But Our Interests Are Aligned!

Professor Harold Hill (Harold Hill!)

Harold Hill: Ladies and gentlemen, either you are closing your eyes to a situation you do not wish to acknowledge, or you are not aware of the caliber of disaster indicated by the presence of a pool table in your community!

— “The Music Man” (1962)

For those of you who have somehow never seen a high school production of “The Music Man”, the plot goes something like this. A con man by the name of Harold Hill comes to River City and convinces the town folk that their youth are on the slippery road to perdition, and that the only solution is to establish a wholesome marching band that Hill is happy to lead. Just pay in advance for those band uniforms and instruments, please.

The modern use of stock-based compensation is a confidence game, in the true sense of the word, that would be very familiar to Harold Hill. What’s the slippery road to perdition? My goodness, it appears that your management team doesn’t have enough skin in the game. Surely disaster is nigh! The solution? Why, stock-based compensation, of course. Wholesome profits for all will flow like water once management’s interests are “properly aligned” with shareholders. Just pay in advance, please.

I know it seems like I’m picking on Marc Benioff, the new savior of Time Magazine. I mean, I guess I did call him a modern-day robber baron in yesterday’s In Brief note. But honestly, I say that in the nicest possible way. Marc Benioff is a freakin’ genius, an absolute master coyote who plays the metagame better than anyone whose last name doesn’t rhyme with Mayzose or Stuffit. Hat’s off to anyone who figures out the market zeitgeist and parlays that into not only billionaire-dom, but liquid billionaire-dom.

No company has played the stock-based compensation game better than Benioff’s brainchild, Salesforce.com, to the benefit of not only Benioff, but everyone in management (particularly sales) at Salesforce. Here’s how it works.

Since Salesforce became a public company, its revenues have grown at a wonderful clip. It’s EBITDA (earnings before interest, taxes, depreciation and amortization) and net income available to common shareholders… not so much.

Source: Bloomberg

Where have all the revenues gone, if not into earnings and net income? Well, if you read the Wall Street analyst reports about Salesforce “beating its earnings estimates” every quarter, you’d think that this chart above must be wrong. Why, Salesforce has lots of profits! Sure, it trades at a high P/E multiple, as befits a company with such great revenue growth, but the consensus Wall Street earnings estimate for this quarter is $0.50 per share. With 756 million shares outstanding, that’s about $375 million in earnings this quarter alone. What gives?

What gives (among other things) is stock-based compensation. The earnings estimates that you’ll hear the CNBC analysts talking about Salesforce “beating” or “missing” are pro-forma earnings. They do not include stock-based compensation. Actual money paid to employees? Yes, that’s included. Stock paid to employees in lieu of actual money? No, that’s not included. If you included stock-based compensation (and all the other pro forma adjustments) as actual expenses, which of course they are, then the consensus Wall Street earnings estimate for this quarter is not 50 cents per share. It’s 2 cents per share.

Since it became a public company in 2004, Salesforce.com has paid its employees $4.8 billion in stock-based compensation. That’s above and beyond actual cash compensation. For tax purposes, it’s actually expensed quite a bit more than that, namely $5.2 billion. The total amount of net income available for common shareholders? $360 million. On total revenue of $52 billion.

Note that none of this includes the money that Benioff himself made in stock sales from 2004 through 2010, where he sold between 10,000 and 20,000 shares of stock in the open market PER DAY, EVERY DAY, for SIX YEARS.

In the immortal words of Ron Burgundy, I’m not even angry. It’s AMAZING what Benioff has been able to pull off for himself and his people. Nor am I suggesting in the least possible way that any of this is illegal or immoral or ethically suspect.

What I am saying is that this is a confidence game in the true sense of the term.

What I am saying is that investors have paid in advance for their band uniforms and instruments.

What I am saying is that you can sell a lot of software if you pay your sales team handsomely and investors don’t care about the expense or the profitability of those sales.

What I am saying is that this is only possible within a vast Wall Street and media ecosystem that tells investors not to care about the expense or the profitability of those sales.

What I am saying is that we have all seen this movie before.


You Provide the Pictures and I’ll Provide the War

Rosebud.

