking
back what they stole and using these resources to reconstruct a culture rooted
in eternal moral principles and virtues, and dedicated to liberty, free
markets, and the proposition that all men are created equal.
There are, unfortunately, problems with this
approach. The first and the most obvious
is that it takes time. While the
Leftists/statists could afford to be patient, those seeking to restore a
declining culture don’t have that luxury.
It’s declining, after all, and before long, it will be gone
entirely. Even operating under the most
optimistic assumptions, one must conclude that the effort to retake the institutions
will be measured in decades, not years.
And by then, the neo-Jacobin statists will have done everything they can
to ensure that the country class is officially a vassal class, more or less
unable to function without the beneficence of its ruling-class masters.
A second and perhaps more significant problem is the fact
that some of the institutions are probably not fit to be “retaken,” if for no
other reason than they were never “taken” in the first place. They were never part of the established order
to begin with. Here, we are referring
specifically to the vast majority of the institutions of higher education in
this country. Whereas Harvard was
founded to train Unitarian and Congregational clergy, Yale was founded to teach
theology and religious languages, Dartmouth was founded to teach Christianity
to the Native Americans, Princeton was founded to serve as a seminary for
Presbyterian ministers, and so on, most American colleges and universities were
never intended to transmit eternal truths and ancient knowledge. Indeed, they were intended to do precisely
With the exceptions noted above, America’s universities
were nearly all founded under the explicit guise that they should be dedicated not
to learning, re-discovering, or teaching the old, but to creating and
constructing the new. In a 2016 essay praising
the American university system, published in The Atlantic, Jonathan
Cole, the John Mitchell Mason Professor of the University at Columbia, put it
Most members of the educated public probably think of America’s greatest universities in terms of undergraduate and professional education—in terms of teaching and the transmission of knowledge rather than the creation of new knowledge. This point of view is completely understandable. They are concerned about the education of their children and grandchildren or relate to their own educational experience.
But what has made American research universities the greatest in the world has not been the quality of their undergraduate education or their ability to transmit knowledge, as important as that is. Instead, it’s been their ability to fulfill one of the other central missions of great universities: the production of new knowledge through discoveries that change our lives and the world.
[T]he United States created the foundation on which great research universities could be built. Those core values included meritocracy; organized skepticism (the willingness to entertain the most radical of ideas, but subject the claims to truth and fact to the most rigorous scrutiny); the creation of new knowledge; the belief that discoveries should be available to everyone and that those that make discoveries should not profit from them; the peer-review system that relies on experts to judge the quality of proposed research that’s seeking funding; and academic freedom and free inquiry, without which no great university can be established.
In short, then, the American university has ALWAYS been
progressive, indeed, was specifically designed to be progressive and to
incorporate progressive values. And
while this is all well and good, when applied to the physical sciences, when it
is applied to the social sciences and the rest of the humanities, it is and
always has been disastrous. This is very
much the same dichotomy that existed in the Enlightenment itself, in the
contrast between, Newton, for example, and Rousseau. There is no way to take “back” such
institutions, given that their very foundation is fundamentally flawed.
None of this will come as news to conservatives, which is
why they spent the last sixty years or so creating their own research
institutions. We know them as “think
tanks” – places like the Heritage Foundation, Cato, and the American Enterprise
Institute. But while there are think
tanks devoted to politics, think tanks devoted to culture, think tanks devoted
to politics and culture, thinks tanks that are conservative, think tanks
that are libertarian, think tanks that are dedicated exclusively to promoting
functional free markets, the statists still, nevertheless, continue to control
This is not to say that these think tanks are not having
an impact. They are, undoubtedly. But it’s not enough of an impact to move the
needle at all. They are discovering – or
demonstrating, more accurately – the third and biggest problem with the idea
that a Gramscian war can be waged to “take back” the national cultural
institutions. As it turns out, not only
are many of the issues that divide this nation beyond politics, they are
actually beyond a national solution of any sort. And as we think about it, that’s precisely as
it should be.
In truth, then, this is not a “come to Gramsci” moment
for us so much as it as a (or another) “come to Kirk” moment. Often ignored among Russel Kirk’s “Ten
Conservative Principles,” is principle Number Eight, which is that
“conservatives uphold voluntary community, quite as they oppose involuntary
collectivism.” Kirk continued:
Although Americans have been attached strongly to privacy and private rights, they also have been a people conspicuous for a successful spirit of community. In a genuine community, the decisions most directly affecting the lives of citizens are made locally and voluntarily. Some of these functions are carried out by local political bodies, others by private associations: so long as they are kept local, and are marked by the general agreement of those affected, they constitute healthy community. But when these functions pass by default or usurpation to centralized authority, then community is in serious danger. Whatever is beneficent and prudent in modern democracy is made possible through cooperative volition. If, then, in the name of an abstract Democracy, the functions of community are transferred to distant political direction—why, real government by the consent of the governed gives way to a standardizing process hostile to freedom and human dignity.
For a nation is no stronger than the numerous little communities of which it is composed. A central administration, or a corps of select managers and civil servants, however well intentioned and well trained, cannot confer justice and prosperity and tranquility upon a mass of men and women deprived of their old responsibilities. That experiment has been made before; and it has been disastrous. It is the performance of our duties in community that teaches us prudence and efficiency and charity.
Alexis de Tocqueville famously warned of the possibility
that tyranny could enter the United States via the establishment of powerful,
centralized administration. He hoped,
however, that Americans would be able to resist this centralization of
administration because of the strength of their civic organizations, the power
and the faith they placed in “community.”
And for a long time, he was right.
The existence of these civic institutions permitted the United States to
remain distinct from its Western brethren and thus to enjoy the fruits of
liberty and true, genuine, and remarkable community. But, like all good things, as they say, this
too came to an end.
Beginning with the Progressive Era and with the Progressives’
aggressive intervention in the day-today affairs of private business, the all-powerful
state emerged like Mike Campbell’s bankruptcy, “gradually, then suddenly.” The New Deal, World War II, the post-war
technocratic consensus, and then, of course, the rise of the cultural Left and
its politicization of everything, placed the erstwhile centrally governed but
de-centrally administered American people under the thumb of the “immense and
tutelary power” of “The State.”
Among the sins of this omnipotent and omnipresent state
is the bowdlerization of “community” of all sorts – local, regional, religious,
civic, athletic, business, social, etc., etc., ad infinitum. This was, we’re afraid, always
inevitable. It was always the
inexorable ambition of the state. This
is not a Republican or a Democrat thing.
It is not a liberal or conservative thing. It is simply where the state has always been
headed. Again, Russell Kirk saw it
coming before any of the rest of us. To
All history, and modern history especially, in some sense is the account of the decline of community and the ruin consequent upon that loss. In the process, the triumph of the modern state has been the most powerful factor. “The single most decisive influence upon Western social organization has been the rise and development of the centralized territorial state.” There is every reason to regard the state in history as, to use a phrase that Gierke applied to Rousseau’s doctrine of the General Will, “a process of permanent revolution.” Hostile toward every institution which acts as a check upon its power, the nation-state has been engaged, ever since the decline of the medieval order, in stripping away one by one the functions and prerogatives of true community – aristocracy, church, guild, family, and local association. What the state seeks is a tableland upon which a multitude of individuals, solitary though herded together, labor anonymously for the state’s maintenance. Universal military conscription and the “mobile labor force” and the concentration-camp are only the most recent developments of this system. The “pulverizing and macadamizing tendency of modern history” that Maitland discerned has been brought to pass by “the momentous conflicts of jurisdiction between the political state and the social associations lying intermediate to it and the individual.” The same process may be traced in the history of Greece and Rome; and what came of this, in the long run, was social ennui and political death. All those gifts of variety, contrast, competition, communal pride, and sympathetic association that characterize man at his manliest are menaced by the ascendancy of the omnicompetent state of modern times, resolved for its own security to level the ramparts of traditional community.
It is clear, then, that the “the state” as it exists
today is both tyrannical in the Tocquevillian sense and largely unchangeable or
at least unchangeable in the direction that the anti-statists would
desire. Recapturing the cultural
institutions is both time consuming and, in some case, likely impossible.
So what, then, are we to do?
There are, we think, only two options. The first of these is simply to accept our
fate, to concede that the state offers comfort, consolation, and a certain
amount of stability. This is the easy
choice, the choice of the sensible egoist.
This is the choice of the young American woman who, two weeks ago,
lectured the protesters in Hong Kong about their foolishness for choosing
freedom over safety. It is also the
choice to become, as Tocqueville put it, “nothing more than a flock of timid
and industrious animals, of which the government is the shepherd.”
The second option is to choose a form of
communitarianism, that is to say to choose, consciously and deliberately, to
reconnect with that which should not be the purview of the state and to share
that connection with like-minded individuals.
As Kirk notes above, “the same process may be traced in the history of
Greece and Rome.” And when it took place
near the fall of Rome, a communitarian ethic took hold among some of the
citizens of the Empire, ensuring that its greatest accomplishments would
survive its statist rot and eventual collapse.
Or, as the quintessential communitarian moral philosopher Alasdair
MacIntyre put it:
A crucial turning point in that earlier history occurred when men and women of good will turned aside from the task of shoring up the Roman imperium and ceased to identify the continuation of civility and moral community with the maintenance of that imperium. What they set themselves to achieve instead—often not recognising fully what they were doing—was the construction of new forms of community within which the moral life could be sustained so that both morality and civility might survive the coming ages of barbarism and darkness.
As some of you may know, this section of the conclusion
of MacIntyre’s After Virtue was the inspiration for the
communitarian-conservative journalist Rod Dreher’s book The Benedict Option. In the final paragraph of After Virtue,
MacIntyre writes that “What matters at this stage is the construction of local
forms of community within which civility and the intellectual and moral life
can be sustained through the dark ages which are already upon us.” Dreher took that as a challenge to
Christians, a warning that they must rediscover their sense of self and find
ways to preserve that in the face of the state’s perpetual encroachment upon
the lives of its subjects. Dreher
explains his thoughts as follows:
If America — and the West — is to be saved, it will be saved as St. Benedict and the Church saved the West for Christianity after Rome’s fall: by the slow, patient work of fidelity in action. The most patriotic thing believing Christians can do for America, then, is to cease to identify the continuation of civility and moral community with the maintenance of the American order, and instead focus our efforts on strengthening our communities. It begins by re-learning our story, and regaining a sense of the holy. All the rest will follow, in God’s time.
This does not require us to turn our backs on our neighbors — indeed, I don’t see how any Christian can justify that. It does mean, however, that to the extent that engagement with the broader world compromises the telling of our Story to ourselves, and embodying that story in practices, both familial and communal, we must keep our distance. My point here is not that we should cease to love America, our home, but simply that the sickness that has overtaken our country, a sickness that has stolen our sense of common national purpose, is quite possibly a sickness unto death.
