A Game of You

Neil Gaiman, “A Game of You” (1993)

As Neil Gaiman says about this fifth collection of Sandman comics, “it’s most people’s least favorite volume, and I love it all the more for that.” I feel the same way about what I write, particularly on social media like Twitter.

We’ve reached a new height (depth, really) of what I call “mirror engagement” on social media. If you don’t see yourself in the Missionary you follow, you get mad. How dare you not reflect my views!

I’ve used this Terry Pratchett quote before, but after the past week on Twitter I’ve gotta use it again.

A European says, “I can’t understand this, what’s wrong with me?”

An American says, “I can’t understand this, what’s wrong with you?”

This quintessential American construct of discourse is in overdrive since the Kavanaugh hearings. I suppose it shouldn’t surprise me. It’s the perfectly natural outcome of what I wrote about in Schrödinger’s Senate Hearing, where people who could share the same political or social space before the hearings are no longer able to do so because they are now in mutually exclusive worlds. Either the cat is dead to you or the cat is alive to you. There’s no third state of the world where the cat might be alive or it might be dead.

But what I find so frustrating and so tiresome is the inability of large swaths of the social media world to accept that someone might see the world differently from them. That the reaction to “I disagree with you” is not “well, okay” but “WHAT IS WRONG WITH YOU?”

I think it’s because of the meaning of social media for most people. I think we all tend to follow people, particularly well-followed posters (the Missionaries of this shadow world, of which I suppose I am one), not because it’s a “conversation” or for “an interesting point of view”, but for a specific entertainment purpose. It’s either a mirror engagement (yes! a semi-famous person looks like me!) or a rage engagement (them’s fighting words, you imbecile!), and never the twain shall meet.

Even the rage engagement is not real rage. It’s a faux rage. No one writes a snarky reply to @realdonaldtrump because they’re really engaging with The Donald. No, they’re posting to their mirror engagement crew, who they know is also in a rage engagement with @realdonaldtrump. It’s not even virtue signaling. It’s pure entertainment. It’s a simulation where they can “engage” with the President of the United States in the company of their supportive mirror engagement crew. Plus dopamine!

What brings out the real emotion and the real confusion is when a mirror engagement goes awry. It’s also confusing when a rage engagement goes against type and agrees with you on something, but the reaction isn’t upsettedness … it’s boredom. The emotion when a mirror engagement goes against type is much more pronounced, much more urgent. It’s a betrayal.

Not a big betrayal. Not a personal betrayal. Not (usually) a permanent betrayal. It’s not even a Heel Turn, to use the pro wrestling phrase, when a Baby Face (a good guy) flips the script and becomes a Heel (a bad guy) in some shocking plot twist.

No, it’s more like when your favorite sitcom has a “very special episode” where they deal with some social issue du jour in a “serious” fashion that of course you find cringe-worthy. That’s not what you want from Three’s Company!

Interestingly (or interestingly to me, anyway) are the words that disappointed mirror engagers use to respond to a Missionary message that expresses an opinion that goes against perceived type. Almost without exception, they will respond with some variation of “YOU’VE LOST CREDIBILITY!” Now this has nothing to do with credibility. Missionaries are just as believable if they think chocolate ice cream is the best ice cream as if they think strawberry ice cream is the best ice cream. It’s not credibility that’s lost to the mirror-engaging strawberry ice cream-loving followers, it’s consistency. What’s lost is the feel-good entertainment they’ve come to expect and were counting on.

So they throw their shoe at the TV set. Go back to our regularly scheduled entertainment!

If they get really mad they change the channel. They unfollow you. Don’t know what happened to that guy! He lost all his credibility with me when he said what he said!

The underlying issue here is that social media is a game, but it’s a different game for different players. For the Missionary, the game is the ego boost and dopamine hit of getting more followers, of becoming more popular. It’s a ratings game. For the civilian, the game is the ego boost and dopamine hit of engaging on a kinda sorta equal footing with the popular kids, either in a rage engagement or a mirror engagement. For both, it’s a slow-twitch massively multiplayer video game, like Fortnite for geriatrics.

For very few, it’s a “connection” or a “conversation” with other human beings as ends in themselves.

But sometimes that happens. A connection. A conversation with a like-minded truthseeker, someone you’d have never met IRL. And that’s like the best thing! My god, I have so few friends IRL. Some amazing, true, lifetime, in-the-foxhole friends, for sure. But not many IRL friends. Through Epsilon Theory, though? They are legion. One of the best parts of my life.

That’s the real disappointment and frustration for me when these “decoherence events” like the Kavanaugh hearings get foisted on us by the Democrats and the Republicans, and everyone loses their goddamn minds if you don’t fall into line with your mirror-engaging community.

There are no friends to be made right now, no connections or conversations to be had on social media. It’s a war out there right now, and by war I mean game. We Missionaries are playing our ratings game, and the civilians are playing their rage and mirror engagement games. It’s all games all the time. Everyone is being highly entertained.

Bread and circuses, my friends, bread and circuses.

Time to take this conversation offline. Or at least off social media.

Announcement on Thursday. Stay tuned.


Schrödinger’s Senate Hearing

The cat isn't dead OR alive. It's dead AND alive.