Time Magazine Sold to Salesforce Founder Marc Benioff for $190 Million

— Wall Street Journal, September 16, 2018

Real-life billionaires aren’t young Citizen Kane. They don’t buy media properties as vanity projects or as part of a crusading public interest. No, real-life billionaires are old Citizen Kane. They buy media properties because they understand the political and economic power of Fiat News. They buy them because these properties are the indispensable asset in an effective metagame strategy to maintain their empires.

Fiat News isn’t counterfeit news. It’s not an outright lie. Fiat News is opinion presented as news, and once you start looking for it, you will see it everywhere. For Charles Foster Kane, modeled after real-life billionaire William Randolph Hearst, the opinion presented as news could be as personal as a glowing review for the screeching operatic debut of his songbird wife, or as political as blaming Spain for blowing up a battleship. As real-life Hearst once said to a staffer, “you provide the pictures and I’ll provide the war.”

For modern-day William Randolph Hearsts, like Jeff Bezos (personal owner of the Washington Post) or Marc Benioff (the new personal owner of Time Magazine), I don’t think the goal is to start a jingoistic war in order to further a political career. But these modern-day Citizen Kanes DO have political goals in mind when they purchase these media assets.

As the old saying goes, you have to fight fire with fire. And to withstand the political barrage that the White House has rained down on Amazon over the past year … a barrage that is only going to increase in scope and intensity over the next decade regardless of who wins the 2020 election, as Bernie and Elizabeth and Kamala all get in on the Amazon-bashing act … Jeff Bezos needs the Washington Post to rain down a barrage of his own.

Salesforce.com isn’t getting the same sort of treatment from D.C. that Amazon is getting. Yet. But I think it’s coming. I think a hard rain is going to fall for modern-day robber barons like Benioff, men who have built multi-billion dollar personal fortunes out of serial acquisitions of profitless software companies and constant stock sales. And by constant I mean constant. From 2004 through 2010, under a series of 10b5-1 plans filed with the SEC, Marc Benioff sold at least 10,000 shares of Salesforce.com stock … Every. Single. Day. You can go on the SEC’s EDGAR website and look it up yourself. It’s really pretty awe-inspiring when you think about it.

What does Marc Benioff want from Time Magazine? He wants this. He wants the ability to create Fiat News. It’s the smart play for an Oligarch like Benioff. A really smart play.


True Freedoms / Hollow Freedoms

Author of The Rights of Man, Thomas Paine

I’m in a mood this morning, getting sucked down by what I see as the casual abdication of our individual autonomy of mind, the exchange of True Freedoms for Hollow Freedoms. And not even a begrudging exchange, but an enthusiastic one. A seller’s market, as it were, for Hollow Freedoms. Then I remembered this piece from a year ago (“Pecking Order” November, 2017). It helped me get back on track in thinking about a positive program forward. Maybe it will help you, too.

In January 1941, eleven months before Pearl Harbor brought the United States into World War II, Franklin Roosevelt gave his Four Freedoms speech, memorialized over the next few years by Norman Rockwell in these famous paintings.

What is autonomy of mind? It’s freedom. What freedoms? These.

Read moreTrue Freedoms / Hollow Freedoms

Lehman and the Meta-Game of Trading

Lehman Brothers sign being carried to auction.

A cornerstone of the Epsilon Theory research project is the meta-game. It’s the subject of the most popular ET note to date – “Too Clever By Half” – and I think it’s the most important game theoretic concept to master if you want to have a successful career in financial services. Or a successful career in anything, really. But what I haven’t written about is when the idea of the meta-game first really hit home for me. It was 10 years ago to the day – September 15, 2008 – the day that Lehman went under.

A “game” in the technical sense of the word is a strategic interaction, meaning that your decisions are contingent on my decisions, and my decisions are contingent on your decisions, and we both know it. Consciously or not, we are all playing games all of the time. A meta-game is a larger game that contains a bunch of smaller games. It’s typically a long-term strategic interaction, and it’s almost always harder to wrap your head around than an immediate game. It’s not the same thing as a repeated-play game, which is its own interesting thing, but not this interesting thing. A meta-game is the big picture. A meta-game is the forest, not the trees. A meta-game is the portfolio, not the trade. A meta-game is the career, not the assignment. And yes, there are meta-games on top of meta-games.