Dreher’s thesis sparked a great deal of controversy but
also a great deal of conversation. And
while most religious public intellectuals refrained from directly endorsing
“The Benedict Option,” First Things hosted a discussion that included Dreher,
Michael Hanby, a prominent Catholic intellectual, and George Weigel, perhaps
the most prominent of all Catholic intellectuals. It ended with Weigel writing that “The answer
in America is to revitalize a civil society rooted in the moral truths embodied
in human nature. Only a civil society so rooted is capable of sustaining
pluralist democracy without imploding into chaos or sinking into the
dictatorship of relativism.” This may
not be The Benedict Option explicitly, but it most certainly is a nod to
communitarianism and to the idea that the pursuit and rebirth of civic life
must take place well removed from the old strategies that centered on
“retaking” the institutions of the state.
Weigel – who, as we say, is quite possibly the most
prominent Catholic intellectual in the country, if not the world – went on
to argue that “only the Church, among American civil-society institutions, can
lead in that long process of national civic renewal.” In 2015, when those words were written, we
might have agreed. But today, even we
aren’t so sure. The other day, Pope
Francis directed Bishop Nicholas DiMarzio of the Diocese of Brooklyn to
investigate the diocese of Buffalo, which has been one center of the priest abuse
scandal. Our initial reaction – which
should tell you something about the American Church’s present ability to lead
the process of civic renewal – was to think of a fox and a henhouse.
And while we wish it were otherwise, in the short-run,
it’s fine, we suppose, because religious Christians are not, by any measure,
the only people in this country who are fed up with our ruling class, with the all-powerful
state they’ve enabled, and with the ensuing BIPARTSAN political shakedown.
We may be wrong about this, but you would be hard-pressed, we’d imagine, to find two people less likely to agree on the centrality of the role of Christianity and the Church in society than the aforementioned Rod Dreher and Ben Hunt, the market commentator who, along with his business partner Rusty Guinn, runs Epsilon Theory. And yet, just four weeks ago, Ben published a piece in which he laid out his vision for challenging “The Long Now.” And Ben’s vision is remarkably communitarian in its aims, which means that it is also, fundamentally, similar to Dreher’s Benedict Option. Though the community he wishes to build is differs significantly from Dreher’s, Hunt nevertheless takes his inspiration from MacIntyre. Roughly a month ago, Ben put it this way:
Every three or four generations, humanity consumes itself with the fang and claw of fascism and collectivism. Every three or four generations, we eat our own.
This is that time. This is the Long Now.
In politics it takes the form of a widening gyre, where the center cannot hold against the onslaught of polarizing political entrepreneurs who eliminate the political promise of the future, replacing it with the Long Now of constant political fear. In economics it takes the form of a market utility, where those same illiberal political entrepreneurs eliminate the economic risk of the future, replacing it with the Long Now of constant economic stimulus….
My question is not how we prevent or avoid the Long Now. Sorry, but that ship has sailed.
No, my question is how we keep the flame of small-l liberal thought and small-c conservative thought alive through the Long Now, so that it can light the world again when this, too, shall pass….
You will hear that the danger at hand is so great, so existential, that NOTHING MATTERS other than combating that danger, that you must sacrifice your most precious possession – your autonomy of mind – to believe in the necessity of these political actions. You must not only think that it is possible for 2 + 2 = 5 if the political exigency is urgent enough, you must believe that it is necessary for 2 + 2 = 5. Orwell called this “collective solipsism”. I call it political nihilism. Either way, THIS is the politics of the Long Now.
And once you believe that NOTHING MATTERS … poof! you have CHOSEN to become a rhinoceros.
So you vote for Bob Menendez. You vote for Roy Moore. You excuse your party’s lies and your politician’s thuggery and moral corruption as necessary to prevent some greater evil.
Here’s the kicker.
There’s not a damn thing that you or I can do to stop this.
There’s only one thing that you or I can do. Luckily, it’s the most important thing….
My advice? Abandon the party as your vehicle for political participation….
THIS is where we stand our ground. Not on some national political scale where we are either turned into rhinos ourselves or trampled into the mud. But on the personal scale. On the scale of our families and our communities. A scale where we can recognize ourselves once again, not as a means to some grand Statist end, but as members of a clear-eyed and full-hearted Pack.
The way through the Long Now is a social movement, not a political party.
A social movement based on resistance and refusal. A refusal to vote for ridiculous candidates. A refusal to buy ridiculous securities. A refusal to take on ridiculous debts. A refusal to abdicate our identity and autonomy of mind.
And it’s more than refusal. It’s more than just saying “Homey don’t play that”, more than just turning the other cheek. There is also action. But it is action in service to our Pack, not action in self-aggrandizement and the celebration of power itself.
As we say, Rod Dreher’s “community” and Ben Hunt’s “pack”
would be rather significantly different from one another. Nevertheless, they would both share the
belief that the American reliance on politics and enabling of the omnipresent state
have failed. They would also share the
belief that there are certain collective values that supersede
contemporary radical individualism, but that those values should be guarded,
taught, and expressed “locally and voluntarily.”
When we left Lehman Brothers – Mark 18 years ago, and
Steve 17 years ago – we formed our own community, our own pack. We didn’t set
out to do so, but, like MacIntyre’s Romans, we – “not recognising fully what [we]
were doing” – rejected the imperium to construct a new form of community. Our community differs from Rod Dreher’s, just
as it differs from Ben Hunt’s, although we consider ourselves adjacent to both,
perhaps in between the two. You, gentle
reader, are our community, our pack, our “sympathetic association.”
As many of you know, The Political Forum community has
not been well these last couple of years.
One difference between our community and Ben Hunt’s pack is that his is,
as he says, “at scale,” while ours is not.
Nevertheless, we fight on, and have plans that we hope will enable us to
maintain our community and to maintain the values we think are important.
Chief among these values is the belief that the ancient
truths and virtues apply to and benefit man, no matter the setting or conditions
of his action or deliberation. And while
countless organizations exist on the Right to foster this same belief and to
encourage this same notion in life and politics, we find that it is sorely
lacking in the practice of business. The
conflict between “self-interest” and “stakeholder interest” is unnecessary and
destructive. It is also both a component
and a product of the crushing of “community” in the general sense. We can’t fix this, obviously. But we can guard the remnants that still
exist and do our best to re-create a community in which this all makes sense.
And that’s what we intend to do.
Watch this space.
If you’d like to connect with Steve, you can email him at firstname.lastname@example.org, and you can connect with him on Twitter at @thepolforum.
The free world has been dunking on LeBron James for more than a week now and it has not gotten old.
Still, something about it has made me uneasy.
Am I uneasy because King James requires some special grace, because I’m worried that we aren’t being full-hearted enough in our criticisms of him? No. Good God, no. Knock yourselves out, y’all. I’m uneasy because once you see clearly the influence the Chinese Communist Party can wield arbitrarily over you and me as citizens of the free world, you see that same power in a million other places. It is like a stereogram, one of those pictures for which our eyes must conquer their natural tendency to coordinate focus and vergence functions to see anything but a series of repetitive dots.
And once you see it, you cannot unsee it.
When I was 18, I toured China and Hong Kong with the University of Pennsylvania Symphony Orchestra. We played at the Meet in Beijing Arts Festival in a kind of ‘partnership’ between our university and a couple in mainland China and Hong Kong. We played Peking Opera that had never been orchestrated for western instruments before shockingly large crowds. We played to a black-tie crowd at a Watermelon Festival outside Beijing. I have a nice letter signed by Henry Kissinger sitting in a box in my attic somewhere.
This was almost 20 years ago, and this is the first time in a very long time that I’ve thought about the ID tags we were asked to wear at both of those events. We were artists, and it was important that we not be allowed to converse or interact outside of our station. Heaven forbid we befoul the air in the vicinity of the local and regional party luminaries in attendance. Our ID tags were religiously checked, even when using the nearby restroom – like visiting Bridgewater’s Westport campus. So we huddled, waiting – in many cases, deeply hungover – in a small green room for several hours as other groups performed. The university, hungry for anything that would increase its presence (read: funding), prestige (read: funding) and reputation (read: funding) on a global stage, happily agreed to any and all such restrictions.
Very small potatoes. And if you want to argue that a “when in Rome” attitude on someone else’s turf is more palatable than watching the Chinese Communist Party squeeze American institutions to influence the free exchange of ideas on our own shores, I won’t argue with you. It was their party, after all. But that isn’t my point. My point is that I am thinking about the power that has been exerted by the CCP on me for the first time in a while. I have seen and cannot unsee how long this has been going on in a million different places. It isn’t new. It always existed underneath the abstracted hand-waving explanations that convinced me to ignore it, like a colorful, repetitive mesh of dots.
And once you see it, you cannot unsee it.
I’m not alone. Here is what we are observing at macro scale:
That it has been common knowledge – something we all knew that we all knew – since the Nixon years that by simply exporting capitalism and free enterprise, we would unshackle the forces of freedom in China.
That this common knowledge is breaking.
Today, we all know that we all know that the influence of the Chinese Communist Party over what youand I do hasbeen aided, not thwarted, by the nominal Chinese embrace of capitalism.I think that this – not the NBA, or Hearthstone, or Disney, but common knowledge about the distorting effects of concentrated power on the efficiency of market outcomes – is the real main event.
Still, before we consider what that means, it’s worth taking a quick look at just how the bullish narratives on US growth in Chinese markets turned on a dime.
Basketball – and by extension, the NBA – has easily been the most successful US sports export, despite playing a very distant second (or third, depending on how you measure it) to the NFL domestically. There are all sorts of reasons for this success, but they all boil down to one simple idea: when there are only five people on the court from each team, each of whom is visible and capable of significantly influencing the outcome of each contest, The Superstars are the Brand. The league’s stars exist, market and develop identities and brands independent of but still in service to the NBA. They have done so in ways that are remarkably in tune with the social and cultural zeitgeist that drives all sorts of consumer purchasing decisions.
In other words, the NBA is the perfect cultural export.
The coverage of and common knowledge about the growth of NBA-related brands in China has accordingly been almost universally positive for years. It will be no secret, but a glance at the narrative map below will tell you that narrative has always been about two things: how good and important it is to sell shoes. Over the twelve months prior to Morey’s tweet, there were 10 articles scored by Quid as being generally positive in sentiment (highlighted as green nodes in the charts below) for every 1 article scored as negative (red nodes).
US companies maximizing their footprint and growth in China was a Good Thing.