“The world is given to me only once, not one existing and one perceived.”
– Erwin Schrödinger

“Schrödinger was wrong.”
– Ben Hunt

Most people confuse Schrödinger’s Cat with the Observer Effect. It’s a lot weirder and more important than that.

Here’s what Schrödinger’s Cat is NOT. There’s a live cat inside a box, and the act of opening the box to see the cat will break one of two glass vials also inside the box. If Glass Vial A is broken, a deadly poison is emitted that kills the cat. If Glass Vial B is broken, nothing happens and the cat stays alive. This is an example of an Observer Effect – that the act of observation determines the outcome.

In the true Schrödinger’s Cat thought experiment, the poison gas vial isn’t broken by the observer opening the box, but could break open by chance over some period of time. As in the Observer Effect experiment, though, there’s no way to know if the cat is alive or dead without opening the box.  After you open the box, the observer knows for sure whether the cat is dead or alive. But before you open the box?

The insight of Schrödinger’s Cat is that the cat is alive AND the cat is dead before the box is opened. It’s not merely unknown whether the cat is alive or dead. The cat is actually alive AND actually dead at the same time.

Wait a second, Ben. What do you mean the cat is actually alive AND actually dead at the same time? Obviously that’s not true. The cat is either alive OR dead. There is a state of the world where the cat is dead, and there is a state of the world where the cat is alive. Maybe we can’t know whether the cat is alive or dead, but it MUST be one or the other. That’s reality.

Schrödinger is saying no, that’s not reality. Schrödinger is saying that reality is – in reality – probabilistic. That the actual physical reality is that the cat is both alive AND dead at the same time. Maybe our human experience of reality does not allow us to have pets that are alive and dead at the same time, but that’s our fault, not reality’s fault.

I’m being a little facetious, because Schrödinger developed his famous thought experiment as a critique of quantum physics, and it’s now used to describe different theories of superpositioning in that weird world, where the smallest building blocks of nature should theoretically exist in multiple states of nature simultaneously. In the macro world of real-life humans doing real-life things, a cat is truly either alive or dead, not both.

I think, though, that it’s not just quantum reality where Schrödinger’s Cat exists. What we’re seeing with the Ford/Kavanaugh hearing yesterday is a social reality where Schrödinger’s Cat also lives.

It is the act of observing that resolves the superpositioning of a cat that is both alive AND dead. If you open the box to look at the cat, you will experience either a dead cat OR a live cat. There is no third state of the world here, no middle ground to be had where the cat is both alive and dead. Same with the Kavanaugh hearings. If you observed the hearings, you opened the box.

Before the Kavanaugh hearings, our social reality allowed the superpositioning of two states of the world, a cat that was both alive AND dead, a specific sexual assault that happened AND a specific sexual assault that didn’t. What do I mean by social superpositioning? I mean that we as citizens weren’t forced to take sides, that citizens who would only later find themselves within totally different states of the world could continue living in the same political reality.

After the Kavanaugh hearings, there’s no more social superpositioning. The cat is alive OR the cat is dead. Again, I’m talking states of the world, not credibility or evidence or arguments or whatever. There is a state of the world where Kavanaugh assaulted Ford in 1982, and there is a state of the world where he did not. Pick one. Now. And once you’ve picked, you no longer co-exist in the same political reality as someone who picked differently. You are truly – and I mean this in a very literal sense – in different worlds. Those different worlds are, in the terminology of one of the main strands of quantum physics, decohered, meaning that they have ZERO connection of any sort with each other. The respective universes go on operating as if the other did not exist. If we both open the box, and I experience a different state of the world than you, then I am – again literally – dead to you.

If you’ve spent a nanosecond on social media over the past 24 hours, you know exactly what I mean.

The last time I experienced a national Schrödinger’s Cat moment, where significant portions of the population experienced mutually exclusive and decohered realities? The OJ Simpson trial. That was a black/white thing. This is bigger, or at least more evenly divided. Which makes it worse.

And unfortunately, once your state of the world has been set, it can’t be reset. That’s the other thing about the Schrödinger’s Cat experiment … it doesn’t run backwards. Once you’ve resolved the superpositioning into one state of the world or the other, you can’t go back.

If you believe in the Ford state of the world today, there’s no waking up in two weeks and thinking, “hmm, maybe the Kavanaugh state of the world could be right. Who knows, really?” Ditto if you believe in the Kavanaugh state of the world. This isn’t a mean-reverting phenomenon. We never go back to a fuzzy probabilistic world where “both sides” can co-exist in a superpositioned social reality.

THIS is what it means to have a widening gyre of politics. There’s no reset button. There’s no walking back the experience of opening these boxes – what I call decoherence events – that are forced on us by both the Democrats AND the Republicans.

A dead Schrödinger’s Cat stays dead.


For more on what it means to have a widening gyre of American politics, see “Things Fall Apart (Part 1)”.

For more on what it means to have decoherence events forced on us by political entrepreneurs of both parties, see “Always Go To The Funeral”.

For an oldie but goodie Epsilon Theory note on Schrödinger and investing, see “Schrödinger’s Portfolio”.