I can’t say this next part without sounding braggy, but I’ll make up for it by sounding quite meh and fallible at the end. 2008 made my career. Our hedge fund did well in 2005 and 2006 and 2007, but lots of hedge funds did well those years. Very few plain vanilla, stock-picking long-short hedge funds were up 20%+ in 2008, but we were. It was the best game I’ve ever played, and yes, it was by turns exhausting and terrifying, but also yes, by god it was fun!

Until Lehman went bust.

It was all funny money until September 15. It was all symbols and flashing numbers on your Bloomberg terminal. It was all playing the game of markets. It was all figuring out in your head how those symbols translated to a portfolio P&L for the day and what your cut of that would be. If you tell me you don’t know what I’m talking about, then you’re a liar. I know that few people had that experience in 2008, but everyone reading this note has had that experience sometime. It’s the experience of greed and it’s the experience of winning. It’s a damn good feeling.

So yeah, I’d love to tell you that my transformative meta-game moment associated with the Lehman collapse was my sudden realization that I had friends who had just lost their jobs, that I was stricken by empathy for their plight or that I was worried about the lives and careers and fortunes that had been ruined. But nah.

How am I gonna get paid if everyone goes under?

Yep, that was my utterly selfish and utterly real meta-game moment. I didn’t mean that I had counterparty risk with Lehman directly. No, I had rewritten (what’s called novation) all of my Lehman OTC contracts over to JP Morgan a couple of months earlier, just like I had gotten out of Bear Stearns prime brokerage a few months before they went belly-up. Like I say, best game I ever played.

But what if it’s ALL finished? What if ALL of the counterparties close their doors? What if the entire system collapses? Who’s going to pay me?

I remember that day with a fair amount of remorse and shame, but not for the reasons you might think. I’m not at all remorseful or ashamed for being self-interested and greedy. If you’re in the professional investment world and you’re going to feel bad for that, then you are in the wrong line of work. No, I feel remorse because as well as I played the game of markets in 2008, I played the meta-game of markets like a noob. Which I was, but still.

September 15, 2008 was the day to start planning a levered long position, if not a levered long product, if not a levered long business. Because if the system collapses then you’re just part of the carnage, and if the system doesn’t collapse then you win.

This was David Tepper’s famous “balls to the wall” thesis in 2010, and it’s why he’s a billionaire and I never will be. This was supposedly part of Warren Buffett’s rationale for selling billions of dollars of naked puts on the S&P 500 and placing Berkshire in existential jeopardy, and it’s part of why he’s the greatest coyote of all time. No one plays the meta-games better than Uncle Warren. No one.

But instead of thinking through the meta-game in any consequential way, I stayed mired in the immediate game of markets. I breathed a sigh of relief when the world didn’t end alongside Lehman, I got paid, and I went on my myopic way. I recognized the meta-game’s existence, but I wasn’t able to conceive of myself as a strategic actor within it.

And that’s why I write Epsilon Theory the way I write Epsilon Theory … because I’m not going to make that mistake again.


Hunt's Law: An Experiment

Dumpster Fire

Hunt’s Law (fake news drives real news out of circulation) applies everywhere today, even to Hunt.

I’ve started posting weekly short-form Epsilon Theory notes on LinkedIn. I’m always interested in finding new venues to spread the ET word, and the good people at LinkedIn corporate are soooo much more helpful and inviting than the good people at another social media behemoth that rhymes with crook.

The distribution feature I was most interested in testing with the LinkedIn posts was comments. I’ve never implemented a comments feature on the ET website, because on the one hand there’s no quicker way to ruin your equity value if you’re hijacked by a know-nothing commentariat a la Zerohedge, and on the other hand there’s nothing sadder than a deserted but oh-so clean comment section. When it works, though, it’s magic.

I’m still not sure where I’m going to end up on comments, but there’s a case study in the hijacking phenomenon happening with the most recent short-form note that I posted on LinkedIn – “Controlling Your Cartoon: Nike and the Necessary Meme” – which is a (very) lightly reworked version of the ET short-form note – “Controlling Your Cartoon: Nike and the Art of the Meme“. To recap what that note is all about, it argues that the polarizing Nike/Kaepernick ad is a smart business move in an already polarized society. In exactly the same way that centrist political candidates lose to more extremist candidates on both the left and the right, so do centrist marketing campaigns lose to more extremist campaigns on both the left and the right.