What does this world look like after Morey’s tweet and the subsequent response from China, the NBA and superstars like LeBron James? For one, the sentiment of articles about the NBA’s branding and marketing efforts in China went from 10-to-1 positive to 2-to-1 negative. But sentiment comes and goes. What is fascinating is how the language in the stories links them to language used in all manner of longer-cycle news stories, like the Hong Kong protests themselves (for obvious reasons), the Trump/China trade war, and importantly, other examples of CCP pressure being applied to US companies and individuals. The language devoted to discussion of economic growth, corporate opportunities and the freedom-enhancing power of Chinese embrace of capitalism?
Gone. Not diminished. Gone.
You’ll also note that the network map is much less tightly packed – that’s how the visualization demonstrates starker differences and distances between major topics and clusters. We used to all sing from the same hymnal about the NBA’s brilliant efforts in China. Now it is a battleground of language and competing missionary behaviors.
In short, the NBA-in-China isn’t just a cool growth story any more. Today we all know that we all know that it is tied up with big, global political, social, cultural, economic and human rights issuesthat the power concentrated in the CCP has prevented markets from reflecting clearly.
Blizzard Entertainment came under similar fire for withdrawing a prize won by a participant in a competition for Hearthstone, its World of Warcraft-themed deck-building game. The reason? He spoke up for Hong Kong protesters in a livestream, and Blizzard management came under pressure from the CCP to take action. Now, in case you didn’t know, Hearthstone’s publisher isn’t a Chinese SOE. It’s a subsidiary of Activision Blizzard, a US-domiciled, US-listed public company.
Despite (still) getting practically no coverage in mainstream publications, eSports is a huge and rapidly growing industry, especially in East and Southeast Asia. Over the same pre-Morey period, the narrative about eSports in China was uniform, cohesive and almost universally positive. It is exactly the narrative map you would expect from a rapidly growing, entertainment-focused industry with a supportive trade media that benefits from its growth and entertainment features (not unlike the financial press).
After Blizzard’s kowtowing to Beijing, as with the NBA brand narrative, the narrative around eSports in China became immediately less cohesive, dramatically more negative, and instantly linked by language and terminology to global political, social and economic conflicts.
Look, I’m not here to tell you that everything has changed for the NBA or Blizzard or any other company that has built its narrative around Growth in China. People will forget that they were mad at LeBron James and the NBA. And I’m talking weeks, not months, people. Sentiment will drift back. Sorry, but it’s true. People really like video games and basketball. On CNBC, by Q4 2019 earnings season, we will be back to “China Growth Initiatives” occupying bullet #1 on US corporations’ MD&A slides. People really like growing earnings. Imagine that.
But the awareness – in general – of what China can do? That can’t be unseen. What’s more, it is a nearly perfect fit with what we have described as the overarching common knowledge (as represented in political media) about the 2020 Election, namely, that it is about identity and unseating incumbent concentrations of financial and political power. Unlike those narratives, however, or those promoted by the drain-the-swamp chants from the Trump 2016 campaign, the China concern has universal appeal. This issue, and the inevitable conclusion that we “must do something about it” isn’t going to go away.
I, for one, am conflicted.
On the one hand, I can’t unsee what I’ve seen. It isn’t just unsavory or undesirable that China be in a position to so directly influence (and punish!) the free exercise of rights in the United States. It is untenable.
I also believe in freedom of action, thought and association. I believe in those freedoms as ends to themselves, untroubled by the need to justify them by evaluating their second-order effects. I don’t stop believing in those ideals when they concern the private commercial interactions between individuals and/or corporations. Not because I have some fanciful belief that unregulated, unrestricted trade across borders will always lead to universally optimal outcomes. Of course it won’t. But because I earnestly believe in rising tides, and in the generally superior function of the informal, unplanned, spontaneous features of markets to organize our collective activities.
I also believe that allowing companies formed by Americans to do business wherever they want will generally lead to better aggregate outcomes than some Very Smart Person with every incentive to parlay their $175,000 public servant salary into a multi-million dollar net worth who believes they have the prescience to dictate which domestic industries ought to be subsidized and retained and which oughtn’t to be. I will always be concerned that the cure for concentrations of power will be worse than the disease.
And y’all, I have good reason to be concerned. Remember, if you would, that any time someone celebrates leaning on the state and policy to solve the distortions caused in markets by concentrated power that the people making those decisions think things like this:
Still, no matter how conflicted or uneasy we may be, these discussions are coming. You and I won’t be able to avoid them. Anti-trust. Restrictions on trade and activities with foreign powers like China. Abolishing billionaires. Maybe even trimming the power of the state (LOL, sorry, just seeing if you were paying attention). This isn’t a temporary topic. Like it or not, this IS the zeitgeist.
So what’s the answer?
Clear Eyes. We see and reject the meme of Yay,Capitalism! , which tolerates no dissent from the idea that mostly-free enterprise is the panacea that will seep in to overturn dictators and tyrants. We do so knowing that the meme form bears little resemblance to the simple belief that unstructured, democratic social organization which funnels rewards to risk-takers is a magnificent, proven mechanism to make men and women wealthier and more free.
Let me say this more clearly for my fellow small-l market liberals: we must be willing to see and identify concentrations of power and their effects without fear that doing so necessarily implies our consent to a state policy-based solution that might be worse.
Full Hearts. We recognize that neither we nor anyone else can be objective about which concentrations of power we deem distorting. Our determinations will reflect our posture and beliefs about a great many things. We will be tempted to see our own conclusions as self-evident and justice-affirming. We will be tempted to see others’ conclusions as attempts to engineer society in their own image. That’s the effect of the widening gyre. But even when everything in our head is telling us that the person we’re arguing with is using the power exerted by China or Facebook or the Banks or Big Government as an excuse to re-engineer society to suit their personal preferences, we listen and treat those arguments in good faith until they have proven otherwise.
Long after we’ve forgotten about the forced rewriting of Disney movie scripts, or the maps of China that ESPN uses on their Sportscenter background, or access bans by gaming and social media companies, this debate will be with us. For those of us who really, truly, earnestly believe in the power of capitalism, we can either lean on the meme of Yay, Capitalism! to thwart all comers, or we can engage in good faith.
“He had seen two main branchings along the way ahead—in
one he confronted an evil old Baron and said: “Hello, Grandfather.” The thought
of that path and what lay along it sickened him.
The other path held long patches of gray obscurity except
for peaks of violence. He had seen a warrior religion there, a fire spreading
across the universe with the Atreides green and black banner waving at the head
of fanatic legions drunk on spice liquor […]
He found that he could no longer hate the Bene Gesserit
or the Emperor or even the Harkonnens. They were all caught up in the need of
their race to renew its scattered inheritance, to cross and mingle and infuse
their bloodlines in a great new pooling of genes. And the race knew only one
sure way for this—the ancient way, the tried and certain way that rolled over
everything in its path: jihad.”
–Frank Herbert, Dune
Dune is easily one of the greatest works of science
fiction ever written. I’d go so far as to say it’s one of the greatest works of
popular fiction ever written.
That’s not to imply Dune is an easy read. Or even a
pleasant one. The first couple hundred pages are incredibly taxing. But it’s
all downhill from there. In fact, I’m convinced this is precisely what us Dune
fans love about the book. Itsdepth rewards you for your effort. But
you have to earn it. Dune is truly a book for “idea people.”
This is precisely why Dune movie adaptations
inevitably disappoint. Sure, Dune has a sci-fi plot. It’s got fairly
well-drawn characters. It’s got action. But the real draw are the Big
Ideas—ideas about how politics, science and religion shape humanity’s
evolutionary path. Ideas about how politics, science and religion are used to manipulate
humanity’s evolutionary path.
One of the recurring images in the book is what we in
finance know as a probability tree. In the world of Dune, if you are at
least a little bit psychic, and you amplify that psychic ability with a
generous helping of hallucinogenic “spice,” you can catch a glimpse of the branching
probability tree that is the as-yet-unrealized future.
Here in the investment and financial advice businesses, we,
too, seem to have reached an evolutionary crossroads. I don’t claim to know
exactly what the industry will look like in ten or twenty years. But like Dune‘s
protagonist, Paul Atreides, I think I can peer through the haze of a spice
trance to glimpse some of the branching possibilities.
Each of these possible futures has different implications
for financial markets and the financial advice business.
The Great Jihad
In many ways The Great Jihad is the most straightforward
path. It’s just not a particularly pleasant one. Here, we as a species fail to
transition from competitive games to cooperatives games. Inevitably, this leads
to big wars and violent revolutions. In this future state of the world, our
portfolios and advisory practices are the very least of our concerns. We’ll be
much more concerned with the simple things in life. Things like not getting
shot, or sent to re-education camps, or starving to death.
If you truly believe we are headed for the Great Jihad, you
want to own gold, guns, crypto and seeds.
The Zombification of Everything
We’re pretty familiar with the playbook for this future,
because it’s more or less what we’ve been living since the 2008 financial
crisis. Here, growth and interest rates remain low for many, many years.
Decades. What’s more, the Nudging State and the Nudging Oligarchy somehow
succeed in stabilizing the social and political tensions that this state of
affairs tends to create.
This is a policy controlled world of zombie companies,
zombie investors and zombie civic institutions.
From an investing standpoint, cheap, beta-oriented
strategies will continue to dominate the product landscape. There will, of
course, be niche opportunities for traders and stock pickers to make money, but
never to such a degree that the policy controlled nature of economic and market
outcomes can be called into question.
As far as financial advice is concerned, this future will
amplify current trends toward focusing on financial planning and even financial
therapy. The role of investment selection in an advisory practice will be
increasingly marginalized, and advisor compensation will increasingly be
divorced from client investment portfolios. There is no need to worry about
investment outcomes in a policy controlled world. Why would anyone pay a
premium for investment advice in such a world?
What’s more, two “truths” will be self-evident in a
Always be buying.
Always be long duration
This is a future without bear markets and without interest
rate risk. Financial asset valuations will have “permanently” re-rated higher
on the back of common knowledge that the cost of capital will always and forever
remain pinned near zero, and that economic cycles have been tamed.
In this world, Ben Graham style value investors are extinct.
To the extent people who consider themselves value investors still have money
to manage, they will claim to adhere to “evolved” value philosophies that
emphasize “quality” or GARP.
However, the Zombification of Everything does not strike me
as a stable equilibrium, precisely due to the social and political tensions
that must be managed to maintain it. This future isn’t so much a destination as
a layover on the way to something else.
The Great Reset
Great Reset is a kind of middle way. It’s not quite the
dystopian hellscape of the Great Jihad. But it ain’t exactly a bed of roses,
I see two possible paths here. The first (and more
unnerving) is that of debt jubilee and MMT. Here it is common knowledge that
neither debt nor deficits matter. This is a future of structurally higher
inflation. It’s only a question of degree. To me, this is the highest
probability future of the three examined here.