Missionary Body Language

Donald Trump Pointing at You

This is my favorite slide when I give an Epsilon Theory presentation. I created it by googling “[name] + finger pointing”. Try it sometime, for any politician you can think of. Odds are, there are several shots of him or her shaking his or her finger at you, admonishing you with body language to LISTEN UP, BUB. Because that’s what a Missionary does to create Common Knowledge. Their goal isn’t to tell you the news. Their goal isn’t to communicate facts. No, their goal is to tell you how to think about the facts. Their goal is to communicate an opinion as if it were fact – what we call Fiat News here in ET-land.

Body language is a critical part of that communication. The finger wag is a classic trope of the genre, and when you’ve got a self-styled master of body language as your Missionary-in-Chief, this is what you get:

But the Donald’s use of body language for Missionary effect doesn’t stop with the finger wag. Whatever you think of the Donald’s policies, you are missing the plot if you don’t realize that he is VERY good at playing the Common Knowledge Game. You are missing the plot if you don’t realize that he uses body language in a very studied manner, that it is part and parcel of his personal success as a politician.

Like so many things, once you start looking for the trained use of body language, you will see it everywhere.

This is called the “reverse steeple”, because it’s the upside-down version of the same move that you see in every James Bond movie when the Evil Genius sits around the Mastermind table, thoughtfully puts his fingers together, and explains his Nefarious Plan to rule the world. It’s a power move. An aggressive move. A dominance move.

In fact, google any “[aggressive egomaniac] + sitting down” and I bet you’ll get a reverse steeple shot. Here’s Conor MacGregor, for example.

Or you could just hold a cat. I never got the whole cat thing for Blofeld, even when it’s done so menacingly by Donald Pleasence, but the truth is that I don’t get any of this body language stuff. And as much as I’d like to say that cat holding is a body language move we will never see in real life, 2018 has managed to prove me wrong on that score plenty of times already.


The Chinese Panoptistate

Image of now-closed Cuban panopticon

Not gonna lie, I didn’t come up with the term “Panoptistate” to describe what China is doing with its social data monitoring effort, but I am definitely going to steal popularize it. I saw the word on Twitter, and if the genius who invented it wants to reach out to me, there’s a six-month free subscription to Epsilon Theory Premium waiting for her or him.

[Wait, what’s Epsilon Theory Premium? See, Nike isn’t the only one who can do a little clever pre-marketing.]

Anyhoo … I may not have invented the term, but I did write a long-form Epsilon Theory note on how the Panopticon – an idea for a self-enforcing prison invented by Jeremy Bentham and popularized in the 20th century by Michel Foucault – is THE metaphor for understanding how Narrative control policies work through the Common Knowledge Game to make us police ourselves.

But then China goes and makes the Panopticon for realz.

It’s one of my shorter long-form notes, so I’m just going to repeat it here. Enjoy.

The Panopticon: a new mode of obtaining power of mind over mind, in a quantity hitherto without example.
– Jeremy Bentham, founder of modern utilitarianism (1748 – 1832) 

But the guilty person is only one of the targets of punishment. For punishment is directed above all at others, at all the potentially guilty. 

– Michel Foucault, “Discipline and Punish: The Birth of the Prison”

Visibility is a trap. 

– Michel Foucault, “Discipline and Punish: The Birth of the Prison”

There is little doubt that hedge funds have entered a new era of transparency and public openness – a transformation that I believe will benefit investors, the public, and regulators… One immediate benefit of this requirement to your industry should be that transparency will enable you to shed the secretive, “shadowy” reputation that some would say has unfairly surrounded you.
– Mary Jo White, SEC Chair, speech to Managed Funds Association, October 18, 2013

The advance of civilization is nothing but an exercise in the limiting of privacy.
– Isaac Asimov, “Foundation’s Edge”

Whatever games are played with us, we must play no games with ourselves, but deal in our privacy with the last honesty and truth.
– Ralph Waldo Emerson (1803-1882)

In 1791, Jeremy Bentham published a book describing what was clearly a revolutionary design for prisons, factories, schools, hospitals – any institutional building where a few administer instruction, discipline, or care to the many. This design, what Bentham called a Panopticon, was trumpeted as “Morals reformed — health preserved — industry invigorated — instruction diffused — public burdens lightened — Economy seated, as it were, upon a rock — the Gordian knot of the poor-law not cut, but untied — all by a simple idea in Architecture!” No shrinking violet here, but the booming, confident voice of the father of utilitarianism, a man who wrote 30,000,000 words in a lifetime of social activism.

A Panopticon has a large circular watchtower in the middle of a larger circle of cells or offices or classrooms or whatever functional task space is appropriate for the building at hand. The outer circle of cells has inner walls and doors made of transparent windows, and the reverse is true of the central watchtower, which is completely opaque as seen from the outside. From the watchtower you can see perfectly into every cell, but from a cell you can see nothing in the watchtower. Importantly, any occupant of a cell can see pretty much every other occupant of every other cell.