To be clear, I’m not upset about the hijacking. I expected this note to be hijacked, because it’s intentionally provocative with the Nike/Kaepernick ad teaser. And wow … it did not disappoint.

Most everyone reading this post is also a LinkedIn member, so I’m not going to take screenshots of all the comments and reprint them here. But here’s a representative submission:

Actually, it’s not really a representative submission, because it’s written well and isn’t over-the-top enraged. But it is representative of the 90% of comments that are responding VERY negatively to the Nike ad itself, and have NOTHING to say or do with the actual content of my note.

But here’s another interesting datapoint. In addition to being the most commented-on note I’ve published on LinkedIn, it is also the most LIKED note I’ve published on LinkedIn, both in absolute numbers and as a percentage of views!

Now … I’ve got a healthy ego, but I’m not so insane as to think that all of these Likes are for the actual content of my note, any more than the comments are for the actual comment of my note. No, the Likes are people who have a positive reaction to the Nike ad itself, but have zero desire to dive into the swirling waters of hater comments.

I’m still mulling over what this all means and whether there’s any way to design a more rigorous experiment here (if only LinkedIn had a Dislike button …), but I’ve got one clear conclusion already:

That social media behemoth with a name that rhymes with crook has already run these experiments and knows the answers.

Oh, and one more thing … Nike’s stock price hit an all-time high yesterday.


Hunt's Law

Queen Elizabeth I

Gresham’s Law: bad money drives good money out of circulation.

Hunt’s Law: fake news drives real news out of circulation.


I first came up with Hunt’s Law for an Epsilon Theory piece called “Fiat Money, Fiat News“. It’s worth your time to read, but out of respect for our TL;DR world, here’s the skinny:

Just as modern money is constructed out of nothing more than the confidence we have in the governments that print it, so is modern news increasingly constructed out of nothing more than the confidence we have in the Missionaries who proclaim it.

And just as counterfeit money drives good money out of circulation by encouraging holders of good money to hoard it rather than exchange it for what might be bad money, so does counterfeit news drive real news out of circulation by encouraging holders of real news to keep quiet rather than engage in an exchange with what might be fake news.

The money aspect of this was first codified in the 1500s by Thomas Gresham, an advisor to Queen Elizabeth I. The Queen was mighty vexed by the moribund English economy of the day, a distress that Gresham laid squarely at the feet of Elizabeth’s father, King Henry VIII. It seems that late in his reign, Henry had decided to start issuing silver coins with only half the silver content of his original silver coins. Once everyone got wise to the diminished actual silver content of the coins, the exchange of food or clothes or land or whatever for silver coins came to a screeching halt. Everyone wanted twice as many silver coins as before to make an exchange, because they weren’t sure whether they were getting the good old coins or the bad new coins. This was particularly problematic in the banking sector, where gold was the ultimate store of value. Rather than be forced by the Queen to exchange their good gold for suspect silver, bankers and anyone else with a gold coin either buried it in the backyard or, better yet, found a way to get their gold out of country entirely.

I thought of Gresham’s law the other day when the stories came out about Trump telling Gary Cohn to just “print more money” to solve our burgeoning budget deficit. He really is a Henry VIII cartoon, right?

And I thought of Hunt’s law this morning when Trump tweeted that only a handful of people had died in Puerto Rico from Hurricane Maria. JFC.

In the 1500s, the big problem was having your currency debased.

Today, the big problem is having your information debased.

To be clear, the debasement of information into Fiat News – the proclamation of opinion as fact – started waaaay before Trump. If you can’t see that EVERYONE in the mass media and mass political universe, on BOTH sides of the political aisle, isn’t engaged in the Fiat News debasement game … well, you’re blind. It’s just that Trump is really, really good at playing this game.

How does it end? Not well, I’m afraid, if history is any guide. Elizabeth I used the carrot and the stick of the State to force the general acceptance of the bad new coins over time. Want that government contract? Gotta play ball. Caught you taking your gold out of the country? Why you must be an Enemy of the People. Off with your head. Literally, not figuratively. Yep, the State has muscle and the State has time. We’ve got fear and greed. One guess how this plays out.