Of course, the worst possible outcome is hyperinflation and
revolution (shades of The Great Jihad there). But I believe there is a “milder”
way forward, too, with “merely” high single digit or low double digit
inflation. After all, this kind of inflation is the most politically expedient
solution to the debt burdens and unfunded liabilities borne by today’s
developed market policymakers.
What does this mean for our portfolios?
Much of what we think we “know” about investing will no
longer work. Stocks and bonds will be positively correlated. Conventional
wisdom about asset allocation will disappoint. Long duration bets will get
crushed. Equity multiples will re-rate lower as the cost of capital rises.
The differences between stocks will matter again.
Why? Pricing power is why. Businesses with pricing power will survive
and even thrive. Businesses without pricing power will struggle. Many will die.
Naturally, this could open the door to a renaissance in
stock picking. Even a renaissance in more traditional forms of value investing.
And what of financial advisors?
We will have to get to grips with the fact that many of our
investing heuristics will not be particularly effective in this regime. They
may even be counterproductive.
The diversification offered by a 60/40 portfolio will
disappoint. Portfolio construction and stock selection will matter again.
Financial therapists whose understanding of investing is limited to the
heuristic that a low cost, 60/40 portfolio is always and everywhere best
portfolio will find themselves at a disadvantage versus competitors who adapt
more quickly to this new economic regime.
Both the Great Reset and The Great Jihad represent explicit
rejections of the Zombification of Everything. Likewise, they represent
explicit rejections of the Cult of the Omnipotent Central Banker. We will
probably still have central bankers after the Great Reset. But common knowledge
will mark them as sorcerer’s apprentices. Everyone will know that everyone knows
that policy controlled markets are a febrile delusion.
I suppose there is also a kind of Golden Path here, where
the Cult of the Omnipotent Central Banker is cast down without debt jubilee or
MMT. How might such a thing happen? Policymakers themselves might eventually
reject the idea of policy controlled outcomes and the tired tropes that come
along with it (Fed Days, forward guidance, etc.). But the Golden Path is a
narrow one, and it strikes me as a low probability outcome.
I conclude with a final Dune quote worth meditating on, whenever we consider the branching possibilities in life, business or the financial markets:
“And he thought then about the Guild–the force that
had specialized for so long that it had become a parasite, unable to exist
independently of the life on which it fed. They had never dared grasp the
sword… and now they could not grasp it. They might have taken Arrakis when
they realized the error of specializing on the melange awareness-spectrum
narcotic for their navigators. They could have done this, lived their glorious
day and died. Instead, they’d existed from moment to moment, hoping the seas in
which they swam might produce a new host when the old one died.
The Guild navigators, gifted with limited prescience, had
made the fatal decision: they’d chosen always the clear, safe course that leads
ever downward into stagnation.”
There is nothing quite like a slow-motion death scene.
And there is no slow-motion death scene quite like the classic from the 1973 Turkish film and popular 2012 meme Kareteci Kiz. The picture you clicked on to get to this piece gives you a small taste of its glory, but you really must watch the video to get the full experience.
Speaking of painfully drawn out deaths, let’s talk about the asset management industry (hey-o!). To that end, I read an interesting thought experiment (read: writing prompt) from our friend Meb Faber yesterday.
Now, Ben has already put his views on the so-called “bubble” in passive management out there, which as per usual were contained in a post that launched a thousand hot takes. His actual observation was pretty uncontroversial. I’ll put it this way: if your clients, boards or bosses are asking you “why didn’t we just buy the S&P 500?” in response not only to stock-picking strategies that didn’t work, but to any investments in foreign stocks, bonds, and other diversifying or objective-oriented investments, then you already understand the narrow point he was making about the always-be-buying impact of the indexing imperative.
As much as we may want it to be (or would like to pretend for argumentation purposes that it is), common knowledge about indexing is NOT confined to an expressed preference for the avoidance of active risk-taking on individual securities (or more accurately, for not paying fees for such activities). It absolutely IS common knowledge that indexing in practice also means a preference for long exposure to US stocks over any other way, place or method of taking investment risk. Honestly, anyone who denies this either hasn’t talked to a client or board in years, is being hopelessly pedantic, or is deliberately or accidentally misleading you to some unknowable end.
Still, Meb’s question isn’t an active vs. passive question, really. It isn’t even a question about active management. Meb’s is a question about our industry, full stop. And it’s a good one. Why do people still pay above-passive fees, when common knowledge about indexing has become so powerful? Is this practice doomed to die? And if so, is it shortable (by which I think we all understand we mean philosophically or conceptually, not whether you need to go find borrow on TROW)?
Like I said, it’s a good question. And I don’t know the answer. Sorry.
What I DO know is that there are a few strong inertial forces keeping the asset management industry alive as it flops around the room with a dozen ragged, bloody exit wounds. If you want to know where this industry is going, I think you’ve got to ask yourself what you think will happen to each:
Human Preference in Advice: Some humans prefer in-person human advice and are price-insensitive to getting it if it comes with relationship. This isn’t a novel opinion, and I’ve already written my piece on this. Confined largely to HNW financial advice – wealth management – both the preference among many consumers for human advice and the fact that the actual value provided by a financial advisor is behavioral and emotional in nature are more powerful bulwarks against erosion than most observers allow. Short the market for advice, and I think you’ll get burned.
Revenue Sharing: This is the uglier side of the otherwise benign influence of wealth management and financial planning. Put simply, actively managed mutual funds and their attendant industry infrastructure are still flopping around primarily because actively managed mutual funds are one of the few things keeping some wirehouse financial advisory platforms afloat. Without 12b-1s, platform participation fees and revenue sharing, many wires couldn’t afford either the business or the staff, and wouldn’t be able to keep FAs from escaping to the warm embrace of advice-driven RIAs. Where does this go? I think it bleeds out gradually, and when these compensation structures are no longer material to any ongoing business, they are killed off suddenly as a false-concession in some regulatory negotiation with the banks.
Fiduciary Fear-Mongering: If you have served on a 401(k) committee, and that committee has hired a consultant, this will not be surprising. If you haven’t, it will probably be a surprise. But ERISA consultants routinely, formally advise plan sponsors that not offering actively managed mutual fund options as complements to passive offerings could subject them to risk of suits or DOL action. No, I am not kidding. This kind of garbage is sticky, and the consultants/lawyers/regulators in this space will keep it that way far longer than any of us would guess.
Risk Transference: An issue for both retail and institutional investors alike, huge categories of the professional money management industry exist simply because advisers or staff of asset owners have a career risk incentive to lay off accountability for missing goals. Separately, and probably more importantly, they must also grapple with a reality in which the theoretical alpha-generative potential of lucky active money management picks is the only thing that fills the gap between projected and actuarial returns. In other words, if asset owners are given the Hobson’s Choice of recommending benefit cuts / spending cuts or telling legislatures / donors / family members that they need to increase contributions on the one hand, or buying actively managed strategies because doing so permits them to include an alpha assumption in their long-term strategic return projections that theoretically could fill the gap, guess which one they pick? Hope springs eternal, y’all.
(And yes, I suppose there are still a few schmucks like us out there who think that occasionally paying someone to identify mispriced assets still makes sense.)
So yeah, I don’t know, but if I were a betting man, I’m betting on this industry being around in something resembling its current form for much longer than most people would extrapolate from current trends. That means people and institutions continuing to pay above-passive fee rates for active management at the portfolio and asset class level. If you’re a full-hearted FA trying to do good, I think you’ll have your shot as long as you want it. If you’re a full-hearted active investor who thinks there are still reasons to own things based on an assessment of their value, so will you.
But all of us would also benefit from eyes clear enough to see that the reasons for the persistence of some parts of our industry as they exist today are not ones to feel particularly good about.
That’s partly because I’ve got so many words burning through my fingers to get out in new notes, but it’s even more so because we’ve created an ongoing Mailbag on the Epsilon Theory website … a place BY Pack members and FOR Pack members, where you’ll find some of the smartest commentary going, and where Rusty and I are in full engagement. At last count, we’ve got something like 2,000 published comments. It’s one of the best things on the internet today.
But these two conversations with Pack members deserve a wider circulation. They deserve a Mailbag note.
First from T.
Six months ago, you extended free premium membership to me because I work in Iraq as an archaeologist. I wanted you to get a sense of what the Epsilon Theory gift means to me.
Everyday we live the widening gyre in ways that Americans don’t appreciate. I work in Ashur, a world heritage site that one day, I hope, will be open again to the world. In order to work there, I rely on human kindness to make the impossible possible. To give you a sense of our gyre.
Archaeologists are targets. We can’t afford private security, so [REDACTED] donates his time and his bodyguard to escort us through ex-ISIS territory to get to Ashur. Once we cross out of the safe zone, the Jaboori tribe (a Sunni tribe) keep us safe with extra patrols and security. We drive through village after village where the war has left a trail of destruction.
Once you arrive at the once beautiful world heritage site of Ashur, a picturesque complex of ruins on the banks of the Tigris, ISIS’ legacy is in full view. ISIS and its supporters had destroyed the museum, the protective cover for the royal tombs, and the ancient gateway. They systematically stripped the residential house and the local archaeology office. The first night, we slept on the floor, with a drip of water as a “shower”.
However, Ashur is a story of resilience. The local village (Sabka) did not have a single ISIS member. With a small private donation, we turned the taps back on, and we rewired the main house and the guard’s house so that we could get a reliable source of electricity. The local staff started work at 530 AM every day, working 14 hour days, in a country where 9 to 2 is considered sufficient. They donated their time so that our team could finish 3 full days of drone flights in order to take almost 12,000 aerial photographs of the site.
Afterwards, I flew to Baghdad to meet the Ministry and the team from the State Board of Archaeology and Heritage to discuss the future of Ashur. Everyone is helping because of a shared connection to a wondrous place that deserves better.
This is my pack. I hope you and Rusty will come visit it one day.
Best wishes from Iraq, T.
I asked T. for permission to reprint his email, and he graciously agreed. Here’s a picture T. forwarded of the damaged archaeology office on the left and the damaged archaeology site on the right.
There are many thing I love about ET, but one of the best things about it is the truths it reveals – truths that are right in front of us but that we don’t see until they are revealed by the truthtellers of ET. I can’t tell you how many ET notes I have read that have made me say “Yes!” and helped me better understand the world.
But not this note.