The beauty of the Panopticon, per Bentham, was that the occupants of each cell would soon come to police themselves. That is, the only thing necessary to create the perception of being watched and monitored and punished for bad behavior was the constant possibility of being watched and monitored and punished for bad behavior, together with the communal witnessing of your fellow prisoners behaving as if they were watched and monitored and punished for bad behavior. It’s not necessary for a guard or overseer to watch each prisoner at all times; what’s necessary is for each prisoner to live in a perfectly transparent cell, so that each prisoner thinks that he is being watched at all times.

The Panopticon design was a means of controlling the minds of prisoners through mental force, as opposed to the traditional goal in 18th century prisons and workhouses of controlling the bodies of prisoners through brute force.

Just like the warden in Cool Hand Luke, just like Dick Clark with American Bandstand, Bentham understood the enormous power of the crowd seeing the crowd. What he added to the calculus of social control was the important catalyst of transparency.

Thinking of transparency and openness as an instrument of social mind control is a hard pill to swallow in an era of social media and reality TV. So many of us embrace personal openness and the sharing of our thoughts…so many of us, as Christopher Hitchens ruefully noted about himself, run towards a camera instead of run away…that it seems almost un-American, rather impolite, and certainly anti-modern to maintain privacy and secrecy in our social relationships. We live in an age where transparency is lauded as a personal virtue and touted as a hallmark of liberty, where public confession is a celebrated ritual and a trusty engine of popular entertainment, where our employers expect as a matter of course that our private lives will merge with our business lives to allow constant access and attention. We live in an age where government requires disclosure of private investment strategies and holdings under the guise of “risk management”, where failure to disclose a private opinion on public securities can be a crime, where – as Dave Egger’s chillingly writes in The Circle –  “Secrets are Lies”, “Sharing is Caring”, and “Privacy is Theft”.

Transparency has nothing to do with freedom and everything to do with control, and the more “radical” the transparency the more effective the control…the more willingly and completely we police ourselves in our own corporate or social Panopticons. This was Michel Foucault’s argument in his classic post-modern critique Discipline and Punish: The Birth of the Prison, which – just because it was written in an intentionally impenetrable post-modernist style, and just because Foucault himself was a self-righteous, preening academic bully as only a French public intellectual can be – doesn’t make it wrong. The human animal conforms when it observes and is observed by a crowd, at first for fear of discipline but ultimately because that discipline is internalized as belief and expectation.

To be clear, I’m not saying that transparency is a bad thing for the society or institutions that enforce it. I simply want to call it by its proper name…an extremely powerful instrument of social control, not a “benefit” for the watched. Firms like Bridgewater that famously require a culture of transparency are, I believe, far more efficient and robust than their competitors that don’t. To take a trivial example apropos in mid-March, do you think that a lot of time is wasted at Bridgewater during work hours by employees sending around NCAA tournament brackets? Yeah, right. Not because there’s some “rule” against researching your NCAA bracket while at work, but because it would be unthinkable (and I mean that in a purely literal sense of the word) to do so within the glass walls of an effective Panopticon. A Panopticon crushes any sense of complacency in its residents, and that’s a really big plus for a modern institution. For the residents themselves, of course, that lack of complacency may manifest itself as a wee bit of constant stress. Or to take an example from the investment industry as a whole, SEC Chair Mary Jo White is absolutely right when she says that transparency is good for regulators. Heck, it’s greatfor regulators. But she’s entirely disingenuous when she touts the removal of secrecy as a good thing for private investment funds.

What’s my investment point in this little diatribe? As investors in highly regulated public markets we are all operating within a Panopticon of sorts. Some of us more obviously than others, but we’re all similarly situated to a rough degree. It’s critical to understand the dynamics of the crowd watching the crowd within a regulatory environment of forced transparency so that we can have a realistic notion of what’s possible and what’s not as we try to achieve our personal or institutional investment goals.

Capturing alpha in an investment strategy requires private information. To the degree that forced regulatory transparency and Big Data technology reduce private information by turning it into common knowledge, there is less alpha in markets. That’s a cold, hard fact. Finding alpha has never been easy. It’s always been the rarest thing in the investing world, but now it’s truly an endangered species, particularly in the stock-picking world of fundamental analysis of public companies. We have moved from a regulatory environment where illegal private information was pretty much defined as stealing the orange growers’ crop report from the USDA a la Trading Places (Mortimer Duke: “Turn those machines back on!”), to an environment where the mere existence of market-beating investment returns is treated as prima facie evidence that you must have been doing something illegal to generate those returns. Professional investors today are scared to death of private information on public companies. It’s never been more expensive or difficult to acquire, and the regulatory assumption is that – if it works – then it must have been illegally obtained. No wonder, then, that so many hedge fund giants accustomed to investing on the basis of private information are sailing as fast as they can for the safe harbor of advocacy and activism, where a large position and a board seat or two may cost you dearly in terms of liquidity but allows you to legally obtain and act on private information as a company insider. And even if you don’t reach the promised land of board membership and true insider status, at least you can talk up your own book with incessant public statements about your “investment thesis” without drawing regulatory scrutiny. All of the big boys play the Common Knowledge game today, because that’s how they adapt to a Panopticon. They make themselves more visible to the crowd and make more public statements because they can create, for a while at least, their own investing reality. They know that if they speak loudly enough and long enough, enough of us little guys will follow their lead on the stock. It’s what little guys DO.