Repo 105

Dick Fuld

Branded a Villain, Lehman’s Dick Fuld Chases Redemption

Wall Street veteran, pilloried over bank’s collapse, has said his firm didn’t have to die. A new book agrees. – Wall Street Journal (September 6, 2018)

Every time Dick Fuld’s publicists succeed in getting a “redemption story” published in the Wall Street Journal or New York Times, I’m going to write an Epsilon Theory brief about Repo 105, the fraudulent scheme that Lehman Brothers ran for years to hide its deteriorating financial condition from investors and regulators alike.

Here’s what makes the world go round: you can borrow more money than you have in liquid assets.

That’s what a mortgage or an auto loan or a college loan is. You don’t have enough cash to buy that house or car or college tuition all at once, so the bank gives you the cash to make the purchase. But by the same token, banks are by necessity lending out more cash than they actually have deposited with them. This is both the gasoline and the oil for the modern economic engine, and if you and I didn’t go into debt and the banks didn’t lend more than they have in deposits, the engine would seize up and our entire economy would come to a screeching halt. This is, in fact, what causes Depressions.

But in exactly the same way that you or I might be in trouble if we borrowed a lot more money than we have stashed away in a bank account somewhere, a bank might be in trouble if it lends out a lot more money than its underlying customer deposits or invested capital or otherwise loan-supporting reserves warrant. And in exactly the same way that the banks review our financial records before giving us a loan to make sure we’re not borrowing too much money for the bank’s standards, so does the government review a bank’s financial records to make sure they’re not lending too much money for the government’s standards. And by government standards I mean laws.

Repo 105 was a multiyear scheme by Lehman to defraud the government and its own investors by falsifying the actual amount of loans it had on the books, making Lehman look safer than it actually was.

It worked like this. A few days before the end of the calendar quarter, Lehman would “sell” billions of dollars worth of loans to another bank. I put “sell” in quotation marks, because Lehman ALSO had an agreement with these other banks to buy the loans back a few days after the quarter ended for the same price as they were sold, plus enough money to cover whatever the going interest rate was on that cash for the few days it was in Lehman’s hands. This is what’s called a repurchase agreement, or repo, hence the name Repo 105 (the 105 refers to the 5% overcollateralization that counterparty banks required to lend the cash to Lehman even for a few days – they knew Lehman was in trouble). Since financial reporting happens at the end of the quarter, Lehman’s books would look like they had more cash and fewer loans than they actually did.

Surely, you say, no law firm would bless this blatant attempt to cook the books? And I say, don’t call me Shirley. I say, well … no US law firm would bless this, so naturally Lehman found a UK firm, Linklaters, to say that this was, in fact, technically a “true sale”. Even then, to pull this off Lehman had to run Repo 105 through their offshore subsidiaries, not through their US-chartered entities. It was really expensive for Lehman to run Repo 105. But also entirely necessary, or else the entire house of cards that WAS Lehman would have collapsed well before September, 2008.

What about Lehman’s auditors, you ask, surely no auditor would go along with this scheme? Again … Shirley. Again, Lehman found that Ernst & Young would indeed sign off on the program, in exchange, of course, for a sharp increase in fees. The state of New York filed civil fraud charges against Ernst & Young over Repo 105 in December, 2010. I believe they paid a (small) fine.

Dick Fuld claims that he knew nothing about the Repo 105 program. The only possible answer to this, and here I’ll apologize in advance for my language, but it’s really the best possible word – bullshit. Did I mention that Repo 105 was a really expensive program to run? Did I mention that Dick Fuld’s nickname was The Gorilla, that he was infamous for controlling everyone and everything at Lehman? Did I mention that Repo 105 was concealing existential risk for Lehman?

If you or I did what Lehman did with Repo 105, we would be charged and convicted of bank fraud. Happens all the time. It’s pretty much what Paul Manafort just got convicted on. This is a crime. It is not a minor crime. It’s an absolute slam-dunk case for any prosecutor in any jurisdiction in the country. And yet, with the exception of the civil fraud charges brought against Ernst & Young, no other charges – civil or criminal – were ever filed by the SEC or the Justice Department in connection with Repo 105. 

When was I radicalized?

When Dick Fuld walked away scot-free from the wreckage of Lehman after getting half a billion dollars in cash comp and stock sales during his tenure.

Never forget.


Controlling Your Cartoon: Nike and the Art of the Meme

Colin Kaepernick

The key to political and commercial success in a widening gyre? Controlling your own cartoon.