The “Make, Protect, Teach” principle Ben espouses misses the mark for me. There is a kernel of truth to it, but only a kernel, and it would set us down the wrong path. The error in the “Make, Protect, Teach” principle is in equating a person’s occupation – what they do to make money and survive in this world – with that person’s value to society. Now, I’m not saying a person’s occupation has no correlation to their value to society, but it is not a direct correlation. Take teachers for instance. Just being a teacher doesn’t make you a positive member of society. There are lots of small-minded, petty, vindictive, and generally crappy teachers out there. And by the same token, being a corporate lawyer, banker, or member of business management doesn’t mean that you aren’t a positive member of society. These occupations (and, full disclosure, I am one of those nasty corporate lawyers everyone loves to hate) are all vital and necessary to modern society and have every bit as much intrinsic value to society as those extolled in the note as being “Make, Protect, Teach”-worthy.
For me, it is not what you do but how you do it. Let me explain. I believe that life is the Great Mystery; an unsolvable puzzle. We understand only a small fraction of what goes on around us, and can only hope to gain a slightly better understanding during our lives. My belief that we live in a fundamental state of mystery underlies my small “l” liberal beliefs. Given the unknowable nature of life, all people need the freedom to believe and act differently, to make mistakes (or what I believe to be mistakes), to be wrong (or what I believe to be wrong), to be different. There are three things that give value to my “mysterious” life:
1. Enjoyment. Have fun, Life is a gift! 2. Increasing my personal understanding of life’s mysteries. Think Big Thoughts! 3. Helping others (family, friends, acquaintances) do 1 and 2.
For me, the pursuit of the “good life” is the pursuit of these three things, for myself and others. Jim Valvano said there are three things we should do every day: 1) Laugh; 2) Think; and 3) Have your emotions moved to tears. I don’t do these every day, but I aspire to. I believe that there are three things that give any person “value” to society: 1) Do they enjoy life and help others enjoy their lives?; 2) Are they both truthful and truth-seeking and do they help other seek truth in their lives?; and 3) Do they love and support their family, friends, acquaintances as they seek to maneuver through life’s great mystery? So, an artist that creates a work of art that helps millions better understand life has great value to society. On the other hand, an artist that creates small-minded drivel that speaks to no one has very little value to society. It is not what you do, it is how you do it. “Make, Protect, Teach” is close, but for me it is “Spread Joy, Seek/Tell Truth, Love/Support Others”.
And by the way Ben, despite my disagreement with this note, you are the best Truthteller I have ever known. As always, thanks for making me Think.
– David H.
When I wrote this note, I really struggled with the idea of giving too much citizenship “weight” to one’s JOB. As David points out, there are plenty of sociopathic, bad citizens who are also teachers or police or engineers. And there are plenty of full-hearted good citizens who are lawyers or management or bureaucrats. But I really do think (and there’s a long-winded Bayesian argument here that I won’t bore you with), that choosing a profession that inherently emphasizes some notion of service over money (in my lingo, Make/Protect/Teach) over a profession that inherently emphasizes the reverse is a MEANINGFUL SIGNAL that you are a citizen. It’s not the only meaningful signal! Coaching a kids’ soccer team … setting up a Maker space at the local library … spending your time (NOT just your money!) in service to your Pack … these are ALL meaningful (and sufficient) signals that you’re in the Make/Protect/Teach framework.
EITHER of these signals is enough for me to give you the presumption of citizenship in the M/P/T framework.
The reason I’m focused on signals is that I’m trying to find a recipe for a mass society – a nation of hundreds of millions of people – to organize their shared concept of citizenship on something that can’t be BOUGHT and something that requires SERVICE, without creating a caste system of “approved” jobs or a requirement for “national service”. Using signals (EITHER a job that inherently favors service over money OR an inherently service-oriented use of your time) will have lots of false positives (“bad” citizens who generate a “good” signal). But that’s far more just than a system that generates lots of false negatives (“good” citizens who do not generate a “good” signal).
I do disagree with David on two points. First, just thinking well-meaning and society-supporting thoughts is not enough. It’s necessary but not sufficient. There must also be ACTION taken in support of those thoughts. Second, the outcome of that action isn’t the important thing, it’s the EFFORT. It doesn’t matter to me if an artist does crappy art that no one likes. It doesn’t matter to me if a writer publishes a crappy blog that no one reads. What matters to me (and I know that I sound like a contestant on The Bachelorette when I say this) is that Makers/Protectors/Teachers are Making/Protecting/Teaching FOR THE RIGHT REASONS. That’s a really tough thing to evaluate in a mass society (much less a small society like the cast of a reality TV show) – which is why I focus on signals and erring on the side of false positives – but I think it’s the right place to make an evaluation.
One last observation … this is the first in-depth conversation I think I’ve ever had with my brother on the meaning of life (and all that). I’m 55 years old and he’s 53. If Epsilon Theory stopped tomorrow, experiencing THIS ALONE would have made it ALL worthwhile. Full-hearted engagement, bringing us closer together … THIS is our purpose. Thank you, David. I love you.
AS BELOW, SO ABOVE.
As Bill Simmons used to say, “yep, these are my readers.” He meant it as a joke after a silly email, and that’s how I’ve used it in the past, too. But no silly or funny emails today. Just clear eyes and full hearts. Because … you know … can’t lose.
Yes, these are OUR readers, and this is OUR Pack, and this is OUR platform for thought and action in service to that Pack.
Watch from a distance if you like. But when you’re ready … join us.
This is Hong Kong right now. The image is powerful. The audio is more powerful.
The people in this image and this video are singing “Do you hear the people sing,” from Les Mis. It is a common protest song, but not the kind of thing that is allowed in 2019 China. If you know the curtain-dropping line from the play, you’ll know why:
Do you hear the people sing? Singing a song of angry men? It is the music of a people Who will not be slaves again
– Les Miserables (1980)
Here is a video of police firing rubber bullets at well-prepared protesters.
Here is an article from the South China Morning Post discussing the aggressive use of tear gas to break up the protests.
The article is, of course, pure fiat news, an opinion piece that presents itself as a news update. The headline is selective and emotionally charged. The images are selected to evoke a particular response. Even when we agree with the narrative it is promoting – especially when we agree – fiat news should always give us pause.
But they aren’t the only ones creating narratives here. The protesters are, too. Singing “it is the music of a people who will not be slaves again” is beautiful narrative creation. Standing peacefully, armed against tear gas and bullets with spray guns, umbrellas and plywood shields? Brilliantly disarming tear gas canisters with cones and water guns? This is Holy, Rough and Immediate theater, all at once.
And it is amazing.
If you’re reading this, you probably know more about what’s going on in Hong Kong than just an airport shutdown. Like us, you’re probably Very Online, a ravenous consumer of global news. But for most of the country it is a different story.
Here, for example, is the front page of CNN.com as of 7:00 AM CT this morning. Dig a little bit and you’ll find something about the Hong Kong protests. Only don’t look for a story about self-determination, disenfranchisement or extradition. You’ve got to look for a story about how this might affect you, fellow American. Found it yet?
MSNBC’s front page has nothing. Zilch. Lots to say about Russia, though.
If you’re willing to scroll down past fiat news send-ups of Comey and Cuomo, Fox will give you a similar angle to CNN. At least they acknowledge the protests. Unfortunately, in doing so their headline writer unwittingly reveals a bit too much about US missionaries’ awareness of the protests: in short, they have not been paying attention to them for the months, not days, that they have been going on.
The Wall Street Journal puts it figuratively above-the-fold – they’ve got a good Hong Kong bureau – but again, the headliner news story is how this will affect your travel plans and the next two weeks of volatility in your portfolio. It IS a financial paper, so some grace is warranted here. Many of their reporters are doing good work. If you’re looking for someone to follow, @birdyword is a good choice.
The New York Times gives the “airport thing” top billing, too, but the nature of their coverage (presented cheerfully next to “What Would Sartre Think about Trump-Era Republicans”) would easily pass CCP censors. Every piece and every blurb being promoted is about the disruption being caused by the protests, and about the damage being done by them.
ET followers and subscribers – especially on social media – have been openly predicting over the last few days how quickly the Epstein case or the Hong Kong protest situation will fade from the zeitgeist, from the narratives about what’s going on in our world.
They won’t fade.
No, not because they’re powerful or timeless. They won’t fade because they don’t exist.
There is no narrative, no common knowledge in the US about these protests. American media have largely stopped covering them, and they aren’t written about as a “connected issue” for other topics. They have rarely, if ever, been connected to language used to discuss trade disputes with China. They aren’t related to the three or four articles grudgingly discussing the Uighur muslim reeducation villages they’ve set up (shh!). But this isn’t just US media. It’s politicians, too, who seem loath to tie anything of everyday significance to what’s happening over there.
The only reason at all the protests are getting coverage is in context of reports about Asian stocks and reports about flights in and out of Hong Kong. That’s it. From Quid, below we present a network graph of the last two days worth of all global news. In bold at the extremity of the northeast quadrant are the entirely peripheral, unconnected, paltry collection of articles about these protests.
I’m sure we will get a lot of “isn’t a clear-eyed view of the protests that they are unlikely to be successful” or “this will all be counterproductive” takes, which are very on-narrative responses. They also might not be wrong.
But wherever self-determination and resistance to the encroaching power of the state and oligarchical institutions find expression, there should our full hearts be also.
And our full voices.
PDF Download (Paid Subscription Required): Does It Make a Sound?
Ahchoo: You don’t have to do this. Look, this ain’t exactly the Mississippi. I’m on one side, see? I’m on the other side. I’m on the east bank. I’m on the west bank. It is NOT that critical.
Robin of Locksley: Not the point! It’s the principle of the thing.
Robin Hood: Men in Tights (1993)
I visited my parents in Texas last week.
They live on the periphery of Houston exurbs and East Texas
country, although – and this is not unusual for Texas – their home is in a development.
What’s more, it is a development with an HOA. The kicker is that it is a gated
HOA. My parents couldn’t care less about whether the community is gated or not.
This just happened to be where they found the home where they knew they wanted
But still, there’s a gate.
The nearest business – other than a gas station at the
highway exit to get there – is a web-based thing some guy runs out of his house
selling pretty rocks and healing crystals. The next closest are a lumber yard
and two feed stores. Town doesn’t really have any crime to speak of. Doesn’t
really have many people to speak of, for that matter.
And of course they change the code every couple of months. Just to be safe. So when I pulled up in the rental Hyundai with my wife and boys at, oh, around 9 PM, well, I had the wrong code. I sat there texting my dad for the new one, but my dad’s about as good at checking his phone as yours. No joy. Luckily, after a few minutes, some good ol’ boy in a white pickup pulled up. So I looped around the little island in the median where the gate control machine was positioned and got behind him.
He pulled through and did something I never thought I’d see. He stopped. Right past the opened gate. I mean that literally. He inched his truck forward so that there was a hair’s breadth between his tailgate and the now-closing community gate. He wasn’t going to let me in. Not only that. He waited, not for the gate to close completely, but for some new development in this high stakes drama of a family with two kids in car seats clearly visible to him as we looped around, parked in a purple SUV trying to get into a residential neighborhood in a crimeless community. Did he call the police? Did he summon the rent-a-cop working the HOA circuit checking on the length of everyone’s front lawns to make his way post-haste to enforce the community’s important security precautions?