Wow, that’s a pretty bleak assessment, Ben. Isn’t there some hope for alpha still out there in the world, even for the little guys? Sure. It’s in your neighborhood. It’s in your family business. It’s in whatever you know really well, some endeavor that by dint of education or experience you happen to have private information about. That’s where you’ll find alpha. Remember Peter Lynch and “buy what you know”? There’s a lot of wisdom in that, so long as you keep in mind that in Lynch’s day you could know an Apple or a Microsoft in a way that is impossible and/or illegal today. In today’s public markets I think it’s still possible to find managers with private information, but you have to look in the cracks and crevices of the market, in relatively small niches where the traders and investors that I refer to as beautiful parasites still live. These managers tend to be relatively small, and they are almost always superb game-players, able to generate alpha by, as Keynes put it, “guessing better than the crowd how the crowd will behave.”

And remember, too, that finding alpha isn’t the only reason to invest in public markets. Liquidity is important. Tagging along with broad-based economic growth through a broad-based capital market is important. But most of all diversification is important. Harry Markowitz, the father of Modern Portfolio Theory, always bristles at that label, saying that there’s nothing modern about it at all. He’s exactly right. Portfolio theory is an old, wonderful idea. You can dress it up in scientific finery as MPT does, and there’s definitely a role for that, but there’s also a very real danger that the arcane language and self-appointed priesthood of modern economic science gets in the way of a personal appreciation of the very real benefits of a diversified portfolio. I’ve written recently about applying the Adaptive Investing lens to questions of diversification, and I’m going to continue focusing on that in the future. Because while alpha in public markets may be rare and getting rarer as private information vanishes before the onslaught of forced transparency, diversification is still there for the taking. And that’s an opportunity I’m happy to use my media microphone to encourage.


Guest Post: The Two Worlds of Data Infrastructure

Big brother from 1984 looking down

Leave no dark corner

China is building a digital dictatorship to exert control over its 1.4 billion citizens. For some, “social credit” will bring privileges — for others, punishment.

– by Matthew Carney, Australian Broadcast Corp, September 18

[Ben’s note: I don’t think there’s any more important issue in the world than the way our personal data flows through global data infrastructure and is controlled by owners of that infrastructure. China, of course, is constructing the Black Mirror version of all this, but I don’t feel like we’re too far behind in the West. So I asked my friend Neville Crawley, who is the single smartest person I know on questions of data infrastructure in general and data infrastructure in China in particular, for his thoughts. What Neville describes below as The Alternative System is worth everyone’s time, attention and effort. It certainly has mine.] 


Last week Eric Schmidt (the former CEO of Google and former exec chairman of Alphabet) made news when Tyler Cowen (an economist) asked him “What’s the chance, say, 10 to 15 years, we have just three to four separate internets?”.

In response Schmidt mused:

“If you look at China, and I was just there, the scale of the companies that are being built, the services being built, the wealth that is being created is phenomenal. Chinese Internet is a greater percentage of the GDP of China, which is a big number, than the same percentage of the US, which is also a big number.

If you think of China as like ‘Oh yeah, they’re good with the Internet,’ you’re missing the point. Globalization means that they get to play too. I think you’re going to see fantastic leadership in products and services from China. There’s a real danger that along with those products and services comes a different leadership regime from government, with censorship, controls, etc.

Look at the way BRI works – their Belt and Road Initiative, which involves 60-ish countries – it’s perfectly possible those countries will begin to take on the infrastructure that China has with some loss of freedom.”

I don’t disagree with any of this, but I do think that we are entering a much bigger and more important competition than one between two sets of internet services with marginal loss of freedom with the adoption of ‘the Chinese system’.

In my view the competition is not about internet services, it’s about foundational data infrastructure and protocols and whether they are designed for self-sovereignty and privacy or whether they are designed for centralized oversight and control.

‘The Chinese System’

‘The Chinese system’ looks broadly like:

  • Very high adoption of mobile services for core life needs (communications, payments, transport etc.)
  • Real name, government issued ID a requirement for all services
  • Centralized databases of consumer data that the government can access

If you have spent  time in China recently and used the WeChat ecosystem it should be pretty clear that the government has (or at least could have if it chooses) perfect knowledge of who you are, what you are doing, and who you are doing it with.

If you haven’t been to China, imagine using the same real name ID under one sign on for Facebook, Uber/Lyft, Amazon, Netflix, Airbnb, Tinder, all Apple and all Google products and services, and that all data produced by these services is perfectly available to the government in real time and is being processed by a really good version of Palantir (rather than a kind of lame Cambridge Analytica).

The ultimate feature (or bug, depending where you sit) of this system is that it allows hyper-targeted sanctions at the individual level.

For illustration, check out this recent super early beta implementation by China of using ‘social credit score’ to ban Chinese citizens from planes, trains and dating apps.

However, the problem isn’t with the crude beta implementation described in the Brookings article above. The issue is that as this system matures and sophisticated link and predictive algorithms are deployed across the many data sets, citizens learn what the algos are likely to deem as undesirable behavior. Then self-censoring kicks in, which is even more controlling than the direct government sanctions.