By now you’ve seen this Nike/Kaepernick ad everywhere, along with the knock-offs and the jokes and the protests.

My personal fave meme adaptation of the Nike/Kaepernick ad is, of course, from Epsilon Theory‘s own Rusty Guinn (@wrguinn), with his brilliant FinTwit take on Bill Ackman.

But I’m also partial to the various Marvel takes here. (WARNING: Spoiler Alert)

There are hundreds of these repurposed Nike/Kaepernick ads out there today, some of them funny, most of them serious, many of them angry.

You’d think that the anger would be a bad thing for Nike. You would be wrong.

In the same way that there is no winning centrist politician and no stable centrist policy in a polarized society, so is there no winning centrist commercial identity and no stable centrist marketing policy in a polarized market.

I’ve written a lot recently (Things Fall Apart, part 1 and Things Fall Apart, part 2) about the political polarization of America. Or, to use the 10-dollar phrase, what happens in a two-party system with high-peaked bimodal voter preferences.

In a nutshell, we are in what Yeats called a widening gyre, where for any centrist candidate or policy, there exists a winning majority of voters on both the left AND the right who will favor a competing candidate or policy on both the left AND the right. This is what it looks like when the political center does not hold.

But it’s not just our political center that doesn’t hold, it’s any system based on expressing an identity. Like buying sneakers. What’s the difference between Nike and adidas shoes? You got me. I don’t think there is an appreciable difference. The only place where Nike can create a difference between themselves and their competitors is in the self-proclaimed identity of the Nike shoe-wearer. So that’s what every bit of Nike’s marketing is designed to do. Not sell you on the fundamental qualities of the Nike shoe, but to sell you on what it tells the world about you to wear a Nike shoe.

How do you sell an identity? You create a highly abstracted version of that identity. What is that? It’s the technical word for cartoon. How do you know if you’ve got an effective cartoon? It becomes a meme. People repurpose your cartoon for their own ends. People make fun of it. People get angry at you. This is not a bad thing. It is, in fact, a necessary thing.

To succeed in a polarized political or economic system, you must create a polarizing cartoon of yourself. Why? Because if you do not create your own cartoon, your adversaries will impose a cartoon on you.

Look no farther than the 2016 presidential election, where the negative cartoon-ification of Hillary Clinton was both the most vicious and the most effective gambit in the last 100 years of American politics. To be sure, The Clintons™ brought soooo much of this on themselves. If there’s ever been a political candidate more ripe to be transformed into a negative cartoon than Hillary Clinton, I am unaware of who that might be. But where Donald Trump embraced and actively created his obvious cartoonishness, Hillary Clinton had her cartoon imposed on her unwillingly, to disastrous result.

Yes, this is why Trump won. And it’s why Nike is winning with this ad campaign.


19th Century White Papers

Glenmutchkin

The most frequent question I get is “what do you read?”, and I sense that people are really disappointed when I tell them comic books, short stories, and science fiction. Oh, I start plenty of “real” books, and I’ll breeze through them, slowing down in parts for something that seems immediately relevant. I’ve got two stacks of these books in my bedroom and four in my office. I’m sure that one day I’ll make my way through them, in exactly the same way I’m sure that I will reply to all of those emails that I’ve carefully tucked away in some folder. Yeah, right.

Read more19th Century White Papers

They Don’t Think It Be Like It Is, But It Do

Oscar Gamble

They don’t think it be like it is, but it do.

– Oscar Gamble (1949 – 2018)

I’ve always loved this beautiful line from Oscar Gamble – who, sadly, passed away earlier this year. I referenced it in the first of my Things that Matter series last year, a note called Whom Fortune Favors.  The gist of it is: when we are active in a specialized field for a very long time, or when we have a highly technical understanding of a narrow field, we often miss what should be obvious truths about that subject staring us in the face.

Read moreThey Don’t Think It Be Like It Is, But It Do

Cartoons Against Humanity

Bugs Bunny the Barber

Wages Are Growing Faster Than You Think, White House Says

Trump advisers calculate hourly pay grew 1% in the second quarter, rather than the official figure of 0.1%, citing a new way to measure

Nowhere is the cartoonification of data more obvious than in the construction of labor reports, and nowhere is it more influential on markets and politics.