I didn’t end up finding out, because I got the code from my
parents and was able to open the gate. As soon as it opened, our knight on his
shining white steed proceeded to his house. I hope his family was all present
to hear this first rendition of his stirring tale of heroism.
Now, maybe you’re saying to yourself, “Rusty, this doesn’t
sound that strange. Maybe there have been break-ins, and he’s just being
conscientious of his neighbors.” I would be open to both of those arguments (I
probably wouldn’t, actually – gated communities are uniformly ridiculous) if I
didn’t have more information:
There is no continuous wall extending from the
gate around any portion of the development. The gate is completely ornamental
There are two other roads – one through a junk
yard and another through a neighboring RV community, which connect to the
community and are open at nearly all times to all comers willing to subject
themselves to 1-2 minutes of inconvenience.
The gates are wide open and unmonitored every
day between 8 AM and 5 PM.
I understand the intent of the gate. It’s an inward-facing
narrative, a story to tell people living there that their community is a refuge,
a place they can come home to without fear. There is (yes, still) some prestige
attached to living in a gated community, and some people derive some pleasure from
that. I’m not saying I agree with any of this, or that all of the people living
there care about these things, but it isn’t hard to grok the intent.
What was so shocking to me was that someone actually believed
in the gate.
The driver of that pickup truck would have blithely entered his community behind a smash-and-grab robber entering when most smash-and-grab robbers do (i.e. during daylight hours when people aren’t there to make it inconvenient) without a second thought. He would never dream of monitoring ingress past this high security feature to the south (pictured below). Probably hasn’t spared a single thought for the two neighboring and connecting properties.
But boy, when someone was trying to get in under a certain
of circumstances over which he had some direct control, his hackles were up. He
knew his duty.
It shouldn’t have been shocking to me. This good ol’ boy isn’t strange. He’s all of us, as investors and citizens alike.
Even when we know something is a story written for us, that
we are being told how to think or feel about something to serve someone else’s
purposes, there is a visceral, emotional part of us that wants to believe it. Needs
to believe it. We yearn to see it as an echo of some truth rather than a
construction, and when some paltry data emerges to confirm it, it becomes almost
irresistible. And when it is something where part of the narrative is control?
There’s a reason why investors loved high-net long/short equity for so many years. Even after they had experienced bad results. Even after they figured out that the incentive fee-on-beta thing was too high a hurdle for even the most gifted stock picker. We wanted to believe the story, and the idea that doing so gave us the ability to be both long or short, to vary our net exposures to respond to market opportunities. Nevermind that we’d never found anyone who was good at those things. It was a story we wanted to believe. More importantly, it was a Control Story.
It was the same thing back when every big asset allocator rotated from the usual awful MSCI macroregional classifications to ACWI and “Global Equities” about ten years ago, and then started rotating back to the old schemes after a couple more years of dominant US equity returns. Gotta be able to more easily overweight the asset classes that did really well in recent years, after all. The story was that managers would have all these levers to pull – Sectors! Countries! Currencies! Cash! Stocks! Even when we know in our heart of hearts that everyone is terrible at making each of these decisions (yes, the exception you’re thinking of in your head is terrible at it, too), it is still a story we want to believe. It is a Control Story.
I leave you to muse about how this could be applied to the stories behind growth PE and buyout funds in 2019.
You and I – and the cowboy in the white pickup – we’re vulnerable to Control Stories because we believe that we and our advisors will make decisions that matter. We will make better use of flexibility, options and control than others. And no matter how much we know in our heads and show in our actions that this is just an ornamental gate built to tell us a story, we will actively seek out ‘evidence’ to prove what we want to believe. If you seek out evidence in that way, you will always, always find it.
So how do we spot gates to a Country HOA in our portfolios, our frameworks and our daily conversations? Here’s a few that spring to mind:
“Multiple Ways to Win” is always and everywhere
a Control Story.
Decisions that are designed to allow you to take
more risk elsewhere are always Control Stories.
Arguments for transparency and what we will do
with it are Control Stories.
You’ve probably got a dozen more. Pop them into the comments below!
No, not every Control Story is wrong. Still, Clear Eyes means dialing up our skepticism when we hear them.
Especially when it’s a story we are telling ourselves.
Don Draper: What you call love was invented by guys like me. To sell Nylons.
In certain circles, it’s fashionable to assert that “words
are violence.” That is to say, certain language is used to perpetuate and
reinforce existing (typically oppressive) social power structures, and this is
a form of coercion on par with physical violence. For brevity, I’m going to
lump everyone who espouses these beliefs together under the broad umbrella of
In other circles, it’s fashionable to ridicule postmodern
ideas and the oft-ridiculous policies they inspire.
However, to the extent postmodern thought keys in on
narrative, and particularly the role of symbolic abstraction in shaping
individual and group identities, I’d argue there’s plenty of analytical utility
Where people run into trouble is when they attempt to turn a methodology for analyzing signs and symbols into a belief system. Because this type of deconstruction is an inherently nihilistic activity. Ultimately, there’s no there there [Incidentally, this also applies to science. Science is a methodology, not a belief system. And belief systems are what separate the Jonas Salks of the world from the Josef Mengeles]. Or, as Venkatesh Rao put it (much more eloquently):
“Losing [all sense of objective meaning] is a total-perspective-vortex moment for the Sociopath: he comes face-to-face with the oldest and most fearsome god of all: the absent God. In that moment, the Sociopath viscerally experiences the vast inner emptiness that results from the sudden dissolution of all social realities. There’s just a pile of masks with no face beneath. Just quarks and stuff.“
But that’s a subject for another note. A full hearts note. This
is a clear eyes note.
And in case you’re wondering, no, words are not equivalent
to physical violence. That is nonsense.
What is not nonsense is the notion that if you can
deftly manipulate the symbols people use to assign and create meaning in their
lives, you can manipulate their thoughts and behavior. We have a name for this
outside academia and the culture wars.
It’s called advertising.
Let’s unpack that Mad Men quote that led off this note. Don Draper is describing what academic types would call the “signified” and the “signifier.” The signified is the abstract concept, love. The signifier is the ad selling Nylons. The ad signals what love means—how love manifests itself in the world. How you should express it. How it should make you feel.
This relationship is the basis for language (human or
otherwise). Heck, it’s the basis for conscious thought. It’s therefore
the building block for both fiat news and fiat thought—the raw material our missionaries
use to build their wolf
Every missionary has his own version of the Don Draper quote.
Politician:What you call values were
invented by guys like me. To win power.
Fancy Asset Manager: What you call ESG was
invented by guys like me. To gather assets.
The Sell-Side: What you call a rotation
trade was invented by guys like me. To earn commissions.
An important thing to remember here is that awareness of how missionaries manipulate signs and signifiers is NOT the same as saying there are no such things as facts. It is NOT the same as saying there is no point to believing in anything. It is NOT an invitation to nihilism.
It IS, however, the foundation for a clear-eyed view of your world.
As they say in poker, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.”
– Berkshire Hathaway Chairman’s Letter (1987)
This is the ur-quote. The True Source from which all hedge fund investor letter quotes spring.
I’m not criticizing. It’s a great quote. I’m also not pointing fingers. We’ve used the true-to-Buffett ‘patsy’ version of the quote at least once in past Epsilon Theory notes. We have used the ‘sucker’ version at least six times, by my count.
Funny thing about this quote, though. It means something different depending on who’s saying it.
It is used most often by Very Smart People to wave indistinctly at a crude straw man in the distance they call Most Investors. This straw man is clothed with all sorts of really lamentable traits, you see. He buys when everyone else is greedy. He sells when everyone is fearful. He hates value stocks and he always pays high active management fees. If you ever happen to play poker with Most Investors, just remember that he is always, always the Patsy.
Slightly less often, it is used by equity investors and fund managers in reference to reasons they have incorporated some acknowledgment of behavioral finance, sentiment, consensus views or momentum into their thinking or their process. It’s the calling card of the Wise-Sounding Skeptic, who can always get some street cred for telling you that there’s no free lunch, or that anything that seems too good to be true probably is. Again, before you hit the search window up there, remember: I’m not pointing fingers.
Ironically, in both of these cases, the focus of the aphorism is about you or about them. The other people at the table, who are sort of the whole point of the thing, are rarely more than an abstraction of individual actors into some archetypal idea of “the market”, if not another layer of abstraction into that loosely related piece of conceptual art called Most Investors. Hell, even Uncle Warren’s original bit was about Mr. Market.
You know who gets it, though? Debt guys.
No, not universally. Contrary to popular opinion (see, I built my own Most Investors, too), there’s no ‘smart’ part of the market. There are plenty of lousy credit long-short PMs, and even more dummies who’ve made a nice living getting pensions locked up in sidepockets or second extensions on way too much of NAV because of poorly executed loan-to-own strategies. But the guys who are actually in the business of worrying about where the rights that matter sit in the cap structure are the guys who are also in the business of understanding who is sitting at the table with them.
Not in some abstracted Mr. Market sense, but in the real-world sense of “Hey, who else actually owns this shit?”
In practice, most modestly shrewd equity investors can get away with abstracting the poker analogy to Mr. Market without worrying too much about who else actually owns what they own and why. There are generalizable archetypes of behavior and preferences. We kind of know how the academic factor quants are going to respond to this or that. We kind of know that there are knowable quantities of price-indifferent passive money. We suspect there’s a certain amount of contrarian capital ready to BTFD, and a certain amount of CTA money ready to take one on the chin when they do. We let that one guy at JPMorgan throw a dart to be breathtakingly wrong again about how much risk-targeted AUM is ‘in motion.’ Whatever mental model we have isn’t going to be anywhere close to perfect, but it’s usually going to be good enough for Bayesian work.
But if anyone is willing to tell you that they have a view on how a speculative asset (see here for the particular definition of this term I mean) will perform in a period of stress for risky assets, or that it should have a weak or negative correlation to, say, equity markets, and if their analysis is based on some trait or analysis of the asset itself and not the behaviors of the specific people who own the thing, they are probably raccoons.
And yeah, there are a lot of suspects for this particular crime. Folks selling you crisis risk portfolios holding selling something other than long USTs? Crypto “hedge funds” with correlation matrices in the deck? They deserve your skepticism.
No, not all of them are guilty.
But if a fund manager, salesperson or consultant tells you they know of an asset class that will buck the trend if and when risky assets deflate, here’s a tip: ask them who the other people sitting at the table in that asset are. Ask them to be explicit. Ask them to tell you why they believe those people will respond that way and not in the price-sensitive way Most Investors respond to broad-based risk aversion.