For example, Ben invites me for a beer on a Tuesday night, but I think he may have been hanging out with dissidents on the weekend, so I politely decline so that our WeChat accounts don’t show up at the same bar at the same time. I’d love to think that I’m above caving into this self-censorship but honestly, with a young family, a decent middle class life and a well performing stock market, maybe I’ll just skip the beer.

This is absolutely happening in China today.

‘The Alternative System’:

I’m calling it ‘The Alternative System’ rather than ‘The American System’ as Schmidt does, because the West doesn’t run on this system (it runs on a kind of fragmented, semi-private-ish version of the Chinese system)

‘The Alternative System’ looks broadly like:

  • Very high adoption of mobile services for core life needs (communications, payments, transport etc.)
  • Self-sovereign identity
  • Distributed data
  • Each individual with a unique encryption key to join ID to data, and the sole right to do so

The beauty of this system is that you as an individual have the sole discretion to reveal what you want to reveal, to whom, when you want. And because your personal data (credit history, for example) is distributed across a decentralized ledger, it’s impossible for governments to prevent you from revealing it. See, it’s not just the ability to keep your data private from government control that’s so important, but also the ability to reveal it without government permission.

To be clear, this system has not emerged yet. But it IS emerging with hundreds of scattered projects working on discrete self-sovereign digital identity and distributed ledger technology.

This is absolutely happening outside of China today.

I can’t really give a good, concrete example of what this would be like because, well, it would just be like being a regular human going about your day-to-day life using lots of technology, but with no one using your data to control you.

It would be kind like a really convenient version of the 90s, I guess. Imagine that!

— Neville Crawley

[Ben’s note: When he’s not writing guest posts for Epsilon Theory, Neville is the CEO of Kiva, which is an amazing company that you should get to know.]


Mailbag: Mastering the Art of French Cooking

Thank you for continuing to write an excellent blog. How funny to read your Julia Child post this morning, not an hour after walking down Washington Street as it becomes Kirkland. I’m visiting Cambridge where I too did my PhD, I too scraped together the Team Elite bona fides (even as its ethos eluded me), and I too lived in a crumbling shared apartment in Slummerville. That area’s now full of fancy lofts, by the way.

I was sipping a $4 coffee and daydreaming about, not kidding, how much longer we can collectively pretend Cambridge hasn’t already become Cambridge(TM), when I passed by Savenor’s and stopped to marvel at a sign in the window: “Wanted: Butcher’s Assistant and Cashier”. For a moment, I was spellbound. Here was the artisanal tradition, robust, unbroken, open to any passer-by willing to learn the trade.

And then I woke up and remembered when and where I was: the butcher’s assistant would need to ask his boomer parents for help with downpayment for the Union Square loft, of course. It’d be an Investment, just like the BA in French Lit.

And then I read your post.

— C.


I got a lot of wonderful email from my homage to Julia Child (“Mastering the Art of French Cooking”), including a note from my Mom! Now that made my day.

This email made my day, too. I found this picture on Savenor’s website, showing Jack Savenor and Julia hovering over some … NY strips (?). Julia is all over the Savenor’s website, and for good reason. Jack truly was a master butcher, and Julia truly appreciated the craft. He made a guest appearance or two on “The French Chef”, and Julia always plugged Jack’s work. She was the best marketing Savenor’s ever had.

And C. is absolutely right … in another day and age, the opportunity to apprentice at Savenor’s as a butcher’s assistant would have been a prototypical American story of labor mobility. It would have been some Portuguese kid from Somerville who had finished high school (maybe), and who would parlay four or five years’ experience with Jack into a professional career as a butcher. It wasn’t a cool job. It wasn’t a cool career. But it was a career that could support a family, buy a modest house, and send his kids to college. It was REAL. And yes, this sort of thing actually happened once upon a time in America. It’s not just mythology.

Today, as C. points out, it’s impossible for a working class kid to take that job. The logistics simply don’t work. But it’s a very cool job today, in sharp contrast to 30 years ago, so I’m sure that Savenor’s had no trouble filling the spot with someone who sees the position as art more than as industry, and has some sort of external support to make the economics work.

I’m still wrestling with what all this means, particularly as MY kids start to graduate from college and make career choices. Something has been gained here, in that the art and craft of butchery is now more widely appreciated. That’s interesting to me, and like I say, it’s a good thing. But something has been lost here, too.

It’s the gentrification not just of neighborhoods, but of commerce and skilled labor.

Keep those cards and letters coming …


It's a Floor Wax AND a Dessert Topping

It's a floor wax AND a dessert topping!

On September 18th, the New York Attorney General’s office released a scathing report on crypto exchanges. Three (Binance, Gate.io and Kraken) were referred for prosecution, and the largest crypto exchange – Coinbase – was described as maintaining a “proprietary trading” operation that faced Coinbase clients and accounted for 20% of total trade volume on the exchange. On September 19th, Coinbase posted a blog report stating that the NY AG’s report was untrue, and that Coinbase “does not operate a proprietary trading desk, nor does it undertake market making actions.”

So who’s telling the truth? Is Coinbase running a prop desk or not?