Read moreCartoons Against Humanity

We're on Number 9

Number 9

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

If you’ve never read Friedrich Hayek’s The Road to Serfdom … that’s okay, most people haven’t. But do yourself a favor and at least read the Classics Comic Book version I’m copying from here, The Road to Serfdom (in Cartoons). The Hayek cult is just as silly as the Elon cult or the Uncle Warren cult or the crypto cult, and I’m not saying that Hayek was some Nostradamus. But I AM saying that Hayek was a really smart guy who believed with all his heart in small-l liberal virtues and keenly observed the politics of the world the last time we got into such a global mess.

We’re on Cartoon #9 today, well on our way to Cartoon #10.

Read moreWe're on Number 9

Hot Rocks

This is my 250th Epsilon Theory post. Yow! While there’s no getting around some repetitiveness on the major themes of ET, like the Narrative Machine or the Common Knowledge Game or the Three-Body Problem, I do my best to keep the story arcs fresh by not repeating myself in the ephemera – the movie quotes and graphics and the like. But there’s one quote that I’ve used three separate times, and two graphics that pop up again and again. So for this 250th note I thought I’d call out these Hot Rocks of Epsilon Theory.

[And yes, one day I fully intend to rent out Swarkestone Pavilion and recreate this Stones pic with the Epsilon Theory band. It’ll be Rusty in the foreground … he is the drummer, after all. Jeremy and I are more the peacock-in-the-window type.]

Here’s the quote:

Shape clay into a vessel;
It is the space within that makes it useful.
Cut doors and windows for a room;
It is the holes which make it useful.
Therefore benefit comes from what is there;
Usefulness from what is not there.
– Lao Tzu (c. 530 BC)

I’ve used this quote in “The Tao of Portfolio Management“, “Who’s Being Naive, Kay?” and “The Arborist“, three notes that speak directly to portfolio construction. A portfolio is, after all, a vessel. It is a container for our financial investments, and what we leave OUT of that container is every bit as important as what we put IN.

But the wisdom of this quote goes way beyond investing. Our homes, our businesses, our friendships, our marriages, our children … our lives themselves … vessels all.

Not every empty space needs filling.

And here’s the first graphic that I’ve used repeatedly in Epsilon Theory notes, ad-man Harvey Ball’s 1963 smiley-face button, brilliantly adapted by Alan Moore and Dave Gibbon for their classic graphic novel, Watchmen:

Watchmen is one of those life-informing books, or at least it was for me. This button, worn by the Comedian, a villainous hero or heroic villain (it’s hard to tell), is my personal emblem of smiley-face authoritarianism, aka the Nudging State. It’s just so messy to stomp on someone’s face when you can cleanly accomplish the same ends with “choice architecture” and “communication policy”.

It’s all Fiat News all the time today, where opinion is presented as fact, and we are all shamed into compliance.

And here’s the second image I’ve used a couple of times in ET notes, originally in “Stalking Horse” and most recently in “Fiat Money, Fiat News“.

It’s an illustration of a wolf trap from Le Livre de la Chasse (c. 1407). It’s a pretty simple design, consisting of a blood trail set through a one-way door in a circular wicker fence built around a central pen with a scared, bleating sheep, but man, is it effective. The design has three crucial elements. First, the circular outer wall is hard for the wolf to escape if he gets wise to the trap, and the circular inner wall keeps the live bait … alive. Second, wolves expect to hunt and track their prey. By establishing a longer trail that must be navigated successfully the wolf becomes more committed to the trap the farther he goes. Third and most importantly, the design prevents the wolves from seeing each other until they get to the end of the blood trail, at which point it’s too late to escape what they now know is a trap.

I think the medieval wolf trap is an almost perfect metaphor for the way that the Nudging State and the Nudging Oligarchy operate. No one forces us to watch CNBC. No one forces us to use social media. No one forces us to nod sagely at the Fed’s every word. No one forces half of us to go into a berzerker rage over every Trump tweet and the other half to go into a MAGA apoplexy over every CNN segment. No, we’re much too smart and much too independent to ever fall for a trap like that.

I’ve said it before and I’ll say it again … I’m pretty sure this painting now hangs in Mark Zuckerberg’s office.