When you do, if they can’t answer, or if they start talking ‘fundamentals’ of the asset, please call your local animal control.
Dry a subject as you’d imagine they would be, buybacks have become a topic every bit as polarizing as some of our political discussions. No matter how nuanced your view, it will be auto-tuned to some extreme by the obedience collar-wielding ideologues on one end of the spectrum or the dog whistle-wielding ideologues on the other.
Even now, someone is preparing a “stop with the bothsideism – it’s just math” response without reading any further.
It’s not about the math.
Sure, in nearly all cases where companies buy back stock, in the narrowest interpretation of that specific action of buying back stock, is management acting ethically and in the interest of shareholders”? Almost universally yes, because math. In a nearly universal range of circumstances, stock buybacks evaluated independent of other considerations are a really good, really efficient way to return capital to shareholders to deploy as they desire. In a very real sense, it can represent a company delivering on its most fundamental duty to the people who trusted it with capital: returning it to them with greater value.
So why isn’t it about the math?
Because the questions being asked about buybacks go beyond “in the narrowest interpretation, is management acting ethically and in the interest of shareholders.”
Because what buybacks (and any form of return of capital) tell us in general about corporate opportunities and American willingness to take business risk to produce returns at a macro scale matters.
Because what that tells us about how central banks and other policymakers are artificially influencing the relative attractiveness of those investment opportunities matters.
Because the way in which stock-based compensation structures may be exploiting the general (and appropriate) approbation of stock buy-backs among investors in order to mask the appearance of higher tax-advantaged compensation matters.
Because the way in which financialization in general is squeezing margins higher and making markets as measured on a P/E basis less expensive-looking matters.
Because even if you don’t think these things are nearly as bad as buybacks are good (and they are good), if you don’t realize that Wall Street is losing this meta-game, you aren’t paying attention.
You will cringe at the predictable framing of the issue around Michael Milken for some damned reason.
You’ll have ammunition ready to dispute the conclusions, robustness and analytical quality of the Fortuna study.
You’ll wince at the loaded word choices. “Draining capital.” “Corrupts the underpinnings of capitalism itself.” Really?
You will be ready to highlight how comparison of buybacks to corporate salaries without applying the same logic to dividends, debt reduction or any other effective return of capital is cherry-picking bias meant to inflame a certain kind of reader.
You will read the closing paragraph, chuckle at its sheer cheek, and find your brethren in the break room, colleagues at other shops and followers on social media to laugh about its bias and absurdity.
And you’d be in the right to do so. It is. It’s biased. It’s absurd.
And yet, it is also worth remembering our oft-told tale of coyotes and raccoons.
You see, you and me? We’re the coyotes. We’re wise enough to understand that those jars of pennies the Wilton retiree is shaking at us won’t actually hurt us. We know we’re right about the math of this efficient return of capital that is buybacks, and we’re going to shout down all this terrible analysis until everyone realizes we’re right. We are too clever by half.
Those guys in boardrooms figuring out ways to take advantage of our charitable passion for this issue to immunize their non-cash comp? They’re the raccoons. And they will continue to succeed in skimming the cream off their artificial EPS beats as long as we’re so focused on arguing with the Gell-Mann Amnesia-ridden readership of the Atlantic about the obvious damn math of buybacks.
It’s. Not. About. The. Math.
If we care about maintaining the flexibility of corporate management teams to deploy and return capital flexibly and with the least interference by regulators and politicians – and we should – every moment that we spend as an industry debating and analyzing the math of buybacks instead of actively seeking out and rooting out raccoonish boards and management teams is an utter waste of time. The right to return capital in a very sensible way will be legislated out of existence (again) while we thump our chests about whether the data-set used in some dumb article properly accounted for survivorship bias.
This topic is firmly in narrative land now, folks, and if you’re playing this as a single debate to be won instead of the metagame it now is, you’ll lose. But at least you’ll be right. So you got that going for you, which is nice.
Within six months of patient zero, they were everywhere.
Every gastropub. Every upscale comfort food concept. Every ‘American Brasserie’
in a gentrifying neighborhood. Every farm-to-table that became an OK-maybe-a-little-Sysco-to-table
after six months of food cost realities.
No, not the actual vegetable. That would be gross. No, I mean Brussels sprouts! These things that we quartered, soaked in olive oil and butter, bathed in salt and pepper and scorched until the memory of green was all that was left. These were things that, seemingly out of nowhere, an entire industry sold aggressively to a generation whose smell memory could still produce on command that acrid, metallic scent of unseasoned frozen sprouts being microwaved in water in a shallow Corningware dish – you know, the one with flowers or a cornucopia-style collection of earthy vegetables on the side?
Y’all, the only reason anyone orders
this vomitous cabbage is because it is transformed into a cartoon of itself.
But hold that thought for a
I had a colleague – now, sadly, passed away – who had a
favorite expression: blue light, blue suit.
The idea behind the idiom was that the job of a fiduciary was not to blindly deliver what a client wanted, but what they needed. Still, one couldn’t get around the fact that clients want to be sold on what they want. If they want a blue suit, then give them a blue suit, dammit. But not an actual blue suit that would be wrong for them. Give them the gray suit they need – and shine a blue light on it if you have to.
I had a boss whose oft-used variant was the red convertible. Do your analysis, add whatever conclusions, bells and whistles you want, even take it up a notch. But the thing I get at the end of the day better at least look like a red convertible.
I met another wealth advisor once who favored a food-related analogy for the same concept. Investors need to eat their broccoli, he said, so figure out a way to make it taste good. It was, as you might imagine, a story offered in defense of investment policy statements which emphasized asset classes and strategies which (nominally, anyway) diversified home country equity risk. Heavy on foreign equities, alternatives, real assets, that kind of thing. After 10 years of S&P dominance, nobody really wanted them, but they needed them. The trick, he figured, was making the clients OK with getting the things they needed but didn’t really care about.
It occurs to me now, I suppose, that the food-related
examples of this idea are overwhelmingly common. I know a CIO, for example, who
characterized some of his firm’s strategies as hiding the pill in the cheese,
a tactic immediately recognizable to any dog owner. It’s your job to give him what
he needs, and it doesn’t matter how he gets it.
This is the heart of the meta-game of money management.
It is easy to see for those inside the industry why this meta-game playing is necessary. I hope that it is also easy for those same people to see how it might go very wrong. In practice, however, our own self-deception about why we sell investment advice in certain ways makes it far more difficult to detect. In the interest of circumventing that self-deception, let me offer another axiom:
There is no wealth management firm in the world for which investment expertise is a sustainable competitive advantage.
This is the Brussels sprouts are objectively gross statement of the story I am telling here. The only difference is that whereas some of you may have sufficiently bad food opinions to reasonably disagree with that statement, if you disagree with the above statement about investment expertise, I think you are probably just wrong.
If you think that the edge in your advice service is performance, you are probably wrong. If you think that the edge in your advice service is investment selection, you are probably wrong. If you think that the edge in your advice service is investment insight, you are probably wrong. If you think that the edge in your advice service is uncovering new investment ideas, you are probably wrong. And yet, if prospective clients don’t believe that we can do each of these things, we will almost certainly fail to build a business. What’s worse, those prospective clients will do business instead with someone less scrupulous.
It is an uncomfortable truth, but the only reason we are usually hired is because we have been transformed into a cartoon of ourselves. A cartoon of relative expertise. A plate of Brussels sprouts, charred and covered with so much fat and salt as to be almost unrecognizable.
The inevitable path of the meta-game conscious financial adviser, then, is the creation of that cartoon of expertise. What does that cartoon look like? Well, we either celebrate some expertisey-sounding thing about our firm that really has nothing to do with expertise or the odds of any investment outcome, or we hold out the notion that something we are doing may be related to producing better investment results without exactly saying it.
We tout the home office’s resources.
We talk about the depth of our teams and resources.
We talk about team credentials.
We talk about our access to unique investments.
We talk about our ESG framework.
We talk about our research, our data, our analyst team.
We talk about our process.
We turn ourselves into a talking head. An expert.
In each of these cases, we may not say that these traits are definitely or explicitly related to better investment outcomes, but the reason we cultivate them and talk about them is absolutely to satisfy the client’s desire to hire a financial adviser with the most investment expertise. It is how we create a cartoon about our expertise, knowing full well that the client will associate that with their expected investment outcomes.
So if you’re a financial adviser, here’s the question you’ve probably asked yourself more than once: is this honest? Is it fair and good and right to heavily emphasize things in marketing that aren’t false, but which don’t really matter that much to the client’s outcomes, simply because we know the prospect or client cares about them? Does the fact that we really are delivering a very credible, high quality advice product at a really competitive fee that is far better than what the charlatans and churn artists out there are pitching mean that we can feel less bad about mentioning our amazing stock guy who’s had a great run the last few years ? Or the fact that our US-tilted portfolios outperformed our peer RIA across town, even though our positioning reflected bad diversification hygiene and our results reflected simple good fortune?
There’s a lot of salt and butter on those Brussels sprouts, y’all. These are hard questions. I don’t have an answer. But I do have a process: Clear Eyes, Full Hearts.
Clear eyes: There’s no way around it. We have got to talk
about these things. Our clients are grown-ups, and don’t deserve our
condescension. Yes, we’ve gotta have a page in our deck with the team’s years
of experience and degrees. Yes, it’s OK to talk about our process and why we
think it works. Yes, it’s OK to talk about historical client outcomes, provided
we’re doing it in a seriously, honestly, humbly non-promissory (and compliant)
Full hearts: No, we don’t have to build our entire proposition
on a cartoon of relative expertise. We don’t have to treat clients like
children, but we also don’t have to treat them like marks. I think that means emphasizing,
not just in marketing but in practice, the elements of financial and investment
expertise that are real, important and rare. I can think of six:
Identifying and consistently reevaluating
and delivering the right level of risk.
Delivering a nuanced, real understanding of
Really influencing household expense
Financial, estate, tax and philanthropy management.
Business consulting for entrepreneurs and
Structuring investments to properly
complement existing illiquid holdings.
The more important truth, of course, is that the single most important thing an adviser can deliver isn’t any of these things. It isn’t a question of investment expertise at all. It’s…well…advice. When risk appetites are high, restraining exuberant behaviors. When risk appetites are low, restraining fearful behaviors. And in all cases, working constantly to ensure that when these times arise, we have the kind of relationship and trust with our clients that will make them listen. The relationship is the thing. And while I’m not saying that you, individual FA, don’t have a couple relationships that are strong enough to withstand a pretty rough go of it, I think we all need to be pretty clear-eyed about how much of these relationships will boil down over time to the perception of the results we produce.
I am also not saying that you should not earnestly try to
outperform peers. I believe that there are behaviorally-driven strategies that
will (nearly) always work over sufficiently long periods, even if those periods
do seem to be getting, ahem, a bit longer. I believe that there are inefficiencies
driven by non-economic actors in a variety of financial markets that can create
opportunities with uncorrelated sources of return. I believe that there are
changes in the structure of markets that occur from time to time that can create
periodic sources of return. Ben and I spend half our time on these things, for
But they can’t be the fundamental value proposition. Not for someone who wants to do this the right way. Control your cartoon, but don’t let it turn you into a raccoon.
Interesting selection. You might be interested to know that something very similar (https://lambdaschool.com/) already exists. I have no association with them, other than working with some graduates and recommending people send their kids there as opposed to University. There are a couple of changes: 1. Students pay no tuition until the graduate and get a job that pays $50K plus/year. 2. The annual amount they pay is charged as a percentage of their salary and is capped both in what’s paid in a year (I think around $17K) and in total (I think its around $30). 3. There is testing to get in. 4. It is based around software engineering. 5. The program takes 9 months to complete. 6. Lambda school is incentivized to get the students jobs, though there is more demand for graduates than there are graduates.
I can attest that their graduates are excellent.
– Andrew Meyer (ET Subscriber, via website)
We are big fans of Lambda . That said, it is a software development-focused program, whereas we think the problem it would solve is much larger. Still, both our theoretical solution and the solution Lambda is actually pursuing are both incapable of solving the credentialing problem on their own. This is a demand-side problem (w/r/t labor), not a supply side problem.
I’ll add an anecdote from my earlier years…..I knew a Burmese family that was rather wealthy – the men told me that as part of their social education, they had to spend one month as Buddhist monks , and beg for food on the streets every day . Regardless of the fact that they lived in big houses with multiple servants or that their parents drove expensive European cars. The idea – to teach them humility …… Of course, they cheated by asking friends and relatives to give them food every day but I thought the original concept – humility – was a good one.
– Cartoox (ET Subscriber, via website)
One of the primary challenges of the American public school setting, I think, is its inability to cultivate humility. The entire experience teaches most students that strident confidence is the path to success. In fairness, that is ONE path to a form of financial success in some professions, but the kind of self-introspection and honesty necessary to achieve more meaningful forms of success don’t come easily to those who (like me) were educated in environments where maximizing relative comparisons was the most immediately profitable path.
I could quibble in detail and pick nits around the edges, but my first reaction is that I wish that had been there for me. This would change the world, and it got me wanting to start a school.
– Howard Wetsmann (ET Subscriber, via website)
Thanks, Howard. Me too.
This is stellar. I’d add a module on design/aesthetics and probably pull the calculus. Just a tiny bit of design training makes a world of difference in almost every aspect of business.
– Brent Beshore (Via Twitter)
I struggled over this exact thing. I don’t know that I’d swap out calculus (it’s a hill I’ve chosen to die on, for better or worse), but Brent is right – design is huge. The ability to frame an idea in words is powerful. The ability to frame it in visuals is no less powerful, and in some circumstances even more indispensable.
If this was your reaction, too, I probably agree with you.
There are some things here with which I’m in violent agreement, and a few which I’m not sure about. Most notably, Daniel’s list is high on meta-skills, as he points out, which I think is spot on in terms of what leads to professional, financial and personal success.These are things like ‘discipline’, ‘decision-making’ and the like.
When we consider education, however, I personally think that we must separate what is important from what a formal direct educational platform is the best venue to convey. I agree with Daniel, for example, that personal discipline, self-control and decision-making processes are going to be far greater indicators of success than whether you remember the derivation of Black-Scholes. Where I differ, perhaps, is that I think that these are skills that are best developed in live workplace situations. Entry-level professional projects have a comparative advantage vs. formal education in developing them, and I would not focus on them in a vocational program. Your mileage may vary, however – just my take.
I’d add a course in ethics. I took an ethics course in biz school that was revealing. The class was mostly mock situations wherein collaboration produced a satisfactory result, but individual promise breakers came out better. Everyone needs to know how it feels to be cheated.
– George Hill (Via Twitter)
Unfortunately, everyone will learn how it feels to be cheated pretty quickly in their career.
This is a similar point to the one I would make to Daniel: much of what we teach is based on what we believe is important, even if the setting isn’t one that will most effectively convey the lesson. Unlike Daniel’s point, however, I think that ethical behavior is a thing which – if it isn’t clear by the time someone has graduated high school – is probably either unlikely to be grasped at all or which has been very consciously ignored by the student. In either case, post-secondary instruction doesn’t seem as useful to me.
If reinforcement is useful, it will be in assuring young professionals that there is a path to financial success and opportunity that permits reciprocity and full heart behavior.Again, however, I think that is a thing that can only be learned in practical settings.
I rather enjoy playing golf. But there’s no denying golf is infested with raccoons trying to sell you stuff. Swing trainers. Special clubs. Systems “guaranteed” to lower your handicap.
This ranges from the oversold…
…to the utterly ridiculous.
Not to mention a fair bit of coattail riding on anyone with
an aerospace engineering background.
Golf’s a lot like investing that way. And a lot like life,
for that matter. Once I realized this, I began to enjoy the game much more, as
an exercise in both mental and physical discipline.
Any progress I’ve made on that front, I credit first and foremost to the book Every Shot Must Have a Purpose, by Pia Nilsson, Lynn Marriott and Ron Sirak. It’s rather critical of current methods of golf instruction and training—particularly of what the authors see as an overemphasis on technical mechanics at the expense of player psychology. Early on, they write:
This is where honesty comes into play. The first step toward expanding our perception of the game in general and reaching a better understanding of our own game in particular is to face reality. If that bad swing was caused because you tensed up under pressure, hitting a million practice balls won’t fix the problem.
Rather than the minutiae of swing mechanics, or gimmicky
shortcuts, you’re better off focusing on:
Course strategy and risk management
Focus and tempo
We see this in investing, too. Particularly when we’re
investing other people’s money. The most grievous portfolio construction issues
I see inevitably seem to center on basic issues of strategy and commitment.
Particularly around whether a portfolio should be built to seek alpha or simply
You don’t have to shape your shots every which way and put
crazy backspin on the ball to break 90 in golf. Likewise, not every portfolio
needs to, or even should, strive for alpha generation.
There are few things more destructive (or ridiculous) you can witness on a golf course than a 20 handicap trying to play like a 5 handicap. And it’s the same with portfolios. For example, burying a highly concentrated, high conviction manager in a 25 manager portfolio at a 4% weight. Or adding a low volatility, market neutral strategy to an otherwise high volatility equity allocation at a 2% weight. (See: Chili P is My Signature)
I’ll go out on a limb and suggest very few financial
advisors and allocators build portfolios capable of generating meaningful
amounts of alpha. The hallmarks of portfolios purpose-built for alpha
generation are concentration and/or leverage.
The hallmark of a portfolio lacking strategic direction and
commitment, on the other hand, is optical diversification that rolls up into
broad market returns (more pointedly: broad market returns less expenses).
I’m absolutely not arguing every portfolio should be
highly concentrated. Or that every portfolio should use leverage. I’m merely
arguing that portfolios should be purpose-built, with portfolio construction
and manager selection flowing logically from that purpose.
How is it we end up with portfolios that are not
We don’t commit to the shot.
Nilsson, Mariott and Sirak describe a textbook golf example:
Patty Sheehan, the LPGA Hall of Fame player, was playing the final hole of a tournament when she needed to hit a fairway wood second shot to a green protected by water on a par-5 hole. A birdie was essential to play in contention, and the possibility of an eagle was a chance she had to take. What resulted, however, was her worst swing of the day–in fact, probably one of the worst swings she ever made in competition—and she cold topped the shot. As the ball bounded down the fairway and into the creek short of the green, she watched her chances of winning disappear with it. […]
[T]he TV commentators missed the point. If they wanted to run a meaningful replay they should have shown the tape of the indecision BEFORE Sheehan hit the shot. First she had her hand on a fairway wood, then she stepped away from the ball and her caddie handed her an iron. Then she went back to the fairway wood. The indecision in the shot selection led to a lack of commitment during the shot. The poor swing resulted from poor thinking.
For an investment committee, the rough equivalent is the
four-hour meeting that results in a 50 bps change (from 4.50% to 5.0%) to the
emerging markets weight in the Growth model portfolio.
At best you are rearranging deck chairs with these kinds of
Granted, when it comes to investing some of us will have a
more difficult time managing shot commitment than others. For the self-directed
individual, this is simply a matter of managing your own behavior. Advisors and
institutions, on the other hand, must manage other people’s behavior,
often in group settings.
There’s no easy solution to this issue. It can be fiendishly
difficult to manage. But there’s at least one essential precondition for shot
commitment in investing and that’s a shared investment philosophy. A code.
I’m not talking about the obligatory investment philosophy
slide of everyone’s investor deck that’s included to pay lip service to a
“process orientation.” I’m talking about genuine philosophical alignment. The
kind of philosophical alignment that runs deep into the marrow of the decision
makers’ bones and therefore permeates every aspect of portfolio design and
What does this look like in practice?
More time spent on philosophical discussions around
persistent sources of returns and, more importantly, whether the investor(s)
can credibly access them.
Significantly less time spent on chasing shiny
objects, debating the merits of individual investment manager performance and
statistical rankings of investment manager performance. (In fact, it’s okay to
spend basically no time on this at all)
Significantly more time spent on managing the
alignment of expectations across investment professionals, clients and other
stakeholders in an accessible, plain-language manner.
This is fairly straightforward in principle, but extremely challenging to execute.
At the urging of some pack members – and because we thought it was a great idea – we will be hosting the first official Pack Gathering in our headquarters town of Fairfield, Connecticut. The idea is, well, ideas. Genuine connection. But if you’re part of the Pack already, we think you probably already know what you’d want to get out of a time like this.
We want an intimate affair, so we are keeping the event to thirty pack-members, solo and sans family for this first event. Because of the limited number of spots, please only sign up if you’re sure you can and will attend.
Spots will be held open for ET Professional subscribers through Friday, July 12th, after which we will open up remaining spots to ET Premium subs. To sign up, simply email Harper at email@example.com.
Date and Time: 5PM on Saturday, August 31, 2019 Location: Fairfield, CT. Address to be provided to those signing up. Format: It’s a BBQ. Think beef, chicken and a pig roast. We will have a couple vegetarian options, but I’ll be honest – they’re going to be lame. Dress like you would for a backyard BBQ. Cost: None. Bring a wine, beer or spirit you’d like to share with the group. If you don’t drink, then feel free to bring something else you think people would enjoy.