My belief – and to be clear I do not have a dog in this fight, and I am happy to be disabused of these opinions if I’m working from incomplete or erroneous information – is this: Coinbase is telling the truth. They do not run a prop desk.

It’s worse than a prop desk.

At least a prop desk takes risk. The Coinbase proprietary trading operation (yes, the NY AG is telling the truth, too) that faces their retail client base through “Coinbase Consumer” takes ZERO risk when it pockets a spread between their worse-than-market offer to retail clients and their on-market bid to professional clients. They are a middleman (while carefully avoiding the legal designation of “market maker”) that executes a trade with retail clients for $x per Bitcoin and then immediately offloads that risk with professional clients at a trade for $y per Bitcoin, pocketing the essentially risk-free profit between $x and $y.

AND they charge a commission on the trade.

Again, if I’m working from bad information here (1% per trade in commission fees, $30-40 spread over past few months of BTC price at $6,000-8,000, commensurately higher spread when BTC price was higher), then by all means set me straight and I’ll be happy to restate my conclusions here. I really mean that. Barring that …

A pretty good definition of a prop desk is this: do you make more money facing your clients in trades than you do in the commission fees you charge clients for executing the trades?

As I understand the way Coinbase makes money in Coinbase Consumer, where on EVERY transaction you have a commission fee of 1% AND a spread profit of something like 0.5%, the answer to that definitional question is clearly NO – this is not a prop desk. Yes, they have proprietary trading (so the NY AG is correct), but no, that proprietary trading is not “a prop desk”. Why not? Because Coinbase makes more money on commissions than they do on prop trading.

But the reason it’s not a prop desk isn’t that their proprietary trading profits are so small … no, it’s that their commission fees are so egregiously large! AND they are pocketing these proprietary trading profits with ZERO risk.

To use the OG Saturday Night Live line, it’s both a floor wax AND a dessert topping.

Coinbase says they do this “to provide an easy-to-use customer experience.”

I say, to steal the immortal Ron Burgundy line, “I’m not even angry … that’s AMAZING.”

We’ll see what financial regulators and Coinbase clients have to say.


The Curse of Category

A famous example of a Type 1 error

A student says, “Master, please hand me the knife,” and he hands the student the knife, blade first. “Please give me the other end,” the student says. And the master replies, “What would you do with the other end?”

― Alan W. Watts, “What Is Zen?” (2000)

We have a blueberry bush right outside our porch. It hasn’t had a great year, and here in the middle of September we are way past blueberry season in Connecticut. I know that. I’m from the South, so I’m familiar with pokeweed, which also has purple berries, but a cluster of pokeberries looks nothing like a cluster of blueberries. I know that. Pokeberries are poisonous. I know that, too.

So why did I eat one this morning?

I made a category error.

Bizarrely, we have a pokeweed plant growing exactly within the blueberry bush. I’ve been traveling a lot (so I haven’t paid any attention to the blueberry bush), I didn’t sleep great (so I was groggy), and I was thinking about my next ET note (so I was distracted). I saw a purple berry with the same shape as a blueberry in exactly the same place where I’ve grabbed blueberries before.

In that moment, I was literally Homer Simpson. Mmmmm … blueberries.

Now I only ate one, and pokeberries are only truly problematic if you eat a handful and you have the body mass of a small child or a dog. My body mass is … umm … some multiple of a small child’s, so I was fine. A bit of, shall we say, intestinal distress, but all short-lived and none the worse for wear and tear.

What’s a category error? It’s calling something by the wrong name. It can be a Type 1 category error, also called a false positive, which is what I did. I said, yum, here’s a blueberry, but it was really a pokeberry. There are also Type 2 category errors, also called false negatives, which would have been the case if these had truly been blueberries but I had said, nah, they’re pokeberries, and passed them by.

Now both Type 1 and Type 2 errors are problematic in life and in investing. In fact, Rusty just published a really good (and really fun) note about Type 1 and Type 2 errors, titled Roadkill. It’s well worth your time. For an older note I wrote about category errors in general, check out Ghost in the Machine. It’s well worth your time, too.

For this In Brief note, though, I just want to make two quick points about category errors. In my experience …

It’s the Type 1 errors that are most likely to kill you. Both in life and in investing. It’s when you’re oh-so sure that you’re chomping down on a really great trade … that’s when you blow up. Or get poisoned.

We’re most likely to make Type 1 errors on the basis of place. All the surface characteristics need to be similar, sure. But that’s just the necessary condition. The sufficient condition is PLACE, like a familiar sector or strategy where you’ve had investment success before. I am convinced that we are lulled into complacency by location more than anything else. Yes, we judge a book by its cover, but even more so we judge a book by what shelf it’s on.


Mastering the Art of French Cooking

Julia Child with a knife
If you’re afraid of butter, use cream.
— Julia Child (1912 – 2004)

I went to graduate school “in Boston”, which is the socially responsible, if risible, way of saying that I went to Harvard. My using the word “risible” just then instead of “laughable” was a dead giveaway, too. Have I ever said that I went to grad school in Boston instead of saying that I went to grad school at Harvard? Yes, I have. Talking about Team Elite education is the new talking about money. Both are uncomfortable to talk about in any, god forbid, non-Team Elite or mixed social settings, which leads to cringe-worthy responses like “in Boston”.