Mailbag: Letter From a Birmingham Museum

A couple of notable emails from Epsilon Theory readers on “Letter From a Birmingham Museum“.


It’s true that once you become aware of these narrative machines, you see them everywhere.

I couldn’t stop thinking, while reading your note, about the current situation in Catalonia, a part of the world I know relatively well. The Spanish central government and the media are focusing entirely on the Catalan government breaking the law and on how an independence referendum is unconstitutional, and they will not debate the morality of such law or higher principles such as the right of self-determination. On the other hand, the independence movement has been able to use children and older folk during marches and protests. This has resulted in powerful images on newspapers and websites all over the world of the police beating old grandmothers in line to vote.

I am not entirely sure how all this will be resolved, but it is fascinating to see how this War of Narratives is developing and how it is very similar to other past wars. Thanks again for the work you are doing; I always have a feeling of growth and improvement after reading your notes.

– Ivan K.

I’m a little embarrassed that I didn’t mention the widespread prevalence of this “but it’s illegal” narrative in political and civil rights struggles across time and across geography. Ivan is absolutely right about what’s happening in Spain, and I would bet that every non-US Epsilon Theory reader can find examples of this State narrative in their own country.


I am just sitting down to this now, and noticed the picture on page 3 of the police officers and their dogs lunging at a young black boy in Birmingham. I can’t help but recommend Malcom Gladwell’s podcast about this exact image, if only to satisfy any curiosity you may have. The title of his podcast is “Revisionist History” (it has a website, and can be accessed on all the normal channels, including iTunes), and the relevant episode is from Season 2 and is called “The Foot Soldier of Birmingham.” It is truly fascinating. Of interest may be the one immediately prior, called “Miss Buchanan’s Period of Adjustment.” They are relevant to all of us, but it sounds like very much to you.

– Henry

Lots of readers called the Malcolm Gladwell podcast to my attention, which I had not heard before. You can access it directly here. In a nutshell, this most famous picture of the Bull Connor era in Birmingham is not at all what it appears to be. The young man in the photo had nothing to do with the “Children’s Crusade”, as the intentional insertion of children into harm’s way in order to become a media cause celebre was called by the organizers of the march. He was just trying to get home. And the policeman in the photo was trying to restrain the dog and protect the young man, not sic the dog on him. But the photo was so evocative, so perfect for the narrative that civil rights organizers and journalists wanted to disseminate, that it didn’t matter. It’s a perfect example of the overwhelming power of Narrative, way more potent than the Truth with a capital T.


Longtime reader of your letter, and a native of Birmingham myself, born ~15 years after you were. I have to admit never having gone to the museum for the same reasons you mention. After reading your note that will change on my next trip home.

– Matt T.

Then my work here is done. Like I say, the Civil Rights Museum is a gut check.


Cheap shot against Trump with the Time Magazine cover and immigration reference.

Bull Connor was a lifelong segregationist democrat who used violence against blacks.

Republican Trump inherited Obama’s immigration policy, that included separating and caging children.

Trump used an executive order to change the policy and keep families together.

Not quite the impression you created.

Maybe you should move out of Connecticut. Or maybe do a little research and “think for yourself”.

– Mark V.

In the immortal words of Bill Simmons when he closes a Mailbag, “yep, those are my readers.” But it’s somehow funnier when Bill does it. This wasn’t the only email I got from readers determined to let me know that Donald Trump is actually reuniting families that were separated by Obama’s heartless decrees. We are well and truly broken. 


Epsilon Theory Core Curriculum, Vol. 1

Once upon a time in the dead of winter in the Dakota Territory, Theodore Roosevelt took off in a makeshift boat down the Little Missouri River in pursuit of a couple of thieves who had stolen his prized rowboat. After several days on the river, he caught up and got the draw on them with his trusty Winchester, at which point they surrendered. Then Roosevelt set off in a borrowed wagon to haul the thieves cross-country to justice. They headed across the snow-covered wastes of the Badlands to the railhead at Dickinson, and Roosevelt walked the whole way, the entire 40 miles. It was an astonishing feat, what might be called a defining moment in Roosevelt’s eventful life. But what makes it especially memorable is that during that time, he managed to read all of Anna Karenina. I often think of that when I hear people say they haven’t time to read.

– David McCullough

Read moreEpsilon Theory Core Curriculum, Vol. 1