Why is it so uncomfortable to talk about elite college education? Because it really is the new system of landed gentry. Because as unequal and polarized as America is today on the dimension of wealth, we are even more unequal and polarized on the dimension of education. The difference in life impact between going to an elite school and going to your local community college is far greater than the life impact of being born really rich and being born really poor. It’s not correlative. It’s causative. And we all know it. It’s probably the deepest, most influential Common Knowledge in our society today. But that’s an Epsilon Theory topic for another day.

Harvard, of course, isn’t even in Boston at all, but in Cambridge. And of course, as a graduate student I was way too poor to live in Cambridge, so three friends and I shared one floor of a triple-decker house in Somerville, one town over from Cambridge. Or Slummerville, as we called it. I haven’t been back in 30+ years, so I’m sure it’s all gentrified now. Back then it was still a working class neighborhood, mostly Portuguese families, near Union Square.

Every day I’d make the walk down Washington Street to get to class, and every day, just across the Somerville/Cambridge border where Washington Street turned into Kirkland Street, I’d pass a grocery store and a liquor store. Both stores were named Savenor’s, but they were owned by different Savenor brothers, and they weren’t friendly with each other. As I heard the story, one brother got the grocery store, which was the crown jewel, and the brother who got the liquor store never forgave him for that.

Most days I’d stop into the grocery store on my walk home to buy something to cook for dinner. I like to cook … always have … and if sports were how I most easily connected with my father growing up, cooking was how I most easily connected with my mother. It connected my parents, too. Both my mother and my father enjoyed watching Julia Child on “The French Chef”, which ran from 1963 to 1972 on whatever your local PBS channel might have been. We had a black and white TV where my brother and I served as the remote control, and I remember my parents laughing along with Julia as she pulled dish after dish from that TV studio oven. I remember my father giving my mother the two-volume “Mastering the Art of French Cooking” for Christmas, and I remember my mother working her way through the dishes over the years.

There’s nothing like Julia Child on TV today. Every bit of TV cooking today is a contest. From the omnipresent and inescapable scold that is Gordon Ramsey to the celebrity chefs holding court on Top Chef to the rotating cast of “personalities” on the 24-hour programming that The Food Network must fill … it’s all contests all the time. Do I watch these shows? Yes, I do. They’re entertaining. They’re entertainment.

But, see, that’s the difference.

Julia Child was entertaining, but she was not entertainment. Julia Child was a teacher. Julia Child was a coach. Julia Child was laughing WITH you if you spilled a little wine or if you ran out of butter, not AT you. Cooking was not a contest for amusement. Cooking was art.

And there she was at Savenor’s. Standing at the butcher’s counter.

I knew that Julia Child lived “in Boston”, meaning in Cambridge, and I had heard from friends that she had a house nearby. But I had also heard that she spent her time in California and was rarely back in the neighborhood. I also vaguely remembered that a butcher would come on the TV show from time to time, but I had never put it all together with the old school butchery that was the heart of Savenor’s.

She spoke with the butcher for a minute and then walked back to the produce section. She was carrying a hand basket. I followed. I knew what I had to do. I was going to buy whatever Julia Child bought at Savenor’s that day. And before you ask, no, the thought never even entered my mind to say anything to her. It would have been … terribly rude … like asking Michelangelo what he saw while he was pondering giant slabs of uncut marble.

Julia Child only bought one thing from Savenor’s that day. She bought corn. White corn. In November.

Now look, I love corn. I’m from Alabama. Corn and the pig are nature’s two perfect foods. But corn is yellow and corn is summer and anything else is … not right. Worse than not right. Actively wrong. This is nuts.

I bought the corn.

I got home and thought about creaming it, but that’s not a small amount of work. So I ended up just boiling it … butter, salt and pepper. It was, naturally, a revelation. Just perfect corn … a slightly different, maybe cleaner or clearer taste than what I was used to. Totally delicious.

Over the past 30+ years, I’ve tried to recreate that dish a dozen times. It’s always been terrible. White corn, yellow corn, doesn’t matter. But of course it’s terrible. IT’S CORN IN NOVEMBER IN NEW ENGLAND, FFS.

The truth is this … it’s entirely possible that I willed myself into thinking the Julia Child corn was delicious. The power of Narrative is so strong, and this was such a powerful story for me as a 22-year-old kid away from the South for the first time in his life – to see freakin’ Julia Child in the grocery store – that this is surely the most likely reason that corn tasted so damn good. And there’s a powerful lesson in that.

But it’s also possible that Julia Child really did see something special in that November white corn at Savenor’s.

I’m wrestling with this a lot these days, here in the dawning of an age of Big Data and AI. Is there still room for art in politics and investing? Is there still room for an artist who can SEE things differently? Who can see the potential and the opportunity for something truly special where everyone else sees … corn in November.

And even if art is still possible in these core social arenas of human endeavor, is it possible to master our art as Julia Child did with hers?

I don’t have an answer yet. And like I say, it’s a powerful lesson even if the answer is NO.

But I sure am hoping the answer is YES.


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.